The Great Economic Experiment

For a while I was convinced that Fidesz's action plan is just the result of confusion and lack of time, that's the reason behind its incoherence. However, probably it is a more refined action to achieve the elbow room they wanted. As one of their basic slogans in the campaign was the end of "traditional economics" they decided to prove how problematic its basic assumptions are. This is an experiment, an empirical test of the Ricardian equvivalence, or at least one of its underlying basic assumptions, that rational actors always presuppose later developments and act accordingly. (In its basic form if the government finances today's debt with borrowing taxpayers will expect tax hikes later and therefore they begin to save instead of spending. However, in a generalized form it suggests that rational actors act not only according immediate advantages and benefits but they consider costs occurring on a longer time-horizon.)

What did the Hungarian government in the last few days? They announced an incoherent package of measures with the aim to keep deficit at 3,8% of GDP and simultaneously boost growth through competitiveness. One that probably won't help to keep deficit under control with measures (see my previous post) and contains measures controversial in itself, like the introduction of flat-tax with countermeasures defending lower income categories from losing form their net income due to higher effective tax rates. One very definite countermeasure was the announcement of higher minimal wages. (According to rough calculations the necessary raise would be around 23% plus at about 4% in higher social contributions after the new gross wage.)

What happened after the government made this plan public? The package as a whole was praised by analysts in Hungary while received with more doubt outside the country. (It is worth to note that one cannot easily imagine more rational actors in economics than financial analysts.) The former category can expect a significant material advantage from the new tax system as they certainly belong to higher income categories, the latter are not affected as they are paid under a different tax regime. Up to this moment no financial analyst exposed the controversial nature of the tax "reform", especially regarding its effects on competitiveness. Neither was doubt raised regarding financiability of the tax cuts, even though the offsetting measures are vague and in their present form unrealistic. Nothing was heard from the associations of entrepreneurs, whose companies will be subjected to these changes. (And entrepreneurs should be rational actors, by virtue of being entrepreneurs.)

However, what we are looking at is contradicting to Ricardian equivalence and its basic underlying assumptions. Although it is probable that competitiveness will be suppressed by the higher wages leading to a result contrary to the will of everyone (and certainly affecting companies' profits), the hole in the budget will be filled with tax hikes affecting income later, people for whom the new tax system will bring immediate benefits support it, despite the prospect of negative measures later. They are not acting according to the Ricardian equivalence.

I think the whole action plan is an empirical test of economics. If the government can expose analysts and entrepreneurs neglecting the basics of rational expectations they can claim that the "traditional" economics really failed and ask for their well deserved higher deficit target. Why bother with the reaction of "rational markets" when they are proven to be irrational?

On taxation I.

As the elections in Hungary in April draw nearer and the result seems pretty sure - at least regarding the person of the next prime minister - more and more speculation appears on the probable economic policy of the next government. Some of these are driven by curiosity and goodwill, others rather by pure and badly veiled self-interest, but one thing is common these are speculations as long as no elaborate program is published. (However, I'm sure that no one will really have any idea until the government will take over its responsibilities and initiates the first measures, but it is not my point here to denounce any party's campaign strategy.) But the issue of taxes has a key role in almost every attempt, usually in the well-known form of the tax cuts = strong growth causality. 

The idea certainly has a popular appeal and precisely because it is so easy to assume that nothing else is needed for living better than cutting taxes. Hand over less to the greedy paws of the state and in return even your future prospects for higher income will be enhanced immediately, it is the perfect populist perpetuum mobile. But beyond this rather simplistic approach the issue of taxes is at the core of almost every attempt to revive economic growth and ensure its sustainabilty and not only in Hungary. Either in the form of tax cuts or at least as a restructuring of the system, placing higher emphasis on property and consumption taxes and relieving a part of the burden on labor as a means to raise the employment rate and improve the employment rate. (The underlying reasoning is quite simple: the only obstacle of employing more people is the high cost of labor and the high taxes as they are disincentives on working, especially when they are accompanied by generous social benefits. Therefore as soon as taxes will lower employers will hire people and those who were earlier reluctant to work due to high taxes will flock to the gates of factories. Everyone can judge this reasoning and think of possible supportive or counterarguments.) May point is not to challenge this idea - although I'm reserved at best towards this simple argumentation - rather I would like to focus on other aspects of the tax issue, like the real effect of tax cuts on personal income - as it is always assumed that it is positive for everyone - and the real nature of the restructuring, the so called "whitening effect" or the macroeconomic role of tax cuts or even tax hikes. All of these from the perspective of a layman, of course and without the pretence of being comprehensive.

Tax cut is a popular promise as it is too easy to assume that the lower the taxes are, the higher one's net income is. In a narrow sense it is usually true - and people even tend to assume the same for so-called restructuring as lower tax rates has an immediate and direct effect on net income level, while the offsetting measures are many times hidden, not to speak of the tendency of the individual to take into consideration the positive perspectives and perceive the negative ones as applying only to others - but taken into account a series of direct consequences this assumption is highly questionable and certainly would need closer scrutiny. (Apart from those idealistic views that postulate a self-financing tax cut, the result of which is a stronger economic activity bringing even more revenues than the earlier system. But it is one of the basics of science that perpetuum mobile is impossible, so let's not deal with this nonsense.)

It is easier to assess the effects of the tax restructuring, as its aim is not to lower the overall level of taxes. The basic proposals - always based on study how the different types of taxes affect economic activity - advises lower taxes on labour costs (in general, not only lower income taxes, but lower social contributions paid by employers and employees as well) and higher ones on consumption (usually VAT, but other taxes connected to retail too) as less distortionary and on property. The effect of higher income is certainly imaginary for a lot of affected people, as the higher VAT immediately offsets a part of the raise in net income. But the effect is different for the different income categories, depending on the consumption/income ratio and the savings rate of the individuals. Those whose consumption makes a higher proportion of their net income will suffer more. It is hard to tell how far this measure can offset the results of income tax cuts, it can be different in every individual case and depends on the reactions as well - scaling back consumption can offer some relief - but the usual assumption is that the lower income categories are hit harder as the weight of basic goods and services (foodstuffs, energy, transport) is usually higher in their personal consumption basket and these are the ones where the possibility for considerable savings is the most restricted.

Not surprisingly a similar effect is detectable in the case of the property tax - in most cases a real estate tax - a favorite choice for many experts. The supporting arguments are usually practical ones - it is impossible to hide a house while it is easy to do it with income (so everyone is guilty of tax fraud, isn't it?), it is easy to tax them and it is in line with social justice as richer people tend to own more valuable properties. Albeit these arguments do not seem to be quite solid ones - for the market value of a real estate depends only in part, sometimes even marginally, on ones own activity - but my aim is to highlight its effect on the reality of income tax cuts. For most people their house is the only or the far most valuable piece of real estate their own and only a very few has capital return on them. (Beyond the advantage of not paying rent for their homes.) Therefore they can only service this tax from their income from work or labour (or in some cases from other incomes, however in case of many countries the wage is the dominant form of personal income for the bulk of the population.) As soon as the real estate is not used for some aim to yield return the property tax becomes in effect a hidden income tax. (Or even not so hidden if someone presume that it is a tax on the indirect income of being free of rental costs for housing.) But in both cases it is a tax levied on earnings and not on capital returns. Nevertheless it could have merits, for eyample a redistribution of wealth, bringing back capital to the economy etc., but it offsets income tax cuts and in a very arbitrary way. Due to the low influence on the market value of one's home, due to soaring real estate prices during boom years and protracted, many times incomplete correction in worse years. And due to the fact that in several ECE countries the ratio of real estate value to net income is probably higher than in many Western countries. It also means that the offsetting effects are different for everyone and only general assumptions and hypothesises can be put forward without a thorough analysis, but one can safely assume that a property tax can easily hit not only the lower income categories, but the middle-class, depending on the home value/income ratio. (The much advised solution to make a property tax deductible from the income taxes could eliminate the effect on the middle class, but wouldn't resolve the problem for lower middle class people and for those in the lower income categories. And selling one's home is also not necessarily a solution, because it would only capitalize a hidden income - the lack of home rental costs - in the form of a financial saving and the loss of income would only be avoided if the newly emerging rental costs would be covered by the return on this capital entirely.)

But these are almost explicit implications of the tax restructuring approach, although not necessarily recognized by those who would be affected. (And the problem of the effect on different social categories still persists, it can easily turn out to bring advantages only to those in the higher income categories.) However, the income tax cuts has a very similar offsetting effect, as long as they are not self-financing (and I would dismiss this assumptions, at least in the short term, because I try to assess the immediate effect on income) or not financed from new sovereign debt issuance. So, one can assume that tax cuts are accompanied by spending cuts. If these are not confined to the laying off of unnecessary public administration personnel (a phenomenon certainly existing, but the extent of which - and conversely the extent of the savings offered by this usually popular move - is hard to guess)  the implications will be higher implicit or explicit costs for public services. (People will either be charged with a higher sum for these or will be obliged to buy them from private entrepreneurs instead receiving them from the state on a lower price etc.*) The first aspect of this offsetting effect is the inflationary one, higher explicit prices for public services will drive the CPI upwards and they will remain at that level even after their statistical effect faded in the next year. (However, some savings can be achieved at the personal level by not buying these services, because earlier everyone paid for them a usually lower individual price in the form of taxes, while from this moment only those would be charged with a higher one-time price than the tax was who effectively would use them. But again it is not easy to make estimates regarding this effect and apart from the case of significant cost savings due to higher efficiency - or because of a more depressed demand due to visible an higher prices - the aggregate sum spent on these services would remain equal, only its distribution would be different. But its analysis is far beyond the means and possibilities of this blog post.) However, beyond inflation one can assume another offsetting effect, the effect of almost compulsory saving. Scaling back the state (spending cuts) usually implies the emergence and reconfiguration of systems like pensions or health insurance on the basis of self-provision. Even if it won't be obligatory legally it would be hard to avoid paying these contributions, because the cost sparing accessibility of public services would depend on them in case of necessity (classic health insurance) or they could mean the difference between a pension barely higher than subsistence level and a decent sum. However it is not necessarily a meaningful investment in the future, as it is rather a forced consumption and obligatory saving. (A kind of "békekölcsön" or "hadikölcsön".) And it has very similar effects and probably would have the perception as paying taxes. At this point the negative effect is more probable on the lower income categories, as for the higher earners, who even vefore the tax cuts had enough income to save a considerable amount, it is a meaningful choice between different risk-reducing strategies and investment forms. In general I would hypothesize that the effect of tax cuts - due to almost compulsory savings - would be only really positive in higher income categories and could even mean a decline of freely disposable income in the lower categories. And certainly surprise many from the middle class.

However, toothpaste advertisers will certainly drew our attention to a possible source of higher revenues, the "whitening effect". It is usually assumed that lower taxes will inspire people to legalize their earlier grey or black incomes, because - as this reasoning assumes - their incentive to hide it was only the horrifying nominal or marginal tax rate. (The implicit assumption of the "whitening effect" is the existence of a highly effective tax administration that can detect tax evasion with a high certainty making this practice risky enough to convince earlier evaders to accept the lower tax rate.) Nothwithstanding the sorrowful fact that the highest estimates of grey economies in the EU are usually produced for low tax level countries (Hungary is of course overtaken in this sense by Romania, Slovakia, Estonia, Latvia, Bulgaria, one can imagine the mood of our experts etc.) the assumption is not in compliance with the basic assumptions of the idea that lower taxes generate more work and with higher labour input higher growth. The main argument behind the reasoning that low taxes = higher employment (more work and more employed) refers to the willingness to work more if the income is taxed more benevolently. The favorite tool of measuring the effects of the tax system is marginal tax rate, i.e. how much can someone retain from one unit of additional income. However, if one considers black economy properly, it means that a significant part of one's income is taxed with a zero rate, therefore the marginal tax of grey and black incomes is zero. So the advocates of the "whitening effect" (while relying on psychological arguments, usually abhorred from if they are used to doubt their economic models) at the end state that people - contrary to their basic premises - will be ready to do the same work with the same intensity if their marginal tax rate will be raised. (And not insignificantly, as any natural number is infinitely more than zero ;) ) Therefore it is highly improbable that people will legalize their untaxed income, or if they do then labour input will decline in the economy, generating less output as the marked raise of the marginal tax rate  is a strong disincentive for work. 

Even if one dismisses this conclusion as absurd (I wouldn't be sure, people are usually not flocking to legalize their incomes even with lower tax rates as long as they are not really deterred by the high risk of being punished for tax evasion, but in this case - as it recently happened in Germany when someone offered for sale a CD with the alleged data of alleged tax-evaders - they usually do it on very unfavorable terms - i.e. high tax rates - as well) the extent of the cut in the income tax rates to unearth hidden incomes is not easy to estimate and certainly depends on the total income/grey income ratio. Because the higher one's illegal income as a ration of the total income is the lower his/her effective tax rate calculated on this total income is. Therefore only a more pronounced cut can bring enough incentive to legalize income. One can hypothesize that people with only occasional grey earnings will more readily pay some tax with a smaller cut (although it is not entirely consistent with the marginal tax incentive idea), while those who are in fact employed as grey workers - either entirely paid under the table or having officially a lower salary than they are receiving - will be convinced only by a very marked step on this route. This is not entirely hypothetic, as the main aim of these cuts is usually to convince the latter category- who are also conceived as the potential source of significant additional budget revenues. (Besides these rather automatic considerations one can also refer to the problem of labour costs beyond the income tax, social contributions and especially those that are paid for by the employer. Even in case of a significant tax cut these elements of labour cost can easily deter employers to offer a legal full salary, they can instead offer a splitting of the gains from the tax cuts - higher official salary with the same or slightly higher net income -, what would also be in fact a higher taxation of these grey incomes.) 

Anyway, one can safely conclude that tax cuts in themselves won't bring more freely disposable income for everyone. (It is important to note that one's income can nominally be higher, but with inflation, higher personal spending and almost compulsory savings the freely disposable income, the part of one's earnings that can be distributed freely into different consumption goods or directed into investment etc. can be even lower than before and ultimately this is what counts in assessing whether one is better or worse off after the tax cuts.) The effect of tax cuts can hardly be assessed in general, it should rather be done with the analysis focusing on different social groups, even though the macroeconomic effects are easier to grasp. But maybe for the individuals their personal fate has a precedence over macroeconomics, however shortsighted it be.

(So much for today, I will continue the analysis of the macroeconomic peculiarities in the next post.)

*There is always the possibility of magical savings due to higher efficiency of private providers, but the empirical evidence for this is controversial at best, therefore I won't make an attempt to guess its extent.

Hungary - once again left behind

For years the idea of Hungary having a unique and unparalleled crisis, that could not happen elsewhere was a dull, repetitive syntactic element of almost every commentator's opinion. Reasons were easy to find: nowhere was such a bad government identified, no society was more attached to its socialist past, no politicians were so fearful of losing elections, no country so corrupt. But at least, being the worst among every ECE country was a mazochistic consolation for supposedly having lost the forerunner position. (However, I have many times bored my few readers with this topic.) We even had and has our own, specific and particular crisis that was caused by our own government. (Yes, even today.) 

And now the world or the fate again turned against this small and much-suffered nation and with the effects of the crisis on state-households slowly, gradually but pronouncedly unfolding everywhere others are again overtaking Hungary, or at least almost literally repeating everything that was once considered as unique and not easily reparable mistakes. Not only in one country, but in a series of states.

Greece is the obvious example in many sense, with accounting tricks, giant budget deficit (once the Hungarian reaching 9,2% of GDP was described as world record and a clear sign of exceptional insanity, than what about a value somewhere between 13,7% and 15,5%?), social resistance to changes, a deficit reduction program considering raising revenues, not exclusively relying on budget cuts etc. 

But something similar happens in neighbouring Romania, the country of a small miracle recently, many times perceived as the next economy overtaking Hungary. After a year of incompetent governing, when politicians was not ready to take energetic action and accept unpopular measures because of the presidential elections at the end of last year, a nominally right-wing government announced some steps not so unfamiliar for people knowing something about Hungary's last few years. A minimal expected tax on companies, change of the tax base effectively raising the tax rate for most of them, simple lay-off of budget personal instead of "structural reforms", introduction of new taxes, like the "junk food tax", preservation of the privileges of the very rich, dubious contract in motorway construction, and immediate retreat as signs of some resistance appear. (The prime minister denounced his minister of finance regarding the lay-off of about 100 000 people from the state sector, and described proposals from ministries on new impositions as ideas of unexperienced people.)  What is clear: there will be weaker domestic demand in an economy earlier fueled by consumption and the government's only hope is EU funds and investment. (What would be badly needed, the minister for economy announced that his intention is to introduce electricity in every Romanian villages in 2012. Think of it, EU 2010!)

But the most ridiculous series of events unfolded in Germany. The liberal party that entered the government as junior partner after the social democrats lost at about 10% of their vote share at last year's elections, in September, represented a very straightforward free-market agenda, and proposed changes on the very same fields as their Hungarian counterparts, for example lower taxes with fewer tax rates (and elimination or reduction of some taxes usually hitting the very rich) turn towards more private health care system, with a unitary contribution for everyone, irrespective of their income. As the state household of Germany is not in a good shape (and as according to some observers the chancellor, Angela Merkel in the last years became more social democratic) it led to very loud and heated clashes inside the coalition. Albeit a meeting of the party chairs last weekend served as a solution for the internal fights that threatened to deepen the problems of a coalition that was welcomed by its members as the realization their dream coalition for more than a decade, but obviously made a very week start, it is not clear whether this attempt will be successful in the long run. And the similarity to Hungary is more than striking. An intransigent liberal party is pushing an agenda against the will of a majority and against the possibilities, always referring to the coalition agreement and causing upheaval. (Ok, in Germany the minor Christian social party also has some role in this situation, as they try to impede the erosion of their voter base with a confrontative image, acting as a counterbalance of the liberals.) 

I won't say, that the fate of the German coalition will be similar to the Hungarian one, but I somehow fail to see the prudent politicians, willing to make personal sacrifices, boldly acting against temporary unpopularity etc. And even the Polish government (in a country which at last, contrary to forecasts, avoided economic contraction) fails to bring budget deficit under control for electoral reasons. We are once again lost, others leading the pack.

Lost in Space and Time

Decisive second round of presidential elections in Romania. Some TV stations has an all-day program covering the events - funny and sad, comical and tragic - with the indispensable talking heads, intellectuals analyzing. An economist - former minister of finance -, a historian - former minister of foreign affairs, - and a political scientist - not a former minister at all - shares their views on Romania. The country is seriously and dangerously divided, as the unexpectedly succesful mobilization shows. The political debate in the capmpaign was on superficial issues instead of programs. The Romanians are dependent on the state. Romania is situated as the last country in the EU in every respect. The governments of the last few years were irresponsible. The country is seen as similar to the Ukrain. (!) As if I would be in Hungary. Maybe some of the Hungarian intellectuals has lrearned Romanian and asked to participate in Romanian TV programs? I don't think so, it would be ruinous to they conviction that Hungary is alone as the only divided country with a population hoping for help from the state, with superficial debates, irresponsible governments and at the bottom of the EU.

Prudent politician vs. Hungarian madness

One of the most typical accusation to the adress of the Hungarian politicains from the business elite that the political elite simply bargains long term advantages fro short term political ones. (The most recent one comes from the prime minister, Gordon Bajnai, who is not really a politician, but one of the experts - with current finance mininster, Péter Oszkó, who arrived with great plans into politics and administration and clearly had to realize that in the public administration best practices from business can be even outright failure...) This statment is usually supported by an argumentation, pointing out that other ECE political elites could have managed their countries better and were more focused on the long term. Well, after a deputy whip of the largest Polish government party told in an interview to Bloomber that his party is not ready to commit political suicide and make budget cuts until the elections in 2011 I think this refine construct could be forgotten. Ukraine is a complet mess, because politicians are not willing to committ the same suicie, Romania similarly, in Serbia - another recent candidate for overtaking Hungary in the self-flagellant and nationalist discourse - the number of pensioners is estimated to be higher at the end of the year as those working (a fact advertised by the largest and most professional Hungarian economic website, www.portfolio.hu as the only case in the region, even though it was already the case in Romania two or three years ago, although to admit it would have meant an abandonment of the idea of the Romanian miracle due to flat tax), and this series could be much longer. It is again a small but clear sign how self-focusing and how detached from realities can this supposedly expert thinking be...

(Oh, and it is not excluded that at the end Germany will experience something similar to Hungary's fate in the 2000s. The liberals in the new coalition are very insistent on their promised tax cuts - the justification is the same: lower taxes mean more employees and more income - while their partner(s) in this "natural" alliance are fighting against their ideas - not only against their proposed tax cuts and the realization of it, but privatization in the health insurance system etc. The conflict is clear and at least superficially not dissimilar to the internal conflict of the Gyurcsány-government in Hungary. Moreover, the tax cuts are a textbook example of redistribution from down to the middle and upper income categories. In the lower segment of income it will be offset by growing costs of public services - litter transportation, contribution to the costs of health care etc. That makes it an illusion or at least a dubious attempt - especially in ECE with relatively low income levels - that tax cuts will bring more purchase power, more demand for local services, consumption goods etc. As long as it had to be offset by spending cuts it will automatically lead to higher cost of public services and in case of low income levels this raise of expenditures will suck up the additional income. While those with a really high income won't really spend more on hair cuts as their hair won't grow faster due to more money....)

Relief and self-congratulation

Hungary is certainly not a peaceful country nowadays, but the growing tensions – albeit connected to the crisis and social poverty – are never directly associated with the financial and economic crisis. Regarding this issue a cautious stance prevails, emphasizing more and more positive effects of the governments measures. The parties behind it seem to accept their fate with resignation, and some of their politicians are ready to think that the cure prescribed by the „experts”, the business elite and the IMF – this at last showed some muscle recently in Romania and in the Ukraine (although only after prolonged period of a total lack of compliance in the former and a skillful tactics of „promise-and-non-fulfillment” in the other) is bringing its first fruits. (Even if it would be the case why are the same fruits sweet for supposedly leftist politicians as for not just supposedly rightist businessmen?) Anyway, the prime minister and the finance minister gave a series of interviews recently confirming that the budget deficit will remain as agreed with the IMF-EU couple and the fiscal restriction has its first effects: Hungary will emerge from this Maelstroem as the most competitive country in ECE.
Faithful readers can be already familiar with my views on this very simplistic and deadly perception of the world – I rarely felt myself better as an underpaid academic knowing that meanwhile I'm living in a very competitive county. The whole idea of competition instead of cooperation in ECE is one of the reasons of the mess we are experiencing. The clear demands and preferences of the society – usually expressed by vote – were always neglected in the name of competivity, as disadvantageous for business etc. and of course as remnants of some dangerous post-socialist, post-communist mindset, incompatible with democracy and capitalism. This stance even reached such heights as to accept lying to the electorate if it serves the aims of the business elite (and middle-class) but despising it if it turned out that the lies veiled a somewhat different, socially more balanced politics.
(One must admit that nowadays a different approach is gaining strength, the one arguing that the failure of transformation – that is in a sense an exaggeration – was caused by social pschychological factors and the mentality. This would be the real hindrance before the implementation of reforms. However, the proposed solution is not to develop ideas fitting to the social realities, rather somehow transform the mentality in order to implement the reforms, that are perceived as having no alternatives.)
Returning to the topic of this post, the government certainly can cite analysts predicting that Hungary will be the most competitive, most fabulous country. (On the one hand it is really comforting, at least no country will be at the end spared of the pains. :) ) But I fear analysts once again won't register success with their predictions, as they didn't before the crisis and since then. (A series of important data appeared in the last two weeks, for example GDP growth rates, and analyst's consensus was usually far from the real data. In case of Hungary they were disappointed but once again nobody asked whether their profession has any relevance, whether they deserve the attention paid to them. If analysts has something wrong, it is always the government's, the politics' the kádárist's fault and not theirs.) The real problem is that these forecasts are based on the usual simplistic model, somehow calculating a potential GDP growth (that is a very slippery issue, the oracle from Delphoi could be almost as successful as analysts, as the future is not known for anybody...). In this case they rely on the assumption – at least as I understand – that lower taxes are an incentive to hire workers, because cheaper labour makes producer prices more competitive and it will lead automatically to a higher employment rate. (What they will produce and first of all who will buy it, it is not a question. As in case of some economists, who – arguing that the lasting problems of labour market participation in Hungary needs a systemic approach instead of the present fragmented one, based on different education programs and state subsidies – came up with the all-encompassing and very systemic solution: in crisis regions a lower minimal wage have to be agreed upon.)
Nevertheless, this issue – what to produce and for whom – would be crucial as export based industry in Hungary was quite competitive even in the recent years (although the effects of the crisis are not clear at the moment), but for example a 5 point cut of the social contributions from July didn't had significant effects on employment, business was not capable to hire workers just for the sake of paying lower labour cost, the unemployment rate was kept at bay only by state-financed public work programs. Maybe next years similar cuts will have a different effect, maybe growing export markets will contribute to the easing of the situation. However, it has its clear limits as well.
Unfortunately the core of the problem lies in the SME-s, oriented towards domestic consumers in services, retail sales, construction. Although lower taxes would seemingly be good for them as well, not only due to lower labor costs (although paying less for some employees not necessarily enough to hire a new one, especially if there is no demand for the products), but through higher net income of the population. But the competivity issue in the export oriented sectors is a hindrance of wage raises as well, making the effects of tax cuts limited. Another possible solution would be redistribution to those whose “marginal propensity to consume” is higher – i.e. who are poor and can not afford even the basic needs on a daily basis – but it is also despised, as not business friendly. For a while credit substituted for real growth of income, but the result is too painfully clear. Without significantly higher wages there won't be really higher demand for services and construction. Moreover, lower taxes usually mean fewer public services or more expensive ones. Effects of tax cuts on personal incomes – especially in a country with lower wages – can be almost entirely offset by higher costs of public services. But not much SME-s will be content, when people will spend their excess money on train tickets instead of a hair cut. It would again flow to the state and not to the companies.
But the simplistic “lower taxes bring higher employment” assumption's validity is doubtful because of other reasons. The immobility, low education, low skills of the workforce reserve (the employment rate was 58% at its best now it is around 55%, the reserve is guessed sometimes at about 1 million people) would make investment necessary. Investment in mobility – affordable housing, not rents as high as a monthly wage, reasonably priced or state supported traffic costs etc., (the company's contribution to public traffic costs of their employees will become a taxable income from 1 January) – and in education would be much needed, but for this aim also redistribution would be much needed. At least as long as offering chances for everyone is perceived as necessary social solidarity and means of cohesion. If not ..., yes, it is another country.
(Moreover, there is a fair chance that at the end, with a rapidly ageing population and dependency ratio, without a European social system, Hungary will end up as having only one chance, to export more and more, making this whole speculation on possible ways out pointless. But even in this case the state would have to invest in children.)
Therefore the self-congratulating manner, the dreams of being once again a forerunner country seem not too well-founded. The result could easily be disappointment of the middle-class seeing that the price of tax cuts is higher payment for public services and freezed gross wages for a long period, therefore lower taxes bring not more money to spend on consumption, the disappointment of the SME-s because of the continuing lack of purchasing power, and even stronger disappointment of the poor, for whom it easily could mean more poverty and less chances to get out from their situation. The already very serious tensions can easily explode at that moment...

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.

With "recovery" exceptionalism and self-flagellation returns

As one can hear more and more positive forecasts and predictions - and the summer recess ended as well - the media is filled again with "analysis". Economists and analysts, politicians and gurus are once again on the scene and pre-crisis narratives are once again sold, without discount. Although this time at least their opposite is on the imaginary shelves...

The self-flagellation, so popular among Hungary's "intellectuals" is back directly or indirectly as well. If a politician of the respective country's makes a statement on the inevitable fast recovery and even faster future growth of Romania, Slovakia, Bulgaria etc. it is immediately bought by the media and distributed, without any comment, contextualization etc. As if the last half a year would have never happened. Nobody seems to be interested in the respective countries beyond a set of basic data, nobody seems to have learned the lessons of debacles. Moreover, a modest, but very visible flow of articles on Slovakia as the country offering the model to follow appeared again, quite in pre-crisis fashion. The past is bright and the future will also be, as they implemented the right economic model. Doubts are not dismissed, they are rather omitted from the picture. One quarter of growth - even though it means quite serious decline on a year-on-year basis and was driven by state spending certainly not sustainable on the long run - was enough for this conclusion. As if nobody would be willing to consider the limitations of dependency on only one industrial sector, the possible impact of the competition for investment on the level of wages, especially with high unemployment depriving the state from predicted incomes, not to speak of the possibility of a second wave of economic decline.

A new all encompassing science - the social biology of our age? Some provocations

At the beginning of the last century for many people the biology seemed to be the universal science, not only explaining the laws of nature but at the same time being applicable for the human society as well. Medical doctors, pioneers of genetics, ethologists saw the human race as living in a natural organism and behaving according the laws of nature. Social-darwinism achieved a certain popularity, individuals and nations (or countries) were seen as inevitably competing each other and for many, who were read to draw the inevitable consequences the emergence of superior and inferior nations or races were the natural course of history, supported by the laws of the nature. Based on the latter they thought themselves capable to prescribe the only possible social organization, assign everyone his or her natural role.

As these ideas - even if unintentionally - were present at the birth of and served as a root of the extremist ideologies - fascism, nazism - now they seem to be compromised and even though some scientist from the field of biology or medical sciences are today still convinced that the nation as a natural unit of humans could be explained by and should be organized according to the natural law, nobody really take them seriously. But if someone considers a bit more thoroughly the - rather vulgar - version of economics - or economic prejudices - prevalent today, some striking similarities can be discovered easily.

The Markets, oh the Markets!

Last week the Hungarian governemnt achieved a great "victory", the parliament passed a bill on the taxes and tax system in next year, modifying the structure of taxes, with cuts in the personal income taxes and the social security contributions and hikes in VAT, introducing a new property tax etc. It laid the foundations of the next budget and it made the ministers quite proud of their production. Moreover, the government was 75 days old and it gave an opportunity for the prime minister and the finance minister to give interviews on the progress made by this new, brave body fighting the crisis so effectively. (One should ask, why is a prime minister, who is admittedly not seeking political career after his term will expire, so keen on making pr, but I really don't know. Maybe he is afraid of the possibility that his parliamentary majority will collapse, but I would doubt that it is the proper way to fight it. And PR-interviews - especially in the Hungarian case, where the "questions", due to the tragic quality of journalists and journalism, seem as if they would have been prepared by the Prime Minister's press secretary - are not only boring, but unconvincing, without any originality.)

Anyway, the finance minister and his boss pointed out that their success is signalled by the markets as well. The strengthening of the forint is a sign of the returning trust. I understand, that sometimes those who are in political positions, feel the necessity (and sometimes they are even compelled) to make stupid statements, in order to gain popularity, portray themselves as capable individuals etc. But this government is supposedly an expert one, the finance minister arrived from Deloitte. I don't really think that he has no idea of the current situation: there is no credible sign of an individual assessing of the forint and its movements against the dollar and euro were and are driven by fears regarding the state of affairs in other countries (most notably in the USA and in the eurozone) and by mere speculation, the so-called carry-trade. Or, with other words: the current movements are the result of a very high interest rate of the Hungarian National Bank and the willingnes of the so-called investors to see green shoots everywhere. Nothing specifically Hungarian, as everyone can see, who compares the movements of the currencies from Poland, Hungary, the Czech Republic, the first one and the latter being considered as more stable economies than Hungary.

But the really frightening probability is, that the minister can be convinced of his truth. Not necessarily because in this case he and his government tries to please actors, who do not really care about its activity, but because sometimes it shows a quite simplistic obsession with the idea of the efficient markets. Well, it is a viable econimic theory, that was capable to make tolerable predictions for decades, but in the light of the recent events even those, who were not aware of its problems are ready to admit that at least some refining would be needed. And as a perspective of the human society, it is rather frightening, as it tries to reduce its complexity in one single indicator: market price.

Moreover, as in the last few weeks I had an opportunity to glance at many products (analyses etc.) from market actors (due to some kind people dealing with economics or the economy, with quite different views) and as a result I'm increasingly convinced that those are less complex than it would be necessary in times of economic turbulances. Not that they would be useless, but they use only a limited range of indicators and data and sometimes too obsessed with the mathematical models, instead of leaving some room for the good old intutition. Although predictions based on the mathematics and market conventions turned out be very risky nowadays.

But this is not the only problem with the Hungarian government's actions. As they are keen to please "markets" and consider as the sign of the success of this efforts the strengtheing of the forint, they are slowly giving up the advantages brought by the rapid depreciation of the national currency and its relative stability in the last two months. The competivity (what they are seeking with tax cuts in a dire budgetary situation, therefore compensating it with budget cuts, equally hurting consumption as the tax cuts are inspiring it) gained suddenly and unintentionally (the eternal comparison, Slovakia was behind Hungary in terms of labor costs at the beginning of the year, although the "experts", among them the minister himself, always complained that Hungary lost its competivity regarding cheap labor to Slovakia, and it was a reason behind tax cuts and social spending cut proposals) are now trickling away. Even though there is some reason behind it - reducing the debt burden of those, who are indebted in foreign currency -, it is at the same time simply the mirror image of the much despised politics of pleasing inactive voters with financial transfers through the social security system. It is very much an attempt to satisfy middle-class rent-seeking, placing the complete burden of adjustment on the shoulders of those, who are living from sthe social security systems. and even though there are many inactive people, who would be capable to work, the lion's share of this group is composed by pensioners and by those, whoe are really living on a subsistance level, without any hope for a decent work. This politics is not seeking the just distribution of the burdens of the crisis, it tries to privilege a group, that bear some responsibility for the situation of the country, as they were ready to take a huge debt burden, many times with repayment rates higher than the half of their otherwise not too large income. And as it is clearly hurting the long term perspectives of the country (Hungary abandoned even the moderate room it acquired through this strengthening of the forint in terms of monetary policy, as the HNB is focusing on the debt level and not on the exchange rate yielding advantages, therefore it is not ready to lower interest rates), either as an economy, or as a society, it is equally problematic, as the rent-seeking of the inactive groups.

The other privileged group will be the entrepreneurs. The tax cuts are aimed to ensure they lasting competivity through making labor cheaper. Although personally I don't think that eternally lowering labor costs through abandoning every public service is a viable strategy of growing welfare and standards of living, this time I would only point out that - as I argued some posts earlier - without a growth of the capital in the economy it is clearly a hidden state subsidy for non-competitive companies (the state subsidizing even negative marginal products of the newly employed labor with renouncing some state incomes), and as usual in those cases it will probably bring only more private profit from public money. It is possible, that in the long run it will really bring some raise in employment rates, but I'm doubtful regarding its effectivity, at least its effectivity imagined by the minister. But it is another story...

(Oh, and meanhwile flagellant exceptionalism surfaced in Romania. A well known blogger counted 13 factors of Romania being affacted worst by the crisis. :) Maybe my next post will cover this funny topic.)

Reminiscences of Ancient Syria? - turncoat economics

It is always flattering when economists regularly expressing their views publicly and supposedly with high authority support one's ideas, even if only unconsciously as they very probably never ever learnt of those. Therefore it is highly understandable if I was very proud of my smart ideas hearing that such an excellent economist as László Csaba (not to be confused with Csaba László, former minister of finance), professor at the Central European University and someone who is not only regularly sought by the media as expert but who also accepts this role and attends different TV and radio shows and gives interviews almost every week, echoed some of my thoughts. The opportunity was provided by the presentation of his new book(s?)"Crisis in Economics?" and in this task he was sided by another renowned expert, Péter Ákos Bod, former chairman of the Hungarian National Bank.

According to Csaba's opinion the crisis brought with it a wave of self-fulfilling pessimism and the real task would be to fight these jinxs as everyone knows that the crisis will have an end. Regarding the fate of economics as a science he didn't dare to make a judgement whether it is in crisis or not, but listed the problems and challenges economists are obliged to encounter. The presumption of absolute rationalism of actors, the capability of the markets for self-correction and the position of the economists as omniscient technicians of the societey, so willingly embraced by many, will certainly be doubted. He can even imagine that the present crisis will be a starting point for a paradigm shift as well. He denied that the road of the ECE countries towards convergence would be identical differing only in the starting points and maybe in their speed. In these assumptions and presumptions he was supported by Mr. Bod.


I won't say that such a set of ideas could not be consistent. But recalling Mr. Csaba's public performance from the last few monthes this book is a complete U-turn. (Just a short collection from the first few pages of a googled list, unfortunately in Hungarian.) He was convinced even in this February that the crisis is not an economic one, rather a financial, he prophesized that there won't be significant contraction. Moreover, he belonged (and still belongs) to the group of economists self-puffedly sitting in a studio and expressing their opinions peremptorily, never expressing reservations regarding its validity, never allowing that other views could have at least some minor relevance. As for the content of those views and proposals, Mr. Csaba never ever expressed something different from mainstream neoliberal ideas, he was always a champion of a smaller state sector, lower taxes and lower social spendings and among his arguments, clearly thought to be irresistible, always hinted to the example of states like Slovakia or Romania. (At least for me it is quite different from the idea of every ECE country having its own path towards convergence, even though in this case Mr. Csaba only wanted to fend off the opinion that the present crisis started outside Hungary and not inside.) To sum up: Mr. Csaba was not only always convinced of his own superiority as an expert, but he havn't got the slightes doubt regarding the mainstream model of economic policy and models and he proved to so overconfident that he dismised the idea of a world economic crisis even three and a half months ago, and attributed the situation in Hungary solely to the faults of its governments.

Everyone has the right to change his opinion. But it would be more credible if he would have been able to spell out some words expressing his sorry over his failure as economist in the recent past, describing clearly the points he reconsidered and not posing continously as the greatest ever Hungarian economists. It would have been made the book even more credible, as one can hardly believe that a serious work (not simply seeking easy publicity and money with a trendy topic) on such an important and complex topic could have been finished in three months (as Mr. Csaba held the opposite view that time) with all the necessary thorough editorial work as well.

I wouldn't waste any words of substance on Mr. Bod whose only considerable contribution to economics was his proverbial and long remered role played at negotiations with taxi drivers blocading the country in 1990, when he was more eager to satisfy his "biological necessities" than to bring the negotiations to a reassuring end, and who is a well-embededd member of the chorus of economists suddenly discovering themselves as non-neoliberals and meanwhile promoting the idea of a low tax, low redistribution, small-state economic model.

Update, 5. 8. 2009.: I have to admit, that I was not entirely fair with Mr. Csaba, but I was only following his public appearances and presumed that he is formulating the same opinion in his scientific texts as well. Now it turned out that he called for attention to the so called new populisms in the flat-tax economies (among them Slovakia), a phenomenon he characterized the politicians willingness to please the entrepreneurs with everything (low taxes, deregulation etc.) and making a fetish from the growth in a paper presented at a conference in March 2008. But as soon as he appeared in a radio or TV studio (and he made it fairly often, in almost every second week) he suddenly forgot about his scientific results and was like a robot, always repeting that Hungary has to cut taxes, spending as Slovakia and our regional competitors made earlier. So, the conclusion: he is not necessarily silly, he is simply mean and unprincipled, in his role as public commentator simply following political aims.