I am researching a new book project at present. I plan with a (development economist) colleague to outline a new development agenda for low income countries. The imposition of neo-liberal policy agenda has artificially and immorally constrained development in the poorest nations. This paradigm is in denial of the opportunities forthcoming to a sovereign government to expand employment and national well-being. We intend to outline a modern monetary approach to economic development as a rival development paradigm. As part of this project, I was reading a research report released last week by the Centre of Economic Policy Research (Washington). The report shows that around 75 per cent of IMF agreements in the current downturn are pro-cyclical. That is we learn what we have always known – the IMF should not be allowed out without supervision.
The research paper:
… looks at IMF agreements with 41 countries. These include Stand-By Arrangements (SBA), Poverty Reduction and Growth Facilities (PRGF), and Exogenous Shocks Facilities (ESF) … [and] … finds that 31 of the 41 agreements contain pro-cyclical macroeconomic policies. These are either pro-cyclical fiscal or monetary policies – or in 15 cases, both – that, in the face of a significant slowdown in growth or in a recession, would be expected to exacerbate the downturn..
Pro-cyclical means going in the same direction as the business cycle. So in a recession, a procyclical policy is one which contracts the economy further – that is reinforces the recession.
Some of the problem arises from the fact that the IMF forecasts for these nations were overly optimistic. The forecasting errors arose because the IMF failed to see the crisis coming. Why?
Easy. Despite it having a huge research capacity the IMF employs economic theory and analytical frameworks which are inapplicable to fiat monetary systems and so the lens through which they attempt to understand the economy is blurred from the start.
Where I see a budget surplus squeezing non-government liquidity and forcing the latter into increased indebtedness to keep the level of spending up and growth going and conclude that a crash is imminent; the IMF sees a virtuous state of government saving and retiring public debt and the non-government sector building wealth. Every six months it releases its World Economic Outlook and we read this sort of analysis from them, as the asset bubble was inflating and it was only a matter of time before it burst.
Further, where I see a budget deficit underpinning social and economic development in a poor nation – providing education, health advances, public infrastructure, employment; the IMF sees a dangerous inflationary bias building up which will release a torrent of speculation on the nation’s currency and social decay will follow.
And again, where I see ships loaded with trees for export and the devastation of a country’s natural eco-system and subsistence agriculture as an anti-development strategy; the IMF encourages export-led growth strategy in every case. It is obsessed with ripping the natural resources from countries and turning sustainable subsistence farming activities into commercialised cash crops. When the world’s supply becomes excessive and the nations start to falter, who else but the IMF steps in with loans. Meanwhile, the subsistence methods become lost because the farms have been turned into machine-laden cash crop centres.
So given the way they attempt to understand the world and tell us about that understanding is flawed at the most elemental level, it is no surprise that the IMF is incapable of foreseeing unsustainable situations emerging. It is also no surprise that they will always invoke policies that constrain and economy from achieving full employment and, instead, propose policies which will never generate sustainable development with high employment levels.
In this context, the Report makes an interesting point:
… the IMF has a history of over-optimistic projections in many countries. So it is not so easy to separate forecasting errors from an underlying bias toward overly restrictive fiscal and monetary policies.
However, we know that the IMF does have an underlying bias towards restrictive policy settings irrespective of their forecasts.
Part of the problem also relates to their obsession with inflation – or expelling it from the system. This obsession dates back to the dominance of monetarism and Milton Friedman in the 1970s and 190s. The IMF thus sees tight monetary policy (that is, high interest rate regimes) as being in some way a safeguard against inflation.
In the current recession this has been especially an issue given the IMF confused the oil price hikes with a permanent upward trend in inflation and pushed tight (procyclical) monetary policy onto nations.
This all might come as a surprise to you given that I have written about the IMF support from the expansionary fiscal policies (and relatively easy money policy) in the current recession – see this blog, as an example.
So what is going on? Well the IMF takes a different view to developing countries. The Report captures it in this way:
The economic argument for this double standard is that developing countries face a much more binding foreign exchange constraint. That is, if they stimulate their economies during a downturn they run the risk of expanding current account deficits and therefore running low on foreign exchange. Countries with hard currencies (the United States, Eurozone countries, Japan) do not face the same constraint, and of course the U.S. has the added advantage that the U.S. dollar is the world’s key currency. However, developing countries that have sufficient reserves are in very much the same position as the high-income countries.
This is backwards reasoning. I should note at the outset that the CEPR, while sympathetic to a progressive policy agenda is still very much wedded to the deficit-dove approach, that old-style Keynesians follow. They see the need for deficits sometimes but worry about public debt issuance (fail to understand why it is issued) and have nonsensical rules that debt-GDP ratios should be stable. In turn, these rules limit the size of the deficit – or so they think.
So “deficit doves” think deficits are fine as long as you wind them back over the cycle (and offset them with surpluses to average out to zero) and keep the public debt-GDP ratio in line with the ratio of the real interest rate to output growth. Torturous formulas are provided to students on all of this under the presumption that the government faces a financing constraint and as long as it is cautious things will be fine.
The CEPR has in recent days proposed employment policies which clearly indicate it doesn’t understand how the currency works. I intend to analyse these in a separate blog sometime soon.
But the point here is that under fixed exchange rates, a current account deficit was problematic and limited by the accumulation of foreign reserves (particularly US dollars) that a country had. Chronic CAD countries were always faced with domestic contraction to take the pressure of their currency and allow the central bank to maintain the fixed parity.
The political fallout that CAD nations had to deal with was one of the reasons the Bretton Woods system collapsed (finally) in 1971. For example, in the 1960s, Britain was faced with stagnation if it held its Sterling parity with the USD. A large nation like this carried clout and its subsequent “competitive devaluations” placed the fixed exchange rate system into jeopardy … and ultimate collapse.
Further, under flexible exchange rate system, any country which is running a CAD is according to modern monetary theory (MMT) “financing” the desires of foreigners to accumulate financial assets (or other assets) in the currency of issue. That is the reason that the foreigners are willing the ship more real goods and services to the country than the latter has to ship back to the foreigners.
So a CAD in any country with flexible exchange rates, are positive for welfare because exports impose costs and imports provide benefits to the nation in question.
It is true that the foreigners may reduce their desire to hold financial assets in the currency of that nation, in which case its trade account is forced to adjust. There is no doubt that a sharp and sudden adjustment can be hard on welfare levels.
It is also true that a lot of countries are bullied into contracting in foreign currencies which then cause it problems if their export revenue declines. The IMF in particular forces developing countries to contract in foreign currencies. This is madness and exposes the country to the risk of insolvency should it run short of foreign currency reserves. MMT tells us that a nation should never contract in foreign currencies if it wants to to preserve the zero risk of insolvency that a sovereign currency bestows on a government.
Finally, as Argentina has demonstrated – a nation that runs out of foreign reserves can default on its foreign currency obligations without long-term problems. Normally, a nation running a flexible exchange rate will not be forced into this position.
As an aside, Argentina’s problems arose from the fact that it was running a currency board where the peso was pegged against the USD. It was madness to enter into such an agreement in the first place given it was sovereign in its own currency. As soon as it entered that agreement (in 1991) it lost sovereignty and was headed for the ultimate collapse that occurred in late 2001.
It is interesting to consider the case of Latvia which has entered an IMF loan agreement during the current crisis. The CEPR Report says:
In the case of Latvia, for example, the pro-cyclical policies have been part of an effort to preserve a pegged exchange rate. This is similar to IMF-supported policy in Argentina during their steep recession of 1998-2002, where a fixed, overvalued exchange rate was supported with tens of billions of dollars of loans until it inevitably collapsed. In cases such as Argentina and Latvia, maintaining the peg means that adjustment must take place through shrinking the economy and real wage declines. Latvia’s GDP is projected to shrink by 18 percent this year.
So Latvia should first abandon the peg and then default on any loans that the government cannot pay or renegotiate them in the local currency – the Lat.
So this obsession of the IMF with stifling current account deficits in developing countries and forcing export-led growth is without a firm foundation in MMT. It reflects the inapplicable notions that mainstream economics uses to analyse economic behaviour. The same precepts that have led to this financial and real economic collapse.
The CEPR Report says:
The purpose of IMF lending during a world recession should be – as much as possible – to provide sufficient reserves so that borrowing countries can pursue the expansionary macroeconomic policies that high-income countries are capable of, in order to minimize the loss of employment and output, as well as more permanent or long-lasting damage that sometimes occurs in the most vulnerable countries.
Again, they are displaying their neo-liberal bias – that governments in developing countries like high-income countries have to borrow to spend in their own currency. Of-course, they do not. They can buy whatever is for offer in their own currency including all the idle labour. Not to many impoverished workers in developing countries will demand USD before they will offer an hour’s work!
What is pro-cyclical policy?
The CEPR Report considered fiscal policy to be pro-cyclical if there was a “a programmed reduction in the fiscal deficit (or an increase in the fiscal surplus) during a recession or significant growth slowdown” and monetary policy to be pro-cyclical if there was “an increase in policy interest rates during a recession or significant growth slowdown” or an explicit “tightening of monetary policy” (via constrained “reserve money growth”).
The following table is taken from Table 1 of the CEPR Report.
The IMF has a long-history of damaging the poorest nations. The so-called structural adjustment programs (SAPs) entered the scene in the late 1970s with the debt crisis that engulfed the world. This was constructed as a crisis for the developing nations but it was really a crisis for the first-world banks. The IMF made sure the poorest nations continued to transfer resources to the richest under these SAPs.
The overwhelming evidence is that these programs increase poverty and hardship rather than the other way around. The following graph comes from the World Development Indicators, provided by the World Bank. It shows Gross National Income per capita, which, in material terms is an indicator of increasing welfare.
Latin America and Sub-Saharan Africa (which dominates the low income countries) were the regions that bore the brunt of the IMF SAPs since the 1980s.
While the high income countries enjoyed strong per capita income growth over the period shown (since 1980), Latin America (and the Caribbean) has experienced modest growth and the low income countries actually became poorer between 1980 and 2006.
The two trends are not unrelated. The SAPs are responsible for transferring income from resource wealth from low income to high income countries.
There are many mechanisms through which the SAPs have increased poverty. First, fiscal austerity is almost always targetted at cutting welfare services to the poor – which often means health and education (the IMF claims that educational and health cuts no longer happen). But moreover, the cuts prevent sovereign governments from building public infrastructure and directly creating public employment.
Second, public assets are typically privatised. Foreign investors often benefit signicantly by taking ownership of the valuable resources.
Third, contractionary monetary policy forces interest rates up which often discriminate against women who survive running small businesses.
Fourth, export-led growth strategies transform rural sectors which traditionally provided enough food for subsistance consumption. Smaller land holdings are concentrated into larger cash crop plantations or farms aimed at penetrating foreign markets. When international markets are over-supplied, the IMF then steps in with further loans. But the original fabric of the land use is lost and food poverty increases.
Fifth, user pays regimes are typically imposed which increases costs of health care, education, power, and in some notable cases, reticulated clean water. Many of the poorest cohorts are prevented from using resources once user pays is introduced.
Sixth, trade liberalisation involves reductions in tariffs and capital controls. Often the elimination of protection reduces employment levels in exporting industries. Further, in some parts of the world child labour becomes exploited so as to remain “competitive”.
I could go on about this at length. I haven’t touched on the way the IMF loans help private firms (often large multinationals like BP, ExxonMobil and others) undermine the natural environment in poor countries.
Anyway, next week I am off to Kazakhstan on an Asian Development Bank mission and I will be providing advice to various Central Asian governments. I will be telling them to float their exchange rates, cut their interest rates, and expand fiscal policy to provide employment guarantees and skills development.
I will report each day while away as to how things are going! The IMF have been visiting this region a lot in the last year or so and so I expect to meet a lot of resistance to different ideas. But things are not working out for these countries and they have tried 15 or more years of market liberalisation and IMF-style remedies to no avail. They realise it is time to do things better. MMT has the answers to help them do that.
Neo-liberal abuse of children
The Washington D.C.-based Employment Policies Institute (EPI) has launched what it calls a “high-profile, multi-million dollar ad campaign highlighting the threat posed by unsustainable borrowing and spending.”
They have a television campaign where young children in a classroom recite the so-called Pledge of Allegiance
I pledge allegiance to America’s debt and to the Chinese government that lends us money. And to the interest for which we pay compoundable with higher taxes and lower pay until the day we die.
Mike Norman (friend of MMT) has the video of the child abuse here. I would rather link to him rather than the original site so they don’t get deluded that 10,000 more hits have come their way.
In the press release the EPI said:
… This campaign is all about getting people to understand the frightening reality of the massive federal debt … People do not realize just how much 12 trillion dollars is, and what it will take for our country to get out from under that level of debt. Americans also aren’t aware of how much money we now owe to foreign governments and just how unsustainable our current level of spending is. We have to do something to defeat the debt now, or we will live to regret it.
You cannot get more manic than that. 12 trillion dollars = 12 trillion dollars. If that is the public debt so what? What is the unemployment rate? What is the GDP growth rate? What is the state of inner-city housing? The education system? The health system? These are the things that will determine America’s future not the debt level.