By Nathan Mandrell
Economic development and the growth of incomes among a populace are one of the core political goals for any political ruler, especially those subjected to the harsh political pressures of regular democratic elections. For nations across the globe, scholars have long identified the critical role that a nation’s financial sector and credit market play in growth and economic opportunity. As the World Bank notes in a 2004 report “financial sector development can make an important contribution to economic growth and poverty reduction, even in the wealthiest nations…by increasing the savings rate and the availability of savings for investment and facilitating and encouraging inflows of foreign capital, financial sector development can boost long-run stability and success in both political and economic fields” (World Bank 2004). It is in this framework, identifying the critical role that finance and banking plays in political and financial fortunes that we can examine Eastern Europe, and how economic development and parity of incomes with the Western European nations (a critical cornerstone for political groups across the region) depends on the diverging fortunes of financial sectors in these incredibly diverse nations.
It is here that Dr. Rachel Epstein from the University of Denver began her April 3 lecture, which was sponsored by the Havighurst Center for Russian and Post-Soviet Studies. The EU, she noted, is not distributing its economic fortunes equally, but rather some nations continue to grow rapidly and others not at all. In her work on banking and financial sectors, she attributes much of this divergence to differences in banking models and state control. Nations that have much larger domestic control over their financial sectors, with either domestic ownership or regulation of private banks or even more leverage through directly state owned banks, tend to outperform those with foreign dominated sectors. Domestic banks are more easily controlled, and governments can then direct credit through a variety of policies towards areas of the economy (such as boosting human capital with education, job training and health outcomes) that are most important for boosting long-term economic potential. As Epstein noted unfavorably for the East Central European (ECE) nations, all nations save Slovenia have over 65% of their banking sectors under foreign control, giving their governments little leverage in financial areas, compared to most of Western Europe which had often less than 15%. It would seem that nations that had more control over their financial sectors would have greater economic outcomes, particularly in times of financial crisis. Yet that wasn’t exclusively the case, and nationally controlled banks only produced favorable economic outcomes in specific conditions.
It is in these specific conditions that Epstein makes her largest advancements in the literature. Using a series of case studies, she examines why nations that retained at least a degree of financial sovereignty could still have diverging economic outcomes. The five nations in question; Poland, Hungary, Latvia, Bulgaria and Slovenia all had semi-autonomous banking sectors, with efforts to maintain effective independent management and domestic control. Hungary and especially Poland have continued to see economic growth, for Poland even during the 2008 recession, while Latvia, Bulgaria and Slovenia have occupied a more typical boom-bust cycle. The differences? Embedded nationalism, a term she coined that denotes an optimal mix of political and market authority that makes banks and their managers both responsive to price signals but also ready to fulfill national political goals.
The managers pursue a goal to generate profit, thereby efficiently and effectively distributing cheap capital. Yet they also have to serve the national economy that help politicians achieve their political goals and provide social benefits outside of capital provision. Embedded nationalism is a trait of nations that strive for independent financial control, yet also maintain robust political competition. These domestic or state owned banks must constantly strive for efficiency, lest they become privately sold (likely to foreign entities) but also serve political interests (such as in counter-cyclical lending, lending during economic downturns) to maintain political usefulness. Poland and Hungary have combined these two factors (at least in the pre-populist era) which allowed for powerful domestic banks to conduct critical economic lending during the recession, while the other three cases had too little domestic focus (Latvia, who tied itself to the West) too little social mindedness from managers (Bulgaria) or too little political competition, which led bank managers to ignore political ramifications of their actions given their cozy political relationships (Slovenia).
Dr. Epstein’s incredibly wide-ranging talk proved decisive both on macro and micro levels of both economics and politics, and her use of Embedded Nationalism presents a strong categorical distinction of the diverging fates of ECE financial sectors. However, I remain skeptical on the broader ramifications of her work. Her case study, involving the five nations based on 2013 performances, follows incredibly specific political and economic fortunes, and in a broader context, how well can Embedded Nationalism guide future policy or explain financial outcomes in other nations, or even the ECE nations today? Political competitiveness in Hungary and Poland have fallen since 2010 and certainly so since 2013 the time of her research, yet broader economic and financial measures don’t seem to support the causal relationships she identifies. Trading Economics reports growth in Poland remains steady while Hungary has only slightly slowed. Meanwhile, direct lending measures and banking solvency (measured with bank capital to asset ratios) remain at average global levels and well above the EU average (Trading Economics 2017). This cursory research is not to directly challenge Dr. Epstein’s impeccably researched arguments, but to draw attention to the external validity of her theories, and prompt further discussion on their pertinence to current ECE nations.
Nathan Mandrell is a first-year MA student at Miami in the Political Science Department. He earned his BA in Political Science from Miami in 2016.
Works Cited
Financial Sector Team (2004). “The Importance of Financial Sector Development for Growth and Poverty Reduction”. Department for International Development. The World Bank. http://ageconsearch.umn.edu/bitstream/12886/1/fi04im01.pdf
European Financial Team (2017). “Hungary GDP Growth Rate”. Trading Economics. Trading Economics Ltd. http://www.tradingeconomics.com/hungary/gdp-growth
European Financial Team (2017). “Poland GDP Growth Rate”. Trading Economics. Trading Economics Ltd. http://www.tradingeconomics.com/poland/gdp-growth
European Financial Team (2017). “Poland Bank Capital to Asset Ratios”. Trading Economics. Trading Economics Ltd. http://www.tradingeconomics.com/poland/bank-capital-to-assets-ratio-percent-wb-data.html
European Financial Team (2017). “Hungary Bank Capital to Asset Ratios”. Trading Economics. Trading Economics Ltd. http://www.tradingeconomics.com/hungary/bank-capital-to-assets-ratio-percent-wb-data.html