Eastern Europe-Not A Homogenous Region
Often you hear the economies of Eastern Europe being referred to as more or less a homogenous region. In reality though nothing could be further from the truth. In few other regions do the economies differ so much among each other as Eastern Europe. Indeed, there are so many different types that describing them all would require too much time and energy from my part. There is really only one thing which they have in common, and that is their ominous demographics, due to a collapse in birth rates in the early 1990s. So I will limit myself to Russia, the Baltic States and the largest of the new EU member states.
Russia differs from the others in two important respects. First of all, it is much bigger than the other countries, both in terms of the size of the population, the economy and the geographic size. Secondly, and perhaps most important in this aspect it is a large net exporter of oil and other commodities. Related to this fact is the fact that Russia in contrast to the others has a large current account surplus. The windfall gains from the commodity price boom have been so large that the Russian government has been unable to find ways to spend them.
Russia's dependence on commodity exports is in the short to medium term actually a good thing for them, as I expect the commodity price boom to continue this year and probably a few more years. But of course, it won't last forever. And at that point, the weaknesses in the rest of the economy could start to appear.
The Baltic States have similarly to America a good microeconomic structure with low tax rates and limited government spending, but terrible macroeconomics. The Baltic States and particularly Latvia have extremely large current account deficits combined with high (double digits) inflation. Particularly Estonia has seen a dramatic slowdown in growth. This has been associated with a small downturn in the external deficit. However, that deficit remains large, and price inflation have actually accelerated. In order to clean out the excesses, a painful recession seems necessary and inevitable. However, in the long run that is a lesser evil compared to trying to postpone the ultimately inevitable.
But the situation is arguably even worse in Hungary. Hungary have, in sharp contrast to the Baltics not enjoyed any previous boom. Hungary has for years had much lower growth then in the other Eastern European countries, and now even has lower growth than in most Western European countries as well. Hungary is really the worst of two worlds. Not only does it have serious macroeconomic imbalances with very high inflation and very high budget and current account deficit, but it also has highly inhibiting levels of taxation and regulations. A combination of the worst parts of the American and French economies, in short.
And there seems to be little political will to deal with the problems in Hungary. A referendum recently rejected with a 80% majority the proposal to reduce government spending and the budget deficit by imposing low user fees in health care and higher education. It is therefore difficult to be anything but bearish about Hungary.
Poland and the Czech Republics seem much sounder both in macroeconomics and microeconomics. While both have current account deficit they seem to be moderate and mostly reflect capital inflows to sound investments. Monetary and price inflation is much lower than in either the Baltic states or Hungary. Meanwhile, the burden of spending is gradually falling, and in Poland there are plans to introduce a flat tax.
The shining star of Eastern Europe is however Slovakia. Slovakia had a growth rate of 14.3% in the fourth quarter of 2007. Even if this perhaps to some extent reflects some statistical distortion, it seems clear that real growth is well above 10%. Meanwhile, despite this rapid growth and despite the fact that Slovakia has pegged its currency to the euro, money supply growth is only slightly higher than in the euro area. Indeed, at 11.2% for M2 money supply growth doesn't appear to be higher than the real growth rate. While that is not low in absolute terms, it is remarkably low considering the extremely rapid real growth rate and the euro peg. How it is possible with such a relatively low monetary growth rate under these circumstances is not clear, and something I'll have to do more research about, but it clearly means that Slovakia's boom is on a sound basis, unlike the previous Baltic boom. It is also something which will likely enable Slovakia to join the euro area already next year, and become the 16th state to join the euro. Ultimately the basis for that boom is the low flat tax system and the fact that these cuts were accompanied by sharp spending cuts, particularly in welfare payments.
Russia differs from the others in two important respects. First of all, it is much bigger than the other countries, both in terms of the size of the population, the economy and the geographic size. Secondly, and perhaps most important in this aspect it is a large net exporter of oil and other commodities. Related to this fact is the fact that Russia in contrast to the others has a large current account surplus. The windfall gains from the commodity price boom have been so large that the Russian government has been unable to find ways to spend them.
Russia's dependence on commodity exports is in the short to medium term actually a good thing for them, as I expect the commodity price boom to continue this year and probably a few more years. But of course, it won't last forever. And at that point, the weaknesses in the rest of the economy could start to appear.
The Baltic States have similarly to America a good microeconomic structure with low tax rates and limited government spending, but terrible macroeconomics. The Baltic States and particularly Latvia have extremely large current account deficits combined with high (double digits) inflation. Particularly Estonia has seen a dramatic slowdown in growth. This has been associated with a small downturn in the external deficit. However, that deficit remains large, and price inflation have actually accelerated. In order to clean out the excesses, a painful recession seems necessary and inevitable. However, in the long run that is a lesser evil compared to trying to postpone the ultimately inevitable.
But the situation is arguably even worse in Hungary. Hungary have, in sharp contrast to the Baltics not enjoyed any previous boom. Hungary has for years had much lower growth then in the other Eastern European countries, and now even has lower growth than in most Western European countries as well. Hungary is really the worst of two worlds. Not only does it have serious macroeconomic imbalances with very high inflation and very high budget and current account deficit, but it also has highly inhibiting levels of taxation and regulations. A combination of the worst parts of the American and French economies, in short.
And there seems to be little political will to deal with the problems in Hungary. A referendum recently rejected with a 80% majority the proposal to reduce government spending and the budget deficit by imposing low user fees in health care and higher education. It is therefore difficult to be anything but bearish about Hungary.
Poland and the Czech Republics seem much sounder both in macroeconomics and microeconomics. While both have current account deficit they seem to be moderate and mostly reflect capital inflows to sound investments. Monetary and price inflation is much lower than in either the Baltic states or Hungary. Meanwhile, the burden of spending is gradually falling, and in Poland there are plans to introduce a flat tax.
The shining star of Eastern Europe is however Slovakia. Slovakia had a growth rate of 14.3% in the fourth quarter of 2007. Even if this perhaps to some extent reflects some statistical distortion, it seems clear that real growth is well above 10%. Meanwhile, despite this rapid growth and despite the fact that Slovakia has pegged its currency to the euro, money supply growth is only slightly higher than in the euro area. Indeed, at 11.2% for M2 money supply growth doesn't appear to be higher than the real growth rate. While that is not low in absolute terms, it is remarkably low considering the extremely rapid real growth rate and the euro peg. How it is possible with such a relatively low monetary growth rate under these circumstances is not clear, and something I'll have to do more research about, but it clearly means that Slovakia's boom is on a sound basis, unlike the previous Baltic boom. It is also something which will likely enable Slovakia to join the euro area already next year, and become the 16th state to join the euro. Ultimately the basis for that boom is the low flat tax system and the fact that these cuts were accompanied by sharp spending cuts, particularly in welfare payments.
posted by stefankarlsson at 7:48 PM
1 Comments:
Does this mean that Slovakia might in fact witness (neoclassical) deflation, since monetary creation seems astoundingly below the real growth rates? This would be quite funny, since a small deflation is what any country should witness under a 100% gold standard, and this again is what politicians and mainstream economists are so afraid about :P...
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