Global Crisis: Weighing the Options

THESIS NUMBER 1   Macedonia's external financing needs (as expressed in its current account deficit) are big. The trade deficit is also unsustainable. Macedonia's sources of foreign exchange are drying up, as well: FDI is down and so are remittances from Macedonian workers abroad. This creates an external financing gap that may threaten macroeconomic stability and the denar's exchange rate.
 
THESIS: Macedonia's foreign debt is moderate. Moreover, the denar is not a convertible currency and is unlikely to come under speculative attack of the type suffered by the ruble, or the forint. Macedonia can still tap foreign credits with few strings attached and foreign aid to finance its external account. An arrangement with the IMF will likely be counterproductive: it will restrict the government's ability to reflate and re-monetize the economy with counter-cyclical deficit spending. It will also hamper the country's monetary flexibility. It should be used only as a last measure. An arrangement with the IMF may also send the wrong signal to the markets (that Macedonia's macroeconomic stability is threatened).   ANTITHESIS: An arrangement with the IMF will restore confidence in Macedonia's macroeconomic stability and in its ability to preserve a foreign exchange anchor. It will increase foreign exchange reserves and allow Macedonia to implement proper and much-needed fiscal and monetary policies. The cost of borrowing from the IMF is also lower than any other form of indebtedness.   THESIS NUMBER 2   THESIS: When the economy goes sour, rational individuals and households save more and spend less. The aggregate outcome of their newfound thrift is recessionary: decreasing consumption translates into declining corporate profitability and rising unemployment. These effects are especially pronounced when financial transmission mechanisms (banks and other financial institutions) are gummed up: frozen in fear and distrust, they do not lend money, even though deposits (and their own capital base) are ever growing. Businesses refrain from investing as credits dry up.   In times of economic crisis, as consumption and investment plummet and unemployment is on the rise, the only way to effectively cancel out this demonetization of the national economy (this "bleeding") is through enhanced government spending and by cutting taxes and reducing fees for government services and goods. Where fearful citizens save, their government should spend on infrastructure, health, education, and information technology. The state's negative savings should offset multiplying private savings and negate the "Thrift Paradox". In extremis, the state should nationalize the financial sector for a limited period of time (as Israel has done in 1983 and Sweden, a decade later). Other steps include: removal of import duties, excise taxes, VAT, and other taxes and fees on all energy products and foodstuffs; freezing, reducing or waiving public sector fees and charges; and subsidizing the consumption of the poorest 10% of the population.   ANTITHESIS: Government stimulus should be symbolic or moderate. The role of the government in Macedonia is already way to big: the tax burden is high and the state is the largest single employer. It is crowding out the private sector and competing with it for scarce capital. Government extra spending should go towards capital investments and not current expenses. In times of anxiety and uncertainty, it is far more important to safeguard fiscal discipline and, by implication, macroeconomic and monetary stability which are the preconditions for true, long-term, and sustainable growth. Enhanced government spending on wages, pensions, and other discretionary current items will only translate into increased imports and an even larger trade deficit. The government should actually cut spending by rebalancing the budget and try to avoid sizable deficits. This way it will be sending a signal to the market that it is a responsible economic player, committed to the long-term health of the economy.   THESIS NUMBER 3   THESIS: The real risk to Macedonia's economy is deflation, not inflation. The National Bank should allow credit formation, reduce interest rates and reserve requirements, buy government bonds and, thus, encourage consumption, bank deposits, and investment. To increase interest rates and depress consumption and investment amidst a global crisis is unwise.   ANTITHESIS: The real risk to Macedonia is inflation, possibly brought on by a devaluation of the denar. In the long-term, real growth will resume only if inflation remains subdued. Additionally, the stability of the banking system is at stake as the quality of the banks' loans portfolios deteriorates owing to an increase in the number of bad loans. Steps should include: Raising interest rates and reserve requirements;  capping interest rates on deposits in the banking system to prevent new credit formation; forcing banks to purchase government bonds to reduce liquidity in the market; administratively capping credit growth and tightening lending to consumers and for real-estate transactions.   THESIS NUMBER 4   THESIS: The government should shield local industry and manufacturing from the effects of the global crisis by imposing import quotas, non-tariff barriers, and other trade restrictions. It could also prefer domestic businesses in tenders and institute a "Buy Local" campaign. It can offer export subsidies; levy duties and excise on nonessential and luxury imported goods as well as on strategic products; cut duties and excise on raw materials. In extremis, it can declare a World Trade Organization (WTO) emergency (which Macedonia's trade deficit fully justifies).   ANTITHESIS: Macedonia relies on flows of foreign capital in the forms of FDI, export proceeds, and remittances. It is fully integrated with the global economy and cannot afford to declare a trade war. Protectionist measures only serve to cushion inefficient industries and manufacturers and will provoke retaliatory measures by Macedonia's trade partners. External competition is a good thing as it forces domestic firms to streamline and cater to the needs and requirements of the marketplace.   THESIS NUMBER 5   THESIS: Foreign Direct Investment (FDI) is the key to Macedonia's prosperity and economic growth. FDI encourages the transfer of management skills, intellectual property, and technology. It creates jobs and improves the quality of goods and services produced in the economy. Above all, it gives a boost to the export sector. While all forms of investments - both foreign and domestic - should be encouraged, the government should play a decisive role in attracting foreign investment and in providing the conditions for its success. As the business climate improves, local businessmen and entrepreneurs will establish firms, manufacture, and export. The government should not directly subsidize the formation or the operation of domestic businesses. This is better left to the private sector.   ANTITHESIS: The government should encourage domestic investment and even subsidize the formation and operation of local businesses. This is the only way to put into use nonproductive capital; prevent capital flight; and guarantee the long-term economic welfare of the citizens of Macedonia. FDI does not foster growth and stability. It follows both. Foreign investors are attracted to success stories, they are drawn to countries already growing, politically stable, and with a sizable purchasing power.   THESIS NUMBER 6   THESIS: Macedonia's macroeconomic stability depends on maintaining an exchange rate anchor: a stable exchange rate against the currency of Macedonia's main trading partners, the euro. To that end, the National Bank should intervene in the markets to support the denar, if necessary by using its foreign exchange reserves. A stable exchange rate guarantees low endogenous inflation and economic growth. The claim that the denar is overvalued and hampers export growth is false. Macedonian firms are not exporting more not because of the exchange rate, but because of outdated technology, wrong or deficient marketing, lack of compliance with standards, antiquated design, and a general lack of competitiveness.   ANTITHESIS: Macedonia would do better to introduce a flexible exchange rate policy coupled with inflation targeting. Introducing an inflation target would create as much macroeconomic stability as any currency peg. The government has at its disposal policy instruments that allow it to control inflation: introducing price controls and freezing the prices of essential products, or even wages, healthcare costs and pensions; releasing commodities, oil, and minerals from strategic reserves; hedging (fixing the future prices of foodstuffs, oil, and commodities by purchasing forward contracts in the global markets).   The National Bank should allow for a gradual devaluation of the currency, within a band or range or as a crawling peg. This will prevent speculative attacks on the denar that currently are depleting the foreign exchange reserves of the country. It will increase the competitiveness of Macedonia's exports and reduce its trade deficit. A strong currency has anti-inflationary effects, so any devaluation must be minimal, slow, and subject to market forces. Still, Macedonia can also devalue its currency without any major repercussions (as not many credits here are denominated in foreign currency and inflation is subdued).

THESIS NUMBER 7

  THESIS: The global crisis discredited the doctrine of the free, laissez faire market. The role of governments is growing and they are assuming additional functions and responsibilities. Strict regulation should be introduced and enforced in various areas: the financial industry; healthcare; employment; international trade; the environment; and so on. The government should become more involved in every phase of the economic cycle: from entrepreneurship to taxation; from banking to manufacturing; and from education to healthcare. It should even consider re-nationalizing some utilities.   ANTITHESIS: This is a temporary crisis that has to do with excesses and imbalances of the system and not with the core beliefs and theories that underlie it. This is not a crisis of capitalism, but of certain capitalists. Governments should let the private sector sort itself out and interfere only to provide public goods and where there are systemic market failures (such as in the banking sector). Even so, governments' involvement should be time-limited and with a clear exit strategy.