Central and Eastern Europe must overhaul its economic growth model as geopolitics fragments global trade and pushes the region onto the frontline of a new era of “geoeconomics”, a senior economist at the Vienna Institute for International Economic Studies (wiiw) said on February 10.

“What we’re seeing with investment is very much linked to geopolitics,” Richard Gieveson, wiiw’s deputy director, told a webinar organised by the think-tank. “We are in a stage of fragmentation, where the region’s growth model is changing … The old growth model is over, and a new one is emerging.”

The shift comes as the region is pulled between the United States, China and Russia, all of which are increasingly using “trade, technology and energy as instruments of power”.

“We are in the age of geoeconomics,” Gieveson said. “The [Central and Eastern Europe] region is on the frontline of this, and it does have every big economic implications.”

Europe’s geopolitical test

Gieveson said Central and Eastern Europe has become “more important than ever” as the world enters “a new age of great power politics”.

“This region will be decisive in Europe’s ability to cope, or not, in a much harsher global environment,” he said. “We are under pressure from all sides in Europe. Whether we manage to thrive in this new global order will depend a lot on what happens in CEE.”

Despite the geopolitical pressure, the region continues to outperform western Europe economically, even as Germany – its main trading partner – struggles.

“Parts of the region are doing much better. They are growing much faster than Western Europe,” he said. “Even at a time of global economic challenges, and weakness in Western Europe, especially Germany, this region continues to grow.”

He added warned that the foundations of that growth were changing rapidly. “We do see signs that a new growth model is emerging.”

According to Gieveson, the structural shocks facing Europe are not cyclical and cannot be solved by waiting for a global recovery.

“These are structural rather than cyclical problems,” he said. “For CEE, this is a choice between action and stagnation – or worse. We can’t go on as we were.”

The pressures are coming from all sides. US-China rivalry is reshaping global supply chains, while Russia has become what he called “a long-term security destructor on the European continent”. 

“Most of the region is effectively at war with Russia. It is under constant hybrid attack, and that has an economic cost.”

Meanwhile, research by wiiw shows that the European Union is losing ground in much of its near neighbourhood to rival powers.

Consumption-led model fades

For much of the post-pandemic period, growth in CEE was driven by consumption, underpinned by strong real wage growth and falling inflation.

“That story is now faltering,” Gieveson said. “Real wage growth is still positive, but it is declining. Consumption is not going to be the central growth driver.” Fiscal stimulus is also set to become less important going forward. 

Instead, Gieveson said the region is entering a phase where investment must become the main driver of growth.

“We see a pretty significant growth model transition underway,” he said. “We see growth still being strong in the region, and in many countries improving, even as consumption slows down.”

In the Central and Eastern Europe region, labour costs have  have risen much more than productivity in recent years, which is pushing companies to invest into automation and productivity. 

“We already see moves in that direction – towards automation and greater adoption of AI,” he said. “We think this has much further to run. This will be a fundamental driver during the forecast period.”

A less open, more defensive economy

Gieveson said the region is likely to look very different when wiiw’s forecast period comes to an end in 2028.

“We think we are going to see a very different economy in CEE,” he said. “It is probably going to be less open and less trade dependent.”

Exports, he noted, are already a lower share of GDP “almost everywhere” in the region. At the same time, investment is projected to take up a larger share of economic output.

“We are going to see a high share of investment in GDP, driven by labour shortages, but also by higher defence spending and the energy transition, which requires huge investment,” he said.

European Union funds will play a critical role in supporting the transition, but they will also become more political, according to Gieveson.

“There will be a rush this year to draw down the last Recovery and Resilience Facility funds, which will support investment,” Gieveson said. “But the European Commission is more willing to cut off funds to countries with governance problems.”

Funding is expected to increasingly be targeted toward defence, digitalisation and the energy transition. “For countries aligned with EU strategic priorities and with good governance, EU funds could become an even more important growth driver,” he said.