Economic Austerity-induced Violence
by Serban V.C. Enache
Nicaragua was embroiled with protests that turned violent two weeks ago. It’s estimated that 34 people have been killed, most on Friday 20th and Saturday 21st, as the conflict extended throughout the country. The majority of deaths occurred in Managua. That Sunday, President Ortega announced that the reform to Social Security, which sparked the protests, shall be dropped in favor of new negotiations. A large peace rally in Managua seemed to quell the tensions, though other protests continue.
The National Social Security Institute (INSS) in Nicaragua is facing a solvency crisis. Expenditures have increased while anticipated revenue has not been met. The social security fund will deplete its reserves by 2019. Nicaragua completed consultations with the International Monetary Fund last year in November. The INSS’ situation was underlined as urgent and policy recommendations for reform were made. The IMF offered four alternative reform packages, all of which included sharp reductions in benefit payments between 20 and 30 percent. Three of the four proposals also included raising the retirement age (to 63 or 65) alongside increases in obligatory contributions. From the IMF’s point of view, the Government will have to transfer revenue to cover shortfalls in Social Security, and thus impact its ability to service debt payments.
Negotiations over reform involved COSEP (the Superior Council of Private Enterprise), workers’ representatives, and the Government. COSEP left the table when its proposed reforms, largely based on the most regressive IMF proposals were rejected. The Government then announced a compromise reform package on Wednesday. In its proposal, the formula for expanding contributions to the system included a 3.25 percent increase in business contributions, an increase of 0.75 percent for workers, and a Government contribution increase by 1.25 percent for public sector workers. In addition, a 5 percent contribution for health benefits was also announced. Though this compromise package was far short of the 20-30% Social Security cuts the IMF recommended, the sacrifice still fell mostly on those with limited means. The Government kept the age for receiving benefits at 60 (COSEP’s position had been to raise it to 65). Increasing contributions (aka taxes on labor) while cutting benefits was guaranteed to spark some protest, and indeed, pensioners marched the day it was announced and they were later followed by students. Likewise, adopting a package opposed by the business community, led COSEP calling for its own demonstrations.
Since 1991, the Nicaraguan Government has pegged its currency, the Cordoba, to the US dollar. More precisely, the Government employs a crawling peg – an exchange rate regime that allows depreciation or appreciation to happen gradually, in Nicaragua’s case, a depreciation of 5 percent every year. How does the peg work? If the Cordoba’s value falls relative to the USD, the Government must use foreign currency reserves to buy Cordobas and remove them from the market. With fewer Cordobas available relative to demand, the value of the currency goes up. Thus, the peg is maintained. A fixed exchange rate system, be it a weak or strong peg, limits the Government’s space for fiscal and monetary policy. In other words, the Government can become insolvent under the peg.
Let’s have a look at Nicaragua’s Sectoral Balances as percentage of GDP to find out the reasons for its financial troubles and why cuts to Social Security, retirement age increases, and tax hikes are NOT the answer for either financial stability or economic progress.
As the graph shows, the country’s large consistent Current Account Deficits are the problem – and they’re only a source of financial constraint on the Government because of the currency peg. The legislative or executive power must renounce the peg, and allow the Nicaraguan Cordoba to float freely. This will maximize the Government’s fiscal and monetary space, and will allow it to operate with negative equity indefinitely, without any risk of bankruptcy – so long as the politicians in power don’t wish the Government to bounce checks. Nicaraguan domestic private sector equity has been seriously eroded since the GFC (Great Financial Crisis) back in 2008.
The country did experience inflation in the last four years, but still lower in average compared to the period between 2010 and 2014. What’s needed to contain inflation is a focus on public investments, a focus on capturing economic rent to remove deadweight costs in the economy, and measures to fight corruption. Increasing the retirement age, cuts to Social Security, and tax hikes on labor and business WON’T lead to financial stability. Currently, private sector debt is fueling GDP growth. When household deleveraging will occur (and that will happen very soon), the country’s going to fall into an outright depression (given the large extent of private sector debt) and – if the peg is maintained – it will render the Government insolvent. This need not be the case, if those in power allow the Cordoba to float freely and engage in deficit spending with the aim to achieve and maintain full employment and price stability.
Serban V.C. Enache is a Romanian journalist and indie author. Though interested in history, politics, and economics, his true passion is for medieval fantasy fiction. https://www.amazon.com/Serban-Valentin-Constantin-Enache/e/B00N2SJD6O/