The global recovery from the deepest recession since the Second World War is picking up steam. China and India lead the recovery, but green shoots are sprouting everywhere, including in France and Germany, the two largest economies in the euro zone. Stock markets are up, real estate prices have stabilized and consumer optimism abounds.
Prospects in New Europe, comprising ten new European Union (EU) member states from Central and Eastern Europe, have also improved. Poland, the largest economy in the region, continued to expand throughout the crisis and will be the only large EU economy to post positive growth this year. Economies in the Czech Republic, Hungary and Romania have stabilized, with GDP contractions bottoming out in the second quarter. Together with Poland, these countries benefited from large currency depreciations, improved export competitiveness and increased public spending in Western Europe, best epitomized by “cash for clunkers” schemes which kept the region’s car factories humming. Poland and the Czech Republic additionally benefited from easing monetary and fiscal policy, healthy banking sectors and low external imbalances. Even the Baltic States seem to have survived the economic equivalent of cardiac arrest, with second quarter GDP shrinking at a slower pace.
Measuring the Rebound
With the risks of crisis diminishing, attention will increasingly turn to how fast and sustainable the growth may be. Will it be as strong as in East Asia, as moderate as in Latin America or anemic and short-lived?
Expected recovery in New Europe can be divided into three distinct groups. Poland and the Czech Republic are likely to benefit most from a global economic rebound, owing to competitive exchange rates, relatively sophisticated exports and strong domestic demand. Hungary, Romania, Slovakia and Slovenia will be in the second group, with a moderate recovery, with Hungary and Romania boosted by depreciated exchange rates, facilitating the return of their exports to euro zone markets, and improved credibility, supported by IMF programs. However, high external debt and tight fiscal policy will stunt their growth. Slovakia and Slovenia, the only euro zone members in the region, will suffer from the strong euro, but benefit from the euro zone’s low interest rates and easy access to financing. The Baltic States and Bulgaria will likely be in the third group, remaining in the economic doldrums and weighed down by large external debts, tight fiscal policy and uncompetitive exchange rates.
New Europe as a whole is likely to rebound from the crisis more like Latin America than Asia, thanks to a strong recovery in Poland and the Czech Republic, which together represent more than half of the region’s GDP. Positive surprises in other countries cannot be discounted, owing to their flexibility, rising inflows of EU funds and enhanced Western export markets. However, growth is not likely to return to pre-crisis rates, as external financial flows diminish, debts are repaid and global growth, no longer supported by American consumers with discretionary income, slows.
A New Development Model
In the longer-term, the pace of growth in New Europe will continue to outstrip that in developed countries, raising its income relative to Western Europe above its highest level since 1500. However, threats to the regional recovery will continue to lurk in the background as euro zone green shoots may prove as temporary as the “cash for clunkers” program, rising unemployment reduces consumption, growing deficits weaken public finances and social discontent, particularly in the Baltic States, strengthens. Currency devaluations in the Baltic States, which seem to be inevitable unless they all euro-ize, with or without ECB’s support, might also wreak havoc on the region.
The pace of convergence can slow to a standstill unless the development model is reconfigured. The crisis has taught that growth should no longer be based on domestic consumption fueled by imported savings, excessive investment in real estate and rapidly appreciating real exchange rates. The new development model should reflect that of East Asia, with high savings, managed exchange rate appreciation and diversified exports, relying more on productivity growth, enhanced labor participation and countercyclical fiscal policy. It will also need to be supported by EU-wide reforms, including centralized financial market supervision, coordinated fiscal policies, fully liberalized services markets and a more flexible approach to euro zone entry.
Given how seamlessly the region has integrated into the global economy there is much at stake for New Europe. Particularly in G-20 meetings, the new format of global leadership finally gives a voice to many heretofore peripheral countries, which often have common interests with New Europe in promoting greater global policy coordination, enhanced multilateralism and a better-supervised global financial system. Global coordination during the crisis has expanded the resources of the IMF and restored confidence in global financial markets, on which New Europe depends. With increased global cooperation New Europe will continue to prosper, and the tentative green shoots of recovery will thrive, heralding a dawn of New Europe’s true Golden Age. |
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