When Reform Doesn't Pay the Bills

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Hungary is the biggest cause for concern. It has allowed its budget deficit to swell to an unsustainable 10% of gdp this year, and the government is now under huge pressure to reduce it. It has announced plans to raise taxes and cut spending, including axing 12,500 public-service jobs. The World Bank and other economists predict that growth will drop dramatically next year, to between 2 and 3% or about half the current rate, as a result of these austerity measures.

Foreign investors are applauding — and waiting to see if the government will do as it says and how the public will respond. "Obviously the austerity program is the ultimate answer to the question of investor confidence and economic stability," says Istvan Varga, the chief executive of Shell Hungary, who believes that "the political and cultural environment is mature enough to cope with these problems." He may be putting a brave face on it. Erkki Raasuke, chief executive of Estonia's largest bank, Hansabank, recently met with institutional investors, and was surprised by their tough questions about the economic environment.

Plainly, despite heady growth, many in Eastern Europe feel left out of the new prosperity, and equally plainly, those left out don't like it. Michal Kajan, a train conductor in Slovakia, says that to maintain his standard of living, he is working for more than 60 hours a week, up from 40. "People were not against the reforms, but it was getting unbearable," he says.

Membership of the E.U. does bring some significant political commitments, and they alone may prevent Eastern Europe drifting too far off the path of reform. Slovakia is a good example. Fico, the new Prime Minister, has already abolished payments by patients for doctors' visits, and he's proposing a "millionaire tax" on earnings above $1,600 per month. Still, he learned an early lesson when the Slovak koruna tumbled after he announced that the country may not rush to adopt the euro as planned in 2009; and though the budget he unveiled last week lifts spending, it nonetheless keeps within the 3% deficit limit set by the E.U. Political populism combined with continued fiscal rectitude make for an odd mixture. But if it allows the discontented of Eastern Europe to let off steam without blowing up their economies, it may be the best alternative around.