Eastern Europe is still a region that many investors associate with the former Soviet Union (regimes that are corrupt at all levels and dysfunctional at the best of times), and there is still a lingering concern that not much has changed since the Soviet Union was disbanded in 1991. However, nothing could be further from the truth. Eastern European countries that are EU member states are fast closing the gap with their western counterparts.
The late Hans Rosling, co-founder and chairman of the Gapminder Foundation and Professor of International Health at Karolinska Institute, observed that people’s perceptions are often based on knowledge obtained at school – knowledge that is outdated by at least 20-30 years. This assertion is borne out when we meet with investors, as we regularly hear the same questions about Eastern European EU member states.
Figure 1 From Soviet Union to European Union – a 30-year timeline
It is almost 30 years since the collapse of the Soviet Union. Only 13 years later, in 2004, most of the former Warsaw Pact countries joined the EU, with Bulgaria and Romania following in 2007. Since then, much has changed for these new member states, albeit to varying degrees when it comes to corruption and economic performance.
As far as corruption is concerned, the general perception is still that most of these new EU member states have not changed markedly since the days of Boris Jeltsin. While some countries clearly still have significant room for improvement, the Baltic states of Estonia, Latvia and Lithuania are already at the same level in world rankings as many of the old EU member states, as shown in Figure 2.
Figure 2 Transparency International – Corruption Perception
(The dark-blue bars are countries where Quantrom is currently invested.)
In 2019, the score for Estonia was already level with Belgium and Ireland, and higher than the US and Japan. Lithuania and Latvia were well ahead of Italy, while Bulgaria and Romania were less than five points behind Greece, which has been an EU member state for almost 40 years.
From a corruption perception viewpoint, investors who already have exposure to emerging markets such as the BRICS countries should not have a problem investing in Eastern EU member states if they base their investment rationale on the above data provided by Transparency International.
GDP per capita gap closing
When investing in a certain asset class or geographical area, one of the most import considerations for long-term investors is whether or not the macroeconomic fundamentals are favourable.
A growing economy will always offer investors a better chance of getting a good return than a contracting economy. As income and wealth increase, there is simply more to share for all participants.
The success of the Eastern European countries that joined the EU is remarkable. Compared with Germany in 2004, when the enlargement of EU took place, Estonia had only 26% of Germany’s GDP per capita; Latvia, Poland and Lithuania were at 19%, while Romania and Bulgaria had less than one tenth. After 15 years of European Union membership, what has happened with these countries economic development?
Figure 3 Development in GDP per Capita in EUR compared with Germany (source : Eurostat)
Firstly, it is important to put this into perspective: German GDP per capita in nominal terms increased by almost 50% from 2004 to 2019, despite the financial crisis of 2008-2009, which is certainly a solid economic performance. Have the new member states been able to match this?
The short answer is yes. In 2019, Estonia had reached 51% of German GDP per capita, followed by Latvia and Lithuania with 38% and 42%, respectively. Poland, the largest of the new member states had 33% of German GDP per capita.
By contrast, the gap with Germany is widening in the old southern EU states. Italy’s GDP per capita is now down to 71% of Germany’s, while Spain has fallen to 64%. Greece and Portugal, meanwhile, have already been overtaken by Estonia in GDP per capita terms.
With COVID-19 having such an adverse impact on Southern Europe, it is difficult not to see the gap in GDP per capita with Germany widening over the coming years. At the same time, Eastern EU countries will most likely continue to narrow the gap with Germany.
The enlargement of EU in 2004 clearly have had a positive effect on both society and the economy development in Eastern Europe. Most likely this development will continue, to the benefit of all stakeholders included foreign investors.