Tag Archives: Politics

Are Hungary’s Unorthodox Economic Policies working?

In 2010, Hungary elected the Fidesz party and its leader Viktor Orban into power. Since then the government has implemented a range of unorthodox economic reforms which have drawn criticism from economists and financial analysts alike. However recent reports indicate that the Hungarian economy may have finally exited a year long period of negative growth. The Hungarian Central Statistics Office estimates that the gross domestic product of Hungary ‘increased by 0.5% in the second quarter of 2013 compared to the corresponding period of the previous year’.  In addition the budget deficit now sits at 1.9% of GDP, well under EU mandated target of 3%. This means that Hungary now displays one of the lowest deficits among the EU 27 and is free from the EU’s Excessive Deficit Procedure monitoring procedures.


Inflation has also dropped to a record low. The Hungarian Consumer Price Index now sits at the lowest level since Hungary’s transition to a market economy. In July it fell unexpectedly to a new low of 1.8% (year on year) compared to 1.9% in June.  When this drop is decomposed we can see that food prices declined by 1.4 percent from the previous month in July, whilst household energy costs fell by 0.4 percent.

Naturally the Fidesz government has claimed that its unorthodox policies are at the heart of this change. What I find interesting about such policies is that they could prove very popular in many European countries, such as my own, where there is a feeling that many banks ‘got let off the hook’.

Since coming to power Orban has introduced biggest tax in Europe on banks and financial companies and imposed large levies upon energy, retail and telecommunications companies. In addition Orban has announced plans to fix the exchange rate for loans taken by individuals in Swiss Francs. In particular, this attempt to lessen the debt burden for such individuals could lead to losses in the banking sector of up to 4.1 billion. In another popular move the government forced energy firms in January to slash their prices by 10% with the promise of another imposed 10% cut in October. Further unorthodox policies include interfering with central bank independence, nationalizing $14 billion in assets from private pensions and a steep 18% hike in the minimum wage.

However there are many who question whether such policies are sustainable in the long run.  Many economists are concerned that such policies will threaten foreign direct investment (FDI) into the country. The general argument is that the current regulatory unpredictability (i.e. high taxes on banks) may damage investor’s confidence and lead to large outflows of capital. This is significant because Hungary’s economy is heavily dependent upon foreign direct investment. For instance UNCTAD’s new inward FDI contribution index, which measures the importance of FDI to a country’s economy, ranks Hungary first among the 79 nations studied.

As discussed by the IMF, the large levies placed upon banks may place an additional drag upon growth. Hungary’s financial sector is heavily dependent upon foreign funding which is worth around €35–40 billion annually. To put this into perspective, foreign firms account for 90% and 70% of the insurance sector and investment banking sectors respectively. The deleveraging process now present in many financial institutions has meant that Hungary has experienced negative credit growth for the last several years and the IMF predicts this could further hinder economic growth.

In addition to this some economists are concerned that the new central bank chief Gyorgy Matolcsy (regarded as Orban’s ‘right hand man’) will opt for a plan of quantitative easing in order to stimulate the economy. This could be problematic because injecting money into the economy may increase imports and the debt burden whilst, at the same time, foreign capital is leaving the country. This could significantly affect Hungary’s ability to finance itself.

Despite these concerns there are still some positive signs for the economy. Germany, which accounts for 24.7% of Hungarian exports, has registered strong growth in the last quarter and now many expect the economy to return to a steady rate. The Hungarian economy will also receive a boost from the opening of a new Audi plant in Gyor which equates to €900 million in additional investment. Other investors have also expressed their desire to keep operating in the country despite regulatory pressures. In a recent interview with FDI Intelligience magazine,  Rhydian Pountney of the UK based engineering company Renishaw PLC stated that,

We are acutely aware of the political issues of the regime but we take the long view and we are not likely to be scared off by the ups and downs of politics,”

Could economists be wrong about the impending crash in FDI? Data from the OECD also suggests otherwise. According to preliminary estimates FDI inflows are now above pre-crisis levels at $13.5 billion. Conjointly the data shows that FDI outflows have also increased in 2012, to $10.6 billion – however this figure is still $2.9 billion below inflows.

Although I do not agree with many of the Fidesz party’s other policies, I believe it will be interesting to observe whether its economic policies will pay off in the long run. If so, it would be interesting to see how the economic community accounts for the success of a number of policies which have aimed to boost consumption at the expense of inward investment.

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We don’t make anything any more…..


One of the most common complaints which I hear working in a machinery retail outlet is that the UK doesn’t make anything any more. Looking around the store this is an easy argument to accept, indeed most of the machinery I sell including lathes, welders and circular saws all come with a ‘Made in China’ tag. Furthermore most of the media reverts to this constant rhetoric, I have seen numerous articles posted in the media over the years foretelling the final demise of the UK manufacturing sector. So what is happening? Are we in a perpetual decline where we no longer have the ability to make anything? Such statements could be no further from the truth.

To begin with here are some interesting facts from a 2009 Price Waterhouse Coopers report that might surprise you. Firstly as of 2009 the UK was the 6th largest manufacturer in world (Some more recent measures vary between 5th and 10th)this includes large global shares within individual markets – the UK holds a 15% global share in the Aerospace sector. Secondly, UK manufacturing output had reached an all time high just before the 2008 global crisis took hold. Lastly, UK manufacturing achieved a 50% increase in labour productivity over the period 1997-2007. Although struggling due to the global downturn in the recent years, the facts show that the UK manufacturing sector is far from dead.

It can be argued that this idea that the UK manufacturing sector is in terminal decline emanates from a number of relative not absolute comparisons. When the relative figures are observed one could be forgiven for believing the above statement. For instance the graph below shows how manufacturing has contributed less and less to the national economy in recent years relative to other sectors.


Service sector growth has far outpaced growth in the manufacturing sector in recent times. This has further led to a decline in the relative number of manufacturing jobs. In 1980 manufacturing accounted for 25% of all UK jobs, by 2008 this number had fallen to 10%. Combine these figures with the fact that the UK’s share of global manufacturing has dropped significantly in the last few decades and you are left with a national sense of pessimism regarding the manufacturing sector. Yet as the paper argues the UK has been punching well above its weight for the last century in terms of size and population. It is therefore inevitable that we are to be caught up or overtaken in relative terms by countries with more abundant natural resources and supplies of labour as the Solow growth model predicts (the theory of diminishing returns states that the introduction of one more unit of capital into a capital scarce country will lead to a greater increase in output than in a country which is in comparison capital rich).

Despite the relative decline of the manufacturing sector as a component of total GDP, it is a rather unheralded fact that UK productivity in the sector has grown by 48% over the period 1987-2007.  The gradual decline of manufacturing jobs is arguably attributable to such productivity increases and more broadly our natural progression to a knowledge economy. Better technologies and workplace practices have meant that we can now produce much more per individual worker. In an similar process which was seen in the agricultural revolution, these technologies and processes mean we require less manpower to produce the same amount of output compared to say, 1950. This fact should be celebrated, not frowned upon as it often is due to its impact upon jobs.

The manufacturing jobs of the future will not be based as much upon an assembly line but instead in the R & D departments where companies attempt to find a niche markets and thereby gain competitive advantages. This is where the knowledge economy comes in, although the UK is not gifted with large surpluses of labour as in China, it does retain a high level of human capital (the level of knowledge and know how an individual possesses) and this will be the driving force of growth in the long term as new innovations are made. So in this sense it is we should not be pessimistically stating we don’t make anything any more, we should be looking with optimism at what we will be making in the years to come.

Some additional facts of note.

  • The UK has the 3rd largest automotive industry in Europe.
  • The UK is home to the 2nd largest maker of aircraft engines in the world (Rolls-Royce).
  • The UK has the 3rd largest pharmaceutical company in the world (Glaxo-Smith Kline)
  • The UK has the 4th largest oil refining capacity in Europe.
  • The UK manufacturing sector attracted £30 billion of net foreign direct investment in 2010.

This is quite a short post as I have only just returned after from the Philippines after a 3 week trip to see my girlfriend. I have intentionally omitted some of the more crucial challenges that the sector faces to focus on what it has achieved contrary to popular belief. Furthermore it should be acknowledged that the transition to a knowledge economy requires a strong manufacturing base and the current economic crisis may threaten this.

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Thatcherism – Some hard truths


In recent news I have been particularly concerned by the vast outpouring of sentiment for Margaret Thatcher over the past day or so. The same rhetoric has been repeated over and over again such as, “She changed the world” and, “the greatest prime minister in modern peace time“. However the most astonishing comment has to be from a fellow named David Cameron who proclaimed, “She saved our country“.

Now I am against the need to follow the standard cultural etiquette of not speaking against someone just because they have passed away. Individuals, particularly influential individuals should be judged on their contribution whether dead or alive. The ability to do this however has non-surprisingly been attacked by many Tory affiliates, for instance former Tory MP Louise Mensch has tweeted, “Pygmies of the left so predictably embarrassing yourselves, know this: not a one of your leaders will ever be globally mourned like her”.

So lets look at the facts, in 1979 when she came to power the country was experiencing double digit inflation, many major industries were in decline and trade unions had brought the country to a standstill in instances such as the winter of discontent. However by a combination of sweeping changes such as privatization, deregulation, industrial relations reform, taxation and deflationary measures the country began to find its feet again. After an initial recession the end result was what has be termed an economic miracle. The graph below shows the change in both inflation and GDP since Thatcher was elected.


This is what David Cameron was referring to when he proclaimed Thatcher saved the nation, GDP growth averaged 3.09% in the 1980s compared to 2.07% in the 1970s. Meanwhile inflation was reduced significantly to single digit values. However all too often politicians, the media and economists focus on such indicators as a sign of development and prosperity. There is a large debate within economics whether GDP is indicator we should be targeting when considering development and well-being. For instance, economist Richard Easterlin discovered empirically that found differences in income across countries and time did not signify a change in levels of happiness and well being. However he found within countries levels of income did positively correspond with levels of happiness.  The findings which became known as the “Easterlin Paradox” led Easterlin to theorize that changes in income do not affect happiness and well-being, relative income is what really matters. In this sense individuals derive happiness from being more well off than their peers, human beings are therefore constantly trying to “Keep up with the Jones”.

In this sense it could be argued that income inequality would be a better indicator to judge Thatcher’s economic performance. During her time in power the UK’s gini coefficient, a measure of income inequality with 0 representing a situation of perfect equality and 100 a situation of perfect inequality, increased from 27.39 in 1979 to 30.54 in 1980. Now this may not seem a great amount but in comparison from 1963 to 1979 (the furthest back the data goes) income inequality had only increased from 26.3 to 27.39 despite surges in inflation.


Other measures of income inequality by the IFS estimate the rise in income inequality to be even higher (gini coefficients and inequality measurements are usually dependent on the method used and can vary considerably).


In the above graph we can see that the level of inequality increased by nearly 8 points from 25.3 in 1979 to 33.9 in 1990. In addition to this the level of poverty also increased substantially during Thatchers reign.


The graph above shows that the percentage of people living below 60% of the median income increased from 13.4% in 1979 to 22.2% by the end of her reign in 1990. The webpage from which these graphs came paints an even grimmer picture such as a rising gender pay gap and record unemployment.

Thatcher’s policies such as the deregulation of the financial markets; the weakening of the trade unions; income tax cuts and the adjustment of industrial policy have all been highlighted by a number of authors as contributing to a wider gap between rich and poor. Although her policies promoted economic growth, this growth was not inclusive and the majority of the benefits accrued to the top end of the income scale. Furthermore it could be argued that the her legacy of promoting the deregulation of financial markets started a inevitable slide towards the 2008 financial crisis.

The death of Margaret Thatcher therefore leaves us to look at how we judge economic performance and development. If economic growth is all that matters then Thatcher’s reign could be considered a relative success. However if we are more concerned with the wider benefits of such growth issues of income inequality should become more prioritized.  Unfortunately this seems to have bypassed our current leader who unquestioned claimed that Margaret Thatcher saved the country. The reality is however, that in the long term, Thatcher’s policies led to a sustained increase in income inequality, decreases in social cohesion and arguably an inevitable road to economic collapse.

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Combating Deflation – The Japanese Experience


The recent announcement by Japan’s new central bank governor Haruhiko Kuroda to engage in a new round of quantitative easing and combat deflation has been met with a rather positive response. This round will increase the monetary base by around 60 to 70 trillion yen a year. The monetary base will increase from the current 29 per cent of GDP to 55 per cent by the end of 2014,  but such a policy does not come without risks.

Firstly we must ask why deflation is such a problem. In the scheme of things a falling price level is good for everyone, right? Well unfortunately deflation can lead to a spiral of reduced demand, production and prices, known as an deflationary spiral. If prices are falling one might ask themselves, “why should I buy now when next week or even next year the price of the item will be lower?” This may lead consumers to withhold demand, lower demand in effect leads to lower prices and at lower prices businesses will be willing to produce less. This in turn leads to lower wages and again decreased demand and the process continues…

Policy makers further fear deflation because it typically renders traditional fiscal policy ineffective. To boost the aggregate demand and prices, central banks will lower nominal interest rates to stimulate investment and make saving less attractive. However if deflation is present the real rate of interest, that is the nominal rate minus the level of inflation, may become negative. This is because the central bank can only lower interest rates to a floor of 0% and not beyond. Doing so would mean that banks would be effectively paying borrowers to borrow from them. Consequently traditional methods of monetary policy become ineffective when interest rates reach 0% in the face of deflation.


Japan’s experience with deflation began in the 1990s after it the collapse of the real estate and stock asset bubble in 1990. During the 1980s the Japanese economy had been booming and this had led to a substantial increase in the amount of available credit. As a result assets such as stocks and real estate inflated well above their intrinsic values whilst banks continued to lend to investors. When the prices collapsed in 1990 triggered by the an interest rate hike, many banks were left with a large proportion of bad loans. The economic slump meant many firms could not repay their loans and furthermore the the banks could not retrieve the full value of their loans because the price of the collateral (real estate) had declined sharply. Instead of accepting these losses and liquidating these malinvestments the banks were propped up by the government in the hope that asset prices would recover. This in effect tied up essential economic resources and led to a marked decrease in domestic investment. This is the beginning of what most commentators have began to call the lost decade.

Since this crisis Japan has been marred by further crises which have hit aggregate demand and thus put deflationary pressure upon prices. Such crises include the Japanese financial crisis and Asian financial crisis in the latter half of the 1990s; the collapse of the US dot com bubble in the early 2000s and most recently the 2008 global financial crisis. All of which have damaged the Japanese financial system and its ability to provide capital.

In addition to this other factors have hurt demand whilst supply has increased. For instance, the rising cost of imports for many Japanese firms has meant that they have been forced to streamline operations and cut costs. This has meant many job losses despite increases in labour productivity. As the graph below shows, taken from Musha research, wages have fallen significant since 1990 despite increased productivity which goes strictly against micro economic theory.


Japanese firms have realised that they can cut investments in labour because productivity has increased. The result is an excess supply of labour which has driven down wages and ultimately consumption. The above factors have all contributed to the deflationary output gap, meaning aggregate supply is outpacing aggregate demand.

To deal with deflation the Japanese have resorted to a unconventional form of monetary policy named quantitative easing. Quantitative easing works through the central bank purchasing financial assets such as bonds, in an effort to increase the reserves of the banks and hence the money supply. The main difference from traditional open market operations is that the purchases made are long-term rather than short-term bonds and that it has a money supply target rather than an interest rate target in mind.

The Japanese government’s goal here is to stimulate investment and spending in the economy. Furthermore it hopes by increasing the money supply the value of the Yen will decrease thus making Japanese exports more competitive. However as noted earlier the policy has risks both for Japan and the wider global economy.

Firstly if the inflation generated by quantitative easing rises more steeply than wages this could reduce both Japanese living standards and consumption. Devaluing the currency by increasing the money supply could push up the price of Japan’s principle imports – oil and gas. As a result the cost of heating, transportation and lighting would increase thus damaging consumption of other goods. In the worst case scenario the policy of quantitative might  lead to higher than expected inflation or even hyperinflation if too much money is created. Furthermore there little is known about how to stop the process once it does begin to work.

Secondly the such inflationary pressure could increase potentially lead to an increase in interest rates. If this were to happen the cost of servicing Japanese debt could increase considerably making the fiscal position unsustainable. This is extremely relevant for an economy such as Japan with gross national debt sitting at 229.773% of GDP .

However on a more fundamental and global level the policy could lead to a race to the bottom or currency war as other countries rush to devalue their currencies. Japan has now joined both the US and UK in delivering such a policy and other members of the international community have already begun to expressed their concern. Currency wars as seen from history lead to no winners as such crises cause uncertainty and therefore reduce international trade.

In conclusion, it seems that this policy is a short-medium term remedy for Japan’s longer term problems. The country must look at the structural causes of it’s economic stagnation, for instance the “demographic time bomb”, policy mismanagement and issues of accountability and transparency. Japanese business is renown for investing in long term solutions perhaps its time the government took the same approach.


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Facing the resource curse: The Challenge for Burma


Burma is a country with vast reserves of natural resources. It’s territory includes substantial reserves of natural gas, oil and minerals. Despite this Burma remains one of the poorest countries in the world. However the establishment of democracy within the country has now meant many international sanctions have been lifted and the country is now open for business. Dependence on resource wealth however may limit Burma’s progress towards development.

The resource curse, coined by the economist Richard Auty in 1993, describes the observation that resource dependent countries tend to under perform on a number of development indicators compared to their resource poor counterparts. For instance GNP per capita decreased by 1.3% per year in the OPEC countries during the period 1965-98 compared with a 2.2% average per capita growth in all lower to middle income countries.

Burma has already contracted one of the symptoms of the resource curse – the Dutch Disease. The disease describes how the increases in wealth brought about by a resource boom may cause an appreciation in the real exchange rate in turn decreasing the competitiveness of other exports such as manufactured goods. Burma presents a clear example of this, natural resources have helped drive up the value of the country’s currency, the kyat, from over 1400 to the U.S. dollar in 2007 to less than 700 in 2011.

In addition to this much of the valuable land and resources are controlled by the military and political elite. Although Burma has established democracy, there is a significant lack of transparency regarding resource earnings and how they are spent. The government does not report annual figures regarding resource revenues and foreign oil companies do not publish how much and how they pay the established military regime. The military still operates firmly outside the law in Burma, the constitution means that the one quarter of all government seats are reserved for members of the army. As a result levels of corruption are particularly high in Burma. Transparency International’s Corruption Perceptions Index (CPI) ranked Burma 172nd out 174 countries, showing the perceived extent of the problem.

This poor institutional and economic environment means that upcoming expansions in the oil and gas industry could further hamper development and fuel corruption. With many western countries lifting economic sanctions upon Burma, the increased levels of trade could further drive up the value of kyat prolonging the effects of the dutch disease. In addition the characteristics of such industries mean that they typically provide few benefits for the wider population. Oil and gas extraction tends to be highly capital intensive employing a small number of workers and concentrate wealth in the hands of the few.

On a broader scale such industries can decrease the need for high quality education. Notable economist Thorvaldur Gylfason argues that resource rich countries tend to neglect education because resource extraction is primarily low skilled. This can have a knock on effect for the development of more labour intensive industries such as manufacturing which require higher levels of education. Furthermore a recent article in the guardian reports that many families are now buying plots of land in oil rich regions with the hope of striking lucky. This has meant that many children now find themselves working in oil fields with obvious consequences for their education and health.

company-worker-working-on-connet-pipeline-at-the-construction-site-outside-of-kyaukmaeThe construction of the new Shwe gas pipeline to China is expected to earn Burma $29 billion over the next 30 years.

Although such abundance of resources should be a blessing for Burma in the long run it could be a substantial burden. The country lacks the institutional framework and regulation to successful reinvest the earnings of such industries into development. Its inefficient tax regime means little of the wealth generated by the resources ends up in the hands of the poor. On the other hand the high levels of corruption and state control mean such wealth is destined to end up in the hands of the influential few.

Burma could learn a lot from the case of  Botswana which is one of the few countries that has beaten the resource curse. This success has been directly attributed to its good governance and the integrity of its public institutions. The country has good levels of democratic accountability, an independent judicial system and a free media. All of which have contributed to Botswana exhibiting low levels of corruption – the country ranks 30th on Transparency International’s CPI outperforming even some western countries such as Spain.

Despite signing up to the Extractive Industries Transparency Initiative, Burma still has a long way to go. There is a strong need for the development of a robust institutional and legal framework to help utilize resource wealth for poverty reduction. Until this is established the opening of trade and construction of more gas pipelines could further hamper efforts towards such development goals.

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