Archive | August, 2012

Living as a Financial Enclave: Banks and Sovereigns in the EU’s Eastern Periphery

17 Aug

Cornel Ban (forthcoming in Triple Crisis)

Before the PIIGS entered the collective consciousness of European elites, the East-Central European member states of the E.U. were supposed to be the root of the European financial woes. Just as the beginnings of the Great Depression are tied to a financial imbroglio of a Viennese bank, it was Austria’s massive exposure to the financial sectors of countries like Hungary or Romania by 2008 that was expected to trigger collapse in the rest of Europe. Yet this did not happen. Why not and with what costs for the economies of the region?
Unfortunately for those quick to cast Eastern Europe as the default troublemaker on the continent, it was instead parts of Western Europe that played leading parts in the European economic tragedy. While there are reasons to appreciate the fact that there have been few shots on the Eastern front of the European crisis, upon a closer reading one is struck by the role that the E.U. and West European banks had in generating the crisis mechanisms and then the ill-designed rescue packages that followed it.

The story of this averted meltdown in the East begins years before Lehman entered a tailspin. After the end of state socialism and especially as these states ran for E.U. membership, the I.M.F. and the E.U. abetted and at times coerced a wholesale transformation of their banking systems. The rules of the game were clear: privatization, deregulation, central bank independence, transnationalization of the interbank market. It took a little more than a decade for this transformation to occur. Financial systems that had been 100 percent owned by domestic state capital in 1990 had become almost entirely foreign owned within 15 years. A recent report found that two thirds of ECE. A recent report found that two thirds of transition countries in 2005 had banking systems controlled by foreign banks. With the exception of Slovenia-the only eastern social-democracy-all other new E.U. members from the East became little more than subsidiaries of (largely) West European banks. What was even more striking was that the share of foreign-owned assets in total banking assets was unprecedented among middle-income countries, with most banking sectors in new E.U. member states reaching between 80 and nearly 100 percent foreign ownership.

So what’s wrong with this picture? After all, the privatization of East European banking systems with foreign capital was a brilliant idea because this privatization broke the links between government incumbents, state banks and state-owned enterprises, right? This creative destruction was credited with ending seemingly endless cycles of non-performing loans, bank recapitalizations, and inflation. Local private capital was weak and tempted to play dirty in politics so turning the new member states into subsidiaries of modern Western banking seemed preferable to developments in countries like Russia or Ukraine. Moreover, since some of the applicant states had major issues with their EU application files, selling state owned banks – usually for a good price – to Western European banks helped to reduce the uncertainty of the membership negotiations. Don’t think of it as a bribe or insider trading. Think of it as “signaling credibility.’ In sum, the Easterners got the coveted E.U. membership and modern finance while the Westerners got as big a market share as one could get anywhere. What could be wrong with that?

Well, pretty much everything – the most problematic issue being how these transformations ended up being key to the crisis generators in the region. First, even during the pre-Lehman boom, while foreign ownership in the financial industry blew a huge consumer credit bubble in Eastern Europe, it made only a marginal contribution to industrial investment. The boom in industrial investment witnessed there had little to do with the presence of foreign banks and much to do with integration into Western supply chains where foreign firms brought their credit lines with them, rather than finance their needs from local banks. Foreign credit was primarily consumer credit with the most pernicious aspect of this development being the consumer boom in “hard” currency loans before 2008, which made devaluation much more tricky when the crisis struck.

Second, while foreign banks channeled excess savings through their East European subsidiaries in good times, in times of crisis they had strong incentives to pull out their money from them in order to consolidate the situation at the “home” parent bank. And indeed in 2008-9 many of them threatened to use this option, triggering fears that the ensuing capital outflow would shut down the economies of the region.
Given this implicit ‘capital flight’ risk generator, the much-vaunted considerations about the superior efficiency of Western banking pale next to the long-term macro costs. For it is at this point the E.U. and IMF intervened and orchestrated a massive bailout of these financial systems, but of course, they made states pay for it.

Ironically, it was in Vienna where an agreement was signed in 2009, with banks, the European Central Bank, the European Commission, the EBRD, the IMF and the states in question sitting around the table. The core of the agreement was that West European banks committed to stay if ECE governments reiterated commitments to austerity and stabilizing the banks’ balance sheets while the IMF and the E.U. put the corresponding bill (fiscal austerity, high interest rates, constraints on mortgagees’ rights, recapitalization I.M.F./E.U. loans deposited with the central bank) on the balance sheet of the states. The cases of Hungary and maybe Romania aside, what the we had then in Eastern Europe was not fiscally reckless states facing up to bond market realities – the same narrative later inflicted on the PIGS but mainly Western banks playing moral hazard games: Bail us and pay for it or we pull out the cash.

It was no surprise then that as the West European sovereign debt crisis hit, another major vulnerability emerged: that foreign banks in Eastern Europe could become the transmission belts for the troubles of Western sovereigns. Following Greece’s tailspin and Austria’s downgrading in the spring of 2012, S&P turned Romanian bonds to junk status because the Romanian banking sector had too much Greek and Austrian financial capital. With talk of the need for a second Vienna agreement in the air, it became obvious that in a world in which much of Western Europe is treated by the markets in the same way developing countries are, the creation of a financial enclave in Eastern Europe made this region more rather than less crisis prone. Trapped in pro-cyclical macroeconomic programs and dependent on investment decisions made in Western Europe, the region’s immediate economic future looks indebted and closely tied to the fate of the euro, a realm of policy over which East European societies have no control.

Forthcoming in Triple Crisis


On the Economic Experiment in Brazil

9 Aug

Cornel Ban in a forthcoming article in Review of International Political Economy:

Brazil is an important pillar of the global economy that offers a plausible alternative to neoliberalism. After a turn to a selected set of Washington Consensus policies and ideas during the Cardoso administration, during the past decade this country built an incipient policy regime that recovered the state as a focal point in development, while staying away from the more heavy-handed and exclusionary aspects of “old” developmentalism. This study set out to find whether the Consensus has been adopted with minor edits, or whether Brazil’s policy regime constitutes a different paradigm. While this country has more than an “eroded” Washington Consensus, it nevertheless did not adopt a full-blown neo-developmentalist paradigm. Instead, during the past decade, and especially since Lula’s second term, Brazilian governments crafted a hybrid paradigm in which some of the policy content of the Washington Consensus has been preserved intact, while some has been gutted and replaced with neo-developmentalist goals and policy instruments. To capture the hybridity of this policy regime that pursues growth with redistribution through “inclusionary state activism without statism” (Arbix and Martin 2010), while avoiding the wrath of transnational finance capital, I dubbed Brazil a case of liberal neo-developmentalism.

What are the constitutive elements of this policy regime? On the macroeconomic front, the goal of macroeconomic discipline emphasized by the Washington Consensus has been maintained. Commitment to this goal has been particularly steady in monetary policy, where inflation-targeting and central bank independence remain central to Brazil’s macroeconomic policy regime. By contrast, the goal of full employment that has been so central to neo-developmentalism has not been brought on a par with macroeconomic discipline. Nevertheless, since 2006 fiscal policy has been edited with a complex array of policies aimed at expanding investment and aggregate demand, an important concern in neo-developmentalist macroeconomics.

Moreover, during the economic crisis, the government used its control over federal public banks to run an off-the-books stimulus camouflaged as credit policy alongside an official stimulus package in order to help close the output gap. While signaling fiscal virtue in its official accounts, the government in Brasilia had no hesitation to use its very powerful public financial institutions to unlock the devices of the credit system blocked by the financial crisis that hit the country in 2009. In so doing, the government showed that macroeconomic stability is not the only goal and that kick-starting demand in a slump, albeit surreptitiously, is just as important. Finally, Brazil reduced its reliance on foreign savings, as if enacting the neo-developmentalist argument that “growth strategies that rely on foreign savings cause financial fragility; get governments caught up in regressive “confidence building” games; and, all too often end with a balance of payments or currency crisis” (Sao Paolo Manifesto 2010).

Brazil’s compromise between the Washington Consensus and neo-developmentalism becomes just as apparent in other policy areas as well. Thus, rather than roll back its interventions in leading sectors of the economy, the state consolidated its presence not only as a regulator, but also as owner and investor. Particularly interesting in this regard is the building of institutional and financial infrastructures able to break the bottlenecks of innovation and serve the region’s most ambitious industrial policy. In general this policy has maintained the outward orientation demanded by the Consensus, yet these interventions were not always market-following and private sector-based, a tendency that seems to be strengthened under the Rousseff administration. The imperative of deregulation has been adopted quite unevenly with regard to finance, yet not at all with regard to labor market institutions, where close labor-left party relations augur well for more inclusionary socio-economic policies. And while conditional cash transfers can be accommodated by a progressive version of the Washington Consensus, Brazil’s constant increases in the minimum wage and the use of state-owned and public-private firms to enable the expansion of welfare and employment programs better fit the commands of neo-developmentalism.

Future scholars could use these insights to undertake a comparative historical analysis of the mechanisms through which Brazil’s “old” developmentalism morphed into the liberal developmentalism after having survived the crossing of various economic deserts. This Latin American country’s previous experience with developmentalism during the first three postwar decades led to a relatively successful industrialization drive that delivered high growth, but came at the cost of enormous foreign debt, mounting inequality, recurrent fiscal and balance-of-payment crises and repressive politics. That none of these tendencies are present in its current version of neo-developmentalism is not a small feat.

So far Brazil’s liberal neo-developmentalism has been a successful policy regime, but its virtuous circles are hardly set in stone. Much of the spectacular growth has come from demand-side fiscal policies adopted during the crisis and from commodities exports. Therefore the sustainability of growth hinges on external demand. Already by the end of 2011, Brazil’s Asian-rate growth rates fell sharply, as demand in Brazil’s trading partners began to decelerate. Although they grew, investment rates remain lower than expected and outside some pockets of excellence that benefit from industrial policy, the external competitiveness of Brazil’s manufacturing is hurt by an overvalued currency. The open economy benefited Brazil’s exports but its other face is the steamrolling of some traditional sectors by Chinese competition. Despite recent progress, Brazil’s educational and physical infrastructures need massive investment to be up to par with that of competitors. Granted, the Brazilian government has good reasons to feel confident that booming foreign investment in 2010-2011 suggests that international capital buys into the liberal neo-developmentalist policy regime. That may be true for FDI, but events in Europe suggest that no policy regime is immune against the extreme volatility of transnational finance capital.

Such threats are hardly negligible. But what remains is that relatively speaking the last decade has been perhaps the Brazil’s best for the greatest number of its citizens. How long will endure the neo-developmentalist alliance bringing together the state, a sizable fraction of the domestic capitalist class, popular organizations, the informal and the rural sector workers? One may hope that the future will lead to more inclusionary growth possibilities and some of the developments recorded in this analysis point in that direction. But, tempting as it is, prediction should be resisted. As some have noted (Blyth 2006; Taleb and Blyth 2011), any political and economic status quo – and this includes Brazil’s liberal neo-developmentalism – can be visited by the “black swans” that make prediction in social science an exceedingly risky affair.

Beyond the Spanish model

9 Aug

Cornel Ban in Triple Crisis

Until recently Spain has been a quiet country known for a successful economic and political transition. In 1977, the entire political spectrum, from the hard right to the communists, signed a compact that sealed the terms of the country’s political and economic liberalization. This was followed by a massive transformation of Franco’s economic legacy during the 1980s and 1990s. During this period, the developmentalist industrialization drive that marked Spain’s postwar period made room for an economic model that aimed to increase competitiveness. It did so by targeting the consolidation and internationalization of the country’s financial, energy and construction sectors. As a result, in the eyes of many, Spain emerged as a European “tiger” economy.

A major weakness haunted Spain’s success, though: permanent double-digit unemployment levels. After a short respite given by German banks inflating Spain’s enormous construction bubble, the specter of unemployment would soon come to question the very bases of the post-Franco settlement.

Even as the post-Lehman crisis raged on, sending unemployment to the highest level in the OECD and putting half of the country’s youth out of work, citizens did not lash out harshly against the status quo. The management of the memory of the Civil War created a political society and a labor movement that feared confrontation politics. Unlike the Greeks, most Spaniards seemed to be joining Ireland in taking a stoic view of the crisis.

By mid 2012, even the famously reflexive and creative indignados movement whose tactics stressed a radical rupture with Spain’s existing political institutions, withdrew from the national scene into myriad neighborhood assemblies that were active yet not immediately threatening to the status quo. Spain’s economic model was failing a record number of its citizens, but the consensual bases of 1977 seemed to endure the test of the worst economic crisis since the transition to democracy.

Yet this Spanish political tradition began to melt into the air in the summer of 2012. The 65 billion-euro austerity hole in the Spanish government’s fiscal coffers adopted in early July led to a string of protests whose repertoire signaled that more contentious forms of politics may be entering the stage.

The country’s relatively tamed labor union movement put hundreds of thousands in the street. The active protest space is no longer the main turf of the ultimately easy-to-ignore indignados. In July coal miners battled the federal police in the Asturias mountains by using makeshift weapons and staging ambushes. Enraged by the government’s reneging on its commitment to subsidize their industry, hundreds of miners walked from various parts of Spain towards Madrid, knowing that the current policy meant permanent unemployment for them. Thousands of Spaniards cheered and fed them along the way. In Madrid, the miners’ column protest swelled into a massive rally on Paseo de Castellana, the city’s leafy main avenue.

It was hardly a dull scene. Stone-throwing, tear gas, rubber bullets and hovering police choppers made up a picture that had little to do with the typically subdued protest style of Spaniards in revolt. The miners’ march on Madrid seemed to be just the beginning of a different age in Spain’s protest politics. Flash protests organized by a broad array of actors, ranging from pot-banging burghers to flamboyantly militant youth, spread like wildfire throughout the country as police tactics became more violent. For weeks, the phantom of protesting Athenians has been visiting Spain on a relatively regular basis and comparisons with Argentina’s corralito era became standard references.

July 2012 may mark the definitive end of the legitimacy of the socio-economic model crafted in the late 1970s. Unemployment now reaches nearly 25 percent, most youth can realistically expect East European wages, and precarious work levels were the highest among developed countries. Massive cuts in the country’s education, health, and welfare systems have struck at the heart of the post-Franco settlement: social peace in exchange for redistribution. A laggard in innovation, Spain saw further cuts in public spending on research.

The Spanish model is broken and cheap fixes like easy credit and construction bubbles are no longer working. The external causes of its deterioration are well-known, with the ill-designed euro and misguided austerity politics being the chief culprits. Less talked about are the ills of domestic bipartisan consensus about what Spain’s economy should look like.

The basic parameters of this consensus have not changed since Spain’s transition. The first pillar of the consensus is a relaxed position on unemployment on the part of the policy establishment. During the past thirty years the prevailing diagnosis of Spain’s persistently high unemployment rates has viewed this as a problem of the supply-side (overregulation, education) and neglected the inclusion of demand-side factors in its causal generators.

Yet despite significant moves towards deregulation, unemployment continued to grow and in July even the OECD, an ardent supporter of the supply-side argument, conceded that further reforms won’t reduce unemployment levels, whose causes are macroeconomic. In turn, putting more young people into college seems like a wasted strategy as well, as data shows that more education fails to improve one’s chances of finding a job, with a large swath of job postings for educated youth consisting of internships that pay remunerations close to the average wages in Romania and Bulgaria, the EU’s poorest members.

Today, the seriousness and the persistence of the unemployment problem is marked by an environment that lacks the balancing mechanisms of the past. Thus, austerity shrunk the possibilities of social compensation through the welfare state, the banking crisis killed both consumer credit and the real estate bubble, while the savings of the famously solidaristic Spanish family have been eaten away by three years of crisis. The wearing out of these compensation mechanisms calls for a systematic and imaginative overhaul of the Spanish approach to unemployment.

Second, Spain’s bet that finance and services should be the main engines of the economy needs to be reconsidered and the bases of the Spanish economy need to be drastically rearranged. It is now painfully obvious that both these sectors fueled the doomsday machine of Spain’s private indebtedness during the 2000s while covering up the true causes of high unemployment and generating a great deal of precariousness in the workplace. Moreover, the costs of their failure have been passed onto taxpayers through bailouts, austerity and external policy conditionality.

Alternatives exist and should be swiftly considered. Spain has fantastic potential in manufacturing. So far, when Spanish policy elites did not brag about Spain’s performance in finance and services, they liked at best to stress Spain’s competitiveness in niche manufacturing. Granted, Spanish wind turbines and medical equipment are world famous, but the success of Germany, Austria or the Scandinavian countries suggests that employment-rich and low-key manufacturing is not something to be scorned and relegated to some “developing country” status.

The success of Northern Spain at becoming internationally competitive in auto parts, tools and machine tools should be noted in Madrid, especially as unemployment levels there are much lower than in the rest of Spain. This reorientation demands a reconsideration of the bases of the education system, as reindustrialization demands high investment in highly skilled engineering jobs. This means better vocational education and state-business-labor relations that ensure an adequate supply of manufacturing jobs paid with a living wage.

Post-Franco Spain gave birth to a liberal political and economic model whose structural weaknesses have been magnified by the Great Recession to the point that its political and economic institutions have lost much of their social support. The linchpin of its debilitating crisis has been the problem of unemployment. Until the crisis, various compensatory mechanisms ensured that this problem would not disrupt the functioning of Spain’s political economy.

But the crisis and particularly the dramatic twist taken by this country’s austerity politics disrupted the functioning of these mechanisms, calling for a new settlement. Unlike in 1977, the terms of this settlement are hardly obvious and the paralysis of policy imagination seems to be the status quo characteristic of policy elites. Perhaps that needs to change. And soon.