Much has been written in the last few days about the election of the conservative Law and Justice party in Poland, and rightly so. The party’s rise to power will shock a shaky EU edifice and fire up the dispute between the US and Russia over control of Eastern Europe. However, the party’s rise is significant in another way that may have an even greater impact in the longer term by consolidating a retreat from the free market across the EU’s eastern half.

For the last few months, Law and Justice has been advocating greater domestic political control over strategic sectors of the Polish economy such as finance, energy, utilities and food production and retail which are almost entirely owned by foreign companies. In the run up to the election, the party declared its intention to hit banks with new taxes before bringing them back under Polish ownership, to secure new protections from the EU for the Polish coal sector and to radically loosen monetary policy in order to pump-prime local companies. This is almost certainly just the beginning of a more developed anti-market policy program.

A Bandwagon in Motion

In setting out these goals, Law and Justice is not so much blazing a trail as jumping on a bandwagon whose point of departure was Hungary. Since 2010, the Fidesz-led government has been steadily rolling back the dominance of the free market. At its most extreme, the government has forcibly brought private operators such as pension fund operators back under state control. Most of the time it has curbed the activities of targeted firms with a combination of crisis taxes, new regulations and administered price controls. When, on occasion, the firm can no longer make a profit and quits the local market, the asset then passes to a Hungarian firm which is controlled using the local patronage system.

Other countries have followed Hungary’s lead. The Slovak government has expropriated two private health insurers and launched a prolonged campaign against the Italian energy giant Enel which owns Slovenské elektrárne.

Croatia is trying to wrest control of its energy sector from the Hungarian company MOL. Albania has nationalized the local operation of the Czech energy company ČEZ and so on. Meanwhile, in those countries which have retained significant state control, such as Slovenia and Bosnia, there is fierce resistance to an extension of the free market.

A Faulty Import

So what lies behind these attempts to re-impose the state on strategic sectors of the economy? Contrary to received wisdom in the West, the adoption of a neoliberal economic model prior to joining the EU has not been an unalloyed blessing for the East. Certainly, the dismantling of socialist-era controls, the lifting of trade and administrative barriers and the sale of inefficient state-owned enterprises, combined with a drive to attract new foreign investment, has enabled huge productivity gains which have made the region much richer in real terms than it ever was under communism.

However, these economic gains have come at a price. For one thing, the loss of state subsidies has forced the closure of swathes of the local economy, especially after exposure to stronger competition from the West. As large industrialists from Germany and Italy moved in, opening up factories in semi-skilled sectors such as car assembly, high-value added activities such as research and development moved west and once diverse economies have been reduced to cheap manufacturing workshops.

Another problem has been the insecurity wrought by transition as the chronically inefficient but otherwise secure environment of socialism gave way to the inefficient but chronically insecure environment of free market capitalism, in which firms lack financial security and workers lack job security.

There is also the problem of growing inequality. While the countries of the region have all become richer in brute terms, many within the country have seen their standard of living plunge, especially pensioners and older workers who have lacked the wherewithal to compete in the new free-market economy. This has come as a serious shock to populations which passed through the levelling experience of socialism.

Finally, there is the problem of oligarchs, created by the privatization of the old state-owned economy. In contrast to socialism, when well-connected individuals managed the economy according to centralized, bureaucratic principles, under the new conditions they can now also own the economy and run it for their own interests. All too often, this has come at the expense of an efficient operating environment and, by extension, of economic growth.

Aftershock

While these factors have all fostered an underlying grievance with the neoliberal model, the catalyst for change has been the financial crisis which began in 2009-10. For much of the last decade, the EU’s east feasted on cheap credit supplied by the foreign-owned banking sector, which itself borrowed cheaply from the ECB and the Swiss National Bank. This was fine for as long as the region’s domestic currencies held up.

But with the onset of the financial crisis, exports collapsed, creditors withheld finance, and the local currencies plummeted. This meant that local borrowers found themselves paying debts in one currency while earning a salary in a much devalued local currency. The effect was to wipe out a large part of the middle class, many of whom were forced to flee abroad.

To compound the agony, the onset of the crisis was accompanied by a sharp rise in commodity prices as rising demand in Asia pushed up the cost of food, utilities and energy. As local firms passed on the price rise, ordinary people bore the cost, especially the poor.

Economic Reset

The upshot was a process of intense reappraisal of the region’s adopted economic system. Back in the 1990s, opinion polls suggested that most people would have been content to preserve the best parts of the socialist system while fixing its most egregious problems. Instead, over the heads of the people, and in collaboration with the European Commission, governments adopted a Western economic model lock, stock and barrel which by 2010 had revealed its inherent defects. The fact that the EU’s economy has also stagnated has only reinforced the perception that there is a better path to development.

These concerns have steadily crystalized into a set of policies, matched to the circumstances of the region. A richer country might focus on subsidizing the poor with welfare, but Eastern European states lack funds. Instead, their solution has been to impose political control over strategic sectors to ensure wide access to the provision of essential goods and services.

The outcome of the Polish election constitutes a milestone in this regional trend. Until now, Poland has been behind the pack, not the least because it avoided recession after 2009 and the need for a radical reappraisal of policy. But this has now changed. As by far the most important and powerful state in the region, its adoption of a hybrid economic model will consolidate and galvanize the regional trend already underway. As a result, the free market is now likely to operate within tighter parameters all over the EU’s eastern half.

Highs and Lows

The picture is not entirely bleak for advocates of a free market model. The reassertion of political control over strategic sectors is not a return to socialism. Far from it, in fact governments across the region all recognize the benefit of a free market in raising prosperity and will leave most sectors of the economy alone.

Indeed, if Hungary’s model is any guide, attempts to curb the free market in strategic sectors will be accompanied by efforts to bolster the bottom-end of the economy with tax cuts and deregulation. The goal is not national ownership but to avoid the risks to social welfare and stability implicit in a completely laissez-faire economy. Philosophically, that is not inconsistent with a dynamic and diverse SME sector.

But investors should not be complacent to the risks. Instead, they must learn to live with the new reality that the media and governments will watch them closely for evidence of profiteering at the expense of ordinary people. So a word of advice to multinationals in the region: if newspapers start muttering about excessive profits and governments start to endorse those concerns, then do something about it and fast. Recent history suggests that when companies ignore accusations of profiteering, the government will make sure they stop making profits altogether. A revolution is stirring.