Economic Ghosts Block Post-Lockdown Recovery By Jomo Kwame Sundaram

(This is an article by economist Dr Jomo Kwame Sundaram that was sent to me. It is worth reading in full. I have some comments in blue)

By Jomo Kwame Sundaram

KUALA LUMPUR, Malaysia, Jun 09 (IPS)  - As governments the world over struggle to revive their economies after the debilitating lockdowns they imposed following their failure to undertake adequate precautionary containment measures to curb Covid-19 contagion, neoliberal naysayers are already warning against needed deficit financing for relief and recovery.

(OSTB : There is no one solution that fits all countries. New Zealand has more sheep than people. China with 1.5 billion people has come out with far less deaths than the US with 1/5 the population - and still increasing. Squeaky clean Singapore has had more cases and deaths than Malaysia.)

Deficit financing options

The range of deficit financing options has changed little since first legitimized by Roosevelt and Keynes in the 1930s and used extensively to finance wartime government spending.

First, debt financing has typically involved government borrowing. More recent understandings of sovereign debt stress the implications of the source of borrowing, domestic or external, e.g., Japan's total government debt now greatly exceeds double its annual national income, but this is not considered problematic as most of it is domestically held by Japanese.

(OSTB : I agree. In Malaysia - at a micro level - we even have a GLC that is reporting some FOREX stress because over 20% of their borrowings are in foreign currency while the huge bulk of their earnings are in Ringgit. This type of currency mismatch reflects poor financial planning. Strangely their currency mismatch has been ongoing for over 20 years.)

Second, price controls, general or selective, can cut both ways, and may require subsidies. 

Price controls on extracted natural resources can also enable governments to capture resource rents to augment revenue.

Third, the widespread use of unconventional monetary measures since the 2008 global financial crisis has forced economists to reconsider earlier monetarist articles of faith about deficit financing by ‘taxing' everyone via inflation, also giving an unexpected boost to modern monetary theory.

Exchange rate policy

Finally, an overvalued exchange rate has been favoured by elites who travel and purchase abroad wanting strong currencies, which they often portray as cause for national pride. After all, governments collect taxes in domestic currency, but pay for international debt and imports with foreign exchange.

(OSTB : That depends on which foreign currency is relevant for your purchases. If you are a traveller it also depends on where you are travelling. The Ringgit may strengthen against the Dollar but weaken against Aussie Dollar or Singapore Dollar.) 

However, a strong exchange rate only provides a temporary solution, worsening balance of payments' difficulties in the longer term, favouring consumers over producers, and importers over exporters, besides encouraging consumption at the expense of savings. Increasing imports for consumption either deplete foreign exchange reserves or require external borrowing.

(OSTB :  A stronger exchange rate should be determined by a more productive economy.  When the rest of the world needs our output more than we need theirs.  Certainly a stronger exchange rate means less Ringgits needed to pay off more foreign currency debt. That should be a good thing. If consumers benefit surely the entire economy will benefit - including producers. There are many countries with strong currencies (eg Switzerland, Japan) which have strong exports and strong forex reserves. Plus a fairly wealthy population - the end game of it all.) 

Overvalued exchange rates' potential for fighting inflation is risky as balance of payments deficits cannot be sustained indefinitely. Exchange rate-based currency board and stabilization arrangements in transition and developing economies are similarly problematic. Economies maintaining overvalued exchange rates have often later experienced severe currency crises.

(OSTB : Among any two countries, the value of one country's currency will be more than the other. Multiply that by about 200 countries in the world.  Do the exchange rates capture the real value and productivity in each country?)

Quasi-nationalist development ideologies and weak elite opposition enabled many East Asian economies to use undervalued exchange rates to discourage imports and promote exports, with effective protection for import-substituting industries conditional on successful exports.

(OSTB : In brief their workers and their people were forced to subsidise a higher standard of living for those who bought their export products.  Singapore did not follow this policy of undervaluing its currency despite being an export powerhouse for a long time.)

Macroeconomic populism?

Deficit spending supposedly responded to ‘populist' demands by ‘distributional coalitions' of interest groups demanding higher wages, cheap housing, public healthcare and free schooling. Undoubtedly, their political support was sought by regimes, elected or otherwise, who were typically unwilling or unable to collect enough revenue to sustain such expenditure.

(OSTB :  Dasar Ekonomi Baru aka Bebal. Except for health care and schooling - which should be a public good, available without paying out of pocket twice - because we have already paid for it through taxation. But the rest of the paragraph refers the Dasar Ekonomi Bebal).

In recent decades, macroeconomic populism has become a catch-all explanation for deficit financing, ostensibly to finance redistributive government spending, regardless of actual expenditure patterns. But rather than populist redistribution, deficit spending was often for ‘security' (i.e., the military and police) or physical infrastructure, rather than social expenditure, or corruption.

(OSTB : Thats a good one - Deficit financing to fund corruption. Yes it does seem to be a policy option.)

The narrative implies that regimes could not resist demands for redistribution, presumably the price of retaining political authority and influence. Undoubtedly, government capacities to directly tax incomes and assets have been constrained, with the influential generally better able to evade taxes.

(OSTB : Spot on. Agree.)

Sovereign debt and fiscal crises, due to borrowing to spend beyond budgetary means, were rarely due to ‘excessive' populist demands. The actual reasons for budgetary deficits were often multiple as well as historically and politically specific, rather than simply due to regimes succumbing to redistributive claims.

(OSTB : For a certainty ALL borrowing is beyond budgetary means. But without borrowing beyond budgetary means the economy may be close to subsistence only. The same principles apply when a village community borrows micro-credit to start a chicken farm. They borrow beyond their own budgets. The big risk is - can they generate more with the borrowing to pay back the debt? Will their "borrowings" be put to productive use? The same applies to government deficit financing. Will the borrowed money create new wealth in the economy that deepens / widens the government's tax base? Because taxes pay government debt.)

US presidential endorsement of Arthur Laffer's ‘supply side' economics' claim of greater growth due to more investments with lower taxes on the rich fuelled the counter-revolution against progressive taxation. Nevertheless, ‘macroeconomic populism' became the default explanation for all manner of deficit financing, including ‘soft budget constraints' in ‘communist' ‘command economies'.

(OSTB : I think the linear programmers should get involved (the mathematicians). In linear programming there is always an optimum. The best curve to fit the data. Too little is bad, too much is inefficient. There is always a golden optimum. Do not overburden the rich with taxes. The rich undoubtedly can organise assets and wealth. However please differentiate the rich who earn an honest income from the crooks. The crooks should be sent to jail. Do not waste economic theory on the crooks.)

Latin American populist fables

Although there have been few truly ‘populist' regimes in Latin America, most famously Peronist Argentina, ‘macroeconomic populism' has become a catch-all term, used to explain why governments increase spending and run budgetary deficits.

(OSTB : The culprit seems to be the desire to be popular - populist policies. Perhaps curing "populism" may be an easier option than finding an economic override for populism. For example if an elected leader can only serve for ONE TERM ONLY of say SIX years and must be "directly elected" by the voters - that may certainly reduce the his populist tendencies.) 

Undoubtedly, many Latin American regimes pursued import-substituting industrialization using high tariffs to protect ‘infant industries' from the 1930s. But high import tariffs augmented, rather than diminished government revenues, in contrast to the tax breaks and subsidies for export growth.

Although precipitated by then US Federal Reserve Bank chairman Paul Volcker raising bank interest rates from 1980 to kill inflation, the Latin American debt crises from 1982 were again misleadingly primarily attributed to preceding populist macroeconomic policies.

Similarly, the significant improvements in popular wellbeing earlier this century in Brazil under the PT, Uruguay under the Frente Amplio, Ecuador under Correa and Bolivia under Morales primarily involved massive employment generation and secondarily, ‘productive' social protection, rather than the unsustainable transfers depicted by macroeconomic populism.

   

Neoliberal ghosts return

Macroeconomic populism thus became the default formulaic Washington Consensus ‘explanation' for deficit financing from the 1980s to explain away all manner of fiscal deficits, and to justify policies imposed by the Bretton Woods institutions, precipitating the region's ‘lost decade'.

The International Monetary Fund required short-term macroeconomic (price) stabilization policies to counter often runaway inflation. The World Bank's typically medium-term ‘neoliberal' structural adjustment policies sought to liberalize not only goods and services markets, but also those for finance, labour and social services, previously provided by governments and state enterprises.

Reviving ideological ghosts from the past, neoliberal commentators are once again warning against deficit financing. Instead of recognizing the need for consistently counter-cyclical fiscal policies over the duration of business cycles, they dogmatically insist on minimal annual budget shortfalls in the short-term, and on balancing budgets by next year, regardless of the recession's nature and duration.

(OSTB : Governments can "fund" development without out-of-pocket cash. Meaning it is not the government that borrows cash. It merely guarantees the debt. So contingent liabilities can increase but not cash debt.)

The stagnation of the last decade was due to the failure to reform adequately after the global financial crisis. Covid-19 recessions are undoubtedly different from recent financial crises, and will need bolder monetary, supply-side and industrial policy measures to catalyse and sustain economic relief, recovery and restructuring measures to address previous maladies and the post-lockdown malaise.

The crisis presents us with an opportunity to do better, to move forward. There is much to learn and do to progress, including abandoning the very modes of thinking which have led to the mess we are in. Exorcising ghosts from the past will be imperative.

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