January 16, 20009 (the date of publication in Russian)
"WE ARE DRAWN INTO A MAELSTROM OF RECESSION". Part 1
Andrey Kobyakov's comments on the global economic crisis, and its implications for Russia
It is the full version of the interview with economist Andrey Kobyakov, director of the RPMonitor Analytical Online Journal and chair of the expert council of Russian Entrepreneur Foundation. The brief version of Andrey Kobyakov's talk with journalists Ilya Brazhnikov and Ilya Khaskevich was published in the December 2008 issue of Politichesky Zhurnal magazine, Moscow.
Q: Many analysts are today trying to figure out whether the current global crisis is going to be restricted to the sphere of finances, or affect other branches of economy. What is your view of the duration of the crisis and the ensuing changes in the global economic affairs? What major challenges is Russia facing in this period?
A.K: This crisis is not going to be restricted, and is not already restricted with the financial sphere. Today, we possess a lot of figures and data indicating that it has seriously affected real economy as well. This would happen in any case, even if the crisis were scales smaller.
In the span of the last several decades, every financial crisis has had a macroeconomic element. Take the Asia crisis of 1997. Though it did not take a global shape, the affected states experienced a serious decline of GDP, as well as major economic indices. It was typical for the crises of the present period of history.
Unlike the crises of overproduction, described by Karl Marx and other classical authors, the modern crisis emerges in 90% cases in the financial sphere, extending later to real economy. Today, we live in an inverted economic reality. In the system analyzed and described by Marx, real economy served as the basis of the socio-economic formation, while the financial sphere carried out the function of servicing. But this design has subsequently changed.
In my university lectures, I ask the students to imagine a person whose head started to grow, and reached a shape several times exceeding the volume and mass of his body. Such a creature cannot properly walk and even stand, as a slight move of his head would disturb his balance. A similar transformation has been taking place in the global economy during the last four decades. The basis and the superstructure have changed places. Using another image, it is a dog wagged by its tail, as this tail – the financial excrescence – has become self-sufficient.
That is why it was clear from the beginning that the disaster, originating in the very heart of the financial world, in the United States – at the American financial markets, in America's financial mechanism – would inevitably spread to other continents and other branches of economy, and become the most severe for the last century, or even more massive.
Q: In mass media, the current crisis is now compared with the Great Depression of 1930s. Some authors, continuing the parallel, associate the Great Depression with the following World War II.
A.K: I don't see any direct connection between the two catastrophes. While America was paving its way out of the crisis through Roosevelt's New Deal, Europe was using different schemes. In particular, John Maynard Keynes, who is incorrectly described as a socialist, was in fact committed to save the Western community from self-destruction. Roosevelt and Keynes could be accused of arbitrary decisions, but in economic terms, there was no other way out of the
situation for the West.
Definitely, the war helped the United States to utterly overcome the depression, but that doesn't mean that Washington deliberately provoked World War II.
Q: Couldn't Pearl Harbor serve as a provocation?
A.K: By that time, the war had already started. Pearl Harbor was an attempt to get the United States involved in the war. Thus, from the standpoint of the Great Depression, the war was not inevitable. But we can draw parallels of another kind.
Take the so-called Kondratiev circles. Acad. Nikolay Kondratiev, an outstanding Soviet economist, was disgraced and executed. However, his studies survived, and were later used by Joseph Schumpeter, returning later, as a reflected beam, to Russia. Kondratievists comprise a numerous community in today's scientific circles.
Kondratiev discovered the so-called big waves of economic conjuncture, also identified as quincentenary cycles. Smaller economic cycles can be explained with concentration of capital, over-investment in particular industries, most commonly according to the classical pattern of overproduction. However, these cycles, lasting for not more than five years, safely recuperate. Their origin, as well as methods of their correction, is well studied.
Larger cycles, described by Kondratiev, represent a more complicated phenomenon that is often explained in a mystical way. However, there are also scientific explanations. One of the hypotheses is based on the assumption that a big wave indicates a change of technological mode, introducing a new cluster of innovations that subsequently determine the mass demand for a very long period, and involve a lot of additional servicing industries. The reserve of growth may be sufficient, say, for 25 years, to be then followed with a phase of decline.
The innovations the period of growth is based upon emerge from basic discoveries, like i.e. the internal combustion engine, the electric lamp etc. The most recent period of ascent is commonly associated with computer technologies, mobile communications, chipization of everything. This revolution in science included Internet economy, electronic banking and other kinds of electronic business.
In any case, the revolutionary invention is supposed to trigger a sweeping change in the structure of public demand, in the structure of basic industrial branches, in related production of construction materials, applied technologies etc.
For instance, the invention of the internal combustion engine promptly reshaped the structure of the fuel and energy balance, as oil was not more required in earlier proportions. Instead, it needed invention of new materials, and thus the invention of redox rubber was inevitable. Natural rubber would be insufficient for the required amounts of tires. In-line assembly, along with new diversification of labor, required a reform of education, spawning an array of special kinds of vocational training servicing narrow specialization of productive labor. This specialization involved new branches of chemistry, as after the gasoline faction was obtained, more refined methods of chemical production processed thinner petroleum factions, generating new industries.
But at that time, in 1920s, Kondratiev foretold the Great Depression, demonstrating that the economy had entered a declining phase of the cycle. Today, we are facing a similar transition to a new phase of decline.
Q: Do Kondratiev waves influence also political processes?
A.K: Yes. This cyclic regularity can be viewed from the standpoint of a broader correlation, involving also social cataclysms, like revolutions. Generally, Kondratiev cycles cannot be interpreted univalently. They've never been accurately measured and thoroughly compared, as the span between them takes generations. Therefore, relevant research is mostly hypothetical. There are various interpretations. For instance, Fernand Brodel from the French school of Annales, or Immanuel Wallerstein share Kondratiev's basic views but envisage them in a broader historical context.
Q: Is the current global decline likely to be followed with a new world war?
A.K: We are now in the initial phase of decline, and it is too early to make such forecasts. Besides, Kondratiev indicated that big cycles never precisely reproduce one another. His theory is not a device for table-turning but an instrument that enables to foresee a higher or lower extent of probability of particular trends or events. The wave theory predetermines not only alarmist calculations: it is also a source of optimism, as every depression is followed with new growth. The mankind is going to experience a new wave of economic progress. However, new growth has to be based on a new cluster of innovations.
A.K: Or, maybe, biological and medical discoveries. To minimize the effects of decline, we should try to identify the new trend in advance. In case we guess the trend, our nation may become one of the leaders at the new wave.
In early 1980s, Ronald Reagan tried to pull the US economy out of the decline similarly to Baron Munchausen who dragged out himself and his horse from the quagmire with his hand. Reagan expanded military spending, and started research in space wars, SDI and so on. This method was cynical and generally doubtful, but still triggered an array of inventions in electronics and communications. We are now facing a temptation to accelerate scientific research and industrial revival by military technologies as well. Some authors believe that the military industrial corporations deliberately start wars in order to write off obsolete weaponry and get contracts for new technologies.
Q: May unemployment trigger social destabilization before this new scientific breakthrough becomes possible?
A.K: Unemployment is already increasing. My friend, employed in advertising business, told me already in September that his company's contracts had fallen by one third. This market was the first to be affected. The decline of incomes from advertising affects TV companies and publishing houses. Ironically, financial analysts were the first category to lose jobs. Mid-level company managers are now also facing layoffs, or their salaries are being slashed. This category has lately got used to high salaries. McKinsey, a major research and consulting firm, in recent years used to pay more to the Russian personnel than to American clerks. The layers of specialists paid 10-15 thousand euro per month already included dozens or even hundreds of thousands people in Moscow. They will now face a choice wither to lose the job, or to agree to a modest 3000 euro salary.
However, these people used to calculate their budget from the level of 15000. Therefore, they borrowed accordingly at the mortgage market. Their mortgage contracts corresponded with the size of the new flat. In Russia, unlike the United States, one could not repawn a new flat that was not yet redeemed. Therefore, the borrower is supposed to return, say, 3000 euro per month. Thus, he is facing a default. In its turn, the bank is uninterested in real estates as well as their prices are going to decline. Therefore, banks try to get rid of real estates. Therefore, we encounter a crisis in construction. A huge amount of houses are half-built or half-sold. Today, developers and contractors offer sometimes a 30% discount.
During the last five years, at least 40% of new flats were purchased for investment purposes. In this year, the market was stalled. This situation can last for several months before companies are forced to slash prices. As soon as prices decline, everybody hurries to sell. This reminds a burning theater: everybody is trying to leave the place, stomping on one another. Everyone realizes that either he will leave right now, or he will die. Thus, the market will collapse. This is a sentence for developers, especially for those who had borrowed heavily to invest in construction, hoping to return the loan and to gain income from the increased price. Instead, the market was first stalled, and they reduced their losses by cutting personnel, mostly employed from gastarbeiters. We already have to deal with a serious social problem, associated with the imported labor force. Losing jobs and joining street crime, they accumulate into an explosive material.
Q: Is this unemployed labor force going to multiply the potential of the so-called "orange threat"?
A.K: I don't think so. Most of the unemployed foreigners are likely to seek jobs in small business. But the same chain reaction is going to affect this sector as well. A year ago, you could hardly find a seat in a mid-level cafe on Friday evening. Due to contraction of spending capacity, the number of cafe-goers will swiftly shrink. The same is happening at the auto market. Purchase of new cars is declining. This means that new assembling factories will slash labor force as well. This is a maelstrom of recession. For instance, our metallurgists are now at a loss, as China hasn't purchased a single ton of steel during several months.
Q: Has the crisis affected China so seriously?
A.K: The problem is not in China but in the United States that used to be the major market of Chinese production. China has got a powerful metallurgic sector of its own, and they purchased steel from Russia only while they required additional amounts to fulfill US contracts. Now, America has frozen practically all the contracts for imports. During the last two months, China's own factories have faced problems as well. Only in November, around 50,000 small Chinese enterprises went bankrupt.
The indices, characterizing the price of freight, are declining as well. Since April, the price of freight has fallen by 90%. That means that the demand for shipping has declined as well, following the final demand. A ten-time contraction means a lot.
Alexander Anisimov, a perfect specialist in Chinese economy, says that we have to look at natural indices. Financial statistics are unreliable: you have to clean these data again and again before you arrive at the reality. When did the US recession in fact start? It depends on how you calculate inflation, as the GDP is estimated in current prices, and then corrected with the deflator. If you downplay inflation, you'll get optimistic figures of growth. The book published in 2003 by Mikhail Khazin and myself, describes manipulations with the so-called hedonic price index. For instance, a computer has become more expensive during a year, but it has also become more sophisticated, with a larger memory, a more powerful video card, etc.
Thus, if calculated from the standpoint of hedonic indices, the price per productive unit has declined and not increased. But in case you routinely use your PC as a typewriter, you don't much care of its productivity and memory, and if you install a "more productive" Windows program, requiring more resources, your work won't become faster.
During the last years, American economic growth indices were calculated according to hedonic price indices. For instance, medical services got more expensive, but you are told that they were getting cheaper, as the dentist's seat had become more ergonomic, and analgesia more efficient.
Anisimov is right. We have to concentrate on real natural indices, especially in cases with high correlation with the real dynamic of the GDP. Cargo shipping is one of the best correlating indices. The abovementioned dynamic of the fright price index demonstrates that the situation is really dire, and that in the following months, we are going to face a recession of a much more serious dimension.
Q: In the United States, salaries were shrinking as far back as in 2005. Was that already the onset of the crisis?
A.K: The indices of real salaries in the United States reached its maximum in 1968, and since that time, they had been steadily declining. Reaching the minimum level in 1991-93, it started growing again, but never exceeded the amount of 1960, comprising about 75% of then-time income, and today, it repeatedly dropped. In other words, the real medium salary is one third lower than it was in 1968 in terms of purchasing capacity.
The era of 1960s was the real golden age of America, and that is why Kennedy is glorified by Americans until today, remaining as a monument in their perception.
What strikes me most of all when i study this period of the US history is the amount of income taxes. The tax scale was certainly progressive. It was never disgustingly flat as it is in Russia. The more you earned, the more you had to return to the state. That was "real socialism". In case your personal income exceeded $1mln per month, you had to pay 87.5%; with a $2mln income, you paid already 92.5%. At that time, taxes for corporate incomes were also high, and at the same time, you had a social market system, capitalism with a human face", with free education, health care and emergency rescue. By the way, they borrowed the emergency rescue design from the USSR: in the West, there was none.
Add trade unions. The economy of that time was still industrial and not postindustrial, and therefore, the trade union system encompassed most of the American labor force. The worker who lost his job during the crisis received an allowance from the state and an allowance from the trade union. That was the real American dream, when the housewife did not have to work, when a household could bring up four children and afford a huge house, two cars, and best private education for the kids. This level is in the distant past. In 1990s, many Americans had to have three jobs to maintain their households. For instance, a middle-class manager would get up at six and wash the floor in a shop before his major job, and in the evening, to assist to a bartender.
Alex Bayer, a US economist and a columnist in Moscow-issued Vedomosti Daily, told me that the described pattern was typical, though by that time, most of the women had to seek employment, but that was still not enough. Thus, the family income had been declining for years. Lately, the decline of income per capita was compensated by reluctance from saving. The ratio of individual savings to individual income has become negative, comprising about minus 1.5% during the last years. That means that people spend more than they can earn. Meanwhile, in terms of macroeconomics, savings are a source of investment. In case the economy was isolated, savings would be the only source of investment, even for the maintenance of the existing potential through amortization.
During the last fifteen years, Americans spent much more, their personal incomes grew. This growth was achieved from foreign investments in stocks. An average American became utterly dependent on foreign capitals. Their lack of savings is compensated by the rest of the humanity that still considers the US dollar as a reliable investment tool.
In the system of division of labor in the so-called postindustrial era, China has become the world's industrial plant, while the United States has become the world's stomach. Imported goods were exchanged for securities. What are American jeans? This commodity exists only in reminiscences. The last Levi Strauss' jeans-producing factory was closed in 1998. Americans wear jeans of Indian, Indonesian, Vietnamese, Chinese or other production. They don't produce even underwear. One third of the US GDP is comprised of financial services.
(To be continued)
Number of shows: 2210