Regional impact of the crisis: Political economy, governance dimensions

1. Regional impact of the crisis: Political economy, governance dimensions Ben Slay Senior economist UNDP Bureau for Europe and CIS 6 July 2010

2. Main points • Macroeconomic impact of the crisis • First phase over . . . • . . . Second phase now starting? • Threat of European “double-dip” recession • Less fiscal space—pressure on social sector • Which countries are most at risk? • Regional impact of crisis: • Political economy dimensions • Governance dimensions (“six myths”)

3. Macroeconomic impact of the crisis • First phase over • Global economy recovering . . . • . . . Thanks to significant policy stimulus • Much fiscal space used in 2008-2009 • Greek crisis: Threat of European “double-dip” recession? • Less favourable public debt dynamics • In EU-15: “PIIGS” • In our region: Hungary • Regional recovery: Very uneven

4. Who’s the worst hit region? We are . . . Regional GDP growth trends (I) Source: IMF World Economic Outlook, April 2010

5. Regional growth trends: Another perspective Source: IMF World Economic Outlook, April 2010

6. Which economies got hit worst in 2009? Source: IMF World Economic Outlook, April 2010

7. Is the recovery happening? In much of the world—Yes Growth relative to previous quarter. Source: JPMorgan, June 2010.

8. But not in Europe . . . Growth relative to previous quarter. Source: JPMorgan, June 2010.

9. “PIIGS” and friends: Bank bailouts boost public debts Gross public debt as share of GDP. Eurostat data.

10. “PIIGS”: Key risks for “neighbourhood” • Trade—slow euro zone growth means: • Slow export growth in “wider neighbourhood” • More pressure on external balances • Capital markets: • Slow growing “wider neighbourhood”—less attractive than other emerging markets • Results: • Weaker currencies • Higher interest rates, less long-term borrowing • Less consumption, investment

11. But: Public debts don’t explain everything Sources: IMF, EIU, Eurostat.

12. National crisis responses: Political economy issues • Policy weaknesses: • Recognition lags • Implementation lags • Uncertain implementation capacity • Philosophical issue: Whom to protect? • Key sectors, firms/banks? • Middle class? • Most vulnerable? • Instruments: Transfers or public works?

13. Policy weaknesses: Causes, implications • Recognition lags: • Economics: Different points of business cycle • Technical issue: Forecasts have been too optimistic • Politics: Electoral cycles, other factors • Implementation lags: • Exchange rate policy: • Devaluation can work fastest . . . • . . . But is not an option for many non-CIS countries • Monetary policy effectiveness limited by: • Fixed exchange rates/euro adoption • Deleveraging, dollarisation, demonetisation • Fiscal policy: How much fiscal space?

14. Political economy of response: Country drivers • Political drivers: • Parliamentary democracies: Electoral cycle • CIS countries: • Can political leadership admit there’s a “crisis”? • Do they even know? • Economics—Different countries: • Are at different points in business cycle • Have more or less fiscal space • Are affected differently by markets’ risk appetite: • Collapsed in mid-2008 • Recovered in 2009:H2 • Weakened in 2010:Q2 with Greek crisis

15. Uncertain implementation capacity: Social safety nets Source: World Bank. Social insurance (e.g., pensions) not included

16. Social policy reform implications

17. Governance and the crisis: Myths and realities (I) • Myth I: Quality of governance and market reform are correlated with extent of crisis • Reality: No clear relationship, positive or negative • Economies that did well in 2009: • Were resource exporters . . . • . . . With fiscal reserves from previous years . . . • . . . That attracted FDI • Myth II: Exporting primary products minimizes effects of crisis • Reality: Not necessarily—Russia, Ukraine are also exporters of primary products

18. Governance and the crisis: Myths and realities (II) • Myth III: Devaluations are good • Reality: Successful devaluations with relatively small tradable sectors (Poland, Turkey, Central Asia) • For other countries—devaluation risks: • Significant pass-through inflation • Balance-sheet mismatches  financial crash • “Beggar-thy-neighbour” competitive devaluations • Myth IV: The crisis was exported to the region by foreign banks • Reality: Region’s banks didn’t acquire “toxic assets” • Instead: Foreign parent banks—and taxpayers—have bailed out local banks across region

19. Governance and the crisis: Myths and realities (III) • Myth V: ECB’s emphasis on price stability (over growth)  EU must rely on fiscal policy • Reality: EU is torn between “constitutional” SGP and fiscal discretion (pragmatic use of “fiscal space”) • Myth VI: Greek crisis—calamity for Europe • Reality—Greek crisis is helping solve some of Europe’s problems: • Euro too strong, exports not competitive? • Greece  Weaker Euro • Absence of integrated fiscal framework, to support monetary union? • Greece  European Stabilization Mechanism

20. Thank you very much! I don’t claim to have the answers . . . . . . But I hope I’m asking the right questions Ben.Slay@undp.org