Top Risk No. 9: Eastern Europe — Elections and Unemployment

By Ian Bremmer and David Gordon

Coming out of global recession, historically high levels of unemployment are a critical factor in a solid majority of the world’s economies. But as a political risk, it’s perhaps most worrisome in Eastern Europe — where upcoming elections in a number of key countries materially increase the likelihood of instability.

High unemployment weakens the popularity and limits the flexibility of incumbent governments, making political leaders especially sensitive to domestic economic and social constituencies, and increasingly tempted by protectionist, nativist, and populist policy options. That’s particularly true where elections are on the horizon, as candidates look to channel the frustration and anger of the unemployed. Governments will increasingly come into conflict with monetary authorities and international lenders such as the International Monetary Fund (IMF), which in turn may send very negative signals to capital markets investors…introducing yet another set of risks to financial stability. In Eastern Europe, Ukraine, Hungary and Latvia look the most vulnerable, but even solid regional performers like Poland may face stresses in the coming year.

Ukraine’s economic contraction and related jump in unemployment has been dramatic. With two rounds of presidential elections likely in the first quarter of 2010, then perhaps fresh parliamentary elections as well, politicians are under enormous pressure to boost public spending and assist debt-burdened enterprises. But this is all in a context of a crucial IMF agreement and framework that puts serious constraints on public spending in return for loan support and guarantees. Whoever emerges as the president and parliamentary leaders will find it incredibly difficult to balance these two sets of competing demands this year.

Hungary’s current government has succeeded in staving off a full blown financial crisis by implementing a series of IMF- and EU-mandated fiscal reforms in the past year. But the economic fundamentals remain weak, unemployment has shot up dramatically, and national parliamentary elections are due in the spring of 2010. The leading opposition party, Fidesz, will almost certainly win those elections, but they are already signaling that they want to re-negotiate IMF-EU mandated budget deficit and spending targets for 2010. We also expect a surge of populist and anti-foreigner rhetoric from Fidesz ahead of the elections. Even if the new government responds to market and IMF constraints after it is elected, the election build up will worry investors — a dangerous scenario given Hungary’s fragile standing in markets.

Latvia, the other particularly high-risk country in the region, also has elections due this year, and politicians there will feel similar social pressures. Relative safe havens such as Poland and the Czech Republic will also have noisy (presidential and parliamentary) elections this year. While the political and economic outlook for Poland remains solid, it’s not smooth sailing. If the Polish government’s leading presidential candidate (Donald Tusk) is underwhelming, populist/nationalist opposition politicians will pounce, highlighting the growing unemployment in the region’s largest economy, which may look more vulnerable as a result.

Next stop…Turkey

Ian Bremmer is president of Eurasia Group, and David Gordon is the firm’s head of research.