International Political Economy


 In the past decades, the media has often been sprinkled by debates regarding the future of the pensions system. Almost every time, the debates revolve around the unsustainability of current system and the need for reform. There are a few ideas on how to deal with this problem, like reducing the value of pensions, increasing the retirement age or moving towards private pension schemes. Unfortunately, these are temporary solutions that don’t solve the deeper problem which created this situation, which is the accelerated population decline of the developed countries.

How does the pension system work?

The pension system works like a loan between generations and is highly social in nature. To understand it, divide the population into 3 groups:

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What you are being told

You are paying a contribution to a large, government controlled fund, which then redistributes your contribution to those who are retired.

How it really works

The public system

In a nutshell: The active population is paying for the education of the young population so that when the young become active, they will be able to support themselves, their family, have a better life and a decent income. In turn, the young population when it turns into active population returns the favour by paying for the pension of the former active population, which has now turned into a retired population. This scheme has sometimes been called – a loan between generations.

The private system

Your pension contribution is largely invested in government bonds, since they’re the safest bet for maintaining the value of your contribution. Also, a small percentage of your contribution is used for financial investments. These investments can take many forms, but it’s not uncommon to be gambles on the stock market. The result is that your contribution is kept at a relatively fair value so that when you retire, you can get a good pension. The downside is that the company that invested your pension may go bankrupt and you are left with no pension or have your pension drastically reduced. This has actually happened in Argentine (2001) or with some pension schemes in the US and UK: example.

The mixed system

Throughout your life the state takes a certain percentage of your monthly salary and uses it for long term investments. These investments maintain the value of your initial contribution over long periods of time. After you retire, your contribution is returned to you in the form of pension. The value of your pension is calculated depending on the overall value of your contribution.

So what’s the problem?

Image

 The problem is related to how the overall social and economic system works. The above pyramids highlight the 3 areas of the population: the young, the active and the retired.

 In the developed countries, up to the 1970s, the distribution of the population was similar to the one in Angola: a small peak representing the retired population, a large middle section representing the active population and a large base representing the young population. Today, in the EU and in the US, the peak is becoming larger and larger, while the middle and bottom sections are gradually becoming smaller. As a consequence, the middle section is having a hard time coping with the (financial and economic) pressure exerted by the upper section.

One of the long term solutions is to de-couple the retired population from the active one by developing pensions schemes (be they private or public), which act like saving accounts for the population. Unfortunately, in the large scheme of things, it doesn’t really matter how you package the pension, since the economic and financial needs of the retired population still need to be fulfilled one way or another by the active population. The retired population is (in theory) a pure consumer, it doesn’t generate wealth and thus the state still needs to support itself from the active population (which is becoming smaller and smaller). In the same way, the interest generated by private pension funds is also highly depended on how well the active population is doing. The private pension funds generate their income and profit by investing in the activities of the active population and thus are depended on it for maintaining the value of your pension.

As a consequence, regardless of how you look at the problem, the current pension system is in difficulty, because the active population is unable to generate the economic wealth and financial resources needed to support the retired population at current levels. The short-term solution is to adjust these levels, either by reducing the value of pensions or by increasing the retirement age, thus reducing the number of people retiring every year.

Another quick way out of this situation is to increase the pool of the active population through immigration. Additionally, in developed countries, immigrants have the tendency of making far more kids than the local population (source), further strengthening the bottom sections of the population pyramid. This is a fair and decent solution for the survivability of the country, but it also marks a turning point in its society, because basically what is happening is that the local population is slowly being replaced by a new, foreign population.

The ideal solution?

Image

The ideal long-term solution is when the population remains stable over-time. This means that every year, the number of people who die must be almost equal to the number of new-borns. Thus, the population doesn’t change fundamentally over-time and it’s able to sustain itself. To have a stable population, a country requires that the local population has a fertility rate of 2 (basically each woman has to have 2 kids in her life-time). By comparison, in most developed countries fertility rates are very low, in Japan for instance, the fertility rate is 1.39. There is no indication that fertility rates will increase in the foreseeable future, and most of the current increase in fertility rates is the result of immigration, since immigrants usually have a fertility rate between 2.25 and 2.5.

P.S. Another (but far-fetched) solution is to discover means to increase the life-span of the population and maintain its youth for much longer periods of time. Sci-fi as it may seem, it does make the entire argument regarding pensions and population distribution entirely mute, since in world where everyone is young and eternal, such an argument is meaningless.

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I cannot help to think that something is terribly wrong with our world. I cannot pin-point it, I cannot say for certain what it is, but it is there, like a splinter in my mind which gives no rest.

I know for certain that this feeling is not something which is specific to myself, but it is something shared by many people.

The difference is that for each us it manifests in a different way. We feel something is wrong and we try to blame it on something, like the stupidity of others, or the government, or the capitalist system, or inequality, or whatever else you can think of… but never ourselves.

Remarkably, all these issues we try to blame are social in nature, and far-reaching, indicating some sort of social connection between ourselves, our problems and our social world. Yet this is somewhat puzzling in a world where each of us thinks in a highly individualistic fashion. Basically, what happens to others shouldn’t affect us. Problem is, this works both ways, if we don’t care about others, then so will others not care about us.

My impression is that somehow we have lost ourselves along the way to modernity, we no longer identify with anything and we try to fill in that void with all sort of issues which, in our view are of concern for everyone. Basically we want to do something that matters and it is noticeable. We search for these issues which are social in nature because we want to be part of something larger, something that gives meaning to what we do. I am fairly certain that while this will patch up our need for social importance and consequently for identity (since our identity is constructed in relation to others) , it will not solve it. We are still making a mess of our planet, we are still trying to live on the back of others without even realising it, and we are stuck with the same social and political issues for decades. We may solve one or two minor problems with our social activism but the big issues are still there, pressing on us, while the average less-social-minded individual dreams of getting a well-paid job and a fancy car. Unfortunately, the more we dream of these material things, the less common they will become since they will not solve our real problems and not make our world better, in fact they lead to the opposite result.

Part of this problem is also because for many years the need for social identification and meaning was filled by religion, but with religion adapting or disappearing in our modern society, now there is a void that needs to be filled with something.

While I cannot give a clear argument for why our modern society has somehow stripped us of ourselves, (in short) my impression is that our modern way of life is at odds with what we are supposed to do; with our fundamental thoughts, feelings or instincts. Maybe the world we create is not compatible with the world we are made to live in. Sometimes, what we think is better, is not necessarily what is better. Maybe this is the splinter that we feel but cannot understand. In in the end, it’s easier to bury our heads in small things that give short-term pleasure, just like a chubby girl eating chocolate when she is upset because her friends told her she is fat, instead of facing the harsh reality.

Time will tell if what we do today is right or wrong. As evolution will continue to shape us both physically and socially, the social systems and personal philosophies that are inefficient will die out. If our world fails, there will be others to take its place. My only concern is that we could have achieved so much and yet we achieved so little.

The funny bit is that, we are not even certain any more who this “we” I just mentioned is. Our problems may run deeper than anyone can imagine.

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Throughout the past few years I have constantly found myself in conflict with the self-centered, present-focused attitude that dominates our society. It is pointless to discuss the divide between the individual and society, between private and public, between agent and structure, between liberalism and utilitarianism which all fundamentally deal with the same problem: Which matters more, the individual or the group as a whole? The obvious answer is both, but the less obvious answer is in what way.

Regardless, this is not what I wanted to discuss. Rather the issue that I wanted to discuss is the lack of perspective in modern day people (in developed countries). By perspective I mean a wider conceptualisation of the world in terms of time. Most of us strive towards short-term benefits like having a nice car, a successful career, social recognition or in less fortunate cases, towards having cloths and food for the next few days. While for some this perspective exists because social and material constraints force the adoption of such a view, there is also a large number of people for whom poverty is no longer an issue and thus they can focus on more complex achievements. Unfortunately, a present-focused view of the world limits the scope of achievements to only those that can happen short-term, forgoing more complex ones that require more time and show benefits later in the future – in some cases well after we are dead. To present my dilemma more clearly: How many would be willing to dedicate their time for future achievements, thus sacrificing some of their well-being today so that future generations would enjoy a better life?

My guess is that very few.

It is as if almost everyone adopted the Keynesian view of “in the long run we are all dead”. The future no longer matters and it remains only in the dreams of Sci-Fi writers and movies.

But has it not occur to anyone that if we no longer care about our future, we may no longer have one?

With all attention turned towards the struggling economies of the developed world it has become less and less important what happens to other parts of the globe. However, in the current economic downturn one must remember that globalisation has NOT disappeared over night. In fact we are pretty much in the same interconnected world we used to be before all this mess started. This means that what happens in one part of the world will, in one way or another, have repercussions on the other side of the globe. So taking this into consideration, we should then at least show some interest to what happens to other parts of the world, especially those which are strongly related to the West and its financial system/crisis.

The issue

Since November last year (2008) exchange rates across Central and Eastern Europe have been plummeting at unexpected rates. Some have even reached lows that have last been experienced in 2003. Obviously the first suspect is the world financial crisis, but this is just a simple explanation that overlooks the deep roots of the problem and what its repercussions might be on the Western countries.

Why are the rates plummeting?

There are 3 main reasons:

1. Western banks and investment funds have been investing heavily in emerging markets. This is because, as these markets are on the rise and many of their assets are under valuated, there is a good chance they could make a nice profit while maintaining a relative low amount of risk. And one of the best emerging markets is or used to be the former communist states of Central and Eastern Europe.

This means that a lot of western cash (dollars, euros and pounds) have been poured into this region. And now, as things have gotten worse back home, Western investors need that money to plug the holes in their own back yard. As a result, investors are just selling off what they have in Eastern Europe and taking the money home. However, their money is not in their home currency (USD, EURO, GBP) it is mostly hold in the local currency. So as they sell the local currency (the currency of Central and East European countries) for dollars and euros, these local currencies start to devaluate.

2. Losing confidence (risk aversion) – as now investors have a hard time knowing where to put their money, the economies of Central and Eastern Europe seem less certain than those they have back home. After all, they should know more about what happens in their home countries rather than what happens in some country all the way across the sea. Also investors tend to trust more the governments of the rich developed world, believing they are better prepared in taking good decisions than those of less developed countries. This means that less dollars and euros are sent towards less developed regions like Eastern Europe. As a result, there is less demand for the local currencies. Thus, the local Central and East European currencies slowly start to devaluate.

3. Growing western deficits – As the trouble in US and Western Europe becomes increasingly more acute, their governments try desperately to salvage the economies. One of the most used methods is to basically inject money into the system, hoping it will somehow stimulate the economy and bring it out of recession. But the money must come from somewhere…

One solution is to print more money but this can very well just lead to inflation and in combination with the economic crisis it might just spell the apocalypse of the capitalist world. The only other solution is to barrow the money from … somewhere, usually from some banks and organisation specialised in lending to governments. Nonetheless, these organisations also need to get the money from somewhere and that somewhere is the rest of the world. Also the money needed must be in western currencies. That means dollars, euros and pounds because you cannot stimulate your economy by injection some other random currency, you need your own. One of the places where a lot of dollars and euros have been poured into is Central and Eastern Europe and now the West needs those dollars and euros to finance their deficits. As more and more government lending organisations try to buy the dollars and euros from Eastern Europe, the local currencies again start to devaluate as they are being sold for the western currencies.

The implications for US and Western Europe:

Now that things have been explained it remains to understand what this tells to the rich developed countries. Going back to the previous points there are two which need more careful attention. Firstly that dollars and euros are leaving Central and Eastern Europe in order to plug the holes of struggling Western financial institutions and secondly to finance Western government deficits. This is not a major issue as long as there still is an easy way to get the dollars and euros from “somewhere” without creating inflation. But what happens if the money runs out? Money is not infinite…

The basic problem is simple, as long as the West can gather money from Eastern Europe, in other words, as long as the currencies of this part of the world continue to devaluate there is still hope for a sound economic recovery of the rich Western world (they will have from where to get the money to support their economies). HOWEVER, if the West does not show any signs of recovery by the time the devaluation stops and the Central and East Europe currencies start to evaluate again, we can safely say that we are probably experiencing the end of a chapter in human history. Hopefully this will not happen.

Other information:

Central and Eastern Europe is not the only region experience currency devaluation; countries across the global are experiencing this. From Kazakhstan, Tajikistan to Philippines and South Korea currencies have been losing ground against the dollar and the euro. But Central and Eastern Europe has a much closer tie to Western Europe and the US, receiving more foreign investment and thus being a better representative case.

The amount of money being drawn out of Eastern Europe is impressive. In the case of Russia, in less than 6 months, $ 800 billion left the country as western investors were bailing out from the Moscow stock exchange and other short term investments, this was in November last year. It was the period when most stock exchanges in the less developed countries collapsed as Western investors virtually fled these countries. These were short terms investments but now we are looking at medium and long terms investments and deposits, once these are out, there is virtually nothing left.

The amount of public deficit ran in Western countries is breaking historic records. In US, in 2008 government deficit was about $ 450 billion (3.4% of the GDP) and for 2009 it is projected at almost $ 1,700 billion (more than 10% of the GDP). In UK it was 4.6 % GDP in 2008 and projected at 9 % of GDP in 2009.

dollar gone crazy

By now everyone in the developed world knows it: we are living an economic crisis. Still unclear is why a recession, which according to economic specialists is not something completely unusual, is now considered a crisis. Maybe it is just a mass-media gimmick or maybe it is something far worse than a recession. For now the answer will be left opened to debate and the focus will go on what shall we expect in the next few months.

Last week, the Commission of the European Union, the institution responsible for managing the major economic aspects of the world’s largest economic power – the European Union, has released its predictions for 2009. Although the picture is not a cheerful one, it is neither a devastating one.

Here is the official link:

http://ec.europa.eu/economy_finance/thematic_articles/article13727_en.htm

And on short what the Commission predicts:

Nr.

Country

GDP growth 2009

GDP growth 2008

GDP growth 2010

Public Budget 2009 (%GDP) (negative = deficit)

EU

-1.90%

-0.20%

0.50%

-4.50%

1 (18 )

Latvia

-6.90%

-2.30%

2.40%

-6.30%

2 (1)

Ireland

-5.00%

2.00%

0.00%

-11.00%

3 (16)

Estonia

-4.70%

-2.40%

1.20%

-3.20%

4 (20)

Lithuania

-4.00%

3.40%

-2.60%

-3.00%

5 (3)

UK

-2.80%

0.70%

0.20%

-8.80%

6 (9)

Germany

-2.30%

1.30%

0.70%

-2.90%

7 (12)

Italy

-2.00%

-0.60%

0.30%

-3.80%

8 (10)

Spain

-2.00%

1.20%

-0.20%

-6.20%

9 (2)

Netherlands

-2.00%

1.90%

0.20%

-1.40%

10 (4)

Belgium

-1.90%

1.30%

0.30%

-3.00%

11 (8 )

France

-1.80%

0.70%

0.40%

-5.40%

12 (5)

Portugal

-1.60%

0.20%

-0.20%

-4.60%

13 (14)

Hungary

-1.60%

0.90%

1.00%

-2.80%

14 (11)

Sweden

-1.40%

0.50%

1.20%

-1.30%

15 (6)

Austria

-1.20%

1.70%

0.60%

-3.00%

16 (13)

Finland

-1.20%

1.50%

1.20%

2.00%

17 (7)

Denmark

-1.00%

-0.60%

0.60%

-0.30%

18 (-)

Luxembourg

-0.90%

1.00%

1.40%

0.40%

19 (15)

Greece

0.20%

2.90%

0.70%

-3.70%

20 (17)

Slovenia

0.60%

4.00%

2.30%

-3.20%

21 (-)

Malta

0.70%

2.10%

1.30%

2.60%

22 (19)

Cyprus

1.10%

3.60%

2.00%

-0.60%

23 (22)

Czech Rep.

1.70%

4.20%

2.30%

-2.50%

24 (25)

Romania

1.80%

7.80%

2.50%

-7.50%

25 (24)

Bulgaria

1.80%

6.40%

2.50%

2.00%

26 (23)

Poland

2.00%

5.00%

2.40%

-3.60%

27 (21)

Slovakia

2.70%

7.10%

3.10%

-2.80%

It looks like EU will not be doing very well, especially in 2009 when there will be a general recession in almost all EU countries. It is noticeable how optimistically the Commission has predicted 2010 with an already recovering EU economy, right now the economic future of the western developed countries is quite gloomy and any predictions beyond 2009 may just be hard to be taken in consideration. Also we must take notice that most of the EU countries try as much as possible to stick to their commitment for not running a to big budget deficit, most trying to remain around 3%. This is a considerably small deficit in times of recession and it is unclear if this will prove helpful in the end.

What can we do?

Most of us wrongly believe that the economy is something impersonal and beyond our control, most of us believe that all we have to do is tighten our belts and wait for the recession to pass. However this is a wrong way of seeing things. The economy we live in, is our economy, is made by us, by our transactions, our work and our ideas, it is not a force of nature or God. We build our economies with our own hands and minds and becoming passive, just waiting for the recession to pass, will not improve things.

It is like living in a house together. The roof has broken and now we all wait for someone or for some way to have it fixed so we can get back to our daily business. Unfortunately the only way to fix the roof is for us to get working on it and stop staring at it. So try to do something, if there are no more jobs try working on your own or with your friends, try ideas that you think might work, be inventive. A recession is not the end of the world.

Remarks:

As a note to my previous article on the economic crisi: “Which countries will be worse hit by the current economic crisis?”. I compared the predictions of the EU Commission with the ones made in the article above. The average difference between the Commissions’s ranking and my ranking was 5 which is not very promising for my predictions. However, when broken down, out of the 27 countries, 4 I got completely wrong, 5 close but not close enough and 18 almost entirely right. I would say that this means that in most cases my predictions were correct. Also it seems that they work very well for big countries with populations above 20 million while for those below they usually tend to unreliable.

Politicians keep telling us that, despite the situation being grim, they have the means to deal with the crisis and save our country’s economy from a long and deep recession. Even when thousands of people lose their jobs daily, they still come on television and tell us that “it will be alright”. The sad and simple truth is that politicians will pretty much say whatever it takes just to gain some public support. In fact, many of the economies hit worst by the current crisis are fairly limited in their ability to deal with it.

Briefly what is happening

In general, the prescribed medicine until now has been to pour money into the economy and cut taxes in order to stimulate consumption and investment. But money does not just come from thin air, it is either printed, thus creating inflation, or is borrowed. In general, central banks or governments try to avoid printing money, because if this leads to rampant inflation it would just worsen the situation. So in most cases, the only way to deal with economic crisis is to run a government deficit, which means cutting taxes in order to stimulate your internal market, while injecting money into the economy and praying that all this would actually work.

Moreover, as the world is highly interconnected nowadays, exporting countries which rely on Western markets for their products suddenly face a drop in demand. As their economies are threatened, the only solution is to try to move from the external market towards the internal market. But again this has its limitation if, for example, you are an oil exporting country, it is unlikely your internal market will be able to compansate for the loss of demand abroad. If you are like China, exporting manufactured goods, then there should not be any major obstacles for turning towards the internal market, provided you can stimulate your internal consumption.

The key elements

Taking this into consideration, by using some broad macroeconomic indicators you can predict which country is better prepared than others to deal with the crisis. In other words: who would be hit worse. Bear in mind, that this is just a broad picture: government leadership, structure of the economy, exporting partners and many other factors can also affect the evolution of events.

Public Debt – this is the debt gathered by the government. Chances are that the bigger this is, the greater is the difficulty of the government to run a deficit. Simply because when you have a lot of debts that you keep stacking, creditors know it is unlikely you will pay them, so they will be reluctant to lend you more money.

External Debt – this is the debt of the entire country to creditors outside it. The bigger this is,  the harder it is once again for the countrys` government and private sector to receive new loans.

Unemployment – The proportion of workers without a job and actively seeking one. In the current situation, if you have a high unemployment rate it probably means you already have some very big issues and the current crisis will probably matter little on top of the problems you already have.

Exports – The amount of good and services you sell to other countries. In the current situation, the more export orientated you are, the bigger the impact on your economy of the fall in the global demand for goods and services. However, in most situations you will be able to revert to your internal market, but this will not be without its costs.

Reserves of Foreign Exchange and Gold – the amount of foreign money and gold you have at your disposal. This money can be used for various means: in exchange for your own currency in case you need it to stimulate your own economy, pay external debts or lend it to other countries so that they can buy your products.

Stock of domestic credit – is the total amount of credit owned by non-banking institutions. Usually not a big deal, but in the current situation, the bigger this,  the larger the number of defaults. This will probably apply better to the states which were worse hit by the financial crisis.

GDP (exchange rate) – the value of all final goods and services produced within a nation in a given year. This value is calculated in the domestic currency and then transformed into USD at the official exchange rate.

GDP (PPP) – the value of all final goods and services produced within a nation in a given year. This value is calculated by evaluating the internal goods and transactions at their value in USA and thus directly in USD.

Building a rating

Putting the above elements together is not an easy task and requires some intuition. The result is by no means a strong predictor. Rather, it is an indicator of which countries will experience more difficulties than others.

The formula: R= [%Public Debt + ExternalDebt as % of GDP + (Exports as % of GDP)/2 – ForeignReserves as % of ExternalDebt – (ForeignReserves as % Exports)/2 + Domestic Credit as % of GDP]

The higher the rating, the less likely the country can deal successfully with the crisis. A world average is computed weighted by the countries economic power (GDP at PPP). And then, based on this average a score can be given.

The results

Unfortunately, there is not enough information to make this formula work for all countries, but there is still enough for 117. Here are the countries ranked by their crisis vulnerability (the higher the score the worse isthe situation for that country):

results2

Countries with scores above 60 are in a very bad situation. 40-60 - pretty bad, but probably a good crisis plan will get them ashore. 20-40 should not be very badly affected but this will depend on leadership. Below 20, some difficulties but generally the crisis will consolidate their position.

And the score of the biggest 20 economies in the world based on their PPP GDP.

Rank Country Vulnerability Score GDP PPP (real valure) (millions of USD)
16 European Union 45.67 14,546,184.50
24 United States 40.54 13,780,000.00
117 China (PRC) 0 7,099,000.00
18 Japan 43.33 4,272,000.00
111 India 17.26 2,966,000.00
13 Germany 47.5 2,807,000.00
4 United Kingdom 62.57 2,130,000.00
110 Russia 17.35 2,097,000.00
12 France 49.07 2,075,000.00
77 Brazil 27.48 1,849,000.00
20 Italy 42.9 1,800,000.00
15 Spain 45.68 1,361,000.00
81 Mexico 26.91 1,353,000.00
19 Canada 43.09 1,271,000.00
83 South Korea 26.75 1,206,000.00
62 Turkey 29.71 853,900.00
71 Indonesia 28.45 843,700.00
23 Australia 40.64 773,000.00
115 Iran 7.08 762,900.00
90 Taiwan 25.71 698,600.00
3 Netherlands 62.58 645,500.00

What does this tell us?

The highest ranked country is Zimbabwe. This may seem weird for some, but given that they currently have an inflation rate of over 230million % (yes, that is correct, 230 million) and that they rely heavily on loans from outside the country, this comes at no surprise.

However, other countries on top of the list are well developed countries. This is because they have a substational Public Debt as well as an External Debt which is sometimes 4 times the size of their GDP, their low foreign currency reserves also means they are somewhat limited in they ways they can help themselves. However, given their good economic performance until now it is likely they can still manage to deal with the situation, but the impact of the crisis will still lay heavily on them.

US has ranked quite well. This is because their External Debt is not very big in comparison with their GDP. Also they can probably rank even better (lower) because although officially they have low reserves of foreign currency they have the power to print dollars which is still a very powerful international currency.

On the other side of the big countries is Russia and China. Both countries have low public debts, low external debts and high reserves of foreign currency. For China the situation is still difficult because they rely heavily on exports, but this can be offset by the high level of foreign currency reserves. They can lend this money to other countries which in turn buy Chinese products with or exchange the money for Chinese currency and help their own economy. For Russia the situation is not that good, especially because they are primarily a gas and oil exporter and they just cannot replace foreign demand with internal one, they will have some difficulties but probably not a crisis.