Has Eastern Europe’s crisis peaked?

Colin Woodard

Hit hard by the global downturn, Europe’s former Soviet-bloc countries are suffering from rising unemployment and poverty; some officials question the post-Communist drive to privatize and deregulate.

OLOMOUC, Czech Republic – Before the worldwide financial crash, things were looking up for this medieval university town, 170 miles east of Prague. Local manufacturing sales were up, unemployment was down, and the local soccer team ranked as a European powerhouse.

But the Great Recession has battered the export-driven Czech economy, and the pain has trickled down to Olomouc’s graffiti-plagued streets. Layoffs of thousands in the textile and machinery industries have driven local unemployment to 11.3 percent, nearly three points above the national average. And soccer club Sigma Olomouc is making news not for beating its rivals, but for the local hooligans who keep beating up visiting Scottish fans in tear gas-assisted assaults.

The global economic crisis has hit Central and Eastern Europe especially hard, less than a decade since the former Soviet satellite countries and newly independent Baltic States emerged from their long and painful transition to a free market system and attained European Union membership.

The sudden downturn in 2008 triggered rising unemployment and yawning budget deficits, and has forced some tough lessons on these young market economies, which until then had enjoyed growing prosperity post-Communism.

“Eastern Europe was seen as the next Asia,” recalls Krzysztof Rybinksi of the Warsaw School of Economics, referring to the rapid growth in Asian emerging market economies in the years preceding the 1997 Asian meltdown.

The International Monetary Fund has rescued three of the newer EU members from bankruptcy: Latvia, Romania and Hungary. The IMF forced all three countries to slash public sector wages, staff, and services, in exchange for tens of billions of dollars in bailout funds. And the Austrian government has thrown money at its banks, which loaned heavily in Central and Eastern Europe, prompting fears about Austria’s own fiscal stability.

“Our neighboring countries are still in the middle of the transformation process to build the infrastructure they need to run their market economies, so they are in a very fragile situation,” says Franz Hahn, an economist at the Austrian Institute for Economic Research in Vienna. “They are very dependent on the availability of foreign capital and if these inflows get thinner, these countries are in big trouble.”

As the shockwaves reverberate from the banks through the real economy, many families face devastating impacts: job losses, price increases, and sudden jumps in mortgage or car payments valued in foreign currencies, according to a study released by the World Bank in December.

The study estimates the crisis has forced an additional 5.7 million people into poverty, or to the verge of it, in the new EU member states of Central and Eastern Europe, plus Croatia.

“Poverty has already increased and we believe it will continue to do so through the end of this year,” says Luca Barbone, the World Bank’s regional director for poverty reduction. “Tragically, the countries that have done the most to reform their financial sectors have exposed themselves to a new threat to their emerging middle classes: excessive household debts.”

Unlike their richer western counterparts, few countries in Central and Eastern Europe can afford significant stimulus spending. Last March the European Union turned down Hungary’s request to set up a €190 billion bailout fund for the region. Ferenc Gyurcsany, then Hungary’s prime minister, warned of “a new iron curtain,” splitting a self-interested West from a suffering East.

Tomas Sedlacek, a Czech bank economist who served as an advisor to former Czech President Vaclav Havel, sees a certain historical irony in the fact that shortly after his country completed a painful de-nationalization of banks and car manufacturers, leading western countries have done the opposite.

“The Washington Consensus was that we had to privatize and deregulate, so we did that,” he says, referring to the pro-privatization and deregulation movement that has dominated policy in the U.S. and among organizations like the World Bank and IMF. “Now we wake up 20 years later to find the imperative of the western world is to nationalize and regulate.”

“Not everything is solved by privatization and deregulation,” notes Sedlacek. “We learned that the hard way.”

Most of Central and Eastern Europe still faces a tough road ahead.

Hungary’s economy contracted by an estimated 6.9 percent last year, and the Organization for Economic Cooperation and Development expects it to shrink another one percent in 2010, while unemployment will increase to over 10 percent.

The Czech and Slovak economies also shrank in 2009, but are expected to return to modest growth in 2010, albeit with more joblessness. While Poland dodged the real pain of the recession altogether, both Latvia and Lithuania saw their economies contract by one fifth.

“I don’t think any country is out of the woods yet,” says Sedlacek. “The demon has repositioned itself from banks and companies to governments, and many of them are very much on the edge. A small crisis or downgrade could really cause a domino effect.”

Hungary’s national debt burden is the greatest among all the E.U. states in the region, at about $100 billion, or 80 percent of its gross domestic product. For now it is making its payments with the help of some $25 billion in IMF and E.U. bailout loans.

“But the credit rating agencies are not much impressed, as the long term outlook has not changed,” says economist Peter Akos Bod, a former head of Hungary’s central bank. “The IMF insists that we reduce our budget deficits, but unfortunately that adds to the recessionary factors.”

The Czech Republic entered the crisis in good shape, but is now confronting the worst budget deficit in its history — 6.5 percent of GDP — as payroll tax revenues contract. Experts say the country is still saddled with inefficient pension and health care systems, which leave the government no room for stimulus spending.

The Czech economy depends so heavily on exports of automobiles and other manufactured goods that the drop in demand in Western Europe and the United States has prompted it to send hundreds of unneeded guest workers back to their home countries, even paying for their plane tickets.

Poland, the one bright spot in the region, avoided the worst of the recession in part because its currency weakened substantially, which curbed imports from abroad to the benefit of domestic producers.

The size of the Polish market — it has more people than Hungary, the Czech Republic, Slovakia, Slovenia and the three Baltic republics combined — made it easier for its companies to survive the crash in foreign demand.

While nobody is sure if a regional crisis has been averted, the sense of impending doom that hung over the region a year ago has lifted somewhat.

“For the time being the worries are much smaller, but a lot still depends on the pace of growth going forward,” says Rybinski.

Some think the crisis has a silver lining in that it is prompting a healthy reappraisal of both public policies and private values.

“The crisis has been bad for some people in particular, but it has also been a good educational lesson for Czech politicians and the people in general,” says Prague-based political analyst Jiri Pehe. “I think they have realized that we had it good for too long, and that maybe we should be more prudent in the future, prepared for any bad times ahead.”

In the provincial industrial city of Zlin, 35 miles southeast of Olomouc, clothing and footwear designer Jana Buch agrees.

“It’s really changed the atmosphere and gotten people to start thinking about what they actually need,” says Buch, noting that in the throw-away society that emerged post-Communism, even fashion designers had stopped thinking about making products that would last.

“I actually believe it’s good and something we needed.”

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Source: http://www.globalpost.com/passport/foreign-desk/100208/has-eastern-europe%E2%80%99s-crisis-peaked