On the Wings of Fear

There is a joke which says that a group of economists got lost during a hiking expedition, and their leader took the map and compass to find out where they were. After some time, the leader happily exclaimed: "Do you see that hill over there? Well, according to my calculations - that's where we are standing now!" The same is with the latest news that the Federal Republic of Yugoslavia is among the countries with the highest growth rate in the world.

In order not to get lost in the flood of such completely unjustified optimism, it is important to stick to the old saying "carry the map, but check with the locals". When the matter is studied in keeping with this old folk wisdom, the picture becomes much less favorable. Although among the creators of our economic policy it is hard to find even a single person who has heard about (let alone understood) it, experts will tell you that the Yugoslav economy, in the last ten years, is in the middle of the populist economy whirlpool. What is it and what does it means?

Ph.D. Dijana Dragutinovic, associate of CesMekon, speaks about it for Vreme: "Populism was developed in the late '70s and early '80s in the South American states, most of all in Peru and Argentina. It was preceded by stagnation, depression, big unemployment, low standard of living and high inflation, which was not exactly hyperinflation. The goal of such policy was growth of production and the standard of living, accompanied by stable prices. Growth of production was supposed to be achieved by expansive monetary and fiscal policy, along with the growth of wages, domestic demand and production for the local market. Stable prices were achieved through their control in the public sector (oil, energy, telephone and telegraph, and public services), while the financial expenses were lowered by means of lower taxes and control of interest rates. The last lever the populist used was the fixed currency exchange rate."

Ms. Dragutinovic does not deny that such policy brings initial success, but experience has shown that this is a short story - success lasts only one year.

"The breaking point of such nice success is the exchange rate, because of the deficit of the balance of payment, which cannot be financed. The problems of stagnation, depression, unemployment, inflation and low standard reoccur, even more intensely because both time and currency reserves are wasted in the interim," explains Ph.D. Pavle Petrovic, director of CesMekon. He claims that the populist economic policy has been consistently conducted in this area between 1989 and 1993.

This, what the Yugoslav economy seems to be today, is, as Ms Dragutinovic claims, "the situation which in fact is populist, but the policy it is not." What has changed? In the meantime, hyperinflation has brought - fear. Only by fear can we explaine the abandoning of the consistent populist whirlpool. Ph.D. Dijana Dragutinovic notes that we are a country which "usually learns from its own and not someone else's experience", and the same thing happened in this case: first our government learned from the 1993 hyperinflation that production cannot be boosted by printing money; then during the years that followed (1994 and 1995), it learned the lesson of interest rates: financial expenses cannot be brought down by controlling interest rates.

"Now we are learning that we cannot close our eyes in front of the fiscal deficit, and when we spoke about it in January 1995, we were bitterly criticized," says Ph.D. Petrovic in his statement to Vreme. Namely, the idea that public expenses must be lowered was refused, with arguments that important things were at stake (pensions, education, health care, army, police and the like). Mr. Petrovic notes that meanwhile public expenses have de facto decreased, but at random. "We now deal with the public expenses deficit which has turned into the unregulated public debt", says for Vreme M.A. Milojko Arsic, who is also associate of CesMekon. Is it necessary to explain the meaning of this to the pensioners, teachers, doctors or soldiers? No, it is sufficient that they take a look at their wallets.

And, as Ph.D. Dragutinovic notes, "it was easier to find the solution for the 2.5% deficit in the national product in 1995, than it is now for the 10% deficit in the national product."

In short, regardless of inconsistency over time (we print a bit, and then we don't) within the pure populist policy (interest rates are not controlled, although their importance is questionable since the debt has not been paid back and has been forgiven), we are still whirling within its circle. At this very moment we have reached the breaking point: exchange rate and a dwindeling balance of payment. It would have happened before, but we patched the holes with unidentified currency reserves and by means of the sale of PTT. The currency backing for the money printed, based on the income from the sale of PTT, M.A. Arsic calls "the new trick" -- but it is also over. This trick is also out of date: the dinar has practically devaluated. Another short story.

South Americans have experienced and learned in the '80s that macro-economic balance (growth of production, stable prices, stable exchange rate and the like) could not be achieved by means of the expansive monetary and fiscal policy, along with the fixed exchange rate. Have we also learned all the lessons? If judged by the stories about how the rate and the prices will remain unchanged in the next year, and the production will be "in the group of the countries with the fastest growth in the world" - we have not graduated yet. Shall we graduate and when will it happen - nobody knows.

And if we had a little bit of wisdom and good will to use someone else's experience, then the solution would be sought in resolving the fundamental mistakes of the Yugoslav economy.

One of these mistakes concerns the rate of the dinar. According to the opinion of the CesMekon's experts, we have three possibilities. The first is to withdraw the surplus of printed money, which also means that the National Bank of Yugoslavia (NBJ) has to sell a considerable amount of currency in order to keep the rate of 3.6 (3.3) dinars for one German mark. As opposed to the end of 1996 and beginning of 1997, much more dinars will have to be withdrawn now (because more was printed and the reaction is late). This choice would cause a deep recession, says Ph.D. Petrovic, and this wasn't done even in Great Britain, Italy, Sweden, Finland and Norway in 1992-3. They found the devaluation cheaper.

The second option is to keep the official exchange rate, but with moderate decrease of the monetary mass. This was also tested in 1995. The results: inflation, temporary maintaining of the production, and then its sharp fall. Plus, the decrease in the amount of the currency reserves of the country, because the black market foreign currency exhange rate much higher than the official rate. The third, and for the CesMekon's experts the optimal solution, is official devaluation of the dinar, while keeping the monetary mass on the same or slightly lower level (MA Aleksic says that the slightly lower level of money will amortize inflation expectations that would occur at first). At the same time, it will be wise to modify also the regime of the exchange rate of the dinar: to switch to a flexible rate instead of a fixed one, and to maintain stable prices and the stable rate by means of monetary (no irregular printing of the money) and fiscal (better collection of income and lower expenses) policy.

The flexible exchange rate does not mean lack of its stability, which is best illustrated by the value of the dinar on the black market in the last few years. It was relatively stable until the beginning of money printing, in spite of the fact that none of the conditions zo which our economist pointed were fulfilled (relations with the world, financial discipline, etc.).

M.A. Arsic especially points out that the thesis that "in our specific conditions" devaluation would cause inflation does not hold true: direct and indirect expenses of devaluation through inflation would come to one third of the inflation rate. M.A. Arsic believes that lowering the rate to the level of 4.7 dinars for one German mark would cause the growth of prices by about 12%. And this growth is inevitable. Our experts think that this is a small price to pay, compared with the possibility of economic stability. "We should meet the events head on, and not wait for the situation to force us to change", states Ph.D. Petrovic.

Everything else is a waste of time, and it is well known that time is money.