Malcolm Sawyer - Financial Development, Financialization and Economic Growth

 

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Jorge Castañeda and the wrong lessons from Liberalization Reforms

Jorge Castañeda, ex-advisor to the left of center candidate Cuauhtémoc Cárdenas, and ex-foreign affairs secretary in the right wing administration of Vicente Fox has written here about the need for further reforms in Mexico. He sings the praises of NAFTA.

"NAFTA brought with it a spectacular increase in Mexican exports, as well as a dramatic shift in their composition. But it proved to be a great disappointment in terms of foreign investment inflows and economic growth, which has averaged 2.6% per year over the last two decades – slower than Peru, Chile, Colombia, Brazil, and Uruguay. As a result, Mexico’s income gap with the US and Canada has barely narrowed."

The change in exports was basically associated to an acceleration of the 'maquilization' process, manufacturing exports with low local value added content. No comments on the massive immigration* and the fact that neither growth nor income distribution have improved after NAFTA (both claims often made about what to expect from it from the free trade crowd).

So what should Peña Nieto do? According to Castañeda:

"Energy reform opens up electricity generation and oil exploration, extraction, and refining to private foreign or domestic investment through licenses, concessions, production sharing, or profit sharing. The oil workers’ union has been banished from the board of directors of Pemex, the national oil company, and new contracts for shale oil and gas, together with deep-water prospecting and drilling, will be signed with a government agency, not with Pemex. 

Once the myriad legal and political obstacles are cleared, Mexico will be able to increase oil and gas production, drive down the price of electricity, and stimulate growth in an otherwise lethargic economy."

In other words, deregulation, weakening of unions to attract foreign capital (more secure environment for capital, since Mexico is such a paradise for workers), and that would lead to growth. No changes from the old Washington Consensus mantra.

You would expect that the failures of "Free Trade", liberalization and deregulation were incorporated, as much as the lessons from financial deregulation in the US after the 2008 crisis, but the resilience of Neoliberal ideas, in the face of adverse evidence, is impressive indeed.

* On lack of convergence with the US and immigration Blecker and Esquivel say: "the data show that there has been no economic convergence whatsoever between Mexico and the United States since NAFTA’s enactment. As a result, the historical Mexico-US economic gap in percentage terms has not been reduced after 15 years of free trade, and the incentives to migrate are probably even greater than before." Read their assessment of NAFTA here.

Michael Pettis on Chinese Liberalization Reforms and Economic Growth

Two posts worth reading by Michael Pettis (here and here; might need subscription). He suggests in the first one that reports that consumption in China is much higher than previously thought are exaggerated (Ken Peng suggested here that consumption levels are 10% higher than what is often assumed, i.e. closer to 45% rather than 35% of GDP). He argues that if China is to continue to grow, even at a slightly reduce pace, then it:

"must find a way to grow without even faster growth in credit, and the best way to do so... is to boost consumption growth by sharply increasing the household income share of GDP and to shift investment from the state sector to far more efficient smaller businesses."

No problem with the first part. Not sure about the second, i.e. the notion that small private businesses are more productive than large public firms. In fact, public investment has been central for Chinese growth all along, and if anything it is the decline in public spending that has hurt the recovery in developed countries.

A note of clarification on why he argues that credit expansion is dangerous in China. He says in his most recent post that:

"A recent China Beige Book survey suggests that a large and rising share of new loans is being extended simply to roll over old loans that cannot be repaid out of operating earnings. China needs credit growth, in other words, just to avoid recognising bad loans, and any attempt to constrain money growth is likely to cause a surge in financial distress."

Fair enough, but as noted before here, these bad loans are in Chinese currency and do NOT represent a real threat to economic growth, since the central bank can always act as a lender of last resort in domestic currency. The solution he proposes makes even less sense, namely: interest rate liberalization, which was in the list of measures proposed by the infamous Washington Consensus (point 4 in Williamson's original decalogue).

The idea is that market determined interest rates would be higher and preclude excessive debt accumulation, I imagine. Also, higher interest rates would reduce investment, particularly in housing, again in my interpretation of what Pettis suggests. Yet, the experience in countries that actually liberalized interest rates, and the whole financial system, was not to reduce debt and tame excessive speculation.

The demand for credit depends on real economic activity and if consumption and investment (in particular public investment that is autonomous) continues to expand it will increase even with higher rates of interest. The effect of interest rate/financial liberalization is to increase the share of the pie that goes to creditors and capital in general, which according to Pettis' correct logic would reduce the redistribution towards wages and slowdown growth.

Mind you, although Pettis seems to think about credit creation in mainstream terms, with credit driving economic activity, he can be read as suggesting that growth is demand-led, which is pretty radical.

New Title: The Handbook of the Political Economy of Financial Crises

From the abstract:

The Great Financial Crisis that began in 2007-2008 reminds us with devastating force that financial instability and crises are endemic to capitalist economies that lack powerful and dynamically changing financial regulations that can keep the powerful forces of leverage and credit within sustainable bounds. Economists from Marx to Keynes, and Minsky to Kindleberger have well understood this profoundly important fact, yet the dominant mainstream economics of "rational expectations", "efficient markets" and "laissez-faire" that rationalized widespread financial liberalization and still dominates the economics profession has gotten it, literally, "dead wrong". The Handbook of The Political Economy of Financial Crises describes the theoretical, institutional, and historical factors that can help us understand the forces that create financial crises - with an emphasis on the crisis of 2007- 2008 - and the strengths and weaknesses of varying theoretical perspectives and policy approaches that have tried to comprehend and limit these financial tsunamis.

See more here.

NOTE: Although all of the chapters will be invaluable to the reader, one in particular that will be worth much perusing is by Prof. James Crotty on the irrelevance of efficient market hypothesis (EMH), which can preliminarily be seen here .

IMF's New View on Capital Controls

By Kevin P. Gallagher and Jose Antonio Ocampo

"Weeks before the spring meetings of the International Monetary Fund (IMF) in Washington next month, GDAE Senior Researcher Kevin P. Gallagher and Colombia University economist Jose Antonio Ocampo offer a critical analysis of the IMF's new view on capital account liberalization and the management of capital flows. The article, “The IMF’s New View on Capital Controls,” appears in India's Economic and Political Weekly (see here).

In the 1970s the International Monetary Fund became an advocate of capital account liberalization, and in 1997 it tried to change its Articles of Agreement to include capital account convertibility among its mandates. In contrast, the IMF embraced in December 2012 a new "institutional view" on this issue. While it remains wedded to eventual financial liberalization, it now acknowledges that free movement of capital rests on a weak intellectual foundation. Gallagher and Ocampo claim that this is a step in the right direction, but that the new institutional view still suffers from a number of shortcomings that will need to be addressed in national capitals and in other international fora.

Although a significant step forward, the new institutional view is still out of step with country experience and economic thinking in many respects. In particular, it continues to insist on eventual capital market liberalization despite the lack of evidence supporting it, is too narrow concerning the sanctioned use of capital account regulations on inflows and outflows, and does not deal with the implications for multilateral aspects of regulating cross-border finance."

What is new about the IMF's views on capital controls?

I wanted to write about this topic for a while, but didn't have enough time. The IMF has adopted a new institutional view on capital controls, which will inform their policy advice and surveillance of member countries, which they suggest reflects "a very broad consensus" [I'm always a little bit wary of broad consensuses]. Note that the Fund is still in favor of capital account liberalization, as noted in the second key feature of their institutional view, which says that "capital flow liberalization is generally more beneficial and less risky if countries have reached certain levels or 'thresholds' of financial and institutional development."

The question is how to get beyond the threshold, but there is no doubt that liberalization should be ultimately pursued, at least to some degree. They do add a cautionary note that full liberalization might be an impossible goal for many countries. In their words: "countries with extensive and long-standing measures to limit capital flows are likely to benefit from further liberalization in an orderly manner. There is, however, no presumption that full liberalization is an appropriate goal for all countries at all times."

The new institutional view is based on the notion that capital flows will continue to move away from the center, and that developing countries will be faced with a persistent pressure for the appreciation of their currencies. Blanchard says in his post that "looking at the relevant set of investors suggests higher flows to emerging markets are here to stay." He also suggests that the biggest threat from those inflows, the so-called Dutch Disease that New Developmentalist authors like Bresser-Pereira (here, for example) have emphasized, is not that dangerous and the empirical evidence about it is not well established [by the way, I tend to agree with Blanchard on this one, and believe that fears of a Dutch Disease are exaggerated].

My concerns with the new institutional view are twofold. On the one hand, I would rather not accept a general rule in which the IMF has a say on when and why a member country should use capital controls. Right now countries have a right to do it. So this new institutional view actually reduces policy space for developing countries. Note that the IMF, in spite of all the talk about the new macroeconomics is enforcing austerity in the European periphery. So the orderly manner that would lead to benefits from capital account liberalization are basically fiscal asuterity and inflation targets (slightly higher, 4% and not 2%).

Second, the view of the relevance of capital controls is limited to its effects on exchange rates, its volatility, the risk of appreciation, and last the possibilities of depreciations with disruptive outflows (or sudden stops). I tend to see capital controls as an essential tool not just for exchange rate management, but also for industrial policy, since the availability of dollars is often essential for determining which sectors can be promoted by allowing imports of essential goods (e.g. capital and intermediary goods), and which ones would be forced to rely on domestic substitutes. Import substitution and alternative development policies, of course, remain an anathema at the IMF.

Further, exchange rates are connected and do affect income distribution. It is far from clear that the only thing a country wants to do is avoid 'excessive' appreciation and loss of external competitiveness. Higher wages, associated with appreciated exchange rates, might be relevant for demand expansion too. At any rate, the point is that a great deal of discretionary power by domestic authorities should be the norm when it comes to capital controls. The less power the IMF has in this respect, the better.

Free Trade and Inclusive Development

By Suranjana Nabar-Bhaduri

One of the central elements in the development of any country is the creation of economic activities that transform the production structure by significantly increasing labor productivity, or the amount of production per worker. By helping to absorb more people into quality employment, the creation of such activities helps to generate a more inclusive and sustainable path of long-run economic growth. While economists and policy-makers accept the necessity of this transformation, there are differing views on the policies that developing countries should follow to achieve this transformation.

Many Western countries and institutions, such as the International Monetary Fund (IMF) and the World Bank, argue that minimizing the role of the State in economic activity, and opening up the economy to external markets is vital to achieving this transformation. But other economists (e.g., Prebisch 1959, Cimoli and Correa 2002, and Ocampo 2005) stress that active industrial and employment generation policies are also essential ingredients for this transformation, and that it is necessary to complement liberalization with such policies.

Read the rest here.