Trumped in Visegrad

Trumped in Visegrad
Populism threatens Visegrad from the inside and out.
By Tim Gosling in Prague September 1, 2016

The rise in political populism across the Western world is a threat to economic growth, even without a lack of direct political power, worry analysts. What does that say for a Central European region dominated by governments playing to the gallery?

The inequalities exposed by globalisation and technology, and the fallout from the global economic meltdown in 2007-08 and the series of geopolitical crises that followed, have opened the way for an ’anti-elitist’ mood to take a grip in Europe and the US. That has produced surges for nationalist parties offering easy answers across the EU, Brexit, and Donald Trump’s unlikely rise to contest the US presidential election.

Although no populist government controls a major Western EU state currently, the increasing popularity of the likes of the Front National in France and UKIP in the UK is resulting in policy that threatens global economic growth. Nationalism, protectionism, loosened fiscal discipline and a lack of reform momentum are only likely to exasperate the major challenges to the global economy, in particular growing demographic challenges in the Western world.

Such pressures are particularly acute in the Visegrad countries of the Czech Republic, Hungary, Poland and Slovakia. At the same time, all four are controlled – partially in Czechia’s case – by openly populist political forces. That suggests the longer-term economic prospects in the region are under threat, and recent data hints at the vulnerabilities.

While current policy across Visegrad should actually be helping boost economic activity in the short term, largely through an end to austerity and increased government spending, analysts insist that rising protectionist policies and immigration clampdowns are a risk for the medium and longer term. At the same time, populist governments are highly unlikely to implement reform.

“The impact of today’s populist surge is already being seen,” writes Gabriel Stein at Oxford Economics in a recent report. “Protectionism is rising, with both the TTP and the TTIP [trade deals] likely to fail. Immigration is likely to face further barriers; and there are calls for a return to industrial policy with support for national champions. All of these are unambiguously bad for medium- and long-term output growth and hence for asset prices.”

“The upswing in support for populist parties mainly heralds bad news for the world economy,” he adds.

As a consequence, analysts at Swedbank argue, it is likely the world economy will stay in a low-growth environment for the next few years. “Global growth will continue to be weak, at about 3% per year,” they forecast.

Purse strings

It’s tricky to offer an accurate forecast for longer-term growth across Visegrad given the uncertainty of future government policy and the spillover effects of populism overseas. However, economic activity has largely disappointed in 2016, even if it remains reasonably solid.

Poland, for instance, looks to be lagging the Law & Justice (PiS) government’s target for GDP growth of 3.4% for this year. A sharp drop in investment suggests PiS’ populist policies, and the consequent conflict with Brussels, has knocked confidence.

“Poor investment activity is not only due to some delays in absorption of new EU funds, but results also from cuts in public outlays and lower investment appetite among private enterprises,” point out analysts at Raiffeisen Polbank. Monetary policymakers insist that it is not interest rates but uncertainty that is holding back investment. “The key for stronger growth remains not on the side of monetary policy, but on the side of economic policy,” the analysts add.

Hungary is witnessing similar dynamics in growth and investment, the latter of which dropped over 20% on an annual basis in the second quarter, according to data released on August 31. Both Budapest and Warsaw plan to expand their budget deficits next year in a bid to offer some economic stimulus and increased populist spending, an effort that Slovakia is likely to match.

“European populism has in recent years concentrated on three topics: immigration, the EU and fiscal austerity. On each of these, they are making headway,” notes Stein. “Fiscal austerity is rapidly dropping out of fashion, with even the German government agreeing that Spain and Portugal should not be penalised for failing to meet their deficit targets.”

Moody’s Investors Service warned about loosening fiscal discipline earlier this year. “Recent elections in the CEE-8 countries have led to the emergence of anti-austerity and euro-sceptic political movements, most recently in Poland and Slovakia,” the rating agency said in a report. “These parties increase domestic political risk and have the potential to reverse fiscal improvements, implement unorthodox economic policies and weaken cooperation and integration within the EU.”

In the short term, increased state spending looks a no-brainer, especially considering the sharp drop in EU funding in 2016 as inefficient absorption of funds in the Visegrad countries meets Brussels’ new funding window. Loosening the purse strings to fill the void, and offering further momentum to consumption – currently the major pillar propping up economic growth in the region – is clearly a vote winner in the wake of the much-maligned austerity.

However, longer term the benefits are not so clear. The populist parties in power in Central Europe will meet continued pressure to spend. In Hungary, Fidesz clearly has its eye on 2018 elections in raising its deficit target for next year by 0.4pp. That will not help reduce state debt, which Budapest has been struggling to do for some years.

Having only escaped in late 2015, Poland risks falling back under the EU’s excessive deficit procedure (EDP) should its deficit rise above 3% next year, as is forecast. That will not help either economy improve their standings with the rating agencies, nor buoy investment – even that from the state.

“High public debt and a trend away from faith in the efficacy of public sector investment will dampen the rise in public investment,” claims Stein.

Fitch Ratings warned on August 31 that should Warsaw’s policies see a return of the EDP, it would be negative for Poland’s credit rating, which is already under pressure from the other rating agencies, and “could potentially result in financial sanctions via reduced disbursements of EU funds”.

Hungary has been chasing a return to investment grade since it slipped into junk in 2012, but “there is no chance of any positive rating action within the next 12-18 months, given the 180-degree shift in fiscal policy direction from tightening to loosening,” predicts Martin Stelzeneder at Raiffeisen Bank International.

Bigger danger

By way of contrast to the rest of the region, the Czechs – seemingly more cynical than their regional peers over political ambition in all its guises – have refused to surrender full control to any populist tendencies since the financial crisis hit. Elected into a coalition on an anti-corruption platform, that leaves Finance Minister and Ano party head Andrej Babis working to tighten fiscal discipline, with only a VAT cut on beer proffered to tempt voters.

The real populist in Prague is President Milos Zeman, who holds little real power but enjoys making anti-immigration and EU rants and meddling from the sidelines in the country’s highly-provincial political manoeuvrings. Yet the rise of such nationalism looks to be the bigger danger to the Visegrad economies in the long run.

The Visegrad countries are already more vulnerable than those to the west to the ill effects of populist policy due to the tight grip on power enjoyed by the likes of Viktor Orban in Hungary and PiS in Poland. Brexit is already set to drop the flow of EU funds on which they lean so heavily, albeit other spillover effects are forecast to be limited. The high dependence of the region’s small open economies on external demand adds an extra layer of risk, and rising protectionism around the globe, and within the EU, is likely to hit them hard.

“From a global perspective, the current strength of populism means that we are likely to see at the very best a slowdown of globalisation; at worst, some rolling back, with the post-war trend of ever lower trade barriers being reversed,” suggests Stein. “This is unambiguously bad for world economic activity; and will most likely be worst for emerging economies, which are frequently the target of protectionist calls.”

That’s the sort of warning that has alarmed Visegrad leaders in recent years, although, as is typical, only in a regional context in which their direct interests are under threat. Suggestions that the passport-free Schengen zone could be partially closed, putting the flow of exports at potential risk, provoked outrage in the region around the turn of the year.

Rainbow nation, rainbow coalition

The threat to free movement around the EU came as Brussels sought to pressure the Visegrad states over their harsh populist stances on immigration, in a bid to get them to take in more migrants arriving during the crisis. However, Orban and Robert Fico in Slovakia have spent the last year or more doing their best to whip up fears of immigration. In Hungary the gambit has worked, pumping up support for Fidesz. The party plans in October a referendum on the EU’s plan to redistribute refugees – which is already essentially dead – in a further bid to consolidate its standing.

Fico, however, has abandoned the outrageous rhetoric since elections in March saw support for his nominally centre-left Smer party slump, voters flocking instead to nationalist and even far-right options. That left the shell-shocked prime minister to cobble together a rainbow coalition whose potential instability does little for the country’s economic prospects.

The very few migrants that might have fancied putting up in Visegrad previously are unlikely to be keen any longer given the mood broadcast, save for those from Ukraine who have been largely welcomed. Yet the region desperately needs young blood.

A new report from the National Bureau of Economic Research in the US even claims cultural and racial diversity spurs economic development, while homogeneity slows it down. In other words, more migrants than those fellow Slavs from Ukraine are needed.

The free movement of labour across the EU has only exacerbated the demographic disaster unfolding in Central Europe. With the highly educated leaving for higher wages to the west, the rapid ageing of society has accelerated. The pension time bomb that is ticking in Europe is closer to going off in Visegrad due to lower savings rates, while pension reform – another common target of populist governments – has been reversed since the start of the decade as political leaders plundered cash stocks in private funds.

“EU countries face ageing population challenges that will have negative implications for growth and put pressure on the sustainability of social security systems,” Moody’s notes. “This is particularly acute for many of the CEE countries.”

Again, the exception is the country that has best resisted populism. “The Czech Republic has a more favourable demographic outlook compared to its peers, supported by a higher expected female participation rate and positive net migration,” the rating agency declares.

Yet even the Czechs are already facing a labour crunch. After just a year or so of genuine recovery from the financial crisis, the labour markets across CEE are tightening at an alarming rate. Rising wages and employment are encouraging consumption to offer a short-term tonic to economies, but are also threatening investment and economic growth down the road.

“Although immigration is a highly emotional subject, it is clear that it is economically beneficial, even where it involves dislocation,” Stein sums up. “This is particularly the case in Europe, an ageing continent, where most countries remain saddled with pay-as-you-go pension policies that assume an ever-rising labour force. Higher barriers to immigration would therefore also be negative for medium- and long-term economic activity.”

Tough nut

Despite the growing dangers of the demographic crunch and labour shortage, governments in Visegrad appear to have few answers, or even much inclination to try to find them. That’s more than likely largely the result of the general inefficiency of governance that has long persisted in the region, but the short-term easy solutions demanded by populism will clearly only make deep and systemic reform even more unlikely.

Indeed, in Poland the ruling PiS appears set to worsen the situation with a plan to scrap a hard-won reform pushed through by the previous government of Donald Tusk (who is now the president of the European Council) to raise the retirement age. The new administration is desperately seeking the funds to allow it to implement the flagship policy promised in its campaign ahead of the elections last year to reverse the hugely unpopular rise of the retirement age to 67.

In the Czech Republic, the ruling coalition officially marked the end of the summer months on August 31 as it agreed to cap the pension age at 65 from 2030. The move will replace the current formula that works to indefinitely raise the retirement age each year. Illustrating the complicated picture in Prague, the move was criticized by Babis, who claims it will cost CZK67bn (€2.5bn) per year.

A glance eastwards illustrates that it’s only when the situation gets really desperate that even mainstream politics finally reacts. Beset by crisis over the best part of a decade, few countries in CEE have made serious efforts to tackle their demographic problems, yet Estonia appears to have come to the point at which it has had little choice.

After years watching its tiny population dwindling rapidly, Tallinn has now rolled out a package that it claims is at least slowing the rot. The retirement age has been raised and changes to the benefits system are designed to push more people into the workforce, while immigrant and repatriation numbers have risen, thanks in no small part for Estonia’s reputation as a shiny technological pioneer in a continent still struggling to rediscover its economic mojo.

However, even in such an apparently progressive part of Central Europe there are issues that remain too challenging for the rainbow coalition led by the mainstream centre-right Reform Party to tackle. The real issue for investment, and therefore the ability of the wider economy to continue to attract the workers needed for growth in CEE, is the need to boost productivity.

That’s a hard enough nut to crack at the best of times, let alone as populism drives the agenda across the Western world. “While more structural reforms and fiscal policy are needed to strengthen long-term potential growth, the political system is weak. In particular, [populist movements] contribute to the inability of governments to conduct reforms aimed at increasing productivity growth,” warns Swedbank.

SEB shares such concerns. “On the whole,” the Swedish bank’s analysts wrote recently, “the Baltics have healthy economic fundamentals but are vulnerable to accelerating pay increases, which risk lowering their competitiveness. Continued restructuring policy measures will be needed to improve the strength of Estonia, Latvia and Lithuania in relation to other countries and to make the region less economically dependent on Russia, for example.”

The latter point suggests that there’s almost always a populist silver lining that governments can try tacking on to tricky reform if they search hard enough and can sell it well.