East European Capitalism – What Went Wrong?

Not all that long ago, the East European newcomers to the European Union (EU) were considered economic miracles which successfully weathered the storms of transformation from socialism, and were ready to settle on stable democratic capitalist development paths. It was even assumed that these countries, toughened by the experience of repeated crises in the 1990s and backed by EU-entry requirements, had developed regulations and institutions that would prove resistant to the current global crisis. Things have turned out otherwise. Almost all new EU member states have accumulated major economic imbalances, and are boarding on steep recessions. Two countries – Hungary and Latvia – had already to turn to the International Monetary Fund (IMF) in order to defend their currencies and keep their economies afloat. Other countries of the region are prone to follow. The crisis in Eastern Europe is not only economic. Surging protests and the increasing appeal of political illiberalism in the region attest to an end of the »political economy of patience« which characterized the first years of post-socialist transformation. What has made the region’s democratic capitalist project so vulnerable? This essay seeks for answers by taking as its starting point the worry expressed by many students of the region in the early 1990s that the double transformation to capitalism and democracy constitutes a challenging agenda. The introduction of capitalism was a political project, and it could only succeed if based on strong democratic legitimacy. At the same time, it was however considered highly unlikely that the population would patiently bear the high social costs of transformation without making use of their newly acquired democratic voice to obstruct market reforms. The crucial question, therefore, was whether East European societies could mobilize resources to increase tolerance for the economic costs of transformation. Comparing the Hungarian and Latvian experiences, I argue that both countries relied on a number of methods to make the pains of economic transformation tolerable. While Hungary mitigated the costs through social policies, Latvia – a newly independent state – used identity politics to instill tolerance for social hardship in its society. Th ese domestic resources were however insuffi cient to create solid support for capitalism, and showed already signs of exhaustion during the 1990s. Increasingly, international actors and markets came to the rescue of the fragile capitalist democracies. The EU’s decision to start entry negotiations off ered an external anchor for reforms, and made the countries also much more attractive for international capital fl ows, which were abundant in the 2000s. The tolerance of international markets and institutions for great economic imbalances allowed governments in both countries to grant their population a broader share of the new system’s wealth. The global financial crisis has however pulled the rug out from under such solutions.