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To halt the recession, correct macroeconomic imbalances, and return the economy to a “normal” state, a number of Romanian analysts, economists, and politicians advocate replacing the current economic model – based largely on consumption, financed in part through public borrowing – with one centred on investment, reindustrialisation, advanced technologies, and wage growth aligned with productivity.

Reform or rebranding? Why Romania’s economic problems are structural, not cyclical

Some components of this so-called “new” model have already been approved by the government. Their implementation, however, remains blocked, uncertain, and, in any event, will require considerable time. The principal measures officially announced include state-aid schemes, strategic investment projects, incentives for domestic production, support for the defence industry and net-zero technologies, the development of Romania’s mineral resources, a 10% tax credit for research, development and innovation, and similar initiatives.

A genuinely new economic model would, however, require a much broader range of reforms. These would include, among other things, the privatisation of state-owned enterprises, administrative and territorial reform, the merger of ministries and government agencies, and a more effective absorption of European Union funds. Yet public debate on these issues oscillates sharply between two opposing positions. On the one hand are proposals intended to satisfy both external partners and the business community, who call for greater economic efficiency. On the other are nationalist or electoral objections to structural reforms, fiscal discipline, and the attraction of foreign capital. Self-described “sovereigntists” reject the solutions advocated both by responsible Romanian economists and by international organisations to reduce Romania’s twin deficits – the fiscal deficit and the current account deficit – and to restructure the economy. They criticise multinational corporations and, more broadly, champion economic protectionism.

Opposition to structural reform has effectively paralysed the legislative process required to implement this “new” economic model. Traditional privatisation – the sale of controlling state shareholdings – has been abandoned, forcing the government to limit itself to the reorganisation of autonomous public enterprises and the listing of minority stakes on the stock exchange. Yet even these limited reforms proved politically explosive. Parliament adopted legislation, initiated by the Social Democratic Party (PSD), prohibiting until 31 December 2027 the sale of any minority stakes in state-owned companies, including their stock-market listing. These decisions followed prolonged opposition by the parties supporting the legislation – the PSD, the Alliance for the Union of Romanians (AUR), and the S.O.S. Romania Party – to the government’s plans for reforming state-owned enterprises. The resulting political conflict fractured the governing coalition, led to the withdrawal of several ministers, and ultimately brought down the government through a vote of no confidence. More than two months later, the formation of a new government remains stalled, while the political crisis has continued to deepen.

Beyond these political developments, however, the public discourse of many Romanian economists, politicians, and opinion-makers reveals a broad consensus among the country’s economic and political elites in favour of state intervention and demand-side economic stimulus. Within this framework, the proposed “new” economic model remains fundamentally statist and continues to rely on an expansionary fiscal policy. Even if fully implemented, it would fail to address Romania’s underlying economic problems.

Romania’s current economic situation is particularly serious. The country is experiencing recession, persistent twin deficits, a level of public debt that is unsustainable in the medium term, and high inflation. This situation is the consequence of maintaining an enormous public sector – comprising more than 1,500 state-owned enterprises and nearly 1.3 million employees in public institutions and authorities – combined with a loose and populist fiscal policy. Together, these factors have generated widespread economic inefficiency, severe external imbalances, and inflation. They have encouraged consumption, discouraged saving, and created the paradoxical situation in which the state allocates record levels of investment as a share of GDP while achieving remarkably poor investment efficiency.

It follows that Romania’s “old” economic model – which emerged, more or less spontaneously, after the collapse of communism – contains numerous perverse incentives, whose harmful effects have proved enduring. In other words, today’s economic difficulties are largely the consequence of preserving important elements of the former communist economic system. Although the post-revolutionary authorities eventually declared, after considerable hesitation, their commitment to the rules of the market economy, and although Romania subsequently joined both NATO and the European Union, its socio-economic structures still retain many of the defining characteristics of a centrally planned economy. The essential feature of that system was inefficiency, accompanied by the waste of resources and chronic shortages. These outcomes were not temporary, nor were they peculiar to particular communist countries. Rather, despite national differences, they were systemic features common to all centrally planned economies.

Under these circumstances, the solution to Romania’s present economic difficulties cannot consist merely in replacing one version of populist economic policy with another. Nor can it be found in cosmetic adjustments to the expansionary policies pursued, in particular, during the periods 2006-2008, 2015-2019, and 2020-2024. The real solution lies in completing Romania’s transition to a genuine market economy through the privatisation of state-owned enterprises and the implementation of the broader structural reforms that have long remained unfinished.

The inefficiency and dangers of expansionary economic policy

By definition, expansionary economic policy is a set of measures adopted by public authorities to stimulate economic growth, increase employment, and boost consumption. It comprises two distinct policy instruments: fiscal policy and monetary policy.

The intellectual inspiration for expansionary economic policy is found in the principal work of the renowned British economist John Maynard Keynes (1883-1946), The General Theory of Employment, Interest and Money. According to Keynesian theory, demand stimulates production, whereas aggregate supply and saving play only a limited role in the process of economic growth.

Keynesian theory, however, is contradicted by Say’s Law, formulated by the distinguished French economist Jean-Baptiste Say (1767-1832), according to which demand is created by supply. Unlike Keynesian theory – which is valid only under specific circumstances, such as unused productive capacity, unemployed labour and natural resources, a short time horizon, rigid prices and wages, a liquidity trap, and deficient aggregate demand –, Say’s Law possesses universal validity. The implication is that expansionary policies inspired by Keynesian economics frequently produce harmful consequences.

A simple examination of ordinary human behaviour is sufficient to illustrate this point.

Individuals organise their economic activity according to their abilities, their preferences between work and leisure, and the manner in which they wish to use their income – either to consume goods and services immediately or to save in order to consume more in the future. Their demand is therefore determined by their own supply.

What is true for one individual also applies to an entire society. The aggregate supply of goods and services produced by the citizens of a country is the result of their productive activities, whether performed as employees, self-employed professionals, entrepreneurs, artisans, farmers, or other producers. These productive activities enable society to create the consumer goods, services, and capital goods it desires. Fundamentally, and over the long run, aggregate consumption is strictly constrained by a country’s productive capacity.

The composition of production is indeed determined by the composition of demand. Producers continuously adapt their activities to the demand expressed in the marketplace. Since consumers’ needs, tastes, preferences, and productive capacities – particularly their capacity for innovation – change over time, market demand also evolves. The defining characteristic of a market economy is that productive activity adjusts to these changing patterns of demand through the price mechanism.

Given a certain volume of production – objectively determined by the available factors of production (capital, labour, technical knowledge, and natural resources), together with their diminishing marginal productivity – a change in the composition of demand merely induces producers to reallocate resources. If, for example, the state artificially increases its own demand for goods and services by financing expenditure through public borrowing monetised by the banking system and, ultimately, by the central bank, the result is not an increase in total output but a change in its composition. Some producers reduce the production of certain goods in order to satisfy government demand for others. Consequently, the state does not increase aggregate demand; rather, it alters the structure of production and consumption.

The foregoing analysis concerns a closed economy. Its conclusions remain equally valid, however, in an open economy.

In an open economy, aggregate demand within any particular country forms only a part of world demand. Consequently, the claim that insufficient domestic demand explains recession or unemployment loses its validity. For a medium-sized country with an open economy – such as Romania today – world demand is, for all practical purposes, unlimited.

The relevant question therefore becomes: why do domestic producers fail to produce more and employ more workers despite having access to a virtually unlimited global market?

The logical answer is straightforward. Domestic firms refrain from expanding production not because demand is lacking, but because prevailing cost structures – shaped by world prices – make additional production unprofitable. They cannot significantly increase exports without incurring losses or accepting lower profits. Here again, the problem lies not with demand, but with the system of relative prices and the incentives generated by those prices.

Accordingly, the proposition that economic growth in an open economy – or at the regional or global level – can be generated through manipulation of aggregate demand lacks any genuine scientific foundation.

The real problem is supply, not demand

Expansionary economic policy is commonly regarded as a tool of economic recovery because contemporary budget deficits are financed through public borrowing, while new money is created, among other things, as the counterpart of government securities acquired by the banking system. From this it is inferred that loose fiscal policy and expansionary monetary policy increase investment and stimulate economic growth.

Within Keynesian economics, investment is considered necessary not because it increases productive capacity, but because it constitutes a component of aggregate demand.

In the political economy of socialism, by contrast, investment represents the principal instrument for transforming society and constructing the material and technical foundations of communism.

The Austrian School of Economics, as developed by Ludwig von Mises and Friedrich A. Hayek, demonstrates that both doctrines are fundamentally mistaken. According to these authors, together with Carl Menger, Eugen von Böhm-Bawerk, Friedrich von Wieser, Murray Rothbard, Israel Kirzner, Hans-Hermann Hoppe, and other representatives of the Austrian tradition, Keynesian economics constitutes a profoundly inflationary pseudo-science that does not solve economic crises, but rather creates and prolongs them. Likewise, the communist economic system is both theoretically and practically impossible, while the communist regime is inherently condemned to economic collapse – a conclusion fully confirmed by historical experience.

Viewed from this perspective, the conclusion most relevant to the present discussion is that expansionary economic policy in general – and its application within an unreformed post-communist economy in particular – generates recession and inflation, precisely the combination currently observable in Romania. In both cases, loose fiscal policy and inflationary monetary policy discourage saving and encourage immediate consumption. As a result, private entrepreneurs – few as they already are – are induced to borrow excessively in order to undertake low-productivity investments that they would not normally make. These distortions are compounded by rising government expenditure and public debt, which further alter the structure of production and consumption, ultimately producing recession and inflation.

It follows that the expansionary economic policies embedded in the proposed “new” economic model will not revive the Romanian economy or correct its structural imbalances. On the contrary, they risk prolonging recession and inflation while paving the way for a broader economic crisis. Romania’s current predicament is fundamentally a problem of supply, not demand, and supply-side deficiencies cannot be resolved without continuing the privatisation process.

The economic processes described above reduce employment opportunities for many entrepreneurs and workers – public-sector employees being the principal exception – thereby lowering production and living standards. Economic contraction and the prospect of crisis inevitably trigger structural adjustments that invalidate the claim that continuously increasing public expenditure, accumulating public debt, and injecting ever greater quantities of liquidity can deliver sustainable recovery.

The genuine solution lies not in perpetuating expansionary economic policies, but in privatising state-owned enterprises, eliminating their excessive debts, depoliticising their management, and establishing a legal framework enabling them to attract both domestic and foreign private capital to finance modernisation and remain competitive. At the same time, private entrepreneurs must enjoy greater economic freedom, enabling them to improve productive activity and continuously adapt the structure of production and consumption.

In conclusion, economic recovery and macroeconomic rebalancing depend upon the creation of productive incentives rather than additional consumption. These incentives arise primarily from the institutional environment, especially the legal and fiscal framework. Consequently, any credible strategy for recovery and rebalancing must simplify and liberalise economic regulation while reducing the tax burden borne by employees.

In their influential book Nudge, Richard Thaler – recipient of the Nobel Memorial Prize in Economic Sciences – and Cass Sunstein demonstrate that people do not always make rational decisions, yet can be subtly guided towards choices that improve their health, wealth, and well-being without restricting their freedom of choice. A truly new economic model should aspire to meet precisely that standard.

References

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