Did monetary forces cause the Hungarian crises of 1931?

Flora Macher is a PhD student at
London School of Economics

Financial crises are a “hardy perennial” and while their recurrence never fails to cause substantial economic loss, on the positive side, researchers of financial history have a long record of episodes that they can use as a comparative reference when they are analyzing the one crisis just occurring. 

A recent EHES working paper by Flora Macher illustrates that there is a clear parallel between the recent sub-prime crisis and a financial crisis of the Great Depression era. The example shows that financial crises are a “hardy perennial” not only in a sense that they never cease to return but also that they always seem to arise from the same human folly.

US politicians, in their drive to increase their popularity, advocated the increase in home ownership in the 1990s and early 2000s and thus chose to promote mortgage lending. For almost a decade, everything seemed perfectly fine, in fact, more than fine. The period was an economic miracle: the fiscal side was solid, monetary conditions were easy, and everybody, even those without income could buy a house. The catch was that unfunded liabilities were accumulating in the financial system and before anyone could identify their existence, the housing bubble blew up and the well-known sub-prime crises started to unfold.

Hungary underwent almost exactly the same events on its march to the Great Depression. In the years leading to the crisis of 1931, Hungarian authorities used the banking system for populist measures catering to the needs of their constituency and helping them to maintain their political power. The only difference from today was that Hungarian policy-makers tried to win over the public not by raising home ownership but by providing subsidies to the agricultural sector.

Hungary was on the losing side after World War I; it suffered significant territorial losses and incurred reparations obligations based on the Peace Treaty of Versailles. Economic, social, and political turmoil followed in the years after the war. Since domestic capital fled or was obliterated and foreign financiers avoided the country, authorities had to resort to the central banks’ printing press to finance the ever increasing expenses of social demands. The subsequent hyperinflation could not be ended by domestic means as the domestic public was unwilling and unable to finance the government deficit through increased taxation. Eventually, Hungary rid its economy from the hyperinflation through a foreign loan arranged by the League of Nations in 1924. (Bácskai 1999) Nonetheless, the stabilization loan was conditional upon the League’s long-term surveillance which demanded a balanced government budget, forbade government borrowing and required full commitment to a legislatively set gold parity through an independent central bank that refrained from financing government debt and constrained its liquidity provision to the economy. Under these circumstances, fiscal and monetary policy had no room whatsoever to yield to domestic social demands.

Nevertheless, domestic political pressures were substantial. The stability of the government was dependent on the support of landed interest. (Romsics 1991) Large landowners’ demands were a top priority for the administration as the aristocracy retained a powerful role in shaping Hungarian politics, and Prime Minister Bethlen himself belonged to this class. The interests of small landowners and farm laborers, who made up over half of the workforce, also had to be satisfied in order to maintain social stability, which rested on very shaky grounds due to widespread poverty. (Ungváry 2013) Under these conditions, economic fragility and rising unemployment had to be avoided.

Since the short leash set by the League and the international creditors behind the reconstruction loan did not allow policy-makers to spend on domestic political interests, authorities had to find a channel through which they could still address the political pressure but, at the same time, not invite the criticism of international institutions and keep foreign capital flowing in. The banking system, enjoying the backing of the monetary and the fiscal authority, hence became a strange guarantor of domestic, and especially agricultural interests. The central bank developed a strong positive bias towards the rediscount of agricultural bills even during a period of restrictive monetary policy to ensure lending to this sector. The government provided substantial guarantees for farm lending. These were indirect means of support from the authorities to the financial system through which banks could inject “stimulus” into the economy and satisfy the political constituency of the ruling regime.

The flipside of this arrangement was that the financial system was assuming all the risk for the economic stimulus, a role that the authorities themselves were unable to pursue. As a result of the policies of indirect stimulus, the banking system became excessively exposed to the agricultural sector.

The share of agricultural lending in total lending (click to enlarge)

However, when in 1930 the country experienced an agricultural crisis, approximately 50-60% of banks’ equity was wiped out by defaults within months. Thus by the end of 1930, the financial system was already highly vulnerable to shocks and eventually experienced a collapse in July-August 1931. Years of recession and long-term slow economic growth was the outcome of meddling with the banking system and then seeing it fall apart. The post-crisis recession lasted until mid-1932 and the four years of crawling recovery afterwards only landed Hungary’s economy at 1926 levels by the end of 1936.

Domestic national income, million pengős (click to enlarge)

Although the US sub-prime episode and the Hungarian debacle of 1931 can be traced back to the same political folly, there is a significant difference in how the two crises were managed once the events were unfolding. Hungarian authorities responded by reinforcing conservative fiscal and monetary measures: monetary policy restrictions, constraints on the flow of capital, and austerity in government spending. The US followed the same route in the fiscal arena and cut back on government spending. In the monetary field, however, US authorities implemented counter-cyclical measures and started on a path of monetary easing that is still the determining policy action today. The US economy fell into a recession in 2009 but within two years it recovered and by today it is 10% above its pre-crisis size.

Comparing the US sub-prime crisis with Hungary’s 1931 events suggests that even though humans will never cease to indulge themselves to short-term gain, we do still improve on how we clean up the mess once a tragedy of excesses has occurred. The new, unorthodox monetary policy actions of today’s central banks are an intriguing experiment with money supply in a modern economy. While its long-term impact is still unclear, in the short-term, it has proved much more effective than the crisis responses to the 1931 calamities.

The blog post was written by Flora Macher, LSE
The working paper is downloadable here: http://www.ehes.org/EHES_86.pdf

A closer look at the long-term patterns of regional income inequality in Spain: the poor stay poor (and stay together)

The publication of the 2010 Eurostat Regional Yearbook provides evidence to portray regional (NUTS2) income inequality in the European Union. Several features stand out. First, the wealthiest region, Inner London, has a per-capita GDP that is 3.24 times greater than the EU-27 average. Besides, Inner London’s per-capita GDP is 12 times that of Severozapaden (Bulgaria), the poorest region. Nevertheless, regional disparities do not just correspond to extreme cases, since a total of 68 regions have income levels less than 75% of the EU-27 average. In addition, the geography of regional inequality in Europe follows a well-defined and persistent spatial pattern, in which wealthy regions are clustered around a continental axis that stretches from the north to the centre of Europe (or the blue banana). These differences and their implications, have become a serious concern for economists and policymakers, and have fuelled the study of regional inequality.

From an economic history perspective it is worth noting the efforts to construct regional GDP estimates (Rosés and Wolf, forthcoming), thereby enabling researchers to make further progress in the study of long-run trends. That has also been the case of Spain. For a rather small territorial scale, province (NUTS3), novel per-capita GDP estimates allow us to create a decadal-dataset beginning in 1860 and ending in 2010. With these data, our aim is to analyse the long-run evolution of regional income inequality in Spain in terms of convergence and dispersion, and also evaluate aspects related to the income distribution, e.g. modality, mobility, spatial clustering. For this, a new EHES working paper by  Alfonso Díez-Minguela, Julio Martinez-Galarraga and Daniel A. Tirado makes use of various exploratory tools: kernel density estimates, boxplots, transition probability matrices, Shorrocks indices, Kendall’s τ, Moran’s I and LISA maps.

We begin our analysis looking at the long-run evolution of regional per-capita GDP inequality. In this sense, Williamson (1965) conjectured that along the process of economic development regional disparities exhibited an inverted U-shaped pattern, with increasing inequality in the early stages, mainly late 19th century, and convergence thereafter. Our results confirm this hypothesis for Spain 1860-2010. As figure 1 illustrates, there was an upswing in regional income inequality, measured with a population-weighted coefficient of variation (WCV), from 1860 to 1920. From then on, convergence across Spanish provinces prevails. However, this downward trend came to a halt in the last decades of the 20th century, and it might be reversing. Moreover, the U-shaped pattern has also been found in other European countries (i.e. Britain, France, Italy, Portugal) though not in Sweden and Belgium.

Figure 1. Regional (NUTS3) income inequality (WCV), Spain 1860-2010 (1860=1)

In Spain, during the early stages of modern economic growth, roughly 1860-1930, market integration was underway and modern technologies were becoming more widespread. With the advent of industrialisation, some Spanish provinces (Barcelona, Vizcaya) specialized in manufacturing, and thus regional inequality increased. Regional disparities were mainly due to the presence of a small group of rich provinces and a large majority of poor ones. This, in turn, stretched the upper tail of the distribution. Regional inequality thus reflected a small group of wealthy provinces and a majority of (relatively homogeneous) poor ones. However, this was compatible with moderate but sizeable mobility in income distribution insofar as the ranking of provinces underwent some changes. Furthermore, from a geographical perspective, relative income levels had a limited relationship with the location of territories within Spain. Spatial clustering, although statistically significant, was not very high, due mainly to the limited number of wealthy provinces. This would be consistent with the presence of poles with few non-contiguous dynamic provinces. 

Since the 1930s, regional disparities gradually declined. Even more, this coincided with the appearance of bimodality in the distribution, which came about not only due to a lessening of the differences between rich and poor, but also to the homogenisation of rich and poor. From 1930 to 2010 regional mobility declined, whereas spatial clustering increased. In this respect, Figure 2 shows the degree of spatial clustering (in terms of per-capita GDP) in 2000. To identify the geographic position of rich (poor) provinces and the degree of spatial autocorrelation, the figure presents Local Indicators of Spatial Association (LISA) of regional income inequality. In the map, blue coloured provinces illustrate the clusters with low per-capita GDP, while red ones reflect those that exhibit high levels.

Figure 2. Spatial clustering. LISA map, 2000

In short, although differences between rich and poor provinces decreased, their relative positions remained fairly stable. Therefore, in terms of policy-making, there are two main features that characterise regional economic inequality in Spain since the Civil War (1936-39). Firstly, there is a quasi-non-existent mobility in class or rank, i.e. provinces have somewhat retained their 1940 relative positions. Hence, the historical trajectories cannot be labelled as an American Dream or Nightmare on Elm Street. Quite the opposite, a marked stability is observed between 1920 and 2010. Secondly, there is a high degree of spatial correlation. This was already present in the previous period (1860-1930), but it has consolidated during the second half of the 20th century. Consequently, a map with ‘two Spains’ arises, where wealthy provinces are located in the north-east while the poorest ones cluster in the south. Bearing this in mind, spatial polarisation becomes a major concern. 

As a result, there appears to be little prospect of improvement for low-income regions that are located further away from the dynamic nodes. Regional policies, mainly applied during the late 20th century, might have had a short-term impact on relative income levels, but they have been unable to alter the long-term dynamics. In addition, the rise of an economic cluster in the north-east of the Iberian Peninsula may be a sign of the crucial and growing relevance of European markets. Interestingly, the centre of gravity has been gradually shifting from the south-west to the north-east. Greater openness and the accession to the EU have strengthened this movement. In recent years the relative poverty of the southern and western Spanish provinces has increased and the spatial polarization of income today is more striking than ever. European economic integration can only reinforce this tendency. Therefore, in the case of Spain, further European political and economic integration calls for the design of territorial cohesion policies aimed at counteracting the structural elements of economic regional inequality highlighted above.

References:

Rosés, J.R. and Wolf, N. (forthcoming). The economic development of Europe’s regions: a quantitative history since 1900 (New York: Routledge).

Williamson, J.G. 1965. ‘Regional inequality and the process of national development: a description of the patterns’. Economic Development and Cultural Change 13:4, Part II, 3-84.

This blog post was written by: Alfonso Díez-Minguela, Julio Martinez-Galarraga and Daniel A. Tirado (Universitat de València)

The working paper can be downloaded here: http://www.ehes.org/EHES_87.pdf