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Trade Deficits and the Health of the Economy-1: Dialog with Nikola Gruevski, former Minister of Finance of Macedonia

Sam Vaknin, Ph.D. - 3/8/2006

NG: The characteristics of the Republic of Macedonia, in its post independence period, from a macro point of view of the activities of exports and imports, are:

- The presence of high trade deficits;
- An increase in the portion of imports not covered by the export of goods;
- A bad structure of both exports and imports.


This, put together, led to an increase in the debts of Macedonia, and to the rescheduling of its older debts, though with no built-in strategy for their gradual decrease.
The Macedonian economy is traditionally dependent on the importation of goods and services, under conditions of deficiencies in domestic raw materials and products for consumption, hi-tech and know how services.

SV: This situation is not unique to Macedonia. With a few exceptions it applies almost fully to the USA, for instance (not to mention Russia). There has been an explosion in international trade in the last two decades (it grew more than threefold). But it has been an asymmetrical explosion: some countries were on the receiving side and benefited disproportionately (like Japan) – others financed this largest unilateral transfer of wealth in history. The result is a new form of mercantilism and economic colonialism. Some countries have become the suppliers of raw materials and cheap labour to others – and ended up consuming the very finished products created with their own raw materials and labour. No one knows why some countries end up this or that way. Geographical location has some influence: sea bound countries do better than landlocked ones. But all other factors suggested by the pundits are nothing but guesswork. Political stability, lack of corruption, good management, developed capital markets, encouragement of exports, macroeconomic stability – all seem to be only mildly relevant. Japan and Germany had endured gross destruction during the Second World War, Brazil and Israel had hyperinflation, Israel went through a bloody path of wars and terror, there are few countries more corrupt than Russia – and yet all these are major exporters. Some of them (Japan) do not even have any natural endowments or relative competitive advantages to speak of. It is a mystery to this very day.

NG: The deficit, basically, can have both positive and negative effects.

The positive effects can be generated if the realized imports include equipment, state of the art technology and techniques, investment in production capacity, re-processing etc. After a prescribed period of time, the conclusion of sales and/or exports, above all of final products, will create higher feasibility, competitiveness and profits, a flow of foreign currency into the country, and finally, will animate new investments and exports. Such developmental deficit will mean additional outside accumulation, opening the possibility to exit to foreign markets, higher production and exports.

SV: This distinction, is, of course, critical. There is a "bad deficit" which goes towards financing consumption (like Macedonia's) – and a "good deficit" which goes towards financing investments with foreign capital. Few people know that Foreign Direct Investment increases the deficit in the balance of payments of a country. But, of course, this is not considered bad at all! The reason is that a good deficit generates sufficient value in the future to return the borrowed money plus a return on it. A bad deficit generates only debts without the future ability to return them. If a deficit were generated by purchasing a new textile machine – it will bring sufficient earnings in its future to cover its cost (which created the deficit in the first place).

But if one buys a fancy Mercedes car – it generates no future income. On the contrary, it generates even more foreign exchange losses (fuel, etc.).

NG: Unfortunately, RM in the latest period, by leading an extremely liberal policy of imports and in the absence of a strategy for economic reconstruction and higher exports, instead of a developmental deficit had realized worryingly high non-developmental deficit. This was the result of the import of consumer goods, often with very suspicious quality, and as "substitutes" for what RM anyhow produces in quantities larger than needed (e.g. tomatoes, are officially are protected, yet big quantities of tomatoes from Turkey are imported). Against it, many products, which RM is forced to import, are not produced locally even though there are conditions for their profitable production. But, because of the lack of capital and of insufficient and non-trading distribution of the banks' credits (both domestic and, more so, foreign capital), such projects are not realized.

The consequences of the non-developmental deficits can be noticed in:

- The unilateral outflow of part of the national income;
- A decrease in the rating and credibility of the national economy and the "attainment" of a status of "country with high investment risk";
- Slow economic development and dynamics, on the way to deflation;
- Higher economic and political addiction of the national economy to foreign countries;
- As a result, the closure of many factories in RM, decreased production, high unemployment, a growing number of welfare recipients, a poorer budget, and an increase of the outside debt of the state. This results in low standards and quality of living.


The last consequence mentioned implies long term non-pay-back consequences, because in the last 10 years we witnessed the following process: the drain of a high percent of the well educated people, against an inflow in the last 50-70 years of which the bigger part was from the less educated classes. So, if in that period we had "cleansing", today we register the process of "brain drain".
SV: It would be naive (and I know that you are far from it) to blame all these dire consequences on a single economic factor, no matter how important. Moreover, deficits are symptoms, not the disease. By treating one's symptoms – one does not achieve healing. The brain drain – to take one example – is the result of the division of wealth among corrupts oligarchs and politicians through bogus "reforms". It is a result of the feeling of the younger generations that there is no where to advance to – unless you were born to the right family or are willing to grossly compromise your moral principles. Corruption, low social mobility, bad "communist-socialist" mentality, oppression, dysfunctional institutions, ignorance, intolerance, lack of foreign investment, geopolitical complications, (financial) crime – are all as important as the trade deficit in retarding the growth of Macedonia.

NG: The trade deficit in RM in 1995 was $514 million, in 1996 - $479,5, in 1997 - $538,8. No doubt in 1998, a deficit of about half million dollars will increase the foreign debt of the state without creating conditions for the founding of more qualitative export companies. The deficit in the current balance of payments of $216 million in 1995 increased to $276 million in 1997.

It is assumed that current account deficits of over 5% of GDP (over 3-4 years) should turn on the red light, especially if the deficits are financed by short-term debt or foreign currency reserves and if the same are the reflection of excessive spending. RM in 1997 officially reached a current account deficit level of 8.3% of the GDP. That definitely presents the upper limit of tolerance. It cannot be expected (especially not in the longer term) to maintain such a high current account deficit without provoking tremors and cracks in other dimensions of the economic system of RM.

RM is not alone in the group of East European countries in transition with such results (Poland sports a 3.2% deficit, Slovakia 7.9%, Czech Republic 6.3%, Ukraine 1.7%, Hungary 2.2%), but it is after Bulgaria which has a surplus of 4.3%, Russia with a surplus of 0.8%, Slovenia with a surplus of 0.4%, etc. According to Business Central Europe, in absolute numbers, in billions of dollars, the situation in 1997 was as follows: Bulgaria +0.2, Croatia –1.9, Czech Republic –3.2, Estonia –0.6, Hungary –1, Poland –4.3, Russia +3.9, Slovakia –1.5, Slovenia +0.1, Ukraine –1.3, etc. It seems that RM is not alone in the club of countries with current account deficits . According to the summer issue of The Wall Street Journal Europe's Central European Economic Review, RM definitely trails the countries in the region in terms of GDP increases (below 2%) in 1997. Belorussia had 10%, Estonia - 9%, Yugoslavia more than 7%, Poland, Latvia, Slovakia, Lithuania, Croatia, Hungary and Slovenia preceded RM. Furthermore, RM is an impressive record-holder in terms of the rate of unemployment, (the lack of) foreign investments, and finally, more positively, it is second-rated in terms of its low inflation rate. Trade deficits are exhibited by many developed countries, but this is different and not comparable with RM.

SV: The saying goes: "There are white lies, plain lies and statistics". Deficit figures are highly misleading. The important questions are: is the economy on a path of growth? Is it export oriented (that is, most of its foreign exchange income is derived from exports? If so, it can easily service its mounting foreign debt. The larger the GDP growth – the smaller the share of the projected deficit. What is the deficit made of? Was the money used to finance the consumption of luxury goods or to finance research, development and capital expenditures? Is it part of an on-going pattern or an aberration? Is the economy booming? If it is prospering – deficits are a good thing because they help to prevent inflation. By directing consumption to imports – inflationary pressures are, in effect, reduced and "exported". Can the country rely on unilateral transfers? Israel can rely on billions of dollars annually from the World Jewery and from the USA. These transfers amortize a large portion of its deficits. Is the country open to outside competition and highly dynamic and mobile? If so, trade deficits are not necessarily a bad thing. They increase the competitive pressures and force the local industry to become leaner and meaner. There is no economic rule that says: "Trade deficits are inherently bad – low inflation is inherently good". In the case of Macedonia, for instance, I think that the low inflation rate is a sign of death – the demise of the economic body. Macedonia needs to reflate urgently – before its markets are deflated out of existence.

The problem with Macedonia's balance of payments deficit is that it is of the wrong kind. It signifies the collapse of local manufacturing, the death of local industries. The consumer is rarely faced with a choice. He has to purchase imports. A lot of people make money from legal (and less legal) imports in Macedonia. Smuggling, contraband, piracy of intellectual property, are rampant. Members of the political elite were given monopolies over certain types of imports. A sizable part of the trade deficit goes to Macedonian pockets. There is simply no interest to encourage local production or exports. This will hurt the profits of the robbers of the national wealth (not to mention the profits of certain customs officials and police officers). Coupled with a stagnant GDP, high unemployment, foreign handouts and strangely and suspiciously stable currency – this is a bad omen.

(continued)