AMERICAN CHAMBER OF COMMERCE IN MONTENEGRO Business Luncheon. Hotel Crna Gora, Podgorica, Montenegro. May 27, 2009

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1 AMERICAN CHAMBER OF COMMERCE IN MONTENEGRO Business Luncheon Hotel Crna Gora, Podgorica, Montenegro May 27, 2009 Jan-Peter Olters World Bank Representative Country Office Montenegro As I looked at the newspapers earlier this morning, two headlines dominated the front pages viz., the purchase of 15 percent of privately-held shares in EPCG by an Italian company and the protests by workers of the troubled aluminum smelter KAP. On the one hand, in Montenegro like elsewhere, there are increasing signs that seem to foreshadow the possibility that the worst of the global economic crisis might be over. The Governor of the ever cautious European Central Bank, Jean-Claude Trichet, recently pronounced that the world economy was around the inflection point. US Treasury Secretary Timothy Geithner as well is on the record of seeing first signs of a healing in the financial sector. At the same time, growth projections including those by the World Bank remain very pessimistic, pointing to significant contractions almost everywhere. Among all the major industrialized countries, the contraction in real GDP during the 1st quarter 2009 was faster than that of the 4th quarter 2008 with the notable exception of France. And repercussions are clearly visible. The American Federal Deposit Insurance Corporation, FDIC, has reported 36 bank failures in 2009 so far, only for the US. The US Government is pondering to take over control at GM, for the longest time the pride of the US economy. There are many companies including those with long and successful histories that do not look all that different from KAP, overburdened with debt, too expensive to be competitive in this difficult environment, and without the financial means to implement the investments necessary to turn the situation around. This suffices, I believe, to describe the foresight that you have had when you established the American Chamber of Commerce in Montenegro a little more than half a year ago. You did not shy away from the challenges of an unusually tough environment. With the AmCham, you have given the business community ultimately the holder of the key to unlock economic recovery a single voice to contribute to, and influence, the public debate on what would constitute an investment climate sufficiently attractive to entice companies to expand their economic activities or to begin new ones. You will certainly have a much better feel of how difficult the current situation is, of how the global economic crisis affects your business and those of your competitors. And I am sure that discussions among your colleagues, like those that I have with mine, tend to culminate in the anxious question as to when this crisis might be over. No doubt, this is

2 the deepest crisis since 1929, but will the consequences be as dire as those 80 years ago? And what do we make of the apparently contradictory pieces of news foreshadowing both nascent economic recovery and large-scale business failures, contributing to a certain degree of confusion. Unless I look at things from the wrong end, I believe that, in the end, this apparent confusion reflects the interaction of leading indicators (i.e., economic data that incorporate, to some degree, market participants expectations as to what is likely to happen in the foreseeable future) and lagging indicators, comprising those effects that take the longest to find their reflection in reported statistics. Let me start with a few leading indicators, reflecting, in some form, sentiments about the medium-term future. To start with, oil is always a good indicator, for a number of reasons. It is an industry with essentially only fixed costs, given that oil exploitation and refinery take a long time to be constructed; implying that relatively moderate changes in demand tend to lead to noticeable changes in prices. The demand for oil can be viewed as a short-hand indicator of global aggregate demand. Given a considerable forward market for oil, the determination of prices reflects a considerable amount of market expectation. As such, the gradual increase in oil prices reflects the (expectation of) a stabilization in demand, if not a steady increase over current figures. Leading Indicators: Oil UK Brent, Light Blend, 38 API, Jan Apr US$ per bbl Similarly, key inputs for products with high elasticities like cars and airplanes, also traded on forward markets, allow for analogous interpretations. Given the domestic significance, I have plotted here aluminum and metal prices. And finally, stock market indices tend to reflect the market s expectation, over all sectors, of the economic prospects, both internationally and domestically.

3 Leading Indicators: Aluminum LME Standard Grade, Minimum Purity, Jan Apr ,200 3,000 US$ per ton 2,800 2,600 2,400 2,200 2,000 1,800 1,600 1,400 1,200 Leading Indicators: Metals Metals Index, Jan Apr Index (2008 = 100)

4 Leading Indicators: Metals Metals Index, Jan Apr Index (2008 = 100) Even though only a select few, I believe that these graphs which are relatively similar in their shapes give some comfort, indicating that the crisis measures taken by governments in the leading industrialized countries succeeded in, at least, halting the collapse of confidence. I do believe that Trichet was right when he talked about the point of inflection, implying that the focus of decision-makers in government and companies can shift from emergency response to recovery plan. Still, the financial sector has spilled over to the real sector, with expectations for growth remaining negative and unemployment upwards. These are lagging indicators, but with consequences that demand the full attention of governments worldwide. It is evident that in all likelihood permanently governments will play a more active role in the economy, not necessarily as an actor but certainly as a referee, reinforcing public institutions, strengthening regulations in those areas where they have failed in the recent past.

5 Lagging Indicators Euro Zone: Unemployment and Growth, 2008-Q Q1 Percent Unemployment rate Real GDP growth rates Q1 Q2 Q3 Q4 Q Source: ECB 2009 The most difficult question is, of course, to determine when government should become an economic actor. In the past, state-run companies have not proven engines of innovation and drivers of productivity. Whether in the banking sector, where the argument probably can be made somewhat more easily, or in industry, governments have become shareholders, at times with a controlling influence. Montenegro is no exception, and the new government will have to take decisions on possible state ownership, in heavy industry as much as in the banking sector. Economists tend to feel very uneasy about this question, as do thankfully many, if not most, politicians. But the world is rarely just black and white. When faced with the socioeconomic consequences of a crisis with the depth like the current one, economists and policymakers alike are struggling with this issue. There are no clear answers except that, as mentioned before, governments have proven to be ineffective entrepreneurs, without any comparative advantage over privately owned companies, with the added risk that excessive government intervention in the market-place tends to disrupt the market, its signals, ultimately leading to inferior outcomes. It seems to me that these types of decisions will have to be taken case by case, based on a set of critical minimum conditions, without which such an emergency operation should not take place. Prior to considering whether or not Governments should consider using taxpayers money for the bailout of, or support to, privately owned enterprises, the following questions will have to be asked, and responses given affirmatively: First and foremost, can the support provided by Government help a company to implement the necessary measures however painful to become economically viable

6 and profitable again, within a reasonable timeframe? If that is not the case, there is no argument for government intervention. Second, is it ensured that government intervention will only be given on an exceptional basis and not permanently? Is it really an emergency operation and not long-term care? If that were the case, government would spend taxpayers money ineffectively, preventing it from investing its funds in areas that promise a much higher return to its citizens and to the companies that operate within its economy. And finally, does government intervention, which is being considered for one company, create incentives for other firms to seek similar help from government? Or are losses simply socialized, removing the risk aspect of entrepreneurial activities? The careful weighing of expected profits and inherent risks and the corresponding investment of privately held funds marks the essence of a successful market economy and if government interventions take away the risk of failure, companies will be induced to take excessive risks, jeopardizing the stability of the entire economy. Economists call this moral hazard, and this was, in essence, the root cause of the current crisis, going all the way back to the subprime crisis and the toxic assets spread successfully throughout the financial sector. If we take all of these arguments together, assessing the costs and benefits of government intervention, weighing these against the costs and benefits of non-intervention, this creates a basis for a decision on whether (or in which form) the government should provide emergency support to struggling companies. In Montenegro s context, the overall political context allows the government to address the outstanding restructuring challenges without undue delay. In all likelihood, whatever the final decision in either sector, everybody will be unhappy with the outcome. There are no clear, no easy, and no inexpensive solutions. But not taking decisions bears costs as well, not only because today s players will start to lose control over the unfolding situation. I am convinced though that over the next few weeks the building blocks of the overall economic policy framework should become evident. Given Montenegro s overarching policy priorities, I believe it is crucial that solutions be placed within the context of the European integration agenda. Your voice, and your concerns regarding the business and investment perspective in Montenegro, becomes an ever more crucial element in this debate. With government and business community being constructive partners, both sides will benefit from an improving economic situation. As mentioned on so many occasions, crises always represent opportunities, the chance to focus on what is really important. The World Bank, whether with its recently launched land administration and management project, or the agriculture project signed today, will provide technical and financial support, upon request by government, in strengthening the business environment.

7 You are well placed to contribute to a constructive debate, to critically accompany the implementation of economic policies in Montenegro, and to provide advice on how to overcome the most critical obstacles in the business environment. That said, I wish you every success in your endeavors, both as AmCham and as entrepreneurs.