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WHITHER CAPITALISM? THE CRISIS OF FINANCIALIZATION FROM THE CORE TO THE PERIPHERY | CEED

WHITHER CAPITALISM? THE CRISIS OF FINANCIALIZATION FROM THE CORE TO THE PERIPHERY

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"....The task is to form a new kind of capitalism with smaller inequalities both globally and within individual societies as well, in which real economy is not subordinated to the financial sector, where SME’s providing job opportunities have access to investment resources just as much as large corporations, where the peripheries are provided real chances for development, and in which more labour-intensive and resource-saving means of production provide solution for unemployment and poverty."

Gábor Scheiring

Abstract. In this paper I give a structuralist analysis of the financial crisis. First I seek to refute the argument suggesting that the main reason behind the crisis was government failure in the United States. Deregulation, by amplifying market failures, was of fundamental importance from the point of view of the crisis. However, deregulation cannot be understood without an examination of the broader social context, the changes that occurred in the capitalist structure and the consequent changes in the power structure. The term 'financialization' denotes the changes in the social and economic structure which give the background to and the context for a better understanding of financial deregulation and liberalization. The particular class and elite coalition maintaining the Keynesian-welfare consensus fell apart; the middle class now relies to a lesser degree on the lower classes for solidarity, while the financial elite gained dominant influence within the economic elite. In the second part of my paper I continue with an analysis of how the financial crisis impacted the Eastern European semi-periphery and especially Hungary. Contrary to the popular view that blames the erroneous macro-economic policy of the governments for the countries' failure, I highlight that the crisis of the peripheries is rooted in the structure of global capitalism and the mistakes in the adjustment strategy of the countries concerned. Excessive dependence on financial globalization and a growth strategy that had built on the inflow of hot money have led to a fragile economic model just as much as the process of financialization in the core countries. I conclude my paper with presenting a number of policy recommendations.

Although some surface treatment has thus far been successfully applied in an attempt to withstand the global economic crisis, entailing the gravest recession since the Second World War, the instability of the current economic system has become obvious. The S&P index of the American stock exchange dropped by 50% in the course of 2008, exceeding the decline during the dot-com crisis in 2000, or that during the 1973 oil crisis. It implied the shedding of as many as 130,000 jobs in the American financial sector alone. Applying a short-term crisis management strategy has unquestionably indicated that the dominant public policy paradigm of the past decades has been transcended, however, this is not the case when it comes to the question of long-term restructuring. Many analysts believe that the crisis has its origin in mistaken governmental policies, therefore what we are facing now is essentially government failure. One version of this argument has been applied equally to countries of the capitalist core and the peripheries as well. In the first chapter of my paper I seek to refute the argument suggesting that the main reason behind the outbreak of the crisis was a mistaken interest rate policy of the Federal Reserve (FED), the central bank of the United States, as well as the high level surplus liquidity that it generated, which had also been promoted by the U.S. government through cheap loans as part of its market-friendly housing policy. I argue that the process of deregulation has been fundamental from the point of view of the crisis, but that deregulation itself can not be understood without taking a broader look at the social context or the changes in the capitalist structure and the consequent rearrangement of the power relations.
As was also pointed out by the European Bank for Reconstruction and Development (EBRD), Eastern Europe may be the region that has been hit hardest by the crisis. Many countries here, previously “star pupils” of the EU accession process, are now experiencing the gravest economic crisis since the change of the regime. In Hungary, Latvia, and Romania the crisis has exposed a host of political, economic and social tensions that had been accumulating for years. Wage decrease in the public sector, the dismantling of public services, and the IMF bailout have all been painful signs of deep-rooted problems. In Hungary there is heated debate about the real reasons behind the economic breakdown of 2008-2009. The dominant viewpoint within the economic policy elite is that the crises in the semi-periphery countries can be attributed primarily to the flawed macro-economic policy of their governments: those that failed to comply with the prescriptions of the Washington consensus have fallen in the storm of the crisis. In the second half of my paper, however, I focus on the case of Eastern Europe and Hungary in arguing that the crisis in the semi-peripheries cannot be understood without an analysis of the structure of global capitalism, nor without an examination of the adjustment strategies the countries adopted, i.e. their industrial and foreign economic policies. In light of such analysis it is untenable to assert that the sole responsibility for the crisis lies with the lack of credibility of governmental economic policy and budgetary overspending. No doubt, the tendency on the part of Hungarian politicians to overspend and the consequent accumulation of state debt have significantly increased Hungary's vulnerability, nevertheless, exposure to hot money, the fetishization of foreign direct investment and the dual economic structure are features of the Hungarian economy that are typical of semi-periphery countries which made their economic growth dependent one-sidedly on the globalized financial system.
Summing up the lessons from the experience in the core and the peripheries, we may claim that the crisis can be considered so far the greatest failure of the market and the capitalist system, and cannot be understood within the framework of finance alone, only through an examination of the prevailing social conditions, the production structure and the power structure that ensued as a result. What has evolved through financialization, a process embracing the entire economy, is a fundamentally unstable financial system that is subordinated to short-term considerations and which negatively affects the sphere of production and labour income, while increasing polarization within the countries and on a global level. In the final chapter of my paper I attempt to outline a crisis management strategy that follows from the analysis.

CRISIS AND FINANCIALIZTION IN THE CORE

FINANCIAL EXPANSION AND INSTABILITY

All analysts agree that in the past decades the capital market had been the most dynamic sector within the world economy. The explosive growth of the financial system is indicated by the rise in foreign currency trade. Prior to 1971, in the framework of the Bretton Woods system, currency exchange rates had been pegged to each other and the dollar to gold, currency trade had been directly linked to real economic activity. In the absence of a global economic regulation, the introduction of floating exchange rates changed the situation. Daily foreign currency trade had increased to over USD 3 trillion by 2007 – twenty-five times as much as in 1980 (USD 120 billion), while there was “only” a fivefold increase in the volume of global trade in goods. In 2004 global foreign currency trade was close to 40 times as much in volume as global trade in goods. Beside a sharp increase in direct currency trade, the expansion of derivatives trading is also noteworthy: in September 2008, its volume was USD 600 trillion, ten times as much as the volume of global trade in goods. A part of this trading serves as a safeguard against risks but the dominant part indicates speculative profit-hunting.
I will shortly elaborate on the extent to which speculation contributes to the efficient operation of markets. For the moment what needs to be stated is that there had been ample warning signs as to the instability of the system – without prompting any particular reaction however. The leadership of the FED was convinced that the financial innovations of the previous decades had been safe and served to ensure the system's stability. Not long before the outbreak of the crisis, a senator had posed a question to Alan Greenspan, President of FED, enquiring whether Mr. Greenspan was concerned about the huge risks the potential collapse of one of the giant institutions held for American and the global economy.
No, I’m not [Mr. Greenspan replied]. I believe that the general growth in large institutions have occurred in the context of an underlying structure of markets in which many of the larger risks are dramatically — I should say, fully — hedged.

In what follows, I will highlight the deficiency of this theory but first let us look at the above argument from an empirical point of view. It was not only the instability of global economy that increased over the past thirty years compared with the 30 years following World War II, but also that of the American economy, as will be shown in the second part of my paper. Bubbles have regularly occurred in the United States since the 1980s. They had appeared in many sectors throughout history, of course, but in this paper I lay emphasis on the change that took place in this respect in comparison to the period after the Second World War. The first phase of the economic boom in the 1980's, following the decline of the Keynesian consensus, led to a real estate bubble in the South-west of the U.S., the bursting of which devastated a large number of the savings and loan associations. In the nineties, it was the stock exchange where a considerable bubble occurred. Between 1994 and 1999, the Standard and Poor's Composite Index increased by 23.6% annually, while company profits grew only by 7.6%. This bubble also burst in 2000. The third economic boom starting from 2002 brought an increase in real estate prices. By the summer of 2007, property prices had gone up by 70% compared to prices in 1995, corrected for inflation. As a result of the real estate bubble, the value of total housing wealth increased by 8 trillion, i. e. by 40%.

THE FAILURE OF THE FINANCIAL MARKET

Some argue that the cause of instability lies not so much in the structure of the financial system as in government failure, for which FED and the central government supporting it are equally responsible. The premise of such a proposition is that the free financial market basically works well and serves social welfare. Mainstream theory suggests that the financial market efficiently mediates between savings and investment opportunities. Market diversification, the appearance of new assets, and profit-making within the financial system (that is, speculation) enhance the efficiency of the mediation function of markets. Although a large share of transactions within finance is not linked directly to real economic activity, altogether they serve the stability of the market. What lies behind such argument is the assumption that prices deviating from equilibrium (for instance, in the case of overvalued currency resulting from government intervention) will be brought closer to the balance by speculators. Thus speculators indirectly contribute to resource accumulation via deepening the financial market. On these grounds the regulating authorities refused to make those interventions that would have reduced the risks accumulated in the system.
In general, arguments related to government intervention into the American economy have little to do with the financial system, the system risks accumulated in it, or with the herd behaviour of its actors. In addition, it makes no sense to speak of a purely unregulated market, as there has always been, and there will always be, government intervention, thus it is not very useful to take a theoretically conceivable unregulated market as the basis of comparison. Thirdly, in international comparison the economic structure of the United States can be rightfully called unregulated when juxtaposed with the European model, in which institutionalised solidarity, negotiation and individual interest representation play a greater role. Although in itself it is a true statement that, compared with other sectors, finance is regulated to a larger degree, yet such assertion ignores trends. On the one hand, it is difficult to support such an argument in light of the increased frequency of crises, which was demonstrated above. On the other hand, it is a fact that many key regulations have been annulled over the past decades, which has also contributed to the instability of the financial system.
Another argument supporting the assumption of government failure refers to the interest rate policy of FED, which undoubtedly contributed to credit expansion and the formation of a real estate bubble. At the same time – as also pointed out by UNCTAD – cheap loans cannot explain why the market was unable to handle risks. Provided that there is easy access to loans, a rational actor in the market is expected to prefer risky loans to a lesser degree, as the marginal utility of less risky loans is relatively greater than in the case of a higher guide interest rate. This is what happened in many Eastern European countries, including Hungary, where expensive loans based on national currency led creditors to turn to riskier foreign currency loans. By contrast, creditors in the United States took increasingly greater risks, as opposed to lower ones generating relatively high revenues, hoping that risk can be more effectively spread through credit derivatives. The argument focusing on the FED's interest rate policy cannot explain why it is that in Japan holding a guide interest rate close to 0% for years did not result in a similar situation. Moreover, the interest rate was low in the 1950's and 1960's as well, yet it did not lead to bubbles – bubbles may occur regardless the interest rate level. It is also hard to understand why the crisis spread at such a speed in the global economy.
Therefore the arguments about government failure are far from convincing in light of real processes. Neither an international comparison, nor a chronological one supports the expectations stemming from mainstream economic theory. In order to understand this it is necessary to notice that actors in the system have a mistaken approach to risk management, their behaviour is pro-cyclical thanks to speculation, which – beyond a certain point – impairs the efficient operation of the market instead of improving it. Therefore we cannot talk of a perfect market but of heard behaviour rather, as well as of extrapolations built on views that are far from the foundations of real economy.
Actors of the financial markets do not conform to textbook rationality in their behaviour, the sum of their actions does not lead to a “Pareto efficient” outcome but is pro-cyclical and generates positive feedback, which in turn leads to the emergence of bubbles. Sociologists have long recognised that the stock exchange does not operate according to the atomistic market model; network-like operation and limited information flow are features of this domain just as well as of other kinds of social interactions. Examining stock exchange processes, Baker found that larger and segmented markets are more unstable, given the inadequate information flow between the groups forming in them and because of the malfunction of community coordination mechanisms that are supposed to guarantee adherence to the basic norms. The smaller the markets, however, the smaller the expanse of the swing. This finding stands in sharp contrast to the mainstream model of financial markets. George Soros uses the term ‛reflexivity’ to explain why traditional theory failed, which, he claims, neglects the fact that market processes are shaped by active participants that react to each other. In their new book, George Akerlof and Robert Shiller speak of “animal spirits” and draw on the notion of limited rationality and apply a psychological approach to study heard behaviour in order to explain the evolution of financial markets.
Hyman Minsky, a recently rediscovered classic author of the crisis literature, was the first to describe (after Keynes) the cycles of financial bubbles. In the first phase, the discovery of a new investment opportunity positively affects investors’ revenues. This is followed by a boom, as the attractive opportunity prompts more and more people to invest in it. After the boom the phase of speculation begins, in which prices begin to diverge from real economic outlooks. Speculation culminates in euphoria, which results in a bubble. However, this process does not last forever and the deterioration of profitability outlooks makes investors retreat. Prices begin to drop, then comes the collapse. The essence of this process is that neither speculation, nor collapse brings the economy closer to a realistic market equilibrium price but cause significant swings instead.
What guarantees the stability of financial markets, according to mainstream theory, is market liquidity, the diversity of assets and market depth. Reality, however, shows a different picture. Liquidity in itself is not a guarantee, only the heterogeneity of actors is, which, however, is not typical of modern financial markets. Market actors take the same courses and rely on similar information in their work, they apply similar formulas and rules of thumb. One of the most important elements of this “common platform” is the financial models that investors use, as they assist investors in the pricing of their assets based on the pattern of market fluctuation in the past. These formulas have for some time given the impression that they help eliminate risks from the system, which convinced regulators as well, who believed that market actors are able to regulate themselves, they are able to assess real risks and apply appropriate prices. As a consequence of the homogeneity of market actors, strategic behaviour – when actors choose their behaviour based on what they assume about the behaviour of other actors – generates unidirectional moves in the entire market. Thus sociological and psychological insights have fundamentally enriched financial theories that are based on erroneous micro-economic foundations.
Such behaviour on the part of market actors leads to the emergence of system-wide risks. These affect all actors in the market, in contrast with market-level or individual risks which are spread among the actors and therefore can be handled on the level of the market. In case a system-wide risk emerges, individual losses correlate positively. There is no market-based protection against such risks, the principle of risk community does not apply any longer, given that every actor should be compensated at the same time, which would imply the breakdown of the insurance system. Even investors’ formulas are inadequate to handle system-wide risks, not to mention the fact that – as we have seen it above – they contribute to the accumulation of system-wide risks by homogenizing the actors’ behaviour. These risks may be manifested in the notion of “too big to fail” which distorts the risk-taking behaviour of major market actors, as they are aware that government intervention will come should any problem occur. Therefore the behaviour of market actors brought about situations that cannot be remedied within the confines of the market.

DEREGULATION

Given such market failures, deregulation is of fundamental importance from the point of view of the crisis, as it has changed the institutional environment which is responsible for motivating the system’s actors and for resolving different problems arising from collective actions. Indeed, the institutional environment of the financial system has gone through a radical and fundamental change as a result of political developments over the past thirty years. Figure 1. demonstrates the most important steps of the deregulation process.


Figure 1. Deregulation of the American financial system
Year Law (amendment)
Impact
1971 Turning point in derivatives trading
William Casey, appointed Chairman of SEC in 1971, uplifted the prohibition of a market in options and futures derivatives.

1980 Depository Institutions Deregulation and Monetary Control Act
Lowering the mandatory reserve requirements; set up
the Depository Institutions Deregulation Committee to
phase out federal interest rate ceilings on deposit
accounts

1982 Garn-St. Germain Depository Institutions Act Authorized savings and loan associations (S&L) to make business loans up to 10% of assets; increased the ceiling on direct investments by S&L associations in non-residential real estate from 20% to 41% of assets.

1999 Gramm-Leach-Bliley Financial Modernization Act Annulled the Glass–Steagall Act, adopted in the framework of New Deal, which introduced the separation of bank types (commercial and investment banks). The merging of the two activities increased the risk-taking propensity of banks offering private banking services.

2000 Commodity Futures Modernization Act Enacted the self-regulation of the OTC derivatives market, giving a boost to the spread of credit derivatives.

2004 U.S. Securities & Exchange Commission ruling (April) Exempted broker-dealers of the largest investment banks from official regulations, which had previously limited the level of capital transfer. As a consequence, credit/deposit ratio increased from 12:1 to 33:1 over a couple of years.

Deregulation enabled American banks to evade banking supervision through setting up the so-called shadow banking system. This system has allowed a great number of institutions to fulfil banking functions, which however were not subject to bank regulations. These institutions (SIV: special investment vehicles or SPV: special purpose vehicles) took over risky investments from their parent banks and, using various accounting tricks, they made possible capital expansion (increased ratio between credit and own capital). For a while it generated considerable profits but at the same time it led to the accumulation of substantial risks as well. The shadow banking system is by no means an insignificant part of the American financial system. According to the calculations made by JP Morgan, the turnover in this unregulated sphere was USD 5.9 trillion in 2007, which is more than half of the turnover of the official, regulated banking system (USD 9.4 trillion). As Paul Krugman pointed out:

As the shadow banking system expanded to rival or even surpass conventional
banking in importance, politicians and government officials should have realized that we were re-creating the kind of financial vulnerability that made the Great Depression possible—and they should have responded by extending regulation and the financial safety net to cover these new institutions. Influential figures should have proclaimed a simple rule: anything that does what a bank does, anything that has to be rescued in crises the way banks are, should be regulated like a bank.

It would hardly be possible to understand the explosive spread of securitization without deregulation , which also prompted speculation and provided incorrect feedback about credit risks, besides contributing to the accumulation of system-wide risks. In the traditional model of the mortgage market, default risk remained with the bank providing the mortgage. With securitization, however, banks sell the mortgages in the form of securities (“originate and distribute model”). As a consequence of securitization, the mortgage and credit derivatives market expanded at an extraordinary rate. By 2008, the nominal value of all OTC derivatives had reached USD 683 trillion, which indicates a tenfold increase over a span of ten years. The idea was to have risks distributed across the entire market. Mortgage agents received premium after every concluded transaction and the bank soon disposed of the loan. Thus in practice, this model drove actors to take excessive risks and made credit relations non-transparent. The so-called collateralized debt obligations (CDO's), derivatives handled in the shadow banking system, were also directly behind the outbreak of the crisis.
Thus the explosive expansion of the financial market, the spread of new type of financial assets and derivative securities, the emergence of the shadow banking system, as well as gradual deregulation, and a pro-cyclical operation and bubble-generating of the financial markets stood directly behind the crisis. However, a number of key questions still remain unanswered. Why did FED promote cheap loans? Why did deregulation take place? Was it because of individual mistakes, an erroneous ideology or the consequences of the changes occurring in the economic structure? I contend that the process of deregulation does not explain satisfactorily the reason why the crisis unfolded right in the given place and at the given time, thus the wider social-economic environment also needs to be studied. Only after that can we draw lessons and conclusions that could help avoid the emergence of a similar situation.

UNDER THE SURFACE: FINANCIALIZATION

In what follows, I will rely on some basic insights of institutional economics and political economy as starting points to claim that economic processes are always embedded in a given social structure and are in constant interaction with the state and other actors of society. Accordingly, the basis of the crisis is rooted in the changing of social relations, the process of the so-called
The term ‛financialization’ describes the complex process whereby the financial system has expanded both in society and geographically, and which resulted in the changing of the role it plays in economic flows. Through this process, productive and financial capital, as well as the relations between capital and labour, have become more and more embedded in financial processes. What resulted from this is that the financial system is less able to fulfil its classic economic function. On the one hand, emerging new assets serve profit-making without linkage to economic foundations and, as demonstrated by the crisis, they fail to contribute to the deepening of capital markets, which otherwise should ensure stability and the spread of risks. What happened was exactly the opposite: increasing profit pressure within the financial system led to non-transparency and instability. On the other hand, financial profit pressure transforms the operation of the productive sector. Neither political, nor technological changes can be understood without examining the social position of actors in the social division of labour, i. e. the balance of power between economic actors.
Profit rate in the American economy had seen a steady decline up until the beginning of the 1970's. In its background there had been a number of processes (primarily competition emerging in the peripheries and redistribution mechanisms created by the welfare state) which I do not have the chance to analyse here in more depth. The decline of the profit rate drove economic actors to seek new solutions via the use of assets, such as enhancing productivity (through flexible employment, generally longer working hours, maintaining real wages, beside technological innovations) and exploring new markets. Within the U.S. economy new markets were to be found in the areas of social services and finance. However, the increasing influence of the financial sector have also implied increased power. As a contemporary Hungarian institutionalist economist, Kamilla Lányi, put it:

The financial world as a power structure already operates in many respects as (symbolic) power that is built on authority. In this function it demands certain privileges: that the business world should accept the signals of financial and capital markets as genuine market signals; that governments should reckon with its possible reactions (its “mood”); and that it should be exempt from bearing the material and political consequences of its behaviour.”

There are numerous examples of the operation of the financial sector as a factor in power relations, ranging from the entanglement of Wall Street and Washington through lobbying to ideological influencing. Let me highlight here as an example the fact that the emergence of the modern derivatives market was not due purely to technological developments or the free interplay of supply and demand. Preceding the demand for them, the first market for derivatives in the U.S. was established in the 1970’s as a result of the conscious brokering activity on the part of financial investors with powerful connections. Although there are examples of futures and options transactions going back to earlier times in history, the modern form of derivatives – the essence of which lies in the fact that it broke away from the real movement of goods – have spread again since the 1970’s only. Learning from the lessons that their role in previous crises provided, derivatives trading had been illegal between 1906 and 1971 unless the parties were able to cover it with real transactions of goods. As a result of conscious political action, however, the role of derivatives was gradually revaluated in discourses, which was also enhanced by the legitimizing power of monetarists and the trust in option pricing formulas. Without the financial lobby, strengthened as a result of structural changes, the emergence of a modern derivatives market would have been inconceivable, given that it preceded not only market demand for them but also the widespread revival of neoclassical economics.
Thus the social structure maintaining the Keynesian consensus has transformed, the role of financial investors has gradually increased, while the influence of trade unions decreased. As a result of structural constraints, it had become more in the interest of the economic elite to promote privatization and financial deregulation. In the new economic structure, the conditions of social self-organizing had been constantly eroding, and it was not in the interest of the economic elite to maintain the Keynesian-welfare consensus any longer, therefore the coalition between industrial producers and the world of work began gradually to fall apart. Its consequence, the new course starting with the Reagan era, is well-known. However, we should not forget about the changes that took place in the social structure even when the focus is on examining the ideological debates and political reforms.
As a result of the changes in power relations, the state has taken a new role in economy as well. In this new development model economic growth had increasingly been founded on finance and the indebtedness of the population, while inequalities grew steadily, thus American society got even farther from the class compromise characteristic to the welfare state. As the privatization of public utilities progressed, new opportunities opened up for insurance companies and investment funds, giving positive feedback to, and strengthening the concentration of, financial capital. Starting from 2000, the American government sought to support the country's struggling economy by tax cuts and increasing military expenses. As Stiglitz also argues, while – contrary to expectations – tax cuts failed to stimulate the economy, they also created ever more favourable conditions for using financial capital for speculation. Therefore the task of economic stimulation was transferred to FED, a task it sought to reach by keeping taxes at a low level. The outcome was a fragile model of economic growth that rested on the indebtedness of the population, the expansion of the financial sector, on import surplus and capital inflow.
Financialization changed the economic structure. The share of the financial sector from the gross national product increased rapidly, which also transformed the modus operandi of real economy. Industrial production came to play a decreasingly decisive role, and in addition to the financial sector, those dependent on consumption and import also began to thrive. Owing to its exponential expansion, the role of the financial sector has gradually transformed, its intermediation function between savings and investments has retreated to the background at the expense of profitable financial undertakings. The result of such solutions, however, was only temporary and profit rate began to drop starting from 2000. This drove more and more investors towards financial speculation. Within the total level of profit, profit from the financial sector increased from 14% in 1981 to 39% in 2001. By 2006 more than 40% of the total profit level in American economy was made in the financial sector. Data presented by Martin Wolf indicate that return on long term investments within the financial sector was around 7%, while profit in the European bank sector was around 12%, and 20% in the case of banks in the United Kingdom. These high profit rates give evidence of a high level of leverage and increased risk-taking.
The strengthening of the financial sector presented concrete material competition, the result of which was that the share of real economy in the gross national income decreased. By the 1980’s and 1990’s the share paid to the financial sector in the cash-flow of non-financial enterprises doubled compared to the average in the 1960’s and 1970’s. On the other hand, more efforts were made in corporate governance to fulfil the requirements of the financial sector and shareholder-values came to the fore as well. Financial investors saw productive investment as one of the many opportunities to utilize capital. In this new model of corporate governance stock options acquired a greater role in bonuses rewarding managers. Using such bonuses, however, clearly indicates that short-term considerations became dominant, therefore obsession with quarterly reports meant that productive investments were increasingly made with the aim of short-term profit-maximization.
It is worth reflecting briefly on how the new model of corporate governance, shaped by the enfolding of financialization, contributed to the erosion of public utilities and to the further polarization of the power structure. As described in the literature on the varieties of capitalism , complex production processes required highly qualified and healthy workforce, therefore producers in the countries tend to rather take a share in financing public utilities. A columnist at The Washington Post pointed out that the education level of the American population had steadily increased up to the 1970's but since 1975 no improvement can be noted in this regard. In the continental model long-term planning continues to play an important role, trade unions still participate in decision-making on company level, as well as on the level of the national economy, income distribution is more even, and public goods are more widely accessible. The quality of public utilities is obviously determined by a host of other factors as well, nevertheless, it is important to draw attention to the way in which financialization – through the altered economic structure, stemming from the change in the position of finances – reacts to redistributive institutions and the power positions.
The World Wealth Report, published by Merril Lynch, gives a fair picture of the polarization effects of financial globalization. It reveals that in 2006 the wealth of the 9.5 million high net worth individuals of the world rose to around 40 trillion, which represents a 11.4% increase. The Boston Consulting Group found that the value of financial assets in the property of households holding an investment of at least USD 100,000 (representing 16.5% of all households) increased by 64% to reach USD 84.5 trillion. The dominant part of this wealth is included in the portfolios of households owning more than USD 1,000,000. Although these make up no more than 0.7% of all households in the world, they hold more than one third of the total wealth in the world. These are the investors who strive to generate huge demand for various financial investments in an attempt to ensure expanded reproduction of their capital. Thus the exponential expansion in finance is equally due to the immense fortunes concentrated as a result of financial transactions.
It is not only the dimension of assets where increased inequalities can be detected. Driven by financial globalization, there has been a significant decrease in the rate between labour income and portfolio income. A report published by ILO reveals that, compared with capital income, the share of labour income declined in three quarters of the studied countries. Latin America saw the greatest decline but there was a considerable change in the proportions in other industrialized countries as well, where the proportion of labour income dropped by 9% in contrast to capital income. Data from the U.S. give evidence of similar trends as well and IMF data also indicate that the proportion of labour income had gradually increased up to the beginning of the 1970’s but began to diminish thereafter (see Figure 2). Researchers at the University of California maintain that while the financial sector’s share from corporate profits showed a gradual and sharp increase, average real wages of the lower 99% of American population decreased by 6% between 1973 and 1999 in contrast with the 64% increase in that of the upper 1%.
Figure 2. Labour incomes in proportion to total national income

In the course of the financialization process, the real living standard of the majority of population deteriorated, meanwhile wealth concentrated on the top of the economic ladder to an extraordinary degree. Income polarization and the decline – or stagnation, in the best case scenario – of real wages gave rise to credit-based consumption among lower social classes. The use of credit cards, the proportion of loans for car purchase and flats bought from mortgage rapidly increased within the economy. The spread of credit derivatives, i. e. the deregulation of the financial market, along with the maintaining of low interest rates, contributed to the expansion of personal lending. In the 1970's an increasing share of Americans chose indebtedness in order to maintain the living standard they had been accustomed to. What is important to see is that not only lower social classes had required mortgages; credit derivatives sale and trade was also one of the most profitable businesses in the United States. Wealthy individuals and investment funds eagerly sought these risky investment opportunities.
The rise in private loans is key to understand the crisis. In Great Britain the share of loans taken out by individuals within the total increased from 11.6% in 1976 to 40.7% in 2006. A similar change can be noted in Japan and the United States as well. In Germany, the proportion of non-mortgage loans declined from 68.2% of the GDP (1972) to 26.8% (2006). Contrary to what neoclassical theory suggests, the United States and Great Britain achieved a relatively high growth rate because not only did savings rate drop steadily but also turned negative: in 2007 it stood at -1%, a level unprecedented since 1933. To explain this development, which is contraintuitive from the point of view of neoclassical theory, we must take a closer look at the imbalance of the global financial system. As we saw in the previous section above, such shifts were equally driven by the U.S. government through its policy to support flat purchase from mortgages as opposed to maintaining the tradition of social housing.
Financialization in the capitalist core countries did not take place in a self-contained economy but in a historically determined setting of the global division of labour. The American growth model implied a persistently negative balance of trade and considerable external debts, while the balance of payments surplus in Europe (particularly in Germany) and in Asia (in Japan and China), and dollar revenues of oil-exporting countries served as cover for the shortfall in the balance of trade. Increasing asymmetries in the balance of payments accelerated the spread of the crisis. The existence of a unified institutional environment and global regulation would have prevented the emergence of such a situation. Starting from the mid 1990’s, a number of developing countries accumulated considerable currency reserves in an attempt to ensure protection from the escalating financial crisis. To this end, they sought to achieve significant surplus in export and the balance of payments, while supporting the economy with implementing a conscious industrial policy on the one hand, and with maintaining exchange rate at a low level. Therefore the absence of global regulation and the spread of unilaterally implemented protection strategies against the flow of hot money are equally important components of the crisis.
Financialization therefore provides the socio-economic background to understanding the deregulation and liberalization of finance. Financialization refers to the fundamental change that the economic structure underwent, which also altered the power position of social and economic actors. Cross-class alliance and coalition within the elite, which maintained the Keynesian welfare consensus, broke up, the middle class is now less in need of solidarity from the lower classes, meanwhile the financial elite gained a dominant role within the economic elite. The advance of the financial sector also implied the retreat of real economy, together with increased competition within the productive sector and a decline of wages and salaries. In a changed power structure the transformation of regulatory and institutional environment also reflected the demands of the financial sector, as an increasingly influential group of actors were able to assert their interests in public policy decision-making. Increased debt level in the population and perpetual current account deficits highlighted the shaky foundations of the new economic model that emerged in the changed power structure and that economic development did not stand on grounds that are sustainable in the long term.
If we accept, based on the above, that financialization stands behind the deregulation and liberalization of the American financial sector, as well as behind the increase in indebtedness and the increased deficit of the balance of payments, then reforms must aim at more than re-regulation that promotes transparency and prudential behaviour. Without influencing the way the power structure evolves or facilitating certain coalitions within the elites and among classes, a re-regulated environment would not prove stable. This is what I will elaborate on in the final section of this paper, but before that let us take a look at the mechanisms through which the crisis affected the peripheries.
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THE CRISIS OF EASTERN EUROPAN SEMI-PERIPHERY

THE FAILURE OF INTERNATIONAL FINANCIAL MARKETS

Mainstream economic theory maintains that financial globalization in the past decades was the key to global development, without which even countries in the Far East would have been unable to achieve the spectacular growth that they did. Therefore re-regulation of the global economy, so the argument goes, must be carried out with great caution. The proponents of such an argument believe that there is no room for manoeuvring with development policy (see Thomas Friedman's famous metaphor of the “golden straitjacket”), which should not be a problem, as the countries that conform to the rules of the Washington consensus can expect capital inflow and economic growth. What is necessary to succeed in the global financial markets then is to put in place a predictable budget with surplus, ensuring an adequately low level of tax burden, and for the government to retreat from development policy. The countries that fail to follow this formula will fall behind. According to this view, this is what happened in Hungary, and this is the reason why the global crisis hit the country so hard, as was also argued by the former shock-therapy finance minister, Lajos Bokros. In the spirit of promoting the process of catching up with Slovakia and Romania as competitors, András Simor, Chairman of the Hungarian National Bank, shares a similar view , and so does the President of the National Bank of Serbia, who stated that “it was time Central- and Eastern European countries made the long due adjustment through budgetary and structural reforms (…) today of their own accord, rather than later under pressure from the market”.
Mainstream theory builds on two assumptions. One is that low savings rate and the underdevelopment of financial markets represent one of the most important obstacles to economic growth and development, therefore access to foreign capital and the improvement of financial intermediation mechanisms stimulate economic growth. According to the other assumption, the unfavourable consequences arising from the interaction of incentives for external lending institutions and domestic borrowers can be evaded by appropriate prudential regulation. In what follows, I argue that these conditions are not always met, therefore taking an undifferentiated position towards foreign capital implies grave mistakes, while financial globalization can not be regarded as the panacea for economic growth. Given that a host of prejudices prevail in Hungarian public discourse, let me quickly add that what follows from the above is not a fetishization of autarky but the need to abandon an uncritical stance towards international capital flows, along with implementing certain selective interventions in the financial market.
Just as instability in the American economy increased as a result of financial globalization, so did that of global economy. The formation of bubbles has been inherent in the development model of the past decades. Changes in the basic structure of global finance (the liberalization of capital flow) contributed to the escalation of local crises and their spread globally. A study carried out by ILO concluded that the frequency of financial crises had increased tenfold by the 1990’s compared to the seventies. An IMF study also reveals increased prevalence of crises in developing countries, which led to greater volatility in consumption and employment. According to Martin Wolf, journalist at the Financial Times, there had been altogether 38 financial crises between 1945-1972, while their number increased to 139 in the period between 1973 and 1997. There is no doubt that the global financial system has become unstable over the past decades. This instability poses serious danger for the periphery’s development. In the 1980’s, 0.6% of the GDP of developing countries was spent annually to cover the costs incurred by the crises, while in the 1990’s the respective value was 0.7%. The global financial market thus incurred substantial welfare losses.
What lies behind this is the market failures that I described in the first part of my paper. These failures can be noticed in international markets just as well as in national economies. Adding to this – on account of their institutional underdevelopment, fragility and dependence on capital – periphery countries are affected more powerfully by the volatility stemming from market failures. Moreover, while the monetary authorities more or less regulate the implications of system-wide risks for the national economy (although the U.S. crisis highlights rather that a far stricter control would be necessary), international institutions do not pay sufficient heed to system-wide risks accumulating in the global economy. This is so despite the fact that persistent balance of payment deficits on one side, and surpluses on the other, as well as the domino effect in international capital flow, all point to the existence of system-wide risks. The inflow of cheap loans may create real estate or stock market bubbles, which is what happened in the Asian financial crisis in 1997-1998 and what occurs nowadays in the Baltic countries. With a change in the investment climate, the bursting of these bubbles may have detrimental consequences for the entire economy.
Beyond volatility, financial globalization has unfavourable impact on the political-economic conditions in the countries of the periphery, it erodes budgetary incomes, shifts the balance of power towards mobile assets at the expense of non-mobile manpower resources, this way increasing the countries' vulnerability. First and foremost, it is important to notice that through its negative effect on tax collection, financial globalization diminishes general government revenues. The possibility of relocation in itself gives a powerful weapon in the hands of investors who can this way force the governments to make substantial tax reliefs and provide direct subsidies. The consequence of this is a downward tax and regulation competition. Although the tools and the exact costs of investment incentives are not made public in most cases (in Hungary there are only vague estimates for these), what we do know for certain is that tax exemption and direct subsidies are tools regularly used by governments. For instance, in 2001 there was fierce competition between Slovakia, the Czech Republic and Germany for hosting BMW's new plant. The winner turned out to be the city of Leipzig, as the German government granted BMW direct subsidy in the value of €418 million, which made up 35% of the total investment amount.
Beside direct competition, transfer pricing is also a product of liberalized capital flow also serving the purpose of tax mitigation. Transfer pricing allows enterprises to organise their internal accounting so that profit should appear in budget lines incurring the smallest amount payable of tax. Naturally, local small enterprises are not in a position to use this opportunity, only large ones. It was also the liberalization of capital flow that enabled tax heavens to become one of the main tools of tax mitigation. The amount of annual loss suffered by developing countries owing to the opportunities tax heavens offer amounts to around USD 500 billion. This amount is five times as much as the total amount of development aid. On account of the money flowing to these places, developing countries in practice have a negative balance with respect to cash flow: the annual outflow of USD 500 billion can hardly be compensated for with the inflowing USD 90 billion in aid money, direct investment of productive capital in the amount of 240 billion, or the money, transferred home by migrants, amounting to several hundred billion.
In sum, it can be stated that financial globalization increases the vulnerability of periphery countries through a number of mechanisms, the most important ones being speculation fever and bubbles, occurring as a result of market failures, and the subsequent capital flight. As I will come to it later, growth driven by hot money flow has unfavourable impact on the economic structure as well, thus undermining its own foundations. Another channel is the negative impact it has on budget revenues, which at the same time alters the power balance around distribution as well by driving taxation towards immobile labour for the benefit of capital.
In light of all this, it is not surprising that data indicate that on macro level the positive impact of financial globalization on economic growth is questionable. There are basically three market channels allowing foreign capital to flow into a country: through foreign direct investment (FDI), via portfolio investment and bank loans. Empirical data show that bank loans fail to contribute to GDP growth, portfolio investments do so to a small degree, and FDI serving production purposes does so the most (a 10% rise in the volume of FDI increases GDP by 4%). Furthermore, empirical literature does not produce evidence of short-term cash flow leading to additional investments. The most critical element then is hot money that generates volatility.

Figure 3. Financial globalization and economic growth
Vertical grid: average annual GDP increment (1970-2004)
Horizontal grid: financial globalization (external assets + external liabilities) in the percentage of GDP

Countries developing at a greater pace rely less on financial globalization and vice versa, the most “globalized” countries demonstrate a slower growth pace. Researchers at Harvard University, Rodrik and Subramanian, go even further with arguing the following:

Even if the impact of financial crises is put in parentheses, it is increasingly evident that financial globalization has no advantages. Neither has it led to investment activities, nor to a higher level of growth [see Figure 3.] Countries with the most dynamic expansion relied less on the inflow of capital. To support financial globalization, we could build only on indirect and speculative arguments that are far from convincing.

In the periphery those countries were able to achieve significant growth which successfully decreased the level of risks arising from financial globalization. Experience thus far shows that limiting cash flow on the short term does not create problems for long term FDI. Moreover, limiting hot money brings greater stability for a country that may become more attractive for investors this way.

EASTERN EUROPEAN SUBPRIME

In light of these theoretical insights, the crisis of the Eastern European periphery countries also shows a different picture. The possibility of national bankruptcy, speculative attacks against the Hungarian national currency, the forint, and OTP bank, have been powerful warning signs of the vulnerability of the Hungarian economy. This vulnerability is due partly to the mistaken governmental economic policy without credibility in the past years, partly to the structure of today’s global economic system, as well as the deficiencies of Hungary’s adjustment strategy. The story of a mistaken, extravagantly spending and economic policy lacking credibility is often invoked in public discourse on economic affairs in Hungary. State debt today is close to 70% of the GDP, therefore forint interest rates are extremely high, which has simultaneously prompted demand for foreign currency loans. Hungarian economy faced two serious threats on the short term. One was national bankruptcy, a condition when the state becomes incapable to finance its current expenses because the market of government bonds – its customary source of credit – freezes. The other threat is closely related to this. Had the state been unable to finance itself, it would have also lacked the necessary resources to rescue banks in trouble, as the United States and many Western European countries did do.
Arguments related to debts and overspending, however, do not hold in international comparison. On the one hand, the government bond market froze in the entire region at the same time, not only in Hungary – this points to the existence of system-wide risks and herd behaviour. On the other hand, those Baltic countries came to face the biggest trouble where budget deficit and gross state debt – the most commonly used indicators to measure “prudent macro-economic policy” were among the lowest in Eastern Europe. Budget deficit therefore in itself is not a satisfactory explanation. Thirdly, undoubted though that the scope of economic policy was limited by the level of state debt accumulated during the Kádár era, still no change was made in the development model even when the level of debt significantly decreased. On the other hand the World Bank assessed that the the Hungarian government’s capacity to shape the economy was still considerably strong. Fourth, it is simply untrue that the Hungarian welfare sate is premature. Social expenditure in proportion to the GDP is on the same level as in Slovenia and the Czech Republic, countries which have best surmounted the crisis, but this level remains well below the Western European average. Fifth, election cycles place pressure on the budgetary policy of every government, regardless the great differences across the Eastern European region, which can not be put down to only one common cause, unless we believe that Hungarian political elite is simply dumber than its counterparts in neighbouring countries – but this would hardly be a convincing social scientific reasoning. The characteristics of the crisis therefore cannot be traced back exclusively to the state of public budget, or to the unconvincing and overspending economic policy. The key is Hungary’s position in the semi-periphery, the strategy it chose to adjust to financial globalization, foreign economic and industrial policy or the lack thereof.
A common feature of Hungary and the Baltic states is exposure to financial globalization, the fact that economic growth was largely built on the inflow of foreign hot money. This has been made possible by the emergence of financialization in the countries of the core, as an increasing level of resources became available for speculative investments with credits and portfolio-investments flowing to semi-periphery countries at a great pace. As a result, profit in the financial sector has taken an increasing share of the generated revenue. Péter Róna calculated that every year in the course of the past five-year period, profitability of the Hungarian financial sector came close, or surpassed, the double the EU average. International data also show a similar level of anomaly. Investments in Central Europe made up 11% of the assets of BA-CA (Bank of Austria), which by now has become the property of UniCredit Bank. Whereas 54% of total profit came from this region in 2004. Annual profit increment in the Central European region was 15% between 2003 and 2007. In the same period Erste Bank increased its profit in the region by 35% on average. In Hungary, as well as in some other countries of the region, the financial sector came to be a key player and the most dynamically developing sector in the economy
The decreasing significance of productive activities within credits and the fact that individuals gained more into the focus (credit card, mortgage loans) indicate a change in the function of the financial sector. What added to this practice was also the stagnation-decrease of real wages in the core countries and the insatiable appetite for consumption of Eastern Europeans emerging from their shortage economies.
As we have already seen, there had been a steady increase in the share of public loans in most of the major capitalist economies. This trend can be noted in the Eastern European semi-periphery as well. For instance, the share of private loans within the credit pool of Bulgaria’s five leading banks rose from 6.8% in 2001 to 40% in 2008. In Hungary, close to one third of total lending was in private loans in 2008.
Foreign-owned banks, dominating the region’s bank system, developed a risky practice, similar in many respects to the American practice of lending. Alike the Baltic states, Hungary witnessed a great inflow of foreign currency loans (see Figure 4.). Foreign currency interest rates were far lower than forint interest rates, with the difference amounting to even 10% at times, therefore foreign currency loans allowed the realisation of a much greater profit level. In addition, in the private loan market banks used a higher surcharge, which means that they pocketed a large part of the difference in interests. This is topped by the fact that although the interest rate of the Swiss franc or the EURO hit rock bottom, dropping to a historically low level, the forint rate increased again after the first phase of the crisis, inter-bank lending started, and not only did Hungarian banks failed to decrease interest rate on loans but increased it instead, which allowed them to make huge profit again through the crisis. The Hungarian Financial Supervisory Authority (PSZÁF) reported that Hungarian financial institutions produced HUF 116 billion before taxes in the first quarter of 2009, which was 25% more than in the previous year. So in the middle of the crisis annual profit in the bank sector was more or less at the same level as the amount the government is saving through the austerity measures affecting budgetary expenses, pension, public sector wages and welfare expenditure.

Figure 3. The ratio of foreign currency loans within the private credit pool of banks

By providing foreign currency loans, the banks made their operation dependent on short-term foreign currency inflow, as only a negligible share of private and business savings were in foreign currency. Short-term loans are risky assets, however: should the banks cease to trust each other, then the “taps will close”. This is what happened in Hungary as well, and this is the reason why the country was exposed so much to the outflow of hot money. Banks found it increasingly harder to cover their liabilities. This is where herd behaviour – which is characteristic to financial markets and which generates more substantial swings compared to the equilibrium price – turned negative. Investors became increasingly disillusioned with Hungarian assets, they began to withdraw money from the system, which resulted in a reversion of capital flow, the forint rate began to drop, loan repayment were endangered and the liquidity of banks deteriorated further, which aggravated trust among investors, when finally panic broke out.
The hands of Eastern European countries in crisis were tied. In the chosen integration model, capital flow is a non-existent option – whereas today it is clear that the crisis management package of the countries that had best surmounted (China, India and Malaysia) the East-Asian currency crisis included an important tool: limiting capital outflow. Thus the only option was to cut budgetary expenses, raising funds from international organisations, which again limited the scope of economic policy.
The shattering of growth that is built on consumption financed from short-term loans was only a question of time. Excessive risk taken by the banks – the Eastern European subprime emerging in the form of foreign currency lending –, the system-wide risk thus accumulating and the failure of international financial markets all forecasted the bursting of the Eastern European bubble. Beyond instability, however, the functional change of finance had a negative effect on real economy in the periphery just as well as in core countries.

DEPENDENCE AND DUALITY

In the absence of adequate foreign economic and industrial policy, financial globalization brings about the splitting of the economy. This fragile economic structure added to the vulnerability of the economy through negatively affecting job creation and budgetary revenues. Similarly to most countries in the region – except Slovenia and partially the Czech Republic –, Hungary committed to an “embedded neoliberal economic model” in the 1980’s.
Beside the maintenance of certain redistributive mechanisms, its essence was the relatively rapidly implemented processes of liberalization and privatization (as compared with the gradualist Slovenia and China) and, partly through this, export building on FDI. By the end of the 1990’s, however, dynamic capital flow slowed down for two reasons: the volume of assets available for privatization decreased dramatically, while cheap labour force was no longer available to build on, given that other countries in the region “woke up” and launched a massive social campaign to attract capital, while the tax burden on the labour force in Hungary kept increasing at the expense of tax income. Today tax relief can no longer be applied as a technique to attract capital, as the EU imposes stricter sanctions to prevent tax competition, demanding that such benefits should no longer be granted.
Besides, speculative money and cheap loans flowing into the region since the 2000’s financed primarily the purchase of consumer goods, so they did not really contribute to the augmentation of economic growth, instead they deteriorated the balance of trade, as a great part of these consumption goods came from import. Driven by increased import competition and the lack of industrial policy, industrial production faced serious challenges in the Baltic countries, which is clearly indicated by the fact, for instance, that complex industrial export falls behind in regional comparison.
Economic growth in the Baltic countries was driven largely by the inflow of speculative money and consumption financed from loans. In Hungary, various factors came together to prevent these mortgages from causing a real estate bubble, while in Estonia and Lithuania this was not so (see Figure 5). The hot money that flowed into the country ended up in property investments, which resulted in considerable hikes in real estate prices. The bursting of a similar real estate bubble must sound familiar for the reader.

FIGURE 5. Increase in real property prices between 2001 and 2007

Hungary is in a better position than the Baltic countries in an important respect, namely in that investment flowing into the complex productive sector is much more significant. Nonetheless, in the absence of an appropriate industrial policy the FDI-intensive sector exists as an “enclave” in Hungarian economy, thus undermining the basis of long-term economic development.
Following from this, Hungarian economy split into two, similarly to what happened in the economy in the Baltic countries, into an effective and dynamic sector of foreign owned enterprises, and into a stagnant, domestic SME sector that falls behind in efficiency and opportunities. We can say that there are only weak, real connections between the two parts. There are three important factors behind this split: the above-mentioned tax reliefs; the taxation of labour, which was given more weight as a result of capital mobility; as well as the lack of industrial policy devised for the complex development of the local economy. As a result of these factors, the foreign sector cut down on the use of labour by stopping job creasing, replacing it with capital investment.
As a consequence of overcapitalization, it is now less worthwhile for foreign enterprises to invest in Hungary. On the other hand the Hungarian SME sector have no room to grow because of its position, as it is basically unable to access capital, and because it is unable to cross the threshold necessary to succeed in the competition. Capital-intensive banks give preference to personal lending and to multinational enterprises over SMEs. SME’s in Hungary are in the worst position to access credit: a Eurobarometer survey carried out among SMEs found that in Hungary only 33% of SMEs found it easy to obtain bank financing, in contrast with the Eastern European average of 54%. This, however, does not mean that SMEs are thriving in Eastern Europe, on the contrary, their share within the total bank lending has been stagnating for years in the entire region. Beside personal lending, foreign owned banks usually give preference to providing credit for large corporations in foreign ownership. Although the SME sector should be providing the bulk of employment, as a result of unilateral dependence on financial globalization, SMEs are in an unfavourable position across the region. EBRD found that the chance that SMEs in the region find it difficult to access bank loans on average is twice as high as in Western Europe. The position of SMEs is further aggravated by that fact that, given a shortage of capital, employment builds on tax mitigation, which prevents the application of corporate management techniques that would increase efficiency and transparency. The sector of multinational companies therefore exists in isolation in the Hungarian economy, its productivity level is 3-4 times higher than that of domestic companies. The growth of this sector, however, is encumbered not only by over-capitalization but also by the fact that its outlooks depend to a large degree on the economic performance of some Western European economies.
There is no doubt that the inclination of Hungarian politicians to overspend and the subsequent accumulation of state debt significantly increases Hungary’s vulnerability. However, growth built on credit-based consumption and the consequent exposure to hot money, as well as the dual structure of the economy are features characteristic to semi-periphery countries which – in the absence of adequate foreign economic and industrial policy – chose an inadequate adjustment strategy to financial globalization. Thus the reasons behind the crisis in Hungary lie more in the system-wide features of globalization rather than in some peculiar political disease. The neoliberal development model failed in Eastern Europe, just as much as in the United States. Vulnerability to the crisis in the region correlates with the level of exposure to financial globalization. Those countries that built their economic growth on the indebtedness of the population and the inflow of hot capital as a result of overvalued currency (Hungary, Latvia, Lithuania, Bulgaria, Ukraine) and failed to concentrate on establishing a strong and single local economy, were more exposed to movements on the international financial markets, as those countries which built their growth on export and the strengthening of their local economies. Although this semi-peripheral dependence was unstable in itself and did not project a sustainable path in the long run, the crisis highlighted more the deficiencies of this model.

CONCLUSIONS AND TRANSFORMATIONS

The 1997-1998 economic crisis in the Far East triggered a discourse about the necessity to base global economic regulations on fundamentally new grounds. Back then, however, the crisis did not spread as far as the capitalist core countries, therefore the debate soon subsided and the only conclusion the governing institutions of the global economy drew was that a prudential macro-economic policy should be promoted. The situation is different now providing some cause for hope. Under pressure from the German and French governments, the final communiqué of the G-20 Summit in Pittsburgh called for the introduction of a global transaction tax. It remains to be seen whether it is realistic to expect that with Germany’s new government of the CDU-FDP coalition such a financial regulation, sort of an extended Tobin-tax, would indeed be put in place. It is important that the re-regulation of finance should not be confined only to the institutional promotion of greater transparency (regulation of OTC markets) and prudent behaviour on the part of the banks. This view would not represent a break from the paradigm that suggests that the market is able to handle risks. System-wide risks pose a serious challenge even for the best risk-analysts, which leads to the volatility of the financial markets. What is needed therefore is system-wide re-regulation, pre-eminently reducing transferability and containing speculation, which would this way stabilize the system.
Although the crisis is directly rooted in deregulation, deregulation in turn is embedded in the transforming wider social context. Therefore a crisis management programme must be elaborated with a view to this – the power structures that should be promoted are ones which stabilize the new financial-economic environment. Thus crisis management measures can be divided into two groups: one group aims to curb speculation and eliminate system-wide risks, while the other includes intervention measures that seek to prevent the re-occurrence of surplus liquidity, to fend off efforts at the circumvention and the reshaping of regulations, to transform the pattern of power relations, and to reverse the processes of wealth polarization. Despite the decrease in real wages, the market-Keynesianism maintaining demand through increasing indebtedness of the population must be replaced with a policy that brings real improvement in the wealth and income position of large segments of society, thus building economic growth on more stable grounds. What is needed then is an action plan consisting of a complex system of medium- and long-term measures, which should be implemented partly locally, partly on regional level, and partly in international partnership.
The consequences that follow from the above for Hungarian politics are the following. On the one hand, Hungary’s external debt path must be settled and made sustainable in order to ensure the reduction of the real interest rate. This requires growth which, however, does not aggravate any further the division of the economy, does not increase Hungary’s energy demand, nor income differences. To this end, dualism in the economic structure must be eliminated: equal competitive conditions and complex development programmes, tailored to the SME sector, are both needed. The reshaping of the tax system may also help putting and end to the malfunctioning economic system: the level of employment-related contributions and taxes must be decreased, while taxes on resources and on consumption increased. Tax relief and subsidies provided for the multinational companies must be stopped and efforts must be made to ensure better access for the SME sector to money (credit and capital).
Hungary has little chance to influence international economic governance, however, the current situation provides a unique opportunity for the country to distinguish itself by supporting such positive and forward-looking proposals and initiatives. As part of international cooperation, the government must be step up for restraining profit repatriation and transfer pricing, making sure that money does not move. It must support the taxation of stock market profits, as well as the Tobin-tax to be imposed on financial transfers, thus constraining short-term speculative moves and “cooling” the financial system. It is equally important that Hungary should take part in efforts aiming to put an end to tax heavens. Stricter regulations should be applied to credit rating institutions that had performed atrociously and which – against all warning – generated the extension of risky loans. Finally, international cooperation should ensure that the operation of the unregulated hedge funds – which are specialized in speculation and institutionalize short-term thinking – is radically limited.
A new aim must be set for the economies. Credit-based consumption, which amassed debts and which came to be the foundation of world economy over the past years, is unsustainable not only from financial but also from an ecological point of view. The development model we must choose and the goals we need to set should be such that are able to reinvigorate the real economy in a way that they do not increase financial instability, while also contribute to mitigating climate change and ecological crisis. As the outcome of these changes, capitalism will not be replaced but – similarly to the measures brought after the crisis in the 1930’s – will be placed on new foundations. The task is to form a new kind of capitalism with smaller inequalities both globally and within individual societies as well, in which real economy is not subordinated to the financial sector, where SME’s providing job opportunities have access to investment resources just as much as large corporations, where the peripheries are provided real chances for development, and in which more labour-intensive and resource-saving means of production provide solution for unemployment and poverty.

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