Rethinking Industrial Policy for Central and Eastern Europe

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Central and Eastern Europe (CEE) is increasingly important in the EU’s manufacturing landscape. The region’s export-oriented economies became an integral part of it through foreign direct investment—supported primarily by EU funding, including Cohesion Policy programs for regional and industrial development, and by national state spending. With its competitiveness at stake, the EU now focuses on industrial policy for cutting-edge technologies with high capital intensity. Many of its new regulations loosen state aid rules to allow generous support by governments to attract investors, which poses a problem for member states with less fiscal room to do so, including the CEE countries. 

This report discusses the opportunities and challenges for CEE countries to build manufacturing with potential to grow and to increase domestic value-added. It examines two case studies in the region: batteries and semiconductors, and their position in the value chains in Czechia and Hungary. 

Hungary has become one of the EU’s leading battery industry hubs and plays a key role in the drive toward self- sufficiency in this field. Its success came principally through government spending on investment promotion. Key issues have arisen regarding the environmental sustainability of new investments, the decision to attract cheap foreign labor without any appropriate long-term labor policy, and the lack of knowledge spillover from multinational companies to small and medium domestic ones to improve their value-chain position. New large investments announced by Chinese companies also raise geopolitical and security issues. 

With its broad innovation and R&D strategy and record low unemployment, Czechia did not make attracting large investments a priority before the COVID-19 pandemic. This has changed and its semiconductor industry is well- placed to draw in new investments in the micro- and nanoelectronics value chain. Czechia has started to support the industry through state aid for a handful of domestic and foreign companies, due to its strategic importance, its high value-added in production output, and the opportunity for stimulating R&D and high-skill employment. 

These case studies reveal key takeaways for Central and Eastern Europe. First, industrial policy based on state aid in small open economies are costly and will not generate long-term benefits if it is oriented solely at production tasks as in the past. Investment must bring innovation and R&D. Second, CEE countries should make financing innovation and R&D the priority, not subsidizing new manufacturing projects. They should rationalize their policy objectives and update and stick to their national strategies. Third, tight budgets and financial consolidation put pressure on selecting projects for state aid. Governments should not provide this aid without a solid cost-benefit analysis of the investments. Fourth, the CEE countries should consolidate the too broad innovation priorities within their national strategies and analyze their long-term growth potential. Fifth, industrial policy must be accompanied by appropriate labor and education policies to support the green and digital transition.

Michal Hrubý is a ReThink.CEE Fellow at the German Marshall Fund of the United States.