Sunday, December 27, 2015

Political Aspects of Unemployment: Brazil’s Neoliberal U-Turn

New paper by Franklin Serrano and Luiz Eduardo Melin. From the abstract:
Throughout the world, the reversion of fortune suffered by the Brazilian
economy since reaching its zenith as recently as 2010 has confounded shrewd commentators, seasoned analysts and market players alike. As 2015 unfolded, ominous projections (“An Economy on the Brink”, “Brazil’s Economy Falters” “Worse May Be To Come”) were no less widespread than expressions of bewilderment (“Whatever Happened to Brazil”, “Brazilian Waxing and Waning”, “Brazil’s Scandalous Boom to Bust Story”), and, more recently, of alarm (“Goldman Sachs Says Brazil Has Plunged Into ‘An Outright Depression’”) concerning the fate of the South American BRIC country. 
Despite profuse official protestations to the contrary, however, Brazil’s afflictions turn out to be of its own making, as it so often proves to be the case. Looking at the set of clearly laid-out policy choices made by the Brazilian government – and the almost as clearly spelled-out political objectives underlying them – should provide enough explanatory evidence to sort out this cautionary tale for developing countries everywhere.
Read full paper here

Tuesday, December 22, 2015

The strange and misunderstood reasons for the Brazilian crisis

Almost done for the year. So do not expect many posts before the end of the ASSA conference (January 5). But as I promised, here are some brief thoughts on the Brazilian crisis.

Brazil is a mess. The economy is collapsing, with an estimated decline of about 3.5% in GDP this year (perhaps worse), and inflation has accelerated, to two digit levels, way above what used to be the upper limit of the inflation target band. Worse, politically the country is paralyzed, with an impeachment process in course with a very uncertain outcome.

The conventional view is sort of split on why this happened. Some suggest that it was the slowdown of the international economy, and the decline in commodity prices, that forced Brazil to adjust (for example, that would be Simon Romero's story in the NYTimes, if you add corruption to the mix; more on that below). The alternative is more explicit about the negative effects of the Workers' Party (PT in Portuguese) policies, suggesting that they reduced confidence and, hence, investment (something along these lines can be seen in the Wall Street opinion pages; see here; subscription required).

In the policy/confidence variation version the argument is that the government spent too much, in particular, in the second Lula administration, and more so in the aftermath of the Global Financial Crisis. There was an attempt to reduce fiscal spending with Dilma Rousseff's election (in this interpretation mostly disguising the spending with creative accounting, more on that below), but that was temporary, and only after Dilma's reelection did the fiscal problems became unsustainable and required adjustment.

Both stories are flawed. First, even though the global economy is growing slowly, and some peripheral economies like China are also slowing down, Brazil has no clear external problem. Current account is negative, but the country is in no danger of an external crisis or default on its foreign obligations, in particular because it is sitting on a huge pile of international reserves. As I noted before Standard & Poor's actually agrees with that view on the justification that they used to reduce Brazilian grading status (last week Fitch's followed the lead and also downgraded Brazil's debt), since they do not cite the external situation as a problem.

So the notion that Brazil needed a fiscal adjustment, to throw the country in a recession, and reduce imports, and solve the external problem seems unfounded. The same is true for the notion that a huge depreciation of the real was needed. In fact, the depreciation has only contributed to the acceleration of inflation, with no impact on the external accounts. Exports have tanked (since the global economy is not doing well), and so did imports (given the recession). Inflation will also have a significant impact on real wages, and will worsen income distribution (which had improved during the PT administration).

But what about the internal problems (both S&P and Fitch actually do blame the fiscal problems). This arguments is even worse, and has some serious logical limitations. Note that this suggests that fiscal deficits in domestic currency might be unsustainable and that inflation results from excessive demand associated to too much government spending. I have discussed this several times in the blog, so I won't delve too much into it.

There is no way a country can default on debt in its own currency. By definition you can  always print money. And yes inflation might follow, but not because printing money causes inflation. The argument implies that economy is generally, and certainly Brazil is not, at full employment. Hence, money printing might lead to more spending and more output, not inflation. However, another effect might be a fear of depreciation, and a run for dollars, and the depreciation might have an inflationary impact.

In other words, the reasons for austerity are not connected really to fear of domestic default. Austerity could be used to solve a current account problem, which is not the case in Brazil, as we saw, or it might be a way of leading to a recession, increasing unemployment and reducing the bargaining power of workers, as Kalecki noted long ago. It is a way to discipline the labor class. And that is what is going on in Brazil (on the slowdown of the economy essentially following the same argument see this paper by Serrano and Summa).

The government could actually spend itself out of the recession (don't worry, it won't). And by the way, since revenue responds to the level of activity, the fiscal outlook would improve. So if the Brazilian crisis is not external and is not fiscal, what caused this crisis. It is a self-imposed political crisis. The relevant question is why is this policy implemented by a left-of center government.

One has to first remember that on some level PT always accepted the conventional thinking when it came to fiscal issues. Lula famously said in his letter to the Brazilian people that he wanted "fiscal equilibrium to be able to grow," suggesting that he had incorporated the notion of contractionary expansion. But, in all fairness, there was some dissent within the party, and with the Plan of Acceleration of Growth (PAC in Portuguese) and, in particular, after the 2008 crisis, it seemed that PT was ready to use government spending to promote economic development. So why after winning the close election last year, in which Dilma decried the economic program of the Social Democratic Party of Brazil (PSDB in Portuguese) did she essentially adopted it?

It is clear that part of the government accepted that fiscal expansion had gone too far, and that workers' demand, and the real wages, were too high. The political pressure was certainly felt, and in addition the nagging issue of corruption might have also played a role. Also, for some reason the so-called New Economic Matrix (which in my view, I might be wrong) was very conventional, trying to reduce interest rates and promoting a moderate fiscal adjustment was seen as a failure for the wrong reasons. The lower interest rates, and the more depreciated currency should have stimulated growth, while the adjustment should have controlled prices. Obviously this New Developmentalist idea failed, since depreciation fueled inflation (which wasn't high, just at the higher end of the target at around 6.5%) and the economy slowed down.

However, the lesson taken from this experiment was that the government lost credibility, since the fiscal adjustment wasn't strong enough and the delays in the payments to public banks (the infamous 'pedaladas'), in particular the development bank (BNDES in Portuguese), were behind the crisis. In this view all depends on 'confidence fairies.' That is, the lack of confidence reduced domestic investment, and lowered growth. A terrible side effect of the generalized acceptance of this view is that now the political use by the opposition of the delays in payments to the public banks, something that was not new, in the impeachment procedures will create a permanent legacy, reducing the ability of future governments trying to pursue expansionist policies.

Finally, a word on the issue of corruption. Yes, there is a significant corruption scandal in Brazil, and before anybody complains, I do hope they get everybody and that the people that are proven guilty end up in paying the price (jail presumably; by the way, if they had something on the president it would have been used for impeachment, rather than a bureaucratic budget issue). I just want to note that there is no evidence (I haven't seen any credible evidence at least) that corruption is worse now, than say with the military back in the 60s and 70s, when most of the connections with big construction firms started. Also, the problems at the state oil company (Petrobras) being investigated go at least back to the Cardoso government. And corruption is not a problem of the government coalition per se. Members of the opposition are involved too, and an impeachment would actually bring to power some of the most evidently corrupt politicians in the country. In that sense, if corruption has not changed, it can hardly be seen as having caused the economic situation. Corruption is just one of the elements used by political groups to obtain advantages.

The problems of corruption that matter in Brazil are associated to the fact that one cannot govern without basically paying for political favors in congress and that means paying the main political force there, the Brazilian Democratic Party Movement (PMDB in Portuguese). It is well known, for example, that Cardoso payed for changing the constitution and allowing his re-election, to cite an example that is old enough, and not connected to the current government. But the country did grow significantly in the past, in spite of corruption.

And, by the way, the susbtitution in the Finance Ministry, with the appointment of my ex-classmate (at all levels, undergraduate, master's and PhD courses) Nelson Barbosa, is unlikely to lead to any significant changes in policy. The fiscal adjustment will continue as he very clearly announced.

Wednesday, December 9, 2015

Neoliberalism Resurgent: What to Expect in Argentina after Macri’s Victory*

No need for a helicopter

The election of businessman Mauricio Macri to the presidency in Argentina signals a rightward turn in the country and, perhaps, in South America more generally. Macri, the candidate of the right-wing Compromiso para el cambio (Commitment to Change) party, defeated Buenos Aires province governor Daniel Scioli (the Peronist party candidate) in November’s runoff election, by less than 3% of the vote.

Macri is the wealthy scion an Italian immigrant family that made its money on the basis of government contracts. He went on to work for the family business and later, defying his father’s wishes, became president of the most popular professional soccer club in the country, Boca Juniors. In 2007, he won election as mayor of the capital city, Buenos Aires—the springboard for his eventual election to the presidency.

This is a momentous change in Argentina’s history, since it is the first time that a right-wing party has won the presidency by electoral means. In the past, conservatives had only gained power through military coups or by disguising neoliberal policies under more progressive electoral promises and the mantle of a left-of-center party—as in Carlos Menem’s Peronist government in the 1990s.

Macri’s economic team includes among its most prominent members Alfonso Prat-Gay, an ex-president of the country’s Central Bank who also worked for JP Morgan Chase. He will be the next finance minister. Federico Sturzenegger, secretary of economic policy in the Economics Ministry under infamous finance minister Domingo Cavallo—author of the main economic policies of the 1990s—is likely to be the next Central Bank president. In other words, the economic team clearly signals a return to the market-friendly policies of the 1990s. This is also true on the foreign policy front, were Macri has already announced that he intends to use the so-called “democratic clause” of the Common Market of the South (Mercosur), the regional trade agreement, to exclude Venezuela for alleged violations of democratic norms. (Macri has backed off that plan since the victory of the right-wing coalition in Venezuela’s recent parliamentary elections.) He has also signaled a closer alignment with the United States.

The economic program of the new administration is quite clear, even though Macri tried to hide his economic advisors before the election, to reduce the impact of their unpopular views at the polls. They will unify the foreign exchange market, in which there is currently a large gap between the official and black-market exchange rates. This implies a “maxi-devaluation” of the peso, from around nine to about 15 pesos to the dollar (assuming that the current black market level is their desired nominal exchange rate). The effects of a depreciation of this magnitude will be massive.

In contrast to previous devaluations—most recently in 2002, after more than ten years of a fixed one-to-one peso-to-dollar exchange rate under Cavallo’s so-called “Convertibility Plan”—this one is not caused by an external crisis. While it is true that Argentina’s current account balance is negative, and that its reserves are relatively low, there is no significant danger that Argentina will default on its external debt now.

The current account deficit is not big, by historical standards or in comparison to other countries in the region, and international reserves can cover the country’s immediate obligations. Besides, under current conditions, with low international interest rates, it would be relatively easy to attract capital flows with higher interest rates, and borrow in international markets. (That would certainly be easier if Argentina could finalize an agreement with the so-called “vulture funds,” the holdout bondholders that did not agree to the rescheduling of debt after the last default.) And, if anything, Macri’s (unnecessary) promise to give in to all the vulture funds’ demands and rapprochement with the United States and International Monetary Fund (IMF) would resolve any short-run problems in financing the current account deficit.

The question, then, is why the Macri government would promote a huge depreciation of the currency with no clear external crisis on the horizon. The notion that the depreciation would solve the current account deficits is fraught with problems. Not only is the external situation not dire—so depreciation would be a “solution” to a non-existent problem—but there is also no evidence that exports will boom after a depreciation. Exports respond more to the growth of the global economy than to a change in relative prices. So for example, China will not demand significantly more soybeans from Argentina, as a result of lower prices, if the Chinese economy is not growing faster.

Actually, the only significant way in which the depreciation will reduce the external problems of Argentina is by causing a recession. Depreciations tend to reduce real wages, since the increase in the price of imported goods leads to inflation, which is not fully recovered by workers. As a result, consumption declines, with a negative impact on economic growth. Macri and his economic team have been very explicit about the need for a huge devaluation and the closing of the gap between the official and the black-market (or “blue,” as it is known in Argentina) exchange rate. This has already triggered an inflationary surge, as noted by the outgoing Economics Minister Axel Kiciloff.

The reason for the devaluation is precisely to cause inflation and a recession, both of which would weaken working-class bargaining power and, as a result, lead to lower real wages. And that is the ultimate goal of the new Macri administration. He has explicitly said so, in one of the videos that his campaign tried to suppress. The video shows him suggesting that the way out of the problems of the 1990s—when devaluation was not an option due to the Convertibility Plan—was to reduce real wages to increase external competitiveness. The maxi-devaluation of the peso will most likely be accompanied by a “fiscal adjustment plan” or, simply put, austerity. This would push the economy further into recession, reducing the bargaining power of workers even more.

Some skeptics suggest that Macri cannot pursue the classic IMF economic package of devaluation and fiscal adjustment, since that would bring about both inflation and recession, a politically explosive combination. However, the administration will deflect political problems caused by the economic crisis that these policies will trigger by suggesting that both inflation and the recession are the results of the negative legacy of twelve years of “populism” under the previous two administrations. In fact, Macri is already doing this, with intensive media support, suggesting that the inflation since the announcement of the depreciation is just a correction to its true level. One can easily see how higher unemployment would be justified in the same fashion, as an adjustment to the true and sustainable level.

In other words, the Macri government will cause a crisis that does not exist right now—though the economic situation may be difficult and growth in the last three years has not been not high—but blame the effects of its neoliberal policies on the previous government. The idea would most likely be to weather a political storm over the next couple of years and then—after resolving the issues with the vulture funds and normalizing relations with IMF—start borrowing abroad again. That would help promote growth again in time for a re-election campaign in 2019. Growth would be also facilitated by the fact that the economy would be coming out of a crisis, with real wages considerably lower and the working class well-disciplined.

Also, Macri will reduce or eliminate export taxes on grain and soybeans (known as retenciones, or “retentions”), strengthening the position of the ruling elites. The reorientation of the economy toward primary-goods (agricultural and mineral) production, along with a larger role for finance, has been the strategy of the Argentine elites since the last military dictatorship. That is why there is such continuity between the economic plans of José Martínez de Hoz under the military dictatorship of the late 1970s and the early 1980s, Domingo Cavallo under Menem in the 1990s, and (one should expect) Adolfo Prat-Gay under Macri in the coming years.

The initial recession and cuts in retenciones would significantly reduce government revenue and most likely lead to larger fiscal deficits. Hence, austerity will actually worsen the fiscal balance, contrary to what the Macri and his advisors suggest. The key is to remember that austerity policies are not designed to reduce fiscal deficits, even if that is offered up as a rationalization; they are a political instrument for disciplining labor. [And if it is any consolation, at least the adjustment will be done by a right-wing party, in contrast to Brazil, where the same program, essentially, is being pushed by the Workers' Party; and yet the right-wing forces are also trying to bring the left of center government of Dilma Rousseff down; more on that on another post].

In fact, the coming larger fiscal deficits will most likely be used to try to cut social welfare expenditures, which increased significantly during the administration of the outgoing president Cristina Fernández and her predecessor (and husband) Néstor Kirchner. It would not be surprising if Macri tries to privatize social security once again, something that Menem accomplished in the 1990s, and which had to be reversed in the 2000s as a result of the private system’s complete failure to provide a decent retirement for seniors.

But if the Macri administration is a throwback to the neoliberal era of Menem, it is important to remember that the current historical context is very different. Back in the 1990s, the fall of the Berlin Wall and the collapse of the Soviet Union gave the neoliberal policies of the infamous Washington Consensus a status of unquestionable truth. Supposedly, ideology had vanished and history had come to an end. No alternative was politically possible. Since then, the 2008 global Great Recession has shown the world the perils of unfettered capitalism, and even if the “Keynesian moment” was brief and austerity policies have reasserted themselves, at least it is widely understood that the “free market” is no solution for the problems of development in a globalized economy.

The socioeconomic situation in Argentina is also very different. Back then, the economy was coming out of two bouts of hyperinflation, a whole decade of very low growth with very high unemployment levels and very low real wages, two decades of social conflict with a considerably weakening of the trade unions, several military coups, and an unresolved human-rights crisis from the last dictatorship. Now, the economy has grown at a healthy pace over the last decade, though with slower growth over the last three years. Unemployment remains at relatively low levels, and though inflation is relatively high, real wages have still grown significantly over the decade, with a considerable reduction of inequality.

Further, not only has the reorganization of the economy strengthened the working class, but civil society has managed to bring violators of human rights to justice, and finally come to terms with the nefarious legacy of the dictatorship, something unique in the region. The new government does not control congress, and the election was close, signaling a divided country. In short, society is more organized and better prepared to face the onslaught of neoliberal policies this time around.

* Forthcoming in the January/February issue of Dollars & Sense (subscribe; the other contributors are actually good). A version of my talk at the Universidad Nacional de San Martín (UNSAM) last month.

Wednesday, December 2, 2015

Interest rates will go up (almost certain now)

Not a conventional rate

Janet L. Yellen said in her speech at the Economic Club of Washington that rates are going to increase. Perhaps there will be no unanimous decision by the FOMC, but gradual increases should start in December. It must be noted that she did say that: "we cannot yet... declare that the labor market has reached full employment." She is also concerned with the weakness of the global economy, and, hence, of US exports. The forecast in a nutshell:
"I anticipate continued economic growth at a moderate pace that will be sufficient to generate additional increases in employment, further reductions in the remaining margins of labor market slack, and a rise in inflation to our 2 percent objective."
And that means that:
"As you know, there has been considerable focus on the first increase in the federal funds rate after nearly seven years in which that rate has been at its effective lower bound. We have tried to be as clear as possible about the considerations that will affect that decision. Of course, even after the initial increase in the federal funds rate, monetary policy will remain accommodative."
So they will increase, but slowly. On a more theoretical note, if you doubt the actual relevance of mainstream neoclassical economics for policy decisions, the whole thing is informed by what the Fed refers to as the neutral interest rate, which is according to Yellen "a concept closely related to the... 'natural' rate of interest" (Figure above shows the staffs calculations). Alan Blinder says the rate will, eventually (he says in 3 years), reach 3.5%.

I wrote too much on the problems of the concept of a natural rate of interest to repeat myself. Oh well.

Tuesday, December 1, 2015

What to expect in Argentina (in Spanish)

My talk in Argentina last week about what to expect after the right wing electoral victory. In Spanish without subtitles.

My brother and Revista Circus made it possible.

Thinking about Inflation: A conversation with Marc Lavoie

The conversation on inflation with Marc Lavoie at the Fields Institute in Toronto. I think that there was an agreement, between us, and most...