Archive | October, 2012

Neo-dependent development and its limits: the case of Romania

31 Oct

During the 2000s foreign direct investment in the “real” economy, albeit much less spectacular than in East-Central Europe, was just noticeable enough for people to have at least the impression that the long coveted catch-up with the “West” was within reach or that deindustrialization could be reversed by West European market forces. After all, as some reputable international consulting groups discovered, socialism may have been a failure, but at least it left behind impressive numbers of people who sold their solid engineering training for very low wages.

The results were impressive and began to unmoor Romania from the cold war propaganda image of a place covered in the soot of obsolete industries. The 300 dollars a month army of engineers left behind by Romanian socialism made possible a boom of Western investment in manufacturing, from cars to airplane parts. International brands like Renault, Ford, Nokia and Mittal opened up some of their largest plants in Romania. The high-end line of H&M, Benetton and other clothiers was for years made by the same Romanian textile factories that had produced for Western markets during state socialism. A wide array of Western firms that are pivotal suppliers for the global car industry opened up large operations in Romania, making car parts a Romanian niche. When Renault announced that it would open a large research and development facility close to Bucharest and began a hiring spree in the engineering departments of Romanian campuses, many felt that the developmental shift from assembling Western products to designing and manufacturing them locally was within reach. The years of fitful economics and hopeless misery seemed over.

There was some truth to this picture. FDI worked in at least one respect: exports. By the end of the 2000s Dutch, Austrian, German, French and Italian firms (in this order) accounted for about two thirds of Romania’s exports during the decade. Contrary to conventional wisdom that paints Romania as a low-end industrial hub, manufacturing attracted most FDI (44 percent), followed by the financial sector, retail and real estate. Unsurprisingly, the socialist planner and the foreign investor had the same preferences: heavy industry. The bulk of FDI was invested in energy, chemicals, means of transportation, mining and steels. Electronics and equipment, two up and coming export sectors, accounted for 2 percent of FDI, outdone by IT with 5.5 percent. Textiles and footwear, the erstwhile export niche of the Romanian economy, received only 1.4 percent of FDI.

The result of all this was the slowdown of the deindustrialization process and even the beginning of a movement up the technological ladder in the export sector. In 2010 Romania’s main export markets were demanding (German, Italy, France) and its main exports were middle rather than low-level products. It’s cars, car parts and electronic components, not textiles and footwear, as it was the case in the 2000s. Moreover, in the midst of the crisis, a wide survey on hundreds of investors found that IT, telecom, energy and pharmaceuticals were expected to be the substantial contributors to future growth and that Romania was perceived in investor circles as a country whose emerging competitiveness clusters signaled a high likelihood of more high-tech development.

By 2010 Romania lagged behind Visegrad countries in terms of the sophistication of its exports but it did not leg behind very far. It ranked 27th in 128 economies in this regard. Granted, only Slovenia and the Czech Republic are in the top ten of the most sophisticated exporters. Also, Hungary and Slovakia are in the same league with capitalist countries with old industrial traditions such as Italy, the US or France. But Romania ranks in the same league with Poland and Spain and does not lag far behind the Netherlands. In contrast, the Baltic states and Bulgaria have export profiles that put them in the company of commodity exporters (Brazil, Canada), traditional low end manufacturing economies (Portugal) or war-ravaged economies (Lebanon, Serbia, Bosnia).

But is this improvement of the country’s export profile a solid piece of evidence for the case of socially disembedded neoliberalism? The facts casts considerable doubts on this. Let’s just mention two of them (more in the next postI:

First, although Romania was a champion in attracting FDI during the 2000s, it nevertheless failed to attract enough manufacturing investment to reverse the deindustrialization process. Every year between 2001 and 2008 the share of industry in GDP shrunk by nearly 1 percent a year and industrial employment continued to decline. The shrinkage of industry did not reflect a rise in the service sector, whose growth was sluggish, but a construction boom, which increased by 70 percent and mopped up most of the employment growth.

Second, it soon became clear that there was little technological trickle down from FDI flows. As in the case of the Visegrad countries, this investment was focused on the use of local labor and government incentives, leaving R&D operations elsewhere. For all its virtues, FDI did not help reduce the low innovation capacity of Romanian economy. While average R & D spending per GDP reaches 2 percent in the EU (with highs of 4 percent in Sweden an Finland), in Romania it is merely 0.47 %, a level similar to that of Bulgaria and Slovakia. Indeed, one can say that in Romania state and capital alike are locked in a low innovation vicious circle. While more than half of R&D in the EU is made by private firms, in Romania this percentage is barely 23 percent, with most R&D originating in the public sector. Romanian research personal declined precipitously after 1990 and continues to do so even today. Although the volume of academic research is significant (35th in the world), it has a weak links with industrial applications and its impact factor is the lowest among EU member states (and on a par with Venezuela and Kenya). There are a few highlights in the area of innovation clusters emerging in the auto and IT sector, both of which benefited from extensive state subsidies and tax cuts. Overall, however, Romania’s potential to improve its innovation file remains limited.


Taking on Too Big to Fail

31 Oct

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Large investment banks live on subsidies

27 Oct

Andrew Haldane throws it in:

“Take the animal kingdom. The square-cubed law explains why a flea, even if it were the size of a man, would not be capable of jumping to the moon. It explains why a hippopotamus cannot turn somersaults. And it explains why King Kong and Godzilla were physiological impossibilities – the weight transfer associated with a single step would have shattered their thigh bones.
There is no longer evidence of economies of scale at bank sizes above $100 billion. If anything, there is now evidence of diseconomies which rise with bank size, consistent with big banks becoming “too big to manage”. Subtracting this subsidy, removing the state crutch, would suggest a dramatically lower socially-optimal banking scale. Like King Kong and Godzilla, these giants would arguably then be physiological impossibilities.”

So what is to be done?

1. Place limits on bank size. How do you do that? Not exactly rocket science. Just cap their balance sheet exposures, for this will reduce their system-wide losses in the event of big bank failure.

2. Separate investment and commercial banking to make sure that retail and investment cultures do not cross-polinate in the toxic ways they have done so far.

3. Inject more competition in the largely oligopilistic banking system we have right now. Can anyone in the banking world be openly against competition?


Is the IMF going through a paradigm shift in fiscal policy?

18 Oct

Cornel Ban

The Great Recession and especially the European crisis saved the IMF from its growing pre-crisis marginality. Yet things have been more awkward for the pride of its economists. Against a gloomy economic background, they bit the bullet in the Fund’s recent World Economic Outlook (WEO) report[1] and openly admitted that they have been wrong about some essential virtues of austerity. Three findings stood out: the size of the fiscal multipliers used for growth projections have been woefully underestimated, countries that engaged in more austerity had less growth than countries that did not and austerity failed to reduce public debt within a reasonable time span. Staff research that strays from the Fund’s policy line is tolerated but seldom makes it into the press conferences of the managing director. This time, however, it did. Christine Lagarde publicly upheld the self-criticism and demanded a recalibration of fiscal consolidation.

Prior to the crisis, in some quarters of the economic profession the research on multipliers settled around the consensus that fiscal multipliers should be around or slightly above 1.[2] During the recession, more papers found that fiscal multipliers are in fact even larger because of monetary policy stuck in the zero lower bound and the occurrence of a deep recession.[3] However, the chorus of voices demanding fiscal consolidation grew, silencing these insights.[4] The IMF lent legitimacy to this chorus when its staff used forecasting models using multipliers of 0.5 to measure the impacts of fiscal consolidation on growth prospects. That means that each 1 euro of cuts and tax increases shaves 50 cents off GDP growth.

In contrast, the October 2012 WEO found that in fact they ranged between .9 to 1.7 (the Eurozone periphery is closer to the higher end of the range), an error that explained the IMF’s extremely optimistic growth projections for countries who frontloaded fiscal consolidation. Assuming the multiplier was 1.5, a fiscal adjustment of 3 percent of GDP-as much as Spain has to do next year- would lead to a GDP contraction of 4.5 percent. It was momentous finding and those who had been skeptical of the virtues of austerity felt vindicated.[5]

This recanting is certainly a big deal but does it mean that the Fund as a whole is backing off the austerity agenda in a big way? Indeed, is the October WEO the IMF’s road to Damascus moment? There was a real seismic tremor in Tokyo when Christine Lagarde defended the findings against the charge of the German finance minister, but an epiphany it was not. The mea culpa on multipliers may put to rest the expansionary austerity thesis, sow discord in EU-IMF relations[6] or send financial media analysts scrambling for critiques,[7] but it has had modest effects on the actual IMF line on austerity. Chief economist Olivier Blanchard rushed to declare in the German press that the IMF does not construe these findings as urging a shift to fiscal expansion.[8] The Fund’s managing director stressed that in fiscally constrained countries deficit cutting should continue, only at a slower pace and without nominal targets. Rather than go for stimulus, she insisted, countries with fiscal breathing room should abstain from both stimulus and cuts. [9]

The last WEO report may have recalibrated austerity in important ways, but was it truly surprising? Not so much. Olivier Blanchard’s research used higher values for multipliers as early as 2001 and his appointment as the Fund’s chief economist during the crisis relaxed the fiscal policy skepticism of the institution, with staff authoring research stating that overly ambitious austerity programs implemented in economic downturns are self-defeating.[10] As early as December 2008 he co-authored a paper that made the frontloading of fiscal stimulus measures a centerpiece of crisis economics.

This entailed tweaking balanced budget rules to prevent cuts in existing programs, increasing the state’s share in public-private partnerships, increases in public sector employment, more transfers for those at the bottom end of the income distribution (the minimum wage workers, the unemployed, the foreclosed). Where the social safety net was narrow, the state had to step in to expand it. While it cautioned against industrial policies targeted at domestic firms, the paper urged governments to offer guarantees on new credit for firms whose fate was threatened by the credit crunch. This was hardly the bad cop material associated with the IMF medicine in the past decades.

But there was an important caveat to all this: fiscal activism was legit only as long as financial markets deemed it sustainable. At the time, it seemed that the entire Eurozone still benefited from “safe haven” status for bond investors so the IMF agreed to fiscal expansions there. But countries that faced pressures in the bond markets (Hungary, Latvia and Romania in 2008-2009) had to engage in fiscal consolidation in order to reduce debt and rebuild confidence. The same applied to Southern Europe and Ireland after 2010.

As a result, the Fund was in agreement with the European policy line on the “periphery” –including by marshaling models with low multipliers-but disagreed with them on the need for austerity in the eurozone’s “core. The last WEO changes a lot of things, but not the IMF’s prescription of austerity where it hurts the most. But as modest as these changes are in policy, given the hard line on coordinated contractions taken by those who matter politically in Europe, the IMF may be a better hope for those who want to save the euro from the scissors of its own designers.

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So what’s the deal with the Brazilian model?

18 Oct

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.

Full text here
Brazil proofs

Austerity and the end of Romanian national-Stalinism

17 Oct

Historically, high sovereign debt and austerity policies have coincided with regime- changing popular uprisings. Nicolae Ceausescu’s Romania was no exception. Why, when faced with a sovereign debt crisis in the 1980s, did his regime choose to pay its foreign debt as early as possible, at the cost of economic recession and dramatically compressed consumption? How did these choices relate to the regime’s failure to survive the end of the decade? The article argues that while exogenous shocks shattered the economic bases of the regime, it was the ideas with which the regime understood development and interpreted the crisis that shaped government policy responses in the 1980s. When the price of oil and development finance went up abruptly in 1979, the low energy efficiency of Romanian industry pushed the country into a situation where debt levels became unsustainable. Committed to a view of development that blended nationalist and Stalinist ideas, but with a focus on policy sovereignty, Ceausescu diagnosed the crisis as evidence that debt-financed development and policy independence were incompatible. Consequently the regime decided to pay off foreign debt through a mix of austerity, import substitution, and export-led accumulation of dollar reserves. By the time all debt was paid off in 1989, the regime’s economic sources of legitimacy were exhausted. In the external environment of 1989, this policy regime change contributed to political regime change even in the absence of an organized civil society. In addition to casting a new light on the causal mechanisms of the Romanian revolution of December 1989, the findings of this article contribute to emerging scholarship that stresses the nexus between debt-induced economic crisis and popular uprisings.

Cornel Ban, “Sovereign Debt, Austrity and Regime Change: The Case of Nicolae Ceausescu’s Romania” forthcoming in East European Politics and Societies.

Full text in proofs here:

austerity stalinism proofs oct 17 2012

Narrating a frontier economy for bonds and equities

15 Oct

How do you tell a story about a country that still has some stuff to sell but whose austerity sputters like a 1950s jalopy? Here’s a sample from FT:

Financial Times

October 14, 2012 4:35 am
Romania pins hopes on its privatisation programme

By Fiona Rintoul

Sometimes investment is about making money and sometimes it is about more than that. For Dragos Valentin Neascu, chief executive of Erste Asset Management in Bucharest, establishing the conditions for domestic and foreign investors to have confidence in Romanian equities and bonds is above all about freeing the EU’s second poorest country from the vagaries of politicians.

“Our lives should be less in the hands of the politicians and more dependent on the real economy,” says Mr Neascu.

However, the kind of freedom Mr Neascu seeks requires the financial markets to develop. That is one reason why he believes entry into the euro is still important for Romania, whatever local difficulties the eurozone may have – although Romania’s euro journey may be of the type where it is better to travel than to arrive.

“The technical criteria associated with euro adoption are very important,” says Mr Neascu. “They are more important than the euro itself. They will make us more predictable as a [bond] issuer. Then companies can finance themselves on the local market and internationally.”

For the moment, however, foreign interest in Romania remains muted. The country is not so much in the wrong place at the wrong time as in all the wrong places. It is classified as a frontier rather than an emerging market, and so it misses mainstream emerging market investment. However, within the frontier markets universe, it is, currently, seen as one of the less compelling options.

“In comparison to global frontier markets, Romania unfortunately does not offer many attractive investment opportunities,” says David Wickham, investment director, emerging markets at HSBC Global Asset Management. “The economy’s near-term performance is closely tied to the success of the EU being able to resolve the Italian, Spanish, Portuguese and Greek debt crisis.”

Before the crisis the Romanian economy was growing at about 7 per cent a year, but gross domestic product growth for 2012 is predicted to fall below 1 per cent. Although, its debt to GDP ratio is not high compared with western Europe, its economy is weakened by its surroundings.

“The Romanian economy does not currently benefit from its low wage costs,” says Mr Wickham. “The European economies [the main export markets and providers of foreign direct investment into Romania] are in, or approaching, recession. This provides no stimulus for the Romanian economy and no relief for its high unemployment rate.”

Not only that, Romania is close to, and tied up with, Greece. “Greek banks have a big exposure to Romanian banks, and so there is the question of what would happen if Greece exits the euro,” says András Szálkai, fund manager in the emerging markets equities team at Raiffeisen Capital Management.

But not all Romania’s problems come from outside. Only a few months ago, investment prospects looked much brighter. Then in April the government collapsed after losing a vote of confidence and Victor Ponta was appointed as Romania’s third prime minister of the year.

“At the beginning of the year, it looked like Romania would be a good story for equity investors,” says Mr Szálkai. “Until May the stock market was up 25 per cent in US dollar terms.”

Political squabbling has meant that a programme of reforms agreed with the International Monetary Fund, including a series of privatisations, has stalled. The Romanian currency, the leu, has also come under pressure against the euro, falling 5.3 per cent this year and hitting a record low in July.

The privatisation programme is critical to broadening choice on the stock market and improving liquidity. Overall, the market capitalisation and liquidity of the equity market would have tripled had the programme gone ahead, says Mr Szálkai.

The hope now is that a general election on December 9 will deliver a clear result and the privatisation programme – which includes Romgaz, the country’s largest oil producer – will be resumed. Not only will this mean that important economic sectors, such as utilities, will be represented on the stock market, it may also encourage private listings.

“Investment bankers have drawn up plans to list family businesses that have developed over the past 10 to 15 years in sectors such as pharmaceuticals and tourism, but these exercises have not been concluded,” says Mr Neascu.

If private listings come hand-in-hand with privatisations, it will make for better representation of Romania’s key sectors. This could help to allay the concerns of foreign investors such as Mr Wickham, who says that currently “it is difficult to invest in domestic consumption stories or companies offering strong top-line growth”.

A deeper stock market would also help the development of domestic institutional investors, such as pension funds and mutual funds, which in turn would provide additional stock market liquidity, creating a virtuous circle.

Meanwhile, a secondary listing on the Warsaw Stock Exchange of Fondul Proprietatea, a portfolio of energy stocks including the unlisted Hidroelectrica, is planned with a view to expanding the shareholder base – a route that other companies may in due course follow.

In time, Mr Neascu hopes that Romanian companies will also seek to finance themselves through corporate bonds. At the moment, the portion of his funds invested in corporate bonds is mainly in leu-denominated bonds issued by international companies in Luxembourg.

“We would prefer to finance the Romanian economy,” he says.

Much hinges, then, on the privatisation programme going ahead smoothly. If it does – and if problems such as corruption, political instability and poor infrastructure can be alleviated – Mr Szálkai is upbeat about Romania’s long-term prospects.

“Maybe in 10 years’ time it will be the new Poland,” he says.