CEE Economies, Policy Choices and likely Scenarios

Each of the 26 EU Member States bar the UK signed up to the idea of greater EU fiscal co-ordination in Brussels last. The Fiscal Compact paper is under review in the EU capitals (see http://rupinder-econ.blogspot.com/2011/12/fiscal-compact-for-eurozone-initial.html ). Even the UK will be there as an observer.

But what of the new members of the EU Club, those countries that had chased the dream of transforming themselves from the yoke of their Communist planned economy legacies to becoming members in the Western European clan of nations…the EU? 

Having made the hard graft to restructure their economies and institutional structures to the comply with the entry standards for EU accession the new EU 10 central and eastern EU states have been hit by a range of domestic and external shocks since the onset of the global financial-and-economic crises since 2008/9.

One wonders what their political elites, strategists and domestic populaces make of it all – particularly in terms of what their political leaders sign up to next as the Old guard of the EU intensify efforts to try to salvage the Euro and possibly with it the EU and the Single Market itself.

At a political level, EU Accession was the name-of-the-game and with it the acknowledgement of being recognised as a full democracy and a functioning market economy able to adhere to the rigours of the EU’s Single Market. In practice, many of the accession check-lists were signed off without true and full implementation (or transposition in EU speak )of the EU laws or Aquis Communitaire. To  be fair many of the more difficult EU chapters on things like environmental standards required up t 2 decades to update to EU benchmarks and so time extensions or derogations were agreed with the EC. 

Economically, EU accession for the former CEE bloc was about convergence – real convergence in particular, or in simple terms a catchup in living standards to the EU average. And per capita incomes have indeed narrowed since the start of transition in 1999 and with different speeds of adjustment across the region. The ex-Soviet Baltic republics are now closely tied into the Scandinavian economy although still reliant in part on the huge ex-Soviet economies to their East. The Visegrads in central Europe are now closely integrated to the German economy although Poland is sufficiently large an economy and populace to have a sizeable internal market of its own that helped to ride out the economic contraction in 2009-10 elsewhere in the EU. 

EU entry promised access to increased integration of businesses, transportation routes and inflows of external knowhow and capital flows from the EU – FDI and portfolio flows. A big draw was the promise of dollops of cash of up to 4% of GDP in the form of Structural Funds as part of the EU’s Cohesion policy.

Some wanted more than simply membership…a privileged Gold Card of full to the Euro club. Slovenia and Slovakia are members and Estonia became 17^th members of the Eurozone in 2011. 

And the promised land was indeed plentiful. 

Maybe too plentiful in some respects – a thesis for another day is whether the free flow of capital across the EU that fuelled cross-border flows of funding – and in turn the asset bubbles from Talllinn in Estonia  in the north, to the Costa del South in Spain to the South and Varna in Bulgaria on the Black Sea to the East, was too out of synch with the relative real economy differences, rigidities and differentials in productivity across the EU.

Although Poland weathered the economic storm well due to sound policy management, the size of its internal market and increasing connectivity to Germany’s growth-model, pretty much all the other CEE economies in the EU have had to undergo a mix of brutal internal fiscal adjustment coupled with lashings of EU sweetners and some IMF medicine.

Aside perhaps from Hungary which has been following what might a somewhat heterodox set of policies – or plan nutty to the rest of us – the rest of the CEE EU 8 managed to stabilise their economies reasonably well (although questions remain about the impact of potential contagion through the banking sectors).

And what now?

• In many ways these economies’ political and economic elites have almost religiously followed the gospel of free-markets that they will go with the flow, hoping that the manna of Structural Funds and soft financing via macro-financial assistance for any banking problems continues to help them along. 

• The Baltics, with strong links with Scandinavia, will toe the line and side with Germany, looking to be part of the Eurozone core or its successor – whatever and whenever. 

• There will be difficulties ahead for the other CEE 5 to navigate the implications of greater fiscal co-ordination underwritten in the Fiscal Compact: the sovereignty issue for the likes of the Czechs and Poland in particular.

• Hungary will be interesting to watch as the government wrestles with its odd mix of nationalism that was already putting it into difficulties with the EU as regards freedom of press and central bank independence and, which will force it to toe a more prudent economic stance.

•  The rest of the wanna-bees in the Balkans will continue to look to western Europe but there has been a general cooling to the EU from surveys taken recently. One wonders what the Croats make of it all – they’ll be EU member 28 in 2013. 
•  The big known-unknown, if I can put it so, is the likely impact in the region of a Greek default or the start of a bank run for any number of reasons that could very easily spread across the region’s still emerging economies.  With financial intermediation as measured by broader measures of money supply or simply as a share of GDP far lower than in mature economies in the EU, the multiplier effect on output of a credit compression could be far more severe.