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Colloquium
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Some Random Reflections Concerning Financing of Social Measures in Countries in Transition (1)Teoria sine praxi,sicut rota sine axiPraxis sine teoria, sicut rota sine via (Latin proverb) Ivo PaparelaProfessor, University of Split and APIS S.A.R.L. Consultants, Paris
The so-called socialist economies collapsed by a process of internal putrefaction, both political and economic. Among the elements which accelerated the process were the ignorance of the real situation and the facts of the economy. Therefore, ad hoc measures and policies could not be appropriate remedies because they were based simultaneously on this ignorance and on the unsound economic "theories" of Marxism.
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Now, most of the big "combinats", which dominated administrative markets, have difficulties penetrating buyers' markets, have poor marketing and commercial services, poor quality of products and, very often, suffer from poor management, little financial strength and no working capital. Therefore few are competitive. Western and Asian corporations, backed by powerful banks, have sufficient productive capacity to supply markets all over the world, including Central and Eastern Europe. This means that industrial firms in Eastern Europe have much idle capacity and are overmanned. Therefore the market value of many corporations is negative. On the macro level, the net value of the corporate sector is negative in all Eastern European countries. However, some of their assets, such as land or buildings, especially if they are in Budapest, Prague or Bratislava, have a marketable value. But the sum of their assets is smaller than their total liabilities. This causes fast growth in unemployment, both open and hidden, and requires an important level of state expenditure for social measures. There are, of course, some companies like PLIVA or SKODA, or natural monopolies and telecommunications, which are of interest to western investors. But the percentage of labour employed by those corporations is small. The new private companies have a very high percentage of "infant mortality", but the court records on this are inaccurate. They are, more often than not, one-man companies without capital and cannot compensate for job losses in big state-owned factories and farms. Neither can the fast-growing financial and service sectors. The Czech example can illustrate this, despite the fact that open unemployment in this country is small, at least for the time being. Table 1
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| Total | Mining & Manufacturing Energy & Water |
Financial Services | Wholesale & Retail Trade | Health & Social Work | |
| 1990 | 5350 | 2113 | 28 | 524 | 280 |
| 1993 | 4850 | 1710 | 65 | 610 | 263 |
The table shows an overall decrease of employment of 500,000, a big relative growth of financial services and trade (mostly small, short-lived shops), though too small in absolute numbers to compensate for the total loss.
Nevertheless, the important goal of economic policy in the countries under investigation is to curb inflation and to bring it under 100%, as can be seen from Table 2.
| 1996 | 1997 | 1997 (a) | |
| Bulgaria | 150 | 150 | 60 |
| Croatia | 6 | 9 | -- |
| Czech Republic | 9 | 20 | 8 |
| Hungary | 27 | 30 | 18 |
| Romania | 45 | 60 | 30 |
| Slovakia | 7 | 20 | 7 |
| Slovenia | 10 | 11 | 9 |
Inflation in most of these countries has been temporarily neutralized by measures which lead to deflation (not disinflation). Deflation will increase unemployment, budget deficits and the scarcity of capital - in other words start-up corporate capital, which is a condition sine qua non for economic development. Long and medium term loans to corporate and household sectors- another important factor- will hardly be available, or available under economically sound conditions, before the beginning of the next century. Therefore the state budget will have to finance simultaneously corporations without markets, people without employment and health care (there is a high correlation between unemployment and health problems), with a decreasing volume of budgetary income. Therefore one can expect further growth of misery. The poverty index shows the percentage of population having an income smaller than the cost of living in each country (Table 3).
| 1989 | 1992 | |
| Bulgaria (b) | 13 | 57 |
| Czech Republic (b) | 4 | 25 |
| Hungary (b) | 14 | 20 |
| Romania (b) | 33 | 51 |
| Slovakia (b) | 5 | 34 |
| Croatia (c) | 10 (1995) | 30 |
| Slovenia (c) | 5 (1995) | 5 |
The poverty index increase is important. However, one has to bear in mind that under the ancient regime this index was rarely published and always underestimated.
The figures in Table 3 reflect the situation before privatization of many big "combinats" in these countries, and one can assume that in 1995 the poverty index was still higher. The level of average wages in the above-mentioned countries is an indication of the welfare level and of the strength of the economy (Table 4).
| Bulgaria | 80 | Hungary | 340 |
| Croatia | 260 | Romania | 90 |
| Czech Republic | 310 | Slovakia | 260 |
| Slovenia | 730 |
It must be strongly pointed out that the average wage does not represent the modal group (biggest sub-set), which in Bulgaria, Romania and Croatia is under the average. This is a statistical observation based on negotiated wages. However, wages are not necessarily effectively paid at due date: in all these countries some corporations and administrations pay their employees with one or more months arrears.
The above, for the European standard low average wage, points to the low productivity, and earnings, in other words, minor wealth creation. This is reflected in the figures concerning GDP (Table 5).
| GDP | GDP/capita (d) | GDP/capita (e) | |
| 1995 | 1995 | 1994 | |
| Bulgaria (f) | 4.5 | 580 | 1250 |
| Croatia | 10.5 | 2330 | 2560 |
| Czech Republic (h) | 33.5 | 3320 | 3200 |
| Hungary (g) | 31.0 | 3069 | 3840 |
| Romania (f) | 15.2 | 650 | 1270 |
| Slovakia (h) | 10.8 | 2037 | 2250 |
| Slovenia (h) | 15.8 | 7884 | 7181 |
Source :
estimated by the author
official data 1994
for Bulgaria & Romania the author produced another estimate that will be discussed later;
In 1993 Hungarian agricultural production dropped 4O%; since then its growth has been 4%/year
Economist Intelligence unit estimated Czech GDP 1995 $44 bln and Slovakian GDP 1995 $15 bln ; French Commercial Counselor in Ljubljana estimated Slovenian GDP/cap. in 1995 at $95OO
The estimates of GDP have been made from average wages (see Table 4) with the hypothesis that added value created by economic activities of the corporate sector, individual entrepreneurs, and farmers is not an accounting and statistical creation; Bulgaria and Romania excepted.
In general it has been assumed than on the macro-level income is higher than or equals consumption or
The problems of economies in transition require that economic science elaborates additional theoretical tools for measuring GDP.
The result is that in those countries hospitals make huge claims against social security funds. The latter claim against the budget and the corporate sector, and pensioners also claim against pension funds, etc. This creates simultaneously liquidity and solvency crises. So, for example, a pension fund cannot pay pensions for, say January at the end of January, but pays them at the end of February; similarly at the end of March for February. And so on until, let us say, the end of June, when pensioners receive nothing until end July, when they receive the amount for June and so on, until the end of the year. This means that only 10 of 12 pension payments have been effectively made during the year. The same is true for wages. When wages are not paid neither are employers' and employees' contributions paid to social security funds and they in turn do not reimburse hospitals. The result is a general degradation of buildings, material and services, and in many cases the already dramatic decrease in the quality and in the quantity of public service, started under the ancien regime, continues. It becomes almost dangerous to go to most hospitals, except one or two in each country, which are reserved for the new elite. Health services are only one among many examples of degradation. Unemployment allowances to those jobless qualified to receive them are also paid with delays, etc. Or, to put it differently, beneficiaries are creditors of the public sector, which pays zero interest for this kind of credit.
Farmers in those countries are also in a difficult situation: they do not have the advantages of wage earners. They have lost markets and their subsidies and suffer tremendous competition from traders who imported agri-products. They have had no transition period for adapting to the new conditions.
The demographic age pyramid, important for planning among other things the financial needs of pension funds, has an unfavorable shape.
In all those countries 25% of the overall population is over 60 years old. But pensioners can represent a smaller or bigger percentage: Slovakia, 30% of the population; Bulgaria 38%; Hungary 29%; Croatia 23%. Among pensioners there are many who are "work invalids" who have "invalid pensions", are under 60 and will be a burden to the budget for quite a long time.
All the above indicates the pressure on public finances (budget) coming from social measures required to keep those countries socially and politically cohesive. Governments, with help from international and supranational institutions, try to find other ways and means of financing social expenditure: e.g. the age of retirement has been or will be increased for both men and women - in some countries gradually, in others immediately. Both health funds and pension funds are separated from the state budget, which pays contributions for civil servants, soldiers, etc. and covers deficits. Para-budgetary health insurance companies, like V.Z.P. in the Czech Republic, insure 6,5 million, or more than half of the population. In Hungary, since April 1996, family allowances are not a "civil right" any more, and are granted only under certain conditions. Small and medium sized private companies in that country have created a special social insurance fund for their employees, but owners of many companies do not pay their contribution. Therefore, employees in many newly created companies are very often without social protection (health, etc.). The new idea of opening health and social services to market competition is on the agenda in Hungary, the Czech Republic, Slovenia and Slovakia. This means that E.U., Japanese and U.S. life insurance companies could be allowed to sell their products to local populations. Local insurance companies do not have the required technical knowledge, level of capital and of "mathematical reserves" in order to offer attractive cover to potential customers. Risks are important, so people cannot afford to pay large premia, because wages are small.
Bearing in mind that about 50% of premia received by insurance companies is used for paying their administrative costs, it is clear that little is left for beneficiary payments, and for reserves. Besides that, local insurance companies cannot find blue chip corporations in the country to invest in their shares. Government bonds are not attractive and real estate of good quality (big towns) is expensive (despite high interest rates), so both make poor rentability. Therefore locally-founded insurance companies will have difficulties raising enough share capital, locally finding good business, creating required levels of services and mathematical reserves.
Eastern European countries should let in those Western life insurance companies that have sound patrimonial and financial records. This solution has some disadvantages, but should be considered seriously by governments. Social costs are high and the state budget (i. e. taxpayers) cannot support them any more in the present economic situation and outlook.
Until now, in this second part, analysis has followed classical public finance patterns, with scope to present several aspects of the problems, which are important, but could be misleading. This has been followed in order that readers could grasp technical aspects of the issue and understand what follows, which deals with the real issue.
The biggest share of social expenditure caused by the slow adaptation of the corporate sector to free market competition in the countries analyzed in this paper, is not in the budgets or para- budgetary funds, but in the balance sheets of state-owned banks. These are revolving short-term loans used for paying immediate costs - mostly salaries. Without them, big "combinats" would close and many hundreds of thousands would join the existing army of jobless and poor.
Without them, big systems, like railways, would have to sack dozens of thousands of their employees. Bad loans can have various juridical forms like debt equity swap, "créances immobilisées" etc. The amount of bad loans accumulated in the balance sheets of the banking sector, regardless of the form, in some of these countries, represents: about 40% of the GDP in Bulgaria, in Croatia 30%, and in Romania 45% (according to the Financial Times). The author has no statistical data for the other countries. However, the Hungarian government gave a powerful financial injection to the Agricultural Bank of about $100 millions and, on top of that, an important issue of government bonds bearing 40% interest has been allocated to the banking sector. This will enable banks to receive back borrowed money in less than three years, which will diminish the weakness of their finance.
To sum up, loans granted by state-owned banks to the state-owned value-consuming "combinats" are the essential tool of social policy and social peace in those countries.
Many big corporations cannot be restructured and privatized, because they will cease to function as an instrument of social policy. As was already said, society could not support additional millions of jobless.
Not that big protests against government are on the horizon. It has been observed that populations living under the poverty threshold rarely, but violently, stage strikes. A dramatic decrease in private consumption, due to eventual massive closures of "combinats", would mean ipso facto an equally dramatic decrease of V.A.T. For this reason, all governments recently increased V.A.T. rates (loans make taxes, or to be more precise wages via loans make more taxes). Taxes are the fuel of administrative (governmental) machines. Lending policies of state owned banks are more social measures and not part of a coherent economic program. They will not stop the "proleterization" of the middle class and appearance of a banana republic type of civil society, with 10% rich and 9O% poor, having occasional jobs or poorly paid permanent jobs. Ruined small "businessmen", writes the Croatian weekly "POSLOVNI SVIJET" will never again seek ordinary employment, but will join the fast growing group of "business desperados" with paralegal and/or illegal activities.
At first, there are phenomena which are not statistically observed and which occur more and more frequently. These phenomena are :
This segment of the population is increasing and is worse off than the jobless who receive their allowances. Government statistical offices could survey late payments of wages and pensions 2 or 3 times a year.
Secondly, there are very inaccurately observed phenomena like:
The ancien regime in those countries left behind a network of institutions' statistical offices: chambers of commerce, Central Banks' departments, and people who, with brief training, could carry on the above-mentioned statistical surveys relatively easily. " Market" implies also good information for all at relatively acceptable cost.
It is less easy with court registers, and their statistics, because courts are poorly equipped. Both judges and court officers need knowledge, training and hardware for organizing, classifying and diffusing the volume of information they receive.
Under the ancien regime, courts played a minor role. Therefore, today, neither judges nor other court officers or employees, nor the executive branch, have a clear idea about the importance of court records and statistics for a private capitalist economy. Supranational and international institutions and their executives (bureaucrats) could also pay more attention to the statistical inaccuracies in the countries in transition.
One good example is unemployment. The figures concerning this condition in these countries are inaccurate.
Of course, there is no country in the world with 100% of needed statistics or even nearly that percentage. However, there should at least be information about the methods used by the statistical service for producing "their figures" on whatever subject. As an example for the above, let us take Hungarian unemployment.
It is officially about 550,000, but it is not explained that those unemployed for more than 15 months have their names removed from the registers of unemployment. Other countries have similar rules. If they are taken into consideration, the unemployment figure in Hungary is about 900,000, almost twice the official figure. Similar situations exist in other countries, especially Romania, Bulgaria and Croatia, and, for the moment, to a lesser degree in the Czech Republic, Slovenia and Slovakia.
So the unemployment figures, based on the author's estimates and on estimates of the Deutsche Bank and Vienna Institute are in Table 6:
| Author | Deutsche Bank | Vienna Institute | |
| Bulgaria | 35 | 20 | 11 |
| Croatia | 30 | 17.5 | 19 |
| Czech Republic | 7 | 4.5 | 3 |
| Hungary | 20 | 10 | 10 |
| Romania | n/a | 12.5 | 10 |
| Slovakia | 15 | 13.5 | 13 |
| Slovenia | 12 | 10 | 13 |
The differences in some cases - Bulgaria, Hungary, Croatia - are not small, and if they are not taken into consideration, budgetary planning is very inaccurate.
Bearing in mind that e.g., in the Czech Republic, the reorganization of certain huge industrial "combinats" has not started as yet, and that reorganization unfortunately starts with cutting manpower costs, one can expect a sharp increase of unemployment if and when restructuring starts. The same is true for other countries.
From the strictly methodological point of view, one regrets that statistical presentation all over the world takes into consideration budget deficits as a percentage of the GDP. GDP is estimated magnitude, and deficit is observed magnitude. So, it would be more appropriate, both theoretically and practically, to compare budget deficits with budget receipts, parafiscal deficits with parafiscal receipts (incomes), excluding all borrowings.
And, here is a question which is transitional between the above statistical accuracy and economic theory. Should the unpaid pensions, hospital services, etc. be also considered as a part of social budget deficit, and ipso facto of the state budget? If the answer is "yes" that means that macro-economic analysis by flows only is insufficient and analysis by wealth (stocks) should be introduced and with it in a U-turn in economic analysis and in the calculation of GDP.
In this respect, the economies in transition are also a serious challenge to economic science. The discussion concerning introduction of capital in French "fonds propres" like share capital plus reserves, plus etc., or in more general terms introducing both patrimonium and net worth into macro-economic analysis, are open. More fundamentally, the link between the old wisdom of Roman law, cannonistes, until modern doctrine "jurisprudence" and economic theory has to be established. And economists when calculating GDP should think that the term " societas in bonnis" existed centuries before the term "net worth".
In other words, and for the needs of this paper, a question can be raised: Is it reasonable to believe that corporations have generated added value and simultaneously consumed their capital? GDP is, as all know, the sum of added values in a national economy. Bad loans - 40% of GNP in Bulgaria - can be considered as a subsidy, because economically speaking, they will not be paid back. Another subsidy is externally introduced funds which assure the life of a corporation unable to "add value" or create a surplus. The non-payment of wages is also a kind of subsidy given by households to the corporate sector.
Governments and business communities know well that large scale bankruptcies are wealth reduction and that they mean ipso facto a large scale devaluation for those concerned (e.g. 20 cts for $1) and a domino effect across the national economy.
Keynes said that the people should be employed to dig holes in the ground and then fill them up again, just to make income circulate. This can hardly be true in a rich country like England, because this is a distribution of national wealth. But in the countries in transition with little wealth this cannot be true.
A low level of wages is a good indicator of added value. But if one considers that wages are not paid that means that GDP has to be reduced. The calculation made for Croatia under the assumption that wages are 50% of the added value (GDP), and that they are, on average, paid with a delay of two months, gives a Croatian GDP of $9.3 billion and a per capita income of $2066, or 11 % less than in Table 5. (One has to bear in mind that Croatia just ended a war).
Bearing in mind that the level of capital depreciation allowances is low (fixed assets are old), that interest on loans is not paid, one could consider that wages in those countries represent 75% of the added value. In that case Czech GDP would be $23 billion and per capita income $2367, instead of $33,5 billion and per capita income $3320 in Table 5, or, about 28 % less. This second figure is closer to the reality. For Hungary the results are $19 billion (instead of $31 billion) and $1881,1 ($3069) or 39% less.
Financial statistics are not accurate enough, so the above figures should be taken as plausible and discussion is open, on theoretical issues as well as on statistics.
Even with accurate statistics, the GDP of a given year should not be considered by analogy to capital placed in an account and which grows with compound interest.
Disinvestment is an autonomous decision to give up an activity, product, or service by selling, transferring, or destroying assets, by reallocation of activities and the like, in order to launch another or similar activity, product or service This is a long process and is a condition sine que non for the takeoff of those economies. Disinvestment has its cost which should be considered when devising investment plans for new activities. Investment means among other things fixed assets plus working capital (the latter reduces the risks of bankruptcy). The output per employee is higher, in a well managed business, if manpower has equipment of good quality and technology. The mining and manufacturing branch in those countries is taken as an example of the evaluation of investment needs (disinvestment costs are not taken into account, but this does not influence the basic methodological approach).
If, as a working hypothesis, it is decided that the ratio of fixed assets plus working capital per employee is $7000 - as was the case for Siemens (worldwide) in 1976 - and knowing that at present 30% of the workforce is employed in the mining manufacturing branch, then the required amount of investment with the 1995 structure of employment/unemployment is given in Table 7.
| Bulgaria | 5.2 | Croatia | 2.1 |
| Czech Republic | 11.9 | Hungary | 7.3 |
| Romania | 21.0 | Slovakia | 2.8 |
| Slovenia | 1.4 |
Other hypotheses can be introduced, like a lower amount of assets per employee, or more or less employment, etc. including the fact that in those countries transformation of residuals like old newspapers into paper, bottles into glass and the like did not start as yet. One reason is that the social aspects are brakes on modernization and can be considered as exit barriers. On top of that, when rate of growth is higher than ROIC (return on invested capital) a corporation does not generate enough internal resources, especially when ROIC is smaller than cost of capital.
Of course roads, railways and energy are also needed in order to use efficiently the above investments, and to attract external and domestic funds. Cash from disinvestment will be small, because asset value is, in general, small. The figures in Table 7 are the sectorial minimum to invest in the next five years. At the same time, two other very important ratios have to be determined, namely: added value per employee and added value per $ of fixed assets (or total assets or both).
This is of direct interest for planning the budgetary and para-budgetary revenues and subsequently the level of expenditure allocated to social activities and social investment. This includes education and training of accountants, lawyers, civil servants, judges and managers in order that they become more efficient.
In Croatia, the author has calculated that the cost of training/education of 11,000 executives, lawyers, etc. two months a year during three years would cost about 40 million dollars.
It has been shown that the essential part of the financing of social policies in those countries is assured through state-owned banks, which support old, technologically backward, labour intensive and loss-making "combinats". It has been also shown that the burden of social costs is very high.
The shortcomings of statistical observation and methodology have been discussed with proposals for some improvements and with the author's own estimates of some statistical data.
Simultaneously, some theoretical problems have been put forward, like the necessity of a "balance sheet approach" to macro-economic analysis, considering explicitly the "capital" (capitaux propres in French or in German Grundcapital + Rücklagen + etc) which is omitted from the macro-economic theory.
Finally, some future measures are suggested, which with other policy and political measures (like fighting kleptocracy) could help the long transition period to end with prosperous market economies, however imperfect.
But to start with, efforts are needed to prevent those countries from passing from Bolshevik barbarism to "banana republic" decadence.
Can the European Union afford banana republics on its doorstep?
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