CHAPTER 14
Eastern Europe
AS THE EURO GOES . . .
Eastern Europe is being held hostage. Except it’s not by communism anymore. Countries like the Czech Republic, Slovakia, Bulgaria, Poland, Romania, and Hungary were once dependent on the largesse of their neighbors to the East. Long gone are the days of Soviet meddling and social experimentation. Today these countries find themselves pretty much on their own. It hasn’t been an easy transition, and, for the most part, these countries have muddled into somewhat functioning democracies. Now, however, the region faces a massive economic threat thanks to the sovereign debt crisis in Europe that began in 2010 in Ireland and then spread to Greece and then Portugal, Italy, and Spain. Regardless of the ultimate resolution, the effects will be felt in these weaker peripheral economies the most. And that will provide both crisis and opportunity.
A visit to a place like Prague in the Czech Republic will give you the impression that these markets are anything but emerging. I recall driving from the airport in Prague through miles of ugly Soviet-era apartment buildings wishing I’d never come. But, once in the old town, everything changed and I was amazed at the wonderland that lay at my feet, literally. The Mala Strana area (little or lesser side) of Prague was so named because of its position on the left bank of the Vltatava River. It’s a walker’s paradise with restricted vehicle traffic. You are surrounded by outstanding examples of Baroque architecture, huge squares, and beautiful galleries. Walking amidst the crowds of tourists and locals are wig-wearing touts proclaiming the various musical events for the evening. One can walk around Wenceslas Square; see the magnificent Prague Astronomical Clock, installed in 1410 in the Old Town Square; and marvel at the modernity that was Prague after the Middle Ages. A former seat of two Holy Roman emperors, an important city for the Austro-Hungarian Empire, and a landmark city of the Habsburg dynasty, Prague has played a central role in Europe for more than a thousand years.
After falling to the communists after World War II, Czechoslovakia, Bulgaria, Romania, Poland, and Hungary went from somewhat thriving countries to vassals of the U.S.S.R., isolated from the West by their Iron Curtain status. Once-thriving economic and cultural capitals like Prague, Budapest, and Warsaw were now Soviet factory towns and remained so until the late 1980s and early 1990s when the decline of the Soviet empire freed them from totalitarian control.
The road back was not easy and continues to be quite difficult in all the countries once hidden behind the Iron Curtain, especially outside the major cities.
From an investment point of view, the countries are probably best looked at as a group rather than individually. Their economic past was reliant on industry, factories, shipbuilding, automotive plants, and the like. These industries are less relevant today, as competition from Asia has made them dinosaurs. Politically and socially these countries had to reinvent themselves overnight, transitioning from central control to independent countries again. Consider the efforts required to rebuild. Governments needed to re-form, a banking system had to be developed, infrastructure needs had to be met, and agricultural reform had to take place. And, all the while economic subsidies from the former Soviet Union all but dried up. Each country had to embark on a process of privatization and a quest for hard currency. It is for these reasons these once-thriving European nations (for the most part) earned emerging market status.
In the period immediately following their newfound freedom, these emerging nations, especially Poland and Czechoslovakia, found themselves the low-cost producers in Europe, and many of the Western European countries shifted manufacturing production to these countries to benefit from favorable cost structures. However, as the ’90s wore on it was clear that Asia would come to dominate industrial production as the rising costs of rebuilding Eastern European countries and their wont for a higher standard of living comparable to their neighbors reduced their attractiveness. And, as is often the case with newly formed countries, heavy deficit spending and the ensuing indebtedness put inflationary and currency pressures on their respective economies, another hallmark of emerging nations.
Today, these countries are still lower cost producers, but the skill set of the general population is not keeping up with the technological shifts that are taking place in the rest of the world. Outside of small pockets of success in places like the automotive sector in the Czech Republic and continued privatizations in Poland, the region is still suffering from the slowdown in European growth in general. For the most part, double-digit unemployment, public sector corruption, accelerating social service and health care costs, and a population with a lesser skill set make these countries much less attractive than their Asian, South American, and African counterparts.
Worse still is their proximity to Western Europe and the former Soviet republics. Europe is mired in a major recessionary environment brought on by the financial crisis of 2010/2011, and the former Soviet republics, Russia especially, are flush with both capacity and their own internal problems. Eastern Europe looks to be mired in a rut right now and when recovery arises, it looks to be in the form of rapid-fire boom-and-bust cycles that may provide trading opportunities but little to get excited about over the longer term.
The region does enjoy excellent infrastructure compared to developing markets in Asia, for example. And, it shares a common European thread dating back many centuries. This can provide an interesting opportunity for those inclined to look to the area for real estate investments. Eastern Europe may become a retirement destination for Europeans much like Mexico is attractive to Americans looking for a low-cost and comfortable place to retire. The region is chock full of natural beauty and during the global real estate boom, many resort-like towns were developed. Many of these projects remain sparsely occupied, especially in places like Bulgaria and the now lower prices are attracting investors and nonresidents alike.
As cost of living in Western Europe continues to top that of any developed country in the world, middle-class residents may look to escape the high tax, high-cost areas of Europe while not venturing too far from home to enjoy a relatively upper-class lifestyle and potentially retirement. Europe is well served by a vast transportation network of rail lines and airports that make traveling relatively painless and quick, when everything is running as it should.
From a stock market point of view, it is easy to buy into a myriad of Eastern European funds. And while these should have a role in your portfolio, the role should be minor compared to the booming markets outside the region, which offer a much better risk-reward picture.
Strengths
Eastern Europe’s proximity to Western Europe is a plus. It offers a lower-cost destination for manufacturing. It has a good infrastructure and mostly democratic governance systems. Eastern Europe is educationally superior to many emerging markets outside Europe. It is linguistically compatible to Western Europe and has strong historic ties.
Weaknesses
Many of the countries are still dealing with a post-Soviet factory/socialist mentality, especially members of the older generation. There are weak currencies, high unemployment, and a seeming inability to modernize quickly enough to stave off competition from Asia.
Opportunities
Tourism and real estate are promising. The region could become the cheaper alternative for many European retirees looking to stretch their euros.
Threats
Asian dominance in manufacturing. There are weak social safety nets. Popular uprisings are not uncommon during periods of economic upheaval. Problems in Western Europe can severely retard economic progress. Rampant corruption exists at all levels of government.