Development Policy in an UnEqual World : Financing for Development and Growth

1. Development Policy in an UnEqual World:Financing for Development and Growth IDEA’s Workshop “Development Experiences and Policy Options for a Changing World Tsinghua University, Beijing, 5 June 2007 Jan Kregel Senior Scholar, Levy Economics Institute of Bard College Distinguished Professor, Center for Full Employment and Price Stability, University of MIssiouri, Kansas City

2. Post War Approach to Development • Constraints: • Deficient Domestic Savings • Scarcity of Domestic Resources • Deficient Capacity to Produce Capital Goods • How to Overcome constraints: • Increase Domestic Savings • External Financing for Development • Official development assistance -- ODA • Private aid and investment flows --FDI

3. Application in the United Nations • First United Nations Development Decade-1960 • One per cent of developed country GDP to be transferred to developing countries to achieve Five per cent growth of GDP • 0.3 per cent private flows, 0.7 per cent ODA • Growth Rate Target Achieved • Official Aid Target Was Not

4. Theoretical Support for External Financing for Development “The basic argument for international investment of capital is that under normal conditions it results in the movement of capital from countries in which its marginal value productivity is low to countries in which its marginal value productivity is high and that it thus tends toward an equalization of marginal value productivity of capital throughout the world and consequently toward a maximum contribution of the world’s capital resources to world production and income.” Jacob Viner, “International Finance in the postwar World,”Journal of Political Economy, 55, April, 1947, p. 98.

5. Implicit Assumption: scarcity of capital in developing countries • Negative relation between capital intensity and rate of return • You can measure capital scarcity/intensity • Foreign capital inflows finance investment • There is a high elasticity of substitution between financial assets and real assets • Fixed Exchange Rates or insurable exchange rate risk

6. Few of these Assumptions can be theoretically verified • No monotonic negative relation between capital intensity and rate of return • No unambiguous measure of capital intensity • No empirical evidence that foreign capital inflows increase domestic investment • However, in Latin America they do increase consumption • There is negligible elasticity of substitution between financial assets and real assets

7. Nor are they verified in practice • Negative net transfers have been the rule • 1960s, • Latin American lost decade of the 1980s, • financial crises of the 1990s • Reserve accumulations of the 2000s • Private Flows have become dominant • Resource flows not subject to development needs, but to private incentives

8. Transfers in First Development Decade under Alliance for Progress Former Chilean finance minister Gabriel Valdes to President Nixon, June 12, 1969 “It is generally believed that our continent receives real financial aid. The data show the opposite. We can affirm that Latin America is making a contribution to financing the development of the United States and of other industrialized countries. Private investment has meant and does mean for Latin America that the sums taken out of our continent are several times higher than those that are invested. ... In one word, we know that Latin America gives more than it receives.”

10. Modern Explanation • Real Growth Theory • Increasing returns to investment in • Human capital • Market institutions • Investment in Developed countries may thus have higher returns than investment in Developing countries • Global Financial Markets may thus may be efficient in producing negative net resource flows • Rediscovery of position of Nicholas Kaldor and Ragnar Nurkse

11. Modern Policy Proposal: Build Financial Institutions “The case for capital account liberalization is a case for capital seeking the highest productivity investments. We have seen in recent months in Asia -- as at many points in the past in other countries -- the danger of opening up the capital account when incentives are distorted and domestic regulation and supervision is inadequate. … The right response to these experiences is much less to slow the pace of capital account liberalization than to accelerate the pace of creating an environment in which capital will flow to its highest return use. And one of the best ways to accelerate the process of developing such a system is to open up to foreign financial service providers, and all the competition, capital and expertise which they bring with them.” Summers, Lawrence (1998) US Government Press Release, 2286, March 9, 1998: “Deputy Secretary Summers Remarks Before The International Monetary Fund.”

12. What do Foreign Financial Institutions Contribute? • Foreign Banks were the first to exit Argentina in 2000 • Before the Corralito was imposed • Before the Suspension of debt service • Did not act to create stable domestic environment • In Brazil foreign banks are less efficient than domestic banks • Foreign acquisitions of Latin American banks have been of the best domestic performers See Mario Tonveronachi, “The Role of Foreign Banks in Emerging Countries – The Case of Argentina, 1993-2000, investigación económica, vol LXV, No. 255, enero-marzo, 2006 and Jon and Fatima Williams ‘Does ownership explain bank mergers and acquisitions? The case of domestic banks and foreign banks in Brazil’, Oxford Centre for Brazilian Studies and Luiz Fernando Rodrigues de Paula, The Recent Wave of European Banks in Brazil”, Oxford: Centre for Brazilian Studies.

13. No Fifth Development Decade: Millennium Declaration • Reduced emphasis on resource transfers • A “directed” aid strategy • To meet “time-bound”, “measurable” Social Development Goals • But, these Goals are really symptoms of underdevelopment • Eliminating them still requires external resources: • $100 billion per year to 2015 • What happens after 2015?

14. 2002 Financing for Development: Global Development Partnership • Developing countries responsible for their own development • Primary source of development finance is Mobilising Domestic Resources • Developed countries to provide additional resources required to support sound national development strategies

15. Return to Traditional Development Theory • What are the available domestic resources? • Most developing countries have abundant natural resources • But all have unemployed, underemployed or underqualified domestic labour • Increasing employment presents the greatest unexploited potential for mobilising domestic resources • Employment increases Income and thus Savings • Nurkse: “All Capital is Made at Home” • Requires policy to ensure incomes is saved and used to increase capital

16. Investment in What? • Traditional Development Theory – Eric Reinert • From Antonio Serra (1612) to US Today • Investment in Building Domestic Industry • Because industry presents increasing returns • Restrict Access to Luxury Consumption Goods • Synergy Between Agriculture and Industry • Build Export Platform • to Fie ance the needed imports for domestic industry • Prebisch at UNCTAD I criticising Import Substitution • Amsden on Asia as a successful example • Get Prices Wrong to Create Comparative Advantage • Prebisch, Nurkse, Kaldor -- Limit Imports of Luxury Consumption Goods • Manage Terms of Trade • Domestically • Internationally

17. Traditional Approach undermines Domestic Mobilisation • External resource transfers fill resource gap • Private flows and Official Aid create debt service obligations • Earnings of foreign currency needed to meet debt service • External surplus = negative net resource transfer • BWI Structural Adjustment Program • Reduce domestic level of activity to free resources to meet debt service • External surplus produced via fiscal surplus • Reduces domestic absorption and resource utilisation • Creates unemployment • Absence of Social Safety Net creates social marginalisation

18. 2005 Summit Outcome emphasised Traditional Approach Employment 47. We strongly support fair globalization and resolve to make the goals of full and productive employment and decent work for all, including for women and young people, a central objective of our relevant national and international policies as well as our national development strategies, including poverty reduction strategies, as part of our efforts to achieve the Millennium Development Goals.

19. Employment joins MDGs • High-level segment of the 2006 substantive session of the Economic and Social Council Ministerial Declaration reinforced the 2005 World Summit position • Make full and productive employment and decent work for all, including for women and young people, a central objective of relevant national and international policies and national development strategies and to be part of efforts to achieve the internationally agreed development goals, including the Millennium Development Goals.

20. Full and Productive Employment • New Development Goal • Full mobilization of domestic labour resources • Requires • suitable employment opportunities • provision of adequate basic education • vocational and occupational training to improve skills and productivity • unemployment benefit scheme that avoids moral hazard and fraud • migration policy - remittances

21. Domestic Policy Space requires Fiscal Sovereignty • Is fiscal surplus sound resource mobilsation policy? • Government spending creates private sector assets in the banking system • Taxation creates private sector debts to the government that must be financed with those assets • If taxes exceed government spending the private sector is in net deficit, i.e. insolvent • If the private sector holds assets for other convenience purposes financial stability requires a government deficit over time equal to the private sector’s demand for money balances

22. Domestic Policy Space requires Monetary Sovereignty • Government spending increases unborrowed bank reserves • Excess reserves drive interbank rates to zero • To keep interest rates positive the government must borrow • As borrower of last resort it can fix the interest rate • Interest rates are thus not constrained by private sector willingness to buy government debt or the size of the deficit • The government does not have to borrow or issue debt in order to deficit spend • It follows that the government can always set the short term policy interest rate independently of the size of the deficit -- viz. Japan

23. How to use policy space to support mobilisation of domestic labour resources? • If private sector development is insufficient to provide full employment • Government takes responsibility to provide employment to all those willing and able to work at or marginally below the prevailing informal sector wage • What does “work” mean?

24. What does “work” mean? • Different according to level of development • Primary goals: • Maintain and improve skill level of the labour force – basic educational skills • Provide social safety net – income maintenance • Provide social inclusion for the unemployed/unemployable – social services • Meet the needs of female heads of households to combine work with family responsibilities • Improve the well-being of society – useful public works

25. Can it be done? • Argentina experience – Jefes programme • Education at all levels an integral part of the programme – primary to occupational • Interministerial cooperation – Labour, Eduction and Social Development ministries cooperated in providing educational programme • Promotes work practice and experience • Provides vocational skills • Improves marginal communities

26. Is Jefes a relevant example? • Verified examples of success • Verified examples of fraud and corruption • Depends heavily on local government for implementation • Depends heavily on individuals • Depends on Federal government for financing • Constrained by government budget goals– but need not be given monetary and fiscal sovereignty that Argentina currently possesses

27. Jefes is not ELR • The Jefes programme was close to the ELR proposal but was an emergency response to the crisis • A suitably designed ELR can build on the success of Jefes • It can be designed to integrate the MDGs as well as the other Internationally Agreed Development Goals to be included in the National Development Strategies mandated at the 2005 Global Summit

28. ELR as an MDG programme • A suitably designed ELR programme to provide employment can also be designed to satisfy: • MDG Goal 1: Eradicate Extreme Hunger and Poverty • MDG Goal2: Universal Primary Education • MDG Goal 3: Promote Gender Equality and Empower Women • MDG 4 and 5 Reduce Child Mortality and Improve Maternal Health

29. New/Old View:How to Lift the Development Constraints? • Savings generated internally by increasing incomes through full employment -- ELR • Financing is assured by limiting reliance on external financial resources – Monetary Sovereignty • Policy to Build Domestic Industry • Policy to Earn Necessary Imports through export promotion • Policy to reduce leakages into imported consumption goods and use of capital to produce domestic luxury goods