Let’s think now about some of the lessons from the global economic crisis for Europe’s policymakers. In my previous five blogs, I’ve discussed the challenges faced by both advanced and emerging European economies as we emerge from the acute phase of the crisis. The questions I attempted to answer have included: In what shape and form will European integration survive the crisis? Will eastern Europe be able to sustain its remarkable catching up with living standards in western Europe?
For my final blog in this series on iMFdirect, I have decided to add a personal touch and draw on my experience as a former policymaker. So while this article builds on the previous five posts, it goes beyond them and includes some highly subjective comments on what lessons I believe the reformers in eastern Europe should take away from the crisis. And, although my primary focus is on countries outside the eurozone, it is clear that the eurozone will need to address long-term challenges, as I pointed out in my post After the Crisis, Much Still at Stake for Eurozone.
Transition has been an undisputed success
The transition from central planning to market-based economies remains an undisputed success. Despite the crisis, a market-based economy remains “the only game in town,” and nobody speaks of centrally planned socialism as a viable alternative. Moreover, the social fiber in the emerging market economies looks robust. For now at least, there is no serious social unrest in sight.
European integration has served the countries in eastern Europe well. In the run-up to membership of the European Union (EU), institutions were strengthened, and new members were granted access to the EU’s single market. During the global economic crisis, structural funds from the EU provided a healthy addition to the flow of investment, and those countries that were hit the hardest were able to access the EU balance of payments facility. However, the EU “halo” —whereby emerging markets were shielded, by virtue of their EU membership, from paying more to borrow external funds—is now gone. Today, what you do yourself in terms of policies matters more.
So what are the big takeaways for policymakers from the crisis?
Good policies and strong institutions matter. Countries with unsustainable fiscal policies and weak institutions were the first to fall and they also had less space to react to the crisis with fiscal stimulus. But good policies go beyond fiscal and monetary responses. They must extend to bank regulation and supervision, and more generally to the quality of public institutions.
Two examples spring immediately to mind. Estonia’s strong institutions and political determination made it possible for the country to keep its budget deficit under 3 percent of GDP during a time of extreme decline in economic activity. Romania’s independent and well-managed central bank helped the country survive a potential liquidity crisis during the recent presidential campaign.
Good fiscal policies start in good times. If you think growth and prosperity is for relaxing and enjoying, rather than to save for a rainy day, you can forget about fiscal stimulus when it’s needed or even allowing automatic stabilizers to do their job during a recession.
And fiscal stabilizers are back in fashion! In the past, in eastern Europe, a crisis used to be automatically associated with expenditure cuts. Now, we are Keynesians again—the message comes from the West, and from some countries in the East, notably the Czech Republic and Poland, which were able to afford fiscal stimulus.
Remember to keep an eye on expenditures. Even if the budget looks great in boom times, in a bust tax revenues fall and leave you dangerously exposed. Also, you cannot have a tax system that resembles that of Hong Kong if you also want social services on par with those of Scandinavia.
Capital inflows are great, but some are better than others. Those that increase your output potential deserve support, but those that just stimulate demand have to be watched carefully. Trying to curtail unwanted capital flows, for instance through prudential regulations, may in some cases be necessary to ensure financial stability. Capital controls, at least in certain situations, should not be ruled out.
Selling domestic banks to foreigners (highly controversial in some emerging markets) turned out to be a rather good idea. Foreign-owned banks helped to rapidly create a modern and efficient financial sector in the region. They also came with a long-term investment horizon and in the current crisis have shown a willingness to maintain their exposure.
Market and competitive pressure due to opening of banking markets also helped strengthen domestically-owned banks. For example, Poland’s PKO BP and Russia’s Sberbank, both domestically owned, weathered the crisis remarkably well. But other domestically-owned banks such as Parex in Latvia and OTP in Hungary, ran into trouble (even if it was the country risk that did most of the damage for OTP). What really matters is whether banks have a sustainable business model, one that is not dependent on short-term wholesale funding.
Self-regulation of the private sector has its limits. The ultimate responsibility for a country’s economy rests with the state. Bailout is the catchword of the day, as emerging market reformers in Europe look to their former role models in the United Kingdom, the United States, and elsewhere. This does not imply a return to an omnipotent “socialist” state with infamous quantitative targets and public ownership. But it does imply that if things go really wrong, the taxpayer may be forced to foot the bill.
Pragmatism, pragmatism, pragmatism. Many (maybe naive) policymakers in the East must feel almost betrayed by the ease with which the rules of market discipline have been abandoned in the West to avoid social unrest and preserve political stability. We have to provide much more refined policy messages to emerging economies. As these economies advance, so does the sophistication of their policymakers.
In times of need, you can count on the IMF. The Fund has listened, learned, and adapted. It is not a bad cop, but rather a doctor. A visit to our clinic may not the most pleasant experience, but for how long can you go on simply with painkillers? And the IMF has become better at understanding its patients’ many different needs. After all, everybody is learning.
