Development Policy Development Policy in an UnEqual Worldin an UnEqual World:: Financing for Development Financing for Development

and Growthand Growth

IDEA’s Workshop “Development Experiences IDEA’s Workshop “Development Experiences and Policy Options for a Changing Worldand Policy Options for a Changing WorldTsinghua University, Beijing, 5 June 2007Tsinghua University, Beijing, 5 June 2007

Jan KregelJan KregelSenior Scholar, Levy Economics Institute of Bard CollegeSenior Scholar, Levy Economics Institute of Bard CollegeDistinguished Professor, Center for Full Employment and Distinguished Professor, Center for Full Employment and

Price Stability, Price Stability, University of MIssiouri, Kansas CityUniversity of MIssiouri, Kansas City

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

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

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.

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

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

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

Transfers in First Transfers in First Development Decade under Development Decade under

Alliance for ProgressAlliance for ProgressFormer Chilean finance minister Gabriel Valdes to Former Chilean finance minister Gabriel Valdes to

President Nixon, June 12, 1969 President Nixon, June 12, 1969

“ “It is generally believed that our continent It is generally believed that our continent receives real financial aid. The data show the receives real financial aid. The data show the opposite. We can affirm that Latin America is opposite. We can affirm that Latin America is making a contribution to financing the making a contribution to financing the development of the United States and of other development of the United States and of other industrialized countries. Private investment has industrialized countries. Private investment has meant and does mean for Latin America that the meant and does mean for Latin America that the sums taken out of our continent are several times sums taken out of our continent are several times higher than those that are invested. ... In one higher than those that are invested. ... In one word, we know that Latin America gives more word, we know that Latin America gives more than it receives.”than it receives.”

Modern Experience of Net Transfers of Resources

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0

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1980

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$ Bi

llions

Developing economies

Africa

Eastern and Southern Asia

Latin America

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

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.”

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.

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?

2002 Financing for 2002 Financing for Development:Development:

Global Development Global Development PartnershipPartnershipDeveloping countries responsible for their Developing countries responsible for their

own developmentown development

Primary source of development finance is Primary source of development finance is Mobilising Domestic ResourcesMobilising Domestic Resources

Developed countries to provide additional Developed countries to provide additional resources required to support sound national resources required to support sound national development strategiesdevelopment strategies

Return to Traditional Development Theory

What are the available domestic resources?Most developing countries have abundant natural

resourcesBut all have unemployed, underemployed or

underqualified domestic labour Increasing employment presents the greatest

unexploited potential for mobilising domestic resources

Employment increases Income and thus SavingsNurkse: “All Capital is Made at Home”Requires policy to ensure incomes is saved and used to

increase capital

Investment in What? Traditional Development Theory – Eric Reinert

From Antonio Serra (1612) to US Today Investment in Building Domestic IndustryBecause industry presents increasing returnsRestrict Access to Luxury Consumption GoodsSynergy Between Agriculture and Industry

Build Export Platform to Fie ance the needed imports for domestic industryPrebisch at UNCTAD I criticising Import SubstitutionAmsden 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 TradeDomestically Internationally

Traditional Approach Traditional Approach undermines Domestic undermines Domestic

MobilisationMobilisation External resource transfers fill resource gapExternal resource transfers fill resource gap Private flows and Official Aid create debt Private flows and Official Aid create debt

service obligationsservice obligations Earnings of foreign currency needed to Earnings of foreign currency needed to

meet debt servicemeet debt service External surplus = negative net resource External surplus = negative net resource

transfertransfer BWI Structural Adjustment ProgramBWI Structural Adjustment Program

Reduce domestic level of activity to free resources to Reduce domestic level of activity to free resources to meet debt servicemeet debt service

External surplus produced via fiscal surplusExternal surplus produced via fiscal surplus Reduces domestic absorption and resource utilisationReduces domestic absorption and resource utilisation Creates unemploymentCreates unemployment Absence of Social Safety Net creates social Absence of Social Safety Net creates social

marginalisationmarginalisation

2005 Summit Outcome 2005 Summit Outcome emphasised Traditional emphasised Traditional

ApproachApproachEmployment47. 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.

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.

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

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

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

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?

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

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

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

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

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

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