Crisis After Crisis - Any Lessons Learnt?

It is now more than half a decade since first a local American turbulence and then a global one shook the world of international finance. Half a decade should have been enough time for all those involved – politicians, economists, bankers, analysts, entrepreneurs and consumers – to digest the events of the global recession and draw conclusions. We in Hungary, on the periphery of the core European countries, are facing additional challenges, as our economic and financial problems – not to mention those related to other aspects of life – existed well before and were independent of the outbreak of the American mortgage crisis. They would not disappear even if global finances miraculously returned to normalcy overnight. Hence in this retrospective essay we will deal with the Hungarian issues separately.

Global recession, to start with, is a misnomer. Of course, today everything is global in the sense that whatever happens in one part of the world, particularly if it is a significant part of the world, will have an impact everywhere else. Still, it is not correct to speak of a global economic crisis: primarily and most fundamentally it is the triad – the United States, Western Europe and Japan – and the regions closely connected to the triad that were hit hard by recession. Whole continents (Latin-America, the bigger part of Asia, Africa) got through the events with little more than a dip in their growth rate. Moreover, a crisis also produces winners; many marketplayers, sectors and countries profited from the events – at the cost of others. Economics, though, is not a zero-sum game. In the long term, the arithmetic is complex: losers can become winners in due course if they learn from the crisis. This is the major question I am addressing here: is there any sign that those most affected have learnt lessons from what happened?

Hungary, on both the political and economic periphery of the troubled European continent, was certainly strongly hit. But our case is so unique that it is useful to start analysing the events from a broader perspective. There have been three crises since the summer of 2007, or to put it otherwise: the international financial crisis has had three stages. In the first stage, the turmoil spreading out from the US banking sector affected the money markets and stock exchanges of the countries in the centre of the world economy as well as economic regions closely connected to the core. At first it seemed to be a containable problem: US GDP continued to increase until the second quarter of 2008: analysts still predicted modest GDP growth for the year or at worst a slight contraction. But then one renowned bank after another went bankrupt, culminating in the fall of the prestigious investment bank Lehman Brothers in mid-September 2008. Suddenly a new stage in the crisis was launched: the local financial turbulence had led to a confidence crisis and financial panic.

The crisis in confidence soon claimed a range of victims: Hungarian government bonds were among the first to be dropped by investors which brought the Hungarian state to the brink of insolvency. Despite denials in public, we suspected there was good reason. If a solid-looking American bank of excellent risk rating can get into trouble, why should businessmen feel secure with riskier less reliable debtors such as the Hungarian Republic?

Loans and credit, the life source of the entire Western economic culture, suddenly became scarce. The brake on the flow of funds had an immediate impact on advanced market economies: foreign trade, investments and, to a lesser degree, employment and consumption began to drop. The main reason why advanced countries fell into deep recession is that they have a more than average dependence on credit, especially required for cross-border transactions. Financial openness – an engine of economic development in economic orthodoxy – had now proved to be a disadvantage. 2009 shook not only the triad but via its network of foreign trade and financial transactions, it also caused even deeper contractions in peripheral economies connected to them, including Hungary, Slovakia, Slovenia, the Czech Republic, the Baltic States and, for other reasons, Ireland.

In the majority of the developed countries the sudden recession was mitigated by increasing public spending in an attempt to bolster aggregate demand. Most were successful and history did not repeat itself. Although the fall in industrial production of the leading countries in 2008–2010 was comparable to the 1929–33 world-wide crash, the impact on consumption this time was stagnation rather than decline. Neither did unemployment soar. It is noteworthy though that the pre-crisis level of employment could not be reached even in countries where production did get back to its pre-crisis level by 2010 or thereabouts, which means that the private economy did not fully recover. And due to the surge in public spending, public debt in those countries predictably increased.

Although such central bank and government measures were enough to stem the global financial crisis, soon it became clear that pumping money and increasing public spending is easy to start but very hard to stop. There was no clear political answer to the obvious question of how to stop either in America or in the European Union with its complicated inner structure. This led to the third stage of the crisis from the beginning of 2010, during which the capital market players started to question the sustainability of governments’ economic policies, and in some cases the mid-term solvency of states as well.

WHEN IN CRISIS, GOVERNMENTS RESORT TO NEW METHODS

Very different economic policy directions during the crisis have been taken by central banks and governments in developed countries, semi-peripheral and peripheral regions involved directly or indirectly. Even within the same country there have been different turns in economic policy. The diversity of measures is natural, since in all three stages different types of negative shocks hit economies that were in quite different situations to begin with. One thing was common: the troubles emanated from credit and banking. When banks sensed that clients they had considered as secure were at risk of insolvency, they stopped their usual loan activities in order to defend themselves. This led to a sudden and extreme shortage of credit, a credit crunch. Even profitable companies or projects with promising returns could not secure loan financing. At first, central banks took conventional measures to increase the quantity of money: they decreased the base rate and reduced the obligatory reserve rate imposed on bank deposits. However, in a state of panic it is not money that is missing from the money markets but trust; central banks can reduce drastically the cost of loans but it is to no avail if banks shy away from even the cheapest funds, afraid of granting corporate loans. In addition, it is pointless to reduce central bank policy rates below zero; then the room for manoeuvre of the central banks’ interest rate policy would totally disappear.

In these cases central banks can deviate from the norms: they can grant loans to companies and municipalities directly, they can restart accepting company bonds for discount or collateral, or they can buy state bonds – transactions that were once considered as normal. These unorthodox methods, however, were only used by leading central banks in bigger wealthier countries; less influential central banks – such as those in the new EU member states and in the developing world – took more cautious stances. In the Hungarian case, due to the permanent inflationary nature of the economy, it was out of the question to reduce the central bank base rate close to zero, so the usual measures of interest rate policy remained in play. In spite of external pressure on the Hungarian National Bank to follow a policy that would stimulate growth, the bank behaved cautiously for understandable reasons, and did not initiate risky steps to stimulate loan activity.

In richer countries new methods were introduced also in fiscal policy to stimulate demand, and to help sectors hit by the crisis. For instance, in several countries tax allowances were given to make owners change their old cars to new ones, or tax measures were enacted to boost household spending. Some governments even mulled over protectionist measures, even if economic history warns us that protectionism only leads to trade disturbances among interdependent economies.

These recent issues are especially interesting from the perspective of our region, which, when it returned to the political community of the developed world in the early 1990s, was massively influenced by the self-confident efficient market paradigm (named neoliberal by its critics) which brooked no doubts about the supremacy of the market. Government officials and decision-makers at the time of the regime change were placed under doctrinal pressure by Western official circles, foreign business players and international banks. Any deviation from the economics mainstream was considered suspicious; outside viewers interpreted any search for a different path in economic policymaking as resistance to change. Local politicians who emphasised the difficulties of the transitional process were prompted to implement more reforms faster, and to co-opt the “best practices” of the developed world. Yet, in rare moments of sincerity, Western politicians confessed that they did not always practise themselves what they preached to the new members.

There are strong and rational reasons why transition countries – with decades of planned economy behind them – should take the written rules of capitalism more seriously. There is no reason, however, to go by economics textbooks to the letter (although a really good textbook will define the starting conditions on which theoretical recommendation leads to the expected result). If textbook conditions do not apply, you must apply local knowledge to generate solutions that will work, all the while making sure that your solution will not divert the economy from the desired convergence path. In our special case we have to do a lot of things in a different way to produce similar results to those countries where developed, fully-fledged capitalism is in place, while keeping our eyes at the same time on the long-term goals as well.

SHORTENED ROUTES ARE NOT ALWAYS FASTER

The Hungarian economic policy of “Sonderweg” or “special path”, has been under a barrage of external criticism since 2010, and is a long story needing more space than is available here. The case is more complex in its domestic and international aspects than the Icelandic, Irish, Spanish or the Greek ones. There was an exaggerated credit expansion in Hungary as well during the 2000s, but the economy was not excessively overheated compared to the above mentioned countries, nor was there a significant real estate bubble before 2008. The policy of the Hungarian government had been defective for years before the crisis hit Europe, but was different from the southern European countries that borrowed cheap euro loans thoughtlessly. The budget deficit reached a critical level in 2002, and got stuck until the end of 2006, when the checks of the EU, belatedly, entered into force, and a correction period started. As a consequence, the economy immediately stopped growing. That was our situation when the global crisis exploded in the autumn of 2008.

Although the events came as a surprise, analysts realised that the fundamentals of the Hungarian economy were not satisfactory at the outbreak of the international crisis. The cabinet of Prime Minister Gyurcsány, with meagre social support, feared the spectre of bankruptcy, and saw no other option but to turn to the IMF and the EU for a bailout, with its corresponding tough loan conditions. This was at the time when the larger half of Europe started to loosen its fiscal policy.

As a consequence, the Hungarian economic contraction in 2009 was deeper than the EU average and that of the wider Central Eastern European region, partly because of the fact that our economic policy during the crisis went once again counter to the European mainstream, as it would later do from 2010. In the general election of that year the political landscape changed, and the new parliamentary majority wanted to differentiate itself from the previous – unsuccessful – government policies in all aspects. Among others, the new government declared the end of austerity and announced a policy of “debt reduction through economic growth”.

Experiencing the hard ships of the deep recession of 2009, such a policy change in Hungary was not surprising, although the nature of the engine of growth had seemed vague from the beginning. Growth via foreign capital inflows? International investors did not entirely write off the region or Hungary, but neither did they show too much interest. One could not expect much dynamism from the domestic market either. What remained was the state and its stimuli, a conclusion apparently reached by the incoming government of Prime Minister Orbán.

The idea of a more active state was not far from the emerging European consensus, but how the ambitious plans of the new Hungarian government would be funded was not clear from the beginning. The private capital market would not have tolerated another phase of debt accumulation. As for the EU regulations on the public deficit and debt, a change in attitude was taking place in the EU. The sovereign risk rating of some peripheral member states started to deteriorate suddenly, and the issue of European public debt levels became an emergency question of high politics. This new stage supported the efforts of the member states sharing the German economic concept that aimed at a quick end to public spending sprees originally intended to mitigate the damage from the crisis. In the summer of 2010 the economic policy buzzword in the EU was austerity which contrasted sharply with the winning Hungarian election promise that “there will be no more restrictions, because the economy will outgrow the debts”. The budget stimulating arguments of the Hungarian government may not have been opposed earlier, but the Europe of 2010 was a different proposition.

Feeling the increasing severity of the external circumstances, the government decided to broaden its room for manoeuvre internally. It came up with the bank levy and surtaxes on particular sectors. A similar measure to increase room for manoeuvre was the withholding of payments in the compulsory private pensionfunds, and thus the de facto return to the pay-as-you-go pension system. It could be argued that the government, together with other member states in a similar situation, originally wanted only to get the European Commission to acknowledge the statistical specialities of the budgetary accounts as a result of the Hungarian pension system, but the EU authorities refused to change their method of calculating the deficit. This is when the temporary retaining of the private pension payments was considered, and not long after that the government came up with the political decision to abolish the whole compulsory private pension funds system. As a result, the budget deficit decreased by several hundred billions of HUF, as the part of the superannuation tax was transferred from the banking sector (and the accounts of clients) to the public coffers and the social insurance fund.

The Hungarian version of the private pension fund system did indeed exhibit many of the problems which persistently afflict us: it was expensively run, client protection was weak, and its regulation kept changing constantly. But there was a choice between two options: one was a reasonable re-regulation and the other was abolition. The government opted for the latter, and the restoration of the pay-as-you-go system: the whole amount of the social security contribution of the active workforce goes to the public fund, from which pensions are paid. Those who have paid their tax-like contributions receive in exchange a promise – which is legally difficult to interpret – that decades later the Parliament at the time will enact budget laws which ensure fair pensions for there tired, and impose taxes on the then active workforce. In any case, the government integrated the accumulated pension fund wealth into the 2011 national budget, and partly spent it in 2011.

Taking away savings from the private pension funds naturally caused conflicts. But that was only one of many controversial measures; others included the imposition of crisis taxes on key sectors; the pre-payment of mortgage loans denominated in foreign currency at an exchange rate defined by law; and several other measures which would be called unorthodox in Hungarian political parlance. Some of these measures, however, are of an orthodox character, since they are already well known, although they differ from the current practice of European countries in similar situations. Some are being applied in other countries (like the bank levies) but to different degrees. Orthodox or unorthodox, a pragmatic evaluation of the whole economic policy of Sonderweg is that if it ends well then the complications en route will soon be forgotten. If the Hungarian economy is kick- started due to steep personal income tax cuts that have been made possible by controversial public tax measures, then only the legal debate remains regarding the interference of the state in civil law contracts. It could be argued that success legitimised the decisions, the end justified the means.

The problem is that the original plan of the government does not seem to work. György Matolcsy, Minister of National Economy, clearly summarised his expectations regarding the temporary crisis taxes in the parliamentary debate on tax laws in the autumn of 2010:

“I understand the alarmed voices: what will happen from 2013? What will happen after 2012, when the Gulf Stream of the crisis taxes that is currently heating the budget disappears? What will happen? Let me tell the esteemed Parliament that there will be economic growth by then, according to our economic policy forecast the gross domestic product of the Hungarian economy will be 10–15 percent higher than today. We will be able to cancel the crisis taxes, because a 10–15 percent higher gross domestic product means approximately 1000 billion HUF higher fiscal income, even if the tax per GDP rate decreases from 39.5 to 35–36 percent.”

Contrary to the above, the economy has failed to grow. In 2010, growth was merely

1.1 percent; in 2011 1.6 percent, and 2012 ended with a shocking 1.7 percent fall in GDP, one of the worst performances in Europe. Growth forecasts for 2013 look flat again: prognoses are in the range of plus half to minus half percent. This means that the crisis tax measures originally meant to be temporary cannot be replaced by growth in public revenue receipts from a growing economy. Thus various taxes have to be kept in force to finance the still very costly Hungarian state, unless public indebtedness is allowed to start anew. But those very taxes impede economic growth.

A part – although hardly the bigger component – of Hungarian economic fatigue can be explained by external reasons: the third stage of the series of crises took the wind out of the sails of the European economies, thus the average EU growth rate turned out to be weaker than expected. However, Germany, the most important economy for us, kept growing and, strangely, faster than the Hungarian economy, so our situation cannot be explained by the slowdown of the locomotive. It seems that the unexpected and unusual economic policy measures have made households more cautious; they have refused to spend more, despite government prodding. Families are saving instead, which in itself is understandable, and welcome. Companies are investing even less than before. The Hungarian tax burden compared to that of our neighbours has remained high: personal income tax has indeed decreased, but there are counterbalancing items: a VAT increase, the introduction of a series of new types of tax (the bank levy, a crisis tax on selected industries, taxes on chips, accident insurance, phone calls, financial transactions). High levels of taxation do not encourage economic growth, and especially not growth in investment. Low investment is not only a problem for today, but for the future too. In addition, underinvestment is not a new problem: our investment rate, a lot less than what is needed for sustainable dynamic growth, has been declining for several years in a row now, and is lower than that of our peers in the region.

This is the point where, as I see it, the special Hungarian case, and the problems in wider Europe and those of the advanced triad meet: namely, there is a loss of perspective. It is called short-termism in the business world, and the tyranny of the moment in political decision-making. Economists, talking of the main reasons of the global financial crisis, have underlined the deformed evaluation and reward system of investment fund managers, bankers and top executives for whom the following quarter’s profit data seem more important than anything else. But decision-makers of the financial world are not alone in having such a short time horizon. What about politicians? We know that time dimensions in politics are particular: whatever lies beyond the election cycle is often irrelevant, even if the educational system, the spatial structure, the public debt, the demography or the pension system are all long-term issues for society. So what about Western society itself?

These are rhetorical questions. It is a well-known fact that one of the differences between the rich triad that has stopped growing and the dynamic BRIC countries that threaten the triad’s economic dominance is that the latter save a lot, while the advanced core – deep in debt – does not save enough. This is more than just a numerical difference. The persons, organisations, states or countries that permanently spend more than their income, place the financial burdens of today’s consumption onto the next new generations.

It is an age-old truth but people are only willing to admit it in times of crisis. Usually, politicians, opinion leaders and everyday people care about consumption and spending, while issues such as lack of savings and investments or the existence of explicit and hidden public debts normally bother only a few experts. However, the search for the particular reasons of this recent crisis leads us to the troubles of the political and financial institutional system underpinning the consumption habits of welfare societies. Even now, most policy recommendations aim at restarting consumption and at making financial mechanisms safer, whereas behind every institutional problem you can find an alarming set of phenomena which are very hard to handle either by conventional or new economic methods.

LESSONS LEARNT AND DOUBTS

Some say that the global financial crisis is heralding the descent of capitalism. Others are burying economics as such, not just neoliberal economics. But even the most radical critics admit: in spite of the crisis, there is no new socio-economic order appearing to emerge and replace the current one. The appeal of the earlier alternative – communism – has not recovered. The countries emerging on the periphery of world economy apparently do not intend to change the system of global market economy. Their economic and political importance has increased to a large extent due to the contraction or stagnation of the rich triad, thus emerging countries prefer to make full use of international trade and money flows rather than to abolish them. In terms of economic aspirations, one-party China, democratic India and the two other BRIC countries wish only to shape the ground rules of the world economy to square with their own values and philosophy of life.

Thus capitalism is here to stay. Mainstream economics seems to be sticking around as well. Its reputation has been dented by the fact that economic theory proved unable either to forecast or to avoid the unexpectedly deep financial crisis, despite the world of finance being its technically most advanced area. Jean-Claude Trichet, the then governor of the European Central Bank remarked bitterly in 2010: the sophisticated models have let us down (Trichet, Jean-Claude: “Reflections on the Nature of Monetary Policy Non-Standard Measures and Finance Theory”. ECB). Decision-makers have to rely more on their experience, judgement, and on the vast knowledge of economic history, he said.

Mainstream economics did indeed receive a lot of justified criticism from within the profession and from the broader community as well; yet no new “-ism” has appeared to take over. Some scholars of economic theory state that the level of advancement of a scientific discipline has nothing to do with its ability or lack thereof to foretell a crisis: forecasting, they claim, is not a duty of economic theory, but rather of those applying the theory, and of the institutions and regulatory authorities responsible for prevention. It is not true either that no one came forward with analyses on the risks accumulated in the financial system: beside many others, Raghuram Rajan, the then chief economist of the International Monetary Fund, published a piece on the internal risks of modern capitalism well before the outbreak of the crisis (Rajan: „Has Financial Development Made the World Riskier?” 2005, NBER); in his analysis, he accurately pointed out the possible problems. The general lesson from the works of leading economics scholars is that risks are an intrinsic part of the market economy as a socio-economic system. Occasional crises are a consequence of the internal logic of the system, although we have to do the utmost to prevent them or mitigate their effects. And what have politicians and public authorities learnt from the events? During the crisis, it seemed like most politicians became Keynesians. But it also seemed that Keynesian theory for most meant only that in times of stagnating demand public spending should be energetically increased. Keynes also taught, however, that in boom years public borrowing has to be repaid, i.e. one ought to think long-term and keep in mind sustainable balance. This part of his message more rarely reaches the ears of politicians. And if society’s decision-making elite is not concerned enough about the future, then it is absolutely understandable that governments take out loans when they face problems in the present, and leave the burden of repayment to the next generation. Children do not have a right to vote, especially not the unborn. Adult voters might of course realise the manipulative intentions of the politician who spends borrowed money, and they could possibly reject a government policy that indebts the future – but there are countless voters who do the same themselves, accumulating private debts.

Then there comes a point when, due to technical reasons and financing difficulties, a correction must come, and this holds true even for the richest countries. The title of a recent article of the above cited Rajan speaks volumes: „The True Lessons of the Recession. The West Can’t Borrow and Spend Its Way to Recovery” (2012, Foreign Affairs, June/July). That wise articles do not change the course of events was well seen during this period of crisis. Although it is not insignificant that an influential public opinion shaper such as Fareed Zakaria exposes the crisis of the whole democratic system, blaming America for today’s problems („Can America Be Fixed? The New Crisis of Democracy”. Foreign Affairs, 2013 January/ February). Back in the 1960s the majority (76 percent) of American citizens thought that “you can trust the government in Washington to do what is right just about always or most of the time”. By the 1970s, this opinion had dropped below 50 percent, and to 19 percent by 2010. During the same period, the debt of the entire US public sector had grown to 107 percent of GDP, up from 42 percent. This was not a unique tendency among rich countries: the public debt to GDP ratio in the United Kingdom swelled to 88 percent from 46 percent in the 1960s, and to an astonishing 236 percent from 50 percent in Japan. But, returning to the US, Zakaria also notes that in addition to the public debt, there is the neglected infrastructure and, in general, a lack of investment. Today’s debates are about budgetary restrictions and taxes, when they should be about reforms and investments, Zakaria says.

America was the first to fall into recession, and it was also the first to come out of it. To a certain extent, the US serves as a forerunner of what is happening or is about to happen elsewhere in the developed world. However, we are still in the phase of searching for a solution, and the decision-makers seem to have learnt very little. Leading central banks compete with one another to persuade consumers to start consuming again by keeping interest rates low, even though the main reason behind the bubble in money markets was cheap money. Governments would like to use fiscal measures to stimulate consumption as the main factor of economic growth, yet something should be done, on the other hand, to stop the swelling of public debt. Authorities have had wide experience in managing the crisis, but very little in the prevention of it.

Even laymen see how Americans are caught between the appeal of fiscal discipline and the hard ideology of conservatism on one hand, and accepting widespread welfare entitlements, on the other. They also see how difficult it is for an EU consisting of so many states to move forward. Hungarian politicians do not conceal their criticism of Western crisis management. Still, with economic stagnation in Hungary which has lasted almost a decade now, we should be more modest in judging the impotence of others. Our economic growth in the early 2000s, modest relative to the rest of the region, was already in part powered by accumulating household,municipalityandcentralgovernmentdebt–takenoutinmostpart in foreign, not local currency. Since 2006 our relative growth lag vis-à-vis our neighbours has increased. Debt data clearly shows that Hungary is a country where the political elite likes to spend on the account of the future generation to secure the support of the current electorate or at least to ensure the indifference of the voters.

Furthermore, beyond the explicit public debt data, implicit public debts should also be taken into account: pensions promised for the still active workforce, huge amounts which should be spent on the decrepit physical and human infrastructure, or the future costs of rehabilitation of cities and housing estates. If America can get into trouble, and the massive investments necessary for its international competitiveness can run out, then it is even more alarming in the Hungarian case.

Soon we will enter into the next electoral campaign in which the arguments, considerations and actions which will dominate public discourse are of the shortest possible terms. Hence, we must open profound and honest debates on the lessons of the crisis – and the sooner the better.