Saturday, December 26, 2009

Random thoughts at the end of a long year

I have to admit I faced a much easier task at the beginning of the year, when the events of the crisis were dominant in the public sphere and easily bound to a coherent narrative. With the pressure - at least seemingly - lowering on a series of countries the picture became more distorted, while some states earlier seen as almost doomed now are considered as almost exempt from the consequences and new countries joined the group of economies in a concerning state. Most notably Greece and Spain. However, Hungary, Latvia, Romania are still considered as basket cases. And some surprises at the end of the year are worth to pay attention to.

The Constitutional Court in Latvia ruled that a core element of the austerity measures of the government trying to meet the demands of the EU and IMF, the cut in the existing pensions is void. Moreover, it has to be repaid until 2015. Although politicians reacted with disappointment, the prime minister even stating that the country would simply go bankrupt if the authorities obey every legal provision, the issues goes in a sense to the heart of every so-called economic and social reform from the last few years. The Western model of state is based - at least nominally - on the rule of law, providing the society with a stability of rights and obligations. The CC in Riga simply decided that pension expectations - anchored by law - are such obligations of the state that can reasonably be expected to be fulfilled by the state. The rule of law idea has been chosen as a pillar of democratic society with a good reason and historically its neglectment led to very severe consequences. This time the government will also try to comply, but there is an inherent contradiction between the preconditions of the agreed loan and the constitutionality of these measures. The economic policy implied by the agreement is thought to be the optimal way to deal with the crisis, but the legal provisions - and sometimes the lack of political support and will - are an objection on this road. However, after mass-scale experiences with a system in which every aspect of life was submitted to the perceived needs of the economy and at the same time economy was considered as the area of society that determines everything else it is hard not to feel reservations. And now, after the collapse of the above mentioned system, we are in an era where exactly the same is happening, this time invoking democracy. (OK, socialist systems also perceived themselves as democratic ones.) The earlier experiences didn't really confirm that submitting the society to economy is a good idea, without reservations.
It is clear that rule of law, especially in times of rapid changes not necessarily equals sustainability of a society and the rules sometimes have to be accomodated to the changing environment. But the ruling could remind everyone that so-called reforms, however bright those ideas seem, need democratic legitimacy and popular support, otherwise, only acting in the name of some kind of rationality they can led to surprising consequences. (Not to speak of how irritating can be the view of technocrats praising measures that diminish the standard of living of everyone but them.)
Otherwise the ruling could raise another important - and for the time being clearly neglected issue, the distribution of the burdens of the crisis and the coming period of adjustment. Especially as two quite contradictory views confront in this regard. The dominant perspective - at least in ECE - sees elderly, inactive people only as burden on the shoulders of the active members of the society and this way justifies the confinement of their social benefits to a minimal level. But the crisis was mainly caused by the excess borrowing and consumption of the active groups of the societies, they were the front runners of consuming beyond possibilities. (At least I presume that more active people got FX loans than pensioners.) And the cut in social benefits - especially with a determination to save those loans from effective default - is nothing else then putting a burden on those who were less responsible for what happened and who would have a chance to regain some of their losses during their remaining active life, while pensioners can not really hope for recovering their losses. One can argue that governments has a very limited room for maneuver and it is true as a general assumption. But especially in cases of low redistribution systems the pose - taken by governments - of the guardians of the (would-be) middle class interests is rather a defence of the interests of the very wealthy, whose income and property is untouchable, at least it taxation is an anathema with the reasoning that it would reduce entrepreneurial incentives. It is maybe the case, but even in this case some moral principles could be taken into consideration. But as long as we have very few data on the disposition of the wealth of those at the upper end of the income scale it is a mistake to presume unconditionally that they invest every additional cent and every piece of their existing property in productive enterprises. Why? Didn't they invested in real estate funds, hedge funds, specific financial products linked to exotic financial indices and derivatives etc.? Would it be more reasonable to think that instead the wealthy - who were always proud how sophisticatedly they manage their wealth compared to the ordinary (“kádárist) people- the pensioners fueled those financial enterprises?

It would be easy to think - and one must admit it is also quite popular - that this greed of some individuals was the structural reason behind the crisis, but scrutinizing the situation more closely one should conclude that unfortunately we are all behind this situation and not only because taking loans irresponsibly was a widespread phenomenon. Moreover, this issue is also connected to the problem that in this crisis companies are less ready to absorb losses with reduction of profit. In an ideal and traditional world of capitalism, characterized by family enterprises of many generations the company is the property of a few people who occasionally can decide to take losses for a certain period and reduce profit. It doesn't necessarily mean that they would do it, but they certainly has a choice, at least as far as they can fulfill their financial obligations to lenders and to the state. From a different angle it means that even though profit is still the main driver of enterprise it is easier to resist immediate action for preserving profitability in times of hardship. But this world of the Buddenbrocks or Morels is in principo less biased towards immediate layoffs than the present, where very an ever growing number of companies has more and more nominal proprietors as shareholders while in fact the management make decisions, the only expectation is to provide shareholders with higher and higher profit. Moreover, the personal income of managers is bound to profit rates, but profit is more and more the result of the rising price of the company's share instead of production. Anyway, it is a logical decision to concentrate on keeping profitability high even in times of crisis and the only means is to cut back production costs as much as they could be aiming at a relatively high profit ratio.
It would be easy to assume that this is still a game that is advantageous only for a small minority of a society, but as social security and services (most notably pension systems and health care) became gradually - and sometimes only partially - privatized the high profit rates are in the interest of everyone who has social insurance as well. As soon as company profitability collapse more people would be hit than one would initially assume, just because pension funds invest in financial products either directly into company shares, or indirectly. In this system social redistribution rate is lower, instead of taxation long term profit yields personal security and stable living environment. But it makes people increasingly dependent on the success of financial companies, maybe exactly because only high profit rates that can only be achieved on these markets can compete with effective redistribution - at least as long as demography do not intervene.
Beyond these considerations there is the problem of financing companies' production. Once again in the traditional and ideal world it is based on direct credit links to banks (many of them also private companies, properties of a limited number of individuals), while modern finance brought about a huge change. Direct financing from the market - issuance of shares, bonds etc. - became more popular. However, this reorientation not only meant an easier access to savings, but a profound change of the traditional way of financing the economy. (Once again in an ideal world.) Savings placed on accounts at banks, borrowed by companies thoroughly scrutinized by those financial institutions and re-payed with a modest return on capital, resulting an equally modest percentage of income on for the initial savers. The increasing importance of the direct financing from the market offered higher profit for individual investors, while production itself lagged behind returns of investment in financial assets. Savings were distracted towards financial markets in a growing proportion, quite logically.

This issue also leads to the problem of sovereign debt and sovereign default, because the privatized systems - although with certain restrictions - channels the savings from the state bonds to other financial products in order to gain more profit, compared to the low return on government bonds. Nowadays sovereign default is considered as a horrific perspective - one of the bigest issues of 2010 - although there were more complete or partial one in the histroy than one would except and the consequences - if it happened in a regulated way - were not always catastrophic. Just to mention a recent example from ECE: Poland defaulted on its external debt and it lasted fro years to achieve an agreement with its creditors but at the end it didn't hampered its development after the change of regime, Romania instead payed back almost literally every cent in the '80s with serious social consequences, Hungary tried to manage its debt for almost three decades with more or less success, but today one of the most important limitations on its economy is the sovereign debt. (And yes, even the US defaulted in fact on some of its debt during the Great Crisis, but as it was well managed it was not a very spectacular event.) However, sovereign default, if it is not well prepared and managed, a very unpleasant event, therefore governments were moe inclined to use inflation for effectively reduce outstanding debt in the past. It also gave a chance o place some of the burdens on the lenders, as inflation hurted them as well. However, with the strengthened independence of central banks and the limitations on direct issuance of money it is more complicated today, even if a country is capable to borrow in its own currency. Markets are too alert to inflation risks and as soon as they suspect it the price of issuing government bonds can easily rise.
But one of the causes of the crisis is the existence of excess liquidity in the world and up to this moment central banks, financial authorities and governments were only successful in replacing it but not effectively reducing it. As long as this excess liquidity remains it is hard to imagine a really stable and sustainable financial system. One way to reduce it is nothing else then write off even in the form of sovereign default. Or more precisely regulated write-off is the alternative of sudden and unexpected sovereign default.

But not only reduction of liquidity would be necessary to really stabilize - and not only repeat the earlier cycle - the world economy, we need stable state finances as well. Sovereign default s looming over our head because state finances proved to be very fragile and facing the crisis almost none of the important economies had reserves to spend. Instead government debt amount and ratio to GDP soared. The usual recipe for this state of affairs is cuts in budget spendings and tax cuts in order to reignite growth. However, exactly the story of the last one or two decades shows that the usual mixture of tax cuts - spending cuts and reforms were not capable to ensure fiscal stability, they even became a factor in the instability after the unheard fiscal stimuli. Just look at Germany, where politicians try to keep electoral promises in forms of huge tax cuts, but sovereign debt is predicted to skyrocket in the next few years. The usual mixture is never really aimed to build up reserves, but to keep the state finances on the edge of managebility, due to popular and business pressure for more and more tax cuts. Maybe it would be more reasonable to modify this approach, as the last few years, with a series of significant tax cuts in Europe riding with the tide of the credit bubble created growth hardly can prove that lower taxes will necessarily result in an upswing of revenues later. Especially as consumption is far from recovering and the environment is hardly promising for investing in production.

The ideas and reasoning above is clearly not all-encompassing and it is only designed to deal with such aspects of the problems that are usually not in the forefront of the discussions. It is not claiming to be universal and sole solution, it's aim is only to highlight that these problems are interconnected with other issues, equally significant for a society. However, one conclusion is clear: democratic societies shall take into consideration these aspects as well and democratic decisions, upkeeping individual and collective freedom can only be made with regards to these besides the sole economic factors. Nevertheless, in a crisis it is hardly the task to distribute surpluses and gains, it is all about distributing the pain. In a righteous way.

No comments:

Post a Comment