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Cycles that shape the world

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Megatrends are shaping the world and of course geopolitics as well and we are most of the time unaware of this. Demography, migration, sustainability (environmental and budgetary) are key issues for Europe and the world from a long term perspective. It is lesser known that megatrends often develop by cycles of different types and lengths.

Nikolai Kondratiev was exiled to the Russian Gulag and executed in 1938 because Stalin did not like his views on the Soviet economy and his theory of economic cycles. How accurate and powerful Kondratiev’s theory was is demonstrated not so much by Stalin’s rage as by the fact that history is cyclical: war followed by peacetime, economic boom by recession, political tranquility by political crisis.

Academics probe into past cycles because they want to be able to predict the future. Why are there cycles in the first place? Why is expansion followed by stagnation and then recession? Simply because production or human output is not constant, but there is a mysterious equilibrium, a certain level which production should not fall short of or exceed. The economy is unaware of this tipping point and when it deviates from the equilibrium, markets crash and an overproduction or overvaluation crisis breaks out. Long periods of economic boom are inevitably followed by a bust and recession. The problem is we never know when and how hard the next crisis will hit. At the height of the crisis in late 2008, the Queen of England asked a simple but pertinent question of her country’s brightest minds. Visiting the London School of Economics, she wondered out loud: “Gentlemen! Why did no one foresee this awful recession?” Of course no one could give a straight answer; the eminent economists just stared at their shoes. A lot of people are convinced that the cycles and crises of the past could provide some guidance. Economists started to investigate economic cycles in the middle of the 19th century, discovering medium-term cycles first and then long-term cycles in the early 20th century. The four main types of economic cycles are known as the Kitchin wave, the Juglar wave, the Kondratiev wave and the Braudel wave. There are innumerous other types — every economist studying cyclical fluctuations was keen to have one named after themselves — but the others do not really deserve attention.

The Kitchin inventory cycle, is a short business cycle of about 40 months. Inventories fluctuate as the short-term approach of businesses influences their stocking and destocking policy. The cycle named after Joseph Kitchin, which is not a proper macroeconomic cycle, is followed by the Juglar cycle, often identified as ”the” business cycle. In 1860, French economist Clement Juglar identified the presence of economic cycles 7 to 13 years long. The low point of such a cycle is marked by an overproduction or financial crisis.

The Juglar cycle is the only one that politics can respond to, simply because this is the longest timeframe that successive governments can comprehend. When we talk about anticyclical policy, economic stimulus plans and recovery packages, we talk about the vicious side of this wave.

The third cycle on our list is called the Kondratiev or long technological wave. The Kondratiev wave spans a period of 50 to 60 years and is divided into a phase of high-growth expansion and a phase of recession. How did Kondratiev discover these waves? He observed prices, wages, interest rates, industrial production and the use of raw materials in the USA, England and France. A thorough analysis of these data revealed a sinusoid running through 150 years. Kondratiev noted that turning points in the wave coincided with revolutions and wars. Some divide the Kondratiev wave into four ”seasons”. The Kondratiev Spring is a time of rapid growth, falling unemployment, improving productivity and relatively stable prices. The economy is in its youth. The Kondratiev Summer sees growth level off as the economy reaches its limits in output and resources, and with it a brief recession as a warning of things to come. The brief recession in the Indian summer shakes up the economy as the Kondratiev Autumn arrives. Stability and normalcy is restored in society, which becomes consumption-oriented and prices begin to soar. With the Kondratiev Winter comes a collapse of the system and brumal depression sets in. A major three to four-year crisis is followed by a decade of deflationary stagnation.

There are several explanations for the Kondratiev wave. Some say that it exists because every generation spends 25 to 30 years of its life in active work, which roughly corresponds to half of the cycle. Others suggest that these waves arise from important innovations that launch technological revolutions (the railway) or investments that bring major improvements in a sector (education), which take roughly a Kondratiev cycle to trickle down to the economy. There are those who think that the next Kondratiev wave will build on the revolution in nanotechnology. Previous cycles have all had a key innovation that opened a new chapter in history. The first cycle (1790-1842) the steam engine, the second one (1843-1897) the railway, the third one (1898-1949) electricity and the car, the fourth one (1950-2000) the airplane and nuclear energy.

The longest cycle is named after the great French economic historian Fernand Braudel. The Braudel wave or secular cycle encompasses the changes of the deepest structures, which are only discernible over long periods of 100 to 200 years. As the pace of change in the world around us accelerates, the cycle’s span is shortened from 200 years to around a century. This fourth wave follows the evolution of comprehensive systems such as the interrelation between agriculture and industry or services and the industry.

Believers in the wave theory claim that these four superimposed heaving waves determine the rhythm of the economy and of history. When the crests or troughs of two waves coincide it has disastrous consequences for humanity. In the decades following the Napoleonic War, in a period of extreme uncertainty, a Braudel and a Kondratiev wave peaked synchronously. The stock market crash and crisis of 1873 was set off by an overlap of a Kondratiev and a Juglar cycle. The Great Depression of 1929 occurred at the low-point of a Kondratiev wave. Nikolai Dmitriyevich Kondratiev timed the publication of his book to perfection. The Major Economic Cycles came out in 1926, when the West’s economic growth looked unbreakable. Three years later people were rushing to the library for a copy of the Soviet economist’s book. The oil crisis of the 1970s was a tumult of waves. A Juglar, Kondratiev and Braudel apex at the same time. Some economists consider the whole theory nothing more than pseudoscience. On the other extreme those who could not give their name to a cycle search for and claim to have found mathematical (read: mystical) correlations between the waves, such as the formula 1 Kondratiev = 3 Kuznets = 6 Juglar = 12 Kitchin. As crises demonstrate, people will take anything to the extreme, be it the economy, science, economics or quantum physics. There is one discipline where exuberance is almost a prerequisite: futurology, whose key drive is to predict the future, which is in fact an important incentive to examine the past. The good Reverend Thomas Malthus is widely considered the first pioneer of futurology. He predicted over 200 years ago that food production would not be able to keep up with population growth, which would lead to famines worldwide. His theory did have one fault, though: he could not possibly foresee the technological developments that gave us modern farm machinery, fertilizers and GMO crops. Although there are many people starving in the world today, the global trend is just the opposite: despite the exponential population growth there is an abundance (if not oversupply) of food on Earth. Starvation in the third (developing) world is the result of political and financial anomalies and war rather than a problem of production capacity.

Jared Diamond, an evolutionary biologist, professor of geography at UCLA and critically acclaimed author of numerous popular science books, believes that there is no need for computerized risk analysis, research of trends and complex climate models to know what the future holds for mankind. Various groups of the human race, civilizations, have always outgrown their natural environment, which led to their decline or extinction. One of his favorite examples is that of the indigenous people of Easter Island. When Polynesians populated the island about 1,500 years ago, it was covered by lush vegetation. When discovered by a Dutch explorer in 1722, the island was barren with nothing but hundreds of monumental statues and a few locals wandering around. The islanders were so primitive that it was hard to believe that their forefathers had had the technological prowess to erect the huge moai. The natives cleared the forests to replace them with arable crops and to use the timber to erect the statues and to build canoes. After centuries of irresponsible logging, the islanders ran out of trees to cut down while the population exploded. Deforestation led to soil erosion, which in turn reduced crop yields and, with the forests gone, they had no canoes for fishing. The island became overpopulated, the food supply dwindled, the ecosystem collapsed, and the natives began killing each other, even resorting to cannibalism. For many this might be a worrying reminder no matter if they believe in waves or not.

Hungarian economist, PhD in international relations. Based in Brussels for fourteen years as diplomat and member of EU commissioners’ cabinets. Two times visiting fellow of Wilson Center in Washington DC. University professor and author of books on EU affairs and geopolitics. Head of department, National University of Public Administration, Budapest.

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The Monetary Policy of Pakistan: SBP Maintains the Policy Rate

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The State Bank of Pakistan (SBP) announced its bi-monthly monetary policy yesterday, 27th July 2021. Pakistan’s Central bank retained the benchmark interest rate at 7% after reviewing the national economy in midst of a fourth wave of the coronavirus surging throughout the country. The policy rate is a huge factor that relents the growth and inflationary pressures in an economy. The rate was majorly retained due to the growing consumer and business confidence as the global economy rebounds from the coronavirus. The State Bank had slashed the interest rate by 625 basis points to 7% back in the March-June 2020 in the wake of the covid pandemic wreaking havoc on the struggling industries of Pakistan. In a poll conducted earlier, about 89% of the participants expected this outcome of the session. It was a leap of confidence from the last poll conducted in May when 73% of the participants expected the State Bank to hold the discount rate at this level.

The State Bank Governor, Dr. Raza Baqir, emphasized that the Monetary Policy Committee (MPC) has resorted to holding the 7% discount rate to allow the economy to recover properly. He added that the central bank would not hike the interest rate until the demand shows noticeable growth and becomes sustainable. He echoed the sage economists by reminding them that the State Bank wants to relay a breather to Pakistan’s economy before pushing the brakes. The MPC further asserted that the Real Discount Rate (adjusted for inflation) currently stands at -3% which has significantly cushioned the economy and encouraged smaller industries to grow despite the throes of the pandemic.

Dr. Raza Baqir further went on to discuss the current account deficit staged last month. He added that the 11-month streak of the current account surplus was cut short largely due to the loan payments made in June. The MPC further explained that multiple factors including an impending expiration of the federal budget, concurrent payments due to lenders, and import of vaccines, weighed heavily down on the national exchequer. He further iterated that the State Bank expects a rise in exports along with a sustained recovery in the remittance flow till the end of 2021 to once again upend the current account into surplus. Dr. Raza Baqir assured that the current level of the current account deficit (standing at 3% of the GDP) is stable. The MPC reminded that majority of the developing countries stand with a current account deficit due to growth prospects and import dependency. The claims were backed as Dr. Raza Baqir voiced his optimism regarding the GDP growth extending from 3.9% to 5% by the end of FY21-22. 

Regarding currency depreciation, Dr. Baqir added that the downfall is largely associated with the strengthening greenback in the global market coupled with high volatility in the oil market which disgruntled almost every oil-importing country, including Pakistan. He further remarked, however, that as the global economy is vying stability, the situation would brighten up in the forthcoming months. Mr. Baqir emphasized that the current account deficit stands at the lowest level in the last decade while the remittances have grown by 25% relative to yesteryear. Combined with proceeds from the recently floated Eurobonds and financial assistance from international lenders including the IMF and the World Bank, both the currency and the deficit would eventually recover as the global market corrects in the following months.

Lastly, the Governor State Bank addressed the rampant inflation in the economy. He stated that despite a hyperinflation scenario that clocked 8.9% inflation last month, the discount rates are deliberately kept below. Mr. Baqir added that the inflation rate was largely within the limits of 7-9% inflation gauged by the State Bank earlier this year. However, he further added that the State Bank is making efforts to curb the unrelenting inflation. He remarked that as the peak summer demand is closing with July, the one-way pressure on the rupee would subsequently plummet and would allow relief in prices.

The MPC has retained the discount rate at 7% for the fifth consecutive time. The policy shows that despite a rebound in growth and prosperity, the threat of the delta variant still looms. Karachi, Pakistan’s busiest metropolis and commercial hub, has recently witnessed a considerable surge in infections. The positivity ratio clocked 26% in Karachi as the national figure inched towards 7% positivity. The worrisome situation warrants the decision of the State Bank of Pakistan. Dr. Raza Baqir concluded the session by assuring that despite raging inflation, the State Bank would not resort to a rate hike until the economy fully returns to the pre-pandemic levels of employment and production. He further assuaged the concerns by signifying the future hike in the policy rate would be gradual in nature, contrast to the 2019 hike that shuffled the markets beyond expectation.

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Reforms Key to Romania’s Resilient Recovery

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Over the past decade, Romania has achieved a remarkable track record of high economic growth, sustained poverty reduction, and rising household incomes. An EU member since 2007, the country’s economic growth was one of the highest in the EU during the period 2010-2020.

Like the rest of the world, however, Romania has been profoundly impacted by the COVID-19 pandemic. In 2020, the economy contracted by 3.9 percent and the unemployment rate reached 5.5 percent in July before dropping slightly to 5.3 percent in December. Trade and services decreased by 4.7 percent, while sectors such as tourism and hospitality were severely affected. Hard won gains in poverty reduction were temporarily reversed and social and economic inequality increased.

The Romanian government acted swiftly in response to the crisis, providing a fiscal stimulus of 4.4 percent of GDP in 2020 to help keep the economy moving. Economic activity was also supported by a resilient private sector. Today, Romania’s economy is showing good signs of recovery and is projected to grow at around 7 percent in 2021, making it one of the few EU economies expected to reach pre-pandemic growth levels this year. This is very promising.

Yet the road ahead remains highly uncertain, and Romania faces several important challenges.

The pandemic has exposed the vulnerability of Romania’s institutions to adverse shocks, exacerbated existing fiscal pressures, and widened gaps in healthcare, education, employment, and social protection.

Poverty increased significantly among the population in 2020, especially among vulnerable communities such as the Roma, and remains elevated in 2021 due to the triple-hit of the ongoing pandemic, poor agricultural yields, and declining remittance incomes.

Frontline workers, low-skilled and temporary workers, the self-employed, women, youth, and small businesses have all been disproportionately impacted by the crisis, including through lost salaries, jobs, and opportunities.

The pandemic has also highlighted deep-rooted inequalities. Jobs in the informal sector and critical income via remittances from abroad have been severely limited for communities that depend on them most, especially the Roma, the country’s most vulnerable group.

How can Romania address these challenges and ensure a green, resilient, and inclusive recovery for all?

Reforms in several key areas can pave the way forward.

First, tax policy and administration require further progress. If Romania is to spend more on pensions, education, or health, it must boost revenue collection. Currently, Romania collects less than 27 percent of GDP in budget revenue, which is the second lowest share in the EU. Measures to increase revenues and efficiency could include improving tax revenue collection, including through digitalization of tax administration and removal of tax exemptions, for example.

Second, public expenditure priorities require adjustment. With the third lowest public spending per GDP among EU countries, Romania already has limited space to cut expenditures, but could focus on making them more efficient, while addressing pressures stemming from its large public sector wage bill. Public employment and wages, for instance, would benefit from a review of wage structures and linking pay with performance.

Third, ensuring sustainability of the country’s pension fund is a high priority. The deficit of the pension fund is currently around 2 percent of GDP, which is subsidized from the state budget. The fund would therefore benefit from closer examination of the pension indexation formula, the number of years of contribution, and the role of special pensions.

Fourth is reform and restructuring of State-Owned Enterprises, which play a significant role in Romania’s economy. SOEs account for about 4.5 percent of employment and are dominant in vital sectors such as transport and energy. Immediate steps could include improving corporate governance of SOEs and careful analysis of the selection and reward of SOE executives and non-executive bodies, which must be done objectively to ensure that management acts in the best interest of companies.

Finally, enhancing social protection must be central to the government’s efforts to boost effectiveness of the public sector and deliver better services for citizens. Better targeted social assistance will be more effective in reaching and supporting vulnerable households and individuals. Strategic investments in infrastructure, people’s skills development, and public services can also help close the large gaps that exist across regions.

None of this will be possible without sustained commitment and dedicated resources. Fortunately, Romania will be able to access significant EU funds through its National Recovery and Resilience Plan, which will enable greater investment in large and important sectors such as transportation, infrastructure to support greater deployment of renewable energy, education, and healthcare.

Achieving a resilient post-pandemic recovery will also mean advancing in critical areas like green transition and digital transformation – major new opportunities to generate substantial returns on investment for Romania’s economy.

I recently returned from my first official trip to Romania where I met with country and government leaders, civil society representatives, academia, and members of the local community. We discussed a wide range of topics including reforms, fiscal consolidation, social inclusion, renewably energy, and disaster risk management. I was highly impressed by their determination to see Romania emerge even stronger from the pandemic. I believe it is possible. To this end, I reiterated the World Bank’s continued support to all Romanians for a safe, bright, and prosperous future.

First appeared in Romanian language in Digi24.ro, via World Bank

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US Economic Turmoil: The Paradox of Recovery and Inflation

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The US economy has been a rollercoaster since the pandemic cinched the world last year. As lockdowns turned into routine and the buzz of a bustling life came to a sudden halt, a problem manifested itself to the US regime. The problem of sustaining economic activity while simultaneously fighting the virus. It was the intent of ‘The American Rescue Plan’ to provide aid to the US citizens, expand healthcare, and help buoy the population as the recession was all but imminent. Now as the global economy starts to rebound in apparent post-pandemic reality, the US regime faces a dilemma. Either tighten the screws on the overheating economy and risk putting an early break on recovery or let the economy expand and face a prospect of unrelenting inflation for years to follow.

The Consumer Price Index, the core measure of inflation, has been off the radar over the past few months. The CPI remained largely over the 4% mark in the second quarter, clocking a colossal figure of 5.4% last month. While the inflation is deemed transitionary, heated by supply bottlenecks coinciding with swelling demand, the pandemic-related causes only explain a partial reality of the blooming clout of prices. Bloomberg data shows that transitory factors pushing the prices haywire account for hotel fares, airline costs, and rentals. Industries facing an offshoot surge in prices include the automobile industry and the Real estate market. However, the main factors driving the prices are shortages of core raw materials like computer chips and timber (essential to the efficient supply functions of the respective industries). Despite accounting for the temporal effect of certain factors, however, the inflation seems hardly controlled; perverse to the position opined by Fed Chair Jerome Powell.

The Fed already insinuated earlier that the economy recovered sooner than originally expected, making it worthwhile to ponder over pulling the plug on the doveish leverage that allowed the economy to persevere through the pandemic. The main cause was the rampant inflation – way off the 2% targetted inflation level. However, the alluded remarks were deftly handled to avoid a panic in an already fragile road to recovery. The economic figures shed some light on the true nature of the US economy which baffled the Fed. The consumer expectations, as per Bloomberg’s data, show that prices are to inflate further by 4.8% over the course of the following 12 months. Moreover, the data shows that the investor sentiment gauged from the bond market rally is also up to 2.5% expected inflation over the corresponding period. Furthermore, a survey from the National Federation of Independent Business (NFIB) suggested that net 47 companies have raised their average prices since May by seven percentage points; the largest surge in four decades. It is all too much to overwhelm any reader that the data shows the economy is reeling with inflation – and the Fed is not clear whether it is transitionary or would outlast the pandemic itself.

Economists, however, have shown faith in the tools and nerves of the Federal Reserve. Even the IMF commended the Fed’s response and tactical strategies implemented to trestle the battered economy. However, much averse to the celebration of a win over the pandemic, the fight is still not through the trough. As the Delta variant continues to amass cases in the United States, the championed vaccinations are being questioned. While it is explicable that the surge is almost distinctly in the unvaccinated or low-vaccinated states, the threat is all that is enough to drive fear and speculation throughout the country. The effects are showing as, despite a lucrative economic rebound, over 9 million positions lay vacant for employment. The prices are billowing yet the growth is stagnating as supply is still lukewarm and people are still wary of returning to work. The job market casts a recession-like scenario while the demand is strong which in turn is driving the wages into the competitive territory. This wage-price spiral would fuel inflation, presumably for years as embedded expectations of employees would be hard to nudge lower. Remember prices and wages are always sticky downwards!

Now the paradox stands. As Congress is allegedly embarking on signing a $4 trillion economic plan, presented by president Joe Bidden, the matters are to turn all the more complex and difficult to follow. While the infrastructure bill would not be a hard press on short-term inflation, the iteration of tax credits and social spending programs would most likely fuel the inflation further. It is true that if the virus resurges, there won’t be any other option to keep the economy afloat. However, a bustling inflationary environment would eventually push the Fed to put the brakes on by either raising the interest rates or by gradually ceasing its Asset Purchase Program. Both the tools, however, would risk a premature contraction which could pull the United States into an economic spiral quite similar to that of the deflating Japanese economy. It is, therefore, a tough stance to take whether a whiff of stagflation today is merely provisional or are these some insidious early signs to be heeded in a deliberate fashion and rectified immediately.

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