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Preliminary Draft. Comments are welcome.

My friend Thomas Palley had recently published a paper on Investigacion Economica making a critical assessment on new developmentalism (see http://www.scielo.org.mx/scielo.php?pid=S0185-16672021000300003&script=sci_arttext&tlng=en). When I saw the paper my first reaction was of incredulity since Palley was one of the earlier supporters of new developmentalism, had being signed in 29 of september of 2010 a document entitled “Ten Thesis on New Developmentalism” (see https://www.scielo.br/j/rep/a/CFZ8xg7rqKrBGcF5fxmSy5H/?lang=en) which propose a list of 10 core principles of New Developmentalism which is agreed with all people that signed the manifesto. In his new article, Palley critizes many principles that he previously had agreed. But, quoting John Maynard Keynes, anyone had always the right to change his/her mind when realizes that is in error. If this is the case, Palley should begin his critical assessment explaining why he had changed his mind about new developmentalism.

Today morning I had the time to make a carefull reading of Palley´s article. My first general comment on his assessment is that Palley, like others critiques of New Developmentalism, identifies the whole school of though with (some, since the references used by him ignores some important material as, for instance, the 2015 textbook on new developementalism) writings of professor Bresser-Pereira; ignoring the fact that New Developmentalism is not a kind of religion, where there is a profhet that had received a revelation from God and then try to convert people to the new faith. Speaking for myself, I had some disagreements with some views of Professor Bresser-Pereira, mainly regarding the concept of industrial equilibrium exchange rate, as I had showed in a recent article published in the Brazilian Journal of Political Economy (Oreiro, 2020). A second general comment is that I do not understand New Developmentalism as a new Theory of Economic Development, as done by Palley (2021, p.30); but rather a synthesis between Classical Theory of Economic Development, Latin American Structuralism and Kaldorian Theory of Demand-Led Growth (Oreiro, Martins da Silva and Dávila-Fernandez, 2020, pp. 27-29) about the deep determinants of economic development. I see no oposition between classical developmentalism and new-developmentalism, but only the recognition of the fact that the both theories are built for different historical stages of Latin-American countries. If for classical developmentalism the basic issue was to overcome the poverty trap by means of industrialization-led structural change; for new developmentalism the basic issue is to overcome the middle income trap by means of the adoption of a new macroeconomic policy regime in substitution of the new macroeconomic consensus that conquered both developed and developing countries since the beggining of the 1990´s. So it is completly unfair Palley´s claim that New Developmentalism make a some kind of compromisse with neo-liberalism.

New developmentalism at its earlier stages (See Bresser-Pereira, 2006, 2007 and 2009) had take for granted that Latin-American countries had already overcome the infant industry phase of their economic development, which means that further development of manufacturing industry demands the substitution of the Import-Substitution Industrialization for Export Promotion of Manufacturing Goods, which is a very similar proposition as the one defended by Kaldor (1967) for whon suceffull cases of industrialization in world history are precisely the ones where countries achieved to increase their share of manufacturing exports in world exports of manufacturing goods. These were the cases of the United States, Germany, Japan and Italy (Nowadays it is the case of China and South Korea). This is the fundamental difference between New Developmentalism and Classical Developmentalism. Moreover, one had to recognize that the world where Classical Theory of Economic Development was raised is very different from the one where New-Developmentalism appears. Globalization and financial liberalization make much more complicated the adoption of tariff protection and multiple exchange rates, instruments broadly used by the Latin American Countries to boost industrialization in the 1950´s and 1960´s. New financial products make possible for boom in commodities prices to translate into capital inflows for countries that are rich in natural resources, allowing a real exchange rate overvaluation for purely financial causes (See Nalin and Yazima, 2020). This means that the severity of the so-called Dutch Disease is directly tied with financial liberalization, a fundamental policy aspect of neo-liberalism.

Paley´s assesment had two parts. The fisrt one where the author make a reasonable fair account of the basic principles of Bresser-Pereira version of New Developmentalism, as it is presented in some of his recent papers, but completly desconsidering his earlier writings or the wirtings of other member of the new developmentalist school. The second part of the paper dedicated to the criticism of New-Developmentalism seems to be very unfair not only with Bresser-Pereira but with the whole school of though. As I will argue Palley´s makes wrong claims about New-Developmentalim (ND hereafter) own internal logic and its relationship with neo-liberalism. And these wrong claims can not be attibuted to “ND´s failure to analitically model the economy”, since a lot of mathematical models inspired by new developmentalist principles were developed in recent years (Gabriel et al. 2016; Santana and Oreiro, 2018; Oreiro, Martins da Silva and Dávila-Fernandez, 2020).

According to Palley ND had four main components: the dutch disease problem, growth with foreing savings problem, developing an internationally competitive technology advanced manufacturing sector and getting the macroeconomics prices right.

Paley´s account of Dutch Disease is very similar to the arguments presented by Diamand (1972). Rich natural resources countries had an unbalaced productive structure where production and export of primary goods are competitive in international markets at a level of (real) exchange rate more appreciated than the manufacturing goods. In terms of Bresser-Pereira framework this means that there is two equilibrium exchange rates: the fisrt one (e2 in Figure 2 of Palleys article) which is the industrial equilibrium exchange rate, the level of (real) exchange rate for which domestic manufacturing firms that operates with state-of-art technology are competitive in international markets and the current account equilibrium exchange rate which is the level of (real) exchange rate compatible with a zero account deficit in the long-run (or zero foreign saving). For countries that had a closed capital account, the current equilibrium exchange rate will be the level of real exchange rate for which trade account is balanced (e3 in Figure 2 of Palleys article). In this case, the actual level of real exchange rate will fluctuate around the current account equilibrium level due to the forces of demand and supply of foreign currency in the exchange rate market, generating an overvalued exchange rate for manufacturing industry in the long run. In this case the economy suffers from Dutch Disease (DD, hereafter)

For a country that had a closed capital account it is relatively simple to deal with DD. One possibility is the domestic monetary authority to intervene in exchange markets, buying international reserves in order to hold real exchange rate at an undervalued level and hence achieve a trade account surplus. In this case the real exchange rate can be adjusted to a level compatible with the industrial equilibrium rate, but which will be extremaly profitable for exports of primary goods. The profit rate obtained in the production and exports of primary goods will be much higher than the one obtained in the manufacturing sector, thus making real resources to flow from manufacturing sector to the production of primary goods, increasing the exports of these goods in the long-term and hence increasing the severity of the DD problem. Here is where export taxes over primary goods are important: An export tax will reduce the profits of the primary sector to more “normal” values, avoiding to create further incentives for private investment in the primary sector and hence increasing the revenue of commodity exports

Palley critizes the export taxes arguing that these taxes will “[…] redistributes rents from the primary sector to the State. Export volumes are unnafected, and so is trade balance” (Palley, 2021, p.16).I had already argued that without such taxes, producers of primary goods will obtain extra-normal profits if the monetary authority tried to achieve a more competitive exchange rate for manufacturing activities by means of reserve accumulation, making their attempts to neutralize DD in the long-run self-defeating.

However, If the economy is operating near full-employment a devaluation of nominal exchange rate, due to reserve accumulation, can produce inflationary pressures due to excess aggregate demand, a case that is not considered by Palley since in his assessment of ND he considers prices to be constant (2021, p.6). In a full-employment scenario, domestic price increases can prevent a nominal exchange rate depreciation to be transformed in a real exchange rate depreciation. That it is why government should had a sound fiscal policy in order to allow the neutralization of DD: if government save all the revenues from export taxes in a form a sovereign fund (Bresser-Pereira, Oreiro and Marconi, 2015, p. 146); then the redistribution of income from primary goods producers to the State will increase the average saving rate of the economy (supposing that the saving rate of the entrepreneurs of the primary sector is considerably lowerthan one), alowing an increase in the trade balance without inflationary effects. If these revenues were spent in government consumption, than the average saving rate will be reduced, increasing the inflationary effects of an nominal exchange rate devaluation.

In a economy with open capital account, the picture turns to be a little more complicated. First of all, current equilibrium exchange rate now requires a trade surplus big enough in order for balance current account (supposing that the country had a positive external debt). This means that current equilibrium exchange rate will be at the left of e3 in Figure 2 of Palley´s article, which means that the size of DD will be reduced in comparison with the case of zero capital mobility. On the other hand, acess to the world financial markets makes possible for a country to run current account deficits with foreign capital inflows. It is here where the model of growth with foreign savings enters in the picture. Neo-liberalism, founded in the traditional neoclassical economics, considers domestic and foreign savings to be complementary, rather than substitutes as stated by ND (this differenciation is missing in the Palley´s review). So a neo-liberal policy-maker would like to incentive the capital inflows by means of setting domestic interest rate in a level higher than the external equilibrium level, given by the sum of international interest rate and country risk premium. This policy would also allow the policy maker to achieve a low inflation rate (See Oreiro, Martins da Silva and Dávila-Fernandez, 2020, p. 33). The capital inflows are an autonomous source of exchange rate appreciation, causing the appearance of current account deficits. It is important to stress that growth with foreign saving is not a market result for ND but a policy choice: policy makers choose to set the domestic interest rate at a higher than equilibrium level in order to (i) increase foreign saving in a (self-defeating) attempt to increase aggregate saving and hence investment and growth; (ii) achieve a low inflation rate compatible with the inflation target defined by the monetary authorities. This choice is oriented by the ideology of neo-liberalism, so it is completely absurd to associate ND with the former; but supported by the exchange rate populism that is endemic in Latin American countries, even for left or right-wing governments.

To deal with the problem of growth with foreign saving is thus fundamental to set the domestic interest rate in the right place, which is the level given by the sum of international rate of interest and country risk premium. Thus, Palley is completely wrong when he writes that “[ND] has no policy prescription for interest rates in the form of an interest rule or interest rate target” (2021, p.14). Ragarding this issue I suggest Palley to read Santana and Oreiro (2018) and Oreiro et al (2021).

Regarding the ND growth model, Palley correctly identifies the exports as the driver of economic growth. As I had already told in the beginning of this note, ND is based in the Kaldorian demand-led growth models where exports demand is the only source of autonomous demand growth in the long-run. Palley argues, however, that government spending can be an important source of autonomous demand according to the so-called super-multiplier model (2021, p. 28). ND strongly rejectes domestic demand – not only government spending – as a driver for autonomous demand growth in middle income countries because (i) such countries had no reserve currency – as USA had – that allowed to finance Balance of payments deficits for indefinitely long periods of time (The so-called “exorbitant privilege” according to former French President Valéry Giscard d’Estaing) and (ii) income elasticity of demand is, in general, higher than one. This means that the simple fulfilment of balance of payments constraint in Thirwall´s sense would require exports to grow at a faster rate than domestic output, which means that growth must be export-led in order to be sustainable in the long-run (Thirwall and Dixon, 1979, p.174).

Appart from this general comments I have some specific critiques to Palley´s article. In page 21 we can read that “The rate of accumulation then depends on the difference between the expected profit rate and the interest rate (…) That is a substantially neoliberal view of accumulation process, and it contrasts with the CD view in which the State occupies a for more activist position”. The investment function of the ND standard model (Bresser-Pereira, Oreiro and Marconi, 2014, p. 66) is the Neo-Robinsonian equation for desired rate of capital accumulation (Blecker and Setterfield, 2019, p. 136), so it is absurd to associate the specification of the investment function to Neo-Liberalism of any kind.

Palley also criticizes ND emphasys on industrialization as the engine of growth. Although Palley is right when he writes that the trend in the last three decades in the high income countries is de-industrialization (2021, p. 290; Palley completely ignores the problem of premature deindustrialization – defined as a reduction of the share of maufacturing in added value and employment in economies where the so-called “Lewis point” is not yet reached and, therefore, there is an almost unlimited supply of labor to the modern sector of the economy – which is the focus of concern of ND regarding middle-income countries. According to Rodrik (2016), whom had already showed public sympathies with some of ND ideas, manufacturing tends to experience relatively stronger productivity growth and technological progress over the medium to longer term. Therefore, premature deindustrialization closes off the main way to achieve fast economic convergence in low- and middle-income countries. It was the industrialization process that permitted catch up and convergence with the West by non-Western nations, such as Japan in the late 19th century, and South Korea, Taiwan, and China, among other countries, in the 20th century. So there seems to be no basis for Palley´s claim that “(sic) those empirical facts cast doubt on ND´s framing of the development in terms of industrialization” (Palley, 2021, p.21).

Another unfair criticism of Palley regards the role of public investment in economic development. There is nothing in the ND literature that denies the important role of investment in infrastructure for economic development. Indeed, Bresser-Pereira and Oreiro (2010) defended the separation of the fiscal budget in current and capital account, arguing that government must run deficits in capital account in order to finance a sustainable increase in the public investment. A sound fiscal policy for ND is a fiscal policy that allowed an increase in public investment without running in a unsustaible increase in public debt as a ratio to GDP. In order to achieve that goal many fiscal rules can be though, from the cyclically adjusted target for primary surplus upon to target for current account surplus of general government, which excludes the government investments but includes the interest rate payments over public debt. Anyone that had followed the articles published by ND authors in the Brazilian press is familiar with the arguments presented here.

Another criticism, I completely disagree with Palley about the historical support for Dilma´s administration budget deficits. As Oreiro and Dagostini (2017) showed, brazilian economy during Dilma Rouseff first term was not suffering from a problem of insuficient aggregate demand, but from lost of economic dynamism due to premature deindustrialization. Increase aggregate demand by fiscal stimulus in such a setting will only increase imports, contributing almost nothing to economic growth.

Regarding the nature of the demand regime in the Brazilian economy, Oreiro and Araujo (2013) using a neo-kaleckian growth and distribution model had showed that the demand regime is dependent upon the state of real exchange rate misaligment. In periods of over-valued exchange rate, the demand regime is profit-led; and in the periods of under-valued exchange rate the demand regime is wage-led. Since Brazil had a trend of over-valued exchange rate in the last 20 years, then the demand-regime prevailing in the Brazilian economy is profit-led.

One last criticism of Palley´s arguments. In page 27 we writes that a more egalitarian distribution requires a higher wage-share. This is not exactly true. If a high wage share is associated with high dispersion of wages, for example by a higher ratio between average and median wages than it is possible for income distribution to be more concentrated than in an alternative scenario where wage share is lower but the ratio of average to median wage is also lower. Finally, it is important to remember that a more egalitarian income distribution can be achieved by means of tax reforms that increase the weight of income taxes relative to indirect taxes in total government revenues and with higher tax rates for higher income groups. Personal income distribution can be dramatically changed without great changes in functional distribution of income.

Before ending this short note, I must admit that Paley critical assessment of ND raised one right issue: ND indeed underestimate the role of industrial policies for economic development. This was due to a theoretical and case-specific explanation. The theoretical explanation regards the concept of industrial equilibrium exchange rate employment by Bresser-Pereira on his writings. For Bresser-Pereira industrial equilibrium exchange rate is the level of real exchange rate that makes firms that use state-of-art technology to be competitive in international markets. The problem is that for developing countries, most firms in the manufacturing sector operates behind the technological frontier. This observation makes me to redefine the concept of industrial equilibrium exchange rate as the level of real exchange rate that, for a given level of technological gap, is capable to keep the manufacturing share on output constant over time (Oreiro, Martins da Silva and Dávila-Fernandez, 2020; Oreiro, Dagostini and Gala, 2020). Once the industrial equilibrium is defined on this way, there is a role for industrial policies in economic development, which is precisely to reduce the technological gap to allow an appreciation of industrial equilibrium exchange rate without compromise the price-competitiveness of manufacturing firms and thus allowed a sustainable increase in the real wage rate.

References

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Oreiro J.L., Manarin D’Agostini L.L., Gala P. (2020). ”Deindustrialization, economic complexity and exchange rate overvaluation: the case of Brazil (1998-2017)”, PSL Quarterly Review, 73 (295):313- 341.

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OREIRO, J. L. C.CARVALHO, L. D. ; GABRIEL, L. F. ; SILVA, E. H. (2021). Flexible Inflation Targeting, Real Exchange Rate and Structural Change in a Kaldorian Model with Balance of Payments Constrained Growth. Revista Ensayos Económicos [forthcoming]

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