Eastern Europe’s fall puts Continent on edge

How quickly the European Union will or will not rally to help its most economically crippled new states in the East is becoming a major political test for the Continent.

Crisis summits will be held this weekend in Brussels to confront the problem, which is escalating as Western banking capital flees the once red-hot economies of the former Soviet states. But the problems may quickly move West.

“The future of Europe may be unfolding in the East,” intoned Le Monde this week. “Western Europe cannot let Eastern Europe fall apart.”

Concern is mounting over the specter of larger political instability, as well as the worries that a prolonged crisis could undercut the East’s emerging middle class. The Baltic states and Hungary, whose liberal Irish-like trade and growth models have collapsed (Latvia went belly up this week) have been hit harder than the Czech Republic and Slovakia, which had taken slower growth approaches. Poland and Romania are more protected by their size, economists say, though Poland’s zloty has lost half its value against the euro in recent months.

This week, the European Bank of Reconstruction and Development warned that the crisis “is threatening to throw nearly 20 years of economic reform into reverse.”

Amid the warning signs, the Continent is now scrambling to respond. On Sunday, nine East European states will hold an “emergency” summit, ahead of an “extraordinary” EU summit later in the day.

A basic question for both gatherings is how much “solidarity” EU leaders will show. Will the crisis be managed within the EU’s formal channels, including using measures like an IMF bailout? That would be the go-slow approach. Or will the crisis be viewed as so potentially dangerous that leaders will unveil a host of major US-style initiatives to recapitalize banks and assist states with stimulus packages? That’s the go-fast approach.

Economist Eloi Laurent, of Sciences Po in Paris, says the issue is one of political will. “We behave like there is still a wall dividing Europe ... but if the US can bulk up 2 thousand billion in the next months, can’t the EU do something for a small Baltic state?”

What started as an ugly economic crisis across Europe – not only in the East – is now shaping into a crisis over the EU’s identity and character, say political economists. Fragile notions of European “unity” are smashing against national interests and an often hidden discourse of “strong” and “weak.”

Ireland is in an economic meltdown. Three key Austrian banks are on the ropes with 80 percent of their capital in the East. Last week, Moody’s warned of default risks for banks in six Western European states that are overextended in the East. Of the former Soviet states, only two – Slovenia and Slovakia – are in the 16-member eurozone. The crisis may keep the rest from joining, at least in the short term.

This isn’t simply a nascent East-West crisis: Also at play is an older “north-south” eurozone crisis – with Greece, Italy, Portugal, and Spain in difficult straits, compared with northern Europe.

Accusations of further drift are likely to emerge Sunday with the expected announcement of a new “euro bond” – a low interest borrowing IOU that will be offered to EU states. The bonds could help Greece and Italy, though they may raise borrowing rates for the other 11 mostly newer states – a prospect decried as a rise of “economic nationalism and protectionism” in the West by Jacek Pawlicki, Europe editor of the Warsaw newspaper Gazeta Wyborcza.

Wealthy EU states, like Germany, are concerned about a backlash against the euro by failing neighbors. Deficits, bank exposure, and job loss in Western Europe is bringing a tilt toward protectionism in France, where President Nicolas Sarkozy recently announced dramatic measures to shore up the French car industry at the expense of new auto plants in the East, angering finance ministers there.

Mr. Laurent says the question in Europe is not if, but when, the EU will affirm that “not one state can fail, which would be a catastrophe. On Sunday, EU leaders should go in front of the cameras and say the EU is one, unified, unequivocally.

“The markets feel the weakness and hesitation of the troubled states, and they are betting this isn’t a reunited Europe. The predatory behavior will stop when the EU clearly backs an undivided Europe,” he says.

The East has benefited greatly from a decade of deep integration with Europe, says Katinkya Barysch, of the Center for European Reform in London. She frames the issue as one between countries that have been managed well versus managed badly. Most former Soviet states have created an industrial base, export markets, supply chains, intertwined banks, and made major political strides. But help from the EU can’t be unconditional, Ms. Barysch says. “East Europe has a strong expectation that rich countries should show solidarity. We can’t let these states go bust, but there also needs to be a shared responsibility. This should be handled through the IMF, which has the experience.

“The EU can’t bail out banks. Should the Spanish taxpayer pay for Austrian banks that made a huge killing in recent years with ridiculous loans in the East?”

German finance minister Peer Steinbrueck has said that Germany cannot stand by while its eurozone neighbors fail – a sentiment that has received praise in the German press. But there are still few specifics about how to rescue them.