Even before the turmoil caused by the
global financial crisis has been adequately dealt with in terms of the
adverse effects on employment and living conditions, governments across
the world are being told that fiscal consolidation is the most important
macroeconomic policy to be addressed. The calamities resulting from sovereign
debt crises are widely advertised by the example of Greece, which in turn
is encouraging many developing countries to opt for measures of austerity
and fiscal retrenchment in an effort to placate markets.
The danger is not only that such policies may be put in place prematurely,
thereby threatening the currently fragile global recovery. There are several
additional dangers. Such a strategy depends upon exports to provide the
source of dynamism for the domestic economy, which obviously cannot work
if all countries or even a large number of them try it at the same time.
It also accentuates and worsens domestic economic inequalities, which
can give rise to social tensions and political instability that also affect
the economy. In extreme cases, it can generate a self-reinforcing economic
free fall, in which market bullishness is compounded by government austerity.
Fortunately, this is not the only option available, nor is it the only
actual experience that can be drawn upon to provide examples. In fact,
even the very recent experience of several countries suggests that heterodox
measures based on different kinds of state intervention can be more successful
in allowing countries to deal with and escape the worst consequences of
global volatility. This is illustrated by the contrasting experiences
of Hungary (which opted for the standard model of adjustment), and Uzbekistan
(which undertook a rather different and more creative pattern of adjustment
based on active state involvement).
Hungary: The perils of pro-cyclical adjustment measures
Hungary was seen in the early part of the past decade as a star performer
among the transition economies of Eastern and Central Europe, lauded by
international organisations, financial media and markets for its far-reaching
market-oriented reforms that began in the 1990s. The country joined the
OECD in 1995, the WTO in 1996 and the European Union in 2004. Hungary's
history of export orientation, highly educated workforce and strategic
geographical position made it an attractive destination especially for
mobile European capital.
Economic growth since 1995 was associated with sweeping economic measures,
beginning with devaluation of the Hungarian forint to encourage exports,
and followed by an extensive privatisation programme, in which most important
public assets were sold, often to foreign buyers; restrictions on public
sector wages and new employment; reduction or removal of state subsidies
on higher education and medical treatment (including on drugs and dental
care); welfare cuts including reduced family allowances, maternity benefits
and child care payments.
The generous tax cuts and other implicit subsidies (for example on energy
costs) offered to foreign investors were associated with a substantial
inflow of export-oriented FDI, particularly in the automobile sector,
which generated a process of export-led growth. Tourism also became a
major source of foreign exchange, income and employment. Despite these,
the current account remained significantly in deficit (at around 6 to
8 per cent of GDP), financed by a combination of direct investment and
borrowing.
This growth trajectory was dramatically affected by the global crisis
in 2007-2008, since it was associated with a sharp decline in exports
and tourism receipts as well as a reversal of capital flows. The period
of growth had also been associated with growing public and private indebtedness,
which became more difficult to service after currency devaluation. The
drying up of private capital markets led to severe liquidity problems.
In November 2008, Hungary signed a Stand-By Arrangement with the IMF for
SDR 10.5 billion, as part of a joint rescue package worked out with the
European Union. Various IMF reviews found that Hungary complied with all
the very severely pro-cyclical conditions imposed, including a massive
reduction of the fiscal deficit from more than 9 per cent of GDP in the
last quarter of 2008 to around 3.8 per cent thereafter. At least partly
as a result of this, real GDP declined by 6.2 per cent in 2009. In fact,
Hungary did not actually take the remaining amount of around under the
SBA 725 million.
The very harsh economic conditions led to social and
political turmoil, with even policemen going on strike demanding their
pay and arrears. The Social Democratic Party implementing these measures
was thoroughly defeated in the elections, which delivered a resounding
majority to the centre-right Fidesz Party that had campaigned on a promise
of less austerity. However, once in power, in June this year the new government
also announced that the fiscal situation was worse than they expected,
and so even more severe fiscal measures would be required.
There were tax cuts for the wealthy, which were explicitly designed to
encourage more private investment and spending, but more pain for workers
and users of public services. Public sector wages are to be cut once again
(in nominal terms in an inflationary environment) by around 15 per cent;
redundancy payments are to be limited to two months' pay, with all other
payments subject to a 98 per cent tax; pensions are to be further cut
along with an increase in the retirement age. Coming after nearly five
years of similar austerity measures, these policies are likely not only
to add to material distress, but obviously prevent or delay any recovery
in the economy.
It could be thought that all this would be enough even for the IMF to
be satisfied, but apparently not! In mid-July, the visiting IMF team actually
broke off discussions with the government and returned home, unhappy that
more was not being done on the expenditure side to reduce the fiscal deficit,
so as to ensure the planned 3.8 per cent of GDP for this year. The IMF
demanded privatization of state-owned enterprises and further reductions
in spending.
Given the IMF focus on fiscal consolidation, it is surprising to note
that the team objected to a proposal of the Hungarian government that
would actually help to reduce the deficit – a proposed tax on the banking
sector that is expected to raise nearly $1 billion. The IMF found this
to be ''high'' and likely to ''adversely affect lending and growth''.
So it seems that not all deficit-reduction measures are apparently to
the taste of the IMF! Anything that affects bankers and other forms of
capital is obviously unacceptable, and the belt-tightening should focus
on the public at large, especially workers. But this time, even the centre-right
party realises that it really cannot afford to risk renewed public anger
at even more such measures, at least until the municipal elections to
be held in October.
So whose interests are being served by such demands by the IMF? While
the pro-cyclical proclivities of the IMF are well known, it could be thought
that that given the recent past and its own statements, it would at least
be slightly shamefaced about insisting upon them. But it may be that it
is being pushed further along this road by the EU, which has become increasingly
insistent on a combined push towards austerity among all wayward European
economies.
The likely devastation on the real economies of Europe is obvious to almost
all observers, and so such a policy appears inexplicable. The purpose
right now, however, is to somehow save the banking system, which is deeply
implicated in the more fragile economies. Thus, banks from just five countries
(Austria, Germany, Italy, Belgium and France) hold more than $126 billion
of Hungarian public debt. This entire exercise is essentially to save
them from any diminution in the value of their assets. Already since the
breakdown of IMF talks, the Hungarian forint has slumped to its lowest
level in the past two years, and yields on bonds have risen, even though
no ''fundamentals'' have changed.
Uzbekistan: A case of heterodox response to crisis
Unlike many other transition economies, Uzbekistan sought to move to a
more market-based economic system with a gradualist and heterodox approach.
Despite criticism from the IMF and other lending agencies, it adopted
an import-substituting industrialization strategy in order to diversify
out of heavy dependence on cotton exports and to utilize its domestic
oil and gas reserves as well as gold and other mineral resources. It moved
from importing 60 per cent of its oil production during the Soviet period
to self-sufficiency in oil by 1995, without any reliance on foreign direct
investment.
In the mid-1990s the country moved closer to adopting IMF-supported liberalization
policies. But the collapse of world cotton prices in 1996 followed by
the devaluation of the Russian rouble in 1998 precipitated a crisis, which
was exacerbated by the suspension of the IMF Stand-By Agreement and the
withdrawal of World Bank funds. Uzbekistan chose to intensify its import
substitution and targeted credit policies, as well as to adopt a ''crawling
peg'' system of exchange rate management to avoid sharp exchange rate
shocks. It was rewarded with stable and then accelerating GDP growth over
the past decade, based on rapidly increasing capital investment. GDP growth
averaged 4 per cent annually in the early part of the decade and increased
to 8-9 per cent before the global crisis (see chart).
This meant that the economy could face the global crises (the rising volatility
of food and fuel prices followed by the financial crisis) in a relatively
strong position. In any case, there was hardly any financial contagion
since there had been only very limited financial liberalization. More
importantly, it was able to cope with the fall in exports through countercyclical
macroeconomic policies. The Uzbekistan government's ability to mobilize
domestic revenues (which continue to account for 30 per cent of GDP) allowed
it to keep its budget broadly in balance through most of the 2000s. It
also has recently started to channel its current account surpluses into
a new Fund for Reconstruction and Development.
These gave it ample fiscal and balance of payments space from which to
initiate a large fiscal stimulus in the wake of the crisis, which was
equivalent to around 5 per cent of GDP in 2009. Capital investment has
increased very rapidly, counterbalancing the effects of export decline.
Contrary to the pessimistic projections of the IMF, industrial growth
accelerated from 2.7 per cent in 2008 to 9.1 per cent in the first half
of 2009.
It is true that the pattern of growth in Uzbekistan has not been associated
with sufficiently rapid employment generation or poverty reduction (McKinley
and Weeks 2009). Nevertheless, its heterodox measures have meant that
the economy could avoid the worst effects of the crisis and continue to
grow, belying expectations of a sharp fall in GDP.
As a result, even those who were earlier critical of such policies have
changed their minds. A mission of Executive Directors of the IMF who visited
Uzbekistan in October 2009 noted that "Uzbekistan has remained mostly
resilient to the global economic crisis as a result of the authorities'
prudent policies that enabled them to accumulate considerable resources
to support growth in this period and withstand the impact of the crisis
and due to its cautious approach to participation in global financial
markets." (IMF Press Release No 09/344,
http://www.imf.org/external/np/sec/pr/ 2009/pr09344.htm)