Turmoil at twenty: World Bank report on crisis in ECA region

The KSE and the World Bank are organizing the presentation of the report "Turmoil at Twenty". It covers the current situation and discusses how ECA countries deal with the current crisis and what are the next steps required to restore economic growth.

The main lesson I draw from the report is that a sound macroeconomic policy helped to soften the impact of the crisis on countries like Czech Republic relative to countries like Latvia or Ukraine. Here, the emphasis on the exchange rate stability in Ukraine came at a large cost of inability of the NBU to fight high inflation and lack of independent monetary policy. As a result, forced exchange rate adjustments created a panic and led to the severe banking crisis leaving the NBU unprepared to fight the crisis more effectively.

Also, the degree of integration to the world economy was not the cause of the crisis but the channel through which market and governance imperfections amplified their negative impact. For example, a housing market bubble was developing because of highly inelastic supply due to the monopolization in the construction market and poor government regulations in the sector but it would not blow out of proportions without easy access to credit. An increasing concentration of exports in just a few commodities (metals and basic chemicals) was developing due to low competitiveness of firms in other sectors but would never reach 40% of total export without the commodity demand boom caused by overinvestment in China and other rapidly growing economies.

As a result, access liquidity and commodity price boom distorted the market incentives and led to the current situation. Hence, conditional on domestic imperfections that can not be fixed in the short run; there is a need for tools that would allow putting restraints on capital inflows and some sort of countercyclical fiscal stabilizers.

Last quick remark, I felt that the authors of the report are too soft on the financial institutions that failed spectacularly due to underestimation of the risks and provision of excessive credit. Also, the authors claim that the countries in the region have necessary tools and legislation to deal with non-performing loans. I feel, however, that at least in Ukraine, the procedure of bankruptcy is not clearly specified and the borrowers are poorly protected from unilateral changes by the financial institutions of the terms of borrowing.

Level of protectionism is rising

According to the Global Trade Alert, Basic metals and basic chemicals are two industries most affected by the protectionist measures. These are two industries in which Ukraine exports the most.
The top three countries that have the most protectionist measures imposed are Russia, India, and US. However, the EU would come first if one include groups of countries.
In terms of product lines that are affected, the top three countries are Russia, Ukraine, and China.

Vote for me! I am in favor of all good things and against all bad things!

Thanks for the tip to Tom Coupe, who is also a professor at KSE.

Top 10 most strange promises of candidates to President’s post

1. Victor Yanukovych: “My aim is 50 million citizens of Ukraine in year 2020”.

2. Inna Bogoslovska: “Ukraine will make “Kyiv initiative” concerning carrying out in Kyiv the negotiations of the world community on new world order topic”.

3. Volodymyr Lytvyn: “Key task – is providing correlation of minimal and maximum wage in proportion 1 to 5”.

4. Petro Symonenko: “ The minimum share of salaries in the product prime cost will be set at 60%.

5. V. Yushchenko: “A hryvnia will become the only payment means in Ukraine. There will be no foreign currency transactions and prices in the home market”.

6. Oleg Tyagnybok: “European Ukrainian-centrism – strategic course of the government”.

7. Anatoliy Hrytsenko: “I will make an official to speak with people in the language, he/she is addressed”.

8. Oleksandr Pabat: “The state monopoly on main land resources will be renewed and the state will take the land on long-term lease”.

9. Yulia Tymoshenko: “Immediately after the crisis we will resume a long term housing mortgage loans at 2-4% per annum for 10-30 years”.

10. Lyudmyla Suprun: “The schools will turn to multimedia scientific-cultural centers of education and development of personality”.

http://www.unian.net/eng/news/news-351640.html

My personal favorites are the promises number 1 and number 9. I am not sure which one is more difficult to make true.

Technologies will save the country, or will they?

Александр Кендюхов, (Chair of All Ukrainian Union of economists) advocates for creation of state-owned corporations that will be export-oriented and work in biotechnology and pharmaceutical industries. To boost their development he suggests:

- get rid of all taxes on businesses including VAT

- introduce a sale tax of 5%

There are several passages that are truly amazing:

"Высвобождаемое в результате сворачивания устаревших индустриальных производств трудоспособное население, не способное к переобучению, получая от государства стартовый капитал, легко включается в малый бизнес" -- it could easily win the prize for the stupidest economic policy ever suggested! An unemployed who can not find a job and who can not be retrained, presumably because he is either a) stupid or b) too old, will supposedly start his own business using taxpayers' money and  become a successful businessman.  Questions: don't you need at least some very specific ability to develop your own business? what is the likelihood of you having this ability  if  you can not be retrained to do other job?

"Продукция высокотехнологичного сектора, представленного преимущественно крупным бизнесом, должна быть ориентирована прежде всего на экспорт, малый бизнес — на внутренний рынок. Стимулируется рост внешнего и сокращается рост внутреннего потребления, что увеличивает накопления населения. Аккумулированные населением денежные средства направляются на покупкуакций создаваемых высокотехнологичных предприятий."  Very interesting: I save money because the consumption is very expensive and there is nothing there to buy, and the government takes my savings and gamble with it by purchasing stocks in some state-owned biotech company that has uncertain chances of succeeding in its venture.

It is really sad that "ALL Ukrainian economists" suggest these kind of economic policies

China as the source of global imbalances

Martin Wolf on China: Why China’s exchange rate policy concerns us

Investment in Ukraine are down by 43.7%

Investments in Ukraine in January-September, 2009 are 43.7% down relative to the same period of 2008. Here is the regional numbers:

Macro: liquidity trap and money supply

Charles Goodhart comments on the collapse in the money multiplier and advocates continuing quantitative easing. The discussion nicely illustrate the difficulties that the central banks face now in an attempt to increase liquidity:

Insight: Deflating the bubble By Charles Goodhart

Published: November 30 2009 16:35 | Last updated: November 30 2009 16:35

Between the failure of Lehman Brothers in September 2008 and March 2009 asset prices in financial markets, world trade, confidence and real output dropped faster than in 1929.

Since then there has been an, almost miraculous, recovery in financial markets and confidence, and a stabilisation and incipient recovery in trade and output. The turning point coincided with the aggressive adoption of quantitative easing (QE), especially in the US and UK. The most common explanation of this recovery in financial markets is that it has been due to the abundant provision of liquidity; and liquidity is exactly what QE generates.

Yet QE has not worked as many had first expected. A now defunct theory of the supply of money had the central bank controlling this by operating to adjust the reserve base of the banking system. Banks were expected to maintain a reasonably stable ratio of reserves to assets/deposits so, if the authorities should raise their reserve base, primarily their deposits with the central bank, then total assets/deposits should rise by the same level.

Since total assets/deposits are normally a large multiple, say 25 times or more, of the reserve base, this relationship appeared to enable the central bank to adjust total bank assets/deposits by a multiple of their open market operations to affect the reserve base, the “money multiplier” as the theory was known.

From June 2008 to June 2009, reserves held by commercial banks with their central bank doubled in the eurozone, and increased by an even greater percentage in the UK and US, yet bank deposits and total bank assets barely changed, so the multiplier collapsed to zero. Banks, in aggregate, just absorbed the additional reserves by allowing their ratio of reserves to deposits to balloon, without any attempt to use their greater liquidity/reserves to expand their balance sheet. Why?

This may appear to have been a purely passive response to cash injection, but nevertheless commercial bank treasurers will have consciously decided that accumulating vast cash reserves was preferable to using them in any other way. This may be partly insurance against uncertain future needs to roll-over wholesale funding. At a time of tightening bank capital requirements, and rising prospective defaults, the limitations on lending to private sector borrowers, except on most favourable terms, are obvious.

But why not buy safe public sector debt? Lower yields on short-dated government bonds, pushed down by QE, as well as interest rate risk, enhanced by rising debt ratios, may make public sector debt appear less attractive compared to the safe remuneration on deposits at the central bank. This is a condition for a typical liquidity trap; hence my proposal for applying a negative return, a charge, on such deposits. Perhaps a lesson that should be learned is that the relativities between the interest rate on bank deposits with, and borrowing from, central banks gives each central bank another degree of instrumental freedom, on top of their control over the official short-term rate.

Despite the total collapse of the money multiplier, QE has, I believe, been a major factor in the recovery of financial markets and confidence. The scale of asset purchases has been so large that it has led to a huge injection of liquidity, and to portfolio rebalancing, on a large scale amongst non-bank financial intermediaries and financial market participants more widely. Bond yields have come down quite sharply, more so in riskier corporate debt than in government debt, as risk premia also get reduced. Equities rise, and exchange rates fall in countries pursuing QE more aggressively (USA and UK) relative to those doing less (eurozone and Japan). The rise in asset prices and fall in yields, has allowed large corporates, including banks, to refinance themselves in capital markets; with fixed and inventory investment still low, such fund raising allowed repayment of bank loans. It is ironic that QE may have facilitated a reduction in bank lending and deleveraging.

So if QE has been such a success, and the prospective recovery still looks anaemic, why not continue it? Partly because the money multiplier has been defunct, QE has operated primarily via a restoration of prices, confidence and capital gains in financial markets rather than impinging directly on the access to credit and expenditure decisions of small and medium enterprises and households, where the real problems remain. If the authorities go on blowing up financial markets too much, at some point yet another bubble will develop. The last time the financial bubble burst, the taxpayers got soaked. There will not be a next time for this support mechanism, since the taxpayer neither can, nor will, repeat it. Central banks need to check their proclivity for generating a further bubble to overcome the effects of the previous bust. Certainly, we can never get the timing exactly right, but now does seem the moment to declare victory for QE and withdraw.

Ukraine is being lost in transition: should it stay, or should it go?

Ukraine is currently in a very awkward position of moving away from CIS (or rather Russia, Belarus, and Kazakhstan emerging trade bloc), but not getting closer to the EU. My new research paper shows that any integration strategy -- CIS oriented or EU oriented -- would be better than the current status of being lost in transition. Here is the graph that demonstrate actual vs predicted aggregate trade under the EU and CIS integration scenarios:

By distancing itself away from Moscow, Ukraine is losing its current trading partners in traditional goods that it exports. By not integrating with EU it is losing in two different ways: its old trading partners from new EU member-states (trade diversion effect) and is finding it more difficult to attract FDI, create competitive products in manufacturing sector, promote its production in the EU market (losing possibility for expansion of manufactured exports and probably agricultural products).
Here is the graph that shows the gains in exports of Ukraine in 4 large groups of products from chosing EU integration rather than CIS integration:

Gazprom faces high uncertanty

Gazprom position as the main gas supplier is weakening in the short run and is very uncertain in the long run:

Kyiv Post:  As it sits on nearly one-fifth of the world's natural gas, Gazprom is and will remain an indispensable player in the gas market, particularly in Europe. But the shock waves from the economic crisis have contributed to create a perfect storm large enough to rock even the largest boats.

EU double standards

An issue of visas is very important in Ukrainian-EU relationships. As another evidence of double standards, Kyiv Posts reports:

The Parliament: EU castigated over Ukraine visa issue 

"...At present, Europeans wishing to visit Ukraine do not need a visa and Kiev eventually wants reciprocal visa-free facilities for its citizens travelling to the EU.

Speaking at a breakfast briefing in Brussels on Thursday, Kostiantyn Yelisyeiev stressed, "We are not asking for the immediate introduction of a visa-free regime because we realise we have to take certain measures.

"But what we are saying is that the EU should be doing much more to help facilitate this."

He singled out four member states – Germany, Belgium, Austria and the Netherlands – for particular criticism, saying they were obstructing the start of "serious" negotiations on the issue."

The state of the macro: new developments

Paul Krugman in his article has criticized the current macroeconomists for throwing out everything interesting from macro models by assuming away bubbles, irrationality, "animal spirit".  A recent conference "What's wrong with current macroeconomics" addressed some of Krugman's concerns. A couple of articles on www.voxeu.org popularize some of the research in that direction:

• "heuristic" economic agents (Top down versus bottom up macroeconomics by Paul de Grauwe) that do not quite understand how the economy works but by optimizing their behavior trying various simple rules
• incorporating politics, institutions, and ideology in their models (The roles of ideology, institutions, politics and economic knowledge in forecasting macroeconomic developments: Illustrations from the recent crisis by Alex Cukierman)

Industrial output in Ukraine is up, but down

There is a typical good news, bad news story:

Industrial output in October, 2009 is 5% up relative to September, 2009 but...

...It is 6.2% down relative to October, 2009

The most troublesome figure is that  the industrial output in January-October, 2009 is 26.4% down relative to the same period of 2008.

Manufacturing industries were hit the most -- 31.2% decline relative to January-October, 2008. Among manufacturing industries, car industry is the clear loser with drop by 63.2%.

New GDP number

Ukrstat reports a preliminary GDP of Ukraine for the Q3 2009:

GDP in Q3 2009 is 84.1% of GDP in Q3 2008


Such an awkward and indirect  statement (why did not they give us a number?) can be explained by the fact that the Chief Ukrainian Statisticians  do not want to upset the prime-minister.

is EU not welcomed anymore?

Current presidential elections are marked with low interest of population in the idea of EU integration. Ukrainians are just giving up on that due to more important domestic problems caused by  economic crisis. However, the EU politicians, if they ever were interested in integration of Ukraine into EU, are also responsible by sending confusing, often discouraging signals. In contrast, Russians have a very clear idea on what they want from Ukraine.

Global trade imbalances are back

This is what worries me about US  trade deficit is growing again:

The illusion of improving global imbalances, voxEU.org, Richard Baldwin and  Daria Taglioni

...projections of improving imbalances are almost surely wrong. The rapid collapse of trade between the third quarter of 2008 and the first quarter of 2009 improved most balances of trade. It could not have done otherwise; if both imports and exports drop rapidly, the gap between them drops equally rapidly. In the same mechanistic manner, the recovery of trade flows – a recovery that seems to have started this summer – will almost surely return the US, Germany, China and others to their old paths.

Zero import duties for chemical industry

Tymoshenko proposes zero import duties on equipment, raw materials for chemical enterprises. It is an example of a new view on industrial policy that was rarely used in Ukraine before: 

She said this at a meeting dedicated to Ukraine's chemical industry in Severodonetsk, Luhansk region, on Saturday. "I believe we need a zero import duty on component parts and raw materials for domestic [chemical] industry," Tymoshenko said. At the same time, Ukraine needs to learn how to protect the domestic while importing foreign chemical products, she said.

Demand for construction jobs is on the rise

Kyiv Post reports that companies are actively searching for construction workers:

The number of construction jobs registered on the professional recruitment portal rabota.ua in October totaled 66.6% of the general number of vacancies in the sector of construction and architecture, while a total of 27.4% of registered jobseekers have applied for construction jobs. 

Trade Deficit in U.S. Increases by Most Since 1999

I really do not understand how can it be a good news in the long run. It means that we are back into the situation that lead to the crisis. If the shock of 2008 could not make the US trade more balanced then the future adjustments will be huge and consequences for all countries very unclear.

Food and energy prices in 1960-2005

Kym Anderson writes about agricultural policy: "... it is not only high-income countries that are resisting committing to further reform, as many developing countries also want to retain their capacity to raise trade restrictions when prices spike. More than that, developing countries are seeking a Special Safeguard Mechanism that would allow them to set tariffs even higher than their ceiling bindings should food prices collapse or imports surge. This would only add to the volatility of international markets for agricultural products, as each country’s actions spill over to other countries and related products."


There is an interesting figure that shows energy prices are unusually high and food prices are unusually low right now:

Europeans demand Ukraine to have a fair election

Europeans really think that Ukraine owes them something. In a new article Tony Barber portrays Ukraine as an unstable, corrupt country that constantly irritates its neighbors. He further says the following: "...the key moment in EU-Ukrainian relations would be its January 17 presidential election. Anything less than a free and fair election, and a mature acceptance of the result by winners and losers alike, would be catastrophic for Ukraine's image in EU eyes."
One might wonder, do Europeans have a moral superiority to say something like that? What has the EU done in the last 5 years to improve its relationships with and help to develop Ukraine? The answer is it has done nothing. There were some talks, conferences, empty promises: all kind of things that the EU bureaucrats are good at. But die the EU made any effort in make the EU open for the movements of people, goods, and capital between the EU and Ukraine. Did the visa issuance improved? No, it got worse. Can Ukrainian farmers access the EU market? No, they can not. Do we have a free trade agreement? No we do not.
Ukraine is in deep political and economic trouble and needs some help from the international community, but all we have got so far from EU are empty words from their side and ungrounded demands. Sorry guys, if you do nothing to help, you have no rights to teach us.

Second wave of the financial crisis for Ukraine?

After the parliament and the president acted based on political considerations, it is the economy that suffers:

Reuters: Fitch cut Ukraine's credit rating on Thursday and said a delay in IMF funding coupled with a huge budget gap would lead to more instability.

Both Yushchenko and Yanukovich act according to a slogan: bad for the country -- good for  us. It is a strategy that brought Lenin to power in 1917, but he was not the one that really benefited from that -- Russia was ruined and could not restore for long time.

Flu mask externality

Kyiv Posts reports:


Two men wearing medical masks and carrying guns of a rare designon the morning of Nov. 11 robbed an outlet in Donetsk of the Finance and Credit bank, ranking among Ukrainian largest commercial banks, and an outlet of Pravex bank, ranking among Ukrainian large commercial banks, in some 30 minutes.

Three reasons why central banks keep assets

Nick Rowe, a professor of economics at Carleton University in Ottawa, Canada, about the reasons why central banks have assets:

Why do central banks have assets?

If you look at the balance sheet of a central bank, you will see it has liabilities (mostly currency) and assets (normally mostly government bonds/bills). Why do central banks have assets? Do they need them?

The wrong answer is that central banks need assets to "back" the value of the currency, and that paper currency would be worthless otherwise. The right answer is: since the government gets all the profits from a central bank anyway, there's no point in giving the government the assets; that owning assets lets the bank reverse course and reduce the money supply if it ever needs to; and it stops the accountants freaking out.

Let's deal with the wrong answer first. According to the "backing" theory of the value of money, the value of a central bank's currency is equal to and determined by the value of the central bank's assets backing the currency. (This is different from the fiscal theory of the price level, which says that the value of currency plus bonds is equal to and determined by the present value of primary fiscal surpluses.)

The backing theory sounds good. How can intrinsically worthless paper money have value? Because it is backed by valuable assets. It's just like shares in a mutual fund, which have value equal to and determined by the value of the assets in the fund.

Here are three arguments against the backing theory of money:

1. The assets of central banks are normally nearly all nominal assets, denominated in the same currency as the liabilities. Suppose the price level were to double magically overnight, and the real value of currency halved. The real value of the bonds held by the central bank would also halve. So a magical doubling of the price level would not violate the equality between the value of the currency and the value of the assets backing it. The backing theory leaves the price level indeterminate. It could only pin down the price level if the assets were real assets. If (say) 10% of the bank's assets were real (gold reserves, plus the building), then a 1% loss of its real assets (the building burns down) would cause a 10% jump in the price level.

2. Suppose a mutual fund held bonds, but all the interest on the bonds (minus the administrative expenses of running the fund) were handed over to some third party, and not to the owners of shares in the mutual fund. Who would want to own shares in that mutual fund? The net present value of the dividends paid to the shareholders would be zero, so the shares would be worth zero too. But this is exactly what central banks do. Every year central banks earn profits from the interest on the bonds they own, minus administrative expenses, and hand the whole of that profit to the government, not to the holders of currency.

3. We don't need "backing" to explain why money has value. People want to hold a stock of money because money is a medium of exchange, and holding a stock of the medium of exchange makes shopping easier. This creates a (stock) demand for money. Provided the central bank restricts the supply of money, the intersection of demand and supply curves creates a positive equilibrium value of money (a finite price level). Now you could argue that if paper money were worthless it could not function as a medium of exchange, so you need to assume paper money has value in order to explain the value it has, so the demand and supply theory of the value of money begs the question.

There is some truth in this criticism of standard theories of the value of money. There are indeed two equilibria: the normal one, where paper money has value, and a weird one, where it is worthless. But Ludwig von Mises, for example, addressed this problem in 1912 with his Regression Theory of Money. Historically, money needed to be commodity money, or have commodity backing, in order to get started. But once it does get started, as a social institution, the demand for a medium of exchange supplements the industrial demand for the commodity, and the commodity backing can eventually be withdrawn as custom keeps us out of the weird equilibrium. (When Cambodia reintroduced paper money, after the fall of the Kymer Rouge, it could not create paper money ex nihilo, but initially made it convertible into rice, IIRC.)

A Ponzi scheme is a financial institution with liabilities and no assets backing those liabilities. Paper money can operate just like a Ponzi scheme, but with one important difference. Mr Ponzi promised his clients high rates of interest and/or capital gains. They would not have held his liabilities unless they believed him. The Bank of Canada promises zero interest, zero nominal capital gains, and a minus 2% real rate of interest on people who hold its paper money. Mr Ponzi could not deliver on his promise, even if he hadn't spent the assets. The Bank of Canada can deliver on its promise, even if it gave away all its assets, provided the (real) demand for its paper money does not fall over time more quickly than 2% per year. (If the real demand for money were falling at 2% per year, a constant nominal supply of money would yield 2% annual inflation).

The Bank of Canada does not need assets, because the long run growth in the (real) demand for its paper exceeds the real interest rate at which people are willing to hold its paper. If Mr Ponzi could have met the same test, he wouldn't have needed assets either. People are willing to hold paper money, even at very negative real rates of return (Zimbabwe), because doing so makes shopping easier.

The only reason that the value of a central bank's liabilities are roughly equal to the value of its assets is that whenever the difference between them (its net worth) gets too big, the bank hands its profits over to the government. If central banks choose to keep assets equal in value to their liabilities, and only hand over their annual profits to the government, then saying the value of their assets determines the value of their liabilities gets causality reversed. It is the value of their liabilities that determines the value of their assets.

So why do central banks hold any assets at all? Three reasons (funny how 3 is a magic number):

1. It makes no difference to the owners of the central bank (the government) whether the central bank keeps the bonds and hands the interest over to the government each year, or whether the central bank gives the bonds to the government. The government gets the interest either way; it just passes through another pair of hands. It's a wash.

2. Normally the real demand for paper money grows at about 3% per year (roughly the same as GDP growth rate), but sometimes it rises faster than this (like last year), and sometimes it falls (like next year?). If the demand for money falls, the central bank needs to reduce the supply of money to prevent inflation, and it reduces the supply of money by selling assets. If it had given away all its assets it wouldn't be able to do this.

3. Accountants like double-entry bookkeeping and balance sheets and stuff so they can keep track of things. They like to record assets on one side, and liabilities on the other side, to make sure that everything adds up, to check that everything's been properly recorded. So they like to list currency as a liability of central banks (even though it isn't, because there's no promise to redeem it, or pay interest on it), and assets on the other side. An accountant would freak out if he recorded currency as a liability and couldn't find an equivalent value of assets. He would say that the central bank is a Ponzi scheme. Which of course it is. And it's just not worth the hassle of trying to explain to accountants that some Ponzi schemes are sustainable, really.

Gold as fiat commodity

An interesting article by Willem Buiter about gold as a fiat money. In the center of the argument lies a proposition that gold has no intrinsic value but it is costly to produce and hard to change its stock, therefore, during the time when paper money supply is rapidly increasing, price of gold can increase very rapidly, but there is always a possibility that the price can go to zero as well.

Gold - a six thousand year-old bubble

Gold is unlike any other commodity.  It is costly to extract from the earth and to refine to a reasonable degree of purity.  It is costly to store.  It has no remaining uses as a producer good - equivalent or superior alternatives exist for all its industrial uses.  It may have some value as a consumer good - somewhat surprisingly people like to attach it to their earlobes or nostrils and to hang it around their necks.  I have always considered it a rather vulgar metal, made for the Saturday Night Fever crowd, all shiny and in-your-face, as opposed to the much classier silver, but de gustibus… .

The total stock of ‘above-ground’ gold is about 160,000 metric tonnes (a metric ton is 2,204 lbs. or 35,264 oz, for those of a non-decimal mind-set).  About 50 percent of this existing stock of above-ground gold is kept as a pure a store of value (for investment purposes), most likely somewhere below-ground, for security reasons. The other 50 percent exists as jewellery.  I would argue that most of this jewellery demand is simply small-scale store of value (investment) demand by households, rather than demand driven by aesthetic considerations or other intrinsic sources of joy associated with having gold hanging from your extremities.

From a social perspective, gold held by central banks as part of their foreign exchange reserves is a barbarous relic (Keynes used the expression to refer to the Gold Standard, but close enough is close enough).  The same holds for gold held idle in private vaults as a store of value.  The cost and waste involved in getting the gold out of the ground only to but it back under ground in secure vaults is considerable.  

How about creative destruction?

Apparently, crisis has little impact on Ukraine through the mechanism of creative distruction.
Between 1 October, 2008 and 1 October, 2009, number of registered enterprises and organizations has increased by 25 thousands: from 1,223 thousands to 1,248 thousands. The largest gains are observed in business services (10 thousand new enterprises and organizations). All sorts of services, retail, repair and maintenance, culture and sports also get an increase. At the same time, number of enterprises and organizations in agriculture and financial sectors declined by 900 and 411 respectively. Despite decline in financial sector, the decline came from closing down 764 branches of banks and not from bankruptcies of the banks.

In term of the legal status, number of labor unions and NGOs has increased by 6.7 thousands. The number of political parties has increased by 714 and now stands at 17204.

Budget deficit in 2009 can exceed 40 bln hryvna

Korrespondent reports that the budget revenue may fall 40 bln short of what has been planned. However, the real picture can not be known until the next year when the annual data becomes available. Traditionally, the budget revenue are much higher during  the last months of the year relative to the monthly average. Also, it is not clear how the government treat the IMF loan: surely, it has not been planned as a part of the government budget revenue but if the government include the borrowed money it can paint  rosier picture just before the presidential election.

According to the  law on state budget, the revenue of the budget are planned at 238 bln hryvna. The budget deficit is planned at 30 bln hryvna.

Money supply during crisis

At the peak of the crisis, in November of 2008, Ukrainians run for cash which rapidly increased currency to deposit  ratio (cr). The changing composition of broad money was responsible for drop in the money multiplier, m. At the same time, reserve-to-deposit ration remained relatively stable.

Interestingly, looking at broader definition of money (M2) which include foreign currency denominated checking deposits and all sorts of saving deposits shows much smoother picture:

My guess is that if we exclude dollar and euro denominated deposits, the second figure will be similar to the first figure. During the financial panic of Fall, 2008 people saw the local currency, hryvna, unstable and run to the banks to withdraw hryvnas and exchange them for dollars and euro.

Ukraine is the IMF's headache

 Mr Strauss-Kahn said “the big problem for me is Ukraine” when answering the question about Eastern Europe in his interview to FT.


Bloomberg reports: Ukraine has failed to comply with the loan’s terms, including raising natural gas prices for households and adopting laws needed to stabilize the financial system. At the same time, Ukraine’s parliament approved a law on Oct. 20 increasing social payments, including the minimum wage, in an effort to win voter support ahead of Jan. 17 general elections.

IFC issued a new survey on investment climate in Ukraine as viewed by private businesses. The main finding it that about 1% of GDP in 2008 was spent on compliance with numerous regulations. Here is the summary on the diagram:

The most problematic area is tax compliance. In this area, Ukraine is  #181 out of 183 countries in another survey, "Doing business: 2010"
Other government agencies that enormously complicate life of the entrepreneurs are those dealing with permits, inspections (fire inspectors are singled out as one of the most business unfriendly), and technical regulations:

According to IFC, most of the regulatory procedures are artificial and do not lead to higher safety, better quality, and tighter competition. To the contrary, Ukraine lags behind most countries in the region in terms of number of enterprises:

It also leads to negative dynamics in introducing innovations and new products:

Reserve accumulation and easy money helped to cause the subprime crisis

Guillermo Calvo outlines the buliding blocs of a macro model that would explain current crisis:

A view that is gaining popularity as one of the fundamental explanations for the current crisis is that emerging markets’ voracious appetite for international reserves coupled with record-low US policy interest rates and lax financial regulation to produce a frantic “search for yield,” the creation of fragile financial instruments, and occasionally outright fraud.

Best assessement of crisis in Ukraine

Edilberto Segura has a very detailed analysis of the current economic situation in Ukraine at the FIRST ANNUAL INTERNATIONAL FORUM ON THE ECONOMIC DEVELOPMENT OF UKRAINE. The report can be found here.

Export diversification in CIS

CIS countries are quite open relative to other countries. For example, Ukrainian trade openness presented at Figure 1 below was very high taking into account that Ukraine is a large country:

 However, the trade of CIS is poorly diversified in products that are not the main items of their export. For example, Russian export of oil and Ukrainian export of metals are diversified geographically quite well, but export of other product is not diversified and  concentrated within the CIS region. Here is the figure from me recent paper "Export diversification across industries and space: do CIS countries diversify enough?" that demonstrates geographical and product diversification of exports in CIS and Eastern Europe:

Shadow economy growth during crisis

According to the ministry of economy of Ukraine, the sharp collapse of the GDP in Ukraine can be partially explained by the relative expansion of the shadow economy. The shadow economy grew by 2.3% in 2008 according to the integral index of shadow economy. Actually it is an average of estimates calculate by three different methods: based on money demand, based on retail sales, and based on the share of unprofitable enterprises. The first two methods reported considerable increase of the shadow economy to 38% (by 12% according to the money demand based method), while the third method gives more conservative estimates of 29%.

The next picture demonstrate the differences in the size of the shadow economy in different industrial sectors in 2008 computed by the share of unprofitable enterprises method:

This figure actually cast some doubts on the method because it really surprising that the share of shadow activities in construction is lower than in the extraction of raw materials.

Pigs as collateral

Bloomberg reports that as much as 25% of all loans made by the Russian banking system can become problem loans. As an example, National Reserve Bank seized collateral of 40,450 pigs offered against a loan from a cash-strapped borrower:

“We had a court decision to take away the collateral, which is the pigs,” Lebedev, 49, said in an interview in Moscow. The borrower, a farm near Samara on the Volga river, agreed “with the local authorities to establish a quarantine” against African swine fever. The former KGB officer is still waiting to collect the pigs offered against a loan of 100 million rubles ($3.5 million). 

Quarterly export and import of Ukraine: back to 2006

After two quarters of 2009, Ukrainian exports and imports are at the level of the 2nd quarter of 2006. There is an upward trend but it will take several years to return to the level of the 3rd quarter of 2008 even under the optimistic view on the world trade recovery:

It is especially disturbing since Ukraine is a very open economy:

Mass falsifications of Moscow 2009 elections and statistics

Statistics presented below can nicely demonstrate manipulations in the last elections in Moscow

Here is the figure that shows how a percentage got by a political party  in a voting district (y-axis) depends on voter's turnout as a percentage of total number of voters. The funny thing is that for all parties except for the ruling  "Edinaja Rossia" (United Russia) backed by Medvedev and Putin, there is no correlation between the voter's turnout and the results of elections, while for "United Russia" (blue dots) there is a nice upward trend.

Source of the figure is here
Question: how does this pattern can be explained>
H0: by pure chance. Probability of this really is almost surely zero
H1: voters of United Russia are very heterogeneous -- they are very active in some areas of Moscow and very passive in other areas. This heterogeneity is not observed for supporters of other parities
H3: An invisible hand messed around with the results of elections

Nobel prize in Economics

Oliver Williamson and Elinor Ostrom have got the Nobel Prize in economics this year. While Williamson was on the list of potential candidates since the time when D. North have got his prize in 1993, E. Ostrom is quite an unexpected choice (here is the Greg's Mankiw list). Actually, she is the first woman who won the Nobel prize in Economics.
The choice might reflect the change in mood among economists since the start of financial crisis. It is safe to reward someone who has not been involved with financial modelling like E. Fama or macroeconomics like R. Barro and J Taylor.

Tobacco companies warn about an increase in smuggling of cigarettes

On the 1st of May, 2009, the government of Ukraine increased an excise duty on tobacco products. A a result, in May-September, 2009, the production of cigarettes in Ukraine has decline by 21.5%. The decline can not be attributed to the current crisis because before the introduction of the new excise, the production declined by 8% only.
The MPs who introduced the excise see here a sign of declining cigarette consumption. However, the tobacco companies think otherwise. They claim that Ukrainian smokers has switched to consumption of Russian and Moldavian cigarettes which are smuggled to Ukraine. They claim to have evidence that during 8 months of 2009 the illegal import discovered by customs has increased by 2500%.
Sociologists are inclined to takes the side of MPs. They report that 1/3 of smokers has switched to cheaper brands and only 5-8% have started smoking imported brands.

EU plans to triple funding for energy research

One of the things that contributed to the current recession is the volatility of oil prices. Diversification of sources of energy would reduce the volatility. All leading economies realize that. EU has joined the US, China, and Japan in search for better energy use and alternative energy sources:

BRUSSELS (Reuters) - Europe has launched a campaign to triple funding for energy research to 8 billion euros ($11.7 billion) a year in a technology race with China, Japan and the United States, but said industry would have to pay the bulk.

"We don't have much choice if we are serious with tackling climate change and remaining competitive," European research commissioner Janez Potocnik told reporters on Wednesday.

Robert Solow on future recovery and state of macro

Robert Solow views the technology oriented investments as the driving force of the future recovery:

3 Questions: Robert Solow on the struggle ahead

Q. What is your assessment of the economy now, and where is it going?

A. Forecasting is hard and dangerous, and I don't do it. But it appears that the worst of the recession is over. However, the economy will be getting better slowly. And saying the economy is getting better is not the same thing as saying the economy is doing well. Real GDP fell by about 3.5 percent during the recession. But capacity increased 2.5 percent. We were producing 6 percent less than we knew how to produce. That gap has to narrow to reduce unemployment. If we rely only on the normal self-curing powers of a market economy, it may take until late in 2010 or early 2011 before we reduce that gap. So for that reason we should not rule out further stimulus in the next six to nine months. It's not easy because we have this enormous deficit. But we should recognize that even if the economy improves on its own, it won't do very much.

I had hoped that President Obama at the beginning of his term, while his popularity was at its highest, would have taken a very strong line. I don't think he could have asked for $1.4 trillion in stimulus, but he could have had a slightly bigger and better package, had he bullied a little bit more. If Obama or [David] Axelrod were to reply, "Boy, are you naïve," about the politics, I don't think I could have answered that. I'm just saying what I think God would have done if God were making these decisions. Congress falls well short of God.

Q. Your research made clear how much technology can contribute to economic growth. To what extent might we see technology driving growth now?

A. I actually think the situation of the economy calls for a surge in technologically oriented investment. We have to expect consumer spending to be weak in our economy, not just for six months, but for the next few years. It will not be as strong a driving force as it has been the past several years. Something has to take its place. Government spending can't, since government will have a hard time financing the inevitable deficits and is not in a position to aggressively increase its deficit spending. 

That leaves two sources of expenditure to replace the pullback of consumers. One of those is net exports. That's a long story. The other is business investment. We need business investment to support the economy. We have every reason to want to divert our resources toward secure and renewable sources of energy, new materials and environmental improvement. It's our job, a place like MIT, to produce those new technologies, then it's the job of private industry to grab them, but I also think it's the job of the federal government to shift incentives, from incentives to consume more to incentives to invest more. Obama ran on this kind of platform, and if he can put some money behind that fundamentally correct view, he might generate something. It's going to take more than that to replace 5 percent of GDP, but that would be a neat place to start. 

Q. In 2005 you wrote that you were "disaffected" by the "assumptions and methods" of macroeconomics. There has been a lot of debate about this subject in the last month. What is your assessment of the state of macroeconomics now?

A. The disaffection I expressed is still my assessment. The beast [the economic crisis] expressed the same disaffection in 2007 and 2008, and the currently fashionable way of doing macroeconomics in the profession literally had nothing to offer in response. The problem as I have thought about it is that currently fashionable macroeconomics likes to formulate things in a way that inevitably endows the economy with more coherence and purpose than we have any right to assume. I certainly hope this is obvious enough to the younger people in the profession, the graduate students and even junior faculty. I expect there will be a revival of doing macroeconomics that does not push that kind of coherence on aggregate economic behavior. Which is not to say that some individuals don't behave in a coherent way, but the system does not translate that behavior into something like a super-individual.

Yuliya Timoshenko lures foreign investors

The prime minister of Ukraine thinks that the economy of Ukraine is too monopolized and invites foreign investors to demonopolize it (link in Russian).
However, the talk is cheap. Foreign investors are really keen to see some actions. My intuition tells me that Tymoshenko will be the next president and she will be in a unique position to preside over a double digit economic growth and surge of investments. I expect it not because I believe that Tymoshenko  knows some magic tricks to revive the economic activity. Simply, the current situation is so bad that there is only way up.

Recession probabilities

Jeremy Piger computes recession probabilities for US in real time:

recession probabilities for the United States obtained from a dynamic-factor markov-switching model applied to four monthly coincident variables: non-farm payroll employment, the index of industrial production, real personal income excluding transfer payments, and real manufacturing and trade sales.  For additional details, including an analysis of the performance of this model for dating business cycles in real time, see:

 Chauvet, M. and J. Piger, “A Comparison of the Real-Time Performance of Business Cycle Dating Methods,” Journal of Business and Economic Statistics, 2008, 26, 42-49.

IMF Financial Global Stability Report, September 2009

Based on the figure below, I really do not see positive changes in the health of the world financial system except for slightly smaller risk for the emerging economics and smaller liquidity risk.

Are we only half way through the financial crisis?

From NY Times: Having shouldered losses of $1.3 trillion to date, the I.M.F. estimated, banks still had to write off $1.5 trillion in bad loans or worthless securities. 

Power of money

Chris Dillow says: "...a research shows that, the more people think about money, the more selfish they behave. "

First ever personal bankruptcy case in Ukraine!

У Харкові з пенсіонерки Тетяни Осипової списали 300 тисяч гривень боргу, себто офіційно звільнили від кредитного тягаря, повідомляє "ТСН".
Це підтвердило рішення Харківського господарчого суду. Процедуру банкрутства можна запустити щодо кожного з громадян України, але до кризи відповідна стаття закону була незапитана.

Stereotypes a century ago

Ha-Joon Chang, "Bad Samaritans: Rich Nations, Poor Policies, and the Threat to the Developing World"

In his 1903 book, Evolution of the Japanese, the American missionary Sidney Gulick observed that many Japanese “give an impression … of being lazy and utterly indifferent to the passage of time”

...McPherson, a Viceroy of India (and therefore quite used to treacherous road conditions), wrote, “I found the roads so bad in Germany that I directed my course to Italy”...

British travellers in the early 19th century also found the Germans dishonest – “the tradesman and the shopkeeper take advantage of you wherever they can, and to the smallest imaginable amount rather than not take advantage of you at all … This knavery is universal”, observed Sir Arthur Brooke Faulkner, a physician serving in the British army. 

Bottoming out

Found here

State of Economics as a science in Russia and Ukraine

Based on a population size, I would accept Ukraine has 3 times fewer scientific documents in Economics and Econometrics than Russia does, and Russia has 2 times fewer documents than US. In reality the picture is grim.
Here is the comparison. 
The overall rankings in Economics and Econometrics reveal that over 1996-2007, Russia is 36th and Ukraine is 55th.
So, what sciences is Ukraine good at? Physics and Astronomy!

Dynamics of construction industry: slow recovery?

Construction industry in Ukraine started to slow down in the beginning of 2008 before the crisis hit other sectors in the Fall of 2008. That can be explained by the housing bubble -- prices have doubled between 2006 and 2007 and the real estate market was frozen since summer of 2007. There was simply no demand for apartments at such a high price. However, the prices started to adjust only in the second half of 2008 and now there are signs of recovery which can be seen from the following figure that reports a grow in construction since the beginning of a year relative to the same period of the previous year:

Crisis: Is it a time to buy Ukrainian?

The table below reports what share of consumer products sold in the first half of 2008 and 2009 has Ukrainian origin.

It seems that Ukrainians substitute consumption of imported goods for locally produced goods. The share of local production has increase from 51.4 to 54.0 %. It is also interesting that share of domestically produced cars has declined from 30 to 25% despite a temporary increase in import tariffs.

Doing business 2010 is out: how is Ukraine doing?

Better than last year but still not so great. Ukraine is #142 out of 183 countries and  moved up by  3 places. It moved up by 34 places in Protecting Investors category which caused the overall progress.

According to the report the business environment in Ukraine is above median in Getting Credit (30th place, moved down by 3 places), Enforcing Contracts (43,  +3), Employing Workers (83, +7).

It is really bad in Paying Taxes (181, +1), Dealing with Construction Permits (181, 0), and Closing a Business (145, 0).

This report is more accurate represenattion of business environment than Global Competitiveness Report because it is based both on subjective and objective data. For example, if we look on how the ranking for paying taxes is computed, it use hard data and compute an index as described in methodological section:

"Doing Business records the taxes and mandatory contributions that a medium-size company must pay or withhold in a given year, as well as measures of the administrative burden in paying taxes and contributions. Taxes and contributions measured include the profit or corporate income tax, social contributions and labor taxes paid by the employer, property taxes, property transfer taxes, the dividend tax, the capital gains tax, the financial transactions tax, waste collection taxes and vehicle and road taxes."

Global competitiveness report 2009-2010

Ukraine has lost 10 positions. However, the value of composite index changed from 4.1 to 4 that is not significant change. Even though I agree with the assessment made by  the World Economic Forum, it is highly subjective and does not capture such factors as 100% hryvna devaluation that made Ukrainian exports more competitive. Among all rankings of institutional and business environment, I would trust "Doing Business" and "Governance matters"  produced by the World Bank more than GCR.
Having said that, here are the assessments:

Trade response to global downturns

Caroline Freund "Trade response to global downturns" found following regularities during the last four economic slowdowns (1971, 1982, 1991, 2001):

• "trade contraction follows the GDP decline and ... trade volume declines by about 1 percent on average in first year of its contraction"
• "The decline in the growth rate of trade (from historical average to trough) is sudden and is on average more than 4 times as large as that of income."
• "deceleration in trade value tends to be far greater than in trade volumes"

What to expect form the current crisis?

"Given current GDP forecasts and trade data available through June, our results imply that the decline in real trade in 2009 could well exceed 15 percent. In addition, global imbalances are likely to be mitigated during the crisis, and this may persist even after the crisis is resolved. Finally, food and beverages are likely to be the least affected products in the coming months."

New sorces of economic data

The current trend away from theoretical models that explain everything to empirical studies that focus on narrower practiacl questions is facilitated by new data sources. Google Finance just launch new indices that can be downloaded and used in economic analysis:

Google Domestic Trends track Google search traffic across specific sectors of the economy. Changes in the search volume of a given sector on google.com may provide unique economic insight. You can access individual trend indexes by clicking on the left-hand navigation.

Another example of new data analysis comes from V. Henderson et al. "Measuring economic activity from outer space". The data investigated by Henderson is actually large foto pictures (3Gb each file) that are available for downloading here.

Political economy of protectionism

Ukrainian MPs can not agree on almost anything: new pension system, tax reform, anti-crisis law, land reforms are debated for decades without reaching any consensus. However, they are very effective in imposing protectionists barriers against imports. After the previous temporary 13% import duties on cars and refrigirators expire on September, 7, the MPs of Party of regions, BYT, and Litvin's Block registered a new legislation that will introduce 15% import duties on cars and meat. It all comes despite the fact that all experts agreed that the previous protectionist measures were ineffective. Imports already declined by 51.3% relative to the same period of the previous year mostly due to almost 100% hryvna devaluation.

Such effectiveness in protectinist measures can be linked to political connections of main car producers in Ukriane with BYT party and refirigirator producers with Party of Regions. It is yet to be established how meat producers are connected to MPs.

Comparing two largest economic crises in recent hystory

A tale of two depressions by Barry Eichengreen and Kevin H. O’Rourke

the world is currently undergoing an economic shock every bit as big as the Great Depression shock of 1929-30. Looking just at the US leads one to overlook how alarming the current situation is even in comparison with 1929-30.

The good news, of course, is that the policy response is very different. The question now is whether that policy response will work. For the answer, stay tuned for our next column.