There are many misconceptions about what a government who understands the capacity it has as the currency-issuer can do. As Modern Monetary Theory (MMT) becomes more visible in the public arena, it is evident that people still do not fully grasp the constraints facing such a government. At the more popularist end of the MMT blogosphere you will read statements such that if only the government understood that it can run fiscal deficits with impunity then all would be well in the world. In this blog I want to set a few of those misconceptions straight. The discussion that follows is a continuation of my recent examination of external constraints on governments who seek to maintain full employment. It specifically focuses on less-developed countries and the options that a currency-issuing government might face in such a nation, where essentials like food and energy have to be imported. While there are some general statements that can be made with respect to MMT that apply to any nation where the government issues its own currency, floats its exchange rate, and does not incur foreign currency-denominated debt, we also have to acknowledge special cases that need special policy attention. In the latter case, the specific problems facing a nation cannot be easily overcome just by increasing fiscal deficits. That is not to say that these governments should fall prey to the IMF austerity line. In all likelihood they will still have to run fiscal deficits but that will not be enough to sustain the population. We are about to consider the bottom line here – the real resource constraint. I have written about this before but the message still seems to get lost.
First of all here is a totally general statement about the capacity of a currency-issuing government that applies to any nation and is a fundamental principle of MMT.
Accordingly, such a government can always use its currency-issuing capacity to ensure that all available productive resources that are for sale in that currency, including all idle labour, can be productively engaged.
That is, such a government can always, without exception, ensure there is full employment.
There is no financial constraint on such a government who desires to achieve that desirable policy goal.
While that might sound salutary, and, by comparison with the ambitions of most governments in this neo-liberal era, is light years ahead on any well-being index, it somewhat evades a further question as to whether achieving this desirable goal moves a nation out of poverty.
So, second, here is another totally general statement to complement the first. The worst-case scenario for a nation, irrespective of its government’s currency-issuing capacity, is defined by the real resources that such a nation can access.
If a nation can only access limited quantities of real resources relative to its population, then no matter what capacities the government might have, that nation, in all likelihood, will be poor.
The ultimate constraint on prosperity is the real resources a nation can command, which includes the skills of its people and its natural resource inventory.
Thus, even if the government productively deploys all the resources a nation has available, it will still be poor if its resource base is limited.
Clearly, productively deploying all resources is a necessary condition for prosperity. And that remains the responsibility of the currency-issuing government after all of the non-government sector spending decisions have been made. But it is not a sufficient condition. A nation has to have sufficient resources to be prosperous.
The problem in this neo-liberal era is that currency-issuing governments use the myth that they are financially constrained to avoid fulfilling the responsibility to achieve full employment no matter how resource rich the nation might be.
So we have the obscene situation where even resource rich nations are succumbing to elevated levels of mass unemployment and increasing poverty rates amidst the ‘plenty’ because the ideological currents at the moment that has spawned an obsessive neo-liberal Groupthink are intent on shifting national income distribution in favour of those at the top end at the expense of everyone else.
Please read my blog – Bad luck if you are poor! – for more discussion on this point.
Moreover, world poverty is not being solved as multilateral institutions such as the World Bank, the UNDP, and the IMF, who remain locked in the grip of the neo-liberal myth that austerity leads to prosperity – or should I say, are principle instruments of that myth.
I was at a United Nations Development Program (UNDP) workshop some years ago to discuss employment guarantees.
While the main focus of the two days was meant to be employment guarantees, the conversation appeared to be dominated by discussions about fiscal space. Almost every presenter (bar me and one other) had several slides covering the topic as if it mattered.
The UNDP appears to be obsessed with the concept and it conditions the way they think about macroeconomics and constrains the way they construct the development agenda.
Their policy vision is so constrained by this erroneous thinking that their capacity to eliminate poverty is limited. Countries will never be able to create the requisite number of jobs necessary to fully employ the available labour while they are being advised by ‘experts’ who operate in the neo-liberal macroeconomic paradigm.
I was heavily criticised at the Workshop for daring to marry my advocacy for the Job Guarantee with Modern Monetary Theory (MMT) logic. One UNDP official claimed I had performed a “dis-service” (quote) to the proceedings by talking about macroeconomics in the context of employment guarantees.
He claimed that any discussion of employment guarantees should be de-coupled from the ideological debate about macroeconomic theory. He was warmly clapped by the audience (with notable exceptions). It was an appalling experience. I packed up at the end of my session and drove a few hundred kms south to Washington D.C. where better waters lay!
The problem is that the UNDP are obsessed with macroeconomics.
In its 2004 publication – Making fiscal policy working for the poor – we read:
Macroeconomic policies represent a key ‘entry point’ for the UNDP’s activities to foster human development. In order to present programme countries with viable macro policy options, UNDP seeks to support access to policy advice that presents a menu of feasible options and alternative analyses.
The link between macroeconomic theory and poverty alleviation goals is undeniable. We have to get the former right before we will make significant progress in eliminating poverty.
But both the UNDP and the IMF push a flawed macroeconomic line, which reduces, perhaps negates their ability to meet their stated charters.
The IMF defines – Fiscal space – as the
… room in a government´s budget that allows it to provide resources for a desired purpose without jeopardizing the sustainability of its financial position or the stability of the economy. The idea is that fiscal space must exist or be created if extra resources are to be made available for worthwhile government spending. A government can create fiscal space by raising taxes, securing outside grants, cutting lower priority expenditure, borrowing resources (from citizens or foreign lenders), or borrowing from the banking system (and thereby expanding the money supply). But it must do this without compromising macroeconomic stability and fiscal sustainability – making sure that it has the capacity in the short term and the longer term to finance its desired expenditure programs as well as to service its debt.
The UNDP also talks about fiscal space a lot. In its 2007 publication – Fiscal Space for What? Analytical Issues from a Human Development Perspective we encounter this definition in the first paragraph:
… is the financing that is available to government as a result of concrete policy actions for enhancing resource mobilization, and the reforms necessary to secure the enabling governance, institutional and economic environment for these policy actions to be effective, for a specified set of development objectives.
While the UNDP always exudes a sort of higher moral ground relative to the IMF when discussing economic development, when it comes down to it, there is not much difference at all between the two.
The UNDP and IMF both assume that government has the same constraints that restricted governments during the gold standard when currencies were convertible and exchange rates were fixed. These definitions, despite their subtle differences, could have been written in 1950.
In a fiat monetary system, whether the nation is rich in real resources or poor, the concept of fiscal space is not captured by these ‘financial’ constraint type approaches.
MMT teaches us that:
- A sovereign government is not revenue-constrained which means that fiscal space cannot be defined in financial terms.
- The capacity of the sovereign government to mobilise resources depends only on the real resources available to the nation.
There are hundreds of developing countries that enjoy currency sovereignty which means they can enforce tax liabilities in the currency that the government issues. It doesn’t matter if other currencies are also in use in those countries, which is common.
For example, the USD will often be in use in a LDC alongside the local currency and be preferred by residents in their trading activities. But, typically, the residents still have to get local currency to pay their taxes. That means the government of issue has the capacity to spend in that currency.
And that brings us back to the real resource constraint which is different to a balance of payments constraint.
As long as there are real resources available for use in a LDC, the government can purchase them using its currency power.
Mass unemployment is a major reason for sustained poverty and there are millions of people unemployed across the LDCs. They are real resources which have no ‘market demand’ for their services. The government in each country could easily purchase these services with the local currency without placing pressure on labour costs in the country.
That should be the starting point for a development plan and one I emphasise when I give advice to governments in poorer nations who seek help with regional and community development strategies.
What would be the consequences of this full employment strategy?
The neo-liberals claim that if we try to eliminate poverty with public sector job creation programs, the newly employed workers will increase their food intake (good) and, given that many LDCs import food, this will blow the current account out as imports rise relative to exports and cause inflation.
Why the inflation? Well because the exchange rate apparently enters a death-spiral (depreciation), which soon enough transcends into a full-blown currency crisis. Phew!
Please read my blog from yesterday – Balance of payments constraints – for more discussion on this point.
The reality is that all open economies are susceptible to balance of payments fluctuations. What is usually not mentioned is that these fluctuations were terminal during the fixed exchange rate system for deficit countries because they meant the government had to permanently keep the domestic economy is a depressed state to keep the imports down so as not to run out of foreign reserves.
For a flexible exchange rate economy, the exchange rate does the adjustment. There is no balance of payments constraint facing a nation in this regard.
Is there evidence that fiscal deficits create catastrophic exchange rate depreciation in flexible exchange rate countries? None at all. There is no clear relationship in the research literature that has been established. If you are worried that rising net spending will push up imports then this worry would apply to any spending that underpins growth including private investment spending. The latter, in fact, will probably be more ‘import intensive’ because most LDCs import capital.
Indeed, well-targetted government spending can create domestic activity which replaces imports. For example, Job Guarantee workers could start making things that the nation would normally import including processed food products.
Moreover, a fully employed economy with a skill development structure embedded in the employment guarantee are likely to attract FDI in search of productive labour. So while the current account might move into deficit as the economy grows (which is good because it means the nation is giving less real resources away in return for real imports from abroad) the capital account would move into surplus. The overall net effect is not clear and a surplus is as likely as a deficit.
Finally, even if ultimately the higher growth is consistent with a lower exchange rate this is not something that we should worry about. Lower currency parities can stimulate local employment (via the terms of trade effect) and tend to damage the middle and higher classes more than the poorer groups because luxury imported goods (ski holidays, BMW cars) become more expensive.
These exchange rate movements will tend to be once off adjustments anyway to the higher growth path and need not be a source of on-going inflationary pressure.
Now, what about a nation that has to import all of its essentials to sustain life?
There is considerable research available which reports on how dependent nations are on food imports. The Worldwatch Institute in Washington does some great research in this regard.
Imports of grain, for example, have been rising significantly over the last several decades. The Worldwatch Food Trade and Self-Sufficiency report shows that in 2013:
… more than a third of the world’s nations — 77 in all — imported at least 25 percent of the major grains they needed. This compares to just 49 countries in 1961, an increase of 57 percent over half a century …
Even more worrying, 51 countries—about a quarter of the community of nations—imported more than half of their grain in 2013, and 13 imported all of the grain they needed.
In part, this trend is being exacerbated by IMF development programs, which push nations into an export-led strategy (with cash agricultural products) and destroy the previous sustainable subsistence agriculture.
World markets get flooded with produce, prices fall, the nations cannot service their debts to the IMF, who then pushes more debt and more draconian policies onto them.
I have also written in the past about the indecent way in which financial markets speculate on food commodities and manipulate commodity prices to their advantage. The losers are not just the counter parties to the financial products but the millions of impoverished citizens who cannot access essential food resources even if they are grown within their national borders.
Please read my blogs – Food speculation should be (mostly) banned and We should ban financial speculation on food prices – for more discussion on this point.
But with those considerations aside, we have to acknowledge that if a nation has little that the world wants by way of its exports, and is food dependent on imports (and perhaps, other essential resources) then the capacity of the currency-issuing government to alleviate poverty is limited.
An understanding of MMT should bring that point home.
There are several major shifts in international thinking that have to occur to alleviate this reality.
First, where imported food (or other essentials) dependence exists then the well-being of the citizens in that nation cannot be solved within its own borders, especially if its export potential is limited.
Imposing austerity on these governments is no solution. The world has to take responsibility to ensure that it alleviates any real resource constraints that operate through the balance of payments.
Note, this is not a balance of payments constraint as it is normally considered. It is a real resource constraint arising from the unequal distribution of resources across geographic space and the somewhat arbitrary lines that have been drawn across that space to delineate sovereign states.
In this context, a new multilateral institution should be created to replace both the World Bank and the IMF, which is charged with the responsibility to ensure that these highly disadvantaged nations can access essential real resources such as food and not be priced out of international markets due to exchange rate fluctuations that arise from trade deficits.
I will write more about what that type of institution might look like in terms of governance, resourcing, and all the rest of it.
But in a progressive New World, there is no place for the current multi-lateral institutions such as the IMF and the World Bank.
Second, there has to be international agreements to outlaw speculation by investment banks on food and other essential commodities.
Third, a further progressive policy intervention, which, ideally, should be agreed to at the international level should be to declare illegal speculative financial flows that have no necessary relationship with improving the operation of the real economy. I will write more about that in due course.
In the absence of such international commitments, nations should consider imposing capital controls where they can be beneficial bulwarks against the destructive forces of speculative financial capitalism.
Please read my blog – Are capital controls the answer? – for more discussion on this point.
Fourth, in some situations a case can be made to impose import controls on equity grounds where the export base is thin and a nation is struggling to amass sufficient real resources to ‘feed and clothe’ its people.
While imports are clearly a benefit and exports are clearly cost there are still equity implications involved in the mix of imports that a nation might enjoy.
I heard once that South Africa had the largest per capita ownership of BMW cars, which is astounding, if true, given the mass poverty of the majority of its population.
Selective import controls, if they can be effectively designed, can ensure that a nation with a limited export base can import goods and services that target the provision of benefits via imports to the poor in the first instance.
Fifth, in some cases it will be in the global interest to restrict the capacity of a nation to export. For example, I’m thinking of those arguments where it is better to leave the coal in the ground than to mine it and worsen the environmental damage already existing.
In those cases, a single nation should not be punished for the pattern of geographic resource distribution and a global response is needed to make sure the damage to that nation’s export potential does not impair its ability to import and fight poverty.
I hope this blog has rounded off the recent discussion about balance of payments, external constraints etc.
I also hope it has clarified that a currency-issuing government can certainly use its capacities to improve the well-being of its citizens but in doing so, the nation may still remain poor, if its real resource space is limited.
A major restructuring of the multinational institutional framework, which includes scrapping the World Bank and its other neo-liberal sibling, the IMF is required to provide solutions to poverty in these cases.
The series so far
This is a further part of a series I am writing as background to my next book on globalisation and the capacities of the nation-state. More instalments will come as the research process unfolds.
The series so far:
The blogs in these series should be considered working notes rather than self-contained topics. Ultimately, they will be edited into the final manuscript of my next book due later in 2016.
That is enough for today!
(c) Copyright 2016 William Mitchell. All Rights Reserved.