Saturday, June 29, 2019

Forty Years of Balance of Payments Constrained Growth and Thirlwall's Law

From original draft by Thirlwall

Thirlwall's seminal paper on the balance of payments (BOP) constrained growth is forty years old. Paul Davidson once referred to the BOP constrained growth as a positive Post Keynesian contribution to economics. The Review of Keynesian Economics (ROKE) will publish soon a special issue with many well-known contributors to the literature, and with a paper by Thirlwall himself.

The idea built on the Kaldorian supermultiplier model (Kaldor mark II), and with a few simplifying assumptions, it showed that economic growth depends on the rate of growth of exports divided by the the income elasticity of demand for imports. A very similar idea, as Thirlwall knew, was developed by Raúl Prebisch and Latin American Structuralists. The model, contrary to the dominant mainstream growth model at the time (the Solow model), was demand-led, and allowed for significant divergence between center and periphery.

The 1970s were a period in which both macroeconomic research was biased towards short-term issues, with stabilization after the oil shocks and inflation acceleration becoming central, and also it was the decade in which heterodox groups were effectively segregated from the profession, publishing in alternative journals. These factors certainly affected the popularity of the model.

The most remarkable thing about the model, beyond its simplicity, is its incredible empirical relevance. So much so that is one of the few regularities that has been called a Law (like Okun's, for example). Financial flows might reduce under certain circumstances, the BOP constraint, but at the end of the day, capital flows must be paid with exports, and that implies that the constraint for developing countries is a strong limit to expansion. In advanced economies, income distribution and class conflict might play a more relevant role.

At any rate, it seems that under different circumstances, particularly regarding the sociology of the economics profession, this would have been a contribution meriting the Sveriges Riksbank Economics Prize in Memory of Alfred Nobel.

Will post more, with links to free papers soon.

PS: I haven't written much on Thirlwall's law, but here is a paper in response to a critique by Jaime Ros and a co-author, published by Investigación Económica, in Spanish.

Friday, June 28, 2019

Capital Flows to the Periphery: Still ‘push’, but with significantly lower risk spreads

Gabriel Aidar and Julia Braga (Guest Bloggers)

We have, in our new paper, gone back to the old pull-push debate on determinants of capital inflows to emerging markets, to look at the behavior of country risk premium spreads. Our Principal Component Analysis of the country-risk spread series of ten emerging economies from 1999 to 2019 revealed that 86% of the total volatility of the original series can be represented by only two components, suggesting the prevalence of common factors in determining country risk. This evidence, reinforced by the correlation of the first major component with global liquidity indicators, corroborates our hypothesis that the sovereign risk trend is driven by external factors, in line with the push literature. This is clearly shown in the graph below that shows the Evolution of the EMBI+ emerging market risk spreads against EMBI Brazil over time.

Our contribution strengthens the thesis, stressed by Medeiros (2008), about the subordination of economic cycles in developing economies to global financial cycles. This in effect imposes an (asymmetric) constraint for the management of domestic monetary policy. To avoid capital outflows and/or successive exchange rate devaluations, the domestic interest rate should not remain lower than the international reference interest rate added to its country risk premium (Serrano and Summa, 2015). This constraint has changed significantly in the 2000s.

In the recent expansionary cycle of global liquidity, many developing economies seems to have taken advantage of this window of opportunity to simultaneously grow more and reduce their external vulnerability. These two movements ended up having the combined effect of lowering the collective external fragility of the developing economies (Freitas et al., 2016; Serrano, 2013). As a result of this change, developing economies experienced a virtually unprecedented period of reduction of Balance of payments crises. As we show in the paper, and can also be clearly seen in the graph, these favorable developments led to a once for all structural break at the level of sovereign risk spreads, that have fallen significantly after 2002. This seems to be the reason why the risk spreads have not risen again to the levels prevailing in the 1990s. Although the risk spreads continued to respond to international financial indicators and have risen both during the 2008/2009 world financial crisis and also in 2014/15, when the FED threatened to raise the interest rate and began to phase down nonconventional monetary policies, developing economies are now in a much better position to deal with those changes. This is what we can read in current pattern of risk premium spreads that, although still vary in response to changes of the relevant international financial indicators, do it around a significantly lower average.


Freitas, F., de Medeiros, C. A., and Serrano, F. 2016. Regimes de política econômica e o descolamento da tendência de crescimento dos países em desenvolvimento nos anos 2000, in “Dimensões estratégicas do desenvolvimento brasileiro. Continuidade e mudança no cenário global: desafios à inserção do Brasil”, 17–46

Medeiros, C. A. de. 2008. Financial dependency and growth cycles in Latin American countries, Journal of Post Keynesian Economics, vol. 31, no. 1, 79–99

Serrano, F. 2013. Continuity and Change in the International Economic Order: Towards a Sraffian Interpretation of the Changing Trend of Commodity Prices in the 2000s, pp. 195–222, in Sraffa and the Reconstruction of Economic Theory: Volume Two, UK, Springer

Serrano, F. and Summa, R. 2015. Mundell–Fleming without the LM curve: the exogenous interest rate in an open economy, Review of Keynesian Economics, vol. 3, no. 2, 248–68

Friday, June 21, 2019

Handbook of the History of Money and Currency

The Handbook (subscription required) has been edited by Stefano Battilossi, Youssef Cassis and Kazuhiko Yago. It has many interesting chapters. Barry Eichengreen writes on what determines that a currency is used as an international currency (or even as the predominant currency). While he follows conventional views in suggesting that role of money as a means of exchange and the importance of the country in international transactions, he does also explore the role of power (military power) behind the key currency. My take on that topic in this paper with David Fields here.

There is also a very readable paper on the history of central banks by Stefano Ugolini here. It follows the evolutionary approach of Roberds and Velde, and in my view also suffers from conventional views on monetary theory that emphasize the exchange role of currencies, rather than the unit of account function. As a result, it downplays the role of fiscal agent of the state, that in my view was key in the early experiences with public banks. I would emphasize the importance of the development of public debt for the subsequent evolution of public banks, and the relevance of early central banks in the management of the Fiscal-Military State. On this see this and this.

There are interesting papers on paper money experiences, by François Velde (here) or on deflation, by  Richard Burdekin (here), to cite a couple.  There is, also, our entry (with Esteban Pérez) on the history of Central Banking in Latin America (here).

Tuesday, June 11, 2019

Catching up and falling behind in historical perspective

The figure below, from a recent piece in the Wall Street Journal, shows the catching up of the South. Note that most occurs after the New Deal, and up to the 1980s. The piece emphasizes the reversal, with divergence since the last recession. This suggests that the New Deal and the period in which the segregationist policies were eliminated were a period of prosperity for the South.

The catching up story is one associated mostly to State action, since the New Deal in many ways was a sort of Marshall Plan for the South (think TVA), even though the WSJ piece emphasizes policies, like lower taxes, and the lack of unions. And there is a lot to discuss there.

But what surprised me by looking at the graph, and the story I think is more interesting, is the apparent relative decline of the West. The story, like that of Argentina, for example, is one of persistent decline over the whole 20th century. And that's obviously not what you would imagine about the West, that went from a backwater, essentially rich in natural resources (e.g. Gold Rush), to a  prosperous region with the most dynamic innovation hubs in the US (Silicon Valley).

So the continuous decline of income per capita in the West is NOT a story of persistent decline. In many ways it is exactly the opposite of that. You start with very low levels of population and income, and an accident, associated to the existence of high value natural resources leads to an economic boom. Gold, oil and other minerals in the case of the West, and in some parts high agricultural productivity. Income per capita shoots fast up, and by the time of the graph you have that it is way above the US average. Which explains the heavy inflow of immigrants, which in turn explains, as the population in the West as a share of total US population increases, the decline in income per capita.

But that process goes hand in hand with the development of sophisticated manufacturing in the West, from aeronautics and aviation to computer and information industries. In this case, the story of lower income per capita with respect to the country is not a history of decline, and the early history, in spite of the high income per capita suggests a relatively unsophisticated economy. That's an important analogy when you think of cases like Argentina.

Wednesday, June 5, 2019

Argentina, Financial Times and the next default

It's been a while since I wrote about Argentina. In all fairness, because it is difficult given all the mistakes of the last few years since Macri's victory. I discussed the prospects of what to expect back then. Since then I posted here and here on the supposed improvement in 2017, and the beginning of the still unfolding crisis in 2018. And this could simply be an "I told you so post," since I did warn about most things that would happen. But there are important and interesting news about Argentina, now that there is at least some clarity about who will run against Macri this year.

Cristina Kirchner finally announced she's running for the vice-presidency, and that her husband's chief of staff (when Néstor was president), Alberto Fernández, will be at the top of the ticket. Some have suggested that this is a great move that will allow to unify Peronism, which might lead to victory in the election later this year. As a response, the editorial board of the Financial Times (FT) published a piece in which it suggests that given the low popularity of Macri's austerity measures backed by the International Monetary Fund (IMF) policies, that a return of Peronism, would be possible, but a huge mistake for Argentina.

There are many problems in FT's analysis. FT's piece suggests that "Mr. Macri's austerity programme is broadly on track to deliver long term gains for Argentina." There is a fundamental misconception in their argument. Argentina's problems are not fiscal, caused by excessive government spending, but external caused by excessive borrowing in foreign currency. Mr. Macri took over in 2015 with foreign debt at around 70 billion dollars, and proceeded to more than double it to approximately 160 billion dollars, as shown in the figure below (elaborated by Juan Matías De Lucchi, for a paper we co-authored in Spanish and that should be published soon). Foreign denominated debt is now higher than it was before the 2002 default, if smaller as a share of GDP (red line).
Note that while Macri inherited a situation of high inflation, significant fiscal deficits (those are in domestic currency), and an external constraint, mostly associated to an energetic external deficit (that one in foreign currency), the external debt situation was deemed sustainable by everybody back then. Note that inflation was ultimately the result of a sequence of small devaluations, and significant wage resistance during the years of Kirchnerism, and that the external constraint resulted from an inability to diversify exports, and particularly of reducing import necessities in the energy sector. The fiscal situation was not problematic, and there was no problem with financing domestic spending, and no serious inflationary pressures coming from the Central Bank financing the Treasury.

The Macri government established those propositions. His team, stacked with very 'serious' mainstream economists like Federico Sturzenegger, who argued that increase in the domestic energy price bills would have no inflationary impact, believed that inflation could be solved in a simple way by stopping the financing of the Treasury. Inflation was in Monetarist fashion a question of too much money. They also believed, to some extent, that a devaluation would solve external problems if it happened. But they expected a surge in foreign investment that would lead to growth and also put pressure for the appreciation of the peso. Of course, the outcome of their liberalization of the foreign exchange market, and their Monetarist experiment led to higher inflation and depreciation.* Fiscal adjustment and the firing of many government workers led to a recession, and higher unemployment. That was the macroeconomic package of the government, even before the IMF.**

Note that there was no need at that point to borrow in international markets in foreign currency. The current account deficit was manageable, foreign debt obligations were relatively low, and the capital flight caused by the liberalization of the foreign exchange market could had been stopped, to some extent, with a hike in the interest rate. Of course they should have been more careful about the liberalization of the external accounts, but that was probably too much to ask from this government of financial operators with deep ties to Wall Street and international financial markets (and a president with accounts in tax havens, documented in the Panama papers).

Macri's government renegotiated the debt with the vultures, the final step for Argentina to re-enter financial markets, under conditions that were excessively generous, one might add. And note that the external debt had already been significantly reduced by the successful renegotiation of the Kirchners with 93 percent of debt holders (and the Macristas talked about a heavy inheritance!). Minor increases in the rate of interest in the US, which in most places led to minor depreciations, coped with interest rates that at times were negative in real terms, led to massive flight. But the government continued to borrow in foreign currency, when almost every country in the periphery has been able to borrow in domestic currency.

That of course was no mistake. This government has promoted a massive increase in foreign debt to finance large amounts of capital flight. The IMF has essentially validated this model, by allowing the government to use the loan to contain the exchange rate. This government has created conditions for a huge amount of dollars to be purchased by essentially their friends in financial markets. It is a financial racket. This is obviously not sustainable, and a relative safe position has been turned into a possible default soon. Not surprisingly the specter of Peronism haunts Argentina.

* On some level the government wanted higher inflation, in order to reduce real wages, something I noted back in 2015. They also wanted a recession, to help reduce the bargaining power of workers.

** As I often say, our elites don't need the IMF, they carry the orthodox gene in their economic DNA.

Podcast with about the never ending crisis in Argentina

Podcast with about the never ending crisis in Argentina with Fabián Amico, and myself and interview by Carlos Pinkusfeld Bastos and Caio Be...