How serious are the sources of vulnerabilities and uncertainties in global and national financial markets?

Prof. Univ. Dr. Nicolae Danila
President of the Section of Economic, Sociological and Legal Sciences of the Academy of Romanian Scientists
October 2023

LARRY ELLIOTT: “THE AGE OF GLOBALISATION IS NOW THE AGE OF INSTABILITY – AND WE NEED A PLAN” (The Guardian, April 2023)

• More and more people are coming to the conclusion that the banking system is sound. But lately there are signs that invite us to adjust some of our views in line with current and prospective reality. We are called upon to ask an essential question: “What are the implications and consequences of the current state and soundness of the banking system, the soundness of the financial system, for the functioning of the economy in each country and how does the future shape up?”

High and persistent inflation, geopolitical and climate change require responses accompanied by decisions and solutions.

• In constructing a possible response we need to look at the sources and causes of the vulnerabilities and uncertainties that have emerged and challenged us in recent years.
• The pattern of the world economy has undergone and is undergoing major transformations. According to World Bank analysis, the global economy is heading for “a lost decade” economically due to developments triggered by the Covid pandemic, war and inflation. I BELIEVE THAT THE FOLLOWING FACTORS ARE MAINLY AFFECTING THE ECONOMIC PROGRESS OF MANY COUNTRIES: AN AGEING WORKFORCE, FALLING LABOUR PRODUCTIVITY, A REDUCTION IN THE VOLUME OF INVESTMENT AND A RISE IN PUBLIC DEBT TO RECORD LEVELS. THIS LIMITS THE POTENTIAL FOR ECONOMIC GROWTH. AT THE SAME TIME, CONTAGION FROM THE IMPLICATIONS OF A POSSIBLE GLOBAL FINANCIAL AND BANKING CRISIS MAY LEAD TO THE ONSET OF A GLOBAL RECESSION.

• The new paradigm is characterised by increasing the value of financial assets at the expense of wage income and investment. The result: loss of competitiveness of firms and the national economy, lower labour productivity and deepening social inequalities.

• INCENTIVES FOR SAVING AND INVESTMENT IN HIGH VALUE-ADDED INDUSTRIES ARE KEY CONDITIONS FOR THE FUTURE OF EVERY NATIONAL ECONOMY. EFFICIENT AND EFFECTIVE USE OF NATIONAL RESOURCES (NATURAL, FINANCIAL AND ESPECIALLY HUMAN) IS A PRIORITY.

• We are witnessing a widespread and dangerous phenomenon in almost all countries: rising public and private indebtedness that is becoming increasingly unsustainable

• We ask ourselves: what has happened to economic growth, to labour productivity growth, how are the risks leading to financial instability manifesting themselves and what is the current and future evolution of inflation?

• We get complacent and are tempted to buy imported products (maybe the quality/price ratio? which is the reality most of the time?) at the expense of those that are or could be made domestically. We don’t seem to care much about the evolution of the current account and the debt phenomenon. Nor of the deepening deindustrialisation of the country. What do we put instead? Which branches can make us competitive, which fields are becoming more attractive and can highlight the good training of young people following significant investments in education, thus making it possible for more graduates to decide to stay in the country.

• The trend of rising and sustained high interest rates in the context of rising public and private debt is reducing the ability of governments, businesses and households to borrow. There is pressure on the requirement to lower interest rates. I believe that economic growth will be negatively influenced in the coming period due to a possible spectre of a global banking crisis that will lead to tighter regulations on financial markets followed by a possible narrowing of the range of financing sources (or if they are found, they will be “offered” at high interest rates due to higher perceived risks, but also due to the trend in monetary policy interest rates aimed at reducing inflationary expectations and strengthening financial stability).
• We are dealing with structural problems at national level.
• The situation can be described quite simply, but the reality in its depth is complex and very risky: continued borrowing to finance deficits unaccompanied by an innovative, forward-looking, well-proportioned strategic allocation of budgetary resources leads to the disappearance or non-implementation of the conditions for new revenue-generating activities for a wide range of beneficiaries, including the budget (from which to service and repay the debt).
• Over the last 20 years, the level of debt, especially public debt, has far exceeded the level of public investment. We should be concerned about this challenging situation: maintaining the sustainability of the debt stock at all times and possibly continuing to finance it through borrowing (at what cost and in what amounts?) We need to identify and implement the basic parameters that will ensure that debt reduction becomes credible and will lead to fiscal sustainability, while being compatible with economic growth and job creation. It can be argued that an increase in public debt that is currently manifesting itself does not identify immediate risks to debt sustainability, however, vulnerabilities in fiscal positions will certainly increase as debt refinancing will be done, among other things, at increasingly higher interest rates.
• WE NEED TO SOUND THE ALARM: NEVER IN THE HISTORY OF AN ECONOMY HAS THERE BEEN SUBSTANTIAL AND PROLONGED ECONOMIC GROWTH WITHOUT AN INCREASE IN INVESTMENT IN THE BRANCHES THAT BRING PROGRESS.
• THE “NEXT GENERATION EU” RECOVERY PLAN AND OTHER FINANCIAL RESOURCES FROM THE EU THAT CAN SUPPLEMENT DOMESTIC FINANCIAL RESOURCES ARE MENTIONED, BUT FINANCING ALONE CANNOT BRING RECOVERY TO THE NATIONAL ECONOMY IF THE DOMESTIC MARKET CONDITIONS FOR INVESTMENT AND ENCOURAGING ENTREPRENEURSHIP ARE NOT SIGNIFICANTLY IMPROVED.
• Interest rates should be lowered gradually, in line with the specific conditions at each stage and the objectives of achieving financial and macroeconomic stability. Low interest rates during the Covid pandemic and after the 2008 crisis have shown that they do not encourage investment, but rather keep money in various forms of liquidity or engage in speculative and risky transactions. The period of low interest rates was a form of indirect ‘taxation’, of indirect ‘penalisation’ of households and firms. In fact, encouraging the shift of savings into liquid and immediately liquid assets has strongly affected long-term investments.
• Financing the transition in the current economy by encouraging and increasing savings and investment requires strengthening financial stability and a risk/return ratio that is as well balanced as possible in the context of the conditions created in a domestic market.
• The gap between potential growth (characterised by low unemployment and very low inflation) and real economic growth is continuously widening. The negative influence comes from the supply side and to a lesser extent from the demand side.
• What do we observe? Countries facing structural weaknesses prefer to borrow (apparently ignoring the ever-increasing financing costs) instead of launching structural reforms that would, among other things, reduce deficits.
• A dangerous phenomenon that has generated “moral hazard” has been the transfer of many risks from the private to the public sector. The private sector has been encouraged to take excessive and unsustainable risks in search of immediate and substantial gains. We note that the phenomenon of moral hazard “flourished” especially during the period of excessive monetary policy accommodation in some countries.
• Maintaining a strong and flexible monetary policy is an essential and immediate requirement in the current environment where we are witnessing high inflation, which is a major risk factor. A professional flexibility in the monetary policy interest rate, accompanied by other measures if necessary, contributes to strengthening financial stability. I BELIEVE THAT WE SHOULD NOT ASK THE CENTRAL BANK FOR MANY MEASURES TO BE IMPLEMENTED IMMEDIATELY, BUT THAT WE SHOULD ASK FOR DECISIONS AND SOLUTIONS REALLY LINKED TO THE ACHIEVEMENT OF FINANCIAL AND MACROECONOMIC STABILITY, THE LAST DESIRE TO BE ACHIEVED THROUGH COORDINATION WITH GOVERNMENT POLICIES.
• An appropriate weighting of fiscal and budgetary policy interventions and solutions in relation to monetary policy is therefore necessary in the common effort to ensure the optimal achievement of macroeconomic stability and sustainability of a positive trend. We can thus avoid increasing social risks and discontent, employee instability, especially in productive businesses, and other complex negative phenomena such as exchange rate developments, thus strengthening national predictability.
• The determined involvement of all market decision-makers, not just the Central Bank, is needed. I am referring mainly to the work of the government, which decides and implements fiscal and budgetary policies, accompanied by the necessary structural reforms. It is necessary to avoid an expansionary fiscal policy (an instrument of a pro-cyclical policy) which can diminish the expected effects of implementing monetary policy decisions. Effectively and efficiently implement the long-awaited policy mix at national level to ensure a sustainable trend with positive effects in the medium and long term. National policy thinking and practice are called upon to address transparently in the medium and long term the priority areas of the national economy, namely productive public investment, social, environmental, energy, digitalisation, infrastructure, R&D, innovation and skills.
• I BELIEVE THAT IT IS DANGEROUS TO FOCUS POLICY DECISIONS SOLELY OR MAINLY ON REDUCING PUBLIC DEBT IN ORDER TO ACHIEVE THE TARGET RECOMMENDED BY THE EU. IT IS NECESSARY TO IMPLEMENT A BALANCED GOVERNMENT POLICY PACKAGE TAILORED TO THE SPECIFICS OF THE NATIONAL ECONOMY AND COVERING THREE ASPECTS SIMULTANEOUSLY: REDUCING PUBLIC DEBT, INVESTING IN AREAS THAT ARE CONDUCIVE TO PROGRESS AND GENERATE HIGH ADDED VALUE, AND STRUCTURAL REFORM. WE ARE DISCUSSING A RECIPE FOR SUCCESS IN THE CURRENT NATIONAL AND INTERNATIONAL CONTEXT.
  I bring up an issue that must concern us and that requires us to take an active position in EU fora. More and more experts are pointing out that the one-size-fits-all rule does not apply favourably to every country. In negotiations with EU decision makers, we should bring the necessary arguments to highlight the specifics of the Romanian economy, the situation of economic performance and especially the situation of public finances, where problems have accumulated that require time for the necessary adjustments to bring sustainability. A long-term, more flexible and differentiated country-by-country approach is needed, with a programme of reforms and adjustments supported financially and politically both internally and by the EU institutions. Recently the Polish Minister of Finance said: “The diversity of EU Member States should not be perceived as an obstacle, but as an opportunity” (September 2023). We are members of the EU, but we have not yet completed the country project, namely integration into the Eurozone, the Banking Union and the Capital Markets Union, Shenghen, which would put us on an equal footing with other EU members. I’m trying to paraphrase an Arab proverb: if you want to go fast, go alone. If you want to go far, let’s go together.
• One of the main objectives at national level is to promote real long-term sustainable economic growth characterised by facilitating conditions that produce gains in labour productivity and competitiveness of the national economy.
• A postponement of structural reforms in conjunction with a policy of increasing indebtedness without beneficial outcomes in the economy in the medium and long term CANNOT BE A SUSTAINABLE OPTION. Rising prices and interest rates will reduce purchasing power and reduce the expected effects of any fiscal or social stimulus (necessary objective).
• THE KEY ELEMENTS OF LONG-TERM SUSTAINABLE ECONOMIC GROWTH BELONG TO THE SUPPLY OF PRODUCTIVE CAPITAL WITH ITS BASIC COMPONENTS, HUMAN AND PHYSICAL CAPITAL.
• ACHIEVING SUCH A TARGET BECOMES POSSIBLE THROUGH POLICIES THAT EMBRACE THE FOLLOWING PRIORITIES: ACTIVATE SOURCES OF REAL GROWTH AND INCREASE INVESTMENT, INCREASE PROFESSIONAL SKILLS AND SKILLS OF THE WORKFORCE (both at the executive and “talent people” levels), WAGE ADJUSTMENTS THAT ARE WELL TARGETED AND DOSED, INCLUDING AND FINANCIAL EDUCATION.
• We need to find the best solutions for the CONDUCT AND MANAGEMENT MODEL OF THE NATIONAL ECONOMY through bold structural transformations. Otherwise we continue to face challenges, vulnerabilities and uncertainties.
  
  I am reminded of the words of Jacques de Larosiere: “We must get out of a model that privileges illusion over reality”.
  (2022).