Sunday, 23 October 2011

IMF programs : two simple metrics in an effort to gauge their chances of success

I’ve been thinking about the adjustment programs put in place by the IMF/EU/whoever. It is self-evident that outcomes have not been uniform across the universe of countries where they were applied.

A good question is what is the differentiating factor among these different cases?

I am (for this post) going to ignore the pace or the actual enactment of reforms, the society’s reaction to them, whether the adjustment comes from the revenues or the expenditures side of the state budget and focus on these respective economies fundamentals.

Besides Greece and Ireland, similar programs have been put in place the past 2-3 years, after the onset of the financial crisis, also in Latvia and Hungary, as well in some other Eastern European countries. Besides Greece and Ireland I want to focus on Latvia and Hungary (it’s still too early to judge the success of Portugal’s program).

As a bit of background, Latvia as well as Hungary enacted the IMF/EU financing/adjustment program in late 2008. Greece embarked on the IMF/EU program on May 2010, while Ireland did so on November 2010. Finally, the IMF/EU program for Portugal was initiated on May 2011.  

My view is that with the use of two simple metrics one could have a good chance of forecasting the relative depth of the recession these programs will bring on, or if you prefer, the amount of time necessary for the programs to bear fruits. To gauge that I’m not going to look at the pace of introduction of structural reforms or anything as important as that, just at the superficial and epidermic metric of GDP growth (after all isn’t that what most people look at?).

The first metric is what percent of GDP private final consumption accounts for. Here are the charts for the five aforementioned countries.

source: AMECO, own calculations

source: AMECO, own calculations

The charts make a few facts apparent. Private final consumption for Greece stands at the staggeringly high 75%, while in Ireland and Hungary it hovers around 50%. The same figure for Portugal and Latvia lies somewhere in the middle of the aforementioned range, at about 65%.

Why is this so important? Well, one of the goals of the programs is the trimming of state budget deficits something that implies cuts in state salaries, while cuts in private sector pay will probably follow as a result of the slump in economic activity.
That can only mean that mean that private final demand will be hit hard and that the internal market will start shrinking. It is only natural that the countries where private final demand accounts for a rather large chunk of GDP will be thrown in a deep recession. 

That means that in order to halt the slide in economic activity these countries need an anchor to hang on to. With the internal market neutralized, this leaves only the external market as a suitor to play that role. The countries that stand a better chance of adjusting fast and less painfully (of course that is a euphemism since in all cases immense amounts of pain is involved) are those that their external sectors are quite large.

Here comes the second important metric then, exports. These are the charts of the said countries external sectors.

source: AMECO, own calculations

source: AMECO, own calculations

According to this metric as well Greece finds itself in the worst position among the selected countries, with its exports accounting for a little more that 20% of GDP. Ireland tops ranks by this metric as well and Hungary follows close behind. Latvia is the middle of the table and Portugal is just a little better than Greece.

Since most people (not all that is) think of GDP growth as an indicator of how the program is faring (and not entirely unjustifiably at that to be honest), I’m going to use that metric too.

Here is the chart for Hungary and Latvia. Look at the depth of the recession in 2009. Just as the two metrics would have forecasted, the one recorded in Latvia was abysmally deeper than the one in Hungary. Also Hungary entered positive growth territory in 2010 while Latvia stopped just short of that (of course I have to remark that the program for Hungary was concluded in October 2010).

source: Eurostat

Now look at the chart for Greece and Ireland. Even while Ireland entered its respective program later than Greece it already managed to slip out of recession (that particular fact is usually judged by GDP growth relative to the previous period and not to the same period of the previous year, but Ireland is out of recession even according to that metric).

source: Eurostat

For countries that score low on these two metrics then probably a lot of pain is in order (always in my humble opinion and I could very easily be wrong here). Their structural problems are too grave and a lot of time and patience is needed to fix them. The aforementioned countries fundamentals, as well as the reasons that they had to seek IMF assistance are different. I let you judge whether IMF programs are the way for these countries to adjust and put their economies on track…

P.S. Now that I look at the title is strikes me as a bit arrogant. Well, I don't claim to be able to do that, after all it's always easier to judge things ex-post. Also, I use a rather epidermic measure (as I remarked earlier in the post) of the programs' success. But the truth is that public's patience for this kind of programs tends to be limited so some quick positive results are almost necessary, always in my humble opinion.

P.S.2. The countries that are/were "succesful" in implementing their respective programs rely on external demand to try and lessen the impact of the slump in private final consumption. In the case of a renewed global recession and in case international trade plummets like it did in 2009, then these countries could be in for a beating...

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