The politics of economics in new Europe
One week after Dennis Blair, U.S. Director of National Intelligence declared the economic crisis the primary threat to U.S. national security Latvia fell victim to the political instability caused by the economic turmoil. Without a strong, coordinate response shoring up Central and Eastern European (CEE) economies, we are risking further political instability in other countries of the region, possibly undermining the legacy of 1989 and EU enlargement.
After decades of impressive economic growth thanks to policies of trade liberalization coupled with European integration, economies in Eastern Europe have been hit hard by the global economic crisis. Some of them, such as Latvia, are experiencing the sharpest economic contraction since the collapse of the Soviet Union. Two weeks before his resignation, the Latvian prime minister announced that the economy has contracted at an annual rate of 10.5%, with economists predicting a further drop of 10% in 2009. Other countries in the neighborhood are also in deep trouble. Last week, analysts warned of Ukraine possibly defaulting on its sovereign debt, with the interest rate reaching 32% on annual bases. The pattern in CEE is reminiscent of the 1998 Asian financial crisis - during the good times economic growth was fueled by a credit boom and borrowing in foreign currencies. As the shock hits - this time in the form of the credit crunch - foreign investors' confidence has evaporated and the fall of local currencies has exacerbated the viscous circle. However, unlike during the Asian crisis, this time countries will not be able to count on a cushion provided by robust growth in other parts of the world. Eastern Europe will not be able to solve their economic problems with export led growth.
The depth of troubles in Central and Eastern Europe comes precisely from what was considered the prescription for success over the last twenty years. The '90s growth paradigm called for deep domestic reforms coupled with opening to foreign investment in local financial systems. Local banks were sold to foreign financial institutions and local companies integrated into the European single market. As western credit dries up and export markets in the rest of the EU stagnates, what used to look like a prescription for prosperity, is seen now by some as a formula for failure.
What happened last Friday in Latvia can repeat itself in other vulnerable democracies throughout the region. The impact of economic downturn on politics in this part of the world might not be benign. Populism and protectionism are already on the rise, and this trend is likely only to deepen with the severity of the economic crisis. The worse the situation gets, the easier it is for populist and eurosceptic politicians to make the case that the post-1989 transformation made the countries of central and eastern Europe particularly vulnerable to the economic crisis.
The transatlantic community, including the EU, IMF, and the World Bank, needs to act in a coordinated manner to prevent economic and political turmoil in countries of Eastern Europe. Instability in what now is a very vulnerable region posses a risk to the gains of the last 20 years. As Mr. Blair pointed out during his testimony to the Senate Intelligence Committee,"Time is probably our greatest threat." The longer we let the economic troubles in new Europe brew, the greater the risk that political fallout from the crisis will have long lasting, negative consequences on the region that has been the biggest success story since the end of the Cold War.
The views expressed in GMF publications and commentary are the views of the author alone.