The poverty of nations

By bne IntelliNews November 30, 2011

Ben Aris in Moscow -

It can be miserable living in an economy in transition. Hyperinflation might destroy your life savings in a matter of months. Your job may be pointless and pay badly - until you lose it that is. And then you could be condemned to poverty because there's no social safety net to speak of.

However, much as changed over the past two decades. While the above is becoming less relevant to people living in the former communist transition economies of Central and Eastern Europe (CEE), as the sovereign debt crisis deepens in the West, many of these worries are starting to affect those living in those developed rich nations.

In October, the US Census Bureau announced that one in seven Americans, or 49m people, are now living in poverty, the highest number since records began 53 years ago. Two weeks later, the UK's Office for National Statistics announced that the number of people out of work has hit its highest level in 17 years and youth unemployment is at an historic high, leading Jared Bernstein, who once ran the White House's task force on how to reverse the decline of the American middle-class, to warn that the British middle class is in danger of suffering a prolonged US-style wage stagnation as a result of widening income inequality and a weak jobs market for the skilled. And Spain capped off the round of bad news saying unemployment is currently 23% - its highest level ever and the highest in the EU. A catastrophe is unfolding among the nations of the developed world.

Compare that with the countries of CEE. The EU stats office Eurostat released a study last year that found the Czech Republic has the lowest poverty rate in all the EU: only 9% of Czechs live at or below the (relative) poverty line, compared with the Western European average of 17%. Almost all of the countries in CEE have poverty rates below 17%, with a few exceptions including Bulgaria, Romania and Ukraine.

The traditional shorthand measure of suffering is the "Misery Index": the simple addition of unemployment and inflation. Unsurprisingly, the Misery Index has been rising fast in the West as governments attempt (and fail) to tackle the twin debt and deficits that plague their economies.

But the Misery Index doesn't fully capture the despair that many citizens are facing today. What does it matter if the prices of ipods are rising at 10% a year if you don't have enough money to put food on the table? So, to better compare the wave of pain that is sweeping the globe, bne introduces a new index - the "Despair Index": the simple sum of the rates of poverty, unemployment and inflation.

Calculating and comparing the Despair Index for western countries and those in CEE, the surprising result is that with poverty falling to near "normal" levels in the countries of Emerging Europe while rising fast in many developed markets, the Despair Index of several CEE countries has either already fallen below that of their developed peers or is about to do so.

And the shocker is that thanks to record low poverty and unemployment levels, Russia's "Despair Index" fell below that of the US this year, to 25.5 and 28.1 respectively as of November. Given that Russia uses the US as a yardstick with which to compare itself, such a result is manna from heaven for a prickly nationalist like Vladimir Putin as he prepares to reassume the presidency.

Some caveats

Comparing poverty in different countries is of course difficult, partly because western governments are not meticulous about measuring poverty in the general population and the benchmarks vary widely from country to country (see box). But as poverty is a relative concept, the comparison is still valid and the trends remain the same.

What is the lowest level the Despair Index could fall to? In an ideal world, inflation would be running at, say, 2% and residual unemployment at, say, 4%. As for poverty, it should be zero in a mature economy with a functioning social security system. That is what democracy is all about: society working together to provide a decent standard living for everyone, even for those who find it hard to get on in life.

However, the fracas over reforms to the US' healthcare system or the UK's National Health Service, plus the persistent poverty that exists in all developed countries, shows the system hasn't always worked properly. The lowest poverty level recorded by any country in the last 20 years was France's 6.1% in 2001. As such, we can take a reading of 12 as the "residual despair" level that any country will feel.

From despair to hope

Life for Russians at the start of the 1990s was truly horrible. The International Monetary Fund-sponsored "shock therapy" introduced in 1992 freed state controls over prices overnight and sent the prices of staples to the moon: inflation reached a peak of 2,333% in December of the same year (that's 6.4% a day, more than what most countries endure in a year). Unemployment was relatively mild at 5.7% in 1993, but the 27.9% of the population living in poverty gave a Despair Index of 2,367, which is off the scale when compared with any and all other emerging markets, the worst of which saw their levels reach the lower hundreds at the worst.

Joseph Stiglitz, a Nobel laureate and former chief economist of the IMF, told an audience at the European Bank for Reconstruction and Development annual meeting a few years ago: "Subsequently, we have found that countries that didn't go through shock therapy have done better in the long term. That was a mistake," he said with a little chuckle, blithely dismissing a blunder that condemned some 50m Russians to poverty and early death.

Still, it could have been worse. The legacy of the Soviet machine lumbered on and three out of four Russians still had jobs, albeit useless ones: the lights didn't go out, the heating wasn't turned off and no-one starved.

After the initial blow, Russia's economy began to recover. By 1997, the ruble was stable against the dollar and poverty fell to a much more manageable 14.3%, although unemployment was creeping up steadily as those Soviet behemoths slowly died on their feet, to reach 10.8% in 1997. Overall, the Despair Index fell to a low of 45.3 in 1997, but still twice the level seen in the developed world.

The next crisis in 1998 delivered another body blow: inflation soared to 40%, unemployment jumped to 13% and poverty doubled overnight to hit 40%. The Despair Index was back at 89 by the end of 1999. But the big difference this time round was that the ruble crisis carried with it the seeds of recovery: the devaluation re-monetised the economy (which had lapsed into a kind barter system), but perhaps more importantly the jump in unemployment effectively pushed Russians out of their state jobs and into the private sector. Thanks to the tide of oil profits, new jobs were being created and there was cash to pay wages. By 2000, the economy was growing at 10% and the Despair Index began a continuous fall that has seen it reach a post-Soviet low of 25.5 this year.

BRICs and stars

A very similar story has played out in most other emerging markets. China also booted workers out of state-owned factories in 1995 - except the Chinese planned their reforms. But unlike Russia, China is not an industrialised country and so there were few jobs for the newly unemployed to go. If Russia suffered its pain in the early 1990s, the Chinese suffered theirs in the first half of the naughties as unemployment soared to 13% by 2002 (according to unofficial academic estimates). It was only in the second half of the decade that the rapid economic expansion finally created new jobs and brought unemployment back down into single digits.

Today, China has the extremely low Despair Index rate of 14 - but here poverty is defined as living on less than $1.25 a day. If Russia's poverty level is applied to China, then its Despair Index would jump to about 29 - one point worse than the US, but still one point better than the UK.

Turkey lies half way between China and Russia: like China, it has an extensive rural peasantry who have lived in poverty for decades; but like Russia, it is also has a well-developed manufacturing sector.

The Turkish poverty rate began the 1990s at around 30% according to the World Bank - twice that of the collapsing Russia - and it had big problems with both inflation and unemployment: inflation was a crippling 70% for most of the 1990s and unemployment was running at between 11% and 15%. Taken together, Turkey was suffering an exceptionally bad despair rate of well over 100.

Following a nasty banking crisis in the early naughties, Turkey knuckled down to the task of enacting deep reforms, egged on by the prospect of EU accession. This year, its Despair Index level is down to an almost respectable 34.8, even if the country is still struggling with high inflation and joblessness.

Finally, Poland, the star of the 2008 crisis as the only EU country to avoid recession, should be representative of Central Europe; surprisingly, Poland does poorly in terms of despair.

From a good base at the beginning of the 1990s with a relatively mild despair level of 78 in 1993, Poland's proximity to Western Europe and economic reforms brought the Despair Index down to 37 by the time it joined the EU in 2003. Since then, though, the country has struggled. Inflation has been brought under control, but poverty and unemployment have remained stubbornly high for most of the last decade. With a despair level of 42 this year, Poland was performing worse than Turkey's 34.8 and Russia's 28.

West moving in wrong direction

The West went through most of this sort of pain centuries ago, supposedly bringing to an end the scourges of hyperinflation, chronic unemployment and poverty. But now all three of these problems have reappeared - and most of them were visible even before the 2008 financial crisis broke.

The 1990s were a good time for most western countries. Economies boomed, driving down despair levels from around 40 at the start of the decade to exceptionally low levels of 20-25 for most of the leading powers; France even saw its Despair Index touch 15 in 2001 after unemployment and poverty hit record lows. But after the dot-com bubble burst, Despair Index levels began to rise again in France and Germany, and then jumped for everyone after the 2008 crisis struck.

It is easy to blame the increasing despair levels on the current crisis, but the US Census reports that poverty in the US had been rising during all of the last decade and incomes have not fallen this far or fast since the Great Depression. American families in 2000 found themselves worse off than they were in 1990, say economists. The crisis just exacerbated that trend. The rate of poverty in the US hit 15.1% in October, higher than that of Russia at 12.3%.

All the major western countries have suffered similar problems. France's Despair Index has worsened from that impressive 15 in 2001 to about 29 today, and the UK's has jumped from a low of 21 in 2007 to over 30.

Rising inflation, unemployment and poverty in all the developed markets is pushing them towards a despair rate of around 30, which is more typical of CEE countries. Only Germany, the European economic powerhouse, has bucked the trend and maintained its Despair Index at a more-or-less constant level of about 25.

End of the monopoly

To conclude, evidence suggests that new and old Europe are moving in opposite directions, but isn't this all just down to the hangover after the borrowing binge that western banks went on since the start of this century?

Celebrity historian Niall Ferguson argues that something more fundamental is happening: the monopoly that the West has enjoyed for the last 500 years over the most important factors that lead to prosperity has been broken, and the feisty young economies of the emerging world are undermining the comfortable western way of life.

Ferguson identifies six of what he dubs "killer aps" that allowed the West to shoot ahead of the rest of the world: competition, science and the industrial revolution, representative government, medicine and healthcare, consumerism and the work ethic. "Westerners were the first people in the world to combine more extensive and intensive labour with higher saving rates, permitting sustained capital accumulation," Ferguson said in a recent interview.

Emerging market governments have been adopting, buying, copying or simply stealing most of these "killer aps" and putting them to work in their low-cost, under-leveraged economies to spectacular effect. The West, on the other hand, is labouring under the weight of overly generous health, pension and social care systems that were put in place when there was more money to spend and people didn't live as long.

How will all this play out? Are the two conflicting trends permanent or only a temporary crisis-induced phenomenon? A lot will depend on how politicians react - but so far they have not provided much evidence to be confident.

The process of convergence that began in 1991 has been catalysed and new and old Europe are moving rapidly together. The West is facing the need for deep structural change if it is going to remain competitive, but is hamstrung by huge budget deficits and public debt levels that until recently were more typical of countries in the developing world. Today, we are all living in "transition" economies, except things are moving in a better direction for one group of transition economies and in a worse direction for the other group of transition economies.

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