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Emerging Markets

Crisis of confidence

The debate over the future of capitalism may have become fashionable in the west. But for emerging economies, there’s a lot more at stake

Lately, questions about the future of capitalism have become commonplace, almost fashionable, in western capitals. Amid the rubble of global finance in New York and London, a bout of soul-searching has taken hold – equally among bankers and policy-makers as among shopkeepers and talk-show hosts.

Yet in the emerging economies at the fringes of global capitalism, there are surprisingly few calls – at least in the mainstream policy debate – for rolling back markets.

“In the emerging markets, there has been no such existential angst about capitalism, no serious questioning of the role of the market,” writes Arvind Subramanian, senior fellow at the Peterson Institute for International Economics, in a recent paper.

The question Subramanian poses is why the global financial crisis spawned a debate on capitalism in the advanced countries, but not in developing nations; the global financial crisis “may have exposed the claim of a decoupled world economy, but it seems to have emphasised the decoupling in policy debate and long-term policy choices.”

Most surprising, he claims, is the fact that “there has not even been a pitch to restrict inflows of fickle foreign capital that were arguably at the centre of this crisis for many emerging markets.”

He argues that the most important reason for the “decoupled debate phenomenon” is that the big development challenge in the developing world is not the state-market boundary but “the more mundane yet fiendishly difficult question of how to improve the state and its basic capacity to deliver law and order, security and other essential services such as health, water, sanitation and education. “That was so before the crisis. That will remain true in its aftermath,” he says.

This is as true of Asia as it is of central and eastern Europe, says Marek Belka, director of the IMF’s European department and a former Polish prime minister. Belka suggests that policy-makers across the former eastern bloc remain more devoted capitalists than their western counterparts.

“Our interlocutors in the region have in most cases displayed deeper allegiance to the market economy than we would expect, or than people in the west,” he tells Emerging Markets.

Belka’s claim is that the global financial crisis has so far failed to undermine the impetus in central and eastern Europe towards market-led reforms. “Nobody in this region at least is seriously talking about dropping market economy, however imperfect it is.”

Although he admits that “we do not have full clarity of what political and social consequences the crisis ultimately will exert on the world and on this region,” Belka says that the “free market, or the market economy to be more precise, is the only game in town. Nobody is talking socialism in this region.”

Belka suggests that few now seriously dispute that macroeconomic stability, openness to trade, strong institutions and liberalised prices are necessary conditions for a successful shift from planned to market economies. But almost two decades since the fall of the Berlin Wall gave way to one of the most important economic revolutions of the past century, alarm is growing over the extent to which the process for central and eastern Europe and the former Soviet Union has fallen short of what backers of the market economy initially envisaged.

The fear is less about a return to socialism; rather, it’s that the biggest casualty of the financial crisis could be the belief of many common people that the transition from communism was bound to lead to a secure, happy and prosperous future.

Human crisis

Concerns about well-being are far from frivolous. According to the World Bank, eastern Europe and the former Soviet Union are in the grip of a human catastrophe. After a decade of strong growth and poverty reduction, the bank says the economic and financial crisis is likely to push almost 35 million people across the region back into poverty – a third of the people that had escaped from it over the last ten years.

The bank expects that the number of poor and vulnerable people in the region will rise by 5 million for every 1% decline in GDP – which suggests, according to Bank economists, that by the end of 2009 almost 25 million more people will be poor and vulnerable, and by the end of 2010 a further 10 million.

Of the region’s 480 million people, 192 million are considered poor or vulnerable by the Bank, and nearly 90 million have moved out of poverty and vulnerability since 1999.

Shigeo Katsu, World Bank Vice President for the Europe and Central Asia Region, said last month in Washington: “Within 10 months of the crisis, countries have started to lose the poverty gains made over the last 10 years. By end-2010, we may unfortunately see 35 million more people fall back into the poverty and vulnerability trap.”

He added: “This is a human crisis that is going largely unnoticed in the talk of the ‘global financial and economic crisis’.”

The World Bank notes that the effects of the crisis are being felt through three key transmission mechanisms: financial, product, and labour markets.

In the financial sector, large current account debtors face immense rollover risks and volatility in foreign exchange markets has also led to uncertainty. At the same time, industrial output has plummeted, and the bank points out that some countries are now experiencing double-digit declines compared to a year ago.

Meanwhile unemployment is sharply up with unprecedented job losses in some countries and others poised for double-digit joblessness in the near future. For countries that rely on remittances –in particular Albania, Moldova and Tajikistan – the consequences could be dire: current simulations for Tajikistan suggest that an anticipated 30% decline in remittances could result in a 5% rise in the number of people living in poverty.

Mortality concerns

The transition from communism to capitalism across the region has had devastating human consequences since the collapse of the Soviet Union – effects which still persist today. UNICEF attributes more than 3 million premature deaths to transition; the UN Development Programme estimates over 10 million “missing men”; and almost two decades since the start of the transition, only slightly over half of the ex-communist countries have regained their pre-transition life expectancy levels.

In January the Lancet, a medical journal, published the first ever study that empirically assesses the role of transition policies on increased mortality rates in post-communist countries. It finds a correlation between mass privatisations and higher death rates in transition countries.

The researchers showed that four or five of the worst countries in terms of life expectancy had implemented mass privatisation while only one of the five best performers had done so. They concluded that the mass privatisation and the “shock therapy” policies that encouraged it, ranked alongside the other causes of extra deaths such as “acute psychosocial stress”, reduced access to good medical care, rising social inequalities, social disorganisation and increased corruption.

And the region still faces overwhelming demographic challenges. The UNDP published a report this month claiming that Russia’s population may shrink by an additional 11 million people in the next 15 years, threatening its economic productivity.

Poor management

Columbia University economist and Nobel laureate Joseph Stiglitz has long maintained that flawed policies and poor management are to blame for the region’s ills – even before the global financial crisis took its toll. “We didn’t manage the transition very well,” he tells Emerging Markets in an interview.

But he says that the assumptions underlying financial globalization must now be reassessed, in light of the devastating blow to the global financial system. “Some rethinking now is surely a good thing. We pushed certain things like capital market liberalisation too far. The kind of financial market integration we had brought risk without reward and in the balance of risk and reward many people would say we got it wrong.”

“We’ve now let loose a lot of bubbles around the region,” he says. “The hope will be that they learn the lesson and they’ll move towards a more balanced market economy after the extremes.”

But former EBRD chief economist and LSE professor Willem Buiter argues that today’s financial crisis does not represent a “transition issue” – at least not for central and eastern Europe. For the more developed parts of the region, he believes today’s economic and financial turmoil represent “mature country problems”.

“It is not a legacy of central planning that is causing them pain. It is the result of their being small countries with big crises who have experienced a classic boom and bust cycle which combined with a global economic recession that is the biggest since the 1930s.”

“[Central and eastern Europe] suffered from inadequate regulation and supervision. But so did the US and the UK.” He notes, however, that transition has gone horribly askew further east, most acutely in the Commonwealth of Independent States (CIS). The region has seen the spread of corrupt, crony and clan capitalism and authoritarianism to various degrees, he says. And the trouble is that the countries most in need of deeper reforms, more growth and better public services tend also to have weakest institutions and so are most susceptible to corruption, Buiter adds.

The challenge posed by increasing corruption, lawlessness and mounting state control across the CIS is perhaps most profound for the EBRD, especially since the bank is specifically charged with promoting democracy, thereby placing it in direct conflict with some of its countries of operation.

The multilateral bank in recent years had stated to shift its focus eastwards as its operations, particularly in western Europe, appeared to be winding down; the eight countries which joined the EU in 2004 – Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Slovakia and Slovenia – were due to stop receiving EBRD funds in 2010, while the Czech Republic graduated early.

But the current crisis could change everything. EBRD president Thomas Mirow said recently that countries of central Europe now “have other concerns than the one of when they will graduate. Let’s cope with the crisis, let’s look at what the crisis has done to these countries and how the recovery looks and then we will discuss when and how [they will graduate].”

No cause for alarm?

Herbert Stepic, chief executive of Raiffeisen International acknowledges that the recent economic crisis had heightened fears of social and political upheaval – not only among the region’s fragile governments but also within the banking elite.

“There was a worry that the process of transformation was suddenly interrupted and that would have meant social uproar in these countries: huge unemployment, crumbling growth and so on,” says Stepic.

In particular, he says that concerns over western Europe’s support for its eastern neighbours was a central component of the bigger fear that transition could be thrown into reverse.

The political consequences of letting eastern Europe go would have been profound, he says. One of Europe’s greatest achievements in the past two decades was peacefully to reunify the continent after the end of the Soviet empire. But if the people of eastern Europe felt they had been cut loose by the west, they could easily fall prey to populists or nationalists in a manner not unknown in European history.

“That would have meant strong social pressure on these young democracies. So we would have created again more or less visibly again a Europe of two dimensions or a Europe of two classes. That was an enormous risk,” Stepic says.

But that worry, he says, has largely receded, in part to what he believes are renewed commitments from western European authorities to stabilize their eastern neighbours’ economies. “That was very much at risk, but now things changed,” Stepic says.

Stiglitz agrees that the fundamental drivers of transition have not been destroyed by today’s crisis. “The market economy is clearly better than what [the region] had before. I wouldn’t say that we’re really at risk of [economic globalization] unwinding,” he says.

But he warns that the process of transition may nevertheless have stalled. “There’s a risk – a very strong risk – of progress going forward being very limited, with some degree of pullback. That’s very very serious.”

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