The Revival of Eastern Europe

The euro single currency looks to have locked most of Western Europe into low growth from which there is no escape, writes Matthew Lynn

Published: 10th November 2014 06:03 AM  |   Last Updated: 10th November 2014 06:03 AM   |  A+A-


On Sunday, a quarter of a century passed since the Berlin Wall came down. On that momentous night, when Communist domination of Eastern Europe crumbled, there were plenty of predictions. A new world order would enforce peace across the world. Cutting military spending as the Cold War faded would boost growth. Or chaotic, catastrophically poor countries would quickly find themselves ruled by dictatorships once again.

One that wasn’t made was that much of what was then Communist-dominated Eastern Europe would overtake the West.

But that is precisely what is happening now. Many of the capitals of Eastern Europe are now richer than their counterparts in the West. With freer markets, lower levels of state spending and debt, and mostly outside a dysfunctional eurozone, they look set to easily outstrip them. Since the Wall came down, most of the East has been moving in the right direction, and the West in the wrong one, with a dramatic impact on prosperity.

As they regained their freedom through 1989, most of the nations of Eastern Europe were basket cases. Soviet planners had lumbered them with heavy industries, which were laughably uncompetitive. They had about as much chance of prospering as the average promoted football club has of surviving in the Premier League – they simply were not equipped to play at this level. At that stage the idea that they might overtake Western Europe would have seemed preposterous.

And yet, when the Bruegel Institute recently calculated the GDP per capita of Eastern European capitals, and compared them with Vienna, as representative of a typical major Western European city, that is precisely what it found. Even a decade ago, everywhere in Eastern Europe was significantly poorer than the Austrian capital. Now, measured by GDP per capita the Polish capital Warsaw, the Czech capital Prague and the Slovak capital Bratislava are all significantly wealthier than Vienna. Warsaw and Bratislava are richer by more than 10 per cent, while Prague is just slightly ahead. Budapest in Hungary is catching up fast, and may soon move ahead of Vienna as well.

And it is not just Vienna that is being overtaken. Rome, Lisbon and Madrid have all been moving backwards, largely on account of the eurozone crisis, so that they too are significantly poorer than that group of booming Eastern European cities. By contrast, every single Eastern Europe capital has moved closer to Viennese standards of living in the last decade, except for Slovenia’s Ljubljana (the Slovenians, of course, were the first Eastern European country to sign up for the euro, so you might be able to work out for yourself what went wrong there).

Of course, capitals are not completely representative – they tend to be the richest part of every country, just as London is in the UK. Major cities are always the first to get rich in any developing economy, but the rest of those countries are not doing badly either. The Poles, Hungarians and the Czechs are up to about 60 per cent of the Austrian standard of living, and closing the gap every year.

The chances are that this trend will continue. Eastern Europe does not get the same kind of attention as other emerging markets, and its growth has not been as spectacular as that of some newly developing nations of Asia, and now Africa as well. But it has still been expanding at a decent rate. The fastest expanding economies in the EU this year will be Latvia, Lithuania and Poland, all of which will expand by 3.2 per cent or more. In Western Europe, only Britain is likely to grow as rapidly. The Czech economy will grow by 2.4 per cent, and the Hungarian by 2.1 per cent. Those may not be spectacular rates, but they are a lot faster than a Western Europe trapped in a grinding recession. And there is still plenty of room for them to catch up with Western Europe as their economies continue to modernise and they develop new industries. Returning migrants may well provide a fresh boost in the decade ahead.

There are three explanations for that rapid transformation. First, they have created freer, more liberal economies. Perhaps because they know what happens when the state gets too big, they have kept it smaller. As a result, taxes are lower.

Next, they have low debts. The Czech Republic is on 41 per cent and Poland on 55 per cent. The Polish constitution limits the debt to GDP ratio at 60 per cent, putting a cap on the government’s ability to spend and borrow. While much of Western Europe faces years of grinding austerity as it tries to get its debts under control, the Eastern half of the continent does not face those headwinds.

Finally, with the exception of Latvia and Estonia, they are all outside the eurozone. The Eastern European capitals have not only overtaken Vienna but they have also soared past their southern peers. Madrid, Rome and Lisbon are now not only poorer than the likes of Warsaw, and they are getting relatively poorer every year as well. The gap is widening relentlessly. The single currency looks to have locked most of Western Europe into permanent low growth from which there is no escape. Even by expanding at 2 to 3 per cent a year, the East will easily outstrip zero-growth Western Europe.

Few Eastern European states are perfect. In some, the rule of law is struggling to establish itself. Demographics are against them. Many have very low birth rates, and mass emigration – especially to Britain – has meant many of their youngest and brightest people are now working in other countries. And yet, their progress over such a short period of time is a remarkable testament to what free markets and limited government can achieve.

When the Wall came down, young Eastern Europeans were flooding into the West in search of a better standard of living. In the next 25 years, the migration is more likely to be in the other direction – young westerners looking for a better life in the East.

© The Daily Telegraph


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