Europe’s New Economic Divide

Europe still wrestles over how to resolve the debt crisis in Greece. The managing director of the International Monetary Fund warned this month that Greece’s debt remains unsustainable, and she urged the country’s European partners to prepare to provide significant relief. “Few voters anywhere in Europe are excited about bailing out Greece’s government,” writes Chris Miller, associate director of Yale's Grand Strategy Program. He points to an east-west divide in addition to the north-south one. Countries in Western Europe that provide generous social programs with high ratios of debt to GDP, are generally less critical of Greece, fearing that they, too, might need bailouts someday. The former socialist countries in Eastern Europe like Poland, Estonia, Latvia and Slovakia are less wealthy than Greece and less sympathetic. Europe’s politics are becoming divided in more ways than one. – YaleGlobal

Europe’s New Economic Divide

A key axis for Europe: free-market advocates in Western Europe ally with those in former communist countries
Chris Miller
Thursday, August 27, 2015

New East-West divide?: An established welfare state like France, whose President Fran

NEW HAVEN: To observers of European politics, it came as no surprise to see France and Germany taking opposing positions as talks over Greece’s new bailout deal came down to the wire in mid-July. The Franco-German engine has driven European politics for decades with separate visions for economic policy: Berlin demands greater fiscal and monetary discipline, and Paris focuses instead on using government spending to stimulate growth.

That much remains true today – but the constellations of countries supporting the German and French positions have shifted. No longer is Europe’s main divide between austere northerners and profligate southerners. The key axis dividing the continent today is east-west, a curious alliance between free-market advocates in Western Europe and those in former communist countries.

Critics used to refer to Europe’s economically weak southerners as the PIGS: Portugal, Italy, Greece, and Spain. Those countries still wrestle with large budget deficits and weak competitiveness. But their main critics are not so much Europe’s north, but its east. The geography of the euro plays a role: Many northern European countries, such as Denmark, the UK, Norway and Sweden, do not use the euro, and so have been disengaged from debates about how to keep Greece in the single currency zone. The roots of the east-west divide are deeper, stemming from Eastern and Central Europe’s painful transition from communism since 1991, and those countries’ interpretations of the factors driving growth since then. Ask many from Europe’s east, and people concede that the 1990s were an unpleasant period. The collapse of state communism left destruction in its wake. The transition to capitalism was marked by high unemployment, inflation and widespread fear of economic insecurity.

Since then, however, most countries in Eastern Europe have become far better off. Throughout the late 1990s and 2000s, GDP growth rates in countries such as Slovenia, Slovakia, Estonia and Latvia were often several times higher than the EU average. As Western European economies lumbered along, the East sped ahead. The Baltics and Slovakia even managed to post Chinese-style double-digit growth rates during the mid-2000s, improving living standards for their populations. Today, the region’s economies remain far more dynamic than their peers in the West. Poland, to give another example, was a rare country that did not even suffer a recession in 2008.

When thinking about Europe’s debt crises in Greece and elsewhere, most Eastern Europeans emphasize the reforms they undertook in the 1990s. Their argument is straightforward. They took tough economic medicine in the 1990s – including privatizing business, raising retirement ages and cutting back social programs – painful at the time, but which yielded a significant payoff. The Greeks, Easterners argue, need a similar treatment. The only way to achieve economic growth is through tough reform, say Easterners.

Eastern Europeans also point to their own performance after the 2008 crisis as evidence that Greece should accept austerity measures. In response to the recession, Greece spent heavily on countercyclical measures, heaping new debt on to its already ballooning obligations. What Greece should have done, Easterners say, is what Latvia did in the face of similar deficits in 2008. The government in Riga adopted swinging budget cuts that pushed the economy into a more painful recession. Yet Latvia’s recession was as short as it was deep. Soon, the country was back in black, with its economy growing steadily since. Latvia managed to adopt the euro even as Greece was considering casting off the single currency. Easterners urge a program of tough love and reforms for Europe’s stragglers.

Critics argue that this narrative is too simplistic, and they have a point. Eastern European countries did embrace structural reforms during the 1990s that boosted efficiency and productivity, and they have kept budgets balanced since then. But Eastern Europe also benefited from a wave of aid from the European Union, averaging 300 euros per person per year, designed to help unite their economies with the rest of Europe’s and bring living standards to the European average. Similarly, some of Eastern Europe’s economic growth of the 1990s may have had more to do with the establishment of new links with Germany’s manufacturing powerhouse rather than structural reforms.

It is also debatable whether the social makeups of eastern and southern Europe are sufficiently similar to assume that policies that work in one region are transferable to others. Eastern Europe, for example, generally lacks strong labor movements. Many of its most controversial structural reforms, including factory closings and pension cuts, took place immediately after the collapse of communist regimes in the late 1980s. Political leaders could credibly describe painful reforms as necessary steps in overcoming the communist legacy.

In Southern Europe labor unions are comparatively strong, making it difficult to regain competitiveness by reducing wages. Because wages are higher than in Europe’s east, Southern Europe is less able to attract investment by offering low labor costs to manufacturers or outsourcing firms. Meanwhile, the region also suffers from the financial legacy of the previous generation. When Greece, Spain and Portugal were transitioning to democracy from military rule during the 1970s and 1980s, deficit spending was used as a means of “buying” social peace through welfare spending. Part of these countries’ debt burden is the legacy of this democratic transition. Much of Eastern Europe, by contrast, benefited from debt write-offs when communist regimes collapsed.

Perhaps the most telling divide between Eastern and Western Europe is political. Few voters anywhere in Europe are excited about bailing out Greece’s government. In many countries, bailout critics have pointed to what they describe as Greece’s overly generous welfare provisions. Western Europeans’ unhappiness over Greece’s impecuniousness, however, is tempered by fear that their expensive welfare states might someday face a similar fate. That is not only true of Southern Europe. Countries such as France and Belgium have relatively high ratios of debt to GDP. In Belgium, the debt-to-GDP ratio is higher than that of Spain – a fact that led many to predict in the early days of the eurozone crisis that Belgium might find itself in a similar situation as had the debt-ridden countries of Europe’s south. Belgian and French voters, therefore, have been far more sympathetic to Greece’s plight.

There is far less sympathy in Europe’s East. In these countries, criticism that Greece’s government is overly generous is far more potent because average incomes in Eastern Europe are lower than in Greece. According to World Bank data, GDP per capita in Greece in 2014 was around $21,000, compared with $19,000 in Estonia, $18,000 in Slovakia and $16,000 in Latvia. By seeking a bailout from eurozone countries, in other words, Greece is asking poorer neighbors for aid. Needless to say, many in Eastern Europe wonder why Greece merits a bailout when some Greeks are living better than they are.

Christine Lagarde, managing director of the International Monetary Fund, announced in August that she views Greece’s debt as “unsustainable and that Greece cannot restore debt sustainability solely through actions on its own.” She urged commitments from Greece’s European partners to provide “significant debt relief.”

Europe’s new economic divide is unlikely to disappear soon. It is driven in part by differing ideologies, but the key splits are structural. The countries in Europe’s east and west have varying economies and histories. As Europe begins the next phase of addressing its never-ending debt crisis, the east-west divide will play an ever larger role.

Chris Miller is associate director of the Grand Strategy Program at Yale and a fellow at the Foreign Policy Research Institute. He is currently finishing a book manuscript on Russian-Chinese relations.

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