An Unhappy Household

As the global financial crisis shows us, free and open markets are great when everyone (or at least a majority of people) prospers, but they are less popular when people are hurting. Problems in the US housing market and banking system have filtered through our global financial web to cause one of the greatest recessions in modern history. Observers once predicted that our problems at home would only result in a hiccup abroad, a testament to the declining influence of the United States. They were wrong, however, and financial hardships in the US are turning into geopolitical nightmares. The most salient example of this comes from eastern Europe, where just last week the Latvian government collapsed. Eastern Europe has served as the perennial success story for economists arguing that non-liberal and non-democratic countries can join the western, capitalist fold (even with some steep up front costs – see Andy’s earlier post on the J-curve). However, awesome growth was fueled by enormous debt, and today with credit markets tightening up, GDP may actually fall by double digits in the Baltic states.

We’ve been hearing this economic story for the last year or so, but there’s a new trend on the political side – protectionism. This weekend, European leaders met to discuss a bailout plan on the order of $240 billion for eastern European nations. The plan ultimately failed to gain momentum. Angela Merkel, Chancellor of Europe’s economic powerhouse, Germany, rejected the plan as too broad in scope for the diverse needs of eastern Europe. While Ms. Merkel is right, it is hard to believe this is the real reason the Euro countries passed on the deal. Imagine trying to sell a $240 billion loan for Mexico here in the US; it’s political suicide to vote for it. The fact of the matter is leaders of western Europe are turning their attentions inward, as Obama is in the US, and one of the easiest ways for them to raise money is by recalling loans and investments in eastern Europe (western banks have invested nearly $730 billion there). Last week, Nicolas Sarkozy offered a 6 billion euro loan package to carmakers that kept jobs in France instead of outsourcing them to the Czech Republic where labor is cheaper. Eastern European heads of state are crying foul with Czech Prime Minister, Mirek Topolanek, accusing the West of instituting “beggar thy neighbor” policies.

All of this threatens the idea of a united Europe, but also presents some fundamental problems with the EU system.  Merkel stated that individual eastern European nations should be dealt with on a case-by-case basis, but there is no consensus on how they should proceed. The Eurozone lacks a cohesive fiscal policy and multinational institutions are too weak to compel a single nation to make a loan. Some countries are pushing to relax the rules to enter the Eurozone, arguing that this would reduce the likelihood that meltdowns like those in Latvia and Iceland would happen elsewhere. The euro provides a safety net for new members, but if inductees lack fundamental economic stability it could adversely affect the currency markets in older member countries.

With more doors shutting on them, eastern European nations will continue to look to international financial institutions like the IMF.  However, the IMF may not be able to meet all these requests. The only alternative may be for eastern European nations to cooperate among themselves, in a sort of "Eastern European Union." Poland and the Czech Republic are faring much better than Hungary and Ukraine, and as such may be able to help.  This may be a naive assumption, and perhaps collectively these countries posses more liabilities on their balance sheets than assets, but as a political union they could more effectively lobby foreign nations for assistance. In this environment where cash is hard for everyone to come by, political clout may be the next best thing.