After a sustained period of transition away from communism to free market capitalism, parts of Eastern Europe are entering into reverse and adopting a hybrid system which privileges state-owned companies and private sector firms whose activities support the government’s strategic goals. The trend is most pronounced in Central Europe and parts of the Balkans.

 

The neoliberal economic model was always controversial because of its uneven distribution of gains in wealth. However, the current change began in the wake of the financial crisis of 2009-10 when foreign investment and exports dried up, economies stropped growing, currencies collapsed and standards of living plummeted, especially for the new middle class. In many cases, the pain of the financial crisis was exacerbated by the policies of austerity, which governments pursued in order to contain public debt. Crucially, the only groups left unscathed appeared to be large-scale foreign investors and the local economic elites with whom these investors dealt.

 

This provoked a widespread questioning of the benefits of free market economics, and the risks to society when large parts of the economy were owned by private, often foreign-owned, companies which worked to their own objectives. Hungary was the first to react, electing a government at the start of this decade on a mandate of curbing the free market in strategic sectors where the government’s inability to control the provision of goods and services had adversely affected ordinary consumers’ standard of living. Since then, the government’s primary target has been the banking sector, which it has blamed for usurious practices, and subsequently punished with crisis taxes and enforced conversion of FX-denominated loans at banks’ expense. Other sectors, which the government has sought to bring under political control, include energy, utilities, pensions, media, insurance, food production and food retail.

 

Subsequently, as Hungary has recorded strong growth and continued to attract foreign investment, its new, hybrid model has been replicated in some measure by Slovakia, Romania, Croatia, Albania and, most recently, Poland. Here, the Law and Justice party has explicitly stated its goal of extending state ownership of the economy as a means of promoting the re-industrialisation of the country, and squeezing various large-scale private operators out of the market.

 

The means of restoring national ownership of the economy vary. At its most benign, a government simply launches a takeover bid on the open market, as Hungary is now doing with the local subsidiary of Erste bank. Meanwhile, at its most malign, firms have been forcibly expropriated without due compensation, as happened in the case of two private health insurers, the Albanian subsidiary of the Czech energy company ČEZ and Hungary’s private pension funds.

 

More commonly, governments have used their power to impose taxes, price controls, regulations or to withdraw operating licences in order to squeeze the profitability of a foreign-owned company and force it to quit the market. At this point, the company is bought either by the state or by a local company, often a party loyalist which the government can control via the local patronage system. This has the virtue of nurturing a local business elite, which the government hopes will be both loyal and sufficiently entrepreneurial to fill the void vacated by foreign investors. While foreign investors are often the target, local firms are not immune. The key factor is whether the firm is willing to abide by the government’s core political goals – usually security, social stability and economic self-sufficiency – or whether it is seen to be excessively self-interested.

 

The flipside of this policy is that governments have made efforts to preserve and privilege national and locally owned companies which do conform to their goals. Politicians across the region have resisted pressure for privatisation of strategic assets - particularly in Ukraine and the former Yugoslavia, where people retain a strong commitment to social ownership - and adopted protectionist measures that restrict foreign competition and limit the liberalisation of the wider business environment.

 

Most of the time, foreign investors have little means of seeking redress against a sovereign actor. Some have taken governments to arbitration. However, politicians have become adept at finding ways to restrict the rights of foreign companies while abiding by the letter (if not the spirit) of their international obligations. As a result, bodies such as the European Commission struggle to sanction ‘economically patriotic’ governments. On the occasions when the Commission does take an EU member state to court, governments have usually found ways to tweak legislation to comply with EU law.

 

Crucially, the picture is not uniform across the region. Some countries, such as Estonia, have not made any serious attempt to bring their economies back under national control. In others, such as Belarus, national control is already near total. Meanwhile, states such as Romania, Serbia, Slovenia and Ukraine, are actively pursuing IMF and EU-agreed programmes of privatisation and liberalisation. However, even in these countries, reforms are not all moving in the same direction: while one part of the economy is increasingly exposed to the free market and foreign ownership, the state also pursues policies that restrict the workings of the market in another

 

Forecast

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The shift towards a more nationalist economic model has been accelerated by the election of the Law and Justice Party in Poland, which is downgrading the role of foreign investors in sectors such as banking, farming, telecoms, chemicals, insurance, retail, media and publishing, while promoting sectors on which national security depends, such as energy (especially coal) and armaments. As Eastern Europe’s largest and most important economy, others may follow where Poland leads, especially if the economy continues to grow rapidly. The Czech Republic, Slovenia, Lithuania and Bulgaria are particularly vulnerable.

 

However, economic nationalism will take hold within predictable limits: there is almost no chance of any country abandoning free market capitalism as its basic model, which almost everyone recognises has produced immense productivity gains over the last 25 years. With governments focused on strategic sectors, most private companies – especially favoured foreign investors such as car manufacturers - will be left to operate freely, providing they do not defy the government’s overall political goals, and may even enjoy lower taxes and fewer regulations. In December, Hungary announced a cut in corporate tax to just 9%, the lowest rate in Europe.

 

However, the value of economic freedom will increasingly be weighed against the cost to security or social stability, especially in the context of a hazardous external environment marked by crisis in the euro zone, two-way sanctions between the EU and Russia, and so on), which increases the level of economic vulnerability faced by Eastern Europe. This will support the movement towards greater political control over strategic sectors and the shift in ownership to the state or trusted local operators.

 

 

Immediate Impacts

 

• Investors in strategic sectors are exposed to one-off measures such as windfall levies and emergency taxes that reduce their profitability in the short term.

 

• Investors in strategic sectors are at risk of declining returns over the medium term due to regulations and controls that limit their ability to generate profit.

 

• Foreign investors may be prevented from entering some areas of the economy, which are informally reserved for local firms or state-owned enterprises.

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Potential Impacts

 

• Investors may be subject to new regulatory or fiscal conditions that make it impossible to generate a profit, forcing them to quit the market.

 

• The increasing role of the state could undermine the efficiency and prosperity of an economy.

 

• The mounting crisis in the EU will make it harder to enforce the rules against governments which violate EU law in the commercial sphere.

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