Unsuspecting

Look back on 10 March, look back on early morning on 11 March. Think of millions of Japanese... How many of them thought on 11 March in the morning their country would be devastated by a destructive earthquake Japan had not seen for decades? I bet the number ranges somewhere between 0 and 100 and is slightly misleading, as to carry out this experiment correctly we should exclude all geologists, seismologists and other people who deal with earthquakes day in, day out. But ordinary people? It struck them out of the blue. This is the life, its charm consists also in unpredictability...

On Friday I watched footages of monstrous tsunami waves wreaking havoc to Japanese coast and apart from sympathy I felt a strong admiration for that nation. Film coverages showing people's behaviour during the earthquake showed an amazing picture of people who, confronted with a dreadful danger, kept a cool head, do not fall into panic and try to wait out the worst. Japanese construction technology again has proved its mastery. Very few building were destroyed by the earthquake of magnitude of 8.9 Richter degrees itself, that was the tsunami wave that really went on the rampage. Trains did not derail when the earth was quaking, they were wiped out by the blast of seawater. Japanese communication and early warning systems also worked perfectly. Thousands of people from coastal areas were told to evacuate just two minutes after the giant wave formed near the epicentre of the earthquake. Given the scale of the disaster, death toll of 10,000 to 20,000 is not a striking figure. Probably if the same happened in any other country, in densely populated area, the number of fatalities would be much, much higher...

On Saturday early morning everything seemed to herald a nice weekend for me. The twist of fate hit my family and me out of the blue. Fortunately, things are slowly getting back to normal, but I had to cross out a few items from my weekend to-do-list, so during this short spring episode (at least the weather is uplifting - sunny, temperature "in its teens") I had to do without the first bike ride this year and gave up on writing an important post about Polish pension system reform. Big apologies for such a short posting.

Hopefully, things will straighten out and next weekend I will publish a post which has been written since late November and will be the longest published on PES. In two weeks, circumstances permitting, I will catch up with the issue of pension reform, the post planned to released today will be supplemented by coverage of a TV debate between one of the biggest advocate of the reform, finance minister Jan Vincent Rostowski, and one the biggest opponent of the reform, Leszek Balcerowicz, tentatively scheduled for 21 March.

All in all, life has reassured and convinced me it should not be the bed of roses. All difficulties toughen us up, if we do not let them kill us, they make us stronger, they shape out resilience. This is the leaf to be taken out of the Japan's book. The earthquake and the subsequent tsunami did bring the Japanese to their knees. Mentally they will get up of their knees quite soon, but the damages will pose a much bigger problem for the economy. Japan is the most indebted country in the world, with the public debt accounting for almost 200% of GDP. For this reason the earthquake will take a heavy toll on the Japanese economy...

On broken promises

In 1990, before presidential election, Lech Wałęsa promised to turn Poland into “second Japan”. In 2007, before parliamentary election, Donald Tusk promised Poland would follow the path of Irish economic miracle and would become “second Ireland”. Both politicians have gone back on their promises and Poland has not taken a leaf from Japanese, nor Irish book. Now do not grumble, we should be grateful they have failed to put those economic miracles into practice.

What do those two countries have in common? The lie on different continents, both experienced periods of long lasting economic growth, both were held up as examples of excellent economic performance, both made quantum leaps, both have been going through severe crises and even despite being hit by them are now far higher developed then the moment they were in “square ones” of their growth path.

Japan got up of its knees over ten years after WW2. Thanks to easy borrowing terms, support from the government and protectionist measures Japan’s industry began to grow rapidly. Japan corporations relied on cutting-edge technologies and were highly efficient what helped the country boost its exports and flood markets of developed countries with high-quality and reasonably-priced products. In 1960s annual GDP-growth rate was running at above 10%, in 1970 it slowed down due to oil crisis, but Japanese economy soon adjusted to rising demand on energy-saving technologies and not only rode out the crisis, but even emerged from it stronger. The period when interest rates were low, pace of economic growth remained high and inflation low lasted until 1990. The last five years of boom were marked by surging stock and property prices – both tripled between 1985 and 1990. Companies and individuals eagerly borrowed money from banks to buy assets, since interest rates on loans were far lower than returns on stocks or properties. The bubble burst in 1990 and the economy of Japan slipped into a period of sluggish growth for a decade. Banks were hardly hit by write-offs on non-performing loans, individuals and companies struggled to repay the debts they had run up in the times of speculative frenzy. Customers were reluctant to spend, what caused the domestic demand to decline. Firms instead of investing in capital stock were paying back its debts. Interest rates were slashed to near zero to stimulate the economy, but neither banks could grant new loans, nor were the enterprises keen to take them out. GDP growth rate averaged out 1% in the 1990s. Adverse effects of bursting of sizeable economic bubble are felt until now.

Ireland in a relatively short period of time turned from backward agricultural country into one a modern, fast-growing economy. The economic miracle is often put down to Social Partnership under which government, employers and trade unions settled on taking a concerted effort move the country forward. They did bring it off, inflation was on decline, growth rate was on the rise, the country attracted outward direct investments owing to corporate tax cuts. For many years Ireland ran budget surpluses and consequently its public debt was decreasing. Good economic performance was fostered by low interest rates and deregulated financial industry, which caused the property bubble to arise. Banks were lending recklessly and bubble grew splendid before it burst. From then Irish banks reported huge numbers of defaults among borrowers, their capitals shrunk as a result of losses on non-performing loans, the government had to bail out most banks and the bail-out programme has caused the public debt to mount. Now not only Irish banks but also the Irish state is on the verge of insolvency.

So what do they have in common? Economies of both countries have been hurt by bursting bubbles. In both countries interest rates were abnormally low for an extended period of time (there was no need to raised them as there was no threat of rising inflation), banks loosened their lending criteria and foisted loans upon almost everyone. In both countries prosperity was brought to a halt by bursting bubbles.

But brush aside economic aspects of economic bubbles, take a look at them from psychological perspective. Bubble (as any other misfortune) inflates when people take for granted nothing bad can happen. Japanese and Irish banks took for granted the property prices would only go up, so even if a borrower failed to repay their debt, they would foreclose a property and recover the money. Individuals and firms also took for granted asset prices would only go up. When an economic bubble is robust almost everyone believes the boom will last forever. Voices of sceptics who claim the disaster is imminent are drowned out.

It is very hard to crack down on the bubble, because as long as it swells, it is convenient to everyone. Government gets higher proceeds from property taxes, property developers count up sky-high profits, banks make lots of money on mortgage loans, property owners are happy because their wealth is increasing, flat broke non-owners are over the moon because banks are leaning over backwards to give them 40-year mortgage for a tiny, dilapidated 30-square-metre flat. And the unemployment is falling, because construction sector needs more workers, who do not get paid worse than qualified workforce. And bear in mind efficiency in construction sector is low, so economic growth generated by it is in a way delusive.

Lessons to be learnt? Do not let property bubbles happen. In the long term they always do more harm than good. Imbalance in an economy will sooner or later cause a turmoil and those to pay for any possible bailouts will be taxpayers. Interest rates on mortgages should not be low (cheap corporate loans have positive impact on the economy in the long run)! Lending for housing purposes should be under supervision! Poland escaped the scenario of bursting property bubble. Property prices did double in some cities between late 2005 and late 2007, but the boom was not followed by bust. Interest rates were never too low, Polish financial supervision did its best to curb lending, particularly in foreign currencies. Banks’ profits in boom period were not as high as they could be, some applicants had their mortgage applications rejected, but Poland averted a much worse scenario. May we never try to repeat any country’s path to economic miracle. Mr Wałęsa and Mr Tusk did not know what they were saying. Their promises were made just before bubbles in Japan and Ireland burst.

Funnily enough, Poland was going through a property boom when Prawo i Sprawiedliwość was in power…

More on economic bubbles in 2011, after I graduate (in my MA thesis I explore the topic, some excerpts to be translated into English and published here after I “defend” it).