Back to the future?

Last April the then-minister for economy, delegated by the liberal party, made a roundtrip in capitals of ECE, where he found fellow liberals in the government. As he was that time already abdicated (the liberals collided with their socialist partners over the necessity of reforms, especially in their form advocated by the liberal ministers after the governing parties suffered a heavy defeat at a plebiscite), it was rather a demonstration of the successes achieved through policies (flat-tax, low social expenditures and redistribution rates etc.) similar to their proposals. At about a week ago this former minister, now chief-whip of the parliamantary club, published an article in the leading newspaper of Hungary recalling this experience, once again arguing on behalf of flat-tax and its accompaniments, at the same time making a hint, rather gloatingly, that he was right even ten month ago.

As Hungary is heavily affacted by the global crisis, besides the government other organizations and institutions are seeking the way out and that kind of ideas has many adherents, actually it is the dominant view among economic organizations (Association of Industrial Entrepreneurs, BIG4 etc.) and among mainstream economists and so-called economists, in fact many of them analysts working for large and not-so-large financial companies, obviusly having more degree form this field than me, but not necessarily as many academic publications. (I must admit that for almost a decade I researched topics of pure or at least tangentially economic history. Even my PhD was conferred for a dissertation on the history of banks of the Transylvanian Saxons, but it does not mean that I have real expertise and will pretend here as someone with economic knowledge.) Anyway, the ex-minsiter found it the appropriate moment to announce that his party was right and it is high time to realize those reforms and at the very same day heavyweight economists (well, it is by Hungarian standard only) threw their full weight behind his party.

Even though there is not much contradictory opinion present in the public, the whole story is highly ironic. As this ex-minister visited Tallin and accompanied by the Estonian prime minister announced the superiority of the Estonian tax-system and the economy fuelled by low redistribution rate compared to the Hungarian situation (he retold this event in the aforementioned article) the small Baltic state already entered the phase of recession (and primarily not because of the looming crisis), predictably a serious one, while Hungary was not yet affected by the crisis. His other example, Romania, from where he once again delivered his message to Hungary, was considered to be on the wrong track of overheated economic growth driven by a housing bubble based on transfers of Romanians working abroad. But, regarding this latter country, even more interesting is the fact, that the revenues of the Romanian budget simply collapsed in the last two months of 2008 (the budget deficit as ratio of GDP more than doubled), in a period when the country was hit by the crisis, because the level of state income from VAT remained well under the expectations due to a drop in consumption. In case of Estonia they are not only thinking of amending their tax system, the Estonian finance minister is considering a lasting raise of the redistribution rate.

One interesting observation can be that these pieces of news were not heard in Hungary, but it is only of secondary importance besides the real questions never asked from the advocates of the same policies as one, two or three years ago: why those measures, allegedly making economic development sustainable, robust and therefore economies impregnable, obviously didn't work? Although there is certainly truth in the opinion that the economic policy of the Hungarian governments was at least sub-optimal in the recent years, in the light of the recent events it is hard to evade the problem whether the ecnomic model emerging after the transformation is still capable to ensure economic and social convergence of these countries to the core of Europe (more sceptical people can even rephrase this question whether it was capable for this task at all) and whether difference in the tax-system and redistribution level is really a substantial difference on the long run?

This one won't be the post of in-depth anlysis, but at least three aspects of the problem can be raised even here, especially as those are not considered by the experts and "experts" who recycled their earlier plans, designed among quite different circumstances.

1. The primary supportive argument is based on competivity. According to those who are still convinced that this is the only way out not only from the crisis but from the lagging growth of the recent years, Hungary and the countries in ECE are competing for FDI and as cost of labor is lower in almost every other country, Hungary has to accomodate to this fact. With tax cuts and budget cuts especially regarding social expenditures (thier rule of thumb is a mechanical comparison, if let'say Slovakia's similar spending amounts to 16% of the GDP, than they has to be followed) and state burocracy. Maybe it is an argumanetation not easy to dismiss but as the flat-tax, low redistribution ratio model was portrayed not only as a rational choice but as the only possible one and as the basis of robust and sustainable growth it is legitimate to point out that no country, regardless of its tax system remained unaffected by the crisis and even some model economies were the first one and many of them are among the most heavily hit. (Not only in ECE, but for example Ireland.) It could raise the problem whether not the tax system, but the very model of integration into the world economy is the real reason behind the effects of the crisis? Almost in every country - the lone exemption is Slovenia - foreign capital played the role of fuelling the economic growth, while goverments, reasonably, tried to accomodate the conditions to the needs of investors, keeping the cost of labor relatively low. But, as it turned out, the societies - in a world where it was easier to compare their standard of living to the Western countries and their production as a result of their work seemed very similar (please, report himself every worker in a factory who knows the real content of the "mysterious" productivity!) and these countries were acknowledged as parts of the West - were eager to catch up with their fellow Europeans. (Own a house, buy a new car, travel abroad etc.) Although tight fiscal policy - especially in Hungary - was promoted as a means of preventing people to spend more then they produce, the integration of the European financial system led to other consequences: people borrowed money they were not earning or receiving through social transfers. We know the result. But maybe both the FDI fuelled economy and the overspending from foreign credit can be structural similarities more important than the differences of the tex system. (Not to mention that those arguing in favor of the flat-tax model in Hungary still use those subtle nationalistic notions and arguments, pointing out countries traditionally seen contemptously by Hungarians, as having overtaken Hungary, in some cases without any basis.)

2. If the relegated position in the Europen integration (someone to the left from me would call it semi-periphery) is a common, structural factor of the ECE economies could the modification (let's call it reform, as those supporting this idea do) of the tax system really result in a long, sustinable growth and real convergence, as it was promised and predicted earlier? (Once it was quite popular to measure how long will it take to reach the per capita GDP level of the EU - on PPP basis, of course - either for Hungary or for its fellow competitors. It was prophesized that 10-15 years is a realistic assumption, with a flat tax system.) Didn't this crises revealed the limits of this model as well? The complete dependence on resources from outside, that can be depleted almost immediately, the abundance of which is hardly to return soon. Can the catch up be realized without profund change in the structures of the economy, a substitution of the industrial sectors based on finishing products, like car making industry, for knowledge based sectors?

3. This question is especially important as the demographic prospects of every country in ECE are very bleak. (Surprisingly, Hungary belongs to the countries with a relatively better future, at least according to Eurostat predictions.) In Latvia drastic drop (30-40%) in the available workforce is predicted in ten years, and on the long run it is forecasted to be a univrsal phenomenon in ECE. The situation is aggravated by the fact, that - contrary to the assumptions of the supporters of flat tax-based competivity - the progress regarding employment was more bound to the emigration of workers than to the alleged positive effects of the lower labor costs on the employment rate. Plainly speaking, the present economic model as it is based on lower labor costs could have a side effect of pushing out a considereable part of the workforce from the country, and their return with time is far from being granted. More pointedly: it is possible that the advocated model uses up the resources of future economic growth even faster then the usual process of making debts and clearly not able to contribute to slowing down the negative demographic process, not to speak of stalling it.

+1 Well, this is the reason of writing the whole post: did anyone, advocating proposals developed many years before the crisis tell us how the future economy, after the effects of the crisis will settle, how it will be reshaped? Will their ideas be really appropriate for those circumstances, especially as the crisis certainly has proven one thing: ECE's integration into Europe is too far-gone? The answer can be dismissive regarding profound changes, but in that case I would expect from those championing this model not to answer with a wholehearted 'no' the question whether the economy will be the same after the crisis as it was before, as they are doing at every occasion.