Kristijan Kotarski

Political Economy of Banking and Debt Crisis in the EU: Rising Financialization and its Ramifications

This paper is structured into four different parts. In the first part the authors analyze the origins of banking and debt crisis in the EU. The state and the evolution of the EU banking sector before the crisis and in its immediate aftermath is analyzed in detail in order to dispel the myth of the existence of an exclusively debt-induced crisis. This part also introduces the notion of financialization into the analysis. The second part analyzes the crisis-related dynamics by using endogenous monetary theory and makes particular use of balance-sheet recession as a concept. The third part introduces political consequences of the banking and debt crisis in the EU by focusing on the political crisis of legitimacy and its impact upon the EU integration process. In order to deal with this topic the authors borrow several concepts from critical international political economy such as transnational elite, knowledge production, and hegemony. We posit a close link between actions of the European transnational elite, crisis origins, and their ramifications. The fourth part focuses on the two most-discussed policy solutions in tackling the crisis: the banking and the fiscal union as well as their feasibility. Additionally, it lays out some fundamental trillemas for creating a viable way out of the crisis which are unfortunately often neglected in public debate. The main argument refers to the growing impact of financialization in the EU and its detrimental effect on the potential for integrated, stable, and prosperous EU economies. The authors explain the changing social, political, and economic landscape and evaluate the main challenges and obstacles to economic and political governance in the EU. The paper is concluded with some heterodox policy recommendations for overcoming them. JEL classification: B52, E51, E52, F34, F50, G01, G20, P48

Banking Regulation in Croatia: Qualitative and Quantitative Assessment

This chapter emphasizes the specifics of the Croatian banking sector and discusses the importance of the regulatory framework for the Croatian banking system in the historical perspective. It analyses the roles of the regulators, bank managers, depositors, taxpayers, borrowers and shareholders in shaping the political economy landscape for banking regulation in Croatia. This covers the period since the demise of socialism until the present day. This is followed by a broad overview of the main developments in the banking sector based on data on financial soundness, with the focus on the period from 2000 onwards. To empirically assess the effects of banking regulation on financial soundness indicators and lending activity, the authors will use vector auto regression (VAR) models. As the key explanatory variable the authors will use the index of regulatory burden and indicator of monetary policy stance, while capital adequacy, liquidity indicators and lending to the private sector are included as variables of interest.

Croatia’s Post-communist Transition Experience: The Paradox of Initial Advantage Turning into a Middle-Income Trap

The central puzzle of Croatia’s post-communist transition has been the extent of economic and institutional divergence with new EU member states bound by common historical legacy and imperatives of institutional transformation following a collapse of the old institutional order. In this chapter we identify two key explanations that stand behind this evolution. First, we claim that the political economy of Croatia’s transition represents the case of partial reform equilibrium where winners represent the biggest threat to successful long-term transition. Second, comparative political economy analysis of five key areas (product market competition, collective bargaining, financial sector, social protection and education) shows that Croatia developed a typical variant of capitalism, which is in its attributes closer to South European capitalisms than to capitalisms prevalent in Central and Eastern Europe (CEE-10) EU member states.

Interest Groups in the Policy-Making Process in Croatia

This chapter seeks to explore the emergence of the modern landscape of Croatian interest groups and the strategies they use to gain access and exert influence in national policy-making venues. It reflects on specific political and social circumstances that affected the development of the scene of organized interests since the early 1990s. In addition, the article explores elements of different forms of organization and articulation of interests that have become entrenched in policy-making processes in Croatia, ranging from pluralism and neo-corporatism to still widespread clientelistic arrangements with some of the most powerful interest groups. The chapter also provides insights into the main factors that determine interest groups’ influence and choice of lobbying strategies. Finally, it analyses the impact of the EU accession on increasing trends of institutionalization of consultation with interest groups in policy-making and gradual adaptation of interest groups’ influence-seeking behaviour to new policy dynamics at both national and EU levels.

Quo Vadis Croatia? The Interplay of Institutions, Interests and Ideas

The first half of our final chapter gives a brief overview of previous chapters. On the other hand, the second half deals with institutions, interests and ideas and how they mutually interact. This is important since underperforming institutions serve as one of key ingredients for explaining economic stagnation and divergence in Croatia. But what explains the emergence of these ill-suited institutions? We add interests and dominant ideas to our debate. We claim that EBRD data, which we use at length, largely explain that interests alone cannot provide the full explanations of Croatia’s institutional and economic underperformance, despite their importance. Ideas matter a lot in that regard. Even more, they matter when we observe the potential avenue for change in Croatia. Fresh ideas might spearhead the reconceptualization of vested interests and unlock institutional gridlock.

Monetary Policy in a Highly Euroized Economy

In this chapter the authors trace the evolution of Croatian monetary policy since independence to the present day. Its aim is to systematically describe and explain a plethora of monetary and macroprudential policy instruments and tools the Croatian National Bank (CNB) used from the moment it was founded, throughout its harmonization with the EU legislative framework, and to explain its future prospects and monetary policy goals. The authors empirically examine deposit and credit financial euroization, as well as associated balance sheet vulnerabilities that pose significant exchange rate and currency-induced credit risks. To demonstrate the potential impact of currency mismatches, authors analyze the case of loans indexed to the Swiss franc. The chapter concludes by a simple econometric analysis of the sensitivity of the nominal HRK/EUR exchange rate, short- and long-term interest rates and investment to foreign exchange rate interventions. This demonstrates the effectiveness of the main monetary policy instrument in Croatia—occasional and unannounced foreign exchange intervention.

Financial deepening and income inequality: Is there any financial Kuznets curve in China? The political economy analysis

The interconnectedness of financial deepening and income inequality has been a highly controversial discussion which has not been concluded despite many empirical and theoretical studies up to date. One of the basic building blocks for many research designs is the reliance upon the Kuznets inverted U-shaped curve which postulates that in the first phase of economic growth income inequality increases, peaks and then decreases to a tolerable level in the later phase after a certain income level had been attained. The role of financial deepening in financing economic growth is an indispensable and necessary condition enabling us to easily draw an analogy between financial deepening and income inequality in a financial version of the Kuznets curve. In spite of 30 years of economic and financial reforms in China, which represents a fairly young history of economic growth and development, there are many indicators that Chinese experience significantly deviates from the presupposed inverted U-shaped curve trajectory and its final equalizing effect. This paper relies on financial deepening data measured by monetary aggregate M2/GDP and domestic banking credit/GDP ratios in its claim that they significantly correlate with rising income inequality. The author’s intention consists not in claiming that financial deepening per se causes income inequality, but provides a political economy analysis of the specific institutional and power configuration which leads to their positive relationship. This configuration is determined by the prevailing banking model, the hukou system, financial repression and the decentralized authoritarian system. On the other hand, the absence of inequality-narrowing institutitons further aggravate the problem. All the aforementioned factors are geared at avoiding mechanical and spurious claims that financial deepening increases or decreases income inequality across countries. A historical institutionalism approach to explain China’s path related to the Kuznets curve prediction shows the central validity of open and inclusive institutions in generating inequality-narrowing benefits of financial deepening.