Chiara Amini – Teaching Fellow in Economics and Business and Raphael Espinoza – Lecturer in Economics
UCL SSEES Centre for Comparative Studies of Emerging Economies

It is a common view that a UK exit from the European Union would cause significant damage to the UK and to the EU.  The Treasury claims that Brexit would make Britain significantly poorer and could result in GDP contracting by as much as 6%. Such a significant impact would not be so surprising, given that trade and investment between the UK and Europe has grown significantly in the last 40 years. In 2014 a study by Ottaviano et al showed that Brexit trade losses would amount to 3.6% of UK GDP, as a result of an increase in taxes, quotas and regulatory legislation. What’s really striking is the fact that these losses have the potential of reaching 10% of GDP, if we consider the dynamic effect of trade on innovation and competition. Earlier this year, JPMorgan estimated that Brexit could reduce GDP growth by as much as 1% between 2016-17. At the same time the bank also warned that Brexit could decrease Eurozone GDP by 0.2-0.3%.

Policymakers in the EU countries of Central and Eastern Europe have been vocal in expressing their concerns about Brexit. The countries this specifically refers to are: The Czech Republic, Estonia, Hungary, Lithuania, Latvia, Poland, Slovakia and Slovenia.  Recently Poland’s President, Andrzej Duda, warned that Brexit could have dramatic consequences for the Polish economy. However, formal analyses estimating the impact of Brexit on the region number on the fingers of one hand. Erste Bank argues that direct economic consequences on the region would be relatively minor as UK trade amounts to only 3-6% of total trade. However, countries such as Poland, Czech Republic, Hungary, Latvia, Lithuania and Slovakia, that run trade surpluses with the UK, are predicted to be most affected. After looking at the macro data, we can argue that Central and Eastern Europe would not only be affected by Brexit directly via a fall in flows from the UK, in terms of migration and remittances, trade and financial flow, but also indirectly through its effect on the Eurozone. As economic shocks spread easily from one country to another, a phenomenon known as ‘financial contagion,’ the impact of Brexit on the Eurozone would further reduce inflows to Central and Eastern Europe.

 

Financial flows from the UK to Central and Eastern Europe appear moderate (see Figure 1).  The median of UK financial flows to GDP is less than 1%.  Trade flows (import and export) are much more important, and they represent around 2.5% of GDP in Central and Eastern Europe.

Figure 1– Median Flows UK- Central and Eastern Europe

 

 

 

 

 

 

 

 

 

 

 

However, taken together, UK trade and financial flows make up a sizeable share of the total flows to the region.  The proportion of UK remittances to total remittances in Central and Eastern Europe is as high as 8%. As far as trade is concerned, this ratio is 4%. Inevitably, some countries in the region have even stronger links with the UK; for instance, in the Czech Republic, foreign direct investment from the UK constitutes 14% of its total foreign direct investment.  Also in the Czech Republic, bank loans from the UK represent 2.5% of GDP. UK remittances also constitute an important part of total remittances sent to Latvia and Lithuania, over 20% of the total.

Moreover there has been a high degree of correlation in the economic growth between Central and Eastern Europe and the UK. This could be the result of financial contagion via other, third party countries. Alternatively, it could stem from both regions’ high integration with the two largest world economies, the US and the Eurozone.  However, the correlation between growth in Central and Eastern Europe and the UK (at 0.56) is higher than that between the US and Central and Eastern Europe. (0.43, see Figure 2) Disentangling such correlations so as to understand how economic shocks are transmitted between countries has been done in a variety of models.

 

Figure 2 – Real GDP growth (Year-on-Year; source: OECD and IMF)

 

 

 

 

 

 

 

 

 

 

Our analysis shows that the UK is a significant source of financial contagion for Central and Eastern Europe. If, as a pessimistic example, estimated by PwC earlier this year, UK GDP fell by 5% as a consequence of Brexit, this would reduce GDP growth in Central and Eastern Europe by no less than 2.5%, as a consequence of third party financial contagion. Since the model is linear, if the fall in UK GDP was only 1%, the impact on Central and Eastern Europe would be only 0.5%.

 

Historically, shocks to UK GDP have contributed around 20 % of the variance in growth in Central and Eastern Europe. In our research for this piece, we employed a well-known statistical methodology, Vector Auto Regression, to examine how growth in Central and Eastern Europe relates to the economic performance of the UK, US and Europe. The historical decomposition of growth in Central and Eastern Europe (Figure 3) attributes the good performance of Central and Eastern Europe in the first decade of this century to strong growth in the UK. This occurred at a time when growth in the Eurozone was disappointing.   

Figure 3. Historical decomposition on GDP growth in Central and Eastern Europe (YoY)

 

 

 

 

 

 

 

We have come to the conclusion that, although it is uncertain what the short-term impact of Brexit on the UK will be, there are good reasons to think that it will have negative repercussions on Central and Eastern Europe.

 

Please note: Views expressed are those of the author(s) and not those of SSEES, UCL or SSEES Research Blog.

 

 

 Allan Sikk finds that a new book on the Baltic-EU relationship has excellent insights into micro-processes of accession relevant to anyone interested in how states respond to EU pressures and adapt to EU membership.

Could the experience of Lithuania, Latvia and Estonia joining the European Union be relevant for the UK? Differences seem to abound – the Baltic states are small, rather remote and their recent historical experiences are obviously very different. However, at a closer look one discovers that the UK and the Baltic states share certain perspectives of the world and even the EU (despite the British elites remaining far more Eurosceptic than their Baltic counterparts). More crucially, both the UK and the Baltic states have a shared affinity to the Nordic countries – an obvious source of inspiration for the Baltic states, but increasingly also for Britain.

Recently, the Prime Ministers of the UK, the Nordic and the Baltic states have twice met for UK-Nordic Baltic summits, initiated by David Cameron in 2011. For someone with an academic interest in Baltic and Nordic affairs, the links are obvious; together with three colleagues at University College London we started an ESRC seminar series on Nordic and Baltic countries a year prior to Cameron’s initiative.

Bengt Jacobsson’s new edited collection The European Union and the Baltic States: Changing forms of governance. (Routledge. 2010) addresses the issue of how domestic politics, more specifically central state administration, has been shaped by the EU accession. Its aim is to go beyond a crude notion of conditionality: that the rewards of membership force states to undertake specific reforms.

Some of the critique of conditionality literature in the opening chapters may be on the harsh side, but the book does provide original insights. It focusses on micro-processes and soft forms of influence – where aspiring member states adapted to formal requirements and, perhaps more importantly, to the Western ways of doing things according to the logic of appropriateness, termed (somewhat cryptically) ‘scripts’. (more…)

Allan Sikk and Sean Hanley detect a new breed of anti-establishment party emerging centre-stage in Eastern Europe.

In both Western and Eastern Europe extremist populism and illiberal movements, we are told, are strong, politically influential and relentlessly on the rise.  In countries such Austria, Slovakia and Poland radical right parties have already held government office. Elsewhere they have sufficient parliamentary representation to influence government formation and help make the political weather. Recent electoral breakthroughs in countries without strong illiberal populist traditions by parties such the True Finns (2011), the Sweden Democrats (2010) or Hungary’s Jobbik (2010) seem to highlight the accelerated growth of such parties.

Given the greater impact of recession and reduced EU leverage in the region, the new democracies in Central and Eastern Europe (CEE) would seem to be especially vulnerable to such tendencies. However, notwithstanding the spectacular rise of far-right in Hungary, recent elections in key CEE states suggest that voters in the region are turning to new parties, which combine familiar anti-elite, anti-establishment populist rhetoric with mainstream pro-market policies, a liberal stance on social issues and calls for political reform.

 Poland’s October 2011 elections, for example, saw the wholly unexpected emergence as the country’s third force of a grouping led by maverick and political showman, Janusz Palikot, on a platform combining anti-clericalism and social liberalism with flat taxation and a slimmed down, citizen-friendly state. In May 2010 a new pro-market anti-corruption party, Public Affairs (VV), campaigning to kill off the ‘dinosaurs’ of the political establishment enjoyed a similarly meteoric rise in the Czech Republic, winning 10% of the vote. In Slovakia in elections a few weeks later the Freedom and Solidarity (SaS) party formed in 2009 by the economist and businessman Richard Sulík entered parliament with a similar vote share on a programme of fiscal conservatism and socially liberal reforms such as the introduction of gay marriage and decriminalisation of soft drugs. Hungary’s Green-ish  Politics Can Be Different Party (LMP) can, with some qualifications, be regarded in a similar light.

 Such centrist or (neo-) liberal populists, or as we prefer to call them anti-establishment reform parties (AERPs), are we believe, a growing and important phenomenon in Central and Eastern Europe and, perhaps Europe more generally.  A more careful and wider look at the CEE region over the last 10-15 years suggests that such AERPs are a widespread and common phenomenon which can, in some contexts, enjoy landslide electoral success: the Simeon II National Movement in Bulgaria (2001), New Era in Latvia (2002) and Res Publica in Estonia (2003) were all new, anti-establishment reformers, which topped – or came close to topping – the poll at their first attempt and headed new coalition governments. (more…)

The authoritarian regime of Aliasandr Lukashenka in Belarus has historical roots but little future, explains Andrew Wilson in his new book

Belarus hit the headlines for all the wrong reasons in December 2010. After another rigged election, Aliaksandr Lukashenka, whom Condoleezza Rice once dubbed the ‘last dictator in Europe’, jailed scores of protestors, including three of the candidates who had had the cheek to stand against him. A still unexplained bomb on the Minsk metro in April killed fourteen. Demonstrations began again in the summer, inspired by the Arab Spring and ignited by a post-election economic collapse, with activists experimenting with social networks and ’silent protests’ to try and avoid arrest, not always successfully.

My book tries to explain how Belarus got into this mess, which I can at least claim was predicted by the last two chapters entitled ‘The Edifice Crumbles’ and ‘The Myth of the Belarusian Economic Miracle’.

The story goes back a long way – as many people argue that, paradoxically, Belarus has no real history. But the weakness of national identity in the present is not because Belarus lacks a past, but because the lands that are now Belarus have long been part of other states and projects. I therefore avoided using the term ‘Belarus’ until chapter five (‘Belarus Begins’). (more…)