THE VIEW FROM MITTELEUROPA: Has EU enlargement been an economic success story?

THE VIEW FROM MITTELEUROPA: Has EU enlargement been an economic success story?
In relation to the EU average, income levels in Central Europe have risen continuously over the long term, which is not the case for all convergence countries in the EU (e.g. Greece or Italy). / RBI Research
By Gunter Deuber in Vienna April 29, 2024

As the International Monetary Fund often likes to emphasise, the EU and EU integration is a comprehensive convergence machine for lots of European countries, some of which are lagging behind. This aspect is becoming very apparent once again in the wake of the upcoming 20th anniversary of the EU's eastward enlargement on May 1, 2004, when five Central European countries (Slovakia, Slovenia, Czech Republic, Hungary, Poland) plus the Baltic states, Cyprus and Malta joined the EU.

Macroeconomic convergence: a success story, with love greetings from Western Europe

Overall, the EU's eastward enlargement has been an economic success story. This applies above all to the real economy. The growing GDP weight of the Central European Region within the EU illustrates this vividly. The share of the five Central European countries (CE-5) in total EU GDP has risen from 4.9 per cent in 2004 to almost 9 per cent today. In terms of their economic strength, the CE-5 countries are now significantly larger than the Netherlands (factor 1.4); in 2004, the aggregate GDP of the CE-5 countries was 80% of that of the Netherlands.

In relation to the EU average, income levels in the region have risen continuously over the long term, which is not the case for all convergence countries in the EU (e.g. Greece or Italy). If there were some frictions, then there were only some pauses of relative catch-up but no sustained, secular or drastic declines. In some cases, weaker convergence phases in the 2010s, such as in Hungary or Slovenia in particular, related to difficulties in the banking sector, which we will discuss later.

In addition to attractive local conditions, foreign forces in particular have long fuelled convergence and in some cases benefited from it. At the same time, the countries and populations themselves have also benefited from the deep integration into the EU single market.


The dynamics and depth of integration into the EU single market can be clearly demonstrated by a few key figures. For example, Poland's exports have grown by almost 700% since 2004, Hungary's (in euros) by almost 400%, Slovenia and the Czech Republic by around 550%. As a result of the EU's eastward enlargement and the secular increase in exports, also based on the extensive inflow of direct investment, trade openness in the region has risen sharply. Trade in goods in the CE-5 countries averages well over the 100% mark (the EU average) and stands mostly at 150-200%.  In this respect, the trade openness of the CE countries (except for Poland and Czechia) is even higher than that of the Netherlands, an EU country that is traditionally very open to trade.

At an average of 55-60%, the level of inward direct investment in relation to GDP is also higher in the CE-5 countries than in many EU countries, and in some cases even higher than in a small and open economy such as Austria.


The CE region's openness to trade and high penetration with direct investments speak for its competitiveness. However, trade openness in the CE (and in general) increases exposure to global economic setbacks, which is a risk factor. This is particularly true with regard to geopolitical risks. The robust integration with Germany as an economic partner means that the CE countries are particularly exposed to cyclical risks.

The high degree of trade openness and FDI penetration also creates potential advantages in the current geopolitical and geo-economic fragmentation – despite the problem areas outlined above. The region can be seen as an attractive stepping-stone to the EU, which is partly reflected in the reallocation of production by Western companies to the region and in Chinese FDI activities.

In macroeconomic terms, it is also true that income levels in the most prosperous CE-5 countries (Slovenia and the Czech Republic) have so far always bounced off the 90% threshold of the EU value, and the Czechs in particular have taken a break from convergence recently. In the case of Slovenia, it took from 2008 to 2023 until this value was roughly reached again. It should be noted here that convergence becomes more complex at such income levels and requires different investments and framework conditions than during the phases of "simpler convergence" at lower income levels.

Increasing interdependencies in the region and calls for local champions

The high penetration of foreign direct investment (and openness to trade) compared to other countries has also given rise to critical local debates about excessive foreign dependency. This is particularly true in the case of (perceived) high dividend outflows or too little local reinvestment in foreign investments. In some cases, this has led to moves towards nationalisation, such as in the banking sector in Hungary and partly in Poland. However, particularly foreign direct investments from Germany and Austria have usually had very high positive local effects, as a high level of local reinvestment activity has usually taken place.

Nevertheless, the region itself still has a very low level of its own foreign direct investment, i.e. investment by local companies from the CE-5 countries in other EU countries or beyond. The stock of own outward foreign direct investment is only around 13%, while the EU average is around 80%. The "gap" between own direct investment abroad and direct investment by others locally is much higher in the CE-5, where the difference is minus 30-50 percentage points, so it is quite understandable that there is a perceived need to promote so-called local champions. With increasing localisation, EU membership can certainly be supportive.

An important trend in recent years is that economic integration within the region itself and with Southeast Europe is increasing, while the sometimes one-sided focus on the economic power of Germany or Western Europe is even becoming less important in some cases. Intra-regional trade between the countries in Central Europe and also with Southeast Europe has increased significantly more than trade with Germany in some cases in recent years. As a result, the relative foreign trade shares here have developed to Germany's disadvantage. Intra-regional exports (Central Europe and South-East Europe) now account for 26% of total exports compared to trade with Germany at a "mere" 28%. In 2004, the ratios here were still 20% (CE/SEE) vs. 28% (Germany).

Catching up in the banking sector is more difficult than in the economy as a whole!

Compared to economic convergence, the picture is anything but homogeneous when it comes to the CE banking sectors and the pace of (catching-up) in financial deepening. Interestingly, while the convergence of income levels towards the euro area average has proved to be more or less uninterrupted, the degree of financial intermediation (loans in relation to GDP) did not increase continuously at all times. In fact, there have even been some drastic reversals.

In terms of financial sector development, the Czech Republic and Slovakia stand out positively, while in Hungary and Slovenia the financial intermediation ratio is still much lower than in 2009 or even 2002 compared to the euro area; in the case of Poland, the catch-up process of the financial sector has come to a standstill since 2009 – in contrast to the economic catch-up process as a whole. In the case of Hungary, banking sector assets have fallen from peak values of 125-150% of GDP to just under 100% at present.

The continued banking sector convergence in the Czech Republic and Slovakia also has to do with stability-oriented economic policy – with very different strategies – and the avoidance of excessive risks in the banking sector. In the case of Hungary and Poland, for example, the extensive foreign currency lending to private individuals should be mentioned here. The same applies to the sometimes very high level of foreign debt in the local banking sectors, such as in Slovenia or Hungary, which was built up before the global financial crisis.

In this respect, all three countries have tended to struggle with problem areas in the banking sector that were the result of overly aggressive convergence expectations and therefore too little risk assessment, too high and/or aggressive debt levels and in some cases these were also fuelled by the (local) banking sector, including some foreign participation.

Interestingly, in contrast to the Czech Republic or Slovakia, all three countries were characterised by a more hesitant banking sector clean-up and privatisation programme at the end of the 1990s or in the run-up to EU enlargement. In this respect, the banks, which are often seen as the "bad guys", cannot simply be blamed for what happened here.

After all, the foreign currency debt and the high level of foreign debt was often due to local preferences, local macroeconomic and financial volatility and, in some cases, blind creditor confidence abroad. In some cases, banks were merely intermediaries or underestimated risks. Moreover, the very high level of foreign participation in the banking sector (85-90 %), which was associated with the tough restructuring here in the 1990s, has never stood in the way of successful convergence in the Czech Republic and Slovakia.

European convergence champions Slovakia and the Czech Republic

In terms of macroeconomic convergence and banking sector convergence, the Czech Republic and Slovakia can be regarded as the most successful EU accession countries from CE in the long term. Interestingly, the two countries have pursued very different development strategies and paths. In the banking sector in particular, both countries have experienced a constant process of financial deepening that is conducive to prosperity; the increase in sustainable penetration of real estate loans, which is directly perceptible to the population, is highest here.

Slovakia has a real estate loan portfolio of just under 30%, the Czech Republic just under 25%; in comparison, Poland and Slovenia only have around 15% and Hungary just under 6-8%. In Hungary, the stock of real estate loans is therefore even lower today than in 2004 (10%) or 2008 (15)! The particularly high figure in Slovakia is also linked to Euro membership and the associated refinancing options.

Austrian banks strengthen their leading role

What remains stable, though, is the leading role of Austrian banks in the region, which has been maintained since their early entry in the mid-1980s. As of 2023, we estimate Austrian banks accounted for 25% of all Western banks’ exposures to CE-5 residents, hence they lead by a wide margin ahead of Belgian (14%), French (14%), Italian (11%) and German (10%) rivals.

This active engagement has notably contributed to coordination of cross-border banking agendas in the region. For instance, the Vienna Initiative framework, first launched at the height of the global financial crisis, helped establish more efficient home-host supervisory cooperation and also promoted international financial institution (IFI) support to the region (e.g. guarantees, SME lending programmes). In some ways, the forum served as a forerunner of broader post-Global Financial Crisis EU initiatives to enhance financial stability and regulatory integration, while it still remains an important platform (Vienna Initative 2.0) for CEE banking actors (e.g. to coordinate pressing local banking sector topics in terms of regulatory and/or market refinancing topics, e.g. MREL financing).

Along the same line, harmonisation of regulatory rules in CE has been a major step forward in the deep and multi-layered EU integration that one should consider on top of simple quantitative convergence indicators. Concerning this facet of the topic the introduction of the Single Rulebook (capital requirements regulation, deposit guarantee schemes, resolution matters) and construction of the Banking Union represent some key milestones in pursuit of a level playing field for banks in the bloc, although there might still be certain national discrepancies (e.g. in MREL calibration) and this generally remains a work in progress.

The deep integration into international and EU-wide banking regulatory practice also ensures that modern macro- and micro-prudential regulatory measures can be implemented in a targeted manner and that CE banking markets and players are regularly part of EU-wide stress testing exercises, etc. In addition, stricter consumer protection rights for retail clients also have an impact. This interplay of EU frameworks and local regulation plus legislation can contribute to greater resilience in local banking markets today.

The economy is not everything!

EU enlargement should be marketed better as an economic success story. This can also encourage further EU enlargement and the European mood as the bloc worries about its economic weight in relation to the USA and globally. But a pure focus on economic issues makes no sense either, perhaps that was even the original sin in 2004! At that time, EU enlargement was seen more as an economic project. The geopolitical dimension was not considered at the time. Neither were the implications for EU unification and EU decision-making mechanisms. For future enlargements, we should take a closer look here and solve likely problem areas first.

Furthermore, economic success does not protect against populism. In this respect, it must also be acknowledged that there are obviously underlying reasons for the rising tide of nationalism and populism in (Central) Europe, which often positions itself against EU unification, whether justified or not. In some policy areas, the EU could help to ease tensions and defuse the situation. Overall, however, the EU must also get used to being the bogeyman from time to time. To a certain extent, this is normal in federations and large nation states.

However, the EU should also take a higher profile in its internal power politics, i.e. act self-confidently towards (existing) members that blatantly violate the EU's basic rules. Brexit shows that leaving the EU is not an easy success story, even for a country of the UK's calibre. Geopolitical fragmentation makes it increasingly likely that small countries will become pawns. In this respect, now is also a good time for the EU to grow up.

Gunter Deuber, Chief Economist of Raiffeisen Bank International AG, has been following the Central and Eastern European region professionally for more than two decades. You can also find a comprehensive Raiffeisen Research commentary by Gunter Deuber here.