And that will happen irrespective of the political leanings of the party. This should not take us by surprise. It comes with the procyclical policies which have been the mainstay of Romania`s development over the last decades, a country that boasts the highest level of economic volatility in the EU. It brought on record growth in favorable settings and equally remarkable dips in less friendly circumstances. If during times of economic growth the government adds tax and consumption incentives, subsequent corrections can only be severe. Adjustments do not happen in the absence of a nudge, but occur mainly when the country does no longer enjoy the benefits of a positive international economic dynamic.
Bragging, as it were, in the face of those who raise the alarm on how abnormal the current procyclicality is, that the economy shows no signs of weakness, is evidence of being naïve. Let us remember that during the 2008 crisis, Romania could easily sustain two-digit current account deficits, getting drunk on ungrounded optimism. It is hard to turn an economy upside down, and it requires quite a lot of determination to actually succeed. It is a time that creates the illusion that, in fact, what you are doing is right and everybody else is either jealous or incompetent. Once there, you need somebody else to return everything to normal, with a good enough reputation and political capital that can be used up.
When the wind of the global economy starts changing, waking up to reality will be tough and, most often than not, those asked to pay for the damages will not be the ones who caused them. That`s the scenario looming on the horizon.
The path that the Romanian economy has engaged in may potentially be sustainable as long as the international setting remains harmless. But international economic prospects, in particular in the EU, are starting to turn sour and economies show signs of slowing down. Such circumstances will expose all the vulnerabilities generated by using deficits to drive consumption – the budgetary and current account deficits – that deliberately ignore the need for public investments.
We cannot continue in the same direction for long and the moment of truth will be knocking on our door. A new government will have to change track and come up with economic policies that promote development first, with consumption far behind on the list. This will turn it into a government of sacrifice, as their investments will only show results in the medium and long-term, while in the short term it will end the party for some Romanians.
Top on the list of priorities will be the budget restructuring which requires the implementation of two actions. On the one hand, increasing revenue sustainably, but also changing the expenditures structure. Cracking down on tax evasion will be an additional source of income, but it takes time. A need for funds to quickly resume investment projects will require a tax hike, with the VAT as the main target, given the very fast outcomes.
A VAT increase will lead to inflation, which could be brushed aside by the NBR, the central bank, being supply and not demand driven. The key interest rate could stay unchanged. That is good news for borrowers, but bad for savers who stand to lose their wealth due to negative real interest rates. Finally, an increase in prices across the board would not be to anyone`s liking.
At the same time the expenditures structure will have to be amended to direct more money to public investments. That involves setting a cap on the public sector wage bill and pensions, at the very least, but most likely a decrease in these expenses will also be needed. That translates into a public sector wage freeze, cutting the number of government employees, scrapping some of the perks, and part of the special pensions handed out now so generously and revisiting public service pension indexation.
None of the decisions above is set to boost the approval ratings of the next government. On the contrary. Higher inflation, against a backdrop of wage and public service pension stagnation, a hiring freeze or redundancies will build up frustration. They will make economic sense and result in badly needed corrections, but that will not comfort those affected, who have lately been led to have unrealistic expectations.
How will the new government justify these unpopular decisions? It depends on which side of the political spectrum it is. A government on one side will blame the predecessors, their unsustainable economic policies, and their misguided priorities. A government leaning the other way will point to unfavorable international circumstances, out of their control, or to multilateral institutions, such as the IMF which forced on them the unpopular decisions that they would not have otherwise taken.
Mitigating negative public reactions to unpopular economic decisions could be done by concurrently taking measures which are not economy-related, but are rated as very significant in the public mind. The ones on the functioning of the judiciary are a good example. Moreover, applying the unpopular measures immediately, at the beginning of the term, may cause the beneficial outcomes to become palpable before the electoral cycle is up, giving the government some space to capitalize on the results. That would be a first …
So anyone up for it?
Have a nice weekend!
