WIIW Research Report No. 231 (October 1996)

Exchange Rates, Competitiveness and Labour Costs in Central and Eastern Europe

(by Peter Havlik)

ABSTRACT

This empirical paper reviews recent exchange rate developments in selected transition countries, and attempts to evaluate the degree of initial currency undervaluations and the scope for real appreciations. It is argued that undervaluation is needed in order to overcome institutional, structural and quality deficiencies. The equilibrium exchange rate of a transition country's currency will therefore remain above its purchasing power parity. A simple simulation shows that excessive undervaluation could be overcome relatively fast, but the low wages and also unit labour costs are a more lasting phenomenon. Realistically, the process of catching up with West European average per capita income levels will be protracted, with the most advanced transition countries (Slovenia and the Czech Republic) reaching the average EU level not before 2010.

Keywords: exchange rates, undervaluation, income catching up

JEL classification: F31, J3

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