The Road to Financialization in Central and Eastern Europe

1. The Road to Financialization in Central and Eastern Europe Daniela Gabor Bristol Business School University of the West of England

2. The background: two distinctive phases of transition (Fabrizio et al, 2009) • ‘First transition’: post-plan disruptions - industrial contraction, volatile inflation, high unemployment (roughly up to 1995) • ‘Second transition’ – harnessing globalization with well- defined development model: • International financial integration • benign tolerance of real exchange rate appreciation • Post-Lehman: vulnerabilities of ‘second transition’ growth model – briefly subprime • Bank foreign-ownership: exposure to cross-border lending and funding distress

3. This paper will argue… • ‘First transition’ matters: financialization as standpoint, contested policy narratives as epistemological approach • Travelling excess demand narratives - the stabilization ‘problem’ - from shortage vs. disequilibrium debates to the translation into IMF policy advocacy (and conditionality) • Excess demand narratives and financialization of banking activity • An alternative account of stabilizing transition

4. Financialization • An interdisciplinary pursuit: critical accounting, sociology (French et al, 2011) • Political economy: increasing importance of financial actors and practice (Esptein, 2005; D’Arista, 2005), in inflation targeting regimes (Vernengo, 2008) • Impatient finance (Crotty, 2003) or short-term trading of risk (Hardie and Howarth, 2009) in currency markets or banking (Gabor, 2010)

5. Financialization and narratives • Narratives: mobilizing accounts that frame a ‘crisis’ and legitimate a response that serves sectional interests • Engelen et al (2011): narratives of governing finance or Aalbers et al.(2011): narratives of securitization • Policy terrain, hegemonic and counter-narratives • Monetary policy – contested terrain (Epstein, 1992)

6. The macroeconomic policy problem in transition • Polish flirtations with limited marketization: macroeconomic stabilization first (Wolf, 1991) • The stabilization problem (Bruno, 1992; IMF et al, 1992, Wolf, 1990): • Soft budget constraint (Kornai, 1982) • Excess household liquidity (monetary overhang) • Misaligned exchange rates • The excess demand narrative: price liberalization in the presence of excess demand (monetary overhang + soft-budget constraints) will lead to inflationary spiral in the absence of tight monetary+ fiscal + income policies

7. The consensus in ‘transition’ debates and the debates in macroeconomics of planning • The sequencing debate - ‘shock-therapy’ vs. gradualism: how to stabilize/liberalize/privatize(Kolodko, 1998) • Post-Keynesians: debating outcomes not diagnostics • ‘the moral crusade of market fundamentalists’ (Amsden et al, 1994) vs. full employment (Marangos, 2002) but accepted repressed inflation:’rising excess liquid balances in the hands of the population with respect to what they would wish to hold if markets cleared at official prices’ (Nuti, 1986: 38) • Consensus on excess demand overlooks the pre-transition debates: disequilibrium vs shortage schools

8. The disequilibrium approach (Portes, 1980) • Disequilibrium models: quantity rationing + price rigidities (Barro and Grossman, 1971) • Disequilibrium models of CPEs (Portes and Winter, 1978, 1980): • Two agents (HH and planners), two markets (L+ CG) • ‘intercompany money’ passive, reflects planning decisions, may mutate in ‘active money’ in HH sector • Disequilibrium in CPE: a temporary state of the consumer market arising from planners’ inability to reach targets

9. Two controversial assumptions • No systematic tendency towards imbalances • Unintended planning /production errors, correctable in new planning period • Disequilibrium in consumer markets • Planning errors - industrial sector – demand for consumer goods or labour (higher wage bills) • Quantity rationing in the consumer goods market may lead to forced savings (a wealth /monetary overhang, Cottarelli and Blejer, 1992) • Empirical testing: CPE switching between excess demand and excess supply states (Portes and Winter, 1980; Portes et al., 1987)

10. The shortage school (Kornai, 1982) • Disequilibrium analysis misrepresents socialist production: pervasive, chronic shortages – incentives in socialist production • Capitalist firm: profit-driven, constrained by demand, disciplined by market • Soviet firm: quantity-driven, constrained by shortages and political negotiations with planners, overfullfilment incentives (politics of planning) • Soft budget constraint: costs ‘validated’ by central planners to stimulate output • Discrete switching from excess demand to excess supply states impossible! • Disequilibrium approaches theoretically and methodologically problematic (impossible to identify an aggregate supply/demand)

11. Disequilibrium vs. shortage • Disequilibrium approach: disequilibrium a macro phenomenon, empirically testable • Shortage approach: managerial decisions at micro-level • ‘There are few tenets of the economics of centrally planned economies which are more likely to cause disagreement than the notion that centrally planned economies suffer from chronic excess demand or shortages of goods and services’ (Kemme, 1989, p. 345)

12. Constructing the consensus (1) • IMF’s standard stabilization approach: financial programming (Mussa and Savastano, 1999) • Crisis and austerity: inflation/bop problems narrated as an excess demand phenomenon • Exchange rate devaluations and contractionaryquantitative criteria for domestic (central bank) credit and spending + floors for international reserves. Calculated as residuals by setting a target for money supply (Easterly, 2004). • Translating policy models to the post-plan context • Disequilibrium treatment of money + shortage treatment of state production

13. As IMF economists put it... ‘There were few monetarists in transitional economies, at least in the beginning [...] The idea that prices were related to money was often not intuitive. Rather, the price formation process was viewed as a complex process that involved many technical elements and many factors outside the authorities’ control, especially external factors. In fact, tight monetary policy was precisely designed to make the traditional cost-plus-mark up pricing policy impossible. This meant that the same situation IMF economists would see as inflationary would often be viewed as too tight a monetary policy setting by the local authorities. They frequently argued that the “monetary coefficient” (that is, the reciprocal of velocity) was too low, and the level of activity required more—not less—money to support it [..] there was always a local variant of the real bills doctrine—namely, credit expansion is not inflationary if it is issued for productive purposes, typically construction or agriculture.’ Allen and Haas (2001)

14. Constructing the consensus (2) • Disequilibrium treatment of money: excess liquidity • ‘passive’ enterprise money - ‘active’ through the wage channel, feeding excess demand (disequilibrium). Excess HH liquidity even in the absence of aggregate excess demand a la Portes (shortage) • Monetary overhang estimates: M2/GDP ratios – around 50% of liquid balances involuntarily held • Shortage treatment of state-owned firms: • Discipline SOEs into hard-budget constraints: tight monetary policy to prevent banks from feeding soft-budget constraints (McKinnon, 1991) + floating ER

15. Framing the stabilization problem (1) • Inflationary pressures: demand vs cost-push • Contesting the unspent purchasing power approach: pervasive informal markets (Alexeev, 1988), M2/GDP ratios indicative of voluntary savings (Cotarelli and Blejer, 1992), money as store of wealth – liquidity preference under uncertainty (Dow, 2004) • Cost push pressures: the organization of socialist production – complex networks of vertically integrated large firms Proposition1. Cost-push pressures, and consequently exchange rate policies, were essential to macroeconomic stability defined in terms of both the price level and the balance of payments.

16. Proposition 1: implications • ‘Multifaceted price systems’ (Zhukov and Vorobyov, 1992) instead of across the board liberalization • Exchange rate stabilization rather than money –based stabilization • Currency stabilization funds (Poland – Sachs, 1996) • Successful exchange rate stabilization (Schadler, 1995) – overshooting monetary targets Proposition1. Cost-push pressures and exchange rate policies were essential to macroeconomic stability

17. Framing the stabilization problem (2) 2. CPE – wage led system • disequilibrium model emphasis on labour as main input in production) • restrictive incomes policy to maintain SOE costs under control (IMF ‘heterodox’ stabilization, Winiecki 1993) but wages: 10-25% of production costs • Proposition2. In formerly planned economies, income policies could not make as important a contribution to stabilization as in countries with commodifiedsocial provisioning.

18. Proposition 2: policy implications • Questions magnitude of monetary overhang • Income policies to contain inflation costs? • Labour bargaining power gradually developed with development of labour market institutions • Narrowing the argumentative terrain around cost-push pressures to wages Proposition 2. income policies could not make a significant contribution to stabilization

19. Framing the stabilization problem (3) 3. Excess liquidity: redefine relationship banking – state owned enterprises • a la McKinnon (1991): immediate impossibility of market-based bank credit allocation (information asymmetries) • Instead of state development bank, credit ceilings to redirect SOE’s to capital markets • The ‘myth of the west’ (Mayer, 1989): banks, not asset markets, as main source of external finance Proposition3. Prioritizing, and not restricting, the provision of liquidity to industrial firms by strengthening the links with the financial sector should have been central to monetary policy narratives.

20. Proposition 3: policy implications • Money and monetary economy of production (Keynes) • The excess demand narrative - industrial restructuring • pervasive liquidity shortages, high interest rates • a ‘transition’ version of endogenous money, inter-enterprise arrears • liquidity problems into solvency problems, industrial collapse, banking crisis • A question of coordination: central bank liquidity policies and industrial policies (Anderson et al, 1996) • ‘[W]e strongly opposed the approach that claimed that the best industrial policy is not having one at all. We in the government have actively and deliberately supported the restructuring of Polish enterprises’ (Kolodko, 1998, p. 3) • Central banks often aligned to excess demand explanations Proposition3. Prioritizing the provision of liquidity to industrial firms by strengthening the links with banking sector

21. Financialization of banking (1) • Recurring bank failures = political validation of soft budget constraints and vested industrial interests • Hesitant financial reform - the Great Divide (Berglof and Bolton, 2001) : cycles of unpaid debt, arrears and pressures for monetization – deterioration of banks’ balance sheet – necessary privatization • Two discursive effects: • Sideline the link btw excess demand narratives and liquidity shortages although credit activity under financial disintermediation conditional on central bank provision of reserves • Posit state owned banks passively (re) produced the soft budget constraint, despite well-documented difficulties for even SMEs to access long-term financing in transition (Klapper et al., 2002)

22. Financialization of banking (2) • Or the puzzle of financial development in transition (Berglof and Bolton, 2001) • Widely different approaches resulted in a remarkably similar financial architecture even on the successful side of the Great Divide. • In the ‘second transition’ financial systems dominated by commercial banks, increasingly foreign owned and lending primarily to governments, short-term. • Enterprise financing came from retained earnings, while highly illiquid and volatile stock markets left foreign direct investment as the only external source for financing long-term capital investment.

23. To conclude • Excess demand narrative crucial for translating the priorities of financialization, defined as shifting relationship between banking and industrial production, into (monetary) policy goals and practices • IMF + central banks – key institutional carriers of the excess demand narrative, constructed through disequilibrium assumption of money neutrality + shortage emphasis on managerial aspects of industrial production • A competing narrative: privileging industrial restructuring through bank provision of long-term capital investment, carefully designed to avoid moral hazard