Summers on secular stagnation, the ISLM, and the liquidity trap

Two short clips from Lawrence Summers talk at the ASSA meeting in San Diego. So he first says that secular stagnation is more plausible now than before. He sees that it can be explained as a shift of the IS curve backwards. His IS has a somewhat marginalist foundation, with a natural rate, and a fairly conventional story for investment. Of course, the negative shift has bee compensated by some sort of stimulus, that is now weaker. I would say a smaller multiplier that affects the slope of the IS would make more sense.

And he does say in the next clip that the IS is steeper, and the LM is flat, or that we are in a liquidity trap. Again, I think it's not really that, and simply a policy decision of the Fed, inevitable given the circumstances, perhaps.

He also, is not optimistic on monetary policy, and is pushing for expansionary fiscal policy. And certainly, even if there are many differences in the way I would portray the current macroeconomic situation, in particular the causes of the slow recovery and what he calls secular stagnation, on the policy issue we are not that far.

James K. Galbraith's Veblen-Commons award

Ritual and prestige among the Institutionalists

Jamie got the Veblen-Commons award, something his father received back in 1976. I introduced him, and as expected discussed a bit his contributions to economics, and the understanding of institutions. His most important contributions are on the field of inequality, and the work he has done with the University of Texas Inequality Project (UTIP).

There are many contributions that Jamie and UTIP have made. His use of the UNIDO payroll data, that he noted in his Godley-Tobin Lecture, has significant advantages over tax records and household survey data, and provides a different picture of global inequality. His use of the Theil decomposition is also original and provides new insights on inequality. And there is the more important contribution, his preoccupation with the macro-foundations of distribution theory.

I suggested, however, that perhaps his most provocative contribution to the understanding of economics and the evolution of institutions is in his notion of the Predator State, that in which private interest has taken over the commanding heights to promote the looting of what is left of the New Deal and Great Society project. This notion harks back to his father's famous trilogy -- American Capitalism, The Affluent Society and The New Industrial State (NIS), in particular the latter.

The evolution of of the bureaucratic state that was disappearing as his father wrote about it -- NIS was published in 1967 -- and its transformation into a predatory machine of the elites is central to understand inequality.

Raúl Prebisch as a Central Banker and Money Doctor

Here we edited with Esteban Pérez and Miguel Torres some unpublished manuscripts from Prebisch related to the Federal Reserve missions, led by Robert Triffin, to the Dominican Republic and Paraguay, in which he emphasizes the need of capital controls in peripheral countries that did NOT have the key hegemonic currency. There is also a discussion of Keynes and White's plans for Bretton Woods, which were partially published before. In Spanish. Happy New Year!

What to expect from the incoming government in Argentina

The government in Argentina has less than two weeks at this point. It is too early to pass judgment. But we can look at the legacy of the Macri administration, and indicate a few things about the current strategy. A paper I have just received from Fabian Amico, that will soon be published in Circus, will be invaluable for my very brief comments here (the new issue of Circus and his paper will eventually be linked here, in Spanish).

The first thing that should be evident is that the 4 years of the Macri administration, that were supposed to restore economic growth, something that had faltered since 2011, essentially as a result of an external constraint, were a failure. Using IMF data, the average GDP growth in the period was -0.2 percent. Yep, negative. Amico uses a local activity index and the results are visibly not very different (his numbers give an overall decline of 1.7 percent for the whole period).

Macri's administration also lifted capital controls, paid the Vulture Funds more than US$ 9 billion, and open the doors to additional foreign borrowing. The Macri government had put all of their bets on the notion that growth would come from private investment and exports, rather than the combination of government spending and higher wages, which allows for higher consumption. Below you can see how well that worked out for them.

As it should be clear only exports grew (Amico calls, aptly, the Macri period an export-led stagnation one), and not as a result of the real devaluation, since they grew at about 2 percent per year, more or less in tandem with the growth of global GDP. So much for the notion that devaluation provides space for policy, and higher growth. The collapse of government consumption, and the fall in real wages were crucial to explain the poor performance. Investment followed the accelerator and collapses with the fall in GDP.

The real depreciation of the exchange rate, as is well-know, affects negatively the real wages, that fell approximately 30 percent during his government, and as I had noted back in 2015, that was the real objective of his government. In that sense, one can say that his government did achieve its main goal. The participation of wages in total income fell 8 percent, as shown below.

The worst mistake was the increase in foreign debt in foreign currency, of course, the currency crisis and the return of the IMF, which I've already discussed (here and here) so I'll not delve again into this.

The Fernández administration, and the new Finance Minister, Martín Guzmán, are doing what was expected, and what seems reasonable under the current circumstances. The increased the retentions, taxes on exports, mostly of the agribusiness sector, started to tax assets held abroad, and eliminated taxes on assets held domestically in pesos, which are measures to try to increase the reserves in dollars. This will certainly complemented with measures to alleviate hunger, and poverty, including the pensions of the elderly poor. They are most likely in negotiations with the IMF to avoid a default, and that is crucial for the success of the economic program.

As Fernández said, his administration inherited the chaos. But there are reasons for hope in the dark.

A Conservative win will create a neoliberal hot zone and dissolve the UK: here’s how to stop it

By Thomas Palley

I could not get this op-ed (written November 6, 2019) published as it was a mix of too dull & didactic, and too partisan or not partisan enough. Anyway, in the wake of the election, I think it was analytically spot on so I have decided to post it. Also, it makes clear the very special circumstances of the UK election. It is a gross distortion to extrapolate from the UK to the US. Unfortunately, that is exactly what elite US media (e.g. New York Times) and neoliberal Democrats are now doing.
Opinion polls are predicting the Conservative Party will romp home in the UK’s upcoming general election. Unfortunately, given the party’s current extremist inclinations, that stands to transform the UK into a neoliberal hot zone and also dissolve the UK within a decade.

The costs of a Conservative winA Conservative majority government will quickly implement a Brexit that inflicts significant economic and political injury. Additionally, it will double-down on neoliberalism which has already done so much damage.

One set of costs concerns the deepening of neoliberal policies that push austerity and increase income inequality. The other set of costs concerns Brexit.

Read rest here.

Central Banks, Development and the Argentinean Economy

My interview (in Spanish) on central banks, development and some moderate optimism about the forthcoming Argentinian government of Alberto Fernández.

Paul Volcker's legacy

Paul Adolph Volcker (1927-2019)

Paul Volcker has passed away, and many obits (NYTimes here) and blog posts will be published in the next couple of days. Most likely, the majority will suggest how Carter appointed him to bring down inflation, a courageous decision, that might have costed him the election, and how Volcker went on to stabilize the so-called Great Inflation. Volcker was the head of the New York Fed from 1975 to 1979, before he was appointed chairman of the Fed in that year. He can be seen as the anti-Marriner Eccles, the first chairman properly speaking, and Roosevelt's central banker. Volcker was the quintessential Monetarist central banker, and his tenure is symbolic of the rise of Neoliberalism,* as much as Eccles' tenure was the symbol of the New Deal social democratic values.

It is important to remember that Volcker actually imposed Milton Friedman's monetary growth targets as the Fed policy, for the first time, since central banks, the Fed included, had traditionally acted by managing the interest rate, rather than trying to control the monetary aggregates. That policy was a failure and was short lived, being abandoned still during his tenure as chairman. Charles Goodhart noted that every time a central bank tried to control a monetary aggregate, the previously stable relationship between that monetary aggregate and economic activity broke down. This became know as Goodhart's Law.

But the Volcker interest rate shock was part of the set of policies that brought inflation down, even if the effects were not necessarily the ones anticipated, and the mechanism not the one assumed by Monetarist theories. It was NOT the result of lower monetary emissions, as much as the fact that higher interest rates, significantly higher, and the recession that followed, together with the opening of the American economy to foreign competition led a large increase in unemployment. The worst recession since the Great Depression, and that reduced the bargaining power of workers.

The other consequence of the interest rate shock, and the more profound globally, was the appreciation of the dollar, which showed that the dollar was still the key currency globally,** and the collapse of the Mexican economy after a default, which led to the so-called Debt Crisis of the 1980s, which not only hit the Latin American periphery, but many countries in Eastern Europe, helping also in the eventual collapse of real socialism. Asian economies, and their Japanese creditors, were hit by the crisis, but managed better the problems of debt overhang, being able to continue to borrow and avoiding the collapse in growth known as the Lost Decade.

Volcker left the Fed in 1987, followed by Alan Greenspan, who was responsible for the deregulation of financial markets (e.g. the end of Glass-Steagall) more than any other person, perhaps. The legacy of financial deregulation is well-known, with a succession of bubbles, and rescues by the Fed of "too-big-to-fail" institutions. Volcker was a critic of financial deregulation after the crisis, suggesting famously that only the ATM was a useful financial innovation. The Volcker Rule, introduced with the Dodd-Frank legislation, forbade banks of using their own accounts for making some investments in derivatives and other financial instruments. In many ways, this was too little, too late.

If you read the regular obits and pieces in the media, I am sure his legacy will be defined fundamentally for achieving low inflation. He would be the father of what Ben Bernanke called the Great Moderation. But his policies are also co-responsible for lower growth rates, on average, wage stagnation, and increasing financial instability, in the center and the periphery.

* And yes Neoliberalism started with Carter, not Reagan, even if the latter was considerably more radical in his pursue of conservative policies.

** It is worth noticing that Volcker was the under secretary for international affairs during the Nixon Administration when the system of Bretton Woods collapsed, and the dollar was allowed to float. In a sense, he was there for the depreciation and then appreciation of the dollar, and the imposition of what has been termed the dollar diplomacy. In other words, he proved that abandonment of Bretton Woods was NOT the abandonment of a dollar based international monetary regime.

Argentina and the IMF

Alberto Fernández, who will assume as the next president in less than two weeks, has said he will not accept the next tranche of US$ 11billion that were part of the US$ 57 billion deal signed by the outgoing Macri administration. Many progressives see this as a good sign, in particular given the history of the IMF with Argentina. I've emphasized, against a lot of heterodox discussion on the subject, that the IMF remains essentially unchanged when it comes to policy prescriptions. So I do get the point.

Note, however, that the best argument for not using it, is NOT the fact that this would increase the leverage with the IMF. It would hardly do that. It's kind of a slap on their face. The leverage comes from the fact that the IMF did commit a huge amount of money, and presumably they knew this was not something that could be repaid under the circumstances that it was contracted. The reasons to accept it or not should be pragmatically associated to whether the country will need them to make the payments next year (and Argentina should negotiate to reduce and eliminate most of the payments, certainly with the IMF in the next few years). I assume that calculation has been made, and, hence, the decision. If Fernández, and his advisors, are hoping for a boost in exports, that might be a mistake.

Also, since someone in Colombia last week asked me whether Argentina should default (the person thought it was a no brainer), my simple reply is that this would be a terrible idea. Yes, the debt in foreign currency, that increased significantly in the Macri administration went to finance capital flight, and in many ways is questionable. And, for sure it was unnecessary, and should had been avoided. But to default implies to be cut from any sources of dollars, and that implies that one must ration imports, which implies by definition that a massive recession would take place. So the default should be avoided.

Note that the follow up question (same person), so why you need imports (of intermediary and capital goods). It's obviously a question of degree, but beyond advanced economies, all economies do need dollars, since it is the vehicle currency, and the one in which the key energy commodities are traded in. There's a reason for those 900 or so US military bases around the globe.

So, yep, not necessary to get the money, if the country doesn't need it for short term obligations. But if we do need it, then there's no shame in getting the next tranche, and negotiate strongly with the Fund.

Venezuela and the embargo

Should have posted this a while ago. I had a conversation with the World Bank economist above on how much of the problems of Venezuela are the result of the embargo. Here a paper by Francisco Rodríguez. Worth reading.

Bernie Sanders in 1998 on the Global Crisis and the IMF role in it

Old clip from C-SPAN. It's still worth watching. Strong critique of the failures of the IMF and neoliberal policies in leading to the crisis. We know now that the subsequent bubble pushed the major crisis for another 10 years.

New Issue of ROKE soon!

The next issue of the Review of Keynesian Economics with Bob Rowthorn's Godley-Tobin Lecture and papers by Barry Eichengreen, Steve Fazzari, Peter Bofinger and Bob Dimand, among others is coming soon.

Heilbroner, Minsky and Heterodox Economics at UNAL Radio

Radio show in Spanish at the website of Universidad Nacional de Colombia. In Spanish of course. A short summary of one of my talks at the conference last week. Thanks to Diego Guerrero and Óscar Morillo.

The Moral Economy of Housing

A new post by David Fields, long time contributor to this blog. From his post:

At its most fundamental level, housing is more than a market segment or policy, it is a social relation that serves as the kernel of human survival, which can have profound consequences for the actors involved, the actions they take, and the outcomes that follow. As such, housing provides a set of meanings and values, a material form of emotional, cultural, political and economic significance. It is an institution that points to polyvalent higher order social arrangements that involve both patterns of social mobility and symbolic systems that infuse human activity with a powerful essence. Housing insecurity, therefore, is not a just a means of financial dispossession, but an ontological crisis concerning personal identity and the relationship to the rest of society.

Read rest here.

The effects of financialization in Latin America: Is there space for monetary policy?

For those in Bogota next Tuesday. I'll link to the live stream, which I think will be available.

Contradictions and Challenges for Growth in Latin America

This week, Thursday at 10am, at the Facultad de Estudios Superiores (FES) Acatlán, Mexico for those around. Organized by Teresa Santos López and with my good friend Ignacio Perrotini.

The IMF's Second Chance in Argentina

Kevin Gallagher and Matías Vernengo

Alberto Fernández and his running mate, former president Cristina Fernández de Kirchner, have won the election in Argentina amid a real danger that the country’s economy will collapse. Outgoing president Mauricio Macri and the transitioning Mr Fernández should work closely with the IMF to put the fragile economy back on a path to stability and sustainable growth.

Read rest here.

Challenges for Economic Development in Latin America at the Universidad del Litoral

I'll be in Santa Fé (Argentina, not New Mexico) next week, talking about the challenges ahead, in a particularly important time for the country.

For those around that want to register go here.

Who really wants the (Brazilian) economy to grow?

Franklin Serrano and Vivian Garrido (Guest bloggers)

When the Brazilian economy was growing with low unemployment rates and reducing income inequality, it was said that “businessmen have never made so much money” and, at the same time, the business community’s discontent with the government was increasing. On the other hand, in the current situation of semi-stagnation that followed from a deep recession, the entrepreneurs of both real and financial sectors declare their unrestricted support to the current government, despite the daily mess and shame of various government members and the bad economic conditions. We believe that, in order to understand both this apparent paradox and the very tendency of the Brazilian economy to stagnate, it is useful to clarify some basic theoretical relationships between investment, growth of demand and profitability.[1]

What matters to entrepreneurs?Entrepreneurs want "profitability". Profitability is not simply about selling more (total profit volume), but about the amount of profit compared to the size of the invested capital. Of course, as the economy grows, the volume or mass of profits invariably increases in absolute terms. But, as Garegnani said, companies do not care about the mass of absolute profits, but about the rate of profit, that is, the amount of profit relative to the capital invested; this variable may simply be called “profitability”. However, in the short run, the capital stock already installed is given; it’s a result of past investments. Then, in this short run, the rate of profit on this capital stock will depend only on the amount of profit and this, by its turn, depends on two factors: how much is produced and sold (the level of output) and the share of the product (and income) that goes to profits. Let us clarify in more detail these two factors.

In order to do so, let's imagine a scenario (let's call it “scenario 1”) in which real wages rise more than the trend of growth of labor productivity. This tends to reduce the rate of profits as the share of profits on sales (the second factor above) falls. It is true that, since in aggregate level these increases in wage share tend to increase the demand for consumption (because the share of wage income spent on consumption is naturally higher than that of profit income), aggregate consumption and production increase, which means that, in the short run, the degree of utilization of already installed capital increases and firms as a whole, partially offset lower margins with higher sales (i.e., the first factor above). Lower margins tend to decrease the rate of profit, but higher sales, on the other hand, tend to increase the rate of profit on this already installed capital stock. But one thing does not fully offset the other. This offset, however, besides being of a short term nature, is also only partial, as any increase in the payroll increases company costs and only part of this increase comes back as additional demand and revenue for them. This is because part of the amount of these additional wages will be spent directly on imported consumer goods (and indirectly on imported inputs of consumer goods produced in the country). Another part of the payroll increase goes either to pay direct taxes or is captured by indirect taxes paid by consumers and embedded in the price of retail goods. And also because part of the payroll is saved or used to pay workers's debts with the financial sector (whose owners tend not to spend these revenues).

So, is this profit rate that matters to entrepreneurs?Not really; or rather, although this is the actual rate of profits realized on the existing capital stock, it is not the rate of profit that determines the expected profitability of entrepreneurs in their new investments. In the latter case, companies are going to invest an adequate amount for the production capacity to adjust to the new expected total demand (which, in the present case, has grown) at a planned or normal degree of utilization, that, in its turn, is calculated to meet the expected fluctuations in demand, which implies that now (beyond the short term), the volume of capital invested will increase. Therefore, because of the rise on real wages, the expected rate of profit on new investments will fall as much as the share of profits will fall, without any partial compensation (as in the previous case), and gradually the profit rate related to the capital that is being installed goes falling as much as the expected rate of profit. And this rate of profit, that is, the rate of profit on the productive capacity planned to be used at the normal level, is the one that matters, because it determines the expected profitability. This longer run profit rate is called the “normal” or “expected” rate of profit.

But why do companies focus on the expected rather than on the actually realized profit rate?Well… due to competitive pressure, firms do not want either to overestimate the expansion of the market (in order to avoid loss), nor underestimate this expansion, otherwise they will lose market shares to rival companies and/or new entrants in their sectors. Hence, any individual entrepreneur who refuses to invest just because he is not content with a lower profitability (i.e., a lower normal rate of profit) while demand is expanding will simply be losing market share to another one. The idea of ​​planning the production capacity to be used at the so-called “normal” level contemplates the possibility of fully meeting the average demand over the life of the equipment while maintaining a slack to meet temporary or seasonal demand peaks, thus avoiding losing market share to competitors during these peaks. And because the productive capacity is planned to operate at the normal level based on the expected demand, then it is the expected not the realized rate of profits that becomes decisive.

Does this mean that, although “upset”, entrepreneurs still invest knowing that their expected profit rate will fall?

Exactly.

So, profitability matters to entrepreneurs but it doesn't matter to the investment decision? What do you mean?

This is where we would like to separate and clarify the confusion between the expected profit rate and the investment decision. The total amount of investment depends only on the expected demand and not on the expected profit rate! This leads us to two opposite but not antagonistic conclusions. First, that the business community generally does not like reductions in the share of profits in income through real wage increases above the rising trend in labor productivity. That is, as we said above, the business community struggle for their profitability, because this is what matters to them. But second, when this scenario of a rise in the wage share actually happens and markets expand, the combination between competition and the lack of a better alternative, cause entrepreneurs to expand their investments, even if expected and realized profit rates are falling, unless they fall below their opportunity cost, given by the interest rate, which is its lower bound. With profit rates still above this lower limit and if demand is expanding, investment continues to grow. A central implication of these propositions is that the reaction of the business community to a downward trend in profitability will not be, therefore, an implausible "investment strike." As Kalecki said: "capitalists do many things as a class, but they certainly do not invest as a class". If and when there is a capitalist reaction, it will consist of doing something like political pressure for the State to change the economic policy regime, in order to reverse the situation in the direction of their own interests.

To illustrate, let us now suppose a second scenario (let's call it “scenario 2”), where we observe such a class reaction that succeeds and, through austerity policies, the government manages to generate stagnation with mass unemployment and this then reverses the trend of rapid growth in real wages. In this second scenario, if demand is no longer expanding and even more if there is unwanted idle capacity in the already installed capital stock, companies have no incentive to invest, no matter how much real wages and other costs or taxes and corporate contributions fall, due to labor reforms or social security or due to tax exemptions to firms in general. As much as the business community can and will be satisfied with this high level of profitability, there is no incentive for additional investment, since it would only create unnecessary productive capacity. Probably some entrepreneurs will invest in innovations to steal market share from other companies. But if the innovators succeed, those other companies that have lost market tend to reduce their own investments in the same magnitude. Unfortunately, without growth of final demand, an aggregate expansion of investment will not be sustained for too long.

And what matters to workers?Naturally, workers generally are interested in more jobs, and in increase in real wages. Both factors are directly connected with higher economic growth because growth tends to generate more jobs. In fact, politically and historically, it is through decreasing unemployment and underemployment that the bargaining power of workers rises (and has risen) and facilitates the achievement of higher real wages and better working conditions. Increases in real wages above labour productivity growth is even better for workers, because, in this case, in addition to the initial increase in wage purchasing power, there is an increase in the economy’s aggregate marginal propensity to consume (share of total income that is spent on consumption) and thus, an additional increase in aggregate demand and employment as a result of this wage increase itself.

In our view, due to a number of structural characteristics of the economy, Brazil was, until 2010, close to the previous situation described above, which is equivalent to our scenario 1. These characteristics had included elements such as: the demographic transition _ reducing the growth of labor supply _ and the low labour productivity growth _ due to a more than proportional expansion of the services sector, what generated more employment than the expansion led by other sectors. In addition, several aspects of the growth pattern adopted, based on a strong rise in the minimum wage, an elevation of job formalization, and an expansion of the welfare state (giving the poor the opportunity to survive or study without working in precarious conditions) contributed to increase the bargaining power of workers, especially the low-skilled ones, which has grown substantially and unexpectedly during the boom of the Brazilian economy since 2004. Nevertheless, since 2011 the government, pressured by the discontentment of the capitalist class with this trend, has taken a number of palliative measures to restore the corporate profitability (especially tax exemptions) and seemed to have been surprised with the lack of positive impact of such measures on private investment, in a context where government had helped to decrease markedly the growth of demand. Then, in 2015, the government decided to assume the austerity policies and the gradual weakening of the welfare state with the reduction of social rights. The capitalist class and its external allies, counting also on the support of the workers with higher salaries (the latter particularly outraged by basic wages increase and progressive measures such as the 2013’s housekeepers PEC[2]) and seeing that they had nothing to fear from a government without any firmness, set out to attack. And, through a succession of coups, the transition to something close to our scenario 2, against the workers' interests,was completed, and here we are now. Profitability conditions improve by each measure taken by the government, helped by the low bargaining power of the workers in this stagnant and mass unemployment economic situation.

In short ...

… With this note, we came up with a scenario that now, we hope, seems less paradoxical, and it is: a) interesting for entrepreneurs; b) uninteresting for workers; c) with an upward trend in the profit rate and d) with low investment growth.

Due to the weak growth of demand that largely resulted from austerity policies, investment and the economy are barely growing and there is a huge and successful effort to focus the political debate on anything but the state of the economy and social rights, in order to prevent the loss of legitimacy and maybe electoral failure of forces supporting the government. Promoting economic growth is not and has never been a priority for big businessmen and, as has been clearly acknowledge, neither growth is a government priority. But who really needs growth are not the entrepreneurs in general _ apart from some small entrepreneurs, for whom and whose family the company generates jobs _ but the workers.

REFERENCES

SERRANO, F. & SUMMA, R. F. (2018) Conflito distributivo e o fim da “breve era de ouro” da economia brasileira. Novos Estudos CEBRAP, v. 37, p. 175.

NOTES:

[1] For more details see Serrano and Summa (2018)

[2] PEC is a brazilian instrument created to facilitate changes in small parts of the Federal Constitution. In the case refered in the text, it was a particular formalization of housekeeper’s jobs.

Argentina and the IMF: What to Expect with the Likely Return of Kirchnerism

Simple Math, Macri + IMF = Poverty

The Argentine economy is on the verge of another default less than two decades after the last one, in 2002. The forthcoming elections, in October 27, will most likely bring back the Kirchnerist opposition back to power, and they will have to negotiate with the International Monetary Fund (IMF), that has the power to prevent a crisis.

Argentina has a long and turbulent history with the IMF that dates back to the country’s entry in the organization in 1956 and to the first loan that was received the following year, after the military coup that brought down the Peronist government in 1955. Since then, the country has been an adept user of IMF resources, ranking among the countries that signed the most agreements. The loan of approximately $57 billion, reached in 2018, is the largest in the IMF’s history, and is a Stand-By arrangement, since it comes with the imposition of economic policies designed by the IMF. This contrasts with the period in which Néstor Kirchner and his wife Cristina Fernández de Kirchner were in power.

Read rest here.

Thirlwall at 40

Thirlwall and McCombie

The new issue of ROKE is out. Three papers are freely downloadable (linked below). Check it out!

Thirlwall's law at 40 by Esteban Pérez Caldentey and Matías Vernengo

Why Thirlwall's law is not a tautology: more on the debate over the law by J.S.L. McCombie

Thoughts on the balance-of-payments-constrained growth after 40 years by A.P. Thirlwall

MMT in Developing Countries at the Real News Network

Full transcript of the short interview here. Paper was linked before. Note that we say that Functional Finance does apply to developing countries, but that the insistence of the advantages of flexible exchange rates, as opposed to managed regimes with capital controls, are not correct.

Real World Economics Review

So the RWER has a whole issue on Modern Money Theory (MMT). I haven't read the whole thing yet (barely started). At nay rate on that later. Whole issue can be downloaded here. Enjoy!

Modern Money Theory (MMT) in the Tropics

Paper has been published as a PERI Working Paper.

From the abstract:

Functional finance is only one of the elements of Modern Money Theory (MMT). Chartal money, endogenous money and an Employer of Last Resort Program (ELR) or Job Guarantee (JG) are often the other elements. We are here interested fundamentally with the functional finance aspects which are central for any discussion of fiscal policy and have received more attention recently. We discuss both the limitations of functional finance for developing countries that have a sovereign currency, but are forced to borrow in foreign currency and that might face a balance of payments (BOP) constraint. We also analyze the limits of a country borrowing in its own currency, because there is no formal possibility of default when it can always print money or issue debt. We note that the balance of payments constraint might still be relevant and limit fiscal expansion. We note that flexible rates do not necessarily create more space for fiscal policy, and that should not be in general preferred to managed exchange rate regimes with capital controls. We suggest that MMT needs to be complemented with Structuralist ideas to provide a more coherent understanding of fiscal policy in developing countries.

Read full paper here.

Official Reforms and India’s Real Economy

By Sunanda Sen
(Former Professor, Jawaharlal Nehru University; Guest Blogger)

That the Indian economy is currently experiencing a slowdown is more than evident, both with the deliberations in different private circles and with official statements signalling a series of remedial measures , mostly focused on the ailing financial sector! However, as we point out, the ailing Indian economy has concerns that go beyond flagging GDP growth and the ailing financial sector.

Downturn in the economy 
As for the downturn, the country’s GDP growth rate has plunged into a low of 5% in the first quarter of the current financial year 2019-20 .The drop has been accompanied by a sharp deceleration in the manufacturing output and a sluggish growth of output in agriculture. Matching both, ‘consumption growth’ has also been weak.

A fact which remains less highlighted in current official concerns includes unemployment, at 7.1% of the labour force during September-December 2018 as reported in the Labour Force Periodic Review. Unemployment has been even higher for urban youth during the period, at 23.4%. Information as is available indicates on-going spread of job cuts in different manufacturing units and wide-ranging distress in rural areas with farmer suicides, which causes added concern.

There also are recent reports of a shrinkage in labour force participation ratio (the proportion of people who are willing to work), indicating tendencies of withdrawal syndromes on part of the unemployed – which have been largely in response to the grim employment prospects. Distress is further manifested in the large numbers of poverty stricken people - both in rural and urban areas –ranging from 22 % to 29% of aggregate population according to different estimates.

The grim facts relating to unemployment and poverty in the real economy of India make it evident that a drop in GDP growth is not just a matter concerning the dampened financial markets and their volatility. Downturns also speak of the real sector – of the dearth of sustainable jobs and the related poverty.

Looking at the prevailing concerns in India for the stagnating economy, analysts often ruminate on the steep drop in stock prices in India’s secondary market which started with the end of the temporary euphoria at end of the national election in May 2019 . One may recall the shooting up of the Sensex beyond 40,000 on June 4, 2019, far surpassing 37,000 on May 13. The index, slumping back to a low of 36,855 on August 30, has , at the time of writing, abruptly shot up, nearing 39,000 , which is a response to the magic wand of the tax bonanza announced on September 20. Causes cited for the earlier downfall include the volatile net flows of Foreign Portfolio Investments (FPI) - recording outflows of Rs 3,700 crore or above in a single month of July 2019. Above went along with the simultaneous drop on India’s foreign exchange reserves by nearly $1 billion between July 20 and July 26, 2019.

Policy measures announced
Concerns relating to the stagnating GDP growth and financial markets in the country has prompted the government to announce a series of measures since the recent official announcements started on August 23, 2019 . The measures included a scrapping of the surcharges on long and short term capital gains as were earlier proposed in the last budget; in a bid to help inflows of foreign portfolio investments. A few stimulant measures as suggested include an investment package of Rs 100 lakh crores on infrastructure, a Rs 70th crore liquidity injection to recapitalize banks and cheaper loans to facilitate property market and auto sector, along with a promise of additional purchases by government departments in auto market . Corporations have also been assured of a no- penalty clause if they fail to comply with the corporate social responsibility(CSR) clause, originally designed to help the underprivileged. Included in the package are also additional roll-backs, of taxes on the ‘super rich’- as introduced in the last budget - in income slabs over Rs 2 crore and beyond Rs 5 crore.

Government announcements on August 30, in the next round, relaxed several rules on single-brand retail, contract manufacturing, coal mining and digital media for FDIs. Another important measure has been the dilution of the current 30% domestic sourcing norms for single brand retail trading in the country.

Official announcements on August 30 also related to the mergers of public sector banks , by combining the ‘bad’ ones with the stronger ones, thus reducing the total number of PSBs to 12. The move is supposed to coordinate with the promised recapitalization plan of Rs 70 th crores, as announced at end of the previous week.

Finally, a big tax bonanza, with rates cut from 30% to 22% has been mentioned on September 30. Above, according to a credit rating agency, Crisil, amounts to a tax savings of Rs 37,000 crores for the 1000 listed corporations. By the same estimates, the expected aggregate tax loss for the government amounts to Rs 1.45 crore; which, incidentally, exactly matches the sum received by the government from the Reserve Bank of India. Remedial official measures, addressed to mend the on-going regressive impact of the Goods and Services (GST) tax on the economy, are also on the cards, with several cuts in this indirect tax on specific items.

How effective to revive the economy?
Sops as above as tax relief - to portfolio as well as corporate investors within and outside the country – while effective in temporarily stimulating the secondary stock market, may not work to reverse the tendencies for the stagnation, even in the financial sector and let alone in the real economy. Contrary to what was expected, the initial response of the stock market continued to be rather non-committal over nearly a month between August 23 and September 20th when the big tax bonanza package was announced. It is possibly too early( and nearly impossible) to project the stock market movements in future. Still more doubtful is an expected positive impact of all above policy moves on capacity creation via the market for initial primary offers (IPOs) - short of which there can be no expansion in the real economy of output, investment and employment.

The stark realities relating to the contrasts between the real and the financial economy reflect itself in the low value of the initial Primary Offers (IPOs). As is well known, the latter indicate new physical investments rather than financial transfers alone as in the transactions of shares in the secondary stock market. A revival of the stagnating real economy demands additional investments in physical terms with related expansions in jobs. Little of those are likely to be fulfilled by a boom in the secondary market of stocks and the related gains on speculative and short term investments. Also in terms of simple national accounts, capital gains or losses relating to the portfolio investors in the secondary stock markets are always treated as ‘transfers’ between parties, and as such not even considered in calculating the GDP in their first round. Possibilities, however, remain of net injections/withdrawals of real sector demand by agents who face capital gains/losses , which deviates from their underlying inclinations to further speculate in the market. However, while the proposed tax benefits will further widen the inequalities within the country, little of those may finally be channeled beyond the speculative zone of stock markets and real estates.

Additions to corporate savings, if generated, will not generate real investments unless demand for the latter is forthcoming in the market. This comes as the home truth that Keynes spelt out more than 80 years back in the context of the Great Depression of 1929-30! Sops to speculation in the market and the lenient tax breaks for super rich as well as corporations may only help to invigorate the current spate of speculation, in stock markets (or even on real estates and commodities) further.

Official concerns as such for the public sector banks sound more than deserving, given the issues with the near bankrupt NDFCs (or shadow banks ) with their easy access to the formal banking sector which generated a large part of the on-going NPAs. In our judgement, the vacuum created with shrinking banking facilities and branches and the total absence of development banks will continue to provide space to the NBFCs and their malfunctioning.

Research, as available indicates how the corporations have made use of credit from banks to meet their liabilities ( as interest payments on past debt as well as payments of dividends to share-holders), replicating a typical Ponzi strategy. Simultaneously investments by corporations have switched from the real to the financial sector with offers of better earnings on financial securities. Corporations, in the process, also have often taken recourse to bankruptcy while adding further to NPAs held by banks. Finally, NPAs also resulted from the absconding and corrupt clients of banks who could run-away with their liabilities. One wonders if the change in governance as suggested by the recent mergers which aim to combine the weak banks with the stronger ones (in terms of current performance ), will help in lifting the PSBs from the current mess.

Incidentally, the soft-pedaling by the RBI with four consecutive cuts in the repo rates, while signalling a nod to expansionary monetary policies, will work to lower the lending rates of banks only if there will be a pick-up of credit demand from the public. And that in turn demands more of investment/consumption demand, especially from the real (rather than the financial) sector. This is because the growth of credit supply is determined by credit demand and not the other-way round! This does not rule out possibilities of additional borrowings at the lower rates to finance speculation in financial markets, which will not help revival of the real economy.

Pattern of stagnation in India’s real economy
As already emphasized in the preceding sections of this commentary, a country’s GDP growth alone hardly indicates the country’s level of development, which include employment, social security and absence of poverty. Recognizing above is important in the context of the ailing Indian economy that is currently subject to concerns more pressing than the plunging financial sector.

Mention can be made here of the structural changes in the Indian economy , with changing relative contributions of its three major sectors.Those include the share for services moving up to 50% and above since the early 1990s and the respective industry and agriculture shares stalling around 25% and 19% or less since then.

The employment situation as currently prevail in the Indian economy include 90% or more people struggling to eke out a survival in the informal sector while the organized formal sectors within industry and services offer 10% or less of jobs, thus pushing the majority of the working population to the dark terrains of the unorganized and informal jobs.

As for the sectoral pattern of employment, agriculture has remained the largest provider, at 48.9% of aggregate employment in the economy during 2011-12. Almost all of above are purely in an informal capacity , thus fetching little of the benefits which are usual when labour is formally recruited. As for jobs available in the industrial sector, the organized sector (dealing with the registered factories employing 10 or more workers ) provides less than 11% of aggregate employment in the country. Of above more than four-fifths are employed on a purely contractual or temporary basis with none of the benefits that normally accompany formal jobs. A recent estimate points at the low employment elasticity of aggregate output at 0.08%, which today is even lower than 0.18% during 2009-11. Much of the above is due to the lower absorption of labour in the production process due to the use of capital-intensive technology. In addition, growth rates are found to be higher in the capital as well as the skill intensive products - as compared to the average growth for industry as a whole.

The service sector, currently providing more than one-half of the GDP, has only a marginal contribution in employment. Data available from the Labour Bureau indicate that of an aggregate 140-150 million jobs in the services sector during 2015, only 26 million were with the organized sector. The remaining jobs, mostly in petty production units and self-employment, include, in our view, large numbers with disguised unemployment in the informal sector.

Services in the organized sector also include the ‘sun-rise sector’ , comprising of the Information Technology-Business Processing Organizations ( IT-BPO). Their contribution to jobs has been rather minimal , as can be expected in terms of their use of capital and skill intensive technology. Growth in India’s services sector is concentrated in activities related to finance, real estate and business services (FINREBS). It needs to be noticed that the FINREBS has a rising share, both in relation to the service sector itself , as well as relating to the GDP. In fact shares of the FINREBS not only have escalated over time but have continued to rise, even with declining GDP growth rates. Thus the growth of the service sector including the FINREBS, as can be expected, while contributing to GDP growth, have failed to contribute much in terms of employment or real activity, an aspect which helps to understand the underlying paradox of high GDP growth with unemployment.

The sectoral contributions as above brings home an explanation of the slow growth in jobs and related poverty– and that too for the majority of the labour force employed in the informal sector who are denied of sustainable wages and benefits as well as job security.

Need for an expansionary policy
While there is an urgent need for public expenditure as investments as well as social sector outlays, the Indian government abides by its self-imposed limits on fiscal deficit to GDP ratios, which restrains additional public expenditure. The dictum is provided by the Fiscal Restraint and Budget Management Act (FRBMA) of 2003 which was voluntarily enacted by the ruling government, largely to attract foreign investments.. Given that the theory of ‘austerity’ as a measure of investment revival by controlling inflation is much discredited at levels of analysis and policies, we find no reason why the country should continue to stick to such measures .

It needs to be recognized that official expenditure remains a per-requisite to stimulation of private spending, especially in the current context of a demand deficient domestic economy as in India. A departure, if effected, from the ineffective policy prescriptions of the mainstream economic theories of fiscal restraint can be expected to generate a climate of expansion within the country.

Considering the gravity of the situation, this is the moment for a call to the state to act and not just protect finance capital which include the speculators who operate in stock markets, the super-rich who are disgruntled and pose the threat to move offshore to avoid the newly imposed surcharges on higher income slabs, to provide relief to the bankers misallocating funds in search of quick and illegitimate gains, or even to protect and incentivize the corporate sector, the former for a negligence to the much too small a benevolence they were subject to in terms of their obligations to fulfill the CSR, and the latter as investment inducements.

We can conclude that it will be a limited exercise on part of the officialdom to view the financial market performance as a true gauge of performance of the economy as a whole.

Indeed, the Indian economy is in dire need for an alternate course of action. The state must focus and restore the real economy with channels to revive investment, employment and other social goals for the majority.
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An earlier version of the paper was published in Economic and Political Weekly on September 1, 2019