The economics of New Developmentalism

New versus Classical Developmentalism

New paper by Tom Palley, titled “The Economics of New Developmentalism: A Critical Assessment” which has been published in Investigacion Economica. Palley argues that "the issues raised will be a key element in the 2022 Brazilian presidential election that will likely pit Ciro Gomes versus Lula in the first round. Gomes aligns with New Developmentalism. Lula inclines to Classical Developmentalism. Of course, economic analysis is just part of the development problematic. It must be reconciled and integrated with the political reality of Latin America’s unethical economic elite, its corrupted political class, and the omnipresent threat of US intervention against change that challenges the economic status quo."

New issue of ROKE is out

The April Issue of the Review of Keynesian Economics is now out. The issue contains a collection of articles covering a spectrum of important issues. It opens with a debate over New Developmentalism which pits development relying on macro prices (especially the exchange rate) against historical state-led development policies. Next, there is an article on the role of the wage share in determining exchange rates. Thereafter, there are several articles on Post Keynesian growth theory. One addresses the evolution of income and wealth inequality, while others empirically assess alternative approaches to theorizing demand growth.

Two paper are open: "A Structuralist and Institutionalist developmental assessment of and reaction to New Developmentalism" by Carlos Aguiar de Medeiros and "Making sense of Piketty's ‘fundamental laws’ in a Post-Keynesian framework: the transitional dynamics of wealth inequality" by
Stefan Ederer and Miriam Rehm.

More on the Argentine adjustment

I'll post a longer discussion later, but I wanted to provide a short update on the situation in Argentina. Everything indicates, as I had noted before, that the government of Macri wanted to accelerate inflation, with depreciation and an increase in the electricity bill.Macri rehired the technician (Graciela Bevacqua) that had been fired by Cristina Kirchner, and that led to the (mostly true) critique that inflation was higher than the official measure indicated.  More importantly, for a government that constantly bashed the previous administration for lying about inflation, they fired the same technician as soon as it became obvious that inflation was accelerating (you can check the numbers in Cavallo's website; this is the son, not the infamous finance minister; as it can be seen inflation accelerates again in November 2015, right after the election, with the huge depreciation of the peso).

Also, it is clear that the economy is slowing down, with the index of production provided by Ferreres suggesting a fall in January of about 1.1%. Not clear what the new unemployment rate is, but the increase in the layoffs in the public sector, and lower growth will lead to higher unemployment. It is true that given the current account problems the economy had already slowed down in the last 3 years or so, but the adjustment and the depreciation will likely throw the economy in a recession (we will see if the hopes of the Argentine new developmentalists pan out, and export-led growth compensates the collapse of the domestic market; I, obviously, doubt it).

Finally, Argentina is also finalizing an agreement with the Vulture Funds, which basically accepts all their demands. Regularizing the situation and having access to international financial markets is not a bad idea, but certainly there was no reason to cave to the Vultures' demands. So more inflation, to reduce real wages, and lower growth, also to weaken the labor force's bargaining power and roll back the social progress of the last decade or so. And that's why Macri was elected anyway.

PS: There are many other problematic issues in this very short administration so far, including the packing of the court, and the treatment of human rights organizations, to name a few. But it seems that in general I more or less got it right in my talk on what to expect in November, and the article that followed.

From BBB-razil to BB+razil or the meaning of investment grade

So Brazil (or here about Petrobras, the State oil company) lost its investment grade status with Standard & Poor's. You would think this is huge given the media attention in Brazil. If you read S&P's actual rationale for the downgrading (here) it is essentially about the fiscal situation. They say: "We now expect the general government deficit to rise to an average of 8% of GDP in 2015 and 2016 before declining to 5.9% in 2017, versus 6.1% in 2014. We do not expect a primary fiscal surplus in 2015 or 2016." They do discuss the political problems too, the corruption investigations,* and the political instability that has plagued the government. There is a discussion of the external vulnerability, but here they are quite sensible and know there is no problem. The report says that: "despite the wider current account deficit, Brazil has low external financing needs compared with its current account receipts and its high level of international reserves compared with some of its peers." So this is a fiscal problem in their view.

And therein lies the problem. They had years ago also revised the outlook of US debt negatively (my comments here), also on the basis of fiscal, and political, factors. As much as the US then, Brazil now has no risk of not paying its internal debt in domestic currency. And yes, the fiscal outlook has worsened, and the reasons are no secret. It's austerity. If you cut spending, output falls, and the recession leads to lower revenue and higher deficits. It's part of the problems caused by policies that S&P's analysts actually favor. Austerity also is the cause of the recession, and the worsening of the growth outlook in the next couple of years, which are also discussed in S&P's rationale for the downgrade. So the fiscal problems that are the main cause for the downgrade are self-inflicted wounds (see Serrano and Summa), and the cause of the lack of growth and the worsening of the future fiscal balances.

But more importantly, the downgrade itself is kind of irrelevant. S&P doesn't think, as I quoted above, that the external situation is particularly problematic. The recession will actually reduce the current account problems, by reducing imports. So there is no external crisis. The devaluation of the real has been part of a global trend, and in part has been reinforced by the government that seems to believe, incorrectly in my view, in the New Developmentalist philosophy that fiscal adjustment (to control inflation) and devaluation (to promote export-led growth) are part of the solution. If the downgrade cannot worsen the external situation, certainly it cannot have an effect on the ability of the government to pay its bills in domestic currency.

At any rate, even if in this case the downgrade is kind of irrelevant, it is important to remember that credit rating agencies were, and still are, one of the worst citizens in international financial markets. They were co-responsible in the bubble, that preceded the crisis, and in the meltdown of the financial sector in the 2008 Global Financial Crisis. The fact that they complain about corruption in Brazil, while they profited giving triple-A ratings to subprime junk is outrageous. And as they say, their views are just opinions. I would add biased and not particularly accurate. They should be put out of business with a public rating agency.

* I could go on on the corruption stuff, but I'll post something later.

Was the devaluation in Argentina good and inevitable: A reply to Rapetti

Back in the mid-1990s I was a student of John Eatwell (his last TA in the microeconomics course at the New School, I think, before he went back to Cambridge), and one thing that has stuck with me over the years is that he argued no economic debate was ever solved by empirical evidence. Hyperbole aside, and I should say it is not a great exaggeration, logic has also not been particularly good a clarifying debates in economics (just think of the Capital Debates).

So last week I wrote this post on why the Argentine devaluation is not a traditional Balance of Payments crisis. As I noted it was a policy decision in the works for a long while. At any rate, neither the real exchange rate, nor the current account are in a position that per se is unsustainable. That is still true, however, Martín Rapetti from the Centro de Estudios de Estado y Sociedad claims I am confused in my criticism of his work, as much as that of Frenkel and Bresser-Pereira, the so-called New Developmentalists, which believe that devaluation is good for growth.

He suggests now that he does not claim that devaluation is good for long run growth (my quote from Bresser in the previous post was very clear suggesting that is in fact what New Developmentalists think). In his words:

"Formulations like mine seem to be the source of another confusion in Matias’ analysis. He argues that people like Luiz Carlos Bresser Pereira, Roberto Frenkel and me were advocating for a devaluation because we support the idea that maintaining a competitive real exchange rate (CRER) is good for growth."

He argues now that the reason for wanting a devaluation was:

"based on the inconsistencies of macroeconomic policy and not on my frustration about the abandonment of the competitive RER strategy that Argentina carried out between 2002 and circa 2008."

Althought Martín does not quite spell out what the contradictions are (and they are not the current account or the real exchange rate apparently, since he says: "He [that would be me, Matías] is right: the current account deficit was only 0.5% of GDP in 2013 (although it would higher without the import controls) and the RER is certainly not as overvalued as in Brazil (which, by the way, is very overvalued [that has no run on the currency, I might add])." The imbalances are one might assume inflation, and the cause of inflation as Frenkel and others have suggested is the excess demand (read fiscal deficits). So he wanted, and by the way I've heard this from almost anybody connected to CEDES, more fiscal adjustment. In fact, in the CEDES story, the government started to move away from good macro policy when Roberto Lavagna, which included several CEDES insiders, left the government at the end of 2005.

On this new position, let me refer again to my previous post (from March 2012) in which I quoted a paper Frenkel presented at a conference organized by Bresser, in which he said:

“the monetary and fiscal policies required to accompany the adoption of a SSCRER target must also have special features: the permanent expansionary stimulus that is part and parcel of the SSCRER heightens the importance of the restraining role to be played by fiscal and monetary policies.”

Let me emphasize this, the notion was that a stable and competitive real exchange rate is so powerful (permanent expansionary stimulus he says, sic) as an instrument for growth that you need fiscal and monetary contraction. Note that devaluation and macroeconomic contraction are the traditional tools of the IMF for countries with balance of payments problems. Part of what I suggested in my previous post is that heterodox authors tended to be more circumspect about the incredible advantages of depreciation. Martín's nuance about disequilibria (fiscal expansion) and not the effects of devaluation on growth are really not clear. If I was confused, he must explain how. Did Frenkel and him changed their position? If so I'm glad, but certainly I'm NOT the one confused here.

His other critique is decidedly bizarre. He argues

"Matías seems to miss the important point that as long as expected depreciation at the exchange rate that the Central Bank is defending is higher than the yield of domestic assets, there would be an excess demand for foreign currency that would eventually lead to the depletion of FX reserves and the collapse of the domestic currency."

First of all, in the post Martín criticizes I say the following:

"Note that if the government on top of the current measures adds fiscal contraction (monetary tightening is a given, since higher rates of interest will be needed to avoid more capital flight; and the effects of monetary contraction can be compensated by subsidized public credit) as the New Developmentalists wanted (since for them inflation was caused by excess demand) then the slowdown will be significant and even a recession could take place."

In other words, yes the government must increase the rate on interest to avoid the expectations of a devaluation. My point indeed was that back in 2012 they should have done that, when the blue was closer to 5, and it was easier to do and avoid a depreciation (which Martín wanted and I didn't) and that he used to think it was good, but now that happened he has second thoughts (you'll see why in a second).

Second, exactly because the problem is the low rates of interest when compared with holding dollars, you see that this is not a problem associated to the exchange rate being overvalued or the current account being unsustainable in the short run. It is something that could have been solved long ago with a higher rate of interest. Mind you, Martín is simply wrong when he says that since 2010 the Central Bank of Argentina was using the nominal exchange rate as an anchor for prices (he is really confused on this one; just check the rate of depreciation), and I should know since I was at the bank at some point during this period (actually Brazil did that, and that explains lower inflation in Brazil).

But here comes the cherry on top of the ice-cream. Why would depreciation still be good for Martín? Because the long-term exchange rate elasticity of exports is actually high. The short-term isn't and that's why in the short run the depreciation will be contractionary and he has some doubts about it. But in the long run things are hunky dory. So here is NOT about imbalances, but depreciation is good for growth because it increases competitiveness and exports (wink, wink, devaluation is not good, but yes it is; and I'm confused!). In his words:

"The problem is that Matías confuses an important distinction between short-run and long-run effects of the real exchange rate on economic performance. In Krugman-Taylor, a real devaluation (a change in the RER) has a negative effect on output and employment in the short run; in Frenkel-Taylor, a competitive RER level has a positive effect on long-run growth."

I guess I missed that class by Lance, and that's the source of my confusion. I should note that I had a few exchanges with Martín on Twitter (see below in Spanish) on which he also suggested that in the long run was good for growth.

@mgrapetti @SSAlfredo y Martin si cambiar los precios relativos resuelve el problema externo, cual es la elasticidad? Pq no das el numero
— Matías Vernengo (@NakedKeynes) June 16, 2013

Here is the problem, Martín (neither him, nor Frenkel or anybody else as far as I know) has shown this great long-term elasticities that show that depreciation in the long-run (the Frenkel-Taylor, not Krugman-Taylor story) is good for growth. The evidence I cited here (from this paper by Fiorito and Silvio and Nahuel Guaita) actually shows that there is no indication of a positive elasticity in any run. If Martín shows that there is some evidence on positive and significant long-term real exchange elasticities for exports (I'm really interested in what methodology he suggests for finding this result, and separate the short and long run elasticities), like Keynes I will change my mind, and try to prove Eatwell wrong on the role of empirical evidence in economic debates. But if you (Martín) cannot come up with evidence to support your nice theoretical model (the Frenkel-Taylor that rules in the long run, are we clear?!), what should we call you? Confused does not seem the correct definition for someone that keeps defending an idea for which there is no evidence (don't worry, I'm not in the game of name calling).

Finally, I should add here, that while I do think that the government has committed mistakes, and allowing the blue (the black market) exchange rate to depreciate and not hike interest rates earlier  is one of those (I would add the need for a more aggressive Import Substitution policy to reduce the external constraint, something I defended as early as March 2012; see here), I still think that this government should be supported and is much better than the alternative (Martín is certainly not in favor of the government).

How bad is the Argentine crisis?

There is a certain view about current events in Argentina that tends to emphasize the potential effects of the devaluation as the collapse of the economic model, and, and, hence, suggest that the post-default process of economic growth should not be taken as an alternative for other countries in distress, like for example Greece and other Southern European countries. This kind of view, expressed for example by Walter Molano in the Financial Times (subscription required; minus the strange argument that the Argentine problem is "geographical"), suggests that policies should be aimed at pleasing international financial markets since the goal is to promote "confidence in the country’s economic management," and that devaluation is necessary for solving the "unsustainable economic imbalances."

First, it must be understood that the current devaluation, which was of the order of 20% in nominal terms in the last days of last week, is part of a plan that was most likely in the works, since the change in the economic team at the end of last November, when the current finance minister, Axel Kicillof, became the sole commander of the economy displacing Guillermo Moreno, and to a lesser extent Mercedes Marcó del Pont (full disclosure, I worked in the central bank during her tenure as president) in the internal domestic dispute.

In other words, this is not a balance of payments crisis (or a currency one) per se, even though it might become one, since it was actually part of a policy decision, first to accelerate the depreciation of the currency, which started in the last month of 2013 after the new finance minister assumed his position, and that culminated with the renegotiation of the debt with the Paris Club (to regain access to international financial markets), and the gradual liberalization of the exchange market, trying to move the official rate closer to the 'blue,' that is, the black market rate. Note that the current account, as I noted before here, is not in a terrible situation, the Brazilian position has been far worse for a longer period, and the real exchange rate was not more appreciated than in Brazil either.

Before discussing my views of what might happen, it is important to note the New Developmentalist views, which are often associated to Bresser-Pereira and in Argentina to Roberto Frenkel and his co-authors, that the re-alignment of the real exchange rate was inevitable and necessary to promote more competitiveness and growth does not hold water (see my previous critique here, and Fiorito and Amico's here). Bresser has in fact argued that this devaluation is likely to be good for Argentina. In his words (the whole article here):

"the peso retrieved the lost competitive equilibrium; the government declared that the peso had reached the desired level, and, without fearing an increase in the dollar's official price, it suspended several restrictions to the purchase of dollars , in order to draw the parallel down. If this strategy of keeping the exchange rate at the competitive level is successful, profit expectations will rise, business enterprises will invest again, the current account surplus will be restored, and the Argentinian crisis will be over."

Martín Rapetti (a Frenkel co-author) remains more skeptical here (in Spanish), but insists it was inevitable (the exchange rate realignment).

In my view, the devaluation was not inevitable and is not particularly good. First, it will be inflationary, and as I noted a few years back, also might be contractionary, so expect less growth this year. The reduced growth is what will hold the current account in a reasonable situation, by the way. Hence, devaluation will not solve either the inflationary problem, nor the external constraint one. In this sense, the crisis (manufactured as it is) is worse than most people understand, since it won't solve any of the pressing problems in Argentina.

Note that if the government on top of the current measures adds fiscal contraction (monetary tightening is a given, since higher rates of interest will be needed to avoid more capital flight; and the effects of monetary contraction can be compensated by subsidized public credit) as the New Developmentalists wanted (since for them inflation was caused by excess demand) then the slowdown will be significant and even a recession could take place. The Plan Progresar (that gives money to young students without jobs) might indicate the opposite disposition, but the crisis might force the government to slowdown the economy to avoid a more serious current account deficit.

A more benign scenario would be that the Central Bank manages to control the depreciation, and stabilize the real exchange rate, likely at a somewhat depreciated rate (how much will depend on wage resistance, and how much inflation we get; my guess is that some real depreciation will take place, and lower real wages will follow, which also will add a contractionary force in domestic demand), but this does not turn into a run on the currency.

As I noted before, there are good reasons to believe that lack of growth in advanced economies and low rates of interests in the center will preclude outflows of capital, if higher real rates of interest are imposed in Argentina (they are still negative now) like Brazil has done. Also, the plateau of commodity prices indicates that the balance of payments will not worsen immediately, so there will still be space to solve the long-term problems associated with excessive dependence on the export of commodities, and to pursue the difficult but necessary process of import substitution.

In short, the default and the process of growth (which was possible because of favorable external conditions, but NOT caused just by that; as I noted several times terms of trade improved less in Argentina than in Brazil, and the former grew far more during the commodity boom period), which was based on fiscal expansion and income redistribution is an alternative to Neoliberal policies. And the way to deal with the limits to the model (which are associated to the external constraint) are not related to the exchange rate, but to industrial policy.

PS: Here a video in which Fabián Amico provides a similar analysis (in Spanish).

Where is the elasticity? (or more on devaluation and growth)

Since 2007 mainstream economists, and often some heterodox (or more precisely eclectic) authors, have suggested that the Argentine economy is on the verge of collapse (see for example my good friend Bresser-Pereira here or this). A typical argument made by both orthodox economists (some of which favored the Convertibility Plan of the 1990s) and the more unconventional is that real exchange rate (RER) appreciation is at the heart of the Argentine problems and the more recent lack of growth.

I have discussed this before here with respect to the so-called Sustainable and Stable Competitive Real Exchange Rate literature (see here). The argument for a SSCRER was put forward by Frenkel and Taylor in a well-known paper, but the notion has many defenders (see the good paper by Blecker and Razmi from Setterfield's essential book on growth), including more conventional authors like Rodrik. At the risk of being repetitive let me point out the pros and cons of the arguments for devaluation.

Depreciation protects local industry and leads to a boost to domestic production, and also, by leading to an increase in exports, reduces the external constraint of the economy. That would be the substitution effect associated to the change in the relative prices. Yet depreciation also (everything else constant) reduces wages, increases the profits of exporters, and leads (yes, the economy is wage-led) to a reduction in spending and lower levels of activity. In this case, a depreciation does help reduce your external constraint, but by leading to a contraction. The second effect, associated to an income effect, was well-known by heterodox authors, having been developed by Albert Hirschman and Carlos Diaz-Alejandro (for the Argentine case) and then formalized by Krugman and Taylor (see here; subscription required).

At the end of the day it is an empirical question. All the evidence seems to suggest, at least for the Argentine case (here paper by Fiorito and others in Spanish; but it seems to be more general, see here) that income effects tend to be larger than substitution effects, and hence one might be concerned about possible contractionary effects of a depreciation.

In the case of Argentina, it is clear that the expansion of the volume of exports goes hand in hand with the expansion of the world GDP (Figure below).

The relation between the real exchange rate and exports is less clear. As it is shown below after the large real depreciation in 2002, growth in the volume of exports goes hand in hand with significant appreciation.

No doubt defenders of depreciation will argue that the big depreciation in 2002 was essential for export growth afterwards (see Rapetti here who argues that "competitive RER was a key factor behind Argentina’s recovery and growth"). But if you put the depreciation in the wider macroeconomic context of 2002, and compare with the current one, you are bound to have second thoughts.

The depreciated nominal exchange rate in a context of high unemployment (around 22%) did not lead to inflationary pressures, since wage demands were subdued (and hence the nominal depreciation translated into a large real one). Second, spare capacity meant that the protection afforded by the real depreciation led to a huge expansion of domestic production, spurred by the expansion of domestic demand (higher real wages and expansion of fiscal spending, particularly in social programs). Exports actually don't seem to move much with the depreciation. There is no econometric evidence for large elasticity of exports with respect to the exchange rate, in the short or long-run (if someone has it please, please, pretty please with a cherry on top share it; it's been frustrating to have an argument with people that argue a point for which there is no known evidence).

Note that all the above mentioned conditions are not in place now. Unemployment is considerably lower (around 7% or so), and the expansion of real wages and government spending have slowed down (so much so, that in the last year the economy has stalled). So maybe we need less Frenkel and Taylor and more Krugman and Taylor to understand what is going on in Argentina right now.