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Uncertainties and responses to the financial and economic crisis

Andreea VASS

The risk of an implosion of the global financial system, as witnessed in October 2008, was overcome thanks to the set of interventionist measures taken by developed states. We all sighed with relief, and thought the worst was over. Well, apparently it isn’t! The uncertainties that we are still facing leave us with nothing but failed assumptions and inadequately planned measures rushed through the mass media. Below are several arguments in this respect.

The effects of interventionist measures in the world’s deve­lo­ped economies will be evident, if at all, only in the last quarter of 2010. In this respect, P. Krugman’s expec­tations for the American eco­nomy and J.-C.Trichet’s for the Euro­pean one concur. I believe we can expect further downward adjustments of the global economic forecasts. Uncertainties are substantial, and the jaws of the economic crisis have only begun to rip our pockets.
So we have significant inconsis­ten­cies between the forecasts of inter­national institutions, of the European Commission (EC) and those announ­ced by Romanian authorities. Which comes as no surprise. Indeed, I believe the EC estimates on Romania’s eco­nomic growth rate are slightly optimistic.
Unless we earnestly acknowledge reality, with its weaknesses and aggra­vating uncertainties, we will only waste the political energies needed for countering the effects of the crisis. Sub­sidies, meal or travel vouchers, new charges on private asset mana­gement institutions, etc., are not solutions to the ongoing economic crisis; on the contrary. We waste money and hamper sectors that are yet to be developed.
Short-term solutions which absorb the already scarce resources we have, cannot help. As the former Polish prime minister and incumbent director of the IMF’s European Department, Belka, put it, the economic crisis offers the opportunity of in-depth reforms, which are impossible to coordinate quickly and effectively in normal times. In other words, long-term solutions must be identified; otherwise we will only generate new major imbalances.

a) The European Commission has just revised its 2009 economic growth forecast for the Euro zone from +0.1%, to -1.5%, and will soon make it public. The Romanian forecasts were based on the past dynamics of the foreign mar­kets that we largely depend on to­day, so these must be once again adjusted.
b) On the one hand, there are subs­tantial differences (close to 3 %) bet­ween European Commission (EC) forecasts made last autumn and those made in January 2009 as regards Romania’s economic growth rate in 2009. On the other hand, there are smaller differences (3/4 percentage point) between current European fore­casts and those confirmed by the Romanian Ministry for Finances (MF), yet there are staggering differences between the EC and the MF as regards Romania’s budget deficit.
c) The International Monetary Fond has lowered its forecasts on the global economic growth rate, from 2.2% (in November 2008), to about 0.5% for 2009 (29 January 2009). In fact, the IMF tells us that with the global economic crisis spreading around, further contractions are to be expected.
a) The European Union late last year prepared a set of measures worth approx. 200 billion euro (1.5% of the EU GDP).
But European experts have recen­tly stated that the situation is a lot gloo­mier, and that these measures will be significantly extended (January 2009):
In the EU, the GDP growth is expec­ted to drop by approx. 1.8% in 2009, before a slight increase in 2010, by 0.5%.
The world economy will severely shrink in 2009, and the European economy will in turn be dealt a heavy blow.
Inflation is to drop quickly.
The European Commission also believes that the American and Japanese economies will witness severe contraction, by -1.6%, and -2.4% respectively in 2009.
Under the current circumstances, uncertainties are considerable.
Unlike the European Commission – which has increased the coverage of banking deposit guarantees (under a directive endorsed on October 15, 2008) to 50,000 euro and temporarily eased the procedures for State aid granting in 2009 - 2010 -  Member Sta­tes are the only ones in a position to draw up “bailout plans“ using national revenues, i.e. taxpayer money.
Famous for the incapacity to beat about the bushes, on November 5 the Germans proposed a Package of anti-crisis measures comprising long-term solutions, which are nonetheless im­me­diately applicable and effective. Adding to these is a recent 100-billion euro package to guarantee loans for companies affected by the collapse of the crediting market.
Germany proves to be by far one of the world’s most creative states in launching effective solutions. The answer to the ongoing crisis raises the stake of the economic incentives package proposed early last week (and briefly presented in a BBC feature on January 2009) to 50 billion euro.
Among other things, the federal government offers 2,500 euro to those who discard vehicles older than 9 years and choose to buy a new car. Both the economy and the environ­ment stand to gain. I wondered whe­ther the world’s largest exporter resor­ted to protectionist measures, by unfai­rly privileging the domestic production. The answer is NO! So what makes such a reaction plausible? The Germans’ confi­dence in their cars: They will most certainly buy German cars. Can you imagine a German buying a Renault these days? Hardly! But what would the Romanians make of such subsidies? A similar plan to rescue carmakers also seems inefficient in the USA.
What I admire the most in this new set of measures is the easing of the fiscal burden on salaries. Specifically, contributions to healthcare funds have been cut down, and a 100-euro bonus is paid to all families for each child. 
Alumnia, the Commissioner for Economic and Monetary Affai­rs, reco­mmends however that all EU Member States facing balance of payments problems (e.g. difficulties in funding the current account deficit or in repaying foreign debts) should first of all discuss them with the European Commission, which is in a position to step in, alongside the European Cen­tral Bank. Only after such consul­tations, can the states in question resort to international institutions such as the IMF. Not least, the excessive deficit procedure is not to be initiated for minor deviations from the 3% of GDP threshold (that is, up to 0.75%).
b) An equally sharp thorn poking Romania’s optimistic eye is the Euro­pean Commission’s much more pessi­mistic forecasts for 2009 Romania:
A 1.75% economic growth rate (as against 4.7% in the autumn of 2008 and against the approx. 2.5% rate targeted by the Ministry for Finance);
Annual inflation standing at 5.7%, as against 7.9% in 2008;
A 7.0% unemployment rate, in contrast with 6.2% in 2008;
A budget deficit yawning to -7.5% of GDP, as compared to -5.2% in 2008 (against the approx. 2% eyed by the Ministry for Finances);
A deficit of the balance of trade standing at -11.9% of GDP, as against -12.9% in 2008.
The Latvians and Spanish will have even more serious problems, because they are likely to see very harsh rece­ssion: -6.9%, and -5.0% respectively this year.
Romania’s European partner markets will not thrive either: Germany (-2.3%), Italy (-2.0%), Hungary (-1.6%) or Austria (-1.2%).
The inconsistencies between the Romanian and current European fore­casts are easy to explain. If we con­si­der the Romanian economy’s depen­dence on agriculture and the “Rain in May means plenty of bread” scenario, then we obviously confirm the Roma­nian forecast – 2.5% economic growth in 2009. If it doesn’t rain, then we will see the 1.8% European forecast come true. There is no telling at this point how intense the economic contraction will be. But there will be contraction, there is no doubt about it, and anti-crisis solutions should not rely on opti­mistic economic growth expectations.
There are a lot deeper mismatches between the Romanian budget deficit forecast made by the European autho­rities (-7.5% of GDP) and the 2% goal pursued by the Ministry for Finance for 2009. This is even easier to explain. The Europeans have taken into account all the legislative commit­ments made in 2008 with respect to pension increases, salary increases, social security contributions, etc., which will burden the 2009 budget. They cannot imagine that in Romania, a law that has been endorsed and takes effect may well not be enforced after all. Which I believe will actually happen.
c) IMF has available an emergency loan fund of about 200 billion US dol­lars, and may resort to additional resources of 50 billion US dollars. Hun­gary, Ukraine, Pakistan and Iceland have benefited from this programme. IMF also initiates three sets of anti-cri­sis solutions available at a government level:
l Specific actions to restore confi­dence in the market, by supplying cash, banking and inter-banking guarantees and even by acquisition of assets from companies that face difficulties;
l Fiscal expansion (i.e. a temporary tax reduction – provided that it is a reversible process) in order to encourage consumption;
l IMF simulations indicate that, if fiscal incentives amount to approx. 2% of the global GDP, and of course, if they are adequately articulated, a moderate multiplication factor (1:1) would enable the global economy to recover 2 percentage points of its growth rate—which is a substantial reduction of the risk of severe economic recession; 
l in Romania, for instance, this pro­posal is unworkable because of the bud­get deficit (put at 5.2% for 2008), of the short-term foreign debt, of macroeconomic policy indiscipline and of the consumer policies, which favour imports over domestic production; 
l we may nonetheless give serious thought to a fiscal reform of social contributions as an example of effec­tive response to the economic crisis; for instance,  simulations for Bulgaria (a research report titled Tax Incentives as Crisis Response),  published by two World Bank economists, Georgi Angelov and Simeon Djankov, in January 2009, indicate that:
l a reduction of such contributions by 7.5 percentage points, i.e. from 31.3% to 23.8%, would facilitate the creation or maintenance of some 130,000 jobs and would increase the economic growth rate by 0.5% ;
l the static and dynamic costs of such a measure would reach approx. 0.63% of GDP;
l such a reform has at least three other core benefits:
i. the government is not vulnerable to corruption, because it is not required to lavishly offer tax incentives, as it would be the case in a fiscal expansion programme;
ii. the tax incentive is direct and benefits all companies and employees;
iii. the fiscal reform is easy to implement, quick and has immediate effects;
reduction of the monetary policy interest rate by national banks - e. g. USA, Japan.

Anti-crisis measures proposed for Romania

 The debate in the media and in governmental circles primarily focuses on proposals made by trade unions, while neglecting more beneficial struc­tural reforms. This would further undermine the public finances, which are already vulnerable because of the budget deficit (put at 5.2% in 2008), of the substantial short-term foreign debt, of the indiscipline of macroe­co­nomic policies, which encourage imports at the expense of domestic pro­duction. This is the trap that the previous “liberal” government also rushed into.
Therefore, I believe at least four measures are worth considering:
l an exemption from the tax on reinvested profits (accounting for max. 25% of the total profit) – in order to encourage investments, production, job creation and implicitly to stimulate demand (a measure included in the PDL governing programme);
l reduction of abusive and useless public spending, a simplified and ef­ficient central and local admi­nistration – estimates go up to 30% of the public spending;
l fast and efficient absorption of the European funds - some 80% of the total structural and cohesion funds are intended for the central and local public administration;
l reduction of social security contributions – at first sight, the reduc­tion of such taxes leads to a decrease of budget revenues; but it will facilitate job creation and/or maintenance, will encourage consumption and produc­tion; the dynamic benefits of this measure will offset its static costs and will boost economic growth;
The multiplicative economic effects of subsidising interventions on the preservation of jobs or on encouraging consumption and/or production, are null. This only postpones the rise of the unemployment rate and the budgetary costs entailed by this, until the resources earmarked for subsidies are used up.
The advantages of such reforms:
l the government is not vulnerable to corruption, because it is not required to lavishly offer discriminating fiscal incentives, as it is the case with sectoral or other subsidies;
l the tax incentives are direct and they benefit all companies and employees;
the fiscal reform is easy and quick to implement and has immediate effects.
As for the priority investments, here are the three major priorities, and if resources are limited, the solution is in public–private partnerships, i.e. concessions on the construction works, as it happens everywhere in Europe:
Better have a motorway toll, than have no motorway at all.

In times of financial and economic crisis, there’s no room for mistakes in public management, and the room for political mistakes in governing this country has shrunk to a minimum.

By Andreea VASS
Publicat în : English  de la numărul 63


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