CAN WESTERN ECONOMIES LEARN FROM CENTRAL AND EASTERN EUROPE?

Graham Jarvis looks to Poland and the Czech Republic for lessons on how the West might better have avoided the present financial and economic crisis.

Quite often the West takes the view that it can teach the rest of the world a thing or two. But in some respects at least, Western economies could learn a thing or two from the recent examples of Poland and the Czech Republic, which have navigated the bad economic weather much better than many of their neighbours – for example, Hungary, the Ukraine, the Baltic States, Kazakhstan and increasingly Russia – and indeed much of the West. Perhaps Poland and the Czech Republic indicate the balance that must be struck between cautiousness and risk-taking? Granted, to inspire growth there must be some kind of risk-taking, but the economies of the UK and the US have suffered precisely because they took too many risks. On the other hand, being too ‘risk-averse’ can cause economies to stagnate.

THE IMPORTANCE OF AGILITY

Dr Agnieszka Gajewska, an infrastructure financier and Associate Director at DEPFA Bank in London, believes that Eastern Europe’s turbulent history has fostered in its people a beneficial agility. ‘Years of communism and unstable economic landscapes, including the painful reforms of the 1990s, have taught individuals to be resourceful and to adapt to an ever-changing economic environment,’ she explains, going on to suggest that Western economies would do well to adopt a similarly common-sense approach to instability: ‘In a post-credit-crunch world, we need to re-evaluate and maybe re-design the foundations of our economies and act accordingly, possibly in a different way to what we have got used to over many years.’

POLAND: AVOIDING MISTAKES

According to Michael Dembinski, Head of Policy of the British-Polish Chamber of Commerce, Poland has experienced a milder downturn than most because it avoided making the same mistakes as many other economies. Polish banks have been cautious – unlike their counterparts in the UK and the US, they avoided both over-lending and, consequently, the creation of a housing bubble. In contrast to Western Europe, household debt in Poland remains very low, and the country has been less exposed to defaulting mortgages and toxic debts such as unsecured personal loans.

Mr Dembinski estimates that up to 70 per cent of Poland’s small and medium-sized businesses (SMEs) have not borrowed a zloty from domestic banks, partly because the corporate and retail banking sector in Poland is not yet mature – entrepreneurs have had to rely on their own resourcefulness and cash flow to grow their businesses. (Besides, Polish entrepreneurs tend to distrust banks.) For their part, Polish banks have focused on delivering basic products and services, instead of ‘dreaming up innovative products that are loaded with unbearable risk’ – a practice that Mr Dembinski believes has caused much economic suffering among the Baltic States.

DEFICITS AND CONTRACTIONS

In August 2008 The Economist declared that ‘The party is nearly over’, the ‘party’ being Eastern Europe’s decade of good economic and political fortune. However, troubles were brewing – years of ‘colossal current account deficits and breakneck growth,’ which weren’t a problem while the good times rolled, have now returned to haunt a number of countries, especially Estonia and Latvia. The Economist Intelligence Unit predicts that Latvia’s budget deficit will blow out to 11 per cent of Gross Domestic Product (GDP) this year while the country’s economy continues to contract. Meanwhile, a fall in domestic demand will drastically cut imports, narrowing the current account deficit from 12.8 per cent of GDP in 2008 to just 1.5 per cent of GDP in 2010.

Similarly, it is predicted that Estonia’s current account deficit will narrow from 9.4 per cent of GDP in 2008 to less than 3 per cent of GDP in 2010. Weakened domestic demand and falling exports will cause GDP to drop 13 per cent in 2009 and 3 per cent in 2010. Estonia’s budget deficit is expected to exceed the Maastricht Treaty’s limit of 3 per cent of GDP in 2009 and increase to 3.7 per cent of GDP in 2010. Political tensions could also cause the demise of the country’s minority government, due to opposition over its fiscal policy and a possible shortfall in tax receipts.

HUNGARY: HIGH LEVELS OF INDEBTEDNESS

Hungary has been particularly badly hit by the crisis. This small, open economy, which in recent years has seen modest growth, is very much dependent on external demand (whereas Poland, for example, has a much larger internal domestic market). In recent years, it has also accumulated high levels of debt. Particularly alarming is the fact that roughly 60 per cent of Hungary’s private debt is denominated in foreign currencies – given the sudden devaluation of the forint, Hungary’s domestic currency, many individuals and businesses have found themselves unable to keep up with their loan repayments.

Kryzysztof Kalicki, President of the Management Board of Deutsche Bank Polska SA, reports that Hungary’s indebtedness equated to 112 per cent of GDP in the first quarter of 2009. In his view, the country is suffering from ‘uncertainty regarding the commitment of the foreign banks as to their operations in Hungary,’ while its ‘export-orientated economy proved to be a liability rather than an asset when exports collapsed in the first phase of the global recession.’ And even though capital outflows have been staved off by a $25 billion financing package put together by the IMF, EU and World Bank, Hungary’s economy is still expected to contract by at least 5 per cent in 2009.

The Press Department of Hungary’s National Ministry for Development and the Economy believes that the most important lesson is that ‘the good times don’t last forever, and therefore one should use the good times to prepare for the worse,’ which in retrospect should have meant using ‘the historic global upturn between 2004 and 2007 to make fiscal savings to prepare for the recession, and to implement structural reforms that are only painful in the short-term.’ If these reforms had been in place, could the contrary have avoided its current malaise and achieved long-term growth? The Press Department certainly thinks so.

CZECH REPUBLIC: ‘NO FINANCIAL CRISIS’

According to Peter Urbanek, Commercial Counsellor at the Embassy of the Czech Republic in London, the Czech Republic has suffered ‘no financial crisis’. Instead, the country’s problems are strictly economic, and can be mainly attributed to a downturn in demand for Czech exports, a significant proportion of which (83 per cent at last count) is traditionally earmarked for EU member countries.

‘Czechs are the fastest at introducing different policies and de-regulating the markets, they are traditionally closer to Western Europe via geographical proximity, and the wealth of the nation is equally spread out,’ says Iwona Golinska, Business Development Director for Central/Eastern Europe and Russia at Intec Telecom Systems, a global provider of business and operations support systems to telecommunications companies. Furthermore, Czech banks ‘look less vulnerable and more solid; they have learnt their lessons from their own recent banking crisis and they have developed their own currency markets,’ says Erik Berglof, Chief Economist at the European Bank for Reconstruction and Development (EBRD), who also believes that the Czech government has done well to regulate the country’s financial institutions.

LEARN FOR A BETTER FUTURE

As Mr Dembinksi admits, it is quite hard to learn from developing countries, given that they themselves are still learning to navigate the path to a brighter economic future. Most Central and Eastern European countries will benefit from the outcomes of the London G20 Summit, as a result of which the IMF will play a major role in their development, and those within the EU (such as Poland) will further benefit through access to additional funding.

Time will tell whether or not the US and UK policy of borrowing and spending our way out of the recession, which formed the basis of the London G20 agreement, is going to work. After all, debt can create a spiral of more debt, and there is no guarantee that it will stimulate economic growth. This is a big risk, and one that needs to be carefully managed, since it was excessive risk-taking that caused the initial financial crisis that led to the world economic downturn. The pain of recession may not be over, but we can at least learn from each other’s mistakes and successes in order to enact the right policies to inspire economic growth.