Why not?

The crisis of Hungary and the drama of the EU – for a brief period separate from each other and the former even resolved at least in the imagery of the prime minister, Viktor Orbán – suddenly got bound to each other very firmly. Not only was the complete dependence of Hungary's economy on and from the European declared, but the unfolding crisis of the eurozone absorbed Hungary's fate last week, at the meeting of the European Council. The issue of whether the prime minister blundered diplomatically or not in Friday morning is significant only in a strictly Hungarian context as a possible demonstration of the governments rapidly diminishing capacity to handle politics and governance, not the first sign in this sense and hardly the last one. But the whole French-German plan bears utmost significance for the country as well and poses some questions concerning the governments confused reaction too.

The interpretations of the council's declaration pointed out at least four important aspects that should be considered from a Hungarian (and more broadly from an East Central European perspective). The proposed new fiscal stability rules can be seen as the end of (or even the outlawing of) Keynsianist economic policies. Furthermore, some argue that a fiscal union following the German blueprint of re-balancing through austerity can bring (or just aggravate) the present state of economics close to depression and bring about a serious challenge to democracy. The latter means that crisis stricken countries, among them Hungary, certainly have to reconsider their place and chances given the restrictive economic environment. But the plan is far from being unproblematic from a pro-European perspective too, it proposes an incomplete transfer union without proper governing bodies and democratic representation, reviving (or even enhancing) the never eliminated complaint of democratic deficit in the EU.

But with all of these issues that certainly should not be neglected or treated in an off hand manner, the Hungarian reaction was very curious. While the government portrays itself (and is selling this idea to its European partners at every occasion) as the champion of far reaching reforms, fiscal prudence and stability, hails itself as the only country that will achieve a budget deficit within the limits prescribed in the Maastricht Tretay, it still failed to sign to a new treaty that will only enshrine these self-proclaimed objects of national pried. Even if its boldly announced aim is to transform the country to the most (or most recently, from today one of the most) competitive countries in Europe , and one that can compete with China. Quite in line with what the Germans are blamed for, trying to make everyone German as a panacea for the crisis.

So, why the restraint? There is an obvious explanation, sovereignty. It means power and as the new fiscla riles and most notably the way they would be enforced would curtail the sovereignty of the parties to the new treaty, the government is not quite willing to hand its power to a European body or accept trusteeship of Germans and French. Especially if it still believes in its vision of a West in decline and an East on the rise. However, even if such considerations certainly played a role in the decision not to accept the new treaty (a position later softened to consulting the parliament on this issue) there is one valid point hidden in all of the verbal camouflage: is it possible to create a fiscal union on the proposed line without hampering or tacitly eliminating democracy? It is not only about the way the Greek and Italian premiers were replaced – seen by many as a plot of mysterious capitalists and foreign politicians –, but about the German plan's content: constitutional fiscal rules that could – in case of a suitable interpretation – ban fiscal stimulus and enforce the further dissolution of welfare institutions. Not that it would be too far from the Hungarian government's aim. It is frequently declaring the end of the welfare state, a new era of work-based society instead of one based on social benefits. But according to its interpretation this process is the result of the rise of the East, an industrious, demographically growing world, whose success can be followed only with its own measures, hence the insistence of gaining competitiveness vis-a-vis China.

But if one considers the process of how the welfare systems were rolled back, it is hard not to see other factors, intra-EU developments behind it. Most notably the insistence on market based investments in ECE after 1989 as opposed to institutional based ones. It meant a competition for investment even into social systems and as in every case investment could be attracted with the fastest and safest return on capital and with the fattest profit. The subsequent necessity to cut welfare systems as there was no need and way to finance them resulted not from the competition from the East but from the competition among new member (and accession) states.

From the above diagnosis one can conclude that some EU-wide measures would be beneficial for the members states in the sense of reducing the pressure on their present welfare systems and societies. Such as a harmonized tax base (part of the German proposal), that would reduce (or probably eliminate) tax competition in order to attract investment. With envisioning more significant reforms of the EU's architecture – in the longer term – there is the possibility to harmonize and connect – and later merge – certain welfare systems, such as health care,, unemployment benefits or pensions. It would alleviate a huge burden from some crisis stricken countries, like in Hungary's case 1-2 billion EUR would certainly reduce the dissipation of medical personnel. And as such changes would require a larger and more flexible EU budget it would make it possible to enact fiscal stimuli even if the member states adhere to the strict fiscal rules proposed. But it needs new political structure, with real political representation and responsibility, an enhanced role of EU instiutions in governing, not (only) intergovernmental action.

But as if such a situation wouldn't be complex enough, internal developments in Hungary makes the country's position even more complicated. Authoritarian tendencies transforming a functioning democracy into an illiberal one at best; a „visionary” economic policy, a mixture of classic nineteenth century capitalism, catholic social thinking from the thirties, neo-liberal dogmas like tax competition and flat-tax, and nationalist protectionism results in an unpredictable and growth restraining voluntarism; an overestimated potential of the country coupled with the belief in national peculiarity, all of these manifested in utterly misguided action and failure to recognize real constraints for the country, ultimately leading to a return to the earlier decried IMF as the only potential source of financing for the next years.

Manoeuvreing between political constraints abroad and a sense of omnipotency at home (given the governments 2/3 majority and its ability to change the constitution according to its will in days) was channeled into an attempt to completely rebuild the state. As a result next year Hungarians have to face not only the expected economic hardships (declining real wages, stagnating, probably even growing unemployment etc.), but the possible chaos brought about radical changes in the structure of the state. (Reducing local self-governments to a minimal role, building a centralized public instruction system, drastic reduction of higher education, centralization of pub,ic administration hitherto enacted by local self-governments etc.) The government during its eighteen months long tenure showed rather incapacity to carry out such sweeping changes, resulting in frequents delays compared to the previously announced deadlines, window dressing without real changes, frequent reversals of earlier measures (the most telling is the example of minor taxes, the government in an attempt to reduce red tape eliminated 10 of them, but in a year introduced another twelve). Nothing happened according to the plans outlined, everything was in a permanent delay and confusion and the deepest changes are still only in the phase of legislation. Not to speak of illusory ideas, like a restructuring of the disability pensions and benefits system, with a failed plan to reconsider the status of almost 400 000 people in six month. Meanwhile the lowest levels of state administration became highly politicized, party commissaries installed, essential systems are underfinanced (health care, education, administration) while the budget renounces significant potential revenues (progressive taxation, a progressive property tax etc.) But there is no EU-wide resolution of the problems on offer from Hungary, neither an attempt to fight for preserving what was left from social equality and cohesion. This fight is not for the greater good of the community – or only in a weird sense, for the greater good of a non-existing, imaginary organic nation –, but for the power of a government sliding into authoritarianism.

The irony of the situation is that the government – while deluding itself that so-called unorthodox measures (windfall taxes etc.) do not mean austerity – creates exactly the same self-generating and self-intensifying cycle of austerity that can be expected from the German plan too. Its followers – and its politicians – still think that it is just temporary, a kind of transition, with the rebuilding of the state finished amelioration of the situation is in sight from 2013. However, given its impact on economic growth and the proven inability of the government to provide effective governance the fight for sovereignty can easily end in a catastrophe. German style austerity carried out while the state simply dissolves. In the face of this prospect – and it is the irony – even a strict, closely monitored IMF-EU program can be favorable.  

Self comment on the previous post

Maybe soemone who has read this blog carefully will obstruct my previous post that earlier I was no friend of banks and suddenly taking an issue on behalf of them can only be the expression of political bias. In order to clarify this (but not denying some political bias, anyway, why should a blogger be unbiased, it is supposedly a very personal genre) let me present my opinion. Firstly, banks are not persons, therefore they could not have virtues and vices and banks as such can hardly commit sins and deserve punishment. Any reference in texts claiming that banks has acted one way or the other is a simplification and a pars pro toto. Banks are instiutions managed by humans, and these humans obviously can be judged even for the morality of their handling of business. However, at the moment, In Hungary these humans should not fear any punishment, it is pardoxically reserved for non-person without the free will that is the basis of any moral judgement. Furthermore, these humans are defended, their income taxes (note I'm speaking of those who run these banks and not those who work at the local bank subsidiary in the cashier's desk) were cut and - implicitely, but logically - they are always included in that virtuous group of hard-working people who were obstructed in their work by the previous, progressive tax system - at least in the fantasy world of these politicians. So, if there is at all someone who deserves punishment it is not the instiution, but the humans.

Secondly, and it is in a way a logical consequence of the above outlined problem, banks as institution can hardly be substituted for anything else than banks, whatever name they will carry. If they were driven to excesses - as they surely were -, if their payment schemes encouraged reckless behavior and ever growing taking of risk through the innovation of new finacial means to distribute these risk around the world then they need regulation, better control. But this is not the same as recklessly punish them with enforcing on them huge losses. Someone malicious could even say that anyone, even the dumbest, can punish the banks but only a few clever can regulate them properly in order to avoid the recurrence of such excesses. Because the banks, be them the good, old family banks or the new investment empires are essential for the economy. The immediate effects of the credit crunch in 2008 (when the flow of capital was frozen in a moment and the economy stalled) and the visible effects of the present reluctance of banks to lend (slow growth, even in Hungary, 0% q-o-q, 1,5% y-o-y in the second quarter of this year after two quarters with y-o-y growth above 2%) prove this very basic truth. It was obvious from the start of the crisis that there will be losses and the main issue will be the distribution of these losses. Not only according to abstract ideas of justice and fairness but according to the very practical necessities of the economy. I was always in favor - not that my opinion would carry any weight in this issue - of strict regulation, limiting the bonus schemes of banks and brokerage houses, dividing banks into retail and investment ones etc. But - however painful it is for my moral and political convictions - I tried to be always aware of the fact that the banking system has to be put in order with the help of the public. Unfortunately not too much was done in this regard and even these meagre achievements were - at least in Hungary - undone by the new government.

Frustration, failure, voluntarism

Hungary is still only a secondary front-line of the renascent crisis, not among the headlines and for a superficial observer (i. e. for most of them) it could seem justified. Although the slippage in this years budget (and the obvious: the flat tax was not capable to stimulate growth) could warrant some worry, the government is imitating action at every negative sign, this time announcing 100 billion HUF correction measures. Hardly credible (enhancing tax collection makes 40% of this amount, and a freeze on government purcheses another 40%) and hardly structural, but it didn't really disturb analysts. Not even the news that the execution of the Széll Kálmán-plan (the bouquet of austerity and supposed reform measures planned to bring 550 billion HUF savings next year and about 900 billion until 2013) suffers from serious slippages, and exactly at those fields from where the government expects the highest savings could shake the belief in these guys. They can at last claim that the government is devoted to the deficit figure and ready to apply new measures if necessary. (I would really like to know how long would they bosses at their banks tolerate if they would announce that they had managed to failed to achieve the planned profit in the first eight months of the year, but they are very committed to the planned number and are ready to make corrective measures.) Anyway, it was hardly the sensation of the week, especially in the light of the government's even harder commitment to the flat tax.

But the end of the week brought back the memories of last year, when hardly a week passed without events and announcement testing everyone's heart and patience. It turned out that something was cooking (besides the books) in the witch's kitchen run by the government, a new plan to save the fx-loan holders.

Well, the malicious will certainly point out that as a complete program with this aim was already implemented and started two weeks ago it was even more short-lived than this year's budget, another object of pride of the government. But as one of the reasons the government came up with this new idea was the not qiite spectacular success of the original program (there was no opportunity to show long queues, praising the government in the TV) it is worth to be mentioned. The other reason behind the new plan – at least in my opinion – is the complete failure of the flat tax and the resulting frustration with the economic policy. I'm sure they attribute the lack of internal demand not to the fact that the new tax system was a tax hike for most of the population and it favored the segment with the least marginal propensity to consume, but to the spiking mortgage rates due to the CHF based loans. I fear it is telling regarding the mind-set of the government that facing the obvious collapse of the whole of their economic governance they decided to stimulate their original stimulus, instead of changing the pattern of redistribution. (Furthermore, they will cement in this tax system with a two-thirds majority law.)

What is the problem with the proposal? Firstly, it is its aim: to „release” the income of households in order to make them spend more on consumption. Secondly, the set-up of the plan and the parameters applied. Not only is there a few evidence that the weakness of the forint was the main reason of the weakness of domestic demand* but it fails to address the major problem caused by the fx-loans: the effective fixed excahnge rate of the HUF. As long as hundreds of thousands has fx-loans the country can not devalue because it will immediately harm, cause pain to millions. But external devaluation would improve export competitiveness faster and with less pain (mainly thorugh import generated inflation) than the internal devaluation (austerity) executed by Fidesz. However, the government only hopes to bring redemption to a quarter of the 1,2 million households with fx-loans with their plan to enforce a conversion of the loans at an exchange rate of 180 Huf (50 forints weaker than last Friday's close), signaling that they do not really want to get rid of the effective peg in order to curve out more room for manoeuvre for the economic policy, but to fend of the popular pressure.

As for the second problem the plan lays the whole of the burden and the losses on the banks. However, the balance sheet of these banks is already full of hidden losses due to the non performing loans and the loss of value of the real estates serving as collateral fro these fx-loans. As long as they can keep their debtors afloat they not necessarily can declare these losses and they can manage „only” with setting up appropriate reserves. So, they can hope – and in this sense their interest is common with their debtors' interests – that at the end these loans will be payed back according to schedule and they can release the reserves set up to cover projected but at the end avoided losses. However, as soon as they are forced to accept the conversion of these loans (or the repayment in one sum) at 180 HUF exchange rate they will realize huge losses on these loans that has to be covered. According to preliminary estimates it can be as high as 1100 billion HUF. It will effectively force them to recapitalize. Even if their owners (Western Banks mainly) will provide them with the necessary capital – that is far from being certain – they will certainly try to find as much foreign capital as they can for this purpose. One option is to freeze lending and use the capital to cover losses. And on the long run they will certainly pay close to zero rates on deposits, as they won't need to accumulate capital this was because they won't lend. (There is of course the secondary effect of losing confidence in Hungary. As this move would be most probably illegal, violation of existing contract by a third party without interest in these contract, violation of property right and that way unconstitutional and against EU law if the government implement it it will be equal with the declaration that no investment and no property – remember the private pension funds! - is safe here.) Anyway, it could bring the banks to the decision to withdraw – gradually or even abruptly – from Hungary. It will certainly cause further reduction in lending and tighten already very tight financial conditions. And such events are rarely beneficial to economic growth, something the government desperately wants to deliver.

As the plan is clearly not part of a coherent one on how to free the Hungarian economy from constraints from which it can be disentangled it is hard to see how it could lead to positive result. It is not aiming to the solution of the most important problem, just for short term political gains. (And it is the expression of frustration as the information on the discussion in Fidesz's caucus suggest. The most important supportive argument against the objections of the more restrained members was that the banks caused this whole mess they should bear the whole of the burden.) Not that there wouldn't be place for an orderly and well balanced solution to the problem. There were even plans proposed by bankers. And even if those were rejected with the cooperation and advice of the IMF and the EU (and with their loan) a kind of bad bank or special financial vehicle could be set up in order to clear the bank's balance sheets, convert the loans and that way achieve simultaneously the re-ignition of bank lending to the economy (that was already constrained by the huge implied losses and the subsequent frenzy to collect enough capital to cover these probable losses) and the lifting of the burden of households. But it would obviously end the economic war of liberation so proudly waged by the government.

*According to the data of the Office of Statistics retail sales grew in this year m-o-m and y-o-y as follows:

               m-o-m        y-o-y

January     0,9% and   0,9%

February -0,3% and   0,1%

March     -0,5% and -0,9%

April       -0,3% and -1,2%

May         0,5% and   0,7%

June        -0,5% and -0,5%

Meanwhile the CHF-HUF exchange rate fluctuated between 220 and 205 HUF in January, between 203 and 214 HUF in February, between 201 and 214 HUF in March, between 200 and 210 HUF in April, between 204 and 221 HUF in May and between 214 and 228 in June. Funnily, retail sales declined in the month when the CHF was weakest.

Scholars of humanties will save the world?

Yesterday - at least as I see, without any qualification and only intuitively - was a fine example how the psychology of the markets work. At the start almost every stock exchange plunged, almost a free fall, but they soon began to recover, most probably on the back of expectations that the FED will announce new measure to boost the sluggish US economy. The expectations ranged as far as the immediate announcement of quantitative easing adn what happened? Well, nothing. The FED reiterated that they are aware of the problems, just as they were earlier, they will keep interest rates practically at zero, just as it was for a while, they will pump back their profit into the financial system, again as it is happening even now, and of course they will consider anything that can help the economy. None of these measures helped to stop the deterioration so far, and to expect a different outcome for now would not be too logical. An none of these measures is new in any sense, not to speak of being surprising. Or did anyone honestly expected the FED to raise its rate in the face of the slump? (Just because today's hedalines speak of markets rebounding due to FED's announcement of keeping rates zero.)

Thus, the FED did not change course, while the markets were expecting something new, that could steer the world economy in another direction. The initial reaction were as one would expect: sell-off at the stock exchange. But, curiously, after some time euphoria settled and the markets rallied. Given what happened it is counterintuitive at best.. Market participants were waiting for the announcemtn of radical changes and what they receieved was the announcement of no change at all. Initially they reacted asthey should, but somehwo reconsidered their position and began to trade like the FED would have given them what they had expected. Instead of the usual market-bashing probabyl it is better to draw some conclusions.

It is not words that matter - sometimes instead of deed - but only how they are interpreted by actors on the market. Even if what they have heard was the opposite what they longed for they could still reinterpret it as if it would be the much desired news. But there is still a delicate case here: it seems words of financial institutions are more or less unintelligible for their audience and it confuses them, This time for the better - leading to positive evolution of the market -, but it can easily turn out to be the opposite. And this is the point where scholars of humanities could have a significant role in ameliorating of the workings of the economy. Who else are in a position to make a thorough textual and discoursive analysis of the words of financial institutions. Probably with a wide scale reserach project every statement and every interview of the respective central banks and their leaders should be collected and alaysed in order to determine the real meaning of words and phrases. And as personalities in the financial world change it would be a never ending story. But with the help of these scholars the markets would have a dictinoary or theasurus of the central banks enbaling them to undertsand their statements immediately. Funny, it seems the markets needs translators and they will collapse without the help of those useless humanity scholars.

August again, leaders on holiday - what about a new Marshall-plan?

Not that it would be a typical one, with almost unbearable heat, slowly radiating from the walls of houses and even the shade of trees not offering relief without the breeze. And I don't believe in theories that for some mysterious reason August would be a month dedicated to and the most suitable for catastrophic events to happen. But after another half a year of "it is a strong recovery, fundamentals are OK, everything will be perfect, only those profligate Greeks should make themselves more accommodated to the inevitable decline of their living standards and work more" narrative suddenly the whole world seems to accept that we are on the verge of absolute collapse and disaster. (So much for the rationality of markets. ;) ) Well, according to the most capable economic leadership in any country of the world Hungary is a safe haven, China will defend it from anything that would happen. But otherwise, the world is doomed. (Just look at exchange rate and the bond yield curve of the last days, no sign of Chinese buying Hungarian debt at least not with discount.)

In a sense it is undeniable, but - I hope for many - not exactly the events are the most worrying, but the apparent lack of any kind of leadership and ideas, what to do and how to act in order to avert the worst. What we only have is a renewed argument whether neo-Keynesians have it wrong or not, whether we should eliminate deficit now and at once or not, whether tax cuts will bring the so urgently needed growth. But as the events unfold no one seems to make an attempt to exert control over them. Those, who are supposed to be leaders, are just gaping at the incoming storm. However, even if sometimes the situation seems to be the contrary, it is lack of invention and new ideas that lies at the root of the sudden outburst of the crisis, everyone hoped (and thought) to have buried very deep. As the debates show the faith in the capacity of the states to act is shaken but there is no other entity to turn to in distress. To leave it for the market is a good idea but it would surely be suicide. Sovereig default would certainly bring down banks and companies, wiping out their - real or imaginary - wealth and resources, and of course individuals too, leading to the - at least temporary - death of those very markets we should turn to. The markets would like to see the states resolving the crisis, but abhor from most of the solutions offered. As long as the present crisis is seen singularly as a competitiveness issue - and not a lack of sufficient demand in the world- the markets will demand more and more austerity, leading to even less demand and so on. It is certainly a delusion from the recovery that the possibility of growth is associated exclusively with competitiveness as if Say's law would be unconditionally true. Despite the fact that in the light of recent revelations the performance of some economies in the last more than one year was probably driven by Chinese and US quantitative easing, creating a favorable environment at the emerging markets. Probably it is really not so easy to accept that extreme high German growth was not something given because the Germans are industrious workers but because there was demand somewhere for their products. (Even if the significant slowing in the last months would suggest otherwise.) The problem is that as long as the demand side is not really taken into account no one is really ready to accept: austerity might bring about the classic deflationary spiral.

Furthermore, the addressing of the international imbalances, the rebalancing of economies has not even begun. Even in Germany with its vigorous growth internal demand remained suppressed, and show only modest strengthening, while the German industry  has till not reached its peak output before the crisis. Not to speak of the other major and minor economies. According to the last IMF report on China even the authorities accept the necessity to direct the country to a more balanced economic model, with better social services, comprehensive pension and health care system, cheaper social housing, all costly and serving as automatic stabilizers but hopefully enhancing internal demand - for imports as well. With the turnaround of emerging economies the developed one could probably better rely on external demand, making plans of debt reduction based on exports via growing competitiveness more realistic, and not only them: there is the Eastern periphery of the EU too. Anyhow, one thing is clear: reform and spending cuts are no quick fix for the problems and even if there would be capacity and determination to implement them at once it would need a lot of time to change the course of those economies and generate growth that would make debt reduction credible.

Unfortunately there are complementary problems concerning the possible resolution of the crisis, structural ones but this time not on the labour market nor in the tax system, but at the very heart of economic governance, and well beyond the all-too-known issue of the Eurozone being a monetary union without a fiscal one. These structural problems mean serious constraint on the possible path of action for politicians and central bankers and accompanied with the lack of imagination makes the successful escape from the crisis one of the least possible outcomes.

The classic panacea for debt is threefold:

- faster growth

- austerity

- inflation

and these are often interlocked and interwoven.

The austerity is only viable in a benign and favorable international environment; when growing export markets offer a substitute for weakening internal demand fast enough to avert a long lasting economic slump. In case of an independent currency the fastest and easiest way is devaluation, otherwise harsh cuts in production costs are needed (and austerity to make it credible that the declining budget revenues won't lead to soaring deficit) and thus the restored competitiveness would enable producers to outbid their rivals. However, at the end the whole process could turn out to be a classic beggar-thy-neighbour policy, reducing cost in competition forcing others to do it and making gains in export at the cost of others and not as a result of a expansionary economic environment.

In order to avoid such successes being short-lived sustainable faster growth at the end needs more demand from somewhere, therefore the first option is very much constrained by the international environment again, if there is no opportunity to generate internal demand. Thus the present economc situation  is anything but favorable to these options: no chance of a devaluation as it is either impossible due to the lack of own currency or due to the practical peg in currencies of countries where significant part of individual, corporate and state debt is foreign currency denominated. And with a markedly slowing world economy - according to some it is almost certainly will be in recession in the second half of the year - there is no internal demand to rely on while austerity wipes out internal.

There is of course the third option - inflation. Most of the debt problems in the last century (actually even before that) were eliminated with this option. Whether it is fair or not, it is an effective way to reduce debt-to-GDP ratio and reduce the value of claims on the state and on the individual as well. Not inflation indexed debt will soon lose its real value when facing 4-5-6% or even higher inflation with negative real interest rates. The problem here is twofold: without the chance to devalue (that is inflationary per se) it can only be achieved by issuing money (and/or directly monetizing debt). But money issuance is usually the privilege of Central Banks that are independent of government, exactly for this reason: not to let the latter monetize their debt and inflate away the problem. 

There are of course psychological factors here in play too. Many fear - and it is not unjustified - from high and protracted inflation as it can be very destructive and usually distributes the burden unfairly across social groups. Furthermore it can push upwards bond rates, just aggravating the sovereign debt situation, making the financing of a country more and not less harder. And there is the much dreaded phenomenon of stagflation, when inflation fails to bring growth and while prices are soaring, the economy still flatlines. So, even if it can really offer a solution - as recently the IMF's chief economist, Olivier Blanchard suggested - it requires desperation and leadership and it can probably achieved only at the price of giving up ideas like the independence of central banks. (As it would need the revocation of their independent right for setting rates and issuing money. But as an ultimate solution at the edge of complete disaster it is still an option - an option that also needs time, at least a bill should be passed in parliament.)

There is of course a substitute for inflation, implemented in the last years too, quantitative easing. This time the central bank pumps money into the financial sector, either buying assets - sovereign bonds etc. - at the market. It is presumed that this money will find its way to companies who want to invest or to individuals who will spend it, because the more money is circulating in the system the less constrained are the banks to lend them. (In a sense it is again Say's law...) Sometimes it works, but in the last years it only had some unintended consequences and perverse effects: a rally at the emerging market stock exchanges and soaring commodity prices, at the end not enhancing the capacity of individuals and companies in the respective developed economies to spend more, but reducing it. The problem lies in the method of pumping the money in the system: through the intermediaries of banks. For companies, As long as demand is sluggish and existing capacities are underutilized (which is certainly the case now, when even Germany has not reached its peak output again) this is just cheap money to reinvest in financial assets (or in cae of a tax cut it is just additional profit).For the individuals this is not necessarily welcome. Those, who are deleveraging (i.e. paying down their debt) the main concern is not how they could take more debt on themselves, but how they could earn more money to pay their monthly rates. (And again: if it would be a tax cut, it would most probably be spent almost immediately on existing debt.) But the main problem - especially in declining economies is to produce something and sell it. (However, it also can be a problem for a rebalancing economy. For example if the US would need to export more and import less in a drive towards a more balanced economy then they also would need to produce something and sell it.) And the main reason they are not doing it is lack of sufficient demand: there are still underutilized capacities, internal demand is suppressed by austerity, external demand suffers from the end of cheap money at the emerging markets and consequently from the slowing of the global economy. So, the task for politicians and economists is twofold: they must ensure that money pumped into the economy is used to purchase - in a very broad sense - additional products in order to make output growing. And the main obstacles they have to face are: fears of sovereign default even in case of economies with an own currency (thus there is no room for fiscal stimulus); and fears of inflation (thus there is no room for monetizing debt).

At this point I’m not claiming that I would be more imaginative than our leaders. But reading Tony Judt’s Postwar made an embryonic idea growing in my mind. If states need to circumvent the obstacles of the markets who perceive every non-conventional action to lift internal demand as dangerous, while conventional action accepted by the markets was proven ineffective then what to do? It is clear that somehow money should be given to companies in order to make them produce, to individuals in order to make them buy goods… Actually something resembling of the post-war Marshall-plan can be a daring attempt but maybe not doomed to fail.

In case of the Marshal-plan goods from the US were transported to the participant countries according to their wishes that were based on plans. These could be consumer goods, investment goods, commodities etc. Usually the US delivered and paid for it, from its own treasury and the receiving countries used them. Either fed the population or built up infrastructure or plants etc. But it always created second tier effects in the receiving countries while it pumped money into US companies – who otherwise would have to face the rapid decline of military orders. Something similar could probably allow distressed countries to invest (in plants, infrastructure, services, human capital, education etc.) and thus generate not only income for their population but lay the foundations of later exports and ensure a healthy level of new orders for companies in the donor countries. (The Germans are planning something on a much lower scale in Greece, but with not much haste and with too old-fashioned methods: offering investment chances for companies.)

There are of course risks and institutional problems as well. Everything should be well-planned and at least moderately effective, i.e. there is no room for huge misallocation for investment, a reason to implement good planning, just in case of the Marshall-plan. Furthermore, few states can be the donors directly, as it would only make their debt grow. But there are ways to bypass these last obstacles. Not only would it be desirable to extend the program to the world (as a means to help addressing international imbalances and rebalancing of economies) but it would distribute the risk very broadly, Furthermore, there are institutions in the world system and in the EU that could implement such a program: the two reconstruction banks, World Bank and EBRD. For example if the EU would decide to issue Eurobonds – and they wouldn’t immediately pass on the money raised to distressed countries – they can place it into a huge reconstruction fund and finance the new Marshall-plan in Europe. They have to capitalize with it the EBRD and then let them coordinate the planning. afterwards the Germans and French can deliver the goods – paid from the fund - to the Greeks, who could earn their wages while using it or selling it or buying it… And the money would at least cover one and a half transaction and not immediately sucked up outstanding debt.

It is far from being an easy and elegant solution and it would still require a lot of human effort. It depends on the capacity and ability of a lot of individuals. But at least it offers the elimination of the main obstacles in the way of a lasting solution and addresses a real problem and not an imaginary one.

Rewind?

With the events of the last few weeks one can easily think we are back to the gloomy days of early 2009. Unfortunately Marx’s famous dictum, everything in history is staged twice, once as a tragedy and again as a comedy, proved to be wrong. The tragedy of East-Central Europe was followed by the tragedy of South Eastern Europe: Greece and the unnoticed one, in Romania. The former literally collapsed (even if in an orderly way), one cannot perceive the measures adopted otherwise. The latter were and is on the verge of collapse, with decisions unheard of earlier taken. (25% cut in the wages of the public sector, 15% reduction of the pensions, closing down half of the existing hospitals, new taxes introduced and an overall tax hike is still not excluded.) Unfortunately no one will really revise his/her earlier views of the country as a rapidly emerging one, albeit the social costs of these measures (and coupled with the drying up of financial transfers from abroad, from workers in Spain, Italy etc. the economic ones) will hardly positive. Even if in a sense they were unavoidable.

Meanwhile, there are no signs of a vigorous recovery in the Baltics, where the strategy of internal devaluation – underway in Hungary, began in Romania and Greece - was fully implemented and hailed by some observers. Moreover, the  Estonian economy – seen as the first to emerge after a series of good signs in export – slipped back in the first quarter f 2010, albeit technically not in recession again. This is not spelling too much good for the new patients.

But the real problem is that it is still not certain that the decisions announced by EU politicians last weekend (a new bail-out fund worth between 500 and 750 billion euros) is the last act of the drama. First of all it is worth to remember: Europe stood here once, 14 months ago, when the idea of a 180 billion fund for the ECE countries – floated by then-prime minister Ferenc Gyurcsány was brusquely refused, most energetically by Angela Merkel. (Whose government, due to the problems I outlined in earlier posts suffered an important setback at last Sunday’s provincial elections in Nord-Rhein Westfalen.) It is not sure whether that amount would have been enough, but in a less strained environment, financial actors less focused on sovereign debt issues, it would have had a chance. Now – calculating with her share in the Greek package – Germany alone has to offer this amount.  And no one knows, whether it will suffice or not. Especially if the „markets” wake up from their excitement (driving them on Monday to exaltation) and realize: the offered solution is twofold and not exactly what they would like to see. It includes intensive monetisation of sovereign debt (something abhorring for monetarism, but a widespread practice throughout history) and bringing increased danger of inflation. (Albeit many, among them Paul Krugman, argue that under the present, deflationary circumstances this is not something one should be afraid of.) The other downside of the offered solution is that it is nothing else than issuance of new sovereign debt by countries already seen as heavily ladden with debt. (After the derivatives of the mortgage playing a role in the first phase of the crisis we can see the creation of sovereign debt derivatives – with what effect?)

I fear at the end the world have to accept the plain fact: the bubble has to be deflated and at the losses have to be distributed somehow, not just transferred from private books to state households. It will be painful, in the form of debt restructuring (in an orderly way) and probably through inflation and affecting everyone as a lot of savings and wealth of ordinary people were accumulated in financial vehicles and it will be accompanied by lower present day and possible future living standards. But at the moment the solution of taking over these debts by states seems not working in the long run and eliminating the burden with vigorous growth –while addressing competitiveness issues will need keeping costs( i.e. wages) as low as possible therefore dumping local demand – will eventually pose the question of where to export?

(Inflation is painful and can easily run out of control. But this process was underway for almost a decade, only outside our books. Anyway, the bubble blown on the financial market was the very sign of inflatory pressure, or even the inflation itself. A very dangerous, self-sustaining one, as the rise in share prices (less supported by growth output than by profit) was a form of inflation. Only as long as this mass of money was kept outside the „real world” its existence was not reflected in „real prices”. But why not apply some concept of inflation to financial market as well? Couldn’t it be a model case for inflation?)

 

Anyway, the new wave of crisis arrived, after more than half a year of restful period. Meanwhile the political landscape in Hungary was completely transformed (just as it was predicted on this blog when Gyurcsány resigned, with the painful campaign…) and we will have a chance to see the new government (pompously describing itself as a new regime born from a revolution) dealing with these issues. Hopefully they will be a bit different from their newly found ally in Romania, where the politicians (often implicitly portrayed as the courageous ones, compared to Hungary) postponed hard decisions and now have to announce a package they didn’t want. But they are almost immediately ready to give in to popular pressure….

 

And probably – If the events will speed up – I will return to posting…

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.

Shameful self-promotion

Just a link for those who can read French. The topic is quite fitting, although the story of this piece is still a bit strange for me.
Lost in Transition? Here is the pdf version.

The typical ECE blindness - Hungary, an "oasis of stability", according to a Romanian business newspaper.

It is really hard not to laugh loudly or weep equally strongly. Ziarul Financiar published an article on Hungary,praising the efforts of the government and even stating that now the country is the most stable in the region. The article is a kind of exemplary of almost everything I have complained at these pages: wishful thinking, promotion of particular interests camouflaged as general ones, posing as well-informed even if it is clear that there was no real inquiry about the facts and the use of non-existent examples from the not-so-beloved neighbours in internal fights.
At the moment Romania is in a political chaos (for foreigners with a modest and secure income it is just a tolerable place), and the business elite proposes solutions putting the whole burden of the crisis on the population, especially on the lower social groups, not accepting any kind of personal loss, moreover even striving for personal gains in the form of further tax cuts. As something similar happened in Hungary in the last few months it is an obvious choice for giving examples and that way the exaggeration - the most stable country etc. - is comprehensible. But there is almost nothing to support this claim, besides statements from the Hungarian government, what is a dubious proof anyway. (Which government facing financial hardships would eagerly admit that their efforts brought moderate results and the seemingly better situation compared to the one a year ago is more a result of the growing risk appetite of the "very efficient" markets than that of thier own efforts.) Moreover, even the mesures listed in the article as the causes of this sudden but well deserved change in Hungary's situation has not too much foundation. The Bajnai government is far from being a technocrat one (the Ziarul Financira obviously portrays it that way because the president, Basescu proposed a prime minister from the Romanian National Bank and this designated premier suggested that his government would have been a technocratic one...), the corporate taxes were not lowered, but slightly hiked. On the other hand a series of measures, however welcome by the Romanian business elite they would be, were not hepling the fiscal stabilization and even the claims attached to them and mentioned in the article - for example lower social contributions will help employers to keep their workforce - did not visibly brought the suggested result (look at the growing unemploymetn in Hungary that is only counterbalanced by government financed public work programs, and not the supposed positive effects of lower labor costs). Unfortunately, what Ziarul Financiar presents as an example to follow, a very desirable set of measures, even in the presented form, is nothing else then a receipe for making social divisions deeper, differences larger, redistributing welth from the botom to the top of the society.
And even the typical ECE negligence is not lacking from the text. Although Bucharest is not far from Budapest and ZF would be certainly capable to send somenone there and who could make a thorough eamination of the situation, hear different opinions etc., they rely on a short note of Bank of America Merril Lynch describing Hungary as the inevitable forerunner of the region! That's the part that makes me weep and laough simultaneously... That kind of pompous and carless behavior! What some guys far away say about a country after putting some basic data in their models is worth more attention, is a more thorough knowledge of the situation than the one someone from there, with some work could have synthetized. (Just beacuse these guys are sitting somewhere in the West in an office building? or because this case, exactly because of the lack of information an be portrayed as a desirable soultion - at least for a certain social group - for the problems at home?) Welcome to ECE...

(Well, shall I explicitly note that the respective article was already taken over by some Hungarian websites?)

Revival - shallow thoughts and campaign unleashed

I mean maybe this blog will revive. I'm not proud of neglecting it - although not deliberately - but sometimes there is no time, or if there is still some, than energy lacks. Anyway I made promises that remained unfulfilled, however, I didn't really find suitable topics to deal with as I was not convinced that apart banalities I could be able to express anything half-original. And only repeating what others already explained - I would spare myself from this kind of self-promotion.
Nevertheless, at the moment I'm in the middle of a savage electoral capmaign, the prize is the seat of the president of Romania, among the contenders we can find Mr. Basescu, whose economic talent was many times highligted at these pages, the president of a the so-called social democratic party, Mircea Geoana, a liberal candidate, Crin Antonescu, the eternal challanger, Vadim Tudor, the extreme nationalist, a literate Hungarian, a poet, Hunor Kelemen. The first three are the serious candidates, the others can influence the result but has no real chance to become head of state. Not that it would be a welcome job, I suspect. Romania, even half a year ago portrayed in Hungary as a rapidly emerging country that will overtake its western neigbor in three or four years, is now on the verge of collapse. Not only had the budget deficit soared - it is predicted to reach 8% of the GDP - and the economy declined, but at the moment the favorite theme of politicians is the lack of the necessary revenues to pay public officials, teachers, justices, nurses, medical doctors etc. The IMF delayed the next part of its credit until a new and stable government will be established.
One reason beind is the campaign itself. I'm even not convinced that the situation is really so dire as it is portrayed, because politicians are clearly seeking the way to put the responsibility for the failure on their rivals. Therefor everyone maneouvers, tries to snooker its opponent(s) and somehow convey the image that if the salaries for next month really won't be paid out it will be their opponent's fault somehow. And as the president - whose party was left alone a month ago by the social democrats as sole government party - can not easily distance himself from the problems, he clearly tried to frame the situation as if only the IMF money would be available for the state. And the objection of the social emocrats to install a knew - minority - government of the presidents party is the only objection in the wy ofn this part of the credit.(It is evidently cheaper, but the Romanian government borrowed continously in this year from local banks huge sums and with a growing risk apettite at the markets even the doubious CCC credit rating wont easily deter "investors" from buying Romanian government bonds.)
But this is only a minor aspect of the crisis and I fear none of the candidates - and no one from the economic elite - is ready to drew the very sober conclusions from the crisis: the model of the recent years at last failed to delver a sustainable growth and it is not easy to imagine that it will in the future. However, every proposal is somehow a repetition of this earlier economic policy. (The social democrats try to mix it with some populist measures, higher salaries, lower prices fro public services etc.) Romania, a realtively poor country with a huge population depending on social assistance due to the lack of employment lived primarily on the remittances of a large guest worker population (at its peak they sent almost 10 billion euros to home in a year) and made it easier for its population to take credit with the help of lower tax rates. (Nevertheless, Romania's tax system was neither simple, nor really low, but the rational and efficient and etc. markets and their even more rational and efficient actors was simply not capable to grasp it, because they only had some very superficial informations...) Although the country attracted some investment, a large part of it went to the real estate sector and real estate prices skyroceted. Just as consumption with them. (Bucharest is quite similar to Latvia in the outlok of its cars and it is striking how many prestigious companies have a shop somewhere in the city. For example Cristophle closed its shop in Budapest after a year, while the Bucharest branch still exists...)
Anyway, it stopped with the crisis, and now people began to feel the harder times. The proposals for reviving the economy do not seem to be far reaching enough: austerity, cutting of social spending (it is usually called better targeting but please, don't tell me, that someone with 200 euros in a month as regular income not deserves some social assistance...) and cutting jobs in the public sector. The latter can be reasonable but the country was never really capable to create jobs, the record low unemployment was simply a result of the emigration. Now the migrants are returning and public officials will be laid out... The problem, unfortunately is the poverty that do not allow domestic consumption to be the driving force of growth. Even not with tax cuts - a liberal proposal - when they would deliver people 20-30-40 euros per month. (This is one of the weakest points of every tax cut ideas in ECE: with a realtively low wage level local SMEs orieted towards the domestic consumers can not raise their prices for services too much. People simply do not have enough money to pay 15 euros for a hair cut after spending the lions share of their income on houshold costs and food.) But the perspectives are not bright, with a rapidly shrinking and ageing population and with the necessity to export more... Romania faces either a very long and protracted struggle alone, offering low wages in order to attract investment in export oriented sector or ... don't really know. With the strain of the crisis slowly withdrawn the chances of a profound change - a turn from a state level regulatory and social system combined with supranational free market towards a supranational level regulatory and social system combined with supranational free markets - seems less and les probable. The aging and poor ECE countries will remain entrapped.
Otherwise the non-political proposals are sometimes even worse. "Economists" analyzing the region from a macro perspective - I'm still stounded seeing how easily they preceive that they are omniscient after putting some basic data in their models - can not really tell what would be the way out. The language and discourse of these actors is shallow and contentless, full of empty signifiers and not a single world with real content. They simply repeat phrases, like structural reforms, tax reforms but at the moment they even not dare to give details. Just phrases. And it is always hard to get rid of the feeling that it is completely immoral: to make such unelaborate proposals (while only onething is certain: in essence they mean the worsening of the situation of the social groups at the bottom of the society) from well-paid positions... Even if it is demagoguery, I can't help to think of it.

Recovery everywhere - why to be scared?

Back from a long summer recess, although the lack of posts recently was not due to my activities (however overburdened I'm am with tasks and responsibilities) rather the lack of impulses and events. One could have seen a rising tide of good news (maybe even the favorite color has changed from green to a more ripened one), a series of countries posting positive growth figures for the second quarter (quarter-on-quarter, in yearly comparison it is rather pathetic) and economic sentiment soaring almost everywhere. As the latter is considered to be a so-called "leading indicator" (i.e. signaling in advance the trends of the respective economy) further economic expansion is expected in the coming month. The change was abrupt, and rather peculiar. While only a half a year ago (almost) everyone forecasted that the world is doomed, now (almost) everyone is prophesizing that our torture is already ended or it will soon end.

Where are the queues? - Impressions from Latvia

If someone would like to visualize the Great Depression of the last century - the one that shaked the world between 1929 and 1933, with far reaching consequences - the first images to pop up would almost certainly be those monochrome ones with horrified people incredulously looking at the headlines or each other, incapable to grasp that a life's savings were lost literally in one moment, or the ones with peoples in ragged clothes queuing in front of a kitchen for the poor, hoping for their daily soup. Not that it was necessarily the general appearance of that crisis, but poverty, misery, hopelessness is dominant in its memory, and somehow defines our visual perception as well. Black and gray, shabby places, rags, dust and dirt.

In the last week I had the opportunity to visit Latvia and travel a bit around the country as well as in its capital, Riga. The primary aim of this journey was not to collect experiences from the middle of the crisis, it was a quite ordinary trip, at least it was simply a kind of holiday, even though our host proved to be an extraordinary one. But anyway, it is almost impossible to forget about the circumstances and the experiences and discoveries of a traveller, however vague, contourless and obscure they could be, will be measured against the background of the present economic misery. Even though if one is aware of the problems with such experiences, the usual behavior of foreigners either to miss the deeper context or to perceive a given place in a stereotypical, often contemptous way or admiring it without real basis and placing it in an uneven and unequal relationship with one's own country.

At the moment the first impression of a superficial traveller would be that Latvia is quite a normal place, where the signs of the crisis are still not visible. Thriving nightlife in Riga, shamlessly high prices, tens of thousands of young people at a pop-rock festival, middle class Latvians making boat trips, German, Italian etc. tourist groups do not signall the inevitable collapse or at least extraordinarily painful adjustment suggested by the economic data and commentators.

The signs of the problems are there of course, we spent our days next to a newly erected residential area, where only one flat from 280 had tenants and after some days spent in the country someone will inevitably make a hint for the spending cuts affecting people, first of all pensioners. But the crisis was not an everyday topic in the circles we were fortunate enough to move in, and even among those who mentioned it - besides those, who addressed the substantial issues as well - some people were speaking of it as being exclusively the fault of reckless banks lending money for those who are not capable to repay it. There was no explicit despair, feeling of the inevitable end etc. Latvia was rather colorful - vivid green, white sand, paler blue sea, yellow, blue and purple flowers, deep blue of blueberries and slowly reddening cranberries in front of the background of harsh green mosses, red bricks of the churches in Riga, light blue, yellow and shining white buildings - not the grey and black. (Ok, dust exists, but it wouldn't be ECE if just next to the National Theater one wouldn't find a shabby road with a dust covered tramway track :) )

Of course any of these observations (better to call them impressions as they weren't the result of any thorough examination or discovery) are only superficial and have no broader relevance. They can at best be anecdotal evidence, nothing else. And there are clear signs of the boom-bust economy, almost everyone uses a car at least one category higher than would be affordable according to their income compared to the "West", BMWs, Audis, Lexuses, Volvos, Mercedeses are running on the roads (otherwise infrastructure was not a favorite destination of money for investment, at least as far as I could have assessed), real estate prices were in an incredible height etc. But on the whole, up to this moment it is rather a pleasant crisis, still nobody really hurt, far from the apocalyptic imaginations. Not that it can forecast anything relevant for the future, it is just a single moment, frozen for eternity...

Detruisez l'Autriche-Hongrie - reloaded?

Indivudal states - as entities and historical individualities - are not eternal ones. A significant part of the world's and Europe's sovereign entities are relatively newly established, and many of the seemingly resilient ones went through phases in the last hundred years when their existence and/or sovereignity was in doubt. It is quite clear in the Eastern part of the EU, where every new member state didn't exist 150 years ago (or at least not in their present form and as sovereign states - for example Hungary or Romania), many of them was established as independent nations after the WWI but ceased to exist between 1939 and 1944, while others emerged as new "powers" of the region. The realignment of ECE happend again in 1945-1947 and after 1989.

The important point is that the present configuration of this part of the continent is not necesserily an eternal, given one sanctioned by thousands of years of history, or a divine action: it is a reasult of the collapse of greater frameworks of states, empires and would be nation states. Those who are familiar with the region's history will almost automaticly associate to violence, war, armed attacks on neighbours after reading such an introduction, especially after the rise of extrem rightist (and extreme nationalist) forces at the election for the European Parliament. But my only concern was to highlight that states can collapse, fail and be dissolved due to the circumstances. Some of them is simply collapsing, as its institutions can not control its territory, others' endgame begins at the fringes, with the loss of efficiency of the state administration and with the emergence of alternative powers at the local or regional level, others simply implode due to their incapacity to fulfil its tasks and responsibilities towards its subjects, and these factors can coincide with each other. But, although in many times a kind of external impact - in the form of war, crisis, presure from a great power etc. - plays an important role in it, the internal incapacity (impotency) of the state is almost never lacking among the factors behind such developments. And - as it is a lesson from these events - even the largest and seemingly quite stable formations can be dissolved very rapidly, at an astonishing pace.

Maybe we can see similar processes at the fringes of the EU today. Countries, struck by the crisis, without room for manouvre and having lost a significant part of their state revenues, compelled to follow prescriptions of great creditors who rushed to their aid and bailed out them, are in more and more dire situation, as they are forced to cut down their public services. The budget cuts in Latvia are affecting the public instruction system, the health care (for example certain surgeries will only be available for clients of foreign helth insurance systems from the autumn, as the Latvian helath care will cease to finance those for Latvian citizens), maybe the police, the judiciary system. In this case it is the result of accross the board budget cuts, but other examples exist in Romania or Hungary as well. In the latter the state financing available for hospitals was reduced significantly and only the reduction of their services could lead to some balnce in the expenses and revenues. (Meanwhile the cuts in the contributions of employers and employees to the health care budget will significantly worsen the financial situation of the health insurance system.) In Romania the lack of funds is almost everywhere, but it surfaces quite sporadically, either in regional or in sectoral terms. According to press reports one county tribunal will be closed in August due to the lack of financing, the salary of judges will be cut with 1/3 of it (in a country where - accoding to the EU's assessment - corruption is in full bloom, and the state is incapable to act against this phenomenon decisively), in many cities there is not enough money to open the schools in September etc. Although the government insists that they will provide at least the necessary basic financing, it is far from being certain, especially as Romania has to comply with the conditions of the IMF and the EU in order to receive the individual tranches of its huge loan.

Not that it would be exclusively a fault of the external world. The Latvian government is desperatly defending a currency peg from an eventual devaluation (and from this perspective salary cuts in the public sector are lying on the road to "internal devaluation"), the Romanian is caught between electoral promises last fall, an uneasy coalition of "social democrats" and "conservative liberals", an alliance for Romania('s wealth), really aimed to divide the resources of corruption among them, and between the coming presidential elections, while in both countries the "econimc miracle" of the last years was "financed" with low taxes and growing consumption - based on loans and loans and loans, leaving no buffer for a case of crisis.

But the most worrying development is concerning the future of the EU. The predictions - forecasting problems in the coherence of the eurozone - are not ceasing, while the handling of the crisis highlighted the deficiencies of the inter-governmental approach in times of crisis. The reluctance of the Germans to develop a real common perception of the crisis, to allow European institutions to act independently (although those never has shown much willingness to act that way) although comprehensible, was certainly not benefitial. And as Wolfgang Munchau points out: after the Constitutional Court's decision on the Lisbon Treaty everything will be even more complicated. Even in the field of common economic policy. Not to speak of facing the real problems, the incapability of ECE in the long run to dael with its underlying social problems and with the impact of the demographic trends without a common social policy. But if the slow dissolution of the East will continue it could easily reach to the heart of the union itself.

Crisis, but more than one? - Hungary

Well, on the one hand it is clear that at the moment the sense of crisis is receding (or only has receded?), "risk appetite" is growing, everyone is looking and seeing "green shoots" even though the data on real economy is at leats controversial and for more sober observers not really promising. (Just one example: the most prestigeous economic news and analysis website www.portfolio.hu published a news yesterday with the title: Incredibly good news from the real estate market in the USA. In reality although in a m-o-m comparison the data showed growth the level of new construction works was only the half of the same indicator a year ago and only at about a fifth three years ago. It suggests that there is a long way to a recovery and a similar GDP level...) But with the present mood hysteria is not so dominant as it was some weeks ago and it also means that there is not really much to write about. As if normality has been returned ...

Otherwise - at the field of politics - spectacular events happened, but they can hardly be called critical, except in Hungary. For the superficial eye a strong correlation between crisis and the astonishing appearance of a strong and neo-fascist party (in the sense the concept is used by Roger Griffin) and the collapse of the center-left governing or majority parties would be obvious. But to treat the phenomenon in a so simplistic way would be misleading and a self-delusion. It's rather a sign of a more profound problem - if one whises, crisis - the huge divides in a country and in a society, accentuated by an economic and social model that was - as it is clear after two decades - incapable to bridge this gap and give at least hope for a fifth or quarter of the country. Incapable, although the model was once implemeted in a very servile way and later with more reluctance as well, in order to cushion the measures. The consequence: means relying only on market and imagining the solution of social problems in a market oriented way failed to deliver the opportunities for well defined geographical regions, quite the contrary, it led to a deepening difference between those areas and the more developed regions of the country. For example as in the early '90s the per capita GDP of the Northern Hungarian county Borsod was at almost 75% of the national level, today it is well under the 50% percent treshold, although investment in a material sense was not scarce in the last decade.

If one would like to sum up this process from a point of view of social history (or historical sociology?) it is quite similar to the process of spreading of capitalism into rural communities, at least in Hungary. The emergence of a capitalist economy in the 19th century was hardly a singular act, rather a long process, starting from certain centers and slowly diffusing into the countryside. Not only in a geographical sense, but in a social one as well. Even if one can detect a kind of enterprise or entrepreneurship in distant villages it is many times confined to individuals or a small fraction of the population. Meanwhile other models of the integration of localities in a capitalist market (world market) emerged and prevailed, like a strong cooperativist movement, wich were capable to preserve (though in many times in a transformed way) the earlier methods of running a local community and at the same time integrate this community as a whole into the broader framwork of a market. The socialst solution for this problem was surprisingly (or unsurprisingly?) similar. Integrate the rural communities around a heterogenous company, dealing with agricultural and some kind of industrial production and using extensively the labor of the villages in this process, while allowing some leeway for the individuals around their homesteads and imitating a kind of self-governance in this company (cooperative).

But after the change of regime - due to the reemergence of some political forces who's program contained the total restoration of agricultural property to those who owned it before the collectivization and due to ideological opposition to the socialist cooperatives as remnants of a failed system and compromised political power, a new model emerged, based on the gradual concentration of the landed property in the hands of a few who were capable to use state funds for investment in machinery, therefore reducing the demand for labor, and in remote areas even this kind of restructuring fell off, leaving there small communities with ageing populations and urban immigrants from the lower social strata at the fringes of capitalism, many of them belonging to the elargest ethnic minority, the rroma. (In many communities money is scarcely used, credit is given by the shopkeeper in forms of listed debts, work or commodities used as payment etc.) And in the last decades there was no sign of market mechanisms intruding in this space and transforming it... There is still a living memory of a rural countryside with opportunities and regular work and a sobering experience of present-day realities. (One can list other problems, unskilled workforce or people with obsolte skills, uneducated population, lack if iniciatives, ideas, capital etc.)

Quite telling is the fact, that under such circumstances no ideas of more active state policies were promoted, only the private initiative was emphasized and recently it took shape in the idea to implement the "bank for the poor" in some form, but not with state intervention, based solely on the finacial means provided by some charitable businessmen. And meanwhile public works are condemned as useless... Those are the regions, where radical opposition of the system as foreign and alien to Hungary scored good results and in some cases even electoral victory, revealing a more specifically Hungarian crisis, that is accentuated by the global one.

(P.S. It is no consolation that I fairly well foretold this political outcome, at least the collapse of the majority parties. Also I'm not relieved by the fact that I've found someone from Latvia who shares my concerns that the present policies can only lead to the abolishment of the state...;) )

A new migration period? - Fears and future of the East

The fear from a mass immigration from the East to the West was always prevalent since the EU accession of the countries in the region became a certainty. Its intensity never really diminished and it surfaces again and again, even though the recent years didn't proved it. For a certain extent quite the contrary happened, the migration was beneficial for both the destination and the country of origin, at least in the short term. But as the intention for migrating is not lower than it was some years ago one can consider it a structural phenomenon in the architecture of the EU, at least for the time being, and with lasting impacts on both the integration and the respective countries.

The main source of and reason for migration from the East to the West is very simple: the possibility to work and earn money, more than it would be possible at home. For a while the system is beneficial not for the countries receiving the wave of migrant and benefiting from the relatively cheap labour, but for the countries in the East, where the bulk of those who try to make a new fortune in the West invest their earnings and savings. Mainly in real estate, but a part of them even start new enterprises as well. But there should be one underlying assupmtion in order to preserve this behaviour: the huge differences have to became more moderate with time and that way enable he migrants to return home and live on their earnings there. (Well, again I know that the whole phenomenon is more complex...)

As far as the accession countries are concerned this last, important precondition was not realized yet. Although for a moment it seemed that soaring wages in some countries (Poland, Romania, the Baltics) can somehow attract the emigrées to return, it proved to be artificial. The raise of wages without the corresponding increase in productivity hurted the competitivity (it was caused by shortages in labour), while the flow of migrants was turned back (at least partially) by the effects of the crisis in the West, that led to the loss of low paid jobs, in a large proportion filled by migrants from the East.

Up to this point it is a rather an ordinary story with ups and downs and I'm not really keen on putting forward the issue of migration and migrants in that context. My aim is to emphasize the structural importance of the phenomenon in the
EU and its significance for its future. As the main reason behind the movement of labour was the huge differences between parts of the EU in a sense it was nothing else than a way to handle the tensions arising from the fact,that the market in Europe is much more integrated than the economic policy and the social systems. While the respective countries in the East were compelled to race for investemnts with relatively cheap labour and it meant low taxes as well, the inflow of money from the West was the only way to raise the standard of living significantly, not only for those in the working age, but for those in the pension systems, as the income for elderly peaple was ridiculous and terrifying at the same time in many cases. On the other hand the migration was in effect a way to deprive those countries from a considerable part of their workeforce, and even if it was not necessarily deliberate, it was an inherent consequence of the accession and the architecture of the EU.

The real problem is, that the countries in the east, even now struggling with the process of ageing, having no good prospects for their future composition of the population in terms of the ratio of active and inactive population are not in a position to make investments in sectors with higher additional value of labour, and there is a fair probability that they will be trapped in this process. They can't provide their population with even the minimal social security (there are countries with an avarage pension at around 100-150 euros per month!) and they could only rely on the migration and the resources sent home by those working in the West. On the other hand migration diminishes the reserves in workforce and soon leads to labour shortages resulting in the raise of wages, unsustainable in terms of competivity, and/or immigration into these countries, very probably leading to social tensions. Moreover, in order to keep the remaining workeforce throgh investment they should provide further tax cuts for companies investing in those countries, eiher for lowering the cost of labour or in the form of a low corporate tax rate. It is almost certainly a vicious circle.

On the other hand migration is not necesserily means of making those countries even poorer subconsciously. The migration can be a way - in this case also not necessarily deliberately - to compell member states to set up a kind of common, or at least harmonized social security system. For the time being migration was only prevalent among those in the working age. But it can evidently lead to the complete failure of the new member states what is a pressure on the whole community and on the other hand there can be a second wave of migrants, this time elderly ones, who are discontent with their situation and perspectives in the respective eastern social security systems and who has a right to settly in the EU anywhere. (Anyway, cynically speaking, as long as the politicians from the West and the Commission urge the Eastern countries to rein in social expenses it also implies that living on 100 euros per month is possible and decent, in compliance with the values of Europe as being an ever growing area of prosperity and therefore the 100 euos pension should be regarded as enough to settle in any other country.) If such a pressure would arise it would simply turn the process, this time the east not exporting the benefits of migration, but the negative effects, and not only in terms of budget expenses, but in terms of social tensions.

It is not a predestined story, of course. But it is certainly among the possible outcomes of an integration where there is no will to resolve the largest divides between new and older members. And as the integration of the capital markets benefited - maybe disproportionately - the older members, the integration of the labour market (more precisely the principle of the free movement of people) could benefit the new member states' population, although in a very peculiar way, clearly distoring the initial intentions behind it.