When Reform Doesn't Pay the Bills

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Is this political shift just a temporary interlude, or does it indicate a fundamental change of economic direction in Eastern Europe, one that would raise troubling issues for the E.U. as a whole and especially for foreign investors in the region? These eight countries only account for about 6% of the total E.U. economy, but their dynamism has been a shot in the arm at a time when Germany, France and Italy have performed sluggishly.

For the moment, many people are giving the new E.U. members the benefit of the doubt. Katinka Barysch, chief economist at the London-based Centre for European Reform, reckons the cooling of reformist zeal is a natural reaction to the raft of measures these countries had to enact to join the E.U. "Most of the Central and East European countries are small and open. There is no danger of them renationalizing their industries. The worst that can happen is that they will not be allowed into the euro zone any time soon," she says. Krisztian Szabados, director of the Budapest think tank Political Capital, concurs. "What we see in the entire region is a fight between strong reformers and strong populists," he says. "And right now the populists are winning. But I don't think they will in the long term."

Yet concerns are growing. The World Bank recently warned that this is not the time to ease up on reform. Recent elections in the region "have revealed a high degree of fragmentation, forcing parties to make fragile alliances and allowing populist forces to gain influence," the bank said. "This is hampering reforms, complicating the required fiscal and macroeconomic stabilization, and delaying euro adoption."

So far, populism is not hurting short-term economic prospects. Growth remains robust throughout the region, from an eye-popping 12% rate in Estonia to 4.6% in Hungary. True, inflation is on the rise, but not yet alarmingly so, and foreign investment is continuing to flow. Yet all eight of the new E.U. members remain far behind their Western neighbors in terms of per-capita income and productivity. They need to maintain their reforming ways if they are ever to catch up. Foreign investment is a case in point: in Poland alone, that will amount to $10 billion this year, according to the state investment agency paiz. But Roman Rewald, chairman of the American Chamber of Commerce in Poland, says that the pace and scale of that investment "should be 10 times higher, taking into account the potential and size of Poland."

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