Apr.
24
2018

Convergence of the East

The desire to catch up with Western living standards is an open secret among the post-socialist states of Europe. Currently, the Hungarian economy enjoys all the tailwinds necessary to make this dream come true. Firstly, real wages are rising, which gives a boost to domestic consumption and growth. Secondly, international growth creates further demand for exported goods, while the influx of EU funds supports investments. The increased savings rates and deleveraging following the financial and Euro crisis provides further case for releveraging and a credit led boom. Political decision makers sensed this opportunity, and quickly adjusted their rhetoric to exploit it for its political capital.

The Achilles-heel of the economy

As mentioned above, all the necessary financial conditions are given. Banks have enough liquidity and capital, private sector debt indicators are on all-time lows, foreign demand and low international interest rates are also conducive. However, I believe that demographic and social factors often avoid the spotlight of economic attention, even though they are just as important as the financial fundamentals.

By now, the aging population is a frequently discussed and broadly accepted problem. The emigration of hundreds of thousands of workers and students further amplifies the issue. Although political decision makers tried to introduce subsidies for families to address the trend, these solutions are often proved to be only short-term. As it is the case with most government subsidies aiming to nudge people towards desirable behaviours, such as family subsidies. The subsidies only encourage people who are already thinking of having a family to shift their pregnancy forward. However, long term averages will only be evened out.

Furthermore, such demographic trends may seriously obstruct the pickup in credit stock numbers. Older generations, who already own property, will show little interest in taking loans. Likewise, corporate leaders who have no heirs at home won’t prioritize business expansion. This conclusion also works in the context of department leaders at multinational firms where staff incentive systems are linked to department performance. Risk appetite and demand for loans are going together, and without potential upside nobody in their right mind would jeopardize their payoff.

Since these generations represent a substantial segment of working-age society, one can indeed argue that a credit led boom might not be feasible. Furthermore, current net savers of want-to-be retirees will soon turn into net consumers, creating potential disturbance in asset prices and undermining future financial stability. It is noteworthy, that these trends are not unique to Hungary, most developed countries are in the same shoes.

Rise of the machines

The changing structure of demographics is not the only challenge developed countries must face. Technological developments, new technologies and their effects on the labour market can also be listed as society-wide concerns. Automatization and robotics often pose bigger challenges to developed industries than the competition of low-cost manufacturers in developing markets.

Given our assumption that a credit led boom can take place, there are still further obstacles on the path towards success. Hungary has been entering the domain of overemployment in the last two years, thus expansive growth can be hardly considered a feasible way. Remaining options to meet the credit supported demand are modernization and automatization, or import. However, adapting modern production methods does not solely bring improved efficiency to the economy, but also its socio-economic problems. Robotics and replacement of human capital requires less, yet well trained workforce. Expectedly, demand for IT technicians and engineers will grow over time, while their blue-collar peers will see their jobs slowly go extinct. Consequently, this implies the booming and melting of real wages respectively, thus obtaining additional training and rechanneling the labour force will be incrementally more difficult.

Moreover, low-value added sectors, such as certain service industries that require complex response, have little scope for automatization. For instance, while it is relatively easy to modernize a factory, hospitality service cannot be fully replaced by machines.

Throughout history the lack of labour and technological advancements often went hand in hand. On one hand, low unemployment and high real wages provided incentive for innovation. On the other hand, emerging industries create a scale of new jobs. Long term trends have always been pointing towards economic growth, however, not without peril.

Political and business elites are often opposers of creative destruction and try to conserve the status quo. The lack of labourer after the Black Plague led to early industrialization, the development of international trade, agricultural revolution, and increased living standards in Western Europe. Meanwhile, the same factors contributed to the emergence of the second serfdom in the East. Without doubt, the Industrial Revolution brought prosperity for the masses in the long-run, however, it also destroyed former professions and created the British Luddite-movement. There is no predetermination in historical trajectories, social tension is almost always inevitable, and turning points often lead to opposing outcomes.

The success of a credit led expansion and the modernization wave do not only bring prosperity, but also socio-economic symptoms. The most likely outcome is the division of society, where blue-collar middle classes will fall behind, while others might rise to the upper class. We have already seen similar trends in the West. Even though there is no known panacea for the symptoms of creative destruction, it is never too early to look for solutions. Reforming higher education and running training programs for people already in their careers might be one option.