CEE Challenge - Rule of Law | Erste Group Bank AG

CEE - 10 challenges for the new decade

No.3 Rule of Law

Quality of regulation seems particularly important for investment activity. Improving institutional set-up is a marathon, however, with positive effects becoming apparent over time.

The institutional setup and regulatory environment are believed to be determinants of economic development across countries, as they define the rules of the game, set boundaries and create incentives. Quality of regulation seems particularly important for investment activity. The Worldwide Governance Indicators Regulatory Quality rank captures changes in perceptions of government ability to formulate and implement sound policies and regulations that permit and promote private sector development. Czechia, Croatia, Romania and Serbia have improved the most in this aspect, but it has not changed much in Poland, Slovakia and Slovenia over the last two decades. Hungary is the only country in CEE where quality of regulation has declined. Substantial growth of total investment since 2004 was driven by many factors, including strong convergence and inflow of EU funds. A positive correlation of private sector investment growth with quality of regulation seems rather obvious, however.

The picture is decidedly more mixed when looking beyond regulatory quality to take a broader view on the rule of law. The rule of law rank (which captures confidence in and adherence to the rules of society, in particular the quality of contract enforcement, property rights, the police, and the courts according to Worldwide Governance Indicators) have improved since 2000 most visibly in Baltic countries but also in Czechia, Romania, Croatia and Slovakia. Back then, Hungary and Poland were ahead of those countries, but have seen a decline in the rule of law over the last two decades. Deterioration in Hungary and Poland also became a concern for the European Union to the extent that it plans to tie EU funds to the rule of law.

Institutions and long-term growth

Capital, labor and technological progress are well-known factors behind economic growth. However, those factors usually do not fully explain the differences between the prosperity of countries. Scholars Douglas North and Daron Acemoglu were among the first to recognize the importance of institutions. Acemoglu sees them as a fundamental cause behind economic development. They can be inclusive, generating prosperity by supporting investments and innovation with secure property rights and balanced distribution of power, or exclusive, dampening growth prospects.

It is not only the type of institutions that influences growth prospects, but also the effectiveness of those institutions and the redistribution of power in society. The CEE region has been continuously lagging behind Western Europe in the quality of institutions for the obvious reasons. Although a Western-like legal system was adopted by CEE countries in the early ’90s, changes in culture, traditions, norms and codes of conduct seem to be a gradual and lengthy process. The Baltic countries, however, are an example of how dynamic changes are possible. Latvia and Lithuania have progressed the most in terms of improving their rule of law ranks (Worldwide Governance Indicators), while Estonia is ranked top among former communist countries. Estonia also scored the best among its peers in the Corruption Perception Index in 2019.

All in all, positive developments after transition cannot be questioned; however, recently observed increase in populism and weakening rule of law might take a toll on long-term growth prospects. We recognize, for example, that lack of structural reforms weighs on long-term potential growth in Romania. Digitalization of the fiscal authority, streamlining of the education system to bring it closer to labor market needs, better capacity of the public administration to absorb EU funds and constitutional reform require solid political support, however. The effects are not likely to be immediate, but should become apparent over time.

Deterioration in democracy level

A falling Democracy Index (Economist Intelligence Unit) is a global phenomenon, as in 2019 it reached its lowest point since its creation in 2006. In the region, Czechia, Hungary and Poland in particular fit the downward trend. Hungary experienced the biggest overall deterioration in the Democracy Index. In Poland, more visible deterioration began in 2015, as a result of which Poland slipped below Hungary for the first time, mostly reflecting concerns over changes in the judiciary system.

On the other hand, Slovakia and Romania seems to have experienced a small uptick in 2019 Democracy Index. Corruption is a hotly debated issue in both countries. In Slovakia several corruption allegations linked to high politics started to emerge following the murder of an investigative journalist and his fiancée in 2018. The new government won elections chiefly thanks to its heavily emphasized anti-corruption electoral campaign. It has announced wide-ranging plans it wants to enact in order to tackle corruption, improve institutional quality and the rule of law in the country. This includes better processes for appointing prosecutors as well as several other judiciary reforms.

In Romania, corruption related issues brought thousands of peoples into the streets in 2017 in response to Social Democratic Party overnment’s legislation proposal to decriminalize the offence of abuse of power. In the course of the following years, European institutions also expressed the concern over Romanian judicial and criminal laws that could even lead to EU sanctions. In 2019, National Liberal Party formed a government and is currently leading in the opinion polls.

< Previous Next >