In your recently published book you examine the relationship between trust and decision-making over economic policy. How did you find this topic? Why is it important? What are the results of your research?
I discovered the importance of trust when I was researching the underlying causes of fiscal deficits for my doctoral dissertation. In the literature there are several theories about why deficits persist. Economic explanations focus on the stance over the cycle and expect deficit over a downturn and surplus during upturns. Political explanations focus on the election cycle and relate deficit to the need to gather votes. Institutional explanations emphasize the importance of the fiscal framework, which governs the budget process. I was unhappy with all of these explanations – the economic argument does not account for deficits over the entire cycle, the political accounts do not explain cross-country variation, while the institutional accounts leave out the origins of the institutions.
As I examined the cases of Hungary and Sweden, which both entered a deep crisis in the early 1990s and chose very different responses, I became attentive to the differences of trust both within the elite and between the elite and the public. This appeared necessary for decision-makers to be willing to bind their hands through self-imposed rules-based policy.
In my current book I outline a theoretical framework for the mechanisms through which trust brings about this outcome. Where the citizens see that policy-makers are only concerned about their own short-term benefits, long-term promises are not credible and votes can be gathered only through short-term populist promises. This however necessitates room for discretion, thus the strengthening of institutions face serious political obstacles. Another mechanism through which distrust affects policy is the relation towards rules in society. Where policy-makers regularly break their own rules, the public is unlikely to feel an inner obligation to abide the rules. This means that institutions cannot fulfill their objective of governing expectations thus there is considerable uncertainty in the society, which also contributes to shortening the time-horizon in decision-making.
In your book you tie the issue of institutional trust to the financial crisis in the EU. What are the mechanisms of this relationship?
While in my doctoral dissertation I focused on the contrasting cases of Hungary and Sweden, in my current book I compared the old EU member states with the 10 new post-Socialist member states. I found that in the old member states the choices over fiscal policy can be well explained by institutional trust. I found that in high-trust countries there is a high level of commitment to fiscal responsibility and this commitment shows up in the choices over consolidation. In high-trust countries long-term promises are credible thus structural reforms and expenditure cuts are possible. In contrast in low-trust countries such as the Southern member states of the EU, fiscal consolidation takes place primarily by raising taxes. These countries also resist the strengthening of fiscal rules.
The story is somewhat different in the new member states of the EU, which all suffer from the Socialist heritage of distrust. Even in Slovenia the majority is distrustful towards the state. However, mostly due to financial market pressures this distrust did not show up in fiscal performance. Instead it manifested itself in private lending, which can also serve the satisfaction of short-term material aspirations. In fact a strong negative correlation could be observed in these countries between deficit and private lending – it seems the two are substitutes. Hungary is an outlier in the region, since both public and private indebtedness rose during the period examined.
The level of indebtedness in both groups is good explanation for the severity of financial crisis, although there are some exceptions such as Ireland.
You mentioned that there are exceptions to the theory and we find countries, where populism did not prevail in spite of lack of trust. Which are these countries?
This was one of my original questions for the book and I structured the research to get some answers. Following the theoretical chapter I have three empirical chapters, where first I analyze a group of countries then conduct two cases studies. In the first empirical chapter I examine the fiscal policy of old EU member states and illustrate the theory with the contrasting cases of Sweden and Portugal. In the second empirical chapter I look at the post-Socialist EU member states and compare Hungary with Slovakia, which are most similar cases – they are both characterized by low trust but Slovakia was able to implement reforms. Finally in the third empirical chapter I analyze the crisis experiences in the 25 countries and look at the surprises to the theory, Ireland and Poland. By examining the outliers I aim to establish the conditions under which the theory works.
Among the new member states Slovakia and Poland are the exceptions, since they were able to conduct responsible fiscal policies in spite of widespread distrust towards the state. The Slovakian case is a combination of leadership and timing – following Meciar there was substantial demand for change and this coincided with the period of liquidity, which preceded the current crisis. The governments between 1998 and 2006 were committed to market-oriented reforms and these were followed by large-scale foreign investments. Thanks to these changes Slovakia could introduce the euro and weathered the current crisis quite well.
Poland is a different case as it entered the period of liquidity during a recessionary period when there was meager demand for credit. Furthermore the institutions enforcing pledges and collateral on the mortgage market were extremely weak and made housing lending risky for investors. Third, the leadership of the Bank of Poland headed by Leszek Balcerowicz was very old-fashioned and imposed significant administrative constraints on any lending boom. As a result, indebtedness was much lower in Poland then elsewhere at the outset of the crisis.
The examples of the two countries show that it is possible to get out from the vicious cycle of distrust and populism and implement long-term oriented policies. Once they prove successful, trust in the system increases, and the lengthening of time horizon makes short-term populist promises are less and less necessary.
Can we say that Hungary is in a unique position in the region in terms of trust towards the state given its historical past?
Yes, we have a somewhat unique heritage with Goulash communism. While in other countries few want back the Socialist system, here there is considerable nostalgia towards the past. Citizens want substantial welfare provisions from the state and in return they are willing to tolerate a lot of mischief from politicians. During socialism the functioning of the second economy essentially meant that a deal was struck between the citizens and the state: in return for overlooking minor breaches of the law such as use of state assets for private gain, the citizens did not question the position of the Communist party. This resulted in a situation when neither the citizens nor the state took the law seriously. The corruption accompanying the transition process strengthened this state of affairs, which is manifested for example by widespread tax evasion. Accession to the EU changed the picture in that the formal institutions of democracy and capitalism were built, while the foreign-oriented privatization strategy implied that the country had to adapt to the expectations of investors. At the same time the heritage of an ambivalent attitude to the law survives – the elite is unwilling to bind itself via rules. For example from 2003 several international organizations warned Hungary about the weakness of its fiscal rules but change occurred only after we needed the bailout packages from the IMF. Now we can see that the current government with its two-third majority is similarly unwilling to accept constraints over its discretion. I think this fits well into the historical heritage.
Interview by Panna Perecz
