A Recession in Eastern Europe?

It Drags Down Especially Germany,

Less France and Italy.

There has been a wide discussion on the impact that the crisis in central and Eastern Europe (CEE) has on the Eurozone through the banking channel. Much less has been said on the impact through the trade channel. Gilles Moec of Bank of America has provided a good analysis of the situation.

He argues that “CEE has become a major source of traction for Western Europe over the last 15 years and now absorbs 20% of Eurozone exports. In Germany, the most exposed Eurozone country, a 20% fall in demand from CEE would mechanically reduce GDP by 1.6%.”

“The direct impact on GDP would be much smaller in the other major Eurozone countries (0.6% in Italy, 0.4% in France and Spain), but these calculations no not take into account the diffusion effects. Given the relatively high level of trade integration within the Eurozone, a sharp additional contraction in GDP in Germany, the biggest economy of the region, would have a significant impact on the rest of the union.”

Moec adds that “Since the 1990s, Western European and especially German corporations have massively invested in CEE to reap the benefits of a relatively skilled but cheap workforce, which helped them to cope with increasing competition from other emerging areas.”

“As a consequence of strong intra-firm activity, the level of trade integration of CEE countries within the Eurozone is now higher than that of countries which are already members of the monetary union. In the first 9 months of 2008 the Eurozone absorbed 51% of total exports from Poland, 52% from Hungary and 57% from the Czech Republic. As a point of reference, only 43% of German exports and 48% of French exports are directed to the rest of the Eurozone.”

Therefore a recession in the eurozone produces deep negative effects on central and Eastern Europe: “... a mere 5% decline in demand from the Eurozone would mechanically result in a contraction in GDP of 1% in Poland, 2.9% in the Czech Republic and 3.1% in Hungary. This is a conservative estimate, since the mechanical impact would be magnified by a steep correction in investment. Consumer spending would also be hit as a consequence of a sharp deterioration of the labour market.”

In short, we had a beneficial circle between core Europe and Eastern Europe which is now morphing into a vicious circle where the Eurozone has also become increasingly dependent on demand from CEE countries: “Since the start of the monetary union in 1999, the contribution of this region (CEE EU members + Russia and Ukraine) to total export growth in the Eurozone has reached 26.9% in cumulated terms, against 7.7% only for the US. The CEE region contributed twice as much to total export growth in the Eurozone than emerging Asia (see chart 1). The share of CEE in Eurozone exports has been exceeding that of the US since 2004, and is now nearly twice as big.”

The country more exposed to a recession in Eastern Europe is Germany: “Germany is by far the most exposed country to a further decline in demand from CEE. This region receives 15% of German exports.”

“If CEE lowers its imports further by 20%, which would be only slightly more than twice the current pace, German GDP would mechanically contract by 1.6%. This would be a conservative estimate, neglecting the second round effects on investment and ultimately consumer spending.”

“The direct impact on GDP would be much smaller in the other major Eurozone countries (0.6% in Italy, 0.4% in France and Spain), but these calculations no not take into account the diffusion effects. Given the relatively high level of trade integration within the Eurozone, a sharp additional contraction in GDP in Germany, the biggest economy of the region, would have a significant impact on the rest of the union.”