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June 2009June 2009

Causes of the Crisis,Transmission to EE,

Impacts & Recommendations

Paul Marer, Ph.D.Business School

Central European University, Budapest

USAID Conference:Competitiveness & Growth

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June 2009June 2009Outline

• Causes of the global crisis; remedies• Transmission to WE and EE

– 10 EU members – 7 West Balkans– 4 Other Eur: Russia, Ukr, Bel, Moldova– 8 Caucasus (Arm, Az, Ga) & Central

___ Asia (the 5 “stans”) 29 countries

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June 2009June 2009Outline (cont’d)

• Commonalities in EE

• Differences

• Economic & social impacts of the crisis

• Outlook

• Recommendations

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June 2009June 2009

Global Crisis:Causes & Consequences

• Causes:– Persistent global S imbalances between

Asia vs America and Europe, incl EE.– Financial manip. system-wide problems– Authorities were dozing at the wheel

• Consequences– Huge losses for financial institutions; credit

markets froze– Fin. crisis spread to global real economy

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June 2009June 2009Global Crisis: 3 Remedies

• Massive additional fiscal spending (if the resulting deficits can be financed)

• Easy monetary policy• Restore the financial sector’s health

– Establish potential losses (“stress test”)– Remove losses from bank balance sheets– Recapitalize the banks (private or public)

The US is moving faster than Europe

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June 2009June 2009Transmission to WE & EE

• UK, Irish, German (!) banks also made poor investments before the crisis.

• As world markets slumped, WE’s trade- dependent economies turned south.

• With a delay, EE’s even more trade-dependent economies also plunged.

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June 2009June 2009

Pre-Crisis Commonalities in EE

• Rapid integration into EU & global economies– Increase of X + M as % of GDP– Even more rapid increase of foreign financial

assets + liabilities as % of GDP – Large net FDI inflows productivity growth

• Net importers of K (except Russia)• Large CA deficits, financed by K inflows• Foreign ownership of the banking sector• Rapid domestic real credit growth

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June 2009June 2009Foreign Banks Dominate

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June 2009June 2009

Commonalities in EEDuring the Crisis

• Banking problems are not as bad as in the US or WE (few toxic assets, low leverage); Ukraine the main exception.

• Foreign bank ownership an advantage• IMF & others IFIs are helpful

– During past 9 months, more than 50% of IMF’s $155b in new loans were committed to EE

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June 2009June 2009Differences in EE

1. Fiscal deficits & public debt especially high in Hungary; current-account deficits very large in some countries (Bu, LA, Es, Lit, Ro)

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June 2009June 2009Differences (cont’d)

2. Different ER regimes– Euro: Slovenia (2007) & Slovakia (2009)– Pegged to Euro: Baltic states, Bulgaria– Most others: “managed floating”

(Pros and cons of adopting the Euro)

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June 2009June 2009Differences (cont’d)

3. FC borrowing vulnerability if (1) local currency ER and (2) the country has insufficient FC to service foreign debt. Large differences among 11 EE (no data for others) – Very high: Latvia, Estonia– High: Hu, Bul, Rom, Lith, Slovenia, Croatia– Low: Czech (!), Slovakia, Poland

Especially vulnerable are countries with high private FC borrowing + high government debt (some of which is in FC), e.g., Hungary

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June 2009June 2009

Economic Impacts of theGlobal Crisis on EE

All EE suffered 3 big external shocks:1. Plunging demand for X2. Dramatic decline in K inflows3. Severe contraction of domestic credit

(reflecting in part the lower availability & higher cost of credits from abroad)

Ave. GDP 6% (same as WE); double digits in the Baltic countries & Ukraine

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June 2009June 2009Social Impacts

• Extreme hardships for many people.

• Populations not aware that most countries face similar problems.

• So far, the chief protest in the voting booths, few violent street demos.

• Especially impressive is the Ukrainians’ and Latvians’ patience.

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June 2009June 2009Outlook for West Europe

EE’s econ. fate is tied to WE (Central Asia’s is tied mostly to Russia)

For West Europe- the worst decline is probably over, but- recovery’s timing & shape uncertain;- medium-term prospects: slow growth

(What will replace the growth engine of excess C in America and Europe? Also, rigidities)

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June 2009June 2009Outlook for EE

Prognosis for WE is unfavorable to EE!! Consider EE’s apparently successful growth

model (mid-1990s through 2008)1. Rapid trade/finance integration w/WE

(made possible by globalization)2. Large K-inflows Δ productivity & improved SOL & financed CA deficits

3. Appreciating real ERs improved SOL EE’s growth model to date meant that sources

of growth, productivity and competitiveness (1 + 2) were largely externally generated.

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June 2009June 2009Outlook for EE (cont’d)

This growth model is not sustainable: 1. Globalization will slow, so further rapid

integration (growing trade/GDP ratios) will be much more difficult.

2. Large K inflows are likely to slow, for the above reason and because wage rates have become more attractive in Asia & LA. And diminished K inflows will make it more difficult to continue to finance large CA deficits and thus excess C.

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June 2009June 2009

Dramatic Slowing of K-inflows to EE

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June 2009June 2009

Recommendation to Policymakers in EE

In the future, EE must rely more on internally-generated sources of productivity and competitiveness.

The list & cross-country measurement of practically all the important domestic factors of competitiveness are found in the annual Global Competitiveness Reports (World Economic Forum).

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June 2009June 2009Recommendation to USAID

In each target country, USAID should identify, in cooperation with the local authorities, select a few factors of competitiveness where the country lags and do what it can -- in partnership with the authorities and with the private sector -- to transform competitive disadvantage factors into new sources of productivity & comp. advantage.