Friday, May 29, 2009

Strategic options for how to use the crisis to Poland's benefit

In this week's edition, The Economist runs two stories on how Indian and Chinese companies use the crisis to expand abroad through acquisitions. These stories dovetail with what I have been saying for a long time (see for instance my article in Rzeczpospolita from September of last year) that Poland's government should take advantage of the crisis to promote foreign expansion of public and private companies. It, of course, can do much more for state-owned entreprises such as PKO BP, KGHM or Orlen. PKO BP is a particularly good example: using the historical weakness of foreign banks, it could cheaply buy banks in Poland, CEE region, and even in Western Europe. The latter option would actually be the best: it would give PKO BP the needed know-how, expertise, brand name, access to markets etc, and serve as a a platform for further expansion.

What needs to be done: first, the government should forgo dividends from large state-owned companies (particularly from PKO BP). second, when profits are not enough, the state should increase equity in selected companies, even if it required increasing budget deficit (although it could be done through BGK, the state-owned bank). third, it should ensure that management boards of the state-owned institutions are as professional as they can be (which is largely the case, but not always). lastly, it should clearly state that it would not punish state-owned companies for being ambitious (it is risky, I know, but there is never a free lunch).

State ownership should not be, however, a long-term option: PKO BP and others should at some point be privatized to long-term domestic investors, such as the pension funds. Let Polish citizens benefit from international expansion of our companies...

Eurobond market would help resolve global imbalances

Barry Eichengreen in his Project Syndicate column talks about what could prevent global imbalances from reemerging in the future. He says the following:

"The other view is that China contributed to global imbalances not through its merchandise exports, but through its capital exports. What China lacked was not demand for consumption goods, but a supply of high-quality financial assets. It found these in the US, mainly in the form of Treasury and other government-backed securities, in turn pushing other investors into more speculative investments. Recent events have not enhanced the stature of the US as a supplier of high-quality assets. And China, for its part, will continue to develop its financial markets and its capacity to generate high-quality financial assets internally. But doing so will take time. Meanwhile, the US still has the most liquid financial markets in the world. This interpretation again implies the re-emergence of global imbalances once the recession ends, and their very gradual unwinding thereafter. One development that could change this forecast is if China comes to view investing in US financial assets as a money-losing proposition. US budget deficits as far as the eye can see might excite fear of losses on US Treasury bonds. A de facto policy of inflating away the debt might stoke such fears further. At that point, China would pull the plug, the dollar would crash, and the Fed would be forced to raise interest rates, plunging the US back into recession."

Should we not try to provide an alternative for Chinese investment. mitigating the risk of continued global imbalance, through developing a eurobond market?

Thursday, May 28, 2009

Live debate on TVP1 on the Polish economy

On May 21 I debated the current state and prospects of the Polish economy in a live program on the main channel of the Polish TV - TVP1. There were four other participants: one additional economist and three politicians. I argued that the governments needs to present asap a full fiscal reform plan what would let public finances survive the next 2-3 years of slow growth.

Taylor on "exploding debt threatens America"

A stimulating op-ed by John Taylor (the one who developed the Taylor rule) in FT on the risks that US's might be downgraded owing to the quickly rising public debt. I tend to disagree with him -- debts can be paid back in the future when the economy recovers -- but like his original arguments.

Sunday, May 17, 2009

Monti on the need to coordinate taxes in the EU

Former EU competition commissioner Mario Monti recently argued that EU should use the crisis to re-start talks on tax harmonization. It should seek a great compromise between Anglo-Saxon and continental values.

Agree with this, although it would make more sense for New Europ to keep lower taxes than in Western Europe to offset disadvantages in the overall quality of the economic environment.

Tuesday, May 12, 2009

Nothing will change Balcerowicz's neoliberal mind

There is an interesting interview with prof. Leszek Balcerowicz in Gazeta Wyborcza (Monday, May 11, 2009) entitled "Leave my capitalism alone". It seems that nothing will change prof. Balcerowicz's neoliberal mind. In essence, he argues that the global crisis is due to state interventon and loose monetary policy. The private sector is not to blame (maybe only partly) He does not mention laisser faire approach to financial sector regulation, tax cuts, financial innovation going astray or weak financial risk managament as sources of the crisis.

I think that he is wrong. Let me just quickly take up his main two arguments:

1. On state intervention - he is yet another guy who erroneously maintains that the growth in the subprime market was due to government's intervenion. First, the law promoting lending to poor households was introduced in 1979, so it can't be blamed for the crisis in XXI century. Second, Fannie Mae and Freddie Mac financed not more than 20% of the subprime market - the rest was financed by the private sector, with no support from the government whatsoever, expect for lack of regulation...

2. Loose monetary policy - he is wrong here, too, although less. Loose monetary did contribute to the crisis. But even if interest rates were higher (if FED followed Taylor rule, inteest rates would not go down to 1% but perhaps to 2-3%), it would not prevent the crisis: financial sector would continue to give money to ninjas no matter what the interest rate and sell it on to all these gullible global investors. The crisis would probably have been slightly smaller (real estate prices would have slightly less space to fall), but it would happen anyway.

Here is my view on the sources of the crisis, in slides.

Thursday, May 7, 2009

How to restructure public finances in Poland

Today I was on the radio TOK FM (recording available) discussing, inter alia, the issue of how to restructure Polish public finances. One of the debaters, Mr. Andrzej Sadowski from the Adam Smith Center, argued--populistically--that most public money is being wasted, but couldn't provide any specific example of what public expenditure needs to be cut except for his favorite topic of public subsidies to Ochotnicze Hufcy Pracy/Voluntary Labor Corps of PLN 200 million, which, however, represents less than 0.1% of total central budget expenditure. When asked to provide more examples, he said that there wasn't enough time...:-)

I think this provides an illustration of how many populists, like Mr. Andrzej Sadowski (and I am trying hard not to get myself started on discussing his persona... I doubt whether he even has a Master's degree in economics --couldn't find his bio-note anywhere, which looks fishy to me... How such a guy, who never wrote a single economic paper, can continue to be invited to serious economic discussions escapes me..), who come up with various weird examples and ideas on how to save public finances without any economic rationale to back it up. That's just nuts.

So, below is my list of what needs to be done in the medium-term (in the short term, as I was arguing before, we should try to increase spending, subject to available financing, to offset falling private demand):

On the expenditure side:

1. Raise retirement for men (65 years now) and women (only 60 years). Equalize both retirement ages (because currently women's pensions end up being much lower than men's) and link the retirement age to life expetancy (like the UK and other countries did): any increase in life expetancy should 1 to 1 increase the official retirement age for both sexes. In time, we would gradually reach 70 years for retirement. This would save billions in spending on pensions and in all kinds of pre-retirement benefits and provide additional tax and social security revenue (that said, the government should help older people find/retain jobs, but this is a different topic). In addition, eliminate or reform priviliged pension systems for the military (one can retire when only 35 years old after 15 years of service, often behind a desk!)

2. Cut the number of extra-budgetary funds and agencies and move their functions to local government (and responsible central government's ministries, where necessary). Which agencies to cut? Check out Kolodko's fiscal reform program for 2003, to which I contributed back then.

3. Eliminate automatic indexation to tens of various social entitlements, such as a funeral allowance (Polish state subsidizes funerals with some PLN 5000, which is indexed to inflation and a couple of other things..). Decrease indexation of pensions and disability allowances to inflation only (now it is indexed to inflation and 20% of the increase in wages), at least temporarily until we come out from the crisis.

4. Implement fully centralized cash management - today some public sector insitutions maintain their accounts with commercial banks rather than--like the rest of the public sector--at the National Bank of Poland. As a result, various public funds and agencies have billions of PLN sitting on their accounts, while the central budget struggles to sell new bonds...

5. Cut spending on the military -there is no need to spend 2% on GDP on it. A lot of this money is being wasted on feeding temporarily drafted soldiers, buying tanks and imported anti-aircraft missiles to defend the sea coast, on procurement which is prone to corruption. We need the military (for many reasons, from the need to comply with promises to NATO to strenghtening our international role through engagement in peacekeeping operations), but we don't need to spend so much on it during the crisis. In the future, armies will be much smaller, more agile, fighting with joysticks directing unmanned aircraft than with boots on the ground (I read it in Friedman's "The Next 100 Years: A Forecast for the XXI Century" )

6. Introduce target-oriented budgets to monitor the efficiency of public spending (and cut spending where it is being wasted).

On the revenue side:

1. Temporarily increase PIT rates for the richest (up from current 32% to 40% from 2008) and increase or eliminate the social security treshold (30 times average monthly wage) over which the richest stop paying security contributions (leading to a tax system which is more or less flat rather than progressive.. more on it in a separate post).

2. Introduce real estate tax asap, based on market values. We have been trying to do that for more than a decade now, with no success. I wonder why???

3. Reform KRUS by increasing social security contributions of the richest farmers to that of people with equivalent incomes in ZUS. This will not only be a source of revenue, but will also help accelerate restructuring of the farm sector: today it doesn't pay for farmers to leave farms and get (much more productive) jobs elsewhere.

that's the list for now.

Sunday, May 3, 2009

Japan shows for the way for the ECB on how to help New Europe

Financial Times's article on "Japan pledges $100bn for struggling Asian economies" talks about Japan providing $100bn in the form of currency swaps and bond guarantees to other Asian nations struggling to cope with the world economic crisis. Part of the money will be allocated within the framework of the Chiang Mai initiative, the equivalent of a regional IMF (without strings attached). Japan is also offering Y500bn in guarantees for potential Asian issuers of yen-denominated, samurai bonds. The Japanese finance minister said that “Japan is at the moment willing to do whatever we can within our limited capacity.”

I want to ask: What is the ECB doing to help its fellow New Europeans (aside from a paltry EUR 15 billion credit line to Poland and Hungary)???

The ECB could more or less solve the crisis in Central and Eastern Europe by (i) commiting itself to support CEE economies with euro financing, if needed and (ii) making it feasible for CEE countries to enter the euro zone in the near future (in essence, promising that it will not cheat CEE countries the way it cheated Lithuania back in 2006).

For now, the ECB is doing neither. In effect, it is dividing the EU into first and second category members, those in and outside the euro zone, undermining the future of the EU.

Yes, yes, I know the excuse: the ECB should be responsible only for the euro zone members. However, (i) ECB would help euro zone countries by helping CEE countries (through, for instance, the banking channel), (ii) the ECB already made a precedent by providing credit lines to Poland and Hungary (why not other countries then?), and (iii) the ECB's credibility would not be undermined (it always shocks me when hard-core macroeconomists suddenly transform into amateur market psychatrists and try to figure out what the markets will think. Do they have any skills whatsoever do to it? Any models or at least some empirical evidence? Do the markets actually "think"?)

A digression on an interesing idea for the EU (or New Europe alone) to set up a trust fund to guarantee corporate bonds: "The 13 countries also agreed to put $500m as initial capital into a new trust fund to guarantee bond issues by Asian corporates. Asian companies have been facing high borrowing costs because of investors’ low risk appetite for emerging markets and this credit guarantee mechanism will be of substantial benefit"

Politics matters: Evidence of rising inequality in the US

I have stumbled upon a very interesting article by Emmanual Saez, this year's recipient of the Clark Bates medal, the so-called Nobel prize for economists below 40.

Saez et al show that " 1 percent incomes captured abouthalf of the overall economic growth over the period 1993-2006."

They also show that politics matters: during Clinton growth has lifted all boats (although inequality still increased), while during Bush II practically only the richest benefitted:

"The 1993–2006 period encompasses, however, a dramatic shift in how the bottom 99 percent of the income distribution fared. Table 1 next distinguishes between the 1993–2000 expansion of the Clinton administrations and the 2002-2006 expansion of the Bush administrations.
During both expansions, the incomes of the top 1 percent grew extremely quickly at an annual rate over 10.1 and 11.0 percent respectively. However, while the bottom 99 percent of incomes grew at a solid pace of 2.4 percent per year from 1993–2000, these incomes grew less than 1 percent per year from 2002–2006. Therefore, in the economic expansion of 2002-2006, the top 1 percent captured almost three- quarters of income growth. "

What explains rising inequality over the last thirty years? The change of intellectual trends driven by Reaganomics and Thatcherism seems to have mattered.

"The labor market has been creating much more inequality over the last thirty years, with the very top earners capturing a large fraction of macroeconomic productivity gains. A number of factors may help explain this increase in inequality, not only underlying technological changes but also the retreat of institutions developed during the New Deal and World War II - such
as progressive tax policies, powerful unions, corporate provision of health and retirement benefits, and changing social norms regarding pay inequality"