Broken Signposts: Eastern Europe’s Economies Take Different Directions
Arvamus 04 Nov 2012  EWR
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Edward Lucas for the Center for European Policy Analysis.

CEPA Non-Resident Fellow Edward Lucas offers a broad assessment of the economic performance and prospects of the Central and Eastern countries, revealing striking differences across the region.

So how’s the East European economy doing? For 30 or more years, that was a sensible question. Economics was the Achilles heel of Communism. It was the most fiercely contested ground during the battle of ideas in the 1990s: Would shock therapy be vindicated? Was voucher privatization better than auctions?

But now that question makes little or no sense. Just as no single “Eastern Europe” exists, there is no single “East European” economy. The differences between big and small, prosperous and dirt-poor, resource-rich and brain-powered, are huge. The big divide in Europe is not East-West, but North-South. And even here the differences are deceptive. Bulgaria is poor and next to Greece. But it does not have Greece’s crippling debts, extremist politicians and social woes. Slovenia is rich and next to Austria. But it is on the verge of needing an EU bail-out, let down badly by its self-indulgent and complacent politicians and their web of financial and business interests.

Even categories can mislead. It is tempting to put all three Baltic States together as the apostles of “internal devaluation” — regaining competitiveness through austerity and wage cuts rather than by uncoupling their currencies from the Euro. In all three countries pro-austerity politicians have done well at the polls (prompting a phone call from President Barack Obama to the surprised but gratified Latvian Prime Minister, Valdis Dombrovskis, after his re-election in 2010.) But the “Baltic” category is misleading. Estonia is a full member of the Euro-zone. Latvia is struggling to join. Lithuania may be having second thoughts. Latvia and Lithuania are plagued by crippling emigration. Estonia, so far, is not.

Nor does it make sense to see the three Euro-zone countries — Estonia, Slovenia and Slovakia — as a category. Slovenia, as already mentioned, is in trouble. Slovakia’s growth is slowing down because of its strong dependence on exports to Germany. The three countries do not work as a team inside the Euro-zone: Estonia is much closer to Finland than to its two “ex-Communist” counterparts.

By far the biggest success story in the region is Poland. It managed to escape recession altogether, partly because of good luck (it had squeezed credit hard during the boom years, so had no bubble to pop); partly because of its size (domestic demand keeps ticking away, giving the economy more resilience than its smaller neighbors who depend chiefly on foreign trade); and partly because of good policy. As Jacek Rostowski, the acerbic Finance Minister, likes to point out, at times in recent months markets have judged Poland’s debt a safer bet than France’s. But now Poland’s formidable consumer boom is slowing down. And public spending can do little to plug the gap because the country is already close to its legal limit on government debt.

Poland’s biggest problem has been not in macro-economic management but on the micro level: slow bureaucracy, bad infrastructure, inadequate education. To be fair, change is afoot. EU money has begun to transform roads and railways. The bureaucratic culture is improving. Poland has rocketed up the World Bank’s “Doing Business” rankings 19 places, from 74th to 55th. But plenty more improvement is necessary and possible (Estonia is in 21st place in the World Bank league, ahead of many long-established capitalist economies). Having failed to reform fast and hard when times were good, Poland now faces the need to take painful steps when the economic weather is unfavorable.

To the south and east the picture becomes even messier. Hungary, Romania and Ukraine are in the IMF’s waiting room. Bulgaria is admirably thrifty (it has one of the lowest debt-to-GDP ratios in Europe) but is painfully exposed to the Greek tragedy. The economies of the Western Balkans are fragile.

The European Bank for Reconstruction and Development has just published its annual forecast for the region. It makes for depressing reading. It notes in particular that the Central Europe and Balkans (CEB) region, previously the star performer, is “highly exposed” to the slowdown in the Euro-zone and European banks’ deleveraging (paying off debts). The Baltics, Slovakia and to some extent Poland retain some resilience, whereas Slovenia, Hungary and Croatia will have at least one year of recession. And Hungary is failing to attract foreign investment (not least because of the erratic policies of Viktor Orbán’s FIDESZ government).

If the Euro-zone was growing, it would be easy to argue that all these countries’ long-term prospects are still bright. They still have big cost advantages over the rest of Europe: wages are around half the Western level. They still have huge room for improvement in infrastructure and productivity. Their membership in the EU (existing or impending) reassures investors and keeps borrowing costs down. The happy story of the 1998-2008 period could continue into the future, with convergence between the two halves of Europe being a realistic prospect in the lifetime of people reading this article.

But that sunny outlook is clouding. Europe may be stuck with low or no growth for a decade as it sorts out its financial architecture, establishes a transfer union between north and south, and salvages its bust banks. The hopeful ideas of the Lisbon agenda — making Europe the most competitive economy in the world — are a distant memory. The task now is to save the single market in its limited present form, rather than expand and deepen it (most importantly by extending its rules to cover services as well as goods and capital).

Stagnation may have corrosive political consequences. During the first years of post-Communist life, expectations were low and readiness to adjust high. Now, the expectations are as high in “Eastern Europe” as in the “West.” If they are not met, voters will want to know why.

Edward Lucas is International Editor of The Economist and a Non-Resident Fellow at CEPA. He has been covering the Central and East European region since the mid-1980s.

The views expressed in this article are those of the author and do not necessarily reflect the opinions of the Center for European Policy Analysis.

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