Download The Political Economy of Finance: Greece from Postwar to EMU

[Seminar notes, do not quote without author’s permission]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’)
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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
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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.
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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.
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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
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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.
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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.
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-
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.
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- 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:
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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.
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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
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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.
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- 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.
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- 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:
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- 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.
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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
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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.
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-
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.
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-
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.
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