Código de Justiniano

Abstract: The consequences of government interventions created problems greater than those they were trying to solve. The state intervention in the richest countries brought high deficit and public debt that paralyzed their functioning.

If no measures are undertaken, many countries will go bankrupt. Pumping additional money and state aid packages have only delayed and made the problem more complex. The fire cannot be put down by adding the oil to the fire. Help provided to undisciplined countries by healthier and stronger economies as well as public finances is shown to be a way towards collective disaster. Therefore, countries need radical and consistent fiscal consolidation, which is advocated in this paper and proposed as the only long-term sustainable response to the challenges of the debt crisis.

Key words: Debt, crises, euro, fiscal consolidation

Economic challenges in 2011

At the beginning of 2011, the features of the global economy were unpredictable shocks, ranging from political turbulences in the Middle East and North Africa to earthquakes and tsunami in Japan. The oil price is reaching its historical maximum, which is additionally firing up the growth trend in food prices and pressuring an inflation increase. The global instability is also accompanied with internal weaknesses and problems of national economies. The largest World economies, and with that the entire global economy, are facing great challenges.

Delays on the budget deal and measures that should stabilise public finances in the United States of America are deepening the uncertainties and risks. High budget deficit and growing public debt are making the largest global economy less safe. For the first time, since the data are being published, the credit rating agency

Standard&Poor’s issued a negative outlook for US bonds. China is creating

increasing concern. The inflation is growing and its restraining by Yuan

 _{Author is a holder of PhD and Docent (Assistant Professor) at the Faculty for International} Economy, Finance, and Business, University of Donja Gorica (UDG), Podgorica; employed at the Ministry of Finance of Montenegro; e-mail: [email protected]

appreciation could affect the reduction of economic growth rate and cause not only economic but also political problems. If the fastest growing economy sharply slows down that would be a new shock for fragile recovery of the global economy.

The Euro zone debt crisis is the issue causing highest concerns for economists, analysts, and decision makers. The special report of the Economist Intelligence Unit estimates that there is a 50% probability of imminent bankruptcy of one country of the Eurozone, while only a 10% probability is given to the recovery of public finances and overall economy of the euro zone without shocks. Largest European banks have problems with shortage of capital, while they are at the same time the biggest creditors of Greece, Ireland, Portugal, and Spain. Weakened banking system can easily slide into insolvency. Thus, increasing overall systemic risk of the Eurozone, and its future is called in question. The guesses are whether it is more likely that one of the weaker economies leaves the Eurozone first or whether Germany will be the first one to do that.

The Western Balkan counties pressured by the crisis have worsened their fiscal positions. While the most developed countries in the World can afford high debts and their regular servicing, that is not the case with small economies subject to exogenous shocks, such are the Western Balkan countries. Fiscal crisis of the Eurozone represents an additional challenge to efforts to stabilise public finances in the Western Balkan countries.

Global Debt Crisis

In the 18th century, David Hume argued, “either the nation must destroy public credit or public credit will destroy the nation”. The history confirms this. High public consumption and over-indebtedness affected deterioration of the most important kingdoms, like old Egypt, Rome, and Greece. Weakness of Philip II of Spain in terms of warfare, financed from borrowing, resulted in not only bankruptcy of the state in 1557, but caused subsequent bankruptcies (four in total). During oil shocks in 1970’s, oil export countries were naïve to believe that historical bankruptcy of countries is something that cannot be repeated. Today, high debts are again threatening to destroy the wealthiest countries in the World.

Public consumption grew more than four times over the course of previous hundred years. In the peak of economic crisis, many rushed to declare the end of the free market and market economy. The state is declared the supreme good, safe heaven and key to all problems. The answer to the economic crisis of developed countries was to use Keynesian recipe. There was a dramatic increase to an already excessively high public consumption. Increase in consumption and reduction of revenues led to an increase of deficit financed through borrowing.

Budget deficit and public debt in OECD countries reached unprecedented amounts during the peacetime. In spite of their reduction in 2010, thanks to the economic recovery and reduced need for the support of the financial sector, an average deficit in the most developed countries was 8% of GDP. Majority of the most developed countries has as the objective to reduce deficit in 2011 and in subsequent years. However, even with implementation of the ambitious plans, the deficit remains high. Consequently, the public debt in the most developed countries, according to present day forecasts, will grow from 75% of GDP, as it was at the beginning of 2008, to over 100% of GDP in 2011 and 115% of GDP by the end of 2014. These are the highest recorded levels after the World War II.

Some countries of the Euro zone (Greece, Ireland, and Portugal) found refugee in arrangements with the European Central Bank and the IMF, since they were not able to borrow additional funds and because of a sharply increase of borrowing costs. Since the outburst of the crisis, the standard IMF’s Stand-by arrangement is again up to date. Most of the developed economies “used” relatively low cost for borrowing and financed themselves at the international market. However, since August 2010 the price of borrowing for majority of countries in the World was increased. Growth of interest rates coincided with the recovery of the global economy and announced further injection of money (QE2) in the United States of America.

Table 1: Fiscal Balances, 2008-2012

Forecasts

2008 2009 2010 2011 2012

Total balances (as % of GDP)

World -2.0 -6.7 -5.6 -4.7 -3.5 Developed economies -3.6 -8.8 -7.7 -7.1 -5.2 USA -6.5 -12.7 -10.6 -10.8 -7.5 Eurozone -2.1 -6.4 -6.0 -4.4 -3.6 France -3.3 -7.5 -7.0 -5.8 -4.9 Germany 0.1 -3.0 -3.3 -2.3 -1.5 Italy -2.7 -5.3 -4.5 -4.3 -3.5 Spain -4.2 -11.1 -9.2 -6.2 -5.6 Japan -4.2 -10.3 -9.5 -10.0 -8.4 Great Britain -4.9 -10.3 -10.4 -8.6 -6.9 Canada 0.1 -5.5 -5.5 -4.6 -2.8 Other countries 2.0 -1.0 0.2 0.9 1.6

Developing economies -0.6 -4.9 -3.8 -2.6 -2.2 Asia -2.4 -4.7 -4.2 -3.4 -2.7 China -0.4 -3.1 -2.6 -1.6 -0.9 India -8.0 -10.0 -9.4 -8.3 -7.5 ASIA-5 -0.8 -3.7 -2.7 -2.8 -2.4 Europe 0.6 -6.2 -4.4 -2.3 -2.3 Russia 4.9 -6.3 -3.6 -1.6 -1.7 South America -0.7 -3.7 -2.9 -2.2 -2.2 Brazil -1.4 -3.1 -2.9 -2.4 -2.6 Mexico -1.3 -4.8 -4.1 -1.8 -2.4

Middle East and North Africa

-0.1 -2.9 -2.1 -4.9 -4.2

Low income economies -1.4 -4.2 -2.9 -2.6 -2.4

Oil producers 4.7 -4.4 -1.4 1.2 1.3 G-20 countries -2.6 -7.5 -6.3 -5.7 -4.3 Developed countries G- 20 -4.2 -9.4 -8.2 -8.0 -5.8 Developing countries G- 20 -0.4 -4.8 -3.6 -2.5 -2.1

Source: International Monetary Fund

In order for OECD countries to set the public debt level, over the course of next five years, to the one from 2007, they must generate annual primary surplus in the range from 8 to 12% of GDP in USA, Japan, Great Britain and Ireland, or between 5 and 7% of GDP in other countries. With present deficits, expected nominal growth rates and optimistic debt expenditure up to 5%, to reach primary surplus up to 10% would mean fiscal adjustment of more than 15% of GDP for many counties.

At the same time, with existing trends and policies, trend of ageing population will lead to a drastic growth of the public debt. Over the course of next five years, the public debt of Japan would exceed 300% of GDP, Great Britain 200%, Belgium, France, Ireland, Greece, Italy and USA 150% of GDP.

The Crises of the Euro zone1

Even though it is integrated economically and monetary, the Euro zone is being increasingly divided. On one hand, there is the periphery zone with countries that were spending above their means during the previous decade thanks to the benefits of the common currency and cheap money, and on the other hand, there is the northern zone, led by Germany, which have had mostly a good management of their public finances and economies. At the same time, economic and monetary union made economic and financial system of the euro zone intertwined and interdependent. Disruptions and bankruptcy of any, even the smallest economic country, may cause a large systemic risk. Debt crisis of the periphery countries means a banking crisis of the entire Euro zone. Some large banks in the most developed countries of the Euro zone, including also Germany, are amongst the most vulnerable ones. Their capital is below the satisfactory level, and their credit exposure to the periphery countries is high, which makes an additional solvency risk. In general, the fiscal parameters (deficit and debt) of the Euro zone are less negative if compared to the United Kingdom and the United States of America, and the private debt is considerably lower.

Table 2: Deficit and Public debt of selected Euro zone countries

2007a ₂₀₀₈a ₂₀₀₉a ₂₀₁₀b ₂₀₁₁c ₂₀₁₂c ₂₀₁₃c ₂₀₁₄c ₂₀₁₅c Greece Deficit -6.4 -9.4 -15.4 -9.7 -8.1 -7.5 -3.0 -2.8 -1.2 Public debt 105.0 110.3 126.8 143.7 155.8 165.1 96.3d 92.0 88.0 Ireland Deficit 0.0 -7.3 -14.4 -34.2 -9.9 -8.1 -7.2 -4.3 -2.2 Public debt 25.0 44.3 65.5 93.9 110.4 125.0 97.0d 91.4 85.7 Portugal Deficit -2.8 -3.0 -9.4 -7.3 -7.0 -6.1 -5.1 -4.3 -3.5 Public debt 62.7 65.3 76.1 81.3 87.7 93.4 96.8 98.9 99.9 Spain Deficit 1.9 -4.2 -11.1 -9.2 -6.7 -5.4 -4.2 -3.3 -2.9 Public debt 36.1 39.8 53.2 60.0 69.6 71.1 72.5 72.6 72.2 Italy Deficit -1.5 -2.7 -5.3 -5.0 -4.6 -4.4 -4.0 -4.1 -4.5 Public debt 103.5 106.1 115.8 119.9 121.2 121.0 120.3 119.7 119.7 Belgium Deficit -0.4 -1.4 -6.1 -4.5 -4.0 -3.6 -3.3 -2.9 -2.7 Public debt 88.0 93.4 100.4 100.4 100.9 102.9 104.8 105.3 106.4 Germany Deficit 0.3 0.1 -3.0 -2.9 -0.5 0.0 0.5 0.6 1.0 Public debt 64.8 66.3 73.5 81.8 77.4 74.3 70.8 66.7 62.6 France Deficit -2.7 -3.3 -7.5 -7.5 -6.4 -5.5 -4.1 -3.3 -2.8 Public debt 63.8 67.5 78.1 84.1 87.4 89.6 89.8 89.2 88.1 a

Actual values; b EIU estimate; c EIU forecast; d Decline in debt incorporates expectations of the EIU of a debt restructuring

1

Sub-chapter “the Crisis of the Euro zone” is based on the document of the „Economist Intelligence Unit (March 2011)”, EIU special report, “State of the union - Can the euro zone survive its debt crisis?”

Source: Eurostat, Economist Intelligence Unit (EIU)

Regardless of the fiscal indicators, the Euro zone is vulnerable and more risky than the United Kingdom and the United States of America. The reason for this is the fact that the Euro zone is not a country and does not have a common fiscal policy, despite the Euro as common currency. The debt of the periphery countries is burdening the banking system of the euro area. It is a consequence of the monetary union where the borrowing risk of some countries is mainly assessed in the same manner – as inexistent. Due to the increase of interest rates, which have the same “bookkeeping” value of risk (and provisions), banks find that lending to the periphery countries pays better. Since decision-makers in Germany and France prefer short-term instead of the long-term solutions, the problem of increase in capital of large banks is postponed. As the crisis deepened in the periphery countries, the problem became more pronounced and more expensive, as is usually the case with the delays.

Increase of a bankruptcy risk in the periphery countries led to an increase of the premium for new borrowings. The cost of borrowing increased dramatically for Greece, Ireland, and Portugal since the beginning of 2010. Spain and Italy have recorded a substantial increase in the borrowing costs.

Figure 1: Selected bonds yields (%; end of period; 10 years maturity)

Source: Reuters

High amount of debt makes that even a small increase in interest rates can cause significant problems. Growth of the interest rates of 100 base points for new borrowings would bring an average increase of deficit and public debt in the most developed economies of 1% of GDP by 2016. The experience shows that a deficit growth of 1% of GDP leads to growth of borrowing costs for 20 base points. The deficit and debt growth would lead to an increase of risk premiums, which would

again translate into higher borrowing costs and additional negative consequences to deficit and debt.

It is increasingly evident that Greece and Ireland, in spite of the ECB and IMF assistance, will not be able to meet their obligations. That would mean a declaration of bankruptcy and debt restructuring. The forecast of the Economist Intelligence

Unit is that these two countries have 50% probability of bankruptcy, and it states

that 2013 is the critical year (see Table 2). A bankruptcy of any of the Euro zone country would mean actually facing the problem. That would mean not only the problem of the debt restructuring, but also consequently the problem of the banking system capitalisation and sustainability of the Euro zone. This is not necessarily the worst scenario for the Euro zone, as it could be an incentive for the “big clean-up” and looking for long-term solutions for a more sustainable and competitive Europe. A scenario of sustaining the periphery countries with high debt levels with the assistance of northern Euro zone members would mean postponing a problem, increasing instability and ultimately discouraging perspective for the entire Europe. Less likely but possible scenario is gradual recovery of the euro zone. A recovery over a relatively short period would be possible with the return of investor confidence, with strong economic growth in the wealthiest countries and implementation of serious fiscal and structural reforms in the periphery economies. Medium-term stabilisation and institutional reforms that would limit decision makers from repeating similar mistakes in future could make the euro zone exit the crisis even stronger.

Fiscal position of the Western Balkans

Problems in the Euro zone are creating additional pressure for other European countries, and in particular for small and open economies subject to exogenous shocks. The Western Balkan countries are those types of countries.

Average public debt in the Euro zone is above 80% of GDP, while average public debt of the Western Balkan countries is around 40% of GDP. Average deficit in the Western Balkan countries is also lower than is the average of the Euro zone. However, we cannot claim that public finances of the Western Balkan countries are less risky or more secure due to positive fiscal indicators.

Table 3: Fiscal balances of the Western Balkan countries, 2008-2012

2008 2009 2010 2011 2012

Total balance (% of GDP) estimate

Serbia -1.9 -3.6 -3.5 -3.3 -2.7 Bosnia and Herzegovina -3.7 -5.8 -4.3 -3.4 -2.3 Croatia -1.3 -4.1 -5.3 -6.3 -6.1 Macedonia -0.9 -2.7 -2.5 -2.5 -2.2 Kosovo -0.2 -0.7 -2.9 -3.3 -4.1 Albania -5.1 -7.5 -3.7 -4.6 -4.6 Source: IMF

Table 4: Net Public debt, 2008-2012

2008 2009 2010 2011 2012

Neo Public debt (% of GDP) estimate

Montenegro 26.5 32.4 38.7 39.8 39.8

Serbia 30.0 31.5 39.2 36.2 35.9

Bosnia and Herzegovina 21.4 26.8 29.9 32.5 32.8

Croatia 29.3 35.4 40.4 48.2 49.9

Macedonia 18.6 21.2 24.0 25.5 25.9

Albania 55.2 60.2 59.7 59.9 60.4

Source: IMF

The Western Balkan countries are not integrated in the European Union and in the Euro zone system. Except for the IMF arrangements, they cannot expect support from the European Central Bank or other institutions in facing an incoming debt crisis. Except for Croatia, all the Western Balkan countries have non-investment credit rating; and by that, they are risky investment destinations even without external shocks and instabilities on the international market. Therefore, fiscal policy of these countries must be additionally cautious and responsible. Actually, they cannot afford additional deficit and public debt levels, as is the case with the rich Euro zone countries, because nobody will finance them.

Consolidation as an agreement

Over the course of last thirty years important fiscal consolidations were implemented in various groups of countries, including G-7, EU members, countries rich in natural resources, main emerging market countries and large number of developing countries.

IMF’s research on fiscal consolidation covers the period from 1971 to 2001 and data were collected on 165 countries. During the observed period, 300 cases of fiscal consolidation were identified where fiscal consolidation exceeded 5% of GDP.

Moreover, 118 cases of adjustment were identified, including consolidation equal or higher than 30% of total state expenditures (whereby adjustment is compared with expenditures preceding the year of the adjustment). Out of observed cases only 38 cases of adjustment were implemented over a period equal or longer than 5 years, while in most of the countries more than two thirds of the total adjustment was focused in the first year.

This research identified 155 large fiscal adjustments (adjustment of more than 6.3% of GDP and 21.8% of state expenditures). They also include 63 cases where more than two thirds of the total consolidation is implemented in the first year and 55 cases of gradual consolidation where one third or less is implemented in the first year. On the other hand, it has identified 154 episodes of small-scale fiscal adjustment (adjustment less than 3% of GDP and 15% of state expenditures).

As a rule, large-scale fiscal consolidations were implemented under more complex macroeconomic conditions. The inflation was considerably higher, while the GDP growth, private consumption and private investments were lower. Furthermore, the share of public debt in GDP was on average two times higher, while the primary budget balance in the year preceding the adjustment was four times higher.

Out of 155 cases of large adjustment, 66 cases can be classified as sustainable. Sustainable adjustments were mainly based on reduction of expenditures. Expenditure reduction made three quarters of the total effort to sustain large-scale adjustment and was focused on the current expenditure, specifically on subsidies and wages.

Research of C. John McDermott and Robert F. Wescott is similar in terms of criteria and results, even though it has less coverage and is focused only to the OECD countries. This research covered 20 OECD countries in the period from 1970 to 1995. Out of 74 recorded cases of fiscal consolidation only 14 can be classified as successful, 48 were unsuccessful, while 12 cannot be classified due to shortage of data. Majority of successful cases of fiscal consolidation were part of a wider reform program which increased overall credibility of a government. The analysis indicates that the fiscal consolidation implemented in a discouraging economic growth rate environment and high interest rates, as it was the case in the period from 1980 to 1982 (global recession), will hardly be successful. However, the size of consolidation and its composition are dominant factors of success/failure.

Average size of a two-year fiscal consolidation in successful examples was 4% of GDP, if compared to the one of 3.2% of GDP in 48 unsuccessful examples. If comparing the composition of the fiscal consolidation, the research indicated that out of 17 cases where most of the fiscal consolidation is implemented through reduction

of expenditures, more than half were successful; while out of 37 examples where consolidation was made through tax increase, less than one sixth was successful.2 Such conclusion is also supported by the fact that average structural reduction of expenditures in successful episodes was 3.7% of GDP, while in case of unsuccessful ones it was only 2.1%. It is important also to mention that number of employees in public administration, salaries in the public administration and government consumption are reduced in successful examples, while in unsuccessful ones they remained at the same level or were increased. Social allocations and transfers were controlled in successful episodes, while in unsuccessful ones they grew in terms of their share of GDP.

Most important conclusions of the IMF research could be summarised as follows: reduction of expenditures proved to be the most common successful instrument in terms of resilience of the adjustment and creation of favourable macroeconomic impacts; in order to ensure the sustainability a fiscal adjustment policy should include reduction of costs for wages of public administration and reduction of the