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Monday, July 9, 2007

The Economist and Eastern Europe

In a recent Afoe post on European Fertility (which was really an extended review of an article in the Economist) I took some considerable stick in comments for being too soft on the journalists over at the Economist who were behind the article (mainly because a large chunk of the "good news" they claimed to have found was, when all is said and done, spin, as Ape Man ably explains in this most moderate of rants from a lifelong Economist subscriber).

This post should produce no such complaints.

My issues today relate to an article The Economist currently have on site entitled "Eastern Europe's economies, Worrying about a crash". In fact, the article is, in the main, about Latvia, a small country which is currently suffering from a very acute form of labour-shortage-induced wage-price spiral, with wages having risen in the first quarter of this year by around 33%, while property prices in Riga - the capital - had gone up last May by something over 60% when compared with a year earlier. (Regular readers will already know that Latvia had already been attracting my own attention somewhat, and those who want a day by day commentary on the unwinding of Latvia's property boom may find it interesting to follow events from the vantage point provided by Latvian Abroad.

Now,as I say, Latvia is, at the end of the day, rather a small country (with only a little over two million inhabitants) so why all the fuss? Well in the first place the problems being experienced in Latvia seem to be rather more general than might appear at first sight. The Financial Times only last Thursday had an article drawing attention to how the same sort of issues, to greater or lesser extent, were affecting all three Baltic states, and the credit ratings agency Standard and Poor's only last week downgraded Estonia's rating from stable to negative citing the growing risk of a hard landing even there. I say "even" since, at least on the surface, Estonia would seem to be the best placed of the three of them. It is also important to note that what is happening in the Baltics takes on even greater significance when situated in the context of a general labour supply problem which, in the shorter or longer term, is about to face all Central and East European "transition" societies, whether they be inside or outside the EU. Hence the importance of comparisons, which, as we shall see, the Economist itself is only too ready to engage in.

Since, however, my theme today is the quality of economics journalism, and the responsibility that those of us who write about economics have for trying to get things right, I will only frontally address this topic here, leaving treatment in depth of the underlying problems being posed in the Baltics for a subsequent post. My issues with the Economist are threefold.

Firstly, when they come to examine the fragility of the current economic growth cycle in Eastern Europe the Economist writers argue that Hungary, despite being a "wobbly" candidate for contagion if things go badly wrong in the Baltics, is in fact likely to escape the worst case scenario of a hard landing as its current economic imbalances unwind, since Hungary has, in general, been "disgustingly lucky", and the best example they have to hand of this "disgusting luck" would seem to be the fact that "exports and industrial production have risen". Now, in fact, while it is the case that Hungarian exports have been rising more quickly than imports in recent months (although please note that this is due in part to a slowdown in domestic demand), industrial output has in fact fallen in 3 of the last 4 months. I sincerely hope that Hungary will avoid a dramatic crash, but if you want to argue that they will, and back this with analysis, then first and foremost you need to get your facts right.

Secondly, in their search for a recipe and a way out, the authors single out Slovakia as a positive role model worthy of recommendation to the rest of the EU8 (and so logically to the Baltic states) since:

"For countries that can do it, keeping their interest rates above the euro's and letting their currencies appreciate helps" and "bringing in foreign workers from places such as Ukraine" may help "reduce upward wage pressures. Slovakia is a prime example of how to pull off both tricks".

Now the problems that are likely to arise in any up-and-coming correction which may occur in Eastern Europe due to the fact that some of the currencies there are systematically pegged to the euro may well constitute an important headache in the days to come, and it is nice to see the Economist waking up to this fact, but since currency hard pegs are not my main topic here, I will simply note the issue and pass by. No, what attracts my attention most about this incredible statement from the Economist is the fact that Slovakia is now itself beginning to suffer from acute labour shortages, as the International Herald Tribune highlighted in an article that went up at more or less exactly the same time as the Economist went live with their view (My thanks to Michal Lehuta for drawing our attention to this little detail on his Central-European Economics Watch blog, and for pointing out that the Slovak government "recently made the requirements for obtaining citizenship tougher"). As the IHT says:

"Slovakia could soon become the world's biggest car producer per capita - if it can find enough skilled workers to assemble the vehicles ".... but .... "Now, having carved out a niche in car manufacturing in recent years, Slovakia is suffering from the same regional labor shortage that is exacerbating concerns that foreign investment could be deterred".

The source for the IHT article was a report published last week by the Vienna Institute for International Economic Studies, which you can find here, and in fairness to our Economist authors the report does say that in Slovakia, as opposed to the Baltics or Romania or Bulgaria, the overheating problem may be containable in the short term and even that "very high growth does seem to be sustainable, at least over the next two years". But then two years at the end of the day do not exactly constitute what you would call a long term outlook for sustainability, so what is it we are saying here, "go down the Slovakian road and you can enjoy life for two more years before you then finally get to crash"?

Yet another time we have here a case of get your facts straight before preaching, I think.

Thirdly, and this is really my biggest beef, the Economist keeps making indirect references to the way in which attracting inward flows of labour may help the EU8 economies out of the trap they are falling into, but it never actually spells out what the underlying problem is, or how - in much more explicit terms - inward migration might really help. Maybe this is because, as they argue in the European Fertility article:

"changes in population are not - in and of themselves - either a good or a bad thing in economic terms, since “there is no short-term correlation between population change and wealth"

In fact, what is happening now in Eastern and Central Europe may finally provide the Economist with just the sort of evidence they feel has so long been lacking.

Basically the situation is this: years of systematic out-migration and a collapse in fertility around 1990 have left all these countries with a significant and ongoing labour supply problem. Claus Vistesen has just done some very interesting background research for Lithuania which really help put things in perspective (and especially the easy-to-read graphs, which are an absolute must). Using back-of-the-envelope-type calculations, if we consider that Lithuania currently has around 50,000 unemployed, and economic growth is reducing this pool by about 5,000 a month, then you don't need to be a mathematical genius to work out that they have about ten moths left before they run out completely, and this is clearly impossible. So push does come to shove, one way or another, within a time horizon of about ten months.

But why am I niggling like this with the Economist? Because behind all this lies a much bigger debate, one about the sources of economic growth, and about the relative size of the demographic and the institutional components in growth. The journalists at the Economist clearly have an in-house view that the demographic component is not important, and this has lead them in one country after another across the globe to either simply ignore the issue, or to say that the importance of demographics is greatly overstated. In Japan, for example, they continue to believe in a sustainable, internal-demand-driven, recovery (despite the fact that as Claus Vistesen explains here), the recent data we have from Japan do not support this assumption at all). In India (which has as we all know, lots and lots of young people just about to enter the labour market) they continue to argue the absurd view that the Indian economy is in grave danger of overheating (a view which Nanubhai Desai systematically refutes in this excellent post here). Meantime, and as is only to be expected in any economy which is running short of natural coolant, overheating is visibly starting to show its face all over Eastern and Central Europe.

So what was up to now a reasonably academic debate is about to become a live macro issue, and my strong chiding against The Economist is simply due to the fact that in turning a blind eye to one possible account of the growth process they will have done nothing of any great substance to inform and forewarn their readers of what may now be about to come. As he wearily raises his telescope over the dust-ridden patch he declares "people, I see no people". Yes, that is just the point.


Well just in case any of you have the impression that the points raised here simply constitute some kind of oversight on the part of the Economist, the Economist Intelligence Unit have dispelled any remaining doubts we may have entertained. They have just published a new study entitled Eastern Europe: booming economies, dangerous politics, which astoundingly - at least going by the blurb - doesn't seem to treat the labour supply constraint question as having any importance at all. At this point I haven't read the whole report, I admit, but then, is it really credible for people to ask would-be clients to shell out £335 for something which seems to miss the central point about what is going on? The quality of our current intelligence is indeed, it appears, severely strained.

Also doing some background digging on Slovakia, I found this data in the Slovak Spectator. Slovakia has a pool of about 200,000 unemployed, and is eating into it at a rate of about 50,000 a year, which gives an outer limit of about 4 years, at current growth rates. But then of course there are skill bottlenecks, and demands on the Slovak labour pool from other countries to think about. So in reality the situation is much tighter than it seems, especially in Bratislava. Slovakia's currency - the Slovak Koruna - does however continue to appreciate, since industrial output has just risen year on year by 17.9%, but the steady increase in the value of the currency may in today's climate, have the rather perverse effect of boosting domestic demand even more by attracting an inward flow of funds in the anticipation of even more currency appreciation, in the process fuelling the Bratislava housing boom mentioned in the above link (which of course means an increased need for construction workers, and on and on we go, of course, until the day we don't).

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