Macroeconomic outlook and challenges in the V4

INTERNATIONAL economic relations between countries in central Europe underwent radical change between 2004 and 2007 on account of the two waves of European Union enlargement, which created new conditions for economic development and convergence.

INTERNATIONAL economic relations between countries in central Europe underwent radical change between 2004 and 2007 on account of the two waves of European Union enlargement, which created new conditions for economic development and convergence.

EU accession lent new momentum to the economic growth and therefore convergence of all the new member states, including the V4 countries – with the exception of Hungary, where the initially higher rate of growth had slowed substantially by 2007 and living standards, measured in terms of per capita GDP, have merely stagnated since joining the EU in contrast to the dynamic growth recorded in the other new member states. Hungary's per capita GDP figure stagnated between 2004 and 2008 at a time when the other members of the V4 converged by more than 8 percent, on average, towards the living standards of the more developed EU countries. On the whole, the region developed at a pace rarely seen before in its economic history and accelerated the rate of convergence, though it will be practically impossible to repeat this in the near future. The economies in the central European region are supposed to formulate radically different economic strategies under the new domestic and international conditions.

Surprisingly for many, new euro area members – Slovakia and Slovenia – are heading towards an increasingly severe downturn in growth in comparison to what was previously expected. Slovakia's opportunities for growth are very much limited in the current situation by the country's vulnerability linked to its one-sided economic structure. The automobile industry is very sensitive to cyclical trends, and the crisis has hit this sector extremely hard, even in spite of the measures taken by government to stimulate demand in the sector. In the long run it may even be questionable just how much an economic structure based on the car industry will be capable – if at all – of reaching previous levels of growth.

The Czech Republic and Poland have relatively stable fundamentals. In Poland, management of the crisis has not taken the form of bank bailout packages or international loans linked to economic conditions but in a continuation of the structural reforms that had already been launched. However, this only partly explains the endurance of the country vis-a-vis the crisis: what is even more important is that it has a very large domestic economy by central European standards and, relatively speaking, is less open, which means changes in international demand do not affect it as much; additionally, domestic demand together with the domestic market are able to reduce the pace of the economic slowdown. Nonetheless, the fact that the IMF provided Poland with a flexible credit facility in spring 2009 to overcome any unexpected financial difficulties just demonstrates the unpredictable and increasingly severe consequences of the crisis. It is important to note that this credit facility can be used at any time and is not tied to any conditions, i.e. it is only there as a safety net.

The Czech Republic enjoys relatively stable macroeconomic conditions, but external demand is much more important than for Poland which is why the Czech economy is set for much more challenging times over the coming period than Poland’s; however, given its features, the economy it is now likened more to healthier Poland than to other economies in the region.

Hungary does not really "stand out" from the other economies in central Europe in terms of expected growth. Yet because of the country's vulnerability and its level of debt it is more often than not grouped with the Baltic states. For this reason there are no reserves which could provide more budgetary options, as is the case in more stable countries (such as the Czech Republic and Poland), nor are there any tools available to stabilise the situation, such as the euro in Slovakia, while the domestic market is too small on its own to stabilise demand.

What should not be forgotten is that thanks to the stabilisation measures taken, demand had narrowed significantly and the economy had slowed down in Hungary even before the crisis erupted.

The EU member states in central Europe can be classified into several groups based on their economic features and outlooks.

One common thread, however, is that the deepening crisis requires significant adjustment from them all. This means either improving the budget position or the external equilibrium, which everywhere goes hand in hand with a decline in economic output and a rise in unemployment. Stabilising the situation essentially depends on how the international funding situation pans out. If the financing and demand problems persist in the long term, this will have dramatic effects even on countries that are in the most stable positions.

Paradoxically, a protracted crisis will trigger structural reforms and significant adjustments more quickly for countries in a worse position from a long-term economic development perspective.

This is why the conditions for long-term growth may turn out favourably in the countries most affected – presuming they follow a satisfactory economic policy.

Nevertheless, this may have severe social consequences in the Baltic states and in Hungary, for example, which just cannot be shouldered.

From the perspective of growth and convergence based on both internal (investments, consumption) and external (capital flows, trade) factors it is evident that the new member states which have coped better with the crisis so far are those which have produced high but not overheated growth since accession coupled with an appropriate level of external and internal financial stability, a low budget deficit and a healthy public debt indicator.

Hungary is in the fourth worst position (after the Baltic states) having lost its growth momentum three years ago (when the external environment was much more benign).

Slovakia is in a dubious position as regards growth trends because while its equilibrium is stabilised by the euro, the economy is structurally one-sided which represents a major risk for the coming period. There are already signs that the economic downturn in Slovakia could be such that it nullifies the majority of the economic successes achieved in previous years.

The Czech Republic and Poland are in a relatively healthy position, but a significant and lengthy economic downturn cannot be reuled out, particularly for the Czech Republic, given that it is very open to the external economy and dependent on exports. With its larger domestic market, Poland may well be able to "ride out" the next phase of the crisis with a minor downturn.

On the whole, the previous economic development model of countries in eastern Europe may have ceased to exist. Development based on cheap external funding has been replaced by development fuelled by domestic savings, which will thus be better conceived but significantly slower. Economic processes of countries in the region will evolve similarly in the period after the crisis following the significant divergence observed in recent years. Every country will have to adapt to a new economic development model that will focus on gradually redressing the balance and mitigating the social implications of the crisis. External constraints will force countries previously not on a sustainable growth path to implement severe adjustments and corrections, which will primarily involve measures encouraging sustainability.

Tamás Novák is a senior research fellow working with the Institute for World Economics of the Hungarian Academy of Sciences

The piece is part of the Visegrad Countries Special, prepared by The Slovak Spectator with the support of the International Visegrad Fund. For more information on cooperation between the Czech Republic, Hungary, Poland and Slovakia please see the following document.

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