Central Europe seems to be enthralled by the populist promise. Hungary’s Victor Orban has gone as far as declaring the demise of liberal democracy and noting the need of Central Europe to embrace an “illiberal” model instead. Highly controversial judicial reform in Poland compelled the European Commission to trigger Article 7 against the country in a recent and unprecedented move that could see its rights to vote in European institutions and access to European funding suspended. Amid a trend of similar incidents across the region, this populist turn has served to underline the growing gap between Central and Western Europe, and will present a new set of challenges for business operations.

The Roots of Populism

In 2017, Central Europe countries could boast a robust overall growth of above 3.5% YOY, with the Czech Republic, Hungary, and Poland, specifically, enjoying a rate of around 4% YOY on average. However, regardless of these positive trends, the overall level of wages has remained well-below those of their more affluent Western European neighbors. While metropolitan and large urban areas have benefitted dramatically from the economic trends, wage growth and unemployment in many smaller cities and rural areas continue to lag. Undoubtedly, consumers in such regions are experiencing real growth in purchasing power, yet the disparities in absolute terms have created a politically divisive environment. High levels of corruption amongst public officials and business elites has led to a disillusionment with democracy and hostility towards established parties.

It is in this environment that the new wave of populism has flourished, based on an otherwise traditional form of populist rhetoric – sharply antagonistic and claiming representation of the non-privileged. Central European populists have also taken a strict stance against corruption, seeking to distance themselves from traditional elites and on numerous occasions accusing their political opponents of being funded by “external actors.” This argument has found traction with many voters, especially in light of the ongoing migrant crisis. In fact, all three ruling populist parties in the region, namely the PiS (Poland), Fidesz (Hungary), and ANO (Czech Republic), are taking advantage of the negative public sentiment towards migrants, while criticizing the European elite of disregarding national values.

The recent Czech general elections saw ANO’s leader Andrej Babis employing a similar approach by vowing to focus on the fight against corruption, despite the fact that he himself is a subject of a fraud investigation. Similarly, President Zeman has continuously implied that a victory for his key opponent in the ongoing presidential elections, the academic Jiri Drahos, will result in a “flood” of illegal migrants and refugees. Similar arguments have been put forward by Orban, who claims that immigration is an external plot aimed at threatening the security and integrity of Hungary. In Poland, PiS head Jaroslaw Kaczynski has pointed out that the highly controversial judicial reforms are aimed at removing the entrenched communist elite from the judiciary, and addressing corruption in the legal system. Yet, at the same time, governments in Poland and Hungary have sought to strengthen their grip on both the domestic media and the judiciary, sparking concerns regarding transparency and the health of civil society.

Populism’s impact on business

Concerns over the economy have so far proven to be unfounded. Despite seeming profoundly Eurosceptic, they have taken advantage of EU funds to boost growth and have embarked on wide public investment projects, recognizing their positive effect on domestic demand and the economy as a whole. Additionally, both in Hungary and Poland, governments have implemented comprehensive welfare programs covering issues such as affordable housing and children benefits, which have had a positive effect in stimulating additional household demand. In fact, the perceived political uncertainty surrounding PiS, Fidezs, and more recently ANO, has failed to produce any significant impact on Central European currencies, with the latter seeing continuous appreciation throughout 2017, regardless of the relatively lax monetary policies across the region (Chart 1).

Hungary’s low corporate tax rate of 9% and Poland’s plans to introduce new tax exemptions for investments in the country beyond 2026, when the Special Economic Zones are set to expire, serve as a testimony to the fact these governments recognize the need to attract external capital if they are to catch up with the wealthier Western Europe. In the Czech Republic, Babis has on numerous occasions confirmed that he does not follow a specific ideological creed, and instead plans to utilize his business background in providing more incentives for businesses to invest and grow.

Those policies, combined with relatively low labor costs and strong external demand, have led to growing investment levels, surging industrial production, and continued expansion of the service industries, which in FrontierView’s view, will continue in 2018 (Chart 2). In other words, while populist tendencies might unnerve some investors, actual data suggests that both business and consumer demand will continue to be elevated, and will present new opportunities for multinationals. Also, the sudden policy shifts, cabinet reshuffles – such as the recent one in Poland –  and ongoing problems with the European Commission have failed to seriously detract from investment and growth in the region. A good example of this is the ongoing political crisis in Czech Republic where Babis’s minority government essentially lost a no-confidence vote and, despite being promised a second chance by President Zeman to form a government, Babis’ potential failure to get reelected at the end of January casts doubt on such prospects. Still, the Czech koruna remained stable, and shocks from the uncertainty have not materialized, indicating both resilient consumers and solid economic foundations.

Looking beyond 2018

Despite the positive outlook, considerable challenges exist in the medium-term, and MNCs operating in the region should prepare accordingly. Essentially every populist government in the region has sought to provide additional incentives for small and medium businesses, varying from investment stimuli to numerous tax breaks, intensifying local competitive pressures for MNCs. Additionally, consistent raises of minimum wages and pensions have significantly increased labor costs in those markets and created talent management issues for MNCs that will become even more prominent in the future. Ultimately, MNCs will see increasing competitive pressure stemming from local businesses while also facing rising labor costs, especially in metropolitan and large urban areas.

At the same time, populist governments will continue to tighten their grip on public institutions through electoral and judicial reforms, presented under the guise of the “fight against corruption.” The resulting lower policy predictability, poor institutional effectiveness, and lack of transparency will mean that businesses will have to monitor the situation on the ground closely in order to quickly adapt to abrupt changes in the regulatory environment. In conclusion, while MNCs will continue to enjoy and take advantage of enticing market opportunities, executives will have to be increasingly aware of the costs that come with populist policies and learn how to navigate through the complexity of regional politics.

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