For economic policy in most Eastern European nations, only the market counts. However, this cannot work in a world where the conditions for traditional macroeconomic management no longer exist.
Heiner Flassbeck is an economist, as well as publisher and editor of “Makroskop” and “flassbeck economics international”
Originally posted in German at Makroskop
Translated and edited by BRAVE NEW EUROPE
To read part 1 go here
How little the two Eastern European countries that we have focused on can be compared with Western countries can be seen very clearly in the development of unemployment (Graph 1). Following the major crisis of 2008/2009, the unemployment rate in Romania hardly rose at all. In Bulgaria it increased significantly, but despite weak economic development after 2013 it is falling at an astonishing rate, almost to the relatively low Romanian level.
For Romania, this can only mean that unemployment is not recorded as such or that the outflow of labour is so rapid that, despite significant declines in production, the labour force does not register as unemployed at home. In the case of Bulgaria, there have probably been considerable migration effects in recent years, which have ensured that official unemployment has remained within limits.
No economic policy is also an economic policy
In terms of global economic policy, both nations are somewhat below the radar, although the blatant weakness in growth would give sufficient cause for action. Both countries have pegged their currencies very tightly to the euro. The rate of the Romanian leu has been almost constant for ten years, but has recently depreciated slightly. Bulgaria has even opted for a currency board in which the lev’s exchange rate is absolutely fixed and which takes monetary policy completely out of the nation’s hands. In this respect, both countries are following the European Central Bank as closely as possible with their monetary policy stance.
Short-term interest rates in both countries are slightly above the euro level, which is particularly important for Bulgaria, as the domestic money supply on the currency board is to be covered at all times by the inflow of foreign currency. With an absolutely fixed exchange rate, foreign “investors” can thus realise a small but absolutely secure arbitrage profit with an investment in lev.
Long-term interest rates also do not differ significantly from those in the euro zone and have tended to move in the same direction since 2011, although there was some divergence in 2017. (Graph 3).
The attempt to keep long-term interest rates very close to the euro area also ties in closely with the second policy area, namely national fiscal policy (Graph 4). Although the public debt ratio (as a percentage of GDP) is very low in both countries, this is the main concern of economic policy as a whole. They attempt at all costs to remain below the 60 percent mark of the Maastricht Treaty. Only then, in the opinion of their governments, will both nations have sufficiently large buffers to protect them from the markets in order not to be the victims of speculation in their own government bonds (explained here in the case of Denmark).
Although both nations have seen their current public deficits rise in the course of this year, governments in both countries are trying not to allow an increase in the public debt ratio. There is a strong belief – as I myself saw recently in Sofia – that a low public debt ratio is considered to be one of the most important conditions for attracting foreign investors.
Fatal fiscal balances
Despite low interest rates and increasing domestic demand, little investment is forthcoming from domestic investors. Thus both nations need to be successful abroad under these self-imposed conditions, i.e. they have to run current-account surpluses systematically. But this is almost impossible because the labour force is pushing for and obtaining rapid increases in wages, as shown in Part 1 of this article.
This puts economic policy in a dilemma. For Bulgaria, where statistics concerning financial performances for key sectors are available, this can be clearly seen (Graph 5). If the calculations presented by AMECO are even halfway correct, the government’s constant attempt to balance its budget is completely absurd. The statistics show that since 2009 companies have been saving heavily and that their behaviour has not yet led to a permanent recession only because private households have become increasingly indebted up to 2017.
The state, which until the Great Financial Crisis of 2008 had apparently tried to keep a balanced budget at all times, has since shown itself to be somewhat more flexible. But is now again trying to attain a slight budget surplus. It is more than surprising that before the 2008/2009 crisis, households and businesses were heavily indebted, with foreign partners profiting from the fact that these sectors were living far beyond their means, resulting in a huge current account deficit. When this was no longer sustainable, however, it was only companies that turned their balance around completely, while private households on average continued to live in debt. The state also reacted counter-cyclically, but quickly sought its salvation by returning to a balanced budget. However the crisis of 2013/2014 forced it once again to deviate from the “path of virtue”.
As I said, we don’t know how reliable the figures are, but the presumably rather secure constellation that Bulgaria is trying to implement – an imitation of solid German financial balances – is absurd in itself. If private households switch back to their normal habit of saving and the state is adamant about avoiding deficits, the Bulgarian economy would have to generate a high current account surplus through rising exports and increasing market share in order to protect the economy as a whole from a crash, and to enable growth. However, this is impossible, given the loss of competitiveness in past years.
As regards Romania, although the AMECO data base shows fiscal balances (Chart 6), the interaction between households and enterprises is more than strange. In two phases (2001 and 2012 onwards) there is a strong contrary movement between the two sectors which cannot be explained by normal economic factors: it probably reflects problems of statistical delineation between the two sectors.
Looking at the private sector as a whole, however, a plausible picture emerges (Graph 7). It can be seen that Romania, too, cannot get very far with its policy of deficit limitation, as the private sector´s balance has been well above zero since 2009. At the same time the country is once again running into a current account deficit.
Direct investment as a solution?
In the almost hopeless situation in which Bulgaria and Romania find themselves, direct investment always rears its head as a solution. Because these countries are not in a position to stimulate investment activity in their own country with their own people, there only seems to the possibility to end the misery with the help of foreign direct investment. That is not wrong in principle, but unfortunately there are few means by which a single country in the EU can make itself attractive for direct investment.
There are many countries in the world with low wages, and in many developing countries wages are much lower and rise less sharply. In addition, companies have much more power there because they can negotiate directly with the government and are not subject to EU legislation. Reducing taxes for businesses is already reaching the natural limit of zero, and subsidies are subject to EU supervision. In Bulgaria, for example, business taxes are already very low (about six percent), which no longer offers much room for reduction.
In the summer, while visiting Eastern Europe, I found politicians – from countries that represent the neo-liberal dogma with a rigour that can only be found in the West among the really incorrigible market radicals – begging for direct investment from China (a country under Communist leadership!). The fact that they are relying on low government debt as an important argument for foreign investors is indicative of the desperation with which they are seeking a solution with the wrong paradigm. They assert that they are open for direct aid (“funds”) from China, because they need China to build their own infrastructure, as they do not possess enough capital to do it themselves. But nobody bothers to ask where China, a developing country with a low average income, obtains its capital.
Every nation has sufficient capital
This clearly shows the confusion that mainstream economists are spreading throughout the world. In reality, any country, rich or poor, can create the capital it needs. There is no predetermined sum of capital and no clearly defined amount of loanable funds. Saving, in the sense of putting aside unspent income, is precisely not the source of capital, as the prevailing doctrine makes us believe.
Saving is, on the contrary, a brake on the process of economic development, because it reduces overall demand and pushes it below the level that the economy needs in order to utilise its capacity. This brake can only be released if there are players willing to incur debt despite the restrictive effect of saving.
Capital is therefore created in the process of economic development and there is sufficient capital precisely when this process works, when the willingness to incur debt is greater than the planned savings. Then incomes are created in companies and private households, which makes it possible to invest and thereby generate new income again. The state can and must initiate this process, even if there is no self-sustaining investment activity at extremely low interest rates. Once the process is under way, the state only has to ensure that the income of the masses keeps pace with productivity growth and the inflation target.
In foreign trade terms, such a strategy must be backed by a monetary system that ensures that inflation differentials between trading partners are balanced at all times. This, too, does not work through the market, but only through state cooperation.
Countries such as Bulgaria and Romania, with their adherence to neo-liberal dogma, are sacrificing their present-day economic development and gambling away their future. Anyone who now, for ideological reasons, prevents the state – as has happened in Asia and especially in China – from investing massively in public infrastructure and the education of its inhabitants is betraying future generations. They are also passing up the opportunity to create an upswing that will attract private investors and can ultimately succeed without permanent stimulus from the state.