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Trade Deficits and the Health of the Economy-5: Dialog with Nikola Gruevski, former Minister of Finance of Macedonia

Sam Vaknin, Ph.D. - 3/15/2006

NG: Within the scope of the roles of increasing investments and changing the economic structure there is the implementation of an efficient court system, which will create an environment in which the commercial banks of RM, by a speedier settlement of their own claims, will make long-term and cheaper credits available. This, indirectly, will influence the process of structural economic change and start to create an export-oriented efficient economy. At this moment, financial resources available in RM, from the banks' point of view, are really "a cat in a bag". The bank can never be certain that its financial resources will be recovered. First, the court mechanism is very slow and inefficient. This means that even if the bank were able to recover its financial resources within a year, or more - the principal plus regular and penalty interest rates would amount to more than the mortgage value and the bank will not be able to recover the full amount of the debt. Second, the realization of a mortgage is a real BINGO in RM. There are a thousand ways to cheat the bank and the creditors with the aim of not returning the credit. The system, instead of protecting the banks, protects the debtors. Thus, in the long run, the basics of the financial system are damaged and it boomerangs. The desperate banks lose the courage to place financial resources because of the uncertain environment, which doesn't guarantee the recovery of their financial resources, or the danger that an eventual devaluation will erode a part of the property's value, especially of the banks of foreign origin, which directly invested in foreign currency after increasing their capital. Slow justice is injustice. Because of that, the banks choose to impose high active interest rates, as they will cover the risk of investing in the economy with a judicial system with the appearance of "Swiss cheese". On the other hand, high interest rates increase the costs of production, which realistically diminishes the export competitiveness of firms' products, casts in doubt new investment projects, and at worst, casts in doubt the very survival of the company and its ability to return the invested money to the bank. This never-ending spiral is vicious if not nipped in the bud. RM is in the situation "invest and export or die". To start with, what should be done is what is written in one of Hitler's biographies: "the negative appearances should be destroyed in the very beginning, not to be analyzed later".

SV: Needless to say that I fully share your views. I just want to remind all of us that an efficient court system is only one of a long series of measures that should be adopted prior to the establishment of a healthy and functioning banking system. Assets need to be registered reliably using advanced computer systems. There should be centralized, real time registers of liens and mortgages. Bad debtors should be blacklisted and the lists should be made public. Bankruptcy proceedings have to be streamlined and implemented. Personal bankruptcy should be introduced with severe restrictions imposed upon such individuals. Legal procedures of seizing assets and materializing them should be made much simpler. A lot of the functions of collection and appropriation of collateral by creditors should be transferred to the private sector. This is a very partial list. There is nothing I can say about the courts that hasn't been said before. They are slow, inefficient, clogged and subject to political meddling. Special commercial courts need to be established to cater to the needs of special groups such as exporters and foreign investors. Judges urgently need to be retrained. But the banks themselves have a lot to do. Their image will be transformed only through actions. It is easy not to repay a loan to an "enemy of the people" (as banks are perceived to be). Banks should become more personal, attuned to the needs of small businesses, young couples, students, industry, exporters. The level of professional education of bank employees must improve. They must be exposed to financial products and instruments in the West. They must innovate and be active partners in the economy and not just money conduits. They must charge interest discriminately: good borrowers should pay MUCH LESS than bad ones. They must share their profits with their employees and with the public. They must be forthcoming to the client: ATM machines, simpler procedures, smaller queues, home banking, information services, capital markets services. They must get rid of political decision making, cronyism and corruption – all rampant nowadays.

NG: Also, RM should impose a policy for the export of finished products, and discourage the export of semi-finished goods and raw materials, of course, after it has already secured the conditions for it. Credits, from the bank for export development and support and from international institutions, should be directed exactly at stimulating the production and the export of as many finished products as possible and towards investments in the construction and tooling of highly profitable factories, in which the bigger part of the production will be export oriented, or import substitution.

As a result of the bad structure of the Macedonian economy (created as part of the old Yugoslav Federation and as result of the extreme liberalization of imports lately), the import coverage ratio in RM drastically decreased. In 1992 the coverage of imports with exports was 99.3%, in 1993 90.6%, in 1994 it drastically plummeted to 73.2%, in 1995 the trend continued to 70.0%, in 1996 it was 70.5% and in 1997 it broke the limit of 70% coverage down to 69%. Such long-term dynamics cannot be withheld even in stronger economies than Macedonia's, and this leads to the total collapse of the economy and the state in the longer term.

SV: Hear, hear. Perhaps it is important to explain to the laymen why. The only reason why a country exports is in order to receive payments in foreign exchange. Why is this needed? After all, internally, all the transactions are concluded using the Macedonian denar. The foreign exchange is needed in order to finance imports. In other words: we export ONLY so that we will be able to use the proceeds to import goods and services. Imports are a good thing. Different countries have advantages in the production of different goods and services. It is better to import a product from a country, which has an advantage in producing it – then to produce it ourselves. Our resources can be better employed where WE have a relative advantage over others.

This is why a consistent, multi-annual trade deficit is dangerous. Ultimately, the country will run out of foreign exchange. It will not be able to import. Its resources will be employed in producing goods and services in which it has no relative advantage (and which it used to import) – in other words: its resources will be wasted. Its wealth will decrease. As its wealth decreases, the value of its commitments will diminish – because people will not be sure how risky the country is. This is why currencies depreciate and debt payments frozen when a balance of payments crisis erupts. Currencies and debt instruments (bonds) are commitments made by countries. They are supposed to store value. But if the value of the country itself is reduced (because its wealth is squandered through the inefficient allocation of economic resources) – the currency must be de-valued.

As trade deficits mount and accumulate (=as the country's foreign exchange reserves dwindle), the country either loses its independence and becomes the surrogate of its donors – or a crisis sweeps across it. Its currency collapses, it freezes its obligations and is doomed to a prolonged recession and to a shortage of goods and services that it can no longer import.

NG: Besides the low quantity of exports, RM has a huge problem with the structure of its exports. The bigger part of the exports of Macedonian products is comprised of cheap raw materials with low-level processing (zinc, tobacco), classical semi-finished products (a hot-cast composite of iron and nickel), pre-paid production (lower level working force and low profitability) or (fresh) agricultural produce. In support of this thesis, here is the list of products, which generated the most foreign exchange income for RM (data from the Bureau of statistics of RM) between 1/1/97 and 1/12/97. At the top of the list appears zinc (raw material) with a value of 54,268,000 USD. Second place is occupied by male shirts (pre-paid production) with 53,706,000 USD, followed by cigarettes and tobacco 50,102,000 USD, other hot-cast iron products (raw material, semi-finished) 49,222,000 USD, tobacco (raw material) 47,508,000 USD, Feronickel (raw material, semi-finished) 33,607,000 USD, Ferosilicium (raw material, semi-finished) 32,252,000 USD, female shirts and blouses (pre-paid production) 31,361,000 USD, mineral water 28,963,000 USD and wine made of fresh grapes (mostly not bottled) 28,944,000 USD.

The bad structure of the exports can be demonstrated by an analysis according to economical uses. The total exports of materials for re-processing in 1995 stood at an extremely high 54.2%, in 1996 it was 49.5% and in 1997 - 52.3%. The export of machine tools in 1995 was 4.2% of the exports, in 1996 - 3.3% and in 1997 -2.9%. Goods for general consumption amounted in 1995 to 37% of the total exports, in 1996 to 47.1% and in 1997 to 44.7%. From these data it is clear that more than half of the Macedonian exports is comprised of the export of materials for re-processing. This is very worrying, especially considering the fact, that the resources, raw materials and mines have a limited life-span, which is about to end soon, and that the price of raw materials might keep falling in the world markets. These are the facts. Naked facts. Every idea has to start developing from facts. The economy, like life, is a drawing where it is not possible to use an eraser.

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