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Will Brexit affect growth prospects in the EU Members of Central and Eastern Europe?

By Blog Admin, on 26 May 2016

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

 

fig 1

 

 

 

 

 

 

 

 

 

 

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)

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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)

 

 

 

fig 3

 

 

 

 

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.

 

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What will the Euro elections tell us about Eastern Europe?

By Blog Admin, on 11 May 2014

Plakat do Parlamentu Europejskiego 2014 Platforma Obywatelska

Photo: Lukasz2 via Wikicommons

Seán Hanley looks ahead to the upcoming European elections and assesses what they may tell us about the enduring differences between voters and parties in Western and Eastern Europe.

The elections to the European Parliament which take place across the EU’s 28 member states between 22 and 25 May are widely seen a series of national contests, which voters use to vent their frustration and give incumbent and established parties a good kicking. Newspaper leader writers and think-tankers got this story and have been working overtime to tell us about a rising tide of populism driven by a range of non-standard protest parties.

The conventional wisdom is that the ‘populist threat’ is all eurosceptic (and usually of a right-wing persuasion) although in some cases the ‘eurosceptic surge’ is clearly a matter of whipping together  familiar narrative than careful analysis.

But, as a simultaneous EU-wide poll using similar (PR-based) electoral systems, the EP elections also provide a rough and ready yardstick of Europe-wide political trends, ably tracked by the LSE-based Pollwatch 2014 and others.

And, for those interested in comparison and convergence of the two halves of a once divided continent, they a window into the political differences and similarities between the ‘old’ pre-2004 of Western and Southern Europe and the newer members from Central and Eastern Europe (now including Croatia which joined in 2013). (more…)

Premature donors? Development aid from Central and Eastern Europe ten years on

By Blog Admin, on 28 November 2013

St. Philip's School Mathare: support and development of the school’s potential, KenyaWhen they joined the EU Central and East European states committed themselves to meet EU norms on international development aid. Small budgets, weak social support and limited political commitment have so far limited the impact of aid from CEE. However, it is too early to dismiss them as ‘premature donors’ argue Simon Lightfoot and Balazs Szent-Ivanyi.

Eastern Europe (CEE) states becoming donors of international development aid. It is also the year that three CEE states – the Czech Republic, Slovakia and Poland – joined the OECD’s Development Assistance Committee (DAC).  DAC membership is symbolically important of joining the ‘donor’s club’, but it also commits members to certain norms and practices in aid spending.  Both events make this an opportune time to review the progress CEE states have made towards meeting global aid norms.

Before we do that it is worth asking whether these countries are ready to become donors.  They classify as high income countries and are number are OECD members, so economically the answer must be yes, despite the impact of the financial crisis on some CEE states. But socially, the self perception of these societies is that they see themselves are poor and awareness of development issues is low, so the answer here is more complicated. And politically, aid is not seen as a salient issue, so there is little political capital gained by ‘selling aid’ to the public.

All of these factors affect the quantity, quality and allocation of the bilateral aid given by the CEE states. On becoming EU members, the CEE states were set quantitative targets for aid as a percentage of GDP. They committed to providing 0.15% by 2010 with the ultimate goal of 0.33% by 2015. No country met the 0.15% target and most are unlikely to meet the 0.33% target. However, given the economic problems of the Eurozone, a number of the other DAC members are similarly unlikely to meet their own targets for aid, with aid levels in Greece and Italy particularly badly hit.

But quantitative targets, while important, do not tell the whole story. (more…)

What drives the rise of Europe’s new anti-establishment parties?

By Blog Admin, on 2 September 2013

A new breed of protest party is being propolled to success in Central and Eastern Europe by a mix of economic hardship, rising corruption and ossified party establishments find Seán Hanley and Allan Sikk.

The spectacular breakthrough of Pepe Grillo’s Five Star Movement in Italy in February underlined the potential for a new type of anti-establishment politics in Europe – loosely organised, tech savvy and fierce in its demands to change the way politics is carried class, but lacking the anti-capitalism or racism that would make them easily pigeon-holeable as traditional outsider parties of far-left or far-right.

 But for observers of Central and Eastern Europe (CEE), the dramatic eruption of new parties led by charismatic anti-politicians promising to fight corruption, renew politics and empower citizens is nothing new. Indeed, over the last decade a succession of such parties – led by a colourful array of ‘non-politicians’ ranging from aristocrats to central bankers, journalists and businessmen – have broken into parliaments in the region.

  Some have achieved spectacular overnight success in elections on a scale easily comparable to Grillo’s and (unlike Grillo) have often marched straight into government. Some examples include Simeon II National Movement (NDSV) in Bulgaria in 2001, New Era in Latvia in 2002 and Res Publica (Estonia 2003) and, more recently, the Czech Republic’s Public Affairs party (2010), the Palikot Movement (Poland 2011), Positive Slovenia (2011) and Ordinary People (Slovakia 2012).

 In a new paper we explore what these parties, which we term anti-establishment reform parties, have in common and what drives their success. (more…)

Does the eurozone crisis threaten liberal reforms in Eastern Europe?

By Blog Admin, on 15 November 2012

Uncertainties about the EU’s future are undermining mainstream parties throughout Europe. In Central and Castern Europe politicians can no longer sell the European model of liberal reforms when that model is itself in crisis, argues Sean Hanley

OccupyFrankfurt October 2011 EZB

Photo: Blogotron via Wikicommons

Although only three EU members in Central and Eastern Europe (CEE), Estonia, Slovakia and Slovenia, have adopted the Euro, the knock-on  effects of stagnation in the Eurozone has pushed governments across CEE towards unpopular austerity programmes, exacerbating social tensions and collapsing support for incumbent parties. The uncertainties about the EU’s future are also undermining mainstream parties in the region. Politicians can no longer sell liberal reforms as part of a successful, tried and tested european model as they once did, when that model is itself in crisis. For many this seems to point darkly towards a turning away from liberal politics in CEE and a growth in euroscepticism, populism and nationalism. (more…)