Developmental Macroeconomics

Luiz Carlos Bresser-Pereira, José Luís Oreiro, Nelson Marconi

• Publisher: Routledge
• Year: 2014
• ISBN:
  9781136664618
• Edition: 1
• Topic: Business
• Subtopic: Business generale
• Index: Business

Developmental Macroeconomics: Access to Demand, the Exchange Rate and Growth offers a new approach to development economics and macroeconomics. It is a Keynesian-structuralist approach to economics applied to middle income countries that emphasizes the strategic role of demand in creating investment opportunities that are essential to economic development. It also explores crucial links between short-term full employment and financial stability with medium term growth.

While this book emphasizes the central role played by the exchange rate it does not ignore other macroeconomic prices (the interest rate, the inflation rate and the profit rate). It develops a group of concepts and models and blends them together in the model of the tendency to the cyclical overvaluation of the exchange rate in developing countries. According to this model, the exchange rate tends to be chronically overvalued. In so far that this is true the exchange rate ceases to be just a short-term problem to be treated by macroeconomics and becomes central to development economics and should be crucially oriented to manage the exchange rate and keep it competitive at the industrial equilibrium level.

The book closes with the presentation of new developmentalism – a national development strategy based on the system of models previously discussed that is both an alternative to old national-developmentalism and to liberal orthodoxy or the Washington consensus.

Part I
Growth and constraints

1
Theoretical traditions and the method

Macroeconomics and development economics are usually studied separately, as if it were one thing to study the stability of economic systems, and another to understand the long-term process of economic growth. In this book, we systematically integrate these two perspectives. After all, the long term is the sum of macroeconomic short terms; investment is strategic in achieving sustainable demand as well as economic growth; and full employment is associated with growth. Therefore, it is more reasonable to integrate macroeconomics and development economics under the designation of development macroeconomics. Yet, our approach is not associated with economic liberalism, but with developmentalism – a form of organizing capitalism and achieving the growth and stability that combines reasonably free markets with a moderate intervention of the state. Thus, ours is a Keynesian and structuralist development macroeconomics – or, to be short, a developmental macroeconomics. Our political assumption – which is not discussed in this book, but is discussed at length in Atul Kohli’s (2004) State-Directed Development – is that the more the state is integrated with the business sector, or the more cohesive the ruling class coalition is oriented to growth, the more developmental the state will be, and the more successful industrialization will be in catching up.

Developmental macroeconomics is a theory applied to developing countries, particularly to middle-income countries where markets are already reasonably efficient in allocating economic resources in the competitive industries. But, as Keynes argued, markets are unable to keep the macroeconomic aggregates balanced. Given the chronic insufficiency of demand in capitalist economies, the expected profit rate tended to be unsatisfactory, and so the rate of investment fell below the level that full employment required. In our developmental macroeconomics, the key macroeconomic variables (besides the investment rate) are composed of the current account deficit and the exchange rate – the less studied of the five macroeconomic prices. Imports, exports, the investment rate, the savings rate, and inflation depend on the exchange rate. Investments depend on it: We may think of the exchange rate as the light switch that connects or disconnects the efficient business enterprises existing in a country from foreign markets and their own domestic markets. We will argue also that the main problem facing developing countries is the tendency towards cyclical and chronic overvaluation of the exchange rate. If this tendency is not dully neutralized, the macroeconomic prices will be out of equilibrium: The exchange rate will be overvalued, the wage rate and all other revenues will be artificially high, the expected profit rate will be depressed, the interest rate will tend to be high, and, if the depreciation of the national currency is still taking place (meaning it didn’t level out), the inflation rate will fall. Thus, while the rentier capitalist will be happy with a high real interest rate, the business entrepreneurs – the men and woman who really accumulate capital and innovation – will only invest to keep their plants technologically competitive. Thus, in this book, we will argue for an active exchange rate policy – which, together with the interest rate policy and the fiscal policy, will keep the macroeconomic prices right, and the economy growing with price and financial stability.

The tendency to the cyclical and chronic overvaluation of the exchange rate – plus the fact that developing countries are financed with foreign money (money that they cannot issue) – means that developing countries are prone to currency or balance of payment crises, which are seldom observed in rich countries whose governments become indebted in their own money. That is the reason why the typical financial crisis in rich countries is a banking crisis. On the other hand, we will see that developing countries (including middle-income countries) tend to suffer from the Dutch disease – the structural cause of the overvaluation. Other causes include policy (particularly the growth cum foreign savings policy), the use of the exchange rate as an anchor against inflation, and exchange rate populism. Thus, to avoid such overvaluation – which fuels consumption, dampens investments, and exposes countries to cyclical financial crises – developmental macroeconomics shows, counterintuitively, that developing countries should have their current accounts balanced or showing moderate surpluses. Only in special occasions it is true that capital-rich countries should transfer their capitals to capital-poor countries.

Not neoclassical

Our approach is not neoclassical. The distinction between developmental macroeconomics and neoclassical macroeconomics does not require an extended discussion. Developmental macroeconomics adopts a different method. There are two major methodological currents of economic thought: the historical tradition and the hypothetical–deductive tradition. The historical tradition uses the empirical, or historical–deductive, method in order to make generalizations from observations of reality – of the regularities and tendencies that characterize this changing reality. The neoclassical tradition, however, defines its core theories (the general equilibrium and rational–expectations macroeconomics theories) using the hypothetic–deductive method, which is suitable for the methodological sciences – such as mathematics, econometrics, and economic decision-making theory – but unsuitable for the social sciences, which are substantive sciences aiming to explain how social systems are coordinated and change through time.

The two theoretical traditions correspond to two ways of organizing national economic systems, policymaking styles, and associated ideologies. The neoclassical tradition is associated with economic liberalism; the historical tradition, with new developmentalism. New developmentalism – as a growth strategy and as a school of thought – has been associated in the past with mercantilist thought, and today is associated with Keynesian, structuralist, and historical–institutionalist thought.

Economists such as William Petty, Adam Smith, Karl Marx, Thorsten Veblen, John M. Keynes, and Joseph Schumpeter – and developmental structuralists like Gunnar Myrdal and Arthur Lewis – belong to the historical tradition. The authors of this book are likewise associated with it. Within the hypothetical–deductive tradition, the greatest economist was Alfred Marshall. His major contribution to economic thought, however, was not to explain how economic systems operate, but to found a complementary to economic theory and highly relevant autonomous science: the theory of decision-making in markets, or economic decision theory, later completed by game theory. For this discipline, the hypothetical–deductive method, based as it is on axioms, is appropriate because it is a methodological science, not a substantive science such as economics, which deals with a concrete social and economic reality.

The neoclassical school and economic liberalism maintain that it is enough to guarantee property rights and contracts and to keep the public budget in balance; then the market will take care of coordinating the economic system in an optimal way that will generate growth, stability, and a satisfactory distribution of income. In contrast, according to new developmentalism, the government has additional macroeconomic roles. Besides guaranteeing property rights, conducting a responsible fiscal policy (which keeps the budget deficit under control), and implementing a competent monetary policy (which keeps the inflation under control), the government is supposed to have an active exchange policy to keep the current account under control and the exchange rate in equilibrium.

Whereas neoclassical economists develop complex mathematical models from a hypothetical–deductive method that assumes the rationality of economic agents, historical economists observe the behaviour of economic aggregates, search for possible regularities and tendencies, and formulate from them simple economic models. Whereas the hypothetic–deductive method authorizes neoclassical economists to formulate highly mathematized and “precise” models, the historical– deductive method allows for less mathematical and more modest models, which are constantly reviewed as technologies, types of property, power relations, and institutions change, or as econometric studies falsify them. Whereas orthodox economists work with the false certainty of their core models, and uncertainty is something that for them depends not on theoretical castles in the air but on their individual capacity to think, historical economists know from the start that economic agents always make decisions under conditions of uncertainty, and that, therefore, economic policymakers also deal with uncertainty daily.

The neoclassical tradition prevailed in the universities between the end of the nineteenth century and 1929, and between 1979 and 2008. Even though it has proven to be essentially misguided (because it uses an unsuitable method for a substantive science such as economic theory), and also damaging (because it inspires an economic liberalism that assumes that markets are self-regulated and always efficient), it continues to dominate graduate programs in the leading universities. Therefore, it continues to inspire misguided economic policies. There are excellent economists with a neoclassical formation, but their real contributions are made when they forgive their core neoclassical models, and use general economics (the economics that all economists are supposed to know) and their privileged intelligence.

Differences from Keynesian and development economics

Our approach is Keynesian and structuralist. It is Keynesian because, first, we are persuaded that the obstacles to economic development are on the demand side rather than on the supply side, despite the significance of development factors on the supply side – particularly education and, consequently, technology, innovation, and productivity. Second, because it is not the interest rate that determines savings, and savings that determine investment (as neoclassical theory assumes), but the other way around: It is investment that determines savings, provided that there is credit available to entrepreneurs. In other words, developmental macroeconomics is based on Keynesian and Kaleckian macroeconomics.

But there are substantial differences between developmental and Keynesian macroeconomics, besides the fact that the former focuses on explaining unemployment and discussing how to achieve full employment, whereas developmental macroeconomics is focused in growth with stability – growth that produces catching up. First, in Keynesian macroeconomics there is the tendency to the insufficiency of demand, whereas for developmental macroeconomics there is additionally the tendency to the insufficiency of access to demand. Therefore, the core Keynesian argument is that investment depends on the existence of effective demand, whereas for developmental macroeconomics, guaranteeing effective demand is not enough: Governments must also formulate an active exchange rate policy, which assures business enterprises the access to demand that an overvalued national currency denies.

Second, given the existence of five macroeconomic prices (the rate of profit, the exchange rate, the interest rate, the wage rate, and the rate of inflation), for Keynesian macroeconomics the wrong price is the interest rate, which will be too high in severe recessions due to the liquidity trap. For developmental macroeconomics, besides the interest rate in recessions, there are three chronically wrong macroeconomic prices: the exchange rate, which will tend to be overvalued, the expected profit rate, which will tend to be depressed, and – less clearly – the real interest rate, which will tend to be high (the liquidity trap will have less explicative clout).

Third, whereas for Keynesian (and also neoclassical) macroeconomics, the two key macro variables are the budget deficit and the interest rate, for developmental macroeconomics they are the current account deficit (or surplus) and the exchange rate – two variables that are directly interdependent. It is true that, given the twin deficits hypothesis, choice between either one or the other deficit would be indifferent, but such a hypothesis only holds when the exchange rate is in equilibrium, and this does not happen often.

Fourth, whereas for neoclassical and Keynesian macroeconomics, current account deficits are natural, for developmental macroeconomics, they should show a surplus if the country faces the Dutch disease.

Fifth, whereas Keynesian and developmental macroeconomics explain both insufficient savings and financial crises with excessive budget deficits or fiscal populism, developmental macroeconomics also explains them with excessive current account deficits (exchange rate populism).¹

Sixth, the Keynesian model was originally a closed model, whereas developmental macroeconomics is an open theory from the start.

Seventh, developmental macroeconomics accepts the Keynesian assumption that the exchange rate is highly volatile, but adds that such volatility or such mis-alignments are not just up-and-down directed, but in developing countries they tend to the overvaluation of the national currency.

Eighth, whereas Keynesian and Minskyan macroeconomics assume that countries become indebted in their own currencies and are prone to banking crises, developmental macroeconomics stresses that developing countries become indebted in foreign currencies (which they can neither issue nor devalue) and, for that reason, are prone to balance of payments or currency crises.

Finally, whereas Keynesian macroeconomics considers only fiscal and interest rate policy, developmental macroeconomics asks for an active exchange rate policy. If the country is able to effectively neutralize the Dutch disease with an export tax on the commodities that originate it, moving the exchange rate to the industrial equilibrium, and if the exchange rate policy is able keep the exchange rate floating around this equilibrium, the developing country will experience not current account deficits, but current account surpluses.

Besides Keynesian, our approach is structuralist, meaning it is associated with developmental economics (the theories of Rosenstein-Rodan, Ragnar Nurkse, Gunnar Myrdal, Arthur Lewis, Raul Prebisch, Hans Singer, Albert Hirschman, and Celso Furtado),² which was dominant from the mid-1930s to the mid-1970s, together with Keynesian macroeconomics, and were instrumental in the Bretton Woods regulation of the international financial system. Development economics came to a crisis along with Keynesian macroeconomics in the late 1970s, when neoclassical economics once again became mainstream economics. Developmental macroeconomics is structuralist because it sees economic growth as a structural process of technological sophistication. It shares with structuralist economics the historical method, the understanding of economics as political economy, the assumption that the state and the market (regulated by the state) are the two main institutions coordinating capitalist societies, and the understanding of economic growth as a structural process invo...