The severity with which the global financial and economic crisis hit many central and east European (CEE) countries took most people by surprise. Until mid-2008, policy-makers from Tallinn to Bucharest were struggling with rising inflation, asset bubbles and strengthening currencies. Within weeks, the focus shifted towards preventing currencies from collapsing and mitigating the ferocity of the economic downturn. The region's economies are, of course, very different. But since late 2008, there has been a strong perception that eastern Europe as a whole is in deep trouble. Unlike in western Europe, there have so far been no major banking crises (with the exception of Latvia where the biggest local bank had to be nationalised). Nor have the CEE countries jumped on the Keynesian bandwagon, at least not yet.
Most of them have put together some kind of stimulus package. But these have consisted mostly of already planned tax-cuts and investments. Instead, the new members hope to rely on accelerated spending of regional aid from Brussels. In the EU's new members, policy-makers are grappling with an additional source of confusion: the paradigm that has guided reform since the 1990s suddenly looks seriously flawed. The main drivers of growth over the past 15 years appear to have turned into impediments to future performance. These drivers were: openness to trade and integration into pan-European supply chains; integration into international capital markets; and ambitious economic reform programmes, largely guided by the EU accession process.
State of the nations
Since the early 1990s, governments in the region have justified many painful changes by the need to get ready for EU membership. The economic crisis will make it harder still for the EU to tell the new member-states what to do.
Germany, the UK and the other big EU countries are now nationalising some of their banks, propping up industries and stretching EU budget rules. The state is making a comeback everywhere. The trouble is that governments in central and eastern Europe are often weak, and sometimes prone to populism, incompetence and corruption. The new members need an external anchor more than the west European countries. But the European commission's authority as a reform watchdog is diminished. The Lisbon reform agenda - designed to encourage EU member-states to liberalise and modernise their economies - seems almost entirely forgotten. The legal framework for the single market is under threat of being weakened. Already, the commission has had to loosen competition and state aid rules to allow for industry bail-outs and emergency bank mergers. It will take years to strengthen the rules again. Since local laws and institutions are weaker in the new members than in many west European countries, this matters.
Solidarity has become an important yardstick for the people in central and eastern Europe and the Baltic states. They often feel that the big EU countries do not pay sufficient attention to their concerns, for example about Russian bullying of neighbouring states or the costs of meeting EU climate change targets in poorer countries. Since the onset of the economic crisis, some of the new members have complained that EU rescue efforts have focused too heavily on the richer eurozone countries and those with big banking sectors. But the EU has already done quite a lot to support CEE countries in trouble. The commission quickly raised money to contribute to the emergency loan packages for Hungary and Latvia ($6.5bn and $3.1bn, respectively). It is now said to be talking about a possible emergency loan to Romania (probably again with IMF involvement).
An increase in political in-fighting and populist rhetoric are likely to accompany the downturn. Many people in central and eastern Europe have become used to double-digit wage growth, rising living standards and increased job security. Having left the pain of the post-transition downturns behind, it seemed that the only way for their economies to go was up. EU entry appeared to deliver what it had promised: prosperity and stability. Most people cared little about politics as long as growth was strong. It is not clear how people will react to mass lay-offs, shrinking pay packages and, in some countries, the curtailment of state benefits.
Reform challenges
Irrespective of the crisis, the medium-term reform challenges for the CEE states remain the same, from streamlining social security systems to moving to a low-carbon economy. Populations are already ageing fast. The World Bank calculates there will be 18% fewer Bulgarians in 2025 than there were in 2000. The shrinking of CEE workforces is inevitable, but the economic consequences will very much depend on whether these countries manage to raise employment rates, boost productivity and put their pension and healthcare systems onto a sustainable footing.
Education reform is also crucial. Most CEE states do well at the level of secondary education. University systems tend to be starved of cash and shackled by bureaucracy and out-of-date curricula. In Bulgaria, Poland and Romania, one in five people under 25 is unemployed - due to a mixture of inadequate skills and rigid labour markets. This means that a large part of tomorrow's workforce is not in education or picking up useful skills on the job.
Most governments can ill afford to spend their way out of trouble but they could seek to placate their electorates by putting structural reforms on hold, or even unwinding some of the privatisations, social security and labour market reforms already achieved. The EU is no longer the anchor it once was, and the west European countries are in a poor position to preach since they are themselves putting reforms on hold and bailing out their industries.
They need to encourage the upgrading of their industries; build up well-regulated, high-quality service sectors; invest in new infrastructure and greener technologies; streamline their social security systems; and improve education and training. The richer EU member-states must be careful not to allow any weakening of the EU's single market framework and they should not forget the Lisbon agenda of modernisation and reform - these things matter to eastern Europe.
This article is an extract from a briefing by the Centre for European Reform: cer.org.uk
