Central Europe Activ

Eastern Europe Adrift

The Economist magazine has an excellent analysis of Eastern Europe’s vulnerability to the current financial crisis. These countries have recently been (re-)integrated into the global economy and this will be their first encounter with a global economic crisis. They seem very vulnerable due to some common patterns of their transition to market economy.

The article cleverly distinguishes between groups of countries: the Baltic States, Ukraine, Russia, Estern Europe and the Eastern Balkans. There are similarities among these countries, most of them new member states in the EU, but there are very significant differences, too.

I find these observations for Central Europe very well founded:

Like most of the new members of the European Union, Hungary has sold off most of its banks to outsiders. That once looked the best way to create a solid financial system, allowing countries to borrow freely and grow fast, without risking the kind of crisis suffered by emerging markets in past decades. In retrospect, it looks risky. For the past decade Western banks, such as Erste Bank and Raiffeisen (Austria), UniCredit (Italy) or Swedbank and SEB (Sweden), have piled in to the promising new markets on their doorsteps, lending boldly and buying up sometimes richly priced local banks. Now those huge loan books—in Austria’s case fully 43% of GDP, compared with 5% for Italy and 1% for Sweden—are souring at a time when wobbly banks may feel that scarce cash is better deployed at home. Such deposits abroad are not covered by home-country insurance. [Even though I would argue with that this cash is better deployed at home. Central European banks have much higher profitability than Western European ones – AD]

This is indeed a very strange way to finance a global economy reintegration: while these countries have issued a lot of government bonds to rebuild their infrastructure and repay Communist-era debt, the for-profit economy turned to the newly privatized banks for loans instead of the small stock or bond markets. As these mid-income countries do not possess enough national savings to rebuild and transform their economies, this seems even in retrospect a clever policy.

And that is the deeper problem for eastern Europe: not so much financial wobbles and weaknesses, but corrupt and incompetent politics. Their leaders found it hard enough to govern efficiently even when times were good. What will happen when foreign investors are stingier and growth slows or stops? […] Ever since the collapse of communism in 1989 [… e]verything from the rule of law to competitive companies needed to be rebuilt (in the case of the central European countries) or constructed from scratch […] The results were impressive. Living standards soared; foreign investment poured in; politics settled down. The richest ex-communist countries are now nearing “Western” countries such as Greece and Portugal. So the fears of some in “old Europe” in the early 1990s that the new neighbours were likely to be poverty-stricken and unstable, exporting hungry migrants and crime to the rest of the continent, looked ridiculously overblown. […] In most of the ex-communist countries, the effort to meet EU and NATO requirements was a high-water mark in terms of political commitment to good government and sound economic policies. Since then, the approach has been to sit back and enjoy the weather: low borrowing costs, high foreign investment, rising tax revenues and higher living standards”.

I do not agree with such claims that the EU and NATO should have raised the entry-level higher, or these institutions could have done much more to force the Central European governments into further reform. The people of these countries have been born in a totally different system, nearly all points of reference, from hospitals where they were born to the pension system that promises them a retirement fund has changed within 20 years. Nearly all companies, brands and places to work were wiped out and replaced. It is very rare that people could live up to such social changes within a generation without unrest or turning back. Such modernization efforts were rarely successful in Eastern Europe and Eastern Asia, and usually ended in disaster in the rest of the world.

I have a further post on my home country Hungary that I know well.

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