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ion D y and c i l o P omic n eco Macro is nt Div e m p lo eve S F E I R ICY B D POL MPD ly 2013 , Ju No. 13 Developmental Macroeconomics Recently launched ESCAP’s Economic and Social Survey of Asia and the Pacific 2013 argues for a shift in macroeconomic policy paradigm. Historically, macroeconomic policies have both stabilization and development roles. and developmental roles. It notes: “The fiscal deficit is a useful indicator for purposes of stabilization and for controlling the growth of government liabilities, but it offers little indication of longer term effects on government assets or on economic growth.”3 Since the 1980s the focus of macroeconomic policies shifted to stabilization alone. It is assumed that low single digit inflation and low or no budget deficits are both necessary and sufficient conditions for growth and development. Therefore, there is a need to identify and incorporate the transmission channels through which fiscal policy influences long-term growth. This requires that “attention be focused on the likely growth effects of the level, composition and efficiency of public spending and taxation.” The Development Committee warns: “Fiscal policy that neglects these effects runs the risk of achieving stability while potentially undermining long-term growth and poverty reduction.” However, while reviewing the lessons of such policy focus, the World Bank observed: “Macroeconomic policies improved in a majority of developing countries in the 1990s, but the expected growth benefits failed to materialize, at least to the extent that many observers had forecast.”1 For the purpose of development, attention should shift to where the deficit is being spent; is it, for example, for enhancing human, physical or social capital that improves productivity and hence growth? If that is the case then public debt, even though rises in the shortterm, would be sustainable. In the Asia-Pacific region, such restrictive macroeconomic policies aimed at stabilization in a very narrow sense have seen drastic declines in public infrastructure investment, especially in agriculture, and a rise in economic insecurity. The region was also hit by the worst financial crisis in 1997 despite reasonable macroeconomic stability. Progressivity of taxation and enlarging the fiscal space are also vital for fiscal policy to play its developmental and stabilization roles. Without that fiscal policy cannot, for example, address inequality. ESCAP’s study finds that both tax-GDP ratio and social security expenditure have negative associations with inequality (Gini coefficient). Lower the tax-GDP ratio and social security expenditure as a percentage of GDP, larger is the Gini. In light of the huge developmental challenges of Asia and the Pacific associated with the region’s high degree of economic insecurity, large development gaps, significant infrastructure shortages and unsustainable environmental impacts, there is clearly a need to balance stabilization and developmental roles of macroeconomic policies. While higher inequality adversely affects domestic effective demand, lower tax revenues constrain government’s ability to pursue countercyclical policies as well as development expenditure. Such balance could entail changing the way fiscal and monetary policies are designed and implemented and how issues of public debt or inflation are viewed.2 This would also need supportive exchange rate and capital account management policies. Monetary policy Fiscal policy The preamble of the IMF’s Article of Agreement IV states that “each member shall ... endeavor to direct its economic and financial policies toward the objective of fostering orderly economic growth with reasonable price stability, with due regard to its circumstances” (Article IV.1.i). The joint Development Committee of the World Bank and the IMF has laid down some guidelines for designing fiscal policy that balances stabilization 1 World Bank, Economic Growth in the 1990s: Learning from a Decade of Reform (Washington, D.C., 2005), p. 95. 3 2 World Bank, Fiscal Policy for Growth and Development: An Interim Report, Washington, D.C., 6 April 2006 (DC2006-0003), p. i. This issues is further analyzed in MPDD Policy Brief No. 14 on Forward-looking macroeconomic policies – re-examining inflation and debt limits. UNITED NATIONS ECONOMIC AND SOCIAL COMMISSION FOR ASIA AND THE PACIFIC 1 The key here is “reasonable” price stability and due regard for country specific circumstances. Therefore, monetary authorities should not excessively focus on a pre-determined inflation target without any regard for growth or causes of inflation. This means due attention to the supply side factors. For example, if inflation is caused primarily by rising food prices due to crop failure, monetary tightening may be counterproductive as far as underlying causes of inflation are concerned. Instead, the appropriate policy would be to expand credit to agriculture to accelerate its revival. noted: “there is a spectrum of possible exchange rate arrangements, depending on various aspects such as the size of the economy, trade and investment structure, the sequencing of capital account liberalization and the level of economic development. No single arrangement is necessarily right for all countries all the time.”6 Given the role of exports and FDI and the need to stabilize the economy a developing country should follow an exchange rate stability approach. An important lesson of the Asian financial crisis is that nominal stability must not end up in real appreciation. Monetary authorities should try to keep real interest rates low or moderate to support investment in light of the fact that World Bank’s Enterprise Surveys show access to finance is among the top-5 business impediments for 93% of the countries in Asia and the Pacific. Access to finance is critical for SMEs as well as for agriculture, which depend solely on the banking sector for external financing. Managing capital flows Capital flows management is a sovereign right of a country under the IMF’s Article of Agreement (Article VI). ESCAP’s 2010 Survey recommended capital flows management in view of the risk of large capital inflows and their sudden withdrawals to macroeconomic management and financial sector fragility. Both the IMF and the World Bank have now recognized capital flow management as an essential macroeconomic policy tool.7 The IMF has suggested a range of tools for managing capital flows.8 This would mean accepting moderate inflation and the use of instruments such as credit other than the policy rate. Central banks should also promote financial inclusion through changes to the regulatory framework. A growing body of research shows that financial inclusion can have significant beneficial effects for individuals and the economy as a whole. For example lack of access to finance can lead to poverty traps and inequality whereas providing individuals with access to savings instruments increases savings, productive investment, consumption and female empowerment.4 Asia-Pacific countries have already introduced several measures to manage excessive short-term capital flows while still encouraging FDI. Therefore, capital account openness should not be viewed as an allor-nothing proposition. Capital account can be open to equity flows – both portfolio and FDI, even when money and bond flows are managed. The monetary authority should also ensure that credit does not fuel speculative activities, especially in the capital market and does not create property bubbles. There is a considerable body of work showing that financial sector deregulation that saw huge wave of bank mergers motivated by the short-term criteria of volatile stock markets led to exclusion of SMEs and small borrowers from formal credit markets.5 In sum, the primary focus of macroeconomic policies should be sustainable and inclusive development, subject to the constraint that inflation remains tolerable and that the balance of payments (current account) remains sustainable. This fiscal policy should accommodate large scale public investment in both physical and social infrastructure needed for a big push to break out from a vicious circle of poverty. Monetary and financial policies should be calibrated to promote agriculture and small scale enterprises and other priority sectors. The exchange rate policy should support structural change and promote exports so that balance of payments does not become a constraint on growth. Capital flows management policy should prevent banking and financial crises and widen policy space. Exchange rate policy Many observers have attributed the 1997-98 Asian financial and currency crises to their pegged exchange rates, and suggested a more flexible exchange rate regime. But a greater flexible exchange rate is not always an optimum policy for the developing world. At the 2001 Kobe meeting of Asia-Europe Finance Ministers, the Chairman’s concluding statement 6 Available from www.mof.go.jp International Monetary Fund, The Liberalization and Management of Capital Flows: An Institutional View (Washington, D.C., 2012); and World Bank, Global Economic Prospects: Crisis, Finance, and Growth (Washington, D.C., 2010). 7 4 For global evidence and general discussion on financial inclusion, see F. Allen and others, “The foundations of financial inclusion: understanding ownership and use of formal accounts”, Policy Research Working Paper, No. 6290 (Washington, D.C., World Bank, 2012). 8 J. D. Ostry and others, “Managing capital inflows: what tools to use?”, Staff Discussion Note, 11/06 (Washington, D.C., IMF, 2011). See a forthcoming MPDD Policy Brief for a discussion of pros and cons of various techniques. 5 See, for instance, A. K. Bagchi and Gary Dymski, eds., Capture and Exclude: Developing Economies and the Poor in Global Finance (New Delhi, Tulika, 2007). The MPDD Policy Briefs Series aims at generating a forward-looking discussion among policy planners, researchers and other stakeholders to help forge political will and build a regional consensus on the needed policy actions and pressing reforms. Policy briefs are issued without formal editing. This issue has been prepared by Anis Chowdhury of the Macroeconomic Policy and Development Division, ESCAP. It is based on the Economic and Social Survey of Asia and the Pacific 2013: ForwardLooking Macroeconomic Policies for Inclusive and Sustainable Development. For further information on the policy brief, please contact Dr. Anis Chowdhury, Director, Macroeconomic Policy and Development Division, ESCAP ([email protected]) www.unescap.org/pdd 2