The anatomy of mediocrity: FDI and Eastern Europe’s mid-level manufacturing trap

Cornel Ban

The 1990s and the 2000s were decades replete with economic myths. Remember the hubristic stories about the end of manufacturing or the endless opportunities afforded by the “new economy”? Remember the paeans to the virtues of radical financial deregulation? Correspondingly, it was a time when many apparently sensible people would scoff at warnings about the export of manufactured goods loaded with predominantly domestic innovations, cautious optimism about the added value of technological somersaults, and skepticism about the benefits of light touch regulation. The new EU member states from Eastern Europe were no exception. In the initially euphoric transitions experienced by those inhabiting the former space of really existing socialism, the new myths had an even greater appeal. Indeed, they provided starry-eyed reformers with the contours of the very market economy of the future.

How times have changed! The financial crisis and the success that the old-fashioned German economy has had in overcoming its worst aftereffects, have had a sobering effect on the frenzied talk and economic “newspeak” of the previous two decades. Vocational training, patient finance, economic coordination and such elements of stigma in, say, 2006, were being reconsidered by 2012 as far as British conservative circles.

Perhaps the most powerful economic myth in the EU’s Eastern rim has been that massive Foreign Direct Investment (FDI) inflows will not only arrest deindustrialization and consolidate strong export economies integrated into Germany’s transnational industrial cluster, but also have a trickle down effect on research and development and keep at home more value over time. Like all economic myths, when looked at from a certain angle, this expectation had some believable features. Chief amongst these was the region’s low cost and vast army of engineers, the wide availability of strong mathematical skills in the skilled labor force, and the extensive network of research institutes left behind by the technoscientific legacy of state socialism. To wit, Hungary and the Czech Republic have a strong industrial tradition dating back to the early 20th century.

As long as the music kept playing and massive FDI kept flowing in the region, turning East-Central Europe into export powerhouses, there were few incentives for policy elites in those countries to take a second look at the details of the evidence about costs of exclusive reliance on FDI for their development. It took the unprecedented collapse of these inflows after 2008, the collapse of Western European demand after the crisis of the euro, and the resulting fiscal problems experienced by these countries to change the reformers’ gazes from starry-eyed to angst-ridden. What stood out in these expressions of concern has been the realization that this FDI-dependent model had in-built structural weaknesses embedded in it that made it perform considerably below the potential of, say, many of the up and coming Asian economies.

Most importantly, it became obvious that FDI had only marginal effects on local research and development capacity, the hallmark of sustainable growth. In fact, it became clear that the entire region was stuck in a bad, medium-level manufacturing trap. For all of them the FDI story started with investments in basic manufacturing and then it went up the scale of technological sophistication, with different speeds, to the mid-level and then remained there. At first it would be textiles, footwear and basic engineering. Then, emboldened by the fact that cold war propaganda about Eastern Europe’s feet-dragging and kleptomaniac labor force was…just propaganda, foreign investors ventured far afield and started investing in car assembly, car parts, electric and electronic equipment. “We found in Romania an incredibly well-trained corps of engineers and industrial workers, whose skills were not unlike anything you would find in West European countries with strong industrial traditions.” This was how it was put to me in 2008 by a Renault executive involved in the manufacturing miracle called Dacia, the Romanian-made car of the Renault group that turned out to be the cash cow of this venerable French industrial firm.

Similar stories came from the Slovakian and Polish car industry or the excellent performance of Hungary-based electronics companies. Indeed, for a while, it seemed like the region would be the next big “tiger,” with FDI also triggering the development of R&D capacities in these industrial fields at the domestic level. Yet this has not occurred on a systemic level. In fact, by itself, the FDI did not create more than a gigantic assembly platform of predominantly mid-level manufactured products. This was true whether one refers to the Czech Republic, a country with one of Europe’s oldest industrial traditions and one of the most sophisticated export economies of the region, or to Bulgaria, where industrialization did not start until much later. The IT sector aside, almost all of innovation was the result of R&D processes taking place in the home base of the foreign investors in question, with generally minimal local content incorporated in them.

What is more, foreign investments in the East European export boom have been carried out using finance provided by the financial institutions of the foreign firms, rather than by the financial sectors of the ex-communist countries. As it turned out, despite the fact that the region was rather special in the world, in that it had converted the bulk of its banks into mere subsidiaries of foreign (mostly West and Northern European) banks. But rather than fund domestic industry or some local innovation boom, these banks proved themselves to much better at funding a consumption bubble that in many cases (Latvia, Hungary, Romania) helped lead the local economies down on the bleak road of EU and IMF orchestrated bailouts by 2010. When credit rating agencies began to fidget about the high level of foreign ownership in the region’s financial sectors, even the most ardent believers in foreign capital as the panacea to the economic challenges of postcommunism began to have doubts.

In short, the FDI-driven export miracles of the EU’s East European member states have not landed these economies on the high-octane development path of postwar Finland, Austria and France, or closer to home, the recent experiences of Singapore, South Korea and to a more limited extent of Brazil. In these countries, the integration into global supply chains involved making an ideal range of domestically designed products compete in world markets against Western household names. But for that to happen it is not enough to create the macroeconomic, regulatory and infrastructure enticement for foreign investors. One also needs intelligent industrial policies, patient public finance and bold and well-funded public-private partnerships in R&D that will integrate FDI into medium and long-term development targets defined by the government.

Unfortunately, with the possible exception of Slovenia, East European reformers either rejected such policies with anti-government fervor or, following the policy fashions of the day, saw them as items of mothballed policy paradigms. The result is that the industrial future of the region looks more like that of Mexico’s maquiladoras than that of the Finnish or Korean industrial powerhouses. This makes one wonder whether in fact it’s not high time for East European policy elites to develop better critical and independent thinking skills when encountering policy fads. Or, who knows, even read a bit of heterodox development economics, just for fun. For if they don’t, their competitors in Asia certainly are.

Let’s not get too excited about the IMF’s shift this fall

Remix show (Vlad nanca and Janek Simon), 2008
exhibition view, Raster gallery

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

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.

Triple Crisis Welcomes Your Comments. Please Share Your Thoughts.
[1] http://www.imf.org/external/pubs/ft/weo/2012/02/index.htm

[2] http://fatasmihov.blogspot.com.au/2012/10/underestimating-fiscal-policy.html

[3] http://www.voxeu.org/article/spending-cuts-improve-confidence-no-arithmetic-goes-wrong-way

[4] https://europeaneconomics.wordpress.com/2012/10/01/five-reasons-why-the-keynesians-lost-the-battle/

[5] http://krugman.blogs.nytimes.com/2012/10/13/times-like-this-are-different/

http://notthetreasuryview.blogspot.co.uk/2012/10/more-on-multipliers-why-does-it-matter.html

http://mainlymacro.blogspot.co.uk/2012/10/multipliers-using-theory-and-evidence.html

[6] http://www.ft.com/intl/cms/s/0/09a54140-13ba-11e2-8260-00144feabdc0.html

[7] http://www.economist.com/blogs/freeexchange/2012/10/fiscal-policy

http://www.ft.com/intl/cms/s/0/85a0c6c2-1476-11e2-8cf2-00144feabdc0.html#axzz29Kgtrmtp

[8] http://www.forexlive.com/blog/2012/10/11/imf-blanchard-no-room-for-further-fiscal-stimulus-in-emu-us/

[9] http://www.ft.com/intl/cms/s/0/1bc1ed24-1441-11e2-8cf2-00144feabdc0.html#axzz29Kgtrmtp

[10] https://europeaneconomics.wordpress.com/2012/10/04/is-the-imf-turning-against-austerity/

Published on Triple Crisis

Privatisation and death

This is from Oxford. No comment

“As many as one million working-age men died due to the economic shock of mass privatisation policies followed by post-communist countries in the 1990s, according to a new study published in The Lancet.

The Oxford-led study measured the relationship between death rates and the pace and scale of privatisation in 25 countries in the former Soviet Union and Eastern Europe, dating back to the early 1990s. They found that mass privatisation came at a human cost: with an average surge in the number of deaths of 13 per cent or the equivalent of about one million lives.

The rapid privatisation programme, part of a plan known by economists as ‘shock therapy’, led to a 56 per cent increase in unemployment, which the study says played an important role in explaining why privatisation claimed so many lives. Many employers provided extensive health and social care for their employees, so through privatisation workers experienced the ‘double whammy’ of losing not only their livelihood but also their means of surviving the crisis.

David Stuckler from Oxford, and colleagues Dr Lawrence King from Cambridge University and Professor Martin McKee, from the London School of Hygiene and Tropical Medicine, took death rates reported by the World Heath Organisation for men of working age (15-59 years) in 25 post-communist countries and compared them to the timing and extent of participation in mass privatisation and other transition policies.

The team took into account other factors that might affect rising death rates (such as economic depression, initial conditions and health infrastructure). They also examined other measures of privatisation from the European Bank for Reconstruction and Development, a bank which gave loans in support of radical mass privatisation.

Our study helps explain the striking differences in mortality in the post-communist world.

David Stuckler, Department of Sociology at the University of Oxford

During the 1990s, former communist countries underwent the world’s worst peacetime mortality crisis in the past 50 years – with over three million avoidable deaths and 10 million ‘missing’ men, according to the United Nations.

However, while life expectancy plummeted in some countries, like Russia and Kazakhstan; the populations’ health steadily improved in other countries, such as Slovenia. Previous research shows that unemployment and levels of alcohol consumption are major factors behind these differences, but this study is thought to be the first to isolate aspects of the reforms process that might cause these variations. It finds that death rates are linked to the speed and type of privatisation and resulting unemployment – and also to the level of social support available. If at least 45 per cent of the country’s population were members of at least one social organisation, such as a church or trade union, they were better protected from the economic shocks, the authors found.

David Stuckler, from Oxford’s Department of Sociology, said: ‘Our study helps explain the striking differences in mortality in the post-communist world.  Countries which pursued rapid privatisation, or ‘shock therapy’, had much greater rises in deaths than countries which followed a more gradual path. Not only did rapid privatisation lead to mass unemployment but also wiped out the social safety nets, which were critical for helping people survive during this turbulent period.’

Professor Martin McKee said: ‘As variants of rapid reform policies are being debated in China, India, Egypt and other developing and middle-income countries, including Iraq, our study reminds us that radical economic reforms affect ordinary people and, in some cases, cost them their lives.’”

Technological innovation and the bases of the new rentier class

Can you wear a T-shirt reading "Technological Innovation Sucks"? Probably not, at least in the era of Apple worship. Oh, and do you remember the pre-Lehman editorializing on how innovation or lack thereof explains everything?

These days innovation is in for the chopping boards when one looks at it from the perspective of the rents that the intellectual property regime generates. Some big wig economists are considering the negative effects. It seems, pace Silicon Valley ideology, that technological innovation is not about to usher in the Keynesian leisure paradise by itself.

Why is that? Ken Rogoff, for one, thinks that techological monopolies stifle ideas that recent changes extending the validity of IP patents have exacerbated this problem. This means that we may be entering a technology stagnation phase because incumbent interests now have the biggest incentive ever to impose artificial scarcity. If you think this is weird, read these fine lines from FT's brilliant Isabella Kaminska:

"We’ve now arrived at a point where technology begins to threaten return on capital, mostly by causing the sort of abundance that depresses prices to the point where many goods have no choice but to become free. This is related to the amount of “free working” hours now being pumped into the economy — the result of crowd sourcing and rising productivity levels — thanks, in part, to the sort of gadgets that allow everyone to work anywhere and anytime, in a work environment that’s generally speeding up as everyone tries to keep up with the competition by doing yet more hours voluntarily.”

Wow, so far from reducing work hours, technological innovations increase labor exploitation, with technology rents exercised by companies playing a big role:

“, robot and technology power is reducing the natural employment rate. But rather than our subsidising those who have lost jobs to technology, so as to spread that manna wealth that’s literally dropped onto the surface of the earth at no-one’s physical disadvantage, companies are using monopoly power to extort rents on the capital that is creating all that free wealth.”

“As technology proceeds in a patent-obsessed world, the fruits of innovation flow to the owners of the capital and invention, forming a whole new rentier class. The financial assets/debts that back the innovation technology, meanwhile, get disproportionally valuable as their purchasing power gets completely out of whack with the output they radically accelerate.”

Such are the new forms of social power in our age.

More here
http://ftalphaville.ft.com/2012/12/10/1303512/the-robot-economy-and-the-new-rentier-class/

Why the German Social Democrats will not slam the brakes on austerity et al

Well, we are used to hearing that the center-left in general has forgotten that we are not in 1998 or so, when the Third Way was triumphant. But one would probably have at least some modest expectations about German social-democrats (SPD) putting up a fight for a saner resolution of the euro crisis because they are the strongest center left party in the EU and could have a shot at governing the EU country with the checkbook. Not so, says Wolfgang Munchau. The only political force in Germany that has an economic narrative that is really different from Merkel’s coalition is the “radical” left. In other words we are leaving times when the center left would not do even as much Keynesianism as the IMF demands: more spending in the surplus zone of the EU.

Here are Munchau’s basic points:

“what is most infuriating is the SPD’s sheer inability to explain in a clear way why the chancellor is wrong. The reason for this inability is that the party has bought into the same panoply of false crisis narratives. It bought into the lie about fiscal profligacy as the cause of the crisis, and the need for austerity to solve it. It bought into the lie that Greece is fundamentally solvent. In particular, it bought into the lie that foreign speculators have brought about the situation. This is how the party ended up supporting the eurozone’s fiscal pact, which remains a solution in search of a problem.

As a quid pro quo for support, the SPD got the financial transaction tax, another big diversion. The lack of such a tax did not cause the crisis, nor will its presence resolve it.

At each point, the SPD endorsed a narrow argument of why it was right to support Ms Merkel at a particular time. In doing so, it ended up supporting her entire strategy. (…) The SPD supported financial deregulation in the late 1990s. The SPD supported fiscal austerity. It supported a constitutional debt brake. If you add it all up, the SPD supports economic policies that have ultimately given rise to the imbalances that have driven the eurozone apart. It is hard to see where the parties differ.

Most people understand that some form of transfer from Germany to the periphery will ultimately be necessary. Yet, for some reason, they also believe that Ms Merkel is the politician who will deliver the least costly solution.

Why? Under normal circumstances, one would have expected Ms Merkel might by now have lost her reputation of being a competent crisis manager. Her contribution to this crisis has been to delay resolution, but her political support is holding up. The CDU has a large and persistent lead in the opinion polls over the SPD. And she enjoys an even larger personal lead over her SPD challenger, Peer Steinbrück.

That conundrum is easily explained. The only real opposition to her policies comes from the post-communist left. With Mr Steinbrück, a former finance minister under Ms Merkel, the SPD has chosen the man least likely to offer a credible alternative. He was, after all, the architect of Germany’s anti-crisis policies until late 2009. Mr Steinbrück and Mr Steinmeier are not campaigning to get rid of Ms Merkel. They are campaigning to serve under Ms Merkel as a junior coalition partner.”

More here:
http://www.ft.com/intl/cms/s/0/32d6ba56-3a22-11e2-baac-00144feabdc0.html#axzz2Dum7fK8K

Understanding the Austerity Blizzard: Blyth’s new classic forthcoming in 2013 with Oxford

A must read.

Mark Blyth, Austerity: The History of a Dangerous Idea, Oxford University Press, forthcoming in 2013

Conservatives today in both Europe and the United States have succeeded in casting government spending as reckless wastefulness that has made the economy worse. In contrast, they have advanced a policy of draconian budget cuts–austerity–to solve the financial crisis. We are told that we have all lived beyond our means and now need to tighten our belts. This view conveniently forgets where all that debt came from. Not from an orgy of government spending, but as the direct result of bailing out, recapitalizing, and adding liquidity to the broken banking system. Through these actions private debt was rechristened as government debt while those responsible for generating it walked away scot free, placing the blame on the state, and the burden on the taxpayer.

That burden now takes the form of a global turn to austerity, the policy of reducing domestic wages and prices to restore competitiveness and balance the budget. The problem, according to political economist Mark Blyth, is that austerity is a very dangerous idea. First of all, it doesn’t work. As the past four years and countless historical examples from the last 100 years show, while it makes sense for any one state to try and cut its way to growth, it simply cannot work when all states try it simultaneously: all we do is shrink the economy. In the worst case, austerity policies worsened the Great Depression and created the conditions for seizures of power by the forces responsible for the Second World War: the Nazis and the Japanese military establishment. As Blyth amply demonstrates, the arguments for austerity are tenuous and the evidence thin. Rather than expanding growth and opportunity, the repeated revival of this dead economic idea has almost always led to low growth along with increases in wealth and income inequality. Austerity demolishes the conventional wisdom, marshaling an army of facts to demand that we recognize austerity for what it is, and what it costs us.
Features

Tackles one of the most important topics in world politics and economics in clear, trenchant language
One of the only accounts that successfully links together the political and economic aspects of the current crisis.

Reviews

“Austerity is an economic policy strategy, but is also an ideology and an approach to economic management freighted with politics. In this book Mark Blyth uncovers these successive strata. In doing so he wields his spade in a way that shows no patience for fools and foolishness.”
–Barry Eichengreen, George C. Pardee and Helen N. Pardee Professor of Economics and Political Science University of California, Berkeley

“Of all the zombie ideas that have been reanimated in the wake of the global financial crisis, austerity is the most dangerous. Mark Blyth shows how austerity created the disasters of the 1930s, and contributed to the descent of the world into global war. He shows how European austerity policies have prevented any recovery from the crisis of 2009, while rescuing and protecting the banks and financial institutions that created the crisis. An essential guide for anyone who wants to understand the current depression.”
–John Quiggin, Australian Research Council Federation Fellow, University of Queensland