At least once a week, my German teacher at the University of Vienna would draw a large dot on the whiteboard, add a bigger semi-circle above it and running down the right-hand side, finishing at the bottom. The dot was Vienna and the lines as they were during the Cold War, when the city was an isolated outpost surrounded by the Iron Curtain borders of Czechoslovakia, Hungary and Yugoslavia.

It hadn’t always been that way, of course, and it isn’t anymore. In the late 19th century and early years of the 20th, Vienna was a thriving cosmopolitan city that attracted ambitious migrants from across the Habsburg Empire. By 1900, less than half of the capital’s population had been born here, and over 40% spoke Czech as a native language.

But when the Empire collapsed, everything changed. Vienna declined “from a glorious imperial metropole,” in the words of historian Tony Judt, “to the impoverished, shrunken capital of a tiny rump-state … finishing up as a provincial outpost of a Nazi empire.” Following the Anschluss, anti-Semitic decrees drove tens of thousands of Jews to emigrate; most who remained were later killed in the Holocaust. The war and its aftermath decimated the city’s population. Having reached a peak of 2.5 million after World War I, swollen by migration, the population had fallen to 1.6 million by 1951, and dropped still further in the 1980s.

When the Iron Curtain spread after WWII, increasingly separating the city from its Central and Eastern European neighbors (since 1989, referred to by the acronym CEE), life on either side was diminished. Vienna became a spy haven but also a cultural backwater. Despite the economic revival from 1955 to 1975 – after the State Treaty insured Austrian independence from the Soviet Union – Austria suffered what Italian scholar Claudio Magris called a “stagnantly conservative atmosphere.” The former Habsburg lands of CEE fared even worse. First subjugated and looted by the Soviet army, they then endured over 40 years of Communist rule and wasteful command economics.

Then, 30 years ago this November, the Berlin Wall fell. The fortunes of both Vienna and CEE have since risen, but the journey has been fraught and is still far from over.

Take the pain early

CEE’s early transition from planned economics to market capitalism was harsh. Output plunged in most countries. In 1990, Poland’s real GDP declined by 11.6% the first year and a further 7% the next. In 1991, the economy of Hungary contracted by 12%. The Bright Young Things at the IMF and other international financial institutions advocated “shock therapy” (including, among other things, mass privatization) based on a policy of “take the pain early; things will get better.”

And for many, they did, at least by the mid-1990s. But not before profound social upheaval and, in some countries, the rise of a gangster class profiting from rushed privatizations. Such was the stress that people born in CEE at the time are a centimeter shorter than predicted, according to the European Bank for Reconstruction and Development (EBRD). Fertility rates plunged.

The “shock therapy” approach to transition has since been discredited, and many former advocates have at least partly recanted. But hindsight hardly helps those in places like Russia, where ugly memories and a sense of injustice still burn. There, the transfer of state wealth to a tiny group of oligarchs was extreme and living standards dropped precipitously: Between the years of 1990 and 1998, the Russian economy posted positive growth only once. Reverberations matter. Current President Vladimir Putin has “capitalized on popular disillusionment with liberal economic policies and particularly with the oligarchic system [of] the 1990s,” according to Russia expert Vasily Astrov.

Two CEEs – boom and bust

As economies stabilized by the mid-1990s, Austria’s border countries were drawn into an upward cycle. The prospect of joining the EU brought foreign capital, driving economic development and further improving accession prospects, which in turn brought in more money. The eastward expansion of NATO, too, brought security and stability.

Not so to the East, where Russia saw NATO as a threat, not an opportunity. The eruption of violent conflict in Yugoslavia – where the EU was humiliated by its inability to act – capsized development and integration. In economic terms, a comparison of Ukraine and Poland best demonstrates the CEE East-West divide: Ukraine was richer than Poland in 1990; now it is four times poorer.

Between the mid-1990s and 2008, the global economy changed dramatically, as what the economist Dani Rodrik calls “hyper-globalization” really got going. China joined the World Trade Organization in 2001. Bankers in London and New York set about inventing complex financial products that only a handful of people understood. The global financial system became a casino, largely revolving around the US housing market. Global growth surged.

CEE rode this boom better than most. Investment – not least from Austria – flooded in. The economic model was simple: Use cheap labor to attract foreign direct investment and develop a modern manufacturing sector. The Czech Republic (today Czechia), Hungary and Slovakia – with Austria’s help – fully integrated into the German industrial core and built up highly sophisticated and competitive manufacturing sectors.

Estonia became a global player in ICT, and was the single most impressive convergence story, going from 27% of Austria’s GDP per capita (adjusted for local costs) in 1995 to 55% by 2008. Over the same period, the wealthiest parts of CEE – Slovenia and the Czech Republic – became richer than Portugal.

Euro-Atlantic institutions hurried eastward, pulled in by the end of the Balkan wars and pushed by the U.S. “unipolar moment.” The EU absorbed 10 new countries in the region between 2004 and 2007 (Croatia would become the 11th in 2013). NATO added the Czech Republic, Hungary and Poland in 1999; a further seven CEE countries acceded in 2004.

During these years, the expansion of consumer credit (led by Austrian banks) helped people who had grown up with communist shortages to indulge in Western-style consumerism. The benefits were tangible, but ordinary borrowers got caught up in things that they didn’t understand, often with disastrous consequences.

Austrian and German firms profited handsomely, but workers in those countries now faced cheap competition. Trade unions agreed to suppress wages in return for job security, and problematic economic imbalances took root.

Things fall apart

The global crisis of 2008-09 was the worst financial event in 80 years. Stock markets collapsed, European economies contracted, and poverty rates skyrocketed. Some parts of CEE, especially Ukraine and the Baltic states, suffered declines in output comparable with the 1930s. This was followed by crisis in the euro zone and a reality check for CEE when it was, as historian Adam Tooze put it, “fobbed off” by the West.

The financial sector was “not our problem,” said German Minister of Finance of Peer Steinbrück. In fact, neither the US Federal Reserve nor the European Central Bank (ECB) extended crisis support to most of Eastern Europe. At the same time, the International Monetary Fund held back, waiting for Europe to act. The IMF is “not for Europe; it’s for Africa,” French President Nicolas Sarkozy had declared. But shut off from ECB credit lines, much of CEE was forced to turn to the IMF after all.

Enter Austria. Concerned by the vulnerability of its own heavily invested regional banks, Austria led the Vienna Initiative. By coordinating with the EBRD, World Bank and EIB, Austria prevented large-scale withdrawals from CEE by Western banks, saving Eastern Europe’s financial sector from a much worse fate.

Economic & political fault lines

The 2008 crisis has left deep scars in Europe, not least for young people – and has, in effect, split the CEE region in two. EU member states, though badly affected by the crisis, bounced back quite quickly (Poland avoided recession entirely). Strong growth has been propelled by rapid wage increases and hefty inflows of EU funds. In the next few years, per capita GDP in Czechia will likely rise above that of Italy, a founding EU member state.

But in the post-Soviet Commonwealth of Independent States and Ukraine, economies are, at best, standing still. Body blows to growth include serious structural deficiencies, lower oil prices, a barrage of US-led sanctions, and war in Ukraine. Households in Russia and Ukraine face declining real incomes, so instead, binge on consumer credit at high interest rates. This trend is “particularly worrisome” says wiiw Ukraine expert Olga Pindyuk.

The divide between Russia and the West has hardened: The 2008 invasion of Georgia, 2014 annexation of Crimea and war in the Donbass sent an unequivocal statement that there was a limit to the eastward expansion of NATO. Rhetoric has sharpened.

In between stand the Western Balkans – a contested zone, but basically in the EU orbit. There, political cracks are showing within Bosnia and Herzegovina, and between Serbia and Kosovo. Serbia remains the key to regional stability but may be going in the wrong direction. And despite the region’s official “EU perspective” – to put it in cumbersome Brussels-speak – a recent French-led decision to delay EU accession talks for North Macedonia and Albania has led to huge frustration and may impede domestic reform.

On the plus side, the name resolution deal between Greece and North Macedonia ended a decades-long dispute and paved the way for the latter’s NATO (and in theory EU) accession. Ordinary citizens in Serbia and Albania have shown themselves willing to take to the streets against what they see as a corrupt political class. They may, in time, force positive change.

Some problems affect the entire CEE region. The huge and persistent wage gap siphons citizens off toward the West, creating labor shortages. Even adjusted for local living costs, wages in CEE range from around 70% of the Austrian level in Slovenia to just 20% in Moldova. In areas of the economy that will determine future success, especially digitalization and automation, the region has already fallen dangerously behind. Reforms to improve institutions, upgrade education and safeguard the environment have not gone far enough. In many cases they have gone into reverse: Hungary’s Orbánization is a case in point.

B ack to the past

Vienna’s star rises and falls with CEE: For Austrian firms that have invested heavily in the region, there is still money to be made but also plenty to lose. As of 2018, Austria was the biggest foreign direct investor in Slovenia and Croatia, and among the top three in a further eight CEE countries. Austrian banks are dominant in many of the region’s markets. Over one-fifth of Austria’s trade is with CEE, making it second in importance only to Germany.

Under former Chancellor Sebastian Kurz, Austria began more actively mediating between conservative CEE governments and Brussels. With tensions increasing between the Visegrád countries (Czechia, Hungary, Poland and Slovakia) and several Western capitals, like Brussels, Paris and Berlin, Austria’s role will only grow in importance.

“I recognize that link to the east,” wrote critic and essayist Hilde Spiel of Vienna in 1968. “Here one notices nothing of the weighty profundity of the Germans… It is the Slavic element, not so much in Austria in general as in the Viennese.” In the three decades following the fall of the Berlin Wall, these words have taken on an added layer of meaning. In addition to the Austrians of Central European descent, over 150,000 CEE citizens now live in Vienna, with the largest numbers coming from Serbia, Poland, Bosnia & Herzegovina, Romania, Hungary and Croatia. They, like their ancestors, have left their mark: The local economy and feel of the city are inconceivable without them.

Many Viennese probably do miss the slower, quieter life as a Cold War outpost that my old German teacher illustrated on the white board. But the 1945-1989 period was clearly an aberration, driven by a geopolitical divide that will not return. Russia is not strong enough for the much-discussed “new Cold War” to become a reality. CEE people here and Austrian firms over there mean that Vienna is again effectively the capital of Central Europe.

Just look at the departures board at the Flughafen Wien in Schwechat. As a colleague from the Balkans told me recently: “Wherever we go, we go via Vienna.” Vienna and CEE are back together, as they have been for most of their history, and as they should be.



Born in 1984, Richard Grieveson is deputy director of the Vienna Institute for International Economic Studies (wiiw), a think tank specializing in CEE. He previously worked for the Economist Intelligence Unit and Fitch Ratings in London, and studied at the Universities of Cambridge, Vienna and London.