In last week’s post on the exposure of TOL’s coverage area to the eurozone sovereign debt crisis, I promised to review the European Bank for Reconstruction and Development’s (EBRD) new Transition Report 2011. Drawing on extensive economic and survey data, “Crisis and Transition: The People’s Perspective” analyzes the economic and political ramifications of the 2008-2010 financial crisis from the standpoint of households and individuals in post-Communist Europe, Central Asia and Turkey. Critically, it also assesses the vulnerability of these “transition” countries to the current eurozone turmoil.
Some interesting findings, both expected and surprising:
- The 2008-2010 crisis hit households in transition countries harder than in Western Europe. More jobs were lost, wages fell further, and social welfare systems were weaker. As a result, 38 percent of households in TOL’s coverage area (sans Turkey) cut expenditures on essentials like staple foods and health care, according to the EBRD, compared with 11 percent in Western Europe.
- Public opinion on democracy and free markets shifted with the crisis. In the 10 European Union member states in TOL’s area, support for both dropped 10 percent from 2006. The opposite trend, however, is evident in Eastern Europe and Central Asia. Two factors could explain the difference, the bank says. One, the crisis, which is associated with liberal economics, hit households in Central Europe harder than their eastern neighbors. A relative crisis response is also possible, the bank says: i.e., for Eastern Europeans and Central Asians, the 2008-2010 economic upheaval was minor relative to the fallout from the Soviet Union’s collapse. Two, nations simply blamed their governing systems, turning “against what they had:” the EU members are free market democracies, so support for this system fell; eastern regimes are more authoritarian, so people took another look at Rousseau and Adam Smith.
- Many TOL countries are highly vulnerable to the sovereign debt crisis. Hungary, Slovakia and Bulgaria are most exposed to the eurozone tumult because Western Europe is a key export market and source of foreign direct investment (FDI) for these countries. The so-called PIIGS – Portugal, Italy, Ireland, Greece and Spain – are the Balkan nations’ Achilles heel. Banks from Italy and Greece, especially, are entrenched in the Balkans, as are West European banks in Central Europe generally. On the bright side, economies farther east are less integrated with the eurozone and thus less vulnerable.
Looking ahead, the EBRD is alarmed by the “dominant position” of eurozone banks in the transition region. Though the EBRD assumes the crisis will be contained, the bank emphasizes that it could spread to larger eurozone economies. In this scenario, several large European banks go insolvent, the eurozone suffers recession, and the transition region is hit by a double whammy: reduced trade and FDI and a banking crisis as West European banks cut the umbilical to eastern subsidiaries.
All of Europe will suffer if cross-border banking is undermined, EBRD Chief Economist Erik Berglof explained in Project Syndicate 14 November:
…unlike the ill-advised exposure to sovereign debt across Europe, cross-border banking through foreign subsidiaries has been beneficial for investors, and for home and host countries – nowhere more so than in emerging Central and Eastern Europe … Allowing foreign banks’ subsidiaries to become orphaned amid a worsening crisis in home countries would undermine confidence in emerging Europe’s financial systems … Ultimately, this would boomerang back on Western Banks, given their deep financial and real linkages with the region.
Which way will things turn? Bottom line: it doesn’t look good. European banks need new capital, but ” …the capacity of Western European governments to backstop banking systems is clearly reaching its limits,” according to Berglof. Moreover, Italy, the eurozone’s third largest economy, is teetering. Interest rates on Italian government bonds topped 7 percent last week, the threshold at which smaller euro economies like Greece needed bailouts. But Italy is too big to bail out.
“With Italy too big to fail, too big to save, and now at the point of no return, the endgame for the eurozone has begun,” New York University’s Nouriel Roubini wrote in Project Syndicate 11 November. Should Italy and other PIIGS default, Roubini added, the subsequent “disorderly eurozone breakup would be as severe a shock as the collapse of Lehman Brothers in 2008, if not worse.”
Nobel laureate Paul Krugman is also pessimistic.
“Not long ago, European leaders were insisting that Greece could and should stay on the euro while paying its debt in full,” he wrote in The New York Times 10 November. “Now, with Italy falling off a cliff, it’s hard to see how the euro can survive at all.”
Analysts have slammed the EU’s “muddle through” approach to the sovereign debt crisis. Given how integrated Europe is both within its own borders and the global economy, I’ve long expected European leaders to overcome national differences and populism to unite behind a bold effort – which, it’s now clear, must include bank recapitalization – to protect a currency union that has increased living standards for millions by encouraging trade, foreign investment and cross-border banking – and, in so doing, prevent what Krugman calls “Eurogeddon.”
But, as any European historian will tell you, economic integration didn’t prevent World War I.
“…the war shattered an integrated global economy,” Yale’s Timothy Snyder wrote in 2010 in Bloodlands. “No adult European alive in 1914 would ever see the restoration of comparable free trade; most European adults alive in 1914 would not enjoy comparable levels of prosperity during the rest of their lives.”
The stakes are also high today.
“If the crisis spins out of control, the financial integration model across advanced and emerging Europe and beyond may be in jeopardy,” the EBRD’s Berglof wrote in the Transition Report. “The model was defended against the odds in the last crisis, but will it survive intact this time?”
Photo from Wikimedia Commons