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ABSTRACT
This article argues that the causes of the crisis in Romania and other new EU member states were different from those affecting Western Europe or the US. The main argument of this paper is that bad domestic monetary, fiscal and regulatory policies were the real crisis generators, while exogenous crisis mechanisms, including contagion from the global financial crisis, were just the trigger. Romania, and other new EU member states, has been facing the crisis of a consumption-led development model, not just a financial crisis imported from more developed economies. This paper brings insights into the impact of the flat-tax regime on consumption and the impact of speculative capital inflows disguised as foreign direct investments.
Notes
1. Watt (Citation2008), for example, observes that the share of profits in the national income of many developed economies rose much faster than productive investments. In turn, non-financial companies moved towards financial investments in order to reap higher short-term profits.
2. Over-investment here is not similar to Hayek and Mises's view, however. Instead, it happens in the absence of an expansionary monetary policy, and it is not necessarily followed by over-consumption. I would include in the over-investment category not only the productive investments, but also the pressure towards the financialization of the non-financial companies, contributing to an excess of financial investments.
3. In February 2009 the European Bank for Reconstruction and Development (EBRD), the European Investment Bank (EIB) and the World Bank launched a joint action plan in support of the banking systems in Central and Eastern Europe, and linked it to the IMF and EU stabilization programmes. Initially a total of 17 parent banks from five countries (Romania, Latvia, Hungary, Bosnia and Herzegovina, and Serbia) signed different commitment letters to maintain their exposure to the region. In the particular case of Romania, foreign banks pledged to increase the minimum capital adequacy ratio for each subsidiary from 8 to 10 per cent and to fully maintain their March 2009 exposure for the time of the IMF programme. To prevent negative spillovers, other countries joined the Vienna Initiative later on (Poland and the Czech Republic).
4. Ironically, in the process of opening its capital account, Romania liberalized the market for derivatives in 2004 at a time when no such financial instruments were yet available. Even as late as 2007, the over-the-counter foreign exchange derivatives' daily average turnover was four times lower in Romania than in Poland and three times lower than in Hungary. Interestingly, the forward foreign exchange daily average turnover was five times lower in Romania than in Poland and eight times lower than in the Czech Republic (BIS, Citation2007).
5. By 2008, Hungary was already engaged in an IMF programme as its public debt problems were uncovered earlier.
6. In a counterfactual analysis of the Asian crisis from 1997 to 1998, Grabel (Citation2003) found that the introduction of some prudential measures could have prevented or tempered the effects of the crisis.
7. One must remember that the Czech Republic, which seems to have escaped a more severe crisis in 2008–09, faced an earlier current account crisis in 1997, just after its capital account opening. At that time, the country fell into recession and it suffered sharp currency depreciation.
8. This doctrine was named after Nigel Lawson, a former Chancellor of the Exchequer, who publicly upheld it in 1988. His view was reinforced by Corden (Citation1994), who expressed the position that the private sector knows better what it is doing, and therefore an increase in the current account deficit determined by a change in the private sector's exposure is harmless.
9. Statement made at the Euromoney conference in Vienna, 15 January 2008, <http://www.ghiseulbancar.ro/articole/47/8844/tot_articolul_Cristian_Popa__Deficitul_de_cont.htm> (accessed 13 October 2012).
10. Statement made in the Romanian newspaper Ziarul Financiar 21 May 2008, <http://www.zf.ro/eveniment/deficitul-de-cont-curent-o-necesitate-pentru-vosganian-o-problema-pentru-isarescu-3092269> (accessed 13 October 2012).
11. Statement made at the Euromoney conference in Vienna, 15 January 2008, <http://www.ghiseulbancar.ro/articole/47/8844/tot_articolul_Cristian_Popa__Deficitul_de_cont.htm> (accessed 13 October 2012).
12. By year-end 2008, household loans represented 70 per cent of household incomes, seven times more than in 2001.
13. This frenzy fuelled unregulated practices such as the granting of small consumer loans based solely on the availability of an identity card, with no guarantees and no proof of revenues.
14. Romanian society comprises a very small upper class, a thin middle class drowned in debts and a majority of the population that lives off small wages and/or various forms of social assistance. Despite high rates of GDP growth, Romania reached the highest level of income inequality among EU member states (Eurostat, Citation2008).
15. In Romania, in 2011, budget revenues from income tax represented 3.8 per cent of GDP, while budget revenues from profit tax accounted for only 1.9 per cent of GDP (the shares were rather constant in recent years).
16. Contrary to the expectations of flat-tax advocates, budget revenues decreased in the first year of reform, compelling the government to increase various other taxes (such as the tax on dividends) to compensate for the initial loss.
17. Barbosa-Filho et al. (Citation2007) argue that, while domestic private net borrowing is pro-cyclical, the government deficit should be counter-cyclical. Net borrowing, calculated as investment minus saving, must be balanced by net lending.
18. In turn, the central bank freed a part of the commercial banks' deposits previously kept under the minimum reserve requirements of the central bank. In exchange, foreign banks, which then controlled almost the entire banking sector in Romania, promised to keep the credit lines open to their Romanian affiliates or branches. Those credit lines amounted to €10 billion in short-term foreign private debt. Bluntly put, the government borrowed money from the IMF in order to keep private debt alive.
19. The measure was implemented only four days after it was first announced.
20. Anecdotic evidence includes building a football stadium on a downhill slope, or designing a park in a rural area. Meanwhile, many villages do not have sewage or gas, and road infrastructure is quite poor.
