Archive | May, 2012

Austerity and Regime Collapse in 1980s Romania (part two)

31 May

From Cornel Ban (excerpts for forthcoming article in East European Politics and Societies)

‘With central bank reserves at a paltry 400 million, a dramatic policy shift was needed to deal with the debt crisis of the Romanian state in 1981. At this point what tipped the balanced against the regime was that creditors convinced the IMF that Romania needed a second chance. According to James Boughton, the IMF’s official historian

Although the staff met on various occasions with major bank creditors in the fall of 1981 to explain the extent of the measures the authorities were taking to strengthen their finances, they gradually came to accept the banks’ doubts about Romania’s comittment to reform. The Fund refused to waive the terms of the stand-by and it allowed no drawings during the first year of the program other than the one made at the time of the initial approval (Boughton 1981).

After two years of struggling to meet its international financial obligations, the Romanian government sent a letter to its main creditors and informed them that it could no longer afford to carry on servicing the principal of its external debt to commercial banks. In January 1982 Romania began negotiating with a consortium of nine creditor banks, with IMF staff as observers. As the banks did not offer a rescheduling agreement in time to resume the stand-by agreement, the IMF staff decided to signal their support for the regime and offered a token drawing of 10 million, an extraordinary measure. This move by the IMF soothed creditors, who eventually agreed to rescheduling in December 1982.

The economic meltdown faced by the Ceausescu regime was so dramatic that the expenses of the national airline (TAROM) and the state’s embassies were paid in cash. Instead of the preferential treatment he expected from the West because of his “maverick” foreign policy, Ceausescu helplessly observed a souring Western mood and the roughness of the IMF terms imposed on Poland, where loans with attached conditionalities severely constrained the policy choices of the government (Eichengreen 1992). With Poland’s fate in full view, Ceausescu could see that the writing was on the wall for the main pillars of his regime’s ideas about development (that is, industrial development and “hard” policy sovereignty). Indeed, Poland offered a nightmare scenario for national-Stalinists: halved investment rates, central planners confined to setting macroeconomic targets, real autonomy for enterprises and risk of liquidation for the unprofitable ones, less discretionary credit and tax policy, depreciated currency, and increases in administered prices (Marer et al 1988).

To meet the debt repayment schedule, Ceausescu demanded a radical revision of the five-year plan that would make the early payment of foreign debt the chief priority of economic policy. No new debt was to be contracted from private lenders or other states. Even the contracting of loans from the Bretton Woods institutions was banned in 1988. As investment in industrial expansion was set to continue, all imports had to be cut drastically and the value of exports had to go up. While income levels were not affected negatively, all strategies meant to amass the dollars necessary for this task were on the table, including the engineering of a massive drop in domestic supply of staples and industrial consumer goods. Overall, between 1981 and 1989 the supply of food staples was nearly halved. The production of consumer goods was also nearly halved during the same period and, to make matters worse, its share in exports was increased (Ionete 1994: 86-87). In marked contrast was similarly indebted Poland, where the government cut consumption by barely ten percent in 1981, only to restore it to its previous levels two years later (Marer et al 1988: 8). Also, while in Romania non-socialist convertible currency imports fell by 43 percent between 1980 and 1983, they decreased only by 5 percent in GDP.

To save dollars, barter deals paid for commodity imports. For example, the export of engineering industry outputs to Iran, Iraq and socialist states was bartered for imports of oil and other commodities that otherwise would have had to be paid in scarce foreign currency. Unfortunately for the Romanian side, as a result of trade deals struck in the late 1970s, Romanian exports were sold at fixed prices that did not account for the increase in the price of energy inputs after the 1979 oil crisis. During the late 1980s, the Brasov Tractor Works (Uzina Tractorul Brasov), one of the industrial champions of Ceausescu’s Romania, was selling tractors to Iran for just under 4000 dollars apiece in order to pay for imported Iranian oil.

Soon the push to pay off debt reached Stakhanovite levels: in 1988 and 1989 Ceausescu decided to pay a billion dollars of debt by selling 80 percent of the country’s gold reserves. As a result of these drastic measures, between 1982 and 1987 Romania boasted the fastest reduction of debt to GDP ratio in the world. Likewise, a current account deficit of 2 billion dollars in 1982 turned into a surplus of 9 billion by 1989. In a determined show of fiscal virtue, the government budget closed with surpluses.

Ironically, in terms of its external accounts and fiscal policy numbers, Romania was a top performer. In 1987, the Bank for International Settlements (BIS) appoached the regime’s central bank governor to convey the message that Romania’s sovereign bondholders found the early debt repayment program to be sufficiently credible. Consequently, the BIS strongly recommended that the rest of the sovereign debt should be paid at the deadlines agreed in the 1982 debt rescheduling agreement. Ceausescu vehemently rejected the recommendation and stayed the course, ending with the message that the regime was pulling the plug on Western finance for good. In the same year, the regime stopped communicating basic data to the Bretton Woods institutions.

The squeezing of domestic consumption through the planned reduction of demand contributed to sharp drops in GDP: from 6 percent in 1983 to -0.5 in 1985 and -5.8 percent in 1989. Indeed, the depth of austerity and the pace of the improvement in trade deficit was far in excess of what markets expected and constituted a “sui generis shock therapy” (Daianu 1999:9) whose effects were magnified by the initiation of new and expensive infrastructure and industrial projects. As the next sections show, the result of the regime’s belt-tightening was oppositional mass mobilization.

Austerity Jams the Economic Engine

Scholars have discussed at length the soft budget constraints and supply shortages that plagued centrally-planned economies (Kornai 1980; 1992; Myant 1989). These mechanisms were probably at work in Romania as well. But Romania was unique in that one of the most damaging aspects of the policy turn after the debt crisis was the cutting of imports of Western technology paired with the unrealistically short deadlines for substituting them with local technology and, where possible, by extending the lifeline of existing technology.

Forced technological substitution contributed to the reduction of the current account deficit and of the level of debt. But as underfunded research institutes could neither replicate nor reinvent imported technologies overnight, the cuts in imports of technology also weighed down the capacity of the industry to maintain its levels of competitiveness. As formerly imported parts and materials were replaced with local substitutes of poor quality, many factories could not liquidate their stocks because of quality issues and had to be “bailed out” by the state (Murgescu 2010: 373). This was particularly the case in high-tech sectors, where the extension of obsolescence deadlines had dramatic effects on quality and the capacity to cope with technological innovation. Moreover, just as it was becoming clear that external competitiveness was increasingly dependent on the integration of information technology, five year plans did not allocate adequate funding to these emerging industries.

The forced import substitution was carried out using a self-destructively autarkic perspective on innovation that stressed a combination of Stakhanovite norms, nationalist posturing, and industrial espionage. In defiance of the intrinsically transnational nature of technological innovation flows, during the 1980s subscriptions to scientific journals and all funds for study abroad opportunities were cut (Grigorescu 1993: 102-135). Average spending on research remained at 24 percent of the West European average and spending on education was also curtailed (Ionete 1993: 69-72; Constantinescu 2000: 335). In a local adaptation of Maoist “anti-intellectualism”, university students and professional researchers were forced to spend several weeks every year harvesting crops rather than carrying on with their research. Moreover, Ceausescu signalled his skepticism at the added value of information and communication technologies. Such policies demoralized the white collar class of engineers, researchers, and other technical experts tasked with keeping Romanian industry competitive through innovation. As a former senior researcher at Cluj’s Physics Institute remembers,

They simply did not get it that research projects for complex parts take years and participation in foreign networks of researchers. We made important breakthroughs in mass spectrometry instruments during the 1970s because of such networks and access to foreign scientific networks. But after 1982 they cut almost all of them and we spent a decade without subscriptions to foreign research journals. When you make it a point out of saving on electricity, heating and journals in one of the country’s elite institutes, as they did at the time, you know that the game of applied physics is basically over.

When combined with the scrapping of individual incentives in the evaluation of worker productivity, this planned de-coupling from the international flow of technological innovations contributed to the beginning of economic decline through losses in productivity. Export performance was affected immediately, as Romanian exports became less likely than before to find a market in the developed capitalist core. Between 1981 and 1989 the losses of state-owned firms increased by 450 percent and profits fell by over 150 percent (Ionete 1993: 104-105; 199). As remembered by Nicolae Vacaroiu, former economist of the State Planning Commission and future premier,

What Ceausescu did after 1982-83 was almost like a form of euthanasia of our industrial competitiveness. He wanted an autarkic research and development system which was sheer fantasy. And he wanted it overnight and on the cheap. The institutes could reverse engineer some Western imports but not others and before you knew it our industry was flooded with poor quality replacements of sophisticated devices (subansamble) that drove down the quality of our exports. And since he [Ceausescu] wanted to pay off foreign debt at all costs, the fall in quality was offset by price markdowns on our industrial exports. It was a self-defeating spiral whose origins were in the extreme austerity Ceausescu decided at the beginning of the 1980s. In the end, this showed up in negative growth figures…

In this dire context the regime remained committed to the industrialization project, even as industry already had the highest share of the economy in Europe. As a consequence, although the pace of annual industrial growth decreased from 3.3 percent during the 1970s to 2.6 during the 1980s, the industry’s share of the national economy continued to increase during the 1980s, (Cojanu 1997: 89). A former regime insider explains,

From an ideological standpoint Ceausescu was very simplistic. For him industrialization and his own freedom to decide what to do about it were paramount. In turn, industry was the guarantee of national independence. Citizens’ material needs, he assumed, were something you could dispense with for the sake of the glorious future. Some specialists [in economics] tried to tell him during the 1980s that things are a little more complicated but he would not hear any of it and tell them that the alternative would be Poland’s gradual loss of sovereignty at the hands of international agencies.

Faced with the Poland scenario, the regime stuck to its guns. Industry remained the main beneficiary of dwindling budget resources and the investment rate remained Eastern Europe’s highest. Enrollement rules in the education system strengthend even further the tendency to channel the overwhelming majority of students into vocational high school and university training programs that served the needs of the industry (Constantinescu 2000: 336-338). Industrialization for industrialization’s sake, even in the face of social catastrophe and technological obsolescence in an increasingly competitive world economy, turned out to be the terminal pathologies of Romania’s brand of national-Stalinist developmentalism. Some investments were productive, such as the nation wide electrification of the country’s extensive rail network or the massive overhaul and expansion of the Black Sea port of Costanta. Others, however, such as the costly building of a canal meant to shorten routes from the Danube to the Black Sea or the push to construct gigantic public buildings in Bucharest, were spectacular manifestations of waste that contrasted sharply with the wartime food and heat rations ordinary citizens had to live with.

In the spring of 1989 the regime announced that the foreign debt was paid in full. Moreover, the regime also boasted a budget surplus of 8.2 percent and exports worth 10 billion US dollars, barely 3 billion less than the much bigger Polish economy. But while the more liberalized socialist economies of Central Europe and USSR were merely stagnating in 1989, in Romania things looked much worse even from the standpoint of the cherished GDP indicators, with a spectacular drop of 5.8 percent of GDP confirming the failure of austerity and forced import substitution (Amsden et al, 1994; 32-33).

Austerity Wrecks Guaranteed Basic Needs

Austerity has a corrosive effect on regime legitimacy, especially when the distribution of wealth is perceived as unfair. Despite the fact that Romania’s income distribution was egalitarian, it became clear that the allocation of the state’s fiscal resources for industrial investment and debt repayment came at the cost of meeting the basic needs of citizens. Because this disregard for needs immediately followed a policy era of accumulation and social welfare, one could say the shift amounted to the Stalinist version of social injustice.

The obstinate comittment to industrial investment in conditions of extreme financial scarcity did not only come at the expense of a decline in technological competitiveness. Political regimes can maintain their legitimacy in conditions of technological and economic stagnation as long as they deliver on the socio-economic agenda that bolsters their legitimacy. This was even more the case in an authoritarian system like Ceausescu’s Romania, where, as we have seen, the majority of the population saw unprecedented levels of improvement in quality of life and social mobility during the first three postwar decades. Indeed, like other Stalinist regimes, Ceausescu’s governed not only through political prisons and intelligence services but also by promising and generally providing guaranteed employment, decent pay and working conditions, affordable housing and leisure, and universal access to education and healthcare. Yet it was precisely the remunerative sources of the regime’s legitimacy that suffered the most from the austerity policies of the 1980s. Unlike Hungary or Czecholsovakia, Romania did not use individual material incentives as intensively in order to secure compliance (Verdery 1991: 85-86). As revealed in testimonials on subjective perceptions of austerity during the 1980s, a dramatic reduction of consumer demand during that decade abruptly terminated the status quo in the relationship between the regime and its subordinates (Nicolau 2003; Latea 2000; neculau 2004).

To get the dollars needed to pay off foreign debt, Ceausescu decided to crack down on both private and public consumption, thus reversing two decades of progress in living standards. The provision of adequate food, housing and health was no longer taken for granted. Schools and the extensive apartment complexes that housed the newly urbanized population saw regular electricity and heating cuts during subzero temperatures because an expanding industry struggling to meet the export targets of the regime needed more electricity (Constantinescu 2000: 144-145). Industry earned precious hard-currency, so consumers had to endure daily blackouts, even though the country produced more electricity than Spain and Italy. Spending on healthcare, the hallmark of the regime’s social progress, was also cut—so much so that by the late 1980s doctors had to offer care without the most basic supplies. Spending cuts and the effective banning of medical imports during the late 1980s led to severe shortages in medical supplies. Even essential items like insulin, cotton pads and single use syringes were hard to come by. Some of the weakest members of society (childless retirees, orphans and abandoned children) were cared for in abysmal conditions. In suggestive contrast, the building of a single new coal power plant (Centrala Termoelectrica Anina) cost nearly three times more than the yearly investment in health and social assistance during the 1980s (Ionete 1993: 43).

The strong export orientation also meant reduced supplies of clothing, footwear, and gasoline. Eerily empty shelves, long queues for everyday items lasting hours on end, and the growth of the informal economy became the new realities of consumer life in urban areas during the 1980s. In a parallel to consumer behavior in capitalist recessions, savings deposits in 1980s Romania went up in real value per annum, even as households experienced unprecedented consumption cuts (C.N.S. 1991).

In what seemed like an uncanny repeat of the early industrialization period of the 1950s, as the government budget was accumulating surpluses, the bout of fiscal virtue saw private consumption as a share of national income drop by 2 percent (World Bank 1991; IMF 1992). And even according to government statistics, food became more expensive, with the share for this item in household budgets going up from 46 percent in 1980 to 51 percent in 1989. Moreover, as food exports increased and food rations were introduced, the per capita calorie intake fell from 3,200 to 2,900 over the same period. In this way, drastic cuts in consumption and social services undermined the very claims of socio-economic progress that the regime’s legitimacy hinged on. The belt-tightening continued even after April 1989, a date celebrated by the regime as it marked the full repayment of Romania’s foreign debt.

Austerity also made the regime increasingly derelict in keeping its promise to deliver decent working conditions. Increased work intensity, night shifts, working Sundays, and higher quotas at no extra pay became the rule in the expanding export sector as management was ordered to meet increasingly ambitious export schedules. The engine of social mobility began to sputter, as the new generations of working age peasants trained to staff the industrial infrastructure had to obtain special permits to live in the cities where they worked. Accordingly, they were forced into long commutes at a time when spending on transportation had been drastically reduced (Murgescu 2010: 380-385).

Mass mobilization and regime change

In 1987, a wildcat strike in the heavily industrialized city of Brasov demonstrated the importance of wage cuts and consumption deprivation as sources of mobilization. Crucially, scholarly accounts and memoirs of this event are in agreement that workers’ demands for restoring the pre-austerity socio-economic status quo soon morphed into demands for regime change, storming of government buildings, and the destruction of RCP symbols. The strike led to a wave of arrests, prosecutions, and long prison terms for the workers involved. In the aftermath of the strike, some in the inner circle of the regime tried to temper austerity but were demoted by Ceausescu. When Florea Dumitrescu, the central bank governor and Ceausescu loyalist suggested that the payment of the foreign debt ahead of schedule irritated foreign creditors, he was marginalized and eventually sacked.

When the socialist social pact was challenged in Brasov, Romania’s own “magnetic mountain,” one would have expected the regime to reverse its consumption suppression strategy. This did not happen, however. Moreover, the minutes of an RCP executive committee meeting from May 5, 1989 certify that Ceausescu remained keen to divert resources away from basic consumption and towards exports (Betea, 2011: 396-397). When trade minister Stefan Andrei asked Ceausescu to at least provide better heating in the huge housing complexes the regime had built, he learned that Ceausescu’s new strategy was to use the 2 billion dollars accumulated in 1989 and the 5 billion in debt owed to Romania to build enough hard currency reserves to turn Romania into a creditor country. A former Romanian diplomat who specialized in Middle East affairs claims that in 1989 Ceausescu’s thinking went as far as planning the establishment of a development bank together with Iran. It became clear that once Romania was cut off from the international bond markets, Ceausescu hoped to turn Romania into a leader of newly industrializing countries, apparently with no consideration for the political costs involved.

Moreover, just as austerity was traumatizing the urban industrial working class the regime had created, the public budget was funding infrastructure and industrial investment in North and Sub-Saharan Africa, Cuba, the Middle East and the USSR. While before 1989 this policy was presented as a calculated attempt to get the dollars needed to pay off the debt and, through barter, the commodity imports demanded by the industry, it was hard to understand why the debt payment terms of these countries extended well into the 1990s given that Ceausescu’s plans to enter the mining business in these countries saw few concrete steps. It also seemed profoundly unfair that as living standards continued to drop in 1989, the regime sat on nearly 9 billion dollars lent or invested in developing countries and the USSR.

This extravagance in Romania’s external accounts was paid not only through extensive mass mobilization. Indeed, Brasov’s rebelling workers were the unheeded canaries in the mine to the anti-regime mass mobilization that brought down the government in December 1989. Unlike negotiated transitions in Spain and elsewhere in Central Europe, the Romanian authoritarian regime died in a violent face off with a protest movement whose backbone was precisely the social class the regime had built and then betrayed: the industrial wage-earners. Contrary to skeptics’ assumptions, it quickly became clear that the high levels of police repression, constant surveillance, and the absence of a robust network of anti-government activists did not prove to be insurmountable obstacles against Europe’s last popular revolutionary movement to end a particularly repressive regime and the grip of a well-entrenched “uncivil society.”

Beginning in Timisoara, a multiethnic city in the southwest, the movement spread throughout most large cities in the country. The regime’s attempts to put down the movement failed despite the deployment of the entire repressive toolbox of the police state, from the “milder” arrests, city blockades and curfews to fire-at-will orders given to armored army regiments. On December 22, 1989, Ceausescu’s flight by helicopter, his abandonment by the repressive apparatus, and his execution a few days later ended Romania’s national-Stalinism. All of this, however, was not before hundreds more had died in various forms of urban warfare, the images of which were grotesquely dramatized in Western media and converted into an imagery of postcommunism as a realm of violence riveted by the devastating effects of “communist” rule (Petrovski and Tichindeleanu 2009).


Germany Imposes Versailles on Greece

26 May


By Marshall Auerbach

Marshall Auerback has 27 years of experience in the investment management business, serving as a global portfolio strategist for RAB Capital Plc, a UK-based fund management group with $2 billion under management, since 2003. He is also co-manager of the RAB Gold Fund. He serves as an economic consultant to PIMCO, the world’s largest bond fund management group, and as a fellow of the Economists for Peace and Security.

Given the German electorate’s long standing aversion to “fiscal profligacy” and soft currency economics (said to lead inexorably to Weimar style hyperinflation), one wonders why on earth Germany actually acceded to a “big and broad” European Monetary Union which included countries such as Greece, Portugal, Spain and Italy.Clearly, this can be better understood by viewing the country through the prism of the Three Germanys, which we’ve discussed before:

Germany 1 is the Germany of the Bundesbank: the segment of the country which to this day retains huge phobias about the recurrence of Weimar-style inflation, and an almost theological belief in sound money and a corresponding hatred of inflation. It is the Germany of “sound finances” and “monetary discipline”. In many respects, these Germans are Austrian School style economists to the core. In their heart of hearts, many would probably love to be back on an international gold standard system.

Germany 2 is the internationalist wing of the country, led by Helmut Kohl. Kohl and his successors are probably the foremost exponents of the idea that Europe can rid itself of the “German problem” once and for all if Germany firmly binds itself to a “United States of Europe” and continues to construct institutions that broadly move the EU in this direction. It is questionable whether this vision has survived significantly beyond the tenure of Helmut Kohl himself.

One can see the inherent tension between these two Germanys. Bundesbank Germany would never allow vague, internationalist aspirations to dilute the goal of sound money, low inflation and fiscal discipline. One could envisage most looking askance at the Treaty of Maastricht and the corresponding threats to these ideals.

Which brings us to the key third variable in German politics: Germany 3, Industrial Germany, the Germany of Siemens, Daimler, Volkswagen, the great steel and chemical companies, the capital goods manufacturers. Clearly, these companies benefited substantially from the economic stewardship provided by institutions such as the Bundsebank, along with the broad adherence to Erhard’s social market economy. But they also recognized the benefits entailed by a completely open and integrated European market (still the largest component of their sales). Currency union, even if it meant admission of fiscal profligates such as Italy and Spain, also minimized the threat of competitive currency devaluation, given the implementation of a European wide euro (as opposed to the narrow currency zone which represented the limits of the Bundesbank’s internationalism).

Industrial Germany rightly perceived that a broadly based euro zone which incorporated chronic currency devaluers such as Italy, permanently entrenched their competitive advantage. And with the support of this key component of German society, Chancellor Kohl, was able to embark on the huge institutional transformation embodied in the Maastricht Treaty.
One could argue that “Germany #3″ made a bad bet, but is this really so?

A few months ago it appeared that the German sentiment data taken in aggregate showed that German domestic demand was turning up and the risk of a German recession was behind us. This was corroborated by truly powerful increases in total German employment, which now stands at a 20 year low.
To be sure, since then we received some weak data on industrial production and real retail sales. This coupled with the big down-tick in the manufacturing PMI rekindled recession fears.

But the previous worrying data about the German economy appears to have been removed with the latest round of positive data with upward revisions. We now have much better data on factory orders and real retail sales. A few weeks ago Germany’s March industrial production was released. It showed industrial production rising a large 2.8% in March; additionally, there was more than a one percentage point upward revision to prior months.

Taking the constellation of German economic data in aggregate – real retail sales, factory orders, industrial production, total employment and the services PMI (which remains well above 50) – it is unsurprising that Germany’s preliminary 1st quarter GDP subsequently came in at 2%.Yes, the periphery remains a disaster, but Germany is still growing. It is also the case that the slowdown in Europe could eventually reach the core and China’s worrying loss of economic momentum and dent Germany’s growth momentum in the future.But for now, there is no significant fiscal restriction to speak of (unlike, say, Spain or Greece), domestic interest rates are super low, employment has been expanding rapidly. In short, it appears that, having absorbed a trade related and sentiment shock emanating from the European periphery, a domestic demand led expansion has probably resumed.

The point is not to celebrate the German economic model per se, but merely to highlight that for all of the gnashing of teeth and whining about “the cost” to Berlin of perpetually “bailing out” the “profligate periphery”, the reality is that Germany has done exceptionally well out of the euro zone and continues to do so.

“Germany #3″ in effect placed the right bet: by locking in chronic devaluers to a currency union (thereby precluding the traditional expedient of currency devaluation to regain export competitiveness), Berlin in effect entrenched Germany’s mercantilist model and consolidated the country’s dominance as the trade superpower of Europe. The benefits are self-evident, given the contrasting data between Germany and the PIIGS.

Of course, one can already hear Germany’s apologists proclaiming that this success is the product of taking “hard decisions” in the earlier part of this century, in particular, the so-called “Hartz reforms”. The Germans have always been obsessed with export competitiveness. In the period before the euro, they would devalue the Deutschmark so that they could increase the sales of their products to their neighbors. Once the Germans lost control of the exchange rate by signing up to the Economic and Monetary Union (EMU), they couldn’t perform this trick anymore. They had to manipulate other “cost” variables in order to sell goods cheaply. So starting in 2002, they focused on wage suppression and cutting into the social safety net for workers through something called the Hartz package of “welfare reforms,” named after Peter Hartz, a key executive from German car manufacturer Volkswagen.

Unlike the American Henry Ford, who created good, well-paying jobs because he knew that having a secure middle class was essential to having a market for his cars, Peter Hartz regarded the relationship between wages and the economy very differently. In his view, squeezing workers was the way to keep a country “competitive”, which is precisely what his “reforms” did. And it had disastrous consequences for the rest of the eurozone –

[As an aside, the other inconvenient little truth is that the much vaunted Hartz “reforms” themselves are really devoid of any kind of democratic legitimacy. It was subsequently discovered that Peter Hartz himself had only secured the acquiescence of Germany’s workers by sanctioning illegal payments to Germany’s powerful works council for which he was given a 2 year suspended sentence.]The Hartz measures have been extremely far reaching in terms of the labor market policy that had been stable for several decades. Bill Mitchell and Ricardo Welters noted that while the reforms appeared to be successful in early 2003, with lots of jobs created, there was a downside: “From the bottom of the cycle, in mid-2003, employment grew much less quickly than in previous upturns. And much of the rise took the form of ‘mini jobs’ – part-time posts paying no more than €400 a month, regardless of hours.”As Mitchell and Welters pointed out, the “reforms” actually decreased regular employment. Workers got stuck with so-called “mini/midi” jobs – a new form of low wage part-time employment. Such jobs were hailed as “flexible” and “efficient” by their champions, while detractors such as Mitchell noted that they were part-time jobs characterized by heightened insecurity, lower wages, and poorer working conditions.

More to the point, Germany benefited from “first mover advantage”: they initiated these reforms in the context of a growing global economy. Demanding such wage repression in the context of a global recession makes such “reform” virtually impossible, to say nothing of the fallacy of composition problems, when all other countries seek to deflate their wages in order to gain the elusive export competitiveness.

All of this is now coming under threat, given the renewed perturbations afflicting the euro zone. Greece’s inconvenient outbreak of democracy has created a new wild card: a new Greek party, Syriza, head of the coalition of the radical left, has vaulted to prominence, It’s new leader Alexis Tsipras, a previously obscure left-wing member of Parliament. led his grouping to second place in the recent national elections with the promise of repudiating the loan agreement Greece’s previous leaders signed in February. He is, in short, the first Greek politician to use the his country’s leverage over creditors.

Rule #1 in negotiations: You must demonstrate to your counter-party that you have credible options to walk away from the table/deal. He has, amongst other things, simply pointed out that the Greek state is quite close to a primary surplus. All that is needed are a few small reductions wages and pensions, and the Greek public sector could finance itself for the foreseeable future. Were it to exit the euro, all of a sudden Athens’s problem becomes the eurozone’s problem.
Yes, Greece only constitutes a mere 2% of Europe’s GDP. And yes, the eurozone authorities are said to be “making preparations” in the event of a “Grexit”. But then again, Lehman was a tiny investment bank which almost brought down the entire global banking system when it was allowed to go bust. And recall that Lehman’s bankruptcy occurred several months after the rescue of Bear Stearns. In theory, the authorities had ample time to construct back-stops to prepare for this eventuality, as is now being said in regard to Greece’s potential exit from the euro zone.

Would a firewall today be any more effective in “cauterising” the Greek wound and preventing the contagion from extending to Portugal, Spain, Italy and then to the core? Tsipras clearly understands this, and he could well be Greece’s next Prime Minister. It would entail massive firepower from the ECB, a “bazooka” that the ECB has hitherto been loath to supply.
In the meantime, the Greek election result has resulted in an acceleration of massive bank runs within the eurozone. There has been a steady flight of deposit funds from the PIIGS into German and other northern European banks (and perhaps to some banks outside Europe) for some time now. Data on the Target 2 financing of these deposit runs by the recipient countries apparently accelerated in the first four months of this year prior to the French and Greek elections. A recent statement by the Greek authorities suggests that the deposit run from Greek banks has accelerated, perhaps hugely, since the Greek elections. This has been denied, but under such circumstances one should never believe official denials.Indeed, late last week, El Mundo reported that depositors had withdrawn one million euros from the Spanish bank Bankia since its takeover by the government on May 9th. The odds are that this deposit run may have as much to do – or more to do – with a flight out of Spanish bank deposits in general that it has to do with any fears about holding deposits in a bank taken over by the Spanish government. In other words, this may be a sign that a deposit run caused by fears about euro exit has now spread in a significant way to Spain. Of course, the authorities are denying such, but under such circumstances one can never believe such denials.Paradoxically, the very existence of a monetary union facilitates bank runs. If you’re a depositor at a Spanish bank in Barcelona, there is nothing stopping you from withdrawing that money and re-depositing it in at a local German bank down the street. There are no capital controls or border controls in effect. With no exchange rate risk! Bank depositors in all of the periphery countries now fear they will wind up with the old currencies which will be worth much less than the euro. These deposit funds go into German and other core European banks who then recycle the funds through the ECB and the national central banks back into the banks of the PIIGS that are experiencing the deposit runs.

Apparently this deposit run and its reflux back into the imperiled banks on the periphery accelerated in the early months of this year before the French and Greek elections. It apparently has accelerated further since.
In effect, the System of European Central Banks is involved in an ever growing and massive bailout exercise which they are not publicly acknowledging.

The German response so far? “Oops. This guy is blackmailing us. What shall we do?” Because Germany as a creditor nation faces huge losses if the entire banking system starts to come under pressure, to say nothing of the end of their vaunted “wirtschaftwunder” as the entire eurozone implodes. Greece, by contrast, has already experienced 5 years of unremitting economic austerity. The country has been virtually reduced to the state of a barter economy. What has it got to lose at this juncture by refusing to roll over to the Troika?

To be sure, the Germans might well say, “Enough is enough” and leave the euro zone (which would probably destroy the currency union). The likely result of a German exit would be a huge surge in the value of the newly reconstituted DM. In effect, then, everybody would devalue against Berlin, shifting the onus for fiscal reflation on to the most vociferous opponent of fiscal activism. Germany would likely have to bail out its banks (particularly the Landesbanken). This might well be more politically palatable than, say, bailing out the Greek banks (at least from the perspective of the German populace), but it would not be without significant short term economic cost for Berlin. And in the interim, the likely currency shock would put an immediate halt to its export machine, as the built-in conferred by the euro zone would be dissipated in the event that Germany reverts to a newly reconstituted DM.

By accounting identity, a fall in Germany’s external surplus would mean a large increase in the budget deficit (unless the private sector begins to expand rapidly, which is doubtful under the scenario described above), so Germany will find itself experiencing much larger budget deficits. It will become a ‘profligate’ if it wishes to mitigate the effects of a collapse in its current account surplus. Quite a reversal in fortune.
So who holds the gun now?

Should Greece leave the euro or just default within the euro?

19 May

From Yanis Varoufakis’ blog:

‘Mark Weisbrot has been arguing, for some time now, that Greece must try to emulate Argentina; that is, to default on its debts not as a bargaining strategy that yields a New Deal within the Eurozone but, rather, in the context of exiting the Eurozone altogether and going it alone. Recently, Paul Krugman has endorsed this position (see here and here). I think they are profoundly wrong.

The differences between the two cases, which render the analogy redundant, are three:

1st difference: The potential of exports to act as shock absorbers

Weisbrot and Krugman point out, correctly, that at the height of Argentina’s crisis, its exports (as a percentage of GDP) were not very different to those of Greece. Based on this argument, they dismiss the idea that Argentina managed to recover after its default-devaluation by means of export-led growth.

While it is quite true that Argentina’s export performance in 2001 was by no means better than Greece’s today, it is crucial to note that Argentina’s export potential in 2001 was vastly superior to that of Greece’s in 2012. By export potential I mean the degree of underutilisation of productive resources whose employment can, potentially, produce goods and services for which there is effective demand. In 2001, Argentina’s farms were woefully underproducing primary commodities that were, at that time, seeing their demand skyrocket. In sharp contrast, idle productive resources in Greece cannot produce much for which there is increasing demand.

Take for instance shipping and tourism, mentioned by Paul Krugman as two potential sources of Greek export growth: Both are in speedy decline! Additionally, whereas in the case of Argentina, its next door neighbour (Brazil) was entering a period of rapid growth, Greece’s neighbours are showing no such signs of vitality. Indeed, our traditional trading partners are also buffeted by recession (pushing down the demand for Greek tourism) while non-EU countries (such as Russia) cannot, and will not, make up the difference to any appreciable degree.

Lastly, on this note, Weisbrot and his co-author Juan Antonio Montesino argue that Argentina’s growth was not ‘export’ driven, noting that only 12% of its GDP growth during the 2002-8 period can be accounted for by exports. With all due respect, I fear that such a pronouncement cannot be made lightly. For it is impossible to separate neatly the effects on GDP of exports from the effect of internal aggregate demand when we take into account the fact that internal demand relies entirely on ‘animal spirits’ (i.e. on the optimistic expectations) of investors into goods intended for local consumption. Put simply, the emergence of strong Chinese demand for Argentinian soy, beef etc., in conjunction with the growth of neighbouring Brazil, has had a major impact on the readiness of Argentinian investors to invest in activities that also generated internal demand. In short, that 12% quoted by Weisbrot is simply a gross underestimate.

2nd difference: Greece has no peg with the euro. It has the euro!

Analysts like Krugman, Weisbrot and Rubini make the utterly good point that Greece would benefit enormously from a devaluation of its currency. Of course it would. Argentina does, indeed, provide a brilliant example of how a massive devaluation can help a country escape a debt-deflationary cycle. As, for that matter, does Iceland. However, what they are neglecting is that it is one thing to break a peg linking your currency to some other hard currency (as in the case of Argentina), or to devalue your floating currency (as did Iceland), and quite another to have no currency but to have to create one from scratch.

In the case of Argentina the peso was in existence. All it took to devalue it was to announce that the 1:1 peg with the dollar was over. Suddenly ALL incomes and ALL savings were devalued by the same percentage. Overnight. End of story. It was not pleasant but it could be done. In the case of Greece it simply cannot. And this makes a world of a difference. Why? Because of two important reasons. First, because of the crushing delay in introducing a new currency. Secondly, because of what I call the bifurcation between the stock of savings and the flow of incomes. But let me take these one at a time.

Delay: Bank of Greece colleagues tell me that it will take months before ATMs are stocked with new drachmas once they get the go ahead to print them. Even if it takes weeks, an economy cannot remain un-monetised for so long, especially when already on the canvass of a deep crisis, without major civil unrest and an almost terminal effect on economic activity.

Bifurcation: Even ignoring the crippling effects of the delay, we must not forget that the ongoing crises has led Greek savers to withdraw oodles of their savings from Greek banks and either shift them offshore (London, Geneva, Frankfurt) or stuff them in their mattresses, or hide them in their freezers (in ‘bricks’ of 500 notes). This means that, by the time we come to an exit from the euro, the stock of savings will be in euros and the flow of incomes and pensions (once the banks re-open) will be in drachmas. So, unlike in Argentina, a Greek euro-exit will drive a wedge between stocks and flows, savings and incomes; with the former revaluing massively relative to the latter. Moreover, the very availability of such large quantities of ‘hard’ currency savings, in the hands of the average Dimitri and Kiki on the street, will ensure that the decline in the value of the new drachma will be precipitous (something that did not happen in Argentina since most savings were in pesos also).

In short, even if we neglect the devastation caused by the delay in the introduction of the new currency (something Argentina did not have to worry about), the new currency will be debased ever so quickly due to this bifurcation, leading to hyperinflation and the loss of most of the competitive gains we might have hoped for from the devaluation.

3rd difference: Greece is perfectly capable of poisoning the water it is swimming in (Europe)

When Argentina defaulted and broke the peg, the ill effects on its trading partners (China, Brazil etc.), as well as on the broader macro-economy in which it was functioning, were negligible. If Greece leaves the euro, however, the results will most certainly prove catastrophic for our ‘economic ecology’, and in a never-ending circle of negative feedback, will bite our struggling nation back.

To begin with, Greece must exit not only the Eurozone but also the European Union. This is non-negotiable and unavoidable. For if the Greek state is effectively to confiscate the few euros a citizen has in her bank account and turn them into drachmas of diminishing value, she will be able to take the Greek government to the European Courts and win outright. Additionally, the Greek state will have to introduce border and capital controls to prevent the export of its citizens euro-savings. Thus, Greece will have to get out of the European Union.

Setting aside the domestic ramifications over loss of agricultural subsidies, structural funds and possibly trade (following the possible introduction of trade barriers between Greece and the EU), the effects on the rest of the Eurozone will also be cataclysmic. Spain, already in a black hole, will see its GDP shrink by more than Greece’s current deflationary record rate, interest rate spreads will tend to 20% in Ireland and in Italy and, before long, Germany will decide to call it a day, bailing itself out (in unison with other surplus countries). This chain of events will cause a bitter recession in the surplus countries clustered around Germany, whose currency will appreciate through the roof, while the rest of Europe will sink into the mire of stagflation.

How good will this environment be for Greece? I submit it to you, dear reader, that the answer is: Not good at all!

In short, whereas Argentina’s and Iceland’s successful default-devaluation strategy did not have adverse effects on the overarching environment in which they had to exist after their bold move, a Greek euro-exit will be the equivalent to poisoning the pool in which we must swim.


Does this mean that Greece ought to grin and bear the massive and misanthropic idiocy of the bailout-austerity package imposed upon it by the troika (EU-ECB-IMF)? Of course not. We should certainly default. But within the Eurozone. (See here for this argument.) And use our readiness to default as a bargaining strategy by which to bring about a New Deal for Europe (in a manner that I have written about here).

What brought Romania into a sovereign debt crisis in 1981?

19 May

From Cornel Ban

The economic failure of the Romanian national-Stalinist developmental state had both structural and contingent causes. Most importantly, the 1979 oil shock undermined an increasingly energy-intensive economy, driving the regime to take on a lot more foreign debt, even as interest rates skyrocketed. Thus, the continuing expansion of steel, petrochemicals, and engineering during the 1970s translated into high levels of energy consumption and increasing vulnerability to exogenous supply shocks. However, the analysis below does not support the argument that the Ceausescu regime “borrowed the rope to hang itself,” as Kotkin put it (2010: 28-30), a view embraced by former regime insiders in Romania. Unlike other socialist states, Ceausescu built the bulk of the debt not at the low interest rates of the 1973-1979 period, but at the high interest rates of 1979-1981, in an effort to save large oil processing capacity it built in the late 1970s. This material constraint was important enough to trigger a reconsideration of Romania’s development path during the 1980s. Ultimately, however, it was the regime’s economic ideas about continuing industrialization in an airtight sovereign policy space that led it to to opt not for further liberalization and scaling down of oil-guzzling industries, but a decisive shift: from an economy based on internal demand and modernization contingent on East-West technological and financial flows, to an economy based on forced austerity in the area of consumer demand, isolation from international finance and technology, and an export strategy shackled by import substitution imperatives.

The first oil shock (1973) did not affect Romania as much as it affected other developing countries because the country was able to supply a large share of its energy needs from local oil fields and managed to strike machinery-for-oil barter deals with Iran, Iraq and Libya (Linden 1986). The post-1973 stagflation led to decreasing demand in the European Community, thus reducing the share of Romanian exports to developed states; some of the losses, however, were offset by growing demand in other developing states, particularly those rich in oil (Lawson 1983; Linden 1986).

Conversely, the second oil shock of 1979 and the debt crisis triggered by monetary policy changes in the developed capitalist core put an end to the buffering effect that these factors had had on the Romanian economy. The main reason for this vulnerability was that the unprecedented expansion of oil-guzzling industries and the reckless investment in oil refineries and the manufacturing of oil processing equipment during the second half of the decade dramatically tripled Romania’s demand for oil, from 5 million tons in 1975 to 16 million tons in 1980 (Murgescu 2010: 392). According to a former trade official, while refineries could count on 10 million tons of domestic oil, their capacity had been expanded to processing 33 million tons. These refineries and refinery equipment factories employed tens of thousands of workers and while their shutdown was not unfathomable, given the proven capacity of the state to reallocate labor, Ceausescu thought this option was oustide the boundary of the economically apporpriate. The 1979 oil crisis also coincided with a peak in Romania’s oil production (Ivanus 2004). Consequently, although Romania had maintained a low level of the debt-service ratio by the standards of both newly industrializing and East European countries, in 1978 it began to increase its foreign debt to pay for the imports required by a threefold increase in oil demand. In this way the regime drove the country into sovereign debt not by “buying” the consent of citizens through extensive consumption, as Kotkin and Gross suggest, but through its rigid ideological commitment to economic ideas that saw massive chemical industry expansion as the “second wave” of socialist industrialization. The commitment to basic needs were there, but it was not paid with debt. As explained by a former planner,

During the 1960s and early 1970s there was nothing particularly odd about developing industrial branches that turned crude oil into plastics, synthetic fibers, refined oil and so on. But after the first oil shock Western industrialists stopped to reconsider further development in these areas. For Ceausescu, by contrast, these industries were part of the increasing industrial complexity required by “multilaterally developed socialism” and it was based on this image of industrialization that he decided to expand these industries in the mid to late 1970s.

The predicament was deepened by two geopolitical shocks. The first was the Iranian revolution, which disrupted Ceausescu’s oil deals with the Shah. Iran was Romania’s main supplier of oil and an alternative had to be found quickly. Unfortunately for the regime, shortly after Iraq replaced Iran in this function, Saddam Hussein’s war with Iran meant deceasing oil sales to Romania (Murgescu 2010: 393). The combined effect of these shocks resulted in increasing dependence on Soviet oil, a situation that challenged one of Ceausescu’s core foreign policy priorities: autonomy from the Soviet Union. Faced with the prospect of sacrificing its prided autonomy from Moscow, the regime preferred to look for alternative solutions.

As much as the oil shock weighed down on Ceausescu’s preferred economic strategies, it was revolutionary changes in the world of finance that eventually bred the conditions for the loss of regime legitimacy. The first financial shift concerned interest rates. In 1979 private international capital became considerably more costly following the United States’ sudden move to increase interest rates at a time when monetarist ideas were gaining traction throughout the West (Eichengreen 1992; Blyth 2002; Stein 2011).
This Western policy shift led to a dramatic rise in the interest rates on sovereign debt, pushing many developing country governments into default (Balassa 1985; Easterly 2001). The era of cheap development finance was over.

According to World Bank data, between 1976 and 1981 Romania’s foreign debt went from 0.5 billion dollars (or 3 perent of GDP) to 10.4 billion dollars (or 28 percent of GDP and 30 percent of exports). In 1981 interest rate payments reached 3 billion dollars, up from barely 8 million six years before. Over the period 1980-1982 the country had to pay 6 billion dollars to foreign creditors, and by 1982 Romania needed 80 percent of its hard currency exports to finance foreign debt. The regime first turned to the IMF for assistance, as it did in the late 1970s, when the IMF disbursed resources to cover flood and earthquake related export shortfalls. In early 1981 the IMF’s Executive Board approved a 1.3 billion loan (300 percent of the Romanian quota) but the creditors’ fear of contagion from the crisis in Poland led them to withdraw deposits from Romania and cancel inter-bank credit lines. The situation was complicated by Western banks’ allegations that Romanian banks were abusing banking practices, including the kitting of checks. Requests for rolling over maturing loans were denied, leading to the accumulation of $1 billion in arrears by the end of the year. The country was effectively evicted from international credit markets and was therefore in non-compliance with the stand-by agreement with the IMF.

With central bank reserves at a paltry 400 million, a dramatic policy shift was needed to deal with the debt crisis.

ECB baroque

19 May

UK-based Romanian economist Daniela Gabor creatively’that even in their own terms, current European Central Bank (ECB) crisis policies, geared to lending banks cash on easy terms for defined periods, cannot stabilise financial markets. The banks still eventually need “marketable collateral” – financial assets which they can use as proof of creditworthiness in financial markets.

Traditionally they have used government (“sovereign”) bonds as their “best”, most trustworthy, financial assets, and they still do. Current ECB policies “cannot offer effective solutions for preserving sovereign bonds as marketable collateral”. Even in its own frame of reference, the ECB should do what it has so far refused to do: act as a “lender of last resort”, a financial backstop, for governments in the eurozone.’

Gabor: The paper first distinguishes between market-based and bank-based measures to then focus on the collateral management strategies of European banks, in the context of an increasing reliance on secured market funding, to discuss a crucial policy challenge in monetary unions with integrated funding markets: banks’ ability to access market funding depends on existing portfolios of marketable collateral – in Eurozone mainly sovereign bonds. The constraints on the central bank’s ability to stabilize markets for collateral may thus worsen banks’ funding conditions through ‘coordinated risks’ between counterparty (bank) and collateral (sovereign). Since bank-based crisis policies cannot offer effective solutions for preserving the role of sovereign bonds as marketable collateral, the dilemma of how to stabilize funding markets within the existing European institutional architecture remains unresolved.

Polanyian notes on the Ongoing Europain

7 May

European elites should hit the road to Damascus. Soon.
From Mark Blyth:

‘It’s probably worth asking if the objective, saving the Euro, is really worth it.

First, what if the price of saving the Euro is the end of the wider European project? The European union is based upon trust, building confidence, sharing the wealth, and mutual support. The new institutions designed to save the Euro — even stricter fiscal rules and a financial “cordon sanitaire” around Greece — are based upon seeing every possible interaction with another state as a moral hazard problem where trust should be eliminated. Designing institutions in this way undermines the capacity to generate trust. Trust is not an optional extra. It is a necessity. Try running a banking system without it and see what happens.

Second, back in the 1990s critics of the Euro pointed to the costs of the convergence needed to make it all happen. There was a decade of anemic growth and high unemployment as multiple states simultaneously tried to get their budget deficits and debts down while maintaining very low inflation rates. The response to those critics at the time was “never mind the short term costs, wait for the long term benefits.” Those benefits seemed to arrive in the 2000s, before the financial crisis hit, when inflation rates and bond yields in Europe fell together while growth picked up. But those benefits now seem to be as much a result of the mispricing of risk in the bond market, free money to the periphery and asset price bubbles, as they are of fiscal consolidation. Indeed, today the “never mind the short term costs” argument has found a new form in “We can’t break it up because the costs will be catastrophic; we must suffer a decade of depression instead as the lesser of two evils,” which makes saving the Euro all cost and no benefit.

The Euro was supposed to obviate the twin problems of serial devaluations and currency volatility. But on the balance sheet of misery, how much devaluation and volatility are worth the impoverishment-by-policy of millions of Europeans and the loss of a generation of growth? If this is the price to be paid for saving the Euro, surely that needs to be recognized ahead of time?

Without asking the right questions, and being honest about what questions to ask, you cannot resolve this crisis. Time is running out to ask the right questions. The elections in France and Greece offer European leaders an opportunity to ask them. If they do not, then austerity-strapped European publics will find their own questions, and the designers of the Euro will not like the answers they provide.’

‘With the exception of the Baltic states, small enough to export a large chunk of their tiny labour markets to compensate, every major European country that has practised austerity now has more debt than when it started. States cannot all cut their way to growth inside a common currency without promoting a general contraction that makes the debt problem worse, not better.

Tragically, mere policy failure is seldom enough to shift a good ideology. As Karl Polanyi noted in 1944 regarding Europe’s last attempt to run a gold standard in a democracy: “Its spectacular failure … did not destroy its authority in all. Indeed, its partial eclipse may have even strengthened its hold since it enabled its defenders to argue that the incomplete application of its principles was the reason for every and any difficulty laid to its charge.” As Mr Rachman compellingly demonstrates, Polanyi’s insight remains sadly germane today.’