Posted by: Dirk | May 31, 2011

Foreign debt in Eastern Europe

Paul Krugman has recently tackled the OECD Economic Outlook helplessness in the face of high unemployment in his column. The IMF is still recovering from theory failure, as INET reports. I have been watching a video where Erik Berglöf, chief economist from the EBRD, speaks about Eastern Europe and the crisis:

The interesting question for me was whether the countries that have had capital inflows in the past did any better than those that did not (like Poland, which did not experience a recession). At 01:54 mins in the video, there is a section titled Why countries that invested in exports fared better than those that invested in real estate – and why it was good to have foreign bank networks. Berglöf speaks of countries that allowed capital inflows and explains that “those countries are in much better shape now”. OK, I thought, so the old idea of borrowing from abroad and the investing in the export sector is still in use and working well. I looked into the Transition Report 2010 and was surprised that it contradicts Berglöf (p. 31, my highlighting):

The main results are as follows (see Table 2.1.1 for details):

• When global trade collapsed in winter 2008-09, a country’s product structure played a key role: exporters of machinery were hit the hardest. Real depreciation did not mitigate the collapse. More diversified export markets may have buffered the collapse, but its statistical significance is weak.
• In recovery the export product structure seems to have lost some of its overwhelming importance, although there is still some indication that exporters of intermediate inputs may have recovered faster than other countries. Rather, gains in competitiveness (real depreciations) both during the crisis and thereafter seem to be the main factor that helps explain cross-country variations in the recovery.

This is quite odd. On page 30, in the beginning of the chapter, it says:

The recovery was initially mostly driven by net exports. By the first quarter of 2010, exports had recovered from their collapse in the winter of 2008-09, in line with the recovery in global trade (see Chart 2.2a). Commodity exporters (Armenia, Kazakhstan, Mongolia and Russia) benefited from rebounding commodity prices, while countries with a heavy export concentration on machinery (Czech and Slovak Republics, Hungary, Poland and, to a lesser extent, Romania) benefited from the global cyclical rebound. Exports from countries whose real exchange rates depreciated during 2009 and 2010 increased disproportionately (see Box 2.1).

This seems to me quite logical. The collapse in world trade hit net exporters harder, and then the recovery of world trade helped them to grow back faster since the output gap was bigger in the first place. This is not to say that being a net exporter or financing your investments, private and/or public, with foreign debt is bad. It’s just that the TR2010 doesn’t support what Berglöf says.

In developing economics, the strategy of financing development through foreign debt is well-known. Berglöf is right when he says that the money should be invested in increasing exports and not in real estate, and that regulation is very, very important. However, countries with strategies of under-valued real exchange rates (through fixed exchange rates or suppressed wage growth) seem to have done very well in recent years when it comes to growth rates. It would be nice to see some empirical facts about these two growth strategies. Claiming that countries which relied on foreign capital inflows do better without empirical evidence is something you could get away with before the crisis. Not anymore.


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