Renewed business dynamism is needed to boost growth and convergence in Europe and Central Asia

Economic activity in the Europe and Central Asia region is expected to remain resilient but slow for a third consecutive year in 2024, mirroring the global economy’s downward growth path. Weaker expansion in the advanced economies and China, and the ongoing impact from Russia’s invasion of Ukraine are weighing on the region’s outlook. The 2022 cost-of-living crisis continues to affect households despite the slowdown in inflation and the significant increases in real incomes last year, with consumer prices now nearly 40% higher than in 2019. Moderating global commodity prices also weigh on the economic expansion in some of the region’s commodity exporters.

Growth in Europe and Central Asia is expected to slow to 2.8% this year, resulting in the weakest five-year growth rate on average during 2020-24 since the late 1990s, according to our latest Economic Update for the region. Growth averaged 3.1% a year on average during 2010-19 and 5.2% a year during 2000-09.

The slowdown in 2024 primarily reflects weaker expansions in Russia and Ukraine and moderation of growth in Türkiye as monetary and fiscal policies there are likely to remain tight. Growth in Central Asia and the South Caucasus is projected to decline as well amid the easing of remittances and trade flows. However, growth is expected to pick up strongly in Central Europe and the Western Balkans because of strong recoveries in labor markets, wages, and investment boosted by European Union (EU) funds. Regional output growth is expected to moderate further to 2.6% in 2025. 

Even this somber outlook faces multiple headwinds. A slower-than-expected recovery in key trading partners, especially in the euro area, restrictive monetary policies for longer, and an exacerbation of geopolitical developments and geoeconomics fragmentation could further dampen growth across the region. Further delays of fiscal consolidations would limit fiscal space and may keep borrowing costs elevated.

Boosting the Private Sector Essential for Growth

Economic development in Europe and Central Asia has been the story of the transition from planned to market economy, the advance of broad and deep structural reforms, and the emergence of private initiative as the main driver of growth. In less than three decades, a dozen countries from the region joined the EU. The successful transition of these countries to EU-integrated market economies with robust institutions and production structures illustrates just how far reforms have taken some countries, including to high-income status. But the ambitious structural reform agenda of the 1990s has slowed in many middle-income countries in Europe and Central Asia, and their transition to market economies is still ongoing.

As a result, productivity growth in many countries in the region over the past decade has slowed. While there has been a broad-based slowdown in productivity across emerging markets and developing economies since the global financial crisis, and in most advanced economies since the 1970s, the decline has been steepest in Europe and Central Asia. Fundamental drivers of productivity growth, including progress in advancing institutional and market reforms, and technology adoption and innovation, which are all key for enabling private sector led growth, have weakened in many of the region’s countries.

The region has plenty of room for improving business dynamism and innovation. Firms in Europe and Central Asia are less productive and less innovative than those in the advanced economies in western Europe. Firm entry and exit rates are lower and firms typically do not grow much over time, pointing to a less competitive and dynamic business environment where firms tend to innovate less, absorb less knowledge, and often become less productive over time.

Boosting business dynamism in Europe and Central Asia will require addressing several challenges, including upgrading the competition environment, reducing state involvement in the economy, dramatically boosting the quality of education, and strengthening the availability of finance. Accelerating the green transition should also help reduce emissions, pollution, and energy prices. Meeting these challenges will look different in different countries but addressing them is an essential condition for stronger economic growth and overcoming the middle-income trap.

Further, deepening integration into global markets will be crucial to help accelerate both the adoption of new technologies and firms overcoming the limits to potential firm growth due to the small size of many economies in the region. Adverse demographics are also a challenge in the countries in the western part of the region, where tightening labor supply due to declining populations is exacerbated by high emigration rates of young and skilled workers.