Who gets under the EU umbrella when it rains?

This anniversary guest post is written by the clever and wittty P O’Neill.

For understandable reasons — the addition of 10, and soon to be 12, new member countries, and the constitutional crisis, the European Union has been preoccupied with foundational questions in recent years. But an older concern is working its way back onto the agenda: how to handle an economic crisis in a member country. The last major convulsion was Black Wednesday in 1992. Yet the only real long term impact of Black Wednesday was on the electoral fortunes of the Conservatives, as the legacy of mismanagement proved very difficult to shake. But there was little other damage: the UK economy managed to shed an exchange rate straitjacket that it had never particularly liked and growth recovered quite quickly, and the Eurozone project, then its in infancy, shed its most reluctant large member, setting the stage for monetary union 7 years later. Furthermore, the crisis itself was limited in scope, as it never concerned the ability of the UK government or the country as a whole to pay its bills.

However, the risk of the latter type of crisis in a member country is now quite high. The most relevant period of comparison is the 1980s, when a number of mostly smaller EU countries had very high public debt and international trade deficits, often in the context of weak coalition governments unable to tackle the problems. Luckily, no country ever actually hit the crisis point where the Union might have had to consider what kind of support to provide. But consider that as late as 1989, the eminent economist Rudi Dornbusch (R.I.P.) could publish an article titled Ireland’s Failed Stabilization (link may require subs.) — reflecting what was then a growing consensus that the Republic was on the brink of chronic basket case status. Could the Irish government have defaulted on debt, or could the country have faced a shutoff in the ability to borrow abroad? We’ll never know, because 1989 is exactly when the turnaround was beginning, and therefore the other countries never had to hash out their exact obligations to a member in distress.

The warning lights are flashing again – this time in eastern Europe, and especially in the recent or imminent member countries of Hungary, Romania, and Bulgaria. Poland is also a source of concern. Some combination of profligate governments, political uncertainty, EU spending booms, and capital inflows have created precarious economic positions for these countries. So far it’s all worked out OK, as foreign investors are looking for good returns anywhere with global interest rates so low and willing to take the bet. EU membership or the prospect thereof makes the long-term outlook seem safe and has driven big capital inflows (for Irish investors, especially for property – check the ads in any of the Irish newspapers). But the numbers are getting to the point where analysts worry. In Hungary, the budget deficit and current account deficit are getting close to 10 percent of GDP. The fiscal problems are not so evident in Bulgaria and Romania but current account deficits are large. If it was Latin America or Asia with these numbers, the panic would be there already.

A combined crisis in all three would be a rather larger affair than a 1980s Irish crisis would have been — with additional complications given that the countries on the other side of the bets on prospects in these countries would also be in the EU. And so a set of questions: Does the EU have the will or the means to tell countries that they are the wrong track? Should the countries seemingly most intent on joining the Eurozone be politely told to forget about it? Should the investors tripping over themselves to get a piece of the action be told that they’re on their own if anything goes wrong? And perhaps the biggest question of all: given the huge western migration that has already occurred even with relatively healthy economies in eastern Europe, what would be the political backlash from even greater flows of workers fleeing a severe recession there? One gets the sense that the EU top brass were counting on a nice quiet period to get the public used to the idea of the constitution again. One fears that events could derail this benign scenario.

6 thoughts on “Who gets under the EU umbrella when it rains?

  1. There are 3 countries that tend to be in EU:Romania,Bulgaria and Moldova. The first is almostly in one step of it, the second wants to enter,however is afraid of its tourism and the last one knows nothing about what it wants. There is one more country-Transnistria, that as well as Moldova is not decided yet. I wonder who will help such countries and what will be its future?Thank you for reading

  2. Hi P. O’Neill. If there is going to be an economic crisis among the new EU members my money would be on Hungary. In fact they already have one, but I suspect this is set to deteriorate further. Some people were itching about Turkey, but I think that was a none-call, Turkey is basically on a sound path despite the bumpy ride (and don’t miss the way the EU is trying to put Cyprus on the back burner till after the Turkish elections). No, I think Turkey is the one to watch in this group.

    If there were dominoes to fall I would then watch Italy. Very closely.

  3. Incidentally:

    “But consider that as late as 1989, the eminent economist Rudi Dornbusch (R.I.P.) could publish an article titled Ireland’s Failed Stabilization (link may require subs.) — reflecting what was then a growing consensus that the Republic was on the brink of chronic basket case status”

    And strangely enough isn’t that just what Dornbusch’s would-be heir – Nouriel Roubini – has been doing with Turkey. Of course for all his mistakes Dornbusch was a giant of his class. Turkey will, evidently, be the Bosphorus Tiger.

    My fears about Hungary are of course compounded by the state of its demography, fertility of 1.3tfr, natural rate of population decline of -0.3% per annum, and zero net migration. This situation is made even more complicated by the life expectancy one.

    Average life expectancy is currently 73. This is – like in the case of many new former easten bloc members – low by EU standards. What we have seen from the East Germany case is that the availability of modern medical care for the elderly can see this rise significantly, and in a short time. Most of this leg of the extension in life expectancy is driven by just that: the availability of intensive medical care at the older ages.

    This is obviously good news, but for state finances it isn’t. These countries have very little in the way of conserved pension funds, and most of the elderly will not be homeowners so they can’t leverage money there. It is hard to see how they can square the circle. Saying Hungary will get its deficit straight by 2010 is poppycock since that is around the time when the problem will begin to get very serious in terms of governemnt spending (between 2010 and 2015 in any event). So the clock is ticking and the sands of time are running out.

  4. Thanks all for commenting. I’m not sure what the EU is going to do with the additional aspiring members that Julie mentions, especially given the unresolved border issues. Look how long it took to sort out the issue of Kaliningrad, now surrounded by the EU, and that was comparatively simple relative to the Transdinestra problems. Ultimately it means that Russia has far more say over the future size of the EU than has so far been acknowledged. Perhaps another thing to add to Polish paranoia.

    Edward, I think you’re right that Hungary is already in de facto crisis. But they are clinging to the exchange rate peg. Something has to give. The demography does look bleak. In fact with the EU increasing assertive about the right of EU residents to receive healthcare in any country, which must be reimbursed by the home country, the healthcare costs now have a component driven by costs in the most expensive country.

  5. Edward, Hungary’s demographics will be a big problem in the long run, but in the short, they’re more good than bad — the dependency ratio is currently falling, not rising.

    I do think that Hungary is potentially in trouble, but a triple crisis in Hungary, Romania and Bulgaria seems very unlikely to me… the three economies are not particularly integrated with each other, and have little in common other than “transition” status.

    Note that if you look closely at their economies, there are some significant differences. For instance, while successive Hungarian governments have been wildly spendthrift, Bulgaria has been running large government _surpluses_ for several years now. On the other hand, Bulgaria’s trade deficit is (relatively) larger than Hungary’s. Meanwhile, while both Hungary and Bulgaria have pegged currencies, the Romanian leu floats free (albeit with regular intervention from the Romanian central bank). So we’re looking at very different sorts of vulnerability to speculative attack.

    One generalization: Hungary has had the worst policy management of the three, both fiscal and monetary. (The Hungarian Central Bank was so incompetent that the forint came under serious attack back in 2003. Nobody seemed to pay much attention at the time, but it resulted in real interest rates briefly surging to around 20% as the HCB moved desperately to defend.) But Hungary also has by far the strongest economy — most industrialized, most productive, most diverse. So, while I could see a short-term crisis in Hungary, in the medium and long terms it should continue to be an attractive destination for investment.

    Bulgaria and Romania are the obverse. Their economies are much weaker and less developed. For instance, 42% of the Romanian population is still on the farm, by far the highest of any EU member. Bulgaria, meanwhile, is running something close to an extraction economy, with exports dominated by raw maaterials and primary products.

    But… both these countries have been showing impressively competent management at the macro level. I’ve already mentioned Bulgaria’s surpluses. Romania has been managing the leu brilliantly. Both countries have established surprisingly high levels of credibility, and both their sovereign bond ratings have been creeping steadily upwards.

    To simplify, you have a strong economy (for a transition country) that’s being managed badly, next to two weakish economies that are being managed relatively well.

    So, while this could go in a variety of ways, I think a “Balkan economic crisis” is unlikely.

    Doug M.

  6. “So, while this could go in a variety of ways, I think a “Balkan economic crisis” is unlikely.”

    I too am doubtful about a ‘triple whammy’, at least in the immediate term, but I am nervous about Hungary. This nervousness is added to since the ratings agencies have been warning that a large quantity of the private debt that has been incurred since 2003 has been denominated in non-forint currencies. If the forint continues to decline with continuing government deficits, or a fiscal tightening recession this could create a more or less classic Dornbusch/Krugman balance sheet negative feedback process.

    You say Hungary is pretty industrialised, is this recent investment or ageing industry, do you know?

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