Balance of Payments .

1. Balance ofPayments. The situation of transition countries

2. Balance of payments. – Global imbalances Today‘stopics Dipl.- Kfm. Thomas Stiegler, University of Göttingen.

3. Balance of payments in transition countries Going a step back. – situation in emergingmarkets End of the last lecture: in the middle term current account should be balanced We were talking about countries like the US, France and German. These are highly developed industry countries The transformation process from socialistic plan economies to market economies and the thereby caused growth process causes some adjustments in the theory. However the long- run aim remains a balanced current account. Dipl.- Kfm. Thomas Stiegler, University of Göttingen.

4. Balance of payments in transition countries Supplyandmoney in socialism. Supply with goods during the socialist times was not sufficient in most countries (CSSR, GDR reached acceptable levels for many fields) As people couldn’t buy all goods desired, they were forced to save money, although they didn’t desire it. some scientists doubt that “money” in socialism was money in the closer definition of economists. (means of exchange didn’t work properly, as it wasn’t accepted everywhere; means of storage of value didn’t work, as couldn’t use saved money to buy goods) Dipl.- Kfm. Thomas Stiegler, University of Göttingen.

5. Balance of payments in transition countries Attheturningpointtowardstransition When transformation started this discussion looses importance, by transferring currencies into convertible currency, they suddenly fulfill the means of money. The unwanted savings are now available for demand for goods However the productivity of the given countries didn’t increase yet Dipl.- Kfm. Thomas Stiegler, University of Göttingen.

6. Balance of payments in transition countries Savingrates in selectedformersocialisticstates Source: www.worlbank.org Dipl.- Kfm. Thomas Stiegler, University of Göttingen.

7. Balance of payments in transition countries Analysis ofthedata (1) having at a look at the data we can see them reflecting different facts: Poland and Russia (USSR) with bad supply situation have high (unwanted) savings The shift of start of transformation between Poland (first half 1989) and Russia (beginning 1992) is visible in the shift of the breakdown of savings Dipl.- Kfm. Thomas Stiegler, University of Göttingen.

8. Balance of payments in transition countries Analysis of the data (2) Inflation plays a role in savings (trivial). Poland (early 90s, stabilized in 1993) and Russia (mid of 90s stabilized in 1996) show extraordinary high inflation rates, therefore the saving brakes down and the saved “socialist” money lost . CSSR as said before had relatively good supply and thus not such a high price driving excess demand. Inflation raise moderate, saving rate went down, but not overshot and ended up with a standard rate. Dipl.- Kfm. Thomas Stiegler, University of Göttingen.

9. Balance of payments in transition countries Life cyclemodelling In the following a model for economic development of transition economies will be shown The model orientates on the Life cycle Analysis first developed by Franco Modigliani Life cycle analysis is used on two stages: To analyze the economy as a whole and to analyze behavior of people taking into concern the demographic situation which is unusual for emerging markets Dipl.- Kfm. Thomas Stiegler, University of Göttingen.

10. Balance of payments in transition countries The youth The first years of a child are not productive. Consummation is far above earnings. Money can be invested in education or in Consummation. As said before productivity after the collapse: low Forced savings disappear, people buy things they couldn’t Decision: Investment or Consummation Dipl.- Kfm. Thomas Stiegler, University of Göttingen.

11. Balance of payments in transition countries Expecteddevelopment – a rational approach Products are not competitive; investments into production facilities are necessary As there is no capital available, capital inflow from abroad is necessary. However this foreign investment should not be as short run credit, but as long term FDI with positive spill over effects Technology and know how should be adapted. Dipl.- Kfm. Thomas Stiegler, University of Göttingen.

12. Balance of payments in transition countries Expected development – a rational approach (2) The demand for consume increases, as products are now available. Lost consummation is caught up. As of the low given economic level high growth is expected. According to intertemporal consummation smoothing future income is spent . Meaning: Investment is increasing, savings are decreasing  S = I + CA then leads to CA deficits Dipl.- Kfm. Thomas Stiegler, University of Göttingen.

13. Balance of payments in transition countries Howoneshouldact… (childhood) to insist on balanced Current Account / Capital Account would thus be a dangerous way, avoiding the needed impulse for economic development. However important points are: using long term productive capital inflows, enabling spill overs using experience of foreign firms in effective market behavior through FDI: exporting the risk of failing abroad (credit: loss is domestic!) not increasing gross foreign debt. (FDI don’t increase debt) Dipl.- Kfm. Thomas Stiegler, University of Göttingen.

14. Balance of payments in transition countries Dangersofthedevelopment often: fixed exchange rates; in times of high interest rates a strong capital inflow will appear. As market mechanisms and potential are still limited danger of misallocation. To positive future expectations. Consummation as of intertemporal smoothing grows to strong.  non sustainable CA; loss of trust and capital inflow Dipl.- Kfm. Thomas Stiegler, University of Göttingen.

15. Balance of payments in transition countries The young adult. after finishing the education, the young adult starts to be productive the demand for goods is not increasing though. The higher income now is used to pay for the credits. A shift from short run spending (consummation) to longer run investments (flat, house, interior) can be observed Dipl.- Kfm. Thomas Stiegler, University of Göttingen.

16. Balance of payments in transition countries Expecteddevelopment – improvingoftradebalance Through the FDI driven modernization of the economy it got more compatible. As product quality improved, exports are starting to grow. formerly imported half and market products can be substituted by local production  These three points lead to an improving Current Account. Dipl.- Kfm. Thomas Stiegler, University of Göttingen.

17. Balance of payments in transition countries Expected development – worsening of factor incomes the balance of factor incomes is worsening:  in the former years an inflow of capital took place. • FDI firms start to work profitable: Outflows of the gains • The credits taken have to be served: interest payments Aim of economic policy should be to keep the re-investment rate high New situation: still deficits in Current Account, but not mainly driven by trade anymore but by factor incomes Dipl.- Kfm. Thomas Stiegler, University of Göttingen.

18. Balance of payments in transition countries Dangers in thisstage The production development is only concentrated on the domestic demand. Then the exports will not increase, but the CA will worsen, as factor incomes worsen and trade keeps its level if the re-investment level is low, the balance of factor incomes gets strongly negative. This would also be a warning signal: the domestic economy is not attractive enough to invest in. Dipl.- Kfm. Thomas Stiegler, University of Göttingen.

19. Balance of payments in transition countries The adult. live is settled. All bigger investments for live are done (house, flat etc.). They just need to be kept. Credits are paid off, however investments for the old ages are now built. the last point means: we are not taking money from anyone anymore but lending it! Dipl.- Kfm. Thomas Stiegler, University of Göttingen.

20. Balance of payments in transition countries Expecteddevelopment The economy reached the level of an industrial country in means of productivity, competitiveness and technology As the catching-up process comes to an end, the level of investment declines (from an extraordinary high) to a normal level This means the re-investment ratio of the FDI declines, leading to a worse balance of factor incomes Dipl.- Kfm. Thomas Stiegler, University of Göttingen.

21. Balance of payments in transition countries Expecteddevelopment (2). The domestic returns on investment are not necessary any more in whole to cover the demand on investment. Capital can be exported At this turning point the capital balance and thus the current account should be balanced Taking the point above, the development of surpluses in trade should strengthen as balance of factor incomes worsen Dipl.- Kfm. Thomas Stiegler, University of Göttingen.

22. Balance of payments in transition countries Dangers in thisstage. Exports are to weak. The CA can not be balanced and an persistent deficit occurs. If to big shares of the production are going out as exports and the economy doesn’t serve the domestic demand to a bigger extend, the accounts can be balanced, but there is no growth in the domestic wealth. (Chinese disease) Dipl.- Kfm. Thomas Stiegler, University of Göttingen.

23. Balance of payments in transition countries The settled adult Live is balanced in financial respects. There are times to save more money, time to spend more money (for example saving for and buying a new car) The standard of living should be kept at the same level on average. In the professional live, the leading positions are reached, others can be instructed, knowledge is given to the younger Dipl.- Kfm. Thomas Stiegler, University of Göttingen.

24. Balance of payments in transition countries Expecteddevelopment There are times of capital exporting (= saving surplus) and times when, consumers use savings for consummation (CA deficits; capital importing) Over the time the periods of surpluses and deficits are balanced, so that there is no structural debt or crediting Technological standards reach highest means. Know how can be exported with high roi rates. Dipl.- Kfm. Thomas Stiegler, University of Göttingen.

25. Balance of payments in transition countries Dangers in thisstage People are used to fast growing of there wealth level. The intertemporal consummation smoothing is not working properly: higher than realistic income growth is expected; spendings are to high; structural CA deficits. (case: USA) high specialization in high tech export goods connected with a weak domestic demand lead to structural surpluses, not paying back the wealth to its creators (people in the country) (cases: Germany, Japan) Dipl.- Kfm. Thomas Stiegler, University of Göttingen.

26. Balance of payments in transition countries Summary To expect a balanced current account of growing economies would be misleading, as it would hinder their growth To allow deficits helps in economical development, as inflow of knowhow, building up a domestic markets, giving the chance for consummation are important There are several dangers of non sustainable development at the different stages, which have to be observed carefully to reach the wanted aim of development Dipl.- Kfm. Thomas Stiegler, University of Göttingen.

27. Balance of payments in transition countries Is Russia a goodexampleof such a TE? NO! …. But why? Russia’s data of the current account is “polluted” by the income of raw materials (oil, gas, gold etc.) As of missing pressure to allocate capital efficient (no absence of capital), the adjustment mechanisms don’t work “Politic of economic strength”; Russia is very closed to foreign capital and investments, hindering the mechanisms to work Dipl.- Kfm. Thomas Stiegler, University of Göttingen.

28. Balance of payments in transition countries The Russiancurrentaccount Dipl.- Kfm. Thomas Stiegler, University of Göttingen.

29. Balance of payments in transition countries The Russiancurrentaccount Source: www.gks.ru (Росстат); author‘s calculations Dipl.- Kfm. Thomas Stiegler, University of Göttingen.

30. Balance of payments in transition countries tryingtoadjustthecurrentaccountdevelopment In million US Dolkars Source: www.gks.ru (Росстат) author’s calculations Dipl.- Kfm. Thomas Stiegler, University of Göttingen.

31. Balance of payments in transition countries Paradox: balanceoffactorincomes In million US Dolkars Source: www.gks.ru (Росстат) author’s calculations Dipl.- Kfm. Thomas Stiegler, University of Göttingen.

32. Balance of payments in transition countries interpretation The Russian economy is monofocused on raw materials like oil, gas, metals. Through exporting these high current account surpluses are realized The share of raw material in exports is rather growing then becoming smaller: this means the importance of classical technical export industries (machinery, cars, other technological products) is not growing Dipl.- Kfm. Thomas Stiegler, University of Göttingen.

33. Balance of payments in transition countries interpretation (2) Yesterday we saw the paradox of the USA, having a positive balance of factor income although persistent CA deficits. Russia shows the evidence vice versa! Russian foreign investments are ineffective. High currency reserves of the central bank are invested conservatively. Russian econonomy often invests in prestige objects, „to be seen“, however, the investments are often not profitable (example: Gazprom pays 200 million Euros just to be main sponsor of a German football team (Schalke 04)) conclusion: russian economy is not up to date. If foreign firms can reach high returns on investment in Russia, we can conclude, that the stage of economy is lower Dipl.- Kfm. Thomas Stiegler, University of Göttingen.

34. Balance of payments in transition countries conclusion There is many evidence from Eastern Europe showing, that the model developed is working. It gives good rules of judgement how far a transformation country already developed Applied to Russia we can get only some results by trying to eliminate the consequences of vast raw material exports As result we see, that Russia seems to be stuck then in the 2nd stage as of its structural deficit in the Current Account Dipl.- Kfm. Thomas Stiegler, University of Göttingen.