The Crisis as a Killer? – Liberal Way Out of the Financial Crisis in Eastern Europe

| Twenty years after the introduction of a market economy in Eastern Europe, the new economies are facing their first challenge. After years of economic growth, the global crisis overtook Eastern Europe as well. We devoted the special June edition of our E-Newsletter to this topic. The situation, however, varies between the states. The countries whose governments have followed a liberal and stability oriented course of action are coping with the turmoil better than the others. The liberal solutions and reform concepts advocated by the Foundation’s partners in Eastern Europe not only offer ways out of the crisis, but also help implement needed structural reforms.
The magnitude of the crisis in some countries is often self-inflicted. The present crisis is felt much more severely in countries which, dazzled by the upswing in some sectors, have put needed reforms on the shelf, whose governments and citizens have been increasingly living on credit, whose ramshackle government and industry structures have not been modernized, and where the stability politics has been given loose rein.
The roots of the dramatic events in Latvia can be seen in the fact that the country had been living beyond its means for years and the late economic boom was built on feet of clay, that is, had been financed through loan-based consumption and a real estate bubble.
In Hungary at least one third of the problems are home-made, as Hungarian government politicians themselves are ready to admit. In reality, the backlash in Hungary came about mainly because the country had for years financed its upturn with loans.
Serbia has not learned from the past that privatization proceeds should be used to reduce the structural economic deficit with targeted investments. Instead, privatization revenues flowed into consumption and were spent. These consumption habits, especially the dependence on loans, are particularly burdensome for this country.
In Russia, as has been said time and again, even by the Russian government, the necessary diversification of the economy has hardly begun, and, in addition, many industrial enterprises are still inefficient. These are important factors for the crisis. The list of sinners and their sins could be expanded even beyond Eastern Europe.
The EU: an Anchor of Stability?
In principle, EU membership stabilizes the eastern Member States and increases their credibility. Emergency financial aid packages with the participation of the EU managed to avert acute crises in the balance of payments and support convergence efforts. Thus, for the time being, the liquidity crises were also averted in some (Western) EU Member States whose banks maintain extremely high liabilities in Eastern Europe (Lang, Schwarzer, 2009).
Membership in the European Union and the euro area, often praised as an anchor of stability, is not necessarily beneficial. Stability policy principles were quickly thrown overboard, especially in Germany and France. The European Commission also sacrificed its role as guardian of the European Stability Pact and competition in favour of a new role as rescuer of the economy; a role which included prudently setting limits on new debt and softening the requirements for national subsidies: in effect, the much-vaunted stability anchor was itself compromised by the crisis (Göbel, 2009). The liberals in the European Parliament had repeatedly and explicitly warned about that. (Bowles, eldr, 2.4.2009).
This ever faster subsidy merry-go-round has not only promoted the trend towards re-nationalization, which is against the fundamental principles of the internal market, but broadened again the economic abyss between the East and the West. The eastern countries have become all the more sceptical when faced with the subsidies that the rich neighbours to the west are pouring into their own economies (Frasch, 2009). The multi-billion dollar incentive packages for economic revival, as well as the scrapping of premiums will prove an expensive flash in the pan, since they encourage only certain sectors and thereby discriminate against others.
A Liberal Way Out
The general health of their national economies, their financial soundness and socio-economic conditions vary significantly between the eastern countries since their reform policies and transition paths in the past two decades sometimes differed significantly from one another. (Lang, Schwarzer; 2009). The countries whose economic and financial policies demonstrate liberal trends and an orientation towards stability are not only better armed against the effects of the global crisis, but also stand a better chance of pushing themselves off the rock bottom faster. The crisis could even be used as a welcome shock when it comes to economic overheating and the misallocation of resources.
| Bild: | Liberal think-tanks in Eastern Europe, partners of the Foundation, have made important suggestions for the introduction of needed structural reforms as the most effective anti-crisis measure. For Ruta Vainiene, President of the Lithuanian Free Market Institute (LFMI) in Vilnius, the three absolute “NOs” are the most significant: no incentive packages, no “bail-outs” and no protectionist measures!
Instead, this liberal economist recommends a reform in central bank policy aimed at curbing unimpeded lending. The consolidation of public finances to serve as a debt brake together with tax relief are also important for her. In addition, the liberalization of labour markets and a reform of public social security systems should be taken into consideration. Free trade is especially important in times of crisis, whereas protectionism serves only uncompetitive industries which could produce neither greater potential for growth nor new jobs.
Svetla Kostadinova, Executive Director of the liberal Institute for Market Economics (IME) in Sofia, agrees with her colleague in Vilnius. In her opinion a fundamental limitation of the role of the state is necessary, especially in times of crisis, through limiting public spending, by reducing regulation and by improving the investment climate for private businesses. Only recently was the IME given very positive feedback for a study they carried out on the ‘affluence effects’ of the lean state (The Optimum Size of Government, 2009;
The State of Play
Current developments prove that in the region these proposals do not only fall on deaf ears (overview by Dr. Borek Severa, Director of the Foundation office in Prague):
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| For example, Estonia, which since the end of the nineties has witnessed an unprecedented economic boom and where new borrowing is prohibited by law, has larger reserves than its neighbour Latvia. In the good times, Estonia had built reserves – ten percent of its Gross Domestic Product. Besides, the crisis led to a decrease in inflation: from 10% in 2008 to -0.6% in the first quarter of 2009. The government will use this development to accelerate the introduction of the Euro.
Because of the severe economic downturn, Prime Minister Andrus Ansip prescribed tough austerity measures in midyear which shattered the coalition between Ansip’s liberal-conservative Reform Party and the Social Democrats. The latter would not support a reduction of social security benefits. Negotiations for a coalition with the rural People’s Union failed for similar reasons.
In the meantime, Ansip remains as the head of a minority government, which aims to keep the overall deficit below 3% of the country’s GDP with a 435 million euro austerity package. For that purpose, the government consistently objects to proposed increases in taxes and fees. However, cuts are still envisaged, including a reduction of unemployment benefits and cutbacks in social security benefits. Next, a reduction of wages and salaries in the public sector is planned. A ‘7-step’ liberal reform package should bring Estonia back on its usual growth track.
Even more than its neighbouring Baltic states, Latvia saw itself balancing on the edge of bankruptcy and was forced into drastic austerity measures: the government under Prime Minister Valdis Dombrovski therefore reduced the 2009 budget by a further 500 million to a total of 4.5 billion lats, but this was a decision made on a national level shoulder to shoulder with the support of all parties represented in the Parliament, the Saeima. Further wage cuts of up to 20% for public servants are envisaged, investment in road construction will be postponed and social programs will be further pruned by 35 million lats. Among other things, child benefits for working parents are to be reduced by 50%. This is despite the growing discontent of the population over cost-saving measures, since Riga had already reduced the salaries of public servants by one fourth several months ago. In the private sector, salary cuts were agreed upon amounting up to 50% in order to save at least some of the threatened jobs, especially since unemployment has risen since 2007 from 5% to 14%. The government also decided to reduce the minimum monthly salary threshold of 180 to 140 lats in order to save jobs.
Although for the first quarter of 2009 Poland was the only EU Member State, which, according to the Warsaw Central Statistical Office GUS, still reported GDP growth, of 0.8%, the projections of the Polish government are for a reduction of GDP growth to 0.2% GDP for 2009 as a whole. Anti-crisis measures have already been initiated: large economic incentive programs approved in early June were renounced, and a “law on the consequences of the economic crisis, for employers and employees” passed. This law, containing specific provisions in the labour code and guidelines for financial assistance from the state to employers was voted in July by the parliament in Warsaw, but it will enter into force in September at the earliest. Under these regulations, if a business has been affected by the crisis for six months, reduced working hours and wage cuts are allowed of up to 50% each.
In May a further measure – the 91 billion zloty anti-crisis package agreed upon by the governing coalition in Poland in December 2008 entered into force: the state guarantees for bank deposits were increased to a ceiling of 50,000 euro and loans to small and medium-sized enterprises were backed up by the public purse in order to revive inter-bank lending. Although the Polish financial institutions were not in practice involved in the ‘subprime crisis’, Poland felt its effects indirectly through the credit crunch and the decline in demand from Western European markets.
Other countries are struggling even more. Since the beginning of the year, political instability in Hungary has deepened with the adoption of anti-crisis measures. Gordon Bajnai, the Prime Minister of the caretaker government, wrote to all parties with parliamentary mandates in the country that the financial crisis was still in full force due to the still high public and external debt, and asked for assistance in establishing a crisis budget for 2010, but received a prompt refusal from opposition leader Viktor Orban.
In Bulgaria, the liberal National Movement for Stability and Growth (NMSS), while a junior partner in a coalition led by the socialists, appealed, together with the conservative opposition for cuts in social spending and against salary increases. The government, however, increased state spending for 2009 by 25% compared to 2008 while revenues declined by 10%. After the landslide victory of the right-wing GERB in the parliamentary elections in early July, the new Prime Minister, Boyko Borissov, announced some unpopular measures: social benefits, pensions and minimum wages would be frozen.
For a common European reaction against the financial crisis solidarity is required, which has been the foundation of successful liberal market regimes for many decades now: as much state as necessary, as much private initiative as possible. The state has to shrink back to its core activities so as to allow citizens and businesses maximum freedom in an environment of unimpeded competition. There is always potential for growth, you just have to be able to find it – and what’s more – you must have the courage to do so.