Eastern Europe Benefits from EU Aid

The European Union has taken flak recently for its response to the financial crisis in Central and Eastern Europe.

In March the now-resigned Hungarian prime minister, Ferenc Gyurcsany, warned of a new iron curtain dividing the continent and said Brussels should commit 180 billion euros to bail out states such as Hungary, Latvia, and others that barely skirted economic collapse when the crisis hopped the Atlantic, and remain in critical condition after years of growth. The European Council on Foreign Relations criticized some old EU members for protectionist rhetoric and parsimony toward their neighbors in an open letter ahead of the G20 summit. And a major U.S. newspaper recently published a story arguing that Western Europe's beggar-thy-neighbor posture threatened the single European market.

But how fair are these charges? How much more could the EU do for its newer members and aspirants farther east?

Certainly, Brussels should fire its PR team. How should the Czech Republic, home to a joint Toyota and Peugeot Citroen car plant, have taken French President Nicolas Sarkozy's remark earlier this year that French factories abroad should repatriate? This smacks of division, not solidarity.

Yet, however alarming from a powerful voice within the union, such bluster is just that. The EU's response to the troubles in Central and Eastern Europe, many of which were self-inflicted, has been appropriate, tactical, and flexible—perhaps especially impressive considering that a 31 March report by the European Commission found GDP in the euro zone down 1.5 percent in the fourth quarter of 2008, the worst performance in decades.

Brussels' handling of the crisis "has actually been pretty sound," says Tomas Valasek of the Center for European Reform in London. "The reality is that EU member states are doing quite a lot to help out Eastern Europe, whether it's within the EU or outside the EU."

Their image problem, it seems, is one of perception becoming reality. The EU has contributed, both directly and through the International Monetary Fund, to each of the recent multibillion-euro bailout packages that have saved Ukraine, Hungary, Latvia, and most recently Romania from the kind of default that crippled Russia's economy in the late 1990s. But these have been billed as IMF packages. Brussels’ participation and behind-the-scenes influence at the fund have gone largely unnoticed, as has the EU’s recent doubling of its emergency aid purse for its eastern members—from which Hungary and Latvia have already received 10 billion euros—to 50 billion euros.


Here's what has gotten notice: leaders' decision in March not to spend 180 billion euros shoring up Eastern Europe's banks (the move Gyurcsany advocated.) In this critics see stinginess and a growing East/West divide. Others, however, see prudence.

"There is this perception out there that the markets look bad, the currencies are depreciating, so Brussels should just pump a bunch of money" into the region, says Jon Levy of the Eurasia Group global consultancy firm in New York. "But there is a huge downside to that. I mean, you can't just run a current account deficit of 25 percent ad infinitum."

Indeed, the economies of the EU’s newer members are diverse, but the root of the problem in those that have received emergency aid is pretty simple: they have been living beyond their means on credit. Latvia, for instance, borrowed heavily to support consumption and real estate booms, enjoying rapid growth in the process. This was sustainable as long as the global financial system was footing the bill. But once the bottom fell out—once credit, capital, and investors became scarce as the financial crisis metastasized—these economies began to tumble as panic spread through stock and currency markets.

So, speaking to Levy's point, is the panacea for nations that gorged themselves nearly to death on credit in the past 20 years really more credit? No, they need to return to Earth. And this is where the EU's response has been both tactical and flexible.

Together with the IMF and other institutions, the EU helped prevent a catastrophic wave of regional default through targeted bailouts while avoiding a single, blanket policy. This case-by-case approach is wise because the union’s eastern members are not homogenous: the Czech Republic, Slovakia, and Poland, for instance, are relatively healthy compared with their neighbors.

At the same time, the aid packages mandate strict fiscal tightening—conditions differ for each recipient but hinge on reducing budget and current account deficits—so these economies emerge from the crisis on a more solid footing.

The European Commission has for years begged Latvia, for example, to tighten its belt to prevent overheating, but now the commission has real leverage: "You want aid money? Then shape up."

The EU's approach will be painful, surely, as aid recipients will struggle to stimulate their foundering economies while meeting the austerity requirements of the bailout packages. (And there won't be much flexibility on those requirements: the IMF recently suspended disbursement of its loan to Ukraine because the basket-case government in Kyiv won't commit to the necessary reforms.) And the EU's approach may be downright excruciating should Western European banks, which boast a huge presence in Central and Eastern Europe and have so far stood behind their eastern subsidiaries, get thrifty.

But after a wild party, there's always a hangover.

Before it's here, it's on the Bloomberg Terminal.