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[Seminar notes, do not quote without author’s permission] The Political Economy of Finance: Greece from Postwar to EMU 1 George Pagoulatos (Athens University of Economics and Business) [email protected] The argument The state-finance connection crucially served (and at times drove) the overarching political economy and government priorities of each of the following periods. Financial interventionism was initially adopted as a textbook policy instrument for a developing country. (PERIOD OF DEVELOPMENT) Then –being institutionally available—it was utilized for a wider range of purposes than presumed by its original raison-d’être, subjected to political expedience and producing undesired consequences. (MAINLY PERIOD OF DEMOCRATIZATION) Finally, financial liberalization (the opposite state-finance configuration) became a principal instrument for externally induced economic adjustment, and potentially a conveyor belt to an unprecedented Europeanization and internationalization of the Greek political economy. (PERIOD OF EUROPEANIZATION AND ‘GLOBALIZATION’) 1 The paper draws on George Pagoulatos, Greece’s New Political Economy: State, Finance and Growth from Postwar to EMU, London: Palgrave Macmillan 2003. For a link to the book’s website, contents, summary, sample chapter, and reviews, visit: http://www.palgrave.com/products/catalogue.aspx?is=0333752775 1 The analytical framework: eclectically structuralist and institutionalist The original forces bearing upon a small and relatively open economy’s policy course are traced in the international system and political economy. Small states contribute to the international system, but their individual input is disproportionately low compared to the degree of their subjection to the international regime. They are policy receivers rather than policy agenda setters. It is in the international political economy that one finds the sources of policy constraint and normative blueprint. The autonomous role of small states is substantially upgraded (or their heteronomy reduced) by their participation in international or peripheral formations, such as the European Union. Such formations mediate and transform pressures and policies applied by other global-level powerful actors. Though in that latter sense international constraints are endogenously transformable, from the standpoint of a small open economy they are predominantly exogenous, and they are considered here as such. The same mutatis mutandis applies to the membership constraints deriving from the EU. These constraints and obligations are typically vested with the force of institutional statute; they usually incorporate the ‘objective’ imperatives of adjustment to the particular juncture of the European political economy under conditions of supranational and intergovernmental interdependence. Incorporating these imperatives into formal policy and institutional text relieves them from ideological ambiguity, and vests them with an urgent sense of ineluctability that allows them to be internalized with less friction by the domestic sociopolitical order of member states. External structural pressures and constraints are applied to the national policymaking system via transmission belts of international regime interdependence, market integration, elite interaction, collective action, and so on. These same mechanisms are also bearers of ideological influence and policy paradigms, generating policy convergence, ‘learning’, compliance, as well as dissent. 2 Their impact is crucially mediated by the domestic institutional framework, which includes the organizational attributes of the state, the market, the political system, and civil society. Such institutional attributes at the aggregate macro-level amount to structural properties of the economy, polity, and society, that allow us, for example, to talk of underdevelopment of capitalist, democratic, or civil society institutions. A structural endowment corresponding to a particular ‘stage of development’ offers the basic litmus test for the appropriateness and viability of institutional and policy imports. Broader contextual non-institutional factors of the sociopolitical and economic reality (important events, cyclical trends, and so on) that do not display the normative strength and durability of institutions also filter external policy and ideological inputs, helping define the terms of their domestic reception. Institutions are notoriously resistant to change. Institutions change nonetheless, in an incremental rather than radical manner, by way of a dynamic interaction in which the impact of institutions is also mediated and filtered by their surrounding context. Interests (state-political, socioeconomic, or corporate; indigenous or transnational) are the foremost agents of institutional change. Once effected, institutional change not only statically represents the given configuration of power but dynamically affects it as well, by altering the distribution of resources between actors. The type of the state-finance connection or the financial regime is politically important because, among others, it indicates where power lies: If financial resources are allocated by the market (as in the capital market-based systems of Britain and the US) then there is diffusion as well as relative mutability of control, and probably economic pluralism through the existence of competing (though collectively powerful in the structural sense) private interests. If financial resources are mostly handled by banks (as in German-type bank-based systems) then powerful and enduring industrial groups will tend to develop, firmly controlled by one or two dominant shareholders (often the banks themselves), able to operate with a relatively long-term horizon. 3 If finally, as in postwar Greece, government is able, through credit interventionism, to direct financial resources to its favored sectors of production, then this government is able, for better or worse, to exercise a significant degree of control over the country’s economic life. This may stimulate development but it may also accelerate the politicization of financial and economic policies. The rationale of postwar financial interventionism was predominantly developmental: - In the 1940s, 1950s and 1960s, industrialization was the universally recognized avenue for development - In order to fund industrialization in a developing country you needed industrial investment, capital accumulation - But in developing countries there was a shortage of capital. Foreign capital would not suffice. Foreign investors are lured to the country but their profits are typically repatriated, limiting the effects of capital accumulation. - The private sector in developing countries was unwilling or unable to initiate industrialization on its own due to a number of market failures: The private sector was undercapitalized and thus unable to incur short-term losses; or those losses were unlikely to be compensated for by future profits; or the private sector may have deemed it more profitable to invest in speculative activities rather then manufacturing. For all such reasons, building a national industrial infrastructure remained the state’s primary task. Through an interventionist framework, the state would direct the financial resources available in the hands of the banks to productive investment, both by private and public sector. So finance for industrial investment could only be provided by the banking system. Where do the banks find the money to lend industries? Through deposits. Deposits 4 flew abundant into the Greek banking system after 1955-56, when confidence in the Greek drachma was gradually re-established. On the other hand, in developing economies, banking oligopolies prevailed. - If credit allocation was left to the market, the resulting credit rates would attract activities such as import trade, where profit margins tended to be higher; - credit market prices would tend to be unaffordable for the productive sectors such as manufacturing, exports or agriculture. Consequently, a government control of lending rates too was deemed necessary for economic development. That was more or less the original postwar developmental rationale of financial interventionism, aiming to encourage or obligate capital transfusions to industry. A crucial common denominator of interventionism was capital controls. Governments sought to insulate their financial markets from international capital flows; they pursued active monetary policy in the service of faster economic growth. In sum: The Greek postwar political economy was underpinned and externally circumscribed by the regime dependencies emanating both from a cold-war international environment and the Bretton Woods system of fixed exchange rates. This external framework enabled (and domestic structural endowment prescribed) economic development initially pursued by: - import-substitution industrialization and financial interventionism - while retaining a foreign trade orientation and a commitment to monetary stability. 5 The Greek postwar economic ‘model’ was defined in an eclectic fashion under the influence of the international ideological and policy context of its time, especially the developmentalist economic orthodoxy and other policy paradigms (such as that of Germany –upon which I did not have the chance to elaborate). These external influences were mediated by domestic sociopolitical and institutional factors as well as by the economic ideology of the principal policymakers. This postwar interventionist architecture began to break down in the 1970s, following the dramatic transformations in the international political economy. In 1973 Bretton Woods was formally abandoned, replaced by floating exchange rates. The momentous US policy shift of the early 1970s, though prompted by economic weakness, reflected a unilateral redefinition of US national interest. In the (neo)liberal international financial order of free capital movements the dollar as world currency and the pre-eminence of American financial markets ensured that the US would continue to receive the main share of international capital. Beginning with the US in 1974, capital liberalization spread to Canada, the Netherlands, Germany, Switzerland, Britain and Japan over the 1970s, and other EC countries into the 1980s and 1990s. In this new international environment of highly volatile interest rates and exchange rates the ability of monetary authorities to control currency fluctuations was substantially curtailed. Currency depreciations under floating exchange rates were not effective: - By raising the price of imported goods (especially including demand-inelastic ones such as oil) currency depreciation led to vicious destabilizing spirals of inflation and further depreciation. - Attacking inflation in that context only made the currency appreciate, cancelling any export benefits sought in the first place. 6 - Trying to ‘fine-tune’ the way between the Scylla of inflationary depreciation and the Charybdis of export-eroding appreciation was practically impossible. From the day after the collapse of Bretton Woods, the highly interdependent EC economies sought to operate collective currency pegs. From the failed European Snake of the 1970s to the EMS in the 1980s and 1990s the course was laden with obstacles. The removal of capital controls in the late 1980s (in accordance with the single market program) made EMS even more difficult to operate, thus clearing the way to the final adoption of a ‘hard peg’ through a full monetary union in Europe. What all this implies is the end of independent monetary policy. As we know from the Mundell-Fleming framework: you cannot have all three together: fixed exchange rates+ capital mobility +independent monetary policy: and European economies chose to sacrifice independent monetary policy, by turning into a simple tool for maintaining the exchange rate. This was also true for countries which had not yet entered ERM/EMS, which Greece entered following its March 1998 devaluation. In an international and European environment of capital liberalization, an independent Greek monetary and credit policy was impossible. And so the program of capital liberalization also necessitated the previous abolition of credit controls and liberalization of interest rates to allow them to adjust to international market levels. Let me now come to Greece’s period of democratization (post-1974) The Greek political economy after 1974 underwent the impact of two major events, one domestic and one external: a) Fall of the junta and the transition to democracy b) The dramatic changes in the international political economy during the 1970s Following these two factors the political use of developmental finance ended up superceding its economic raison d’être: - Industrial protectionism made the state particularly susceptible to sectoral pressures for low-interest finance and a real devaluation or depreciation of the drachma to offset the growing loss of competitiveness. 7 - As part of an export-oriented deepening of industrialization, revived post-1974 with the effort to gain full accession to the EC, the Karamanlis government sought to prop up manufacturing exports and direct investment towards heavy industry. However, cost-push factors had dramatically deteriorated and some of the heavy hothouse industry sectors on which public investment would focus (such as shipbuilding) were already on the verge of international decline. Similar or worse was the case of traditional labor-intensive light industries of consumer goods (such as textiles), principal beneficiaries of postwar ISI policies, which into the 1970s were losing ground to low-cost East Asian producers. - The loss of the state’s pre-1974 repressive political mechanisms necessitated a heavier reliance on social and economic policy instruments for cementing public support. This meant presently delivering (instead of deferring) tangible economic benefits and effectively sheltering the real economy from international shocks. - By the mid-1970s and into the 1980s, conditions were probably ripe for what sociologists would view as increased affluence and political democracy (Greece’s graduation into a middle-income country status) undermining societal willingness to defer consumption, thus leading to declining rates of capital accumulation, slower economic growth, and higher inflation. These circumstances amounted to a transfer of systemic power from state to societal politics. - Such conditions entrenched the power of selective credit recipients. The predominance of economic protectionism over the need to disinflate, and the governments’ political dependence on groups such as farmers and the small business sector, heavily obstructed any efforts to raise interest rates, or divest those groups of their preferential treatment. - Democratization brought a primacy of politics over policy. This political context was conducive for developmental finance to be instrumentalized in the service of two paramount political projects: 8 a) democratic consolidation, under the Karamanlis government 1974-81, was the first, necessitating economic expansion and redistribution. b) the second was PASOK’s effort to consolidate its left-of-center government to power, by cementing a wide popular base of ‘non-privileged’ strata through a broad range of often clientelistically targeted social benefits. Both these major political projects were served primarily through the state-controlled financial system: cheap credit, at negative real lending rates, and uninhibited government access to finance, notably through debt monetization. A generation of overindebted ailing firms, including public enterprises, and a swelling public debt were the visible results of the abuse of financial interventionism. When international interest rates rose, the drachma further depreciated, and especially when interest rates were liberalized, the public debt servicing cost rose dramatically. In sum: International monetary instability, combined with capital mobility, eventually necessitated a more or less universal shift of Western countries to disinflation over the 1980s. The Greek domestic response to the international momentum of financial liberalization and disinflation was somehow delayed, mediated as it was by domestic sociopolitical factors. The shift to economic stabilization and disinflation The starting point of Greek economic convergence was the 1985 stabilization program. On the domestic front financial liberalization really entered the agenda after PASOK’s 1985 re-election under conditions of galloping inflation and a serious balance of payments shortfall. Both the single market program and the urgent need to reduce inflation necessitated domestic financial liberalization. 9 Monetary stabilization required the Bank of Greece to be able to raise real interest rates (which since 1973 had been mostly negative) to European levels and above. That was predicated on interest rate liberalization. The Bank of Greece and liberalization Central Banks (CBs) in general favored domestic financial liberalization as it improved their ability to conduct monetary policy. - Direct credit controls, the postwar leading stabilization instrument, by the second half of the 1970s had become increasingly incapable of stabilizing the economy: as public deficits were pushing money supply growth upwards, it was hard to control credit supply without raising the interest rates. Obviously, liberalization implied a strengthening of the Bank of Greece vis-à-vis government, though that gain in autonomy would be offset by the central bank’s greater subjection to the globalized financial markets. Over the 1990s, financial liberalization led macroeconomic adjustment and disinflation in three closely related ways. First, as said, financial liberalization was the sine qua non precondition for allowing monetary policy to carry the brunt of stabilization. Liberalization allowed the introduction of new instruments of monetary management, including open market operations. Second, financial liberalization generated short-term government securities markets and mutual funds which allowed public deficits to be absorbed by private investors. Third, the greater role of private investors in public deficit financing imposed discipline in the government’s macroeconomic policies. Deregulation enabled the upward convergence of real interest rates to EU levels (in fact, at much higher than EU levels), making possible the reversal of the previous 10 policy of accommodation or managed depreciation into a policy of real appreciation of the drachma. This amounted to a momentous monetary and exchange rate policy shift, coming to full accord with the Bundesbank-led European central banking orthodoxy of the time. By targeting the exchange rate, monetary policy became the chief instrument for disinflation and macroeconomic convergence with the EMU targets. Winners and losers from liberalization The losers of financial liberalization (apart from all previously favored credit recipients) included the ‘spending ministries’ such as those of Industry, Agriculture, and Defense, as well as public enterprises deprived of their privileged lines of credit. Principal among the direct losers of liberalization was the Treasury (to be distinguished from the National Economy Ministry) agonizing over the rise of the debt-servicing cost. Let me come to the bankers. Greek banks, especially state-controlled ones, until the early 1990s were apprehensive of the single financial market, as it would reverse the protectionism they enjoyed. - However, soon into the 1990s it became clear that financial liberalization overall presented a bankers’ window of opportunity for getting rid of restrictions and taxes and for maximizing profits. - Moreover, the ‘hard drachma’ policy that followed until EMS entry allowed banks to reap safe profits from transacting in a steadily appreciating national currency. - Finally, the phasing out of the compulsory investment ratio in Treasury bills (completed in 1993) brought about an important transfer of power from government to the banks. Banks were able to demand an attractive yield in order to absorb the new issues of government paper. 11 - As a result, liberalization enhanced the bargaining power even of state-controlled banks vis-à-vis government. The new political economy of EMU and financial globalization EMU involves obvious advantages for Greece: - For a weak-currency, high-inflation country like Greece, the Euro offers not only the tremendous benefit of monetary stability but also a potentially strong world currency. - EMU relieves the economy from the balance of payments constraint. - EMU eliminates the very rapid and large capital movements and encourages higher financial stability within the Eurozone. - A low-inflation economic environment revives certain long-term financial markets (such as fixed-interest mortgages or long-term debt instruments). - The decline of interest rates under EMU (as the exchange rate premium and the inflation premium fall) substantially reduces the debt servicing cost, facilitating fiscal consolidation. The major risk under EMU seems to be one associated with asymmetric shocks: A peripheral country with significant structural weaknesses (a relatively extensive primary sector, a manufacturing sector dominated by traditional, low-productivity, small-scale units, a rather oversized domestic-oriented services sector), Greece under EMU may be particularly susceptible to an enduring supply-side shock and declining competitiveness, especially if existing market rigidities persist. What are the notable implications of financial globalization - The national capital market (increasingly integrated into a Europe-wide capital and money market) becomes the pacesetter of economic activity. 12 - Stock market fluctuations exercise a growing impact on the real economy, as demonstrated by the wealth effect released in the bubble days of the 1999 annus mirabilis of the Athens Stock Exchange, but also the negative wealth effect following the plunge after 2000. - The importance of the capital market also implies a direct exposure to the fluctuations of major international financial markets, the American economy and market acting as global economic pacesetter. There are serious potential negative implications involved in the emerging centrality of the capital market. - Short-termism is a principal feature of financial decisions in a capital marketbased system. It places a premium on share-price performance rather than investment decisions leading to longer-term optimization or an expansion of sales and employment. (Enron made all that very clear) - the shareholders’ democratic control over the management in defense of the company’s longer-term interest could prove illusory. - Capital markets are prone to herd behavior, moving prices out of line, and leading to speculative bubbles. - Increased financial competition encourages speculative activities (FOREX speculation or speculative maturity mismatching) that are unproductive and may also be destabilizing. Such problems loom larger in shallow capital markets (such as Greece in the 1990s) where manipulation and gaming become easier. - Moreover, there is significant risk of financial liberalization (combined with low interest rates) leading to a consumption boom, financed by excessive private sector indebtedness, which at a subsequent stage may act as a drag on growth, amplifying downturns. All that said, and though change is clearly advancing, corporate governance in Greece continues to retain most of its traditional features: 13 - The financial system remains bank-based. The vast majority of smaller companies continue to rely on bank finance. - Publicly quoted companies for the most part tend to rely on stable shareholder systems. - Hostile takeovers in the national capital market are rare. - A monitoring role is, to a considerable extent, delegated to banks, supplemented by reputation monitoring from suppliers, customers, and to a lesser extent expert institutes and associations. - Venture capital, though rapidly growing, remains limited, and relatively risk averse. Some of the political implications of globalization Through the channel of free capital and trade flows, Greece is subject to the typical effect identified with globalization: that is the rising bargaining power of mobile factors of production, and especially financial and multinational capital, at the expense of less mobile factors and especially labor. This effect of globalization on labor restraint in Greece is arguably mitigated by high degrees of public sector employment and the predominance of public sector unions in the ranks of national-level labor representation. Moreover, though Greek economic internationalization in institutional terms is unprecedented (single European market, capital liberalization, a single currency), along the lines of several important criteria of openness Greece’s internationalization remains relatively limited. These criteria include trade openness, FDI flows and stocks, correlation between domestic savings and investment, international differentiation of stock portfolios, number of Greek multinationals. Thus we must retain a degree of caution when talking about the actual globalization of the Greek economy. 14 Overall, the Greek case is consistent with the thesis that financial integration and globalization tend to undercut labor union bargaining power by expanding the exit option of capital and by promoting economic tertiarization and labor differentiation. Such conditions encourage trade unions and socialdemocratic governments to embrace neocorporatist strategies of social dialogue for achieving wage moderation and for minimizing the loss of social entitlements. Globalization, the EMU program and the ascendancy of the primacy of disinflation from the 1980s and through the 1990s had a further political implication: the progressive shift of European socialist and socialdemocratic parties to the center, in their effort to attract private capital and inspire confidence to the markets. We saw that with PASOK after 1993 and especially since 1996. There is a final political implication of financial liberalization and financial ‘deepening’. The broad number of shareholders, bondholders, mutual fund and pension fund investors have an interest in ‘sound finance’ and market-oriented structural reforms, to support a stable growth of the financial market. Their entrenchment and wide political spread tends to strengthen adherence to orthodox and disinflationary economic policies. In conclusion: what does all this tell us about the importance of the state-finance connection We have traced the political economy of postwar Greece from the 1950s to the EMU by focusing attention on the state-finance connection. This focus has been warranted in many ways. - State-controlled finance was the most important postwar developmental instrument. It provided the principal tool for financing government spending. It operated, whenever it did, as the long arm of indicative planning and industrial policy. Financial interventionism allowed state actors to define infant industries and ‘national champions’, to afford preferential treatment to selected sectors, subsectors, or individual producers, and to exclude others. A bank-based financial 15 system, with a heavily undeveloped capital market, forced businesses to turn to predominantly state-controlled banks for finance. - State-controlled finance served as a principal mechanism of state intervention, being both an instrument of economic stabilization and one of (re)distribution and selective policies. Thus financial interventionism formed an inseparable extension of the postwar distributive of clientelistic state. - Moreover, the armory of postwar financial interventionism was systematically relied upon for monetary stabilization. The entire developmental model of the postwar Greek economy was premised on state-controlled finance. Both economic growth and monetary stability during the Bretton Woods era were made possible under financial interventionism. Financial interventionism was pivotal in supporting Greece’s postwar industrialization and development, as well as in underwriting the economic decline of the 1980s. - Credit interventionism created overleveraged industries of high vulnerability to an external shock, such as that of the 1970s. - It generated a moral hazard condition of easy credit to those overindebted firms as well as to government, ‘socializing’ the cost of the failure of the former, and facilitating electorally-driven fiscal laxity for the latter, and in both cases postponing painful overhaul and restructuring. - The results of the abusive distortion of financial interventionism were evinced in the inflationary public debt trap of the 1980s and 1990s, where a growing share of economic resources was swallowed up in servicing interest payments, crowding out productive investment. - As the effects of institutionalized financial laxity accumulated beyond the point of being economically sustainable, they necessitated a particularly harsh disinflation in the 1990s, led by financial liberalization and monetary reform. Financial liberalization, the dismantling of the state-finance connection, was of no less momentous implications. 16 - On a real as much as symbolic level it meant the final abandoning of the postwar developmental institutions of administered finance. - On a state sovereignty level, it completed the alignment of the domestic economy to European and global financial market forces. - On a macroeconomic level it meant accession to the primacy of disinflation, and its pursuit through indirect instead of direct monetary instruments –which also implied the erosion of expansionary policies. - On a socioeconomic level financial liberalization brought a significant reallocation of economic (and thus, one might say, political) resources from sectors traditionally favored for developmental or redistributive purposes (manufacturing industry, SMEs, agriculture) to an increasingly emboldened financial sector and mobile, globalized business capital. - On a political and ideological level, financial liberalization also generated the forces that would buttress the disinflationary orientation of economic policy under EMU. Financial deepening promoted a rentier mentality and a wide number of financial investors and eventual stakeholders in ‘sound finance’ and macroeconomic discipline. - Finally, at the level of institutional architecture, financial liberalization had important regulatory implications, as monetary and banking policies were transferred from the sphere of government intervention to the regulatory jurisdiction of an eventually independent central bank. - Overall, the effects of financial liberalization involved the government at large subscribing to a mechanism of self-imposed macroeconomic discipline through institutional self-binding. - It involved a choice of policy commitment over policy discretion. 17 - It finally involved a transition from the primacy of politics that had dominated the postauthoritarian era to the primacy of policy and the constraining impact of economics. 18