New Developmentalism: Introducing a New Economics and Political Economy 180392778X, 9781803927787

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New Developmentalism

New Developmentalism Introducing a New Economics and Political Economy

Luiz Carlos Bresser-Pereira Emeritus Professor, Getúlio Vargas Foundation, Brazil

Cheltenham, UK • Northampton, MA, USA

© Luiz Carlos Bresser-Pereira 2024

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical or photocopying, recording, or otherwise without the prior permission of the publisher. Published by Edward Elgar Publishing Limited The Lypiatts 15 Lansdown Road Cheltenham Glos GL50 2JA UK Edward Elgar Publishing, Inc. William Pratt House 9 Dewey Court Northampton Massachusetts 01060 USA A catalogue record for this book is available from the British Library Library of Congress Control Number: 2023948396 This book is available electronically in the Economics subject collection http://dx.doi.org/10.4337/9781803927794

ISBN 978 1 80392 778 7 (cased) ISBN 978 1 80392 779 4 (eBook)

EEP BoX

Contents List of figuresvi Introduction to New Developmentalism vii 1

The method and the schools

1

2

The developmental schools and anti-imperialism

12

3

The capitalist revolution and the developmental state

27

4

Forms and phases of capitalist development

41

5

New developmentalism’s microeconomics

56

6

Macroeconomics and austerity

64

7

The interest rate

75

8

Inflation and the limitations of economics

83

9

The profit rate and the wage rate

94

10

Determining the exchange rate

104

11

Growth and stagnation

111

12

Policy of current account deficit

123

13

Foreign exchange, investment and growth

131

14

The Dutch disease and its neutralization

139

15

Green and social

149

References163 Index177

v

Figures 3.1

Per capita growth 1500–1950 of Western European countries, Japan, China, and India

32

11.1 Growth per capita of England/Britain, 1270–2016 (log.)

111

11.2 Industrial GDP per capita (2014) and GDP per capita (PPP, 2011) 113 11.3 Expected profit rate and the investment rate

117

11.4 Exports, imports and GDP growth

119

12.1 The current account balance and the exchange rate

123

12.2 The exchange rate cycle

129

13.1 Current account and equilibrium exchange rate

133

14.1 Two Dutch disease concepts

141

14.2 An export tax neutralizes the Dutch disease by shifting the supply curve

145

15.1 Income inequality in the US 1910–2010

157

15.2 Income inequality in France 1910–2010

157

15.3 Productivity and wage rate in the US 1948–2014

159

vi

Introduction to New Developmentalism This book summarizes and discusses new developmentalism (ND), a new economics and political economy that a group of economists have been developing in Brazil for the last 20 years. It is a reaction to the near-stagnation that has characterized most middle-income countries, especially Latin American, since the 1980s. Its origins lie in Marxist political economy, post-Keynesian economics, and classical structuralist developmentalism. It may also be called new developmental theory, perhaps a more appropriate name, but in this book, I will use new developmentalism which is how the theory became better known. Classical structuralist developmentalism, originally called “development economics” in the Global North and “structuralist theory” in Latin America, was born during World War II. It was a developmentalist school of thought that critiqued liberal-orthodox or neoclassical economics and proposed moderate state intervention in the economy and an anti-imperialist economic-nationalist stance towards the imperialism and economic liberalism of the Global North.1 This school did not have a macroeconomics, adopting the principles of the Keynesian revolution. The most legitimate representatives of these two schools adopted the historical-structural method associated with Marx and the other political economists who rejected the ahistorical way of thinking of neoclassical economics. Post-Keynesian economics and classical structuralist developmentalism were the major heterodox economic theories and policies of the 1960s. The first was the science of Joan Robinson, Nicholas Kaldor and Paul Davidson, the second the science of Raúl Prebisch, Arthur Lewis, Albert Hirschman, and Celso Furtado. It was the theory in which I was trained as an economist. In the 1980s, both theories went through a crisis when the neoliberal era replaced the “golden age” of capitalism and liberal-orthodox economics returned to dominate in universities. After the “neoliberal turn”, the World Bank, which was the main centre of developmental economists, became the leading international institution and pressured developing countries to adopt neoliberal reforms – most notably trade and financial liberalization. ND began to be developed when it became clear that it was possible to enrich classical structuralist as well as post-Keynesian theories and policies – to offer new tools that would explain why most developing countries have remained almost stagnant for 40 years and which new policies to adopt. The vii

viii

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classical structuralists had bet on industrial policy, while the post-Keynesians had bet on effective demand, but the theory and policies they offered were not enough to help developing countries, especially commodity exporters, to resume growth and catch up with developed countries. ND was developing while the central and peripheral economies were facing major changes. After World War II, the core countries adopted Keynesian and developmentalist rather than liberal policies and experienced the “Golden Age of Capitalism” (1945–1973). But in the 1970s, the US and the UK fell into economic crises, which made room for orthodox economics to again become dominant in universities and policymaking. Neoliberals argued that policy failures were worse than market failures, and economic liberalism was understood as the necessary condition for a sound economy and democracy: liberal democracy. While this was happening in the central countries, on the periphery of capitalism, some countries such as Brazil and Mexico in Latin America, and India and South Korea in Asia, were successfully industrializing by adopting the developmentalist strategy of industrialization proposed by structuralist developmentalism. Rich countries reacted negatively to this strategy because it blocked the exports of their manufactured goods into developing countries and created difficulties for their foreign investment. However, the core countries did not reject developmentalist policies altogether and allowed the World Bank to finance the industrialization of developing countries, including the state-owned enterprises that were then being created. However, around 1980, there was the neoliberal turn in the central countries – the transition from a social-democratic and developmentalist social formation to a neoliberal one. From then on, the core countries, led by the United States, began to pressure the rest of the world to open up their economies. The World Bank became the agent of neoliberal reforms, whose policies were synthesized in the Washington Consensus. Trade and financial liberalization became the new name of the game. Around 1990, peripheral countries, with the exception of East Asian countries and India, abruptly adopted neoliberal reforms by opening up their economies. Deindustrialization and near stagnation followed. During the 1980s and 1990s, the developmentalist response to these changes came from sociologists such as Peter Evans and Dietrich Rueschemeyer – who co-edited a book with the suggestive title, Bringing Back the State (1985),2 – and from some leading developmental economists: Alice Amsden, Robert Wade, and Ha-Joon Chang studied East Asian countries, with a focus on industrial policy, while Gabriel Palma and Lance Taylor invested in structuralist macroeconomics.3 These economists advanced the analysis of economic development in peripheral countries and offered an analysis of the successful growth of East Asian countries, but they did not offer a theory to explain the near-stagnation of many middle-income countries. It was in this historical context that, in the early 2000s, I began to build the “new developmental-

Introduction

ix

ism” theory. I was reacting to the near-stagnation that Brazil and many other developing countries were experiencing, as well as reacting to the inability, not only of orthodox economics, but also of structuralist developmentalism, to overcome it. Classical structuralist developmentalism managed to guide the growth of several developing countries, but with the great foreign debt crisis of the 1980s, it proved unable to resist the neoliberal ideology and liberal economic orthodoxy that had then become dominant in the central countries, and that had immediately pressured the rest of the world to adopt radical economic liberalism. Ten years later, around 1990, Latin American countries submitted to pressure from the Global North and engaged in trade and financial liberalization and privatization. Not surprisingly, these countries have not resumed their growth. The three original visions that gave rise to ND were, first, that a developmental macroeconomics aimed at middle-income countries was needed; secondly, that the exchange rate was viewed as one of the main determinants of investment in developing countries, where there is a tendency towards cyclical overvaluation; thirdly, that governments should recover from the low level of public investment, which had fallen from the foreign debt crisis of the 1980s, and from the wave of privatizations of monopolistic and profitable state-owned enterprises that came with neoliberalism. There was already some research that showed a positive relationship between a competitive exchange rate and economic growth, but a theory was missing. ND focused on this problem and came up with a theory. If the exchange rate is chronically overvalued, competent companies using state-of-the-art global technology would not have access to demand and would not invest. Typically, economics sees this macroeconomic price as a short-term price that is not part of development theory but of macroeconomics and international trade. But, if the exchange rate tends to remain appreciated for several years, it becomes a central problem for economic development theory. On the other hand, while investment should be predominantly private, state-owned enterprises have a key role in investing in infrastructure and some basic input industries. In ND, there is an economics and a political economy. Economics seeks to define in abstract terms the process of production of goods and services, the distribution of income generated by that production – in the form of wages, profits, and rents – and the stability and growth of economic systems. ND’s political economy discusses the historical process of capitalist development, the formation of the nation-state and the industrial revolution – which together form the capitalist revolution – and the role of capitalists, managers, and the working class in this process. In this analysis, ND introduces new ideas, such as the industrial equilibrium exchange rate; the rate of replacement of domestic savings for foreign savings; access to demand; the two forms of economic

x

New developmentalism

organization of capitalism (developmentalism and economic liberalism); the distinction between the capitalist revolution in the center and the periphery of capitalism; and the financial–rentier coalition in the neoliberal phase of capitalism. These ideas are relatively new and contribute to our understanding of the world in which we live. ND's economics is a system of ideas that critiques orthodox economics and is based on what I call “general economics” – a set of simple concepts and models that virtually all economists use – as well as on post-Keynesian Economics, the only heterodox school that is almost as systematic and encompassing as orthodox theory. ND innovates by making a methodological critique of neoclassical economics; by including macroeconomics in the theory of development; with a new model for determining the exchange rate; with an investment function in which the exchange rate plays a key role in that it ensures competitive firms have access to demand that a chronically appreciated exchange rate rejects; and with the economics of inertial inflation. Its approach to macroeconomics is original in defining the five macroeconomic prices: the rate of interest, the rate of wages, the rate of profit, the rate of inflation, and the exchange rate. One of the reasons ND focuses on the exchange rate is that, despite being a crucial variable in determining both profits and a country's competitiveness and trade relations, it is probably the macroeconomic price that economists have studied the least. Following the classical tradition, ND defines economic development as “the historical process of capital accumulation and technical progress that increases productivity, income per person, and living standards.” It is difficult to think of a situation in which such a process does not involve structural change.4 Developmental economists often distinguish economic growth – the increase in income per person – from economic development, which involves structural change, but I prefer to see them as equivalent. We may have cases where there is growth without development, but they are very special cases. Other academics claim that development requires decreasing inequality, but if we accept this view, from a theoretical point of view, the most relevant episodes of economic development – for example, China's economic development from 1980 to 2020 – would have to be discarded. ND rejects the conventional truth that capital-poor countries should attract capital from the rich world and criticizes the policy of running current account deficits to grow with external debt (so-called “foreign savings”). ND also offers a new concept of the “Dutch disease” – a competitive disadvantage faced by countries that export commodities – and offers two methods to counteract it. One method is the adoption of import tariffs on manufactured goods, a policy that many countries have pragmatically adopted for a long time. Policymakers in these countries did not know that in this way they were neutralizing the Dutch disease, but they did know that economic development

Introduction

xi

required industrialization and that industrialization would stop the moment they dropped import tariffs. Economics relied on only one non-protectionist argument in favor of import tariffs: the “infant industry” argument that has limited validity; after some time, each industrial sector ceases to be “infant”. ND developed a second non-protectionist argument to justify import tariffs – the argument from neutralizing Dutch disease that consists of imposing import tariffs on manufactured goods (and export subsidies for the same goods). The reader may have noticed that in this introduction I use the word “developmentalism” with two meanings: either as a style of policymaking, or as the name of an economics. Developmentalism is both a form of economic organization of capitalism and the name of two theories: classical structuralist developmentalism and new developmentalism. ND focuses on middle-income countries that have realized, or are carrying out, their industrial and capitalist revolution. However, several of its findings are general enough to be used by central economies. ND theory depends on the contributions of many economists who have worked with me in developing a new theoretical framework that explains why some developing countries have succeeded in catching up – reducing their economic gap to rich countries – while others have lagged behind. Interest in new development ideas is increasing around the world and is transforming thinking around economic development. ND allows us to better understand the causes and remedies for development and near-stagnation in middle-income countries, and in certain cases it is useful in relation to rich countries. We understand, for example, that Latin American countries have stopped catching up while East Asian countries have continued to grow rapidly because in 1990, the former countries failed to neutralize the Dutch disease by liberalizing trade, while the latter lacked abundant natural resources thus not having the competitive disadvantage. Associated with this, we learned that the main method that countries use to neutralize this disease was the use of import tariffs, although most of them did not know about it. They knew, however, that they had to industrialize in order to grow. That this was the policy that the US used because it was an exporter of commodities and only opened up its economy in 1939. Developing countries that opened up their economies before neutralizing the disease fell into the interest-rate– exchange-rate trap or the liberalization trap. With the concept of exchange rate populism, we understand why so many developing countries practice an interest rate level above the international average plus country risk, or adopt the policy of growth with foreign savings. Regarding rich countries, we understand better why the US has all but stopped industrializing while China has become the world’s factory. We also understand that the Euro Crisis was an internal exchange-rate problem, and the drastic austerity that the “Troika” (a group formed by the European Commission, the European Central Bank and

New developmentalism

xii

the International Monetary Fund) forced countries with external debt to adopt had the objective of reducing real wages and, thus, restoring the balance of the internal exchange rates. In this introduction, I want to express my thanks to the friends who have helped me write this book over the past year. I cite Tiago Porto, who followed the work from the beginning, and Eliane C. Araujo, who read the manuscript and made suggestions. Others read specific chapters, as was the case of Arthur Barrionuevo, Paulo Gala, Fabio Anderaos and Rafael R. Leão. I extend my thanks to José Luis Oreiro and Nelson Marconi, who wrote a book with me on the macroeconomics of development and led younger researchers on ND. Yoshiaki Nakano wrote the first two articles on ND with me. Alexandre Abdal, André Nassif, Carmem Feijó, Elias Jabbour, Fabio Brittes Terra, Fabrício Missio, Fernando Ferrari Filho, Francisco Eduardo Pires de Souza, the late François Chesnais, Frederico Gonzaga Jayme Junior, Gilberto Tadeu Lima, Guilherme Jonas Gomes da Silva, Jan Kregel, Leda Paulani, Leonardo Burlamaqui, Luiz Felipe Alencastro, Luiz Fernando de Paula, Luiz Gonzaga Belluzzo, Marco Flavio Cunha Resende, Miguel Bruno, Pedro César Dutra Fonseca, Pierre Salama, Ricardo Bielschowsky, Robert Boyer, Robert Guttmann, and Robert Wade are friends who have contributed to the ideas developed here. And Carlos A. Medeiros, who has been critical of ND. I am grateful to Cecilia Heise, an extraordinary assistant, and to my editors at Edward Elgar Publishing, who realized that New Developmentalism was increasingly catching the attention of people interested in economic development and invited me to write this book. My final thanks are always to my ever-loving wife and companion, Vera.

NOTES 1.

2. 3. 4.

It should be noted that in this book I use a capital letter for state, as an institution (the constitutional-legal system and the organization that guarantees it), and I use state with a lowercase letter to indicate forms of territorial society such as the nation-state and the city-state, which are formed by a nation and a state. Evans and Rueschemeyer (1985). Amsden (1989); Wade (1990); Chang (2002); Taylor (1983); Palma (2005). The classic situation where we had this problem was in countries where there were modern enclaves that were totally separate from the dominant traditional society. Today, cases of such radical dualism are rare, if any.

1. The method and the schools This book offers a summary of new developmentalism (ND): an economics and political economy that studies developing countries, especially middle-income countries.1 It is a theory that adopts the historical–structural method and is critical of orthodox or neoclassical economics, which instead uses the hypothetico–deductive method. ND discards such economics that is dominant in the universities in central countries, which has at its core the general equilibrium model and theory of rational expectations, which have turned neoclassical economics into a radical defence of economic liberalism. Economists must always consider that they work with a substantive science whose criterion of truth is its adequacy for reality. This may seem obvious, but it is not so obvious when we distinguish the substantive sciences (natural or social sciences, which have a substantive object of study) from the methodological sciences (which do not have an object of study but have a goal: to help thinking). Physics, biology, and economics are examples of substantive sciences, while mathematics and econometrics are methodological sciences. In the methodological sciences, the analyst starts from axioms and deduces the rest logically, which makes sense because there is no reality to be understood. The substantive sciences are different. Scientists work with observations combined with logical reasoning. They begin by observing reality and try to generalize or define “laws” by looking for regularities and tendencies. This is the empirical method or, in the social sciences, the historical–structural method. The criterion of truth in the substantive sciences is its adequacy for reality. In the methodological sciences, in which there is no reality to explain, a statement is true if it is logically consistent. That is why, in mathematics, theorems are so undeniable that their exposition ends with “QED” (quod erat demonstrandum – “what was to be demonstrated”). In contrast, in the substantive sciences, the problem of accuracy is central, but certainty is virtually impossible, because reality is ambiguous, contradictory, and constantly changing. This is not, however, a cause for despair, because the constituent element of every science is stable, though not equally stable. Neutrons and atoms in physics are more stable than cells in biology, which are more stable or predictable than humans, who are relatively free. Freedom is our most excellent skill, but it makes the social sciences intrinsically uncertain. That is why economists, or sociologists, or anthropologists must be modest. You will see in this book that I use words like “often” and “usually.” This is due to the historical method and 1

2

New developmentalism

the fact that in the real economy, facts or causes do not always have the same consequences, despite the controls that social scientists adopt to demarcate their predictions. On the other hand, as Charles Peirce (1839–1914) – the great American pragmatist philosopher – argued in the late nineteenth century, we cannot prove that our findings are true, because the proof is based on induction, as Hume argued in the eighteenth century; a black swan can always appear. But for Peirce, we can only consider our findings to be true until a new study shows that the theory is clearly not adequate for reality. In the early part of the twentieth century, Karl Popper (1902–1994), based on Peirce, developed “methodological falsificationism” without quoting Peirce and was credited with this excellent idea. However, Popper himself was not a realist-falsificationist as he supposed, but a conservative-idealist philosopher to whom research did not really matter – what mattered to him was deductive logic. With the concept of “naïve falsificationism,” he allowed scientists to legitimately ignore a lot of research that falsified (refuted) the findings of a given theory.2 This is what neoclassical economics essentially does. The number of models that are persistently refuted is enormous, but the neoclassical school of thought remains dominant in universities, and these models continue to be taught. There is also the problem of empirical verification. For the methodological sciences, this does not exist, and for the substantive sciences, its solution is far from simple. The researcher formulates the hypothesis, deducing it from what they observed, and then verifies whether the hypothesis is right or wrong. If the hypothesis is specific, verification is relatively simple. In economic matters, however, the most relevant hypotheses are complex, involve many variables, and the standard method of verification – econometrics – is faltering. Here it is necessary to deepen this discussion. I refer the reader to two articles in which I criticize orthodox economics from a methodological perspective. In the first, I criticize neoclassical economics, whose core (the general equilibrium model and the theory of rational expectations) is exclusively hypothetico–deductive. In the second article, I argue that economic theory should basically use historical models, but it can also use syllogisms as long as the conditions on which they are based are real or historical.3 An example of a syllogism is the law of comparative advantage. It is a beautiful syllogism, because from its premises it comes to a surprising conclusion – that two countries must trade, although one of them is more efficient than the other in all tradable goods. But liberal orthodoxy abuses it to justify trade liberalization, ignoring that the conditions that make it valid (full employment and the short-term) are rarely present in the long-term development process. In the case of the social sciences, in addition to logic and observation, we must consider dialectics. Social reality is intrinsically contradictory – cause-and-effect relationships can work in two directions, depending on

The method and the schools

3

specific conditions. For example, we will see in this book that, in the short run, the exogenous variable is the exchange rate. It goes out of balance due to some external shock and, consequently, changes the current account balance. At the same time, in the long run, a permanent current account surplus or deficit can only be the result of a political choice, and the endogenous variable will be the exchange rate. From all this, I come to a moral conclusion: economists should be modest. Economic syllogisms can be useful, but observation of reality must always take precedence over logic. Neoclassical Economists are often prisoners of their central axiomatic models. Heterodox economists do not suffer from this original sin, but the truth of their claims and findings is relative. In 1962, Thomas Kuhn showed that the natural sciences advance as they reach new paradigms, which he defined as new basic ideas that became consensual among recognized scientists. In the social sciences, including economics, we don’t have paradigms; we have schools of thought. This reflects not only how uncertain the predictions involved in economic theories or models are, but also how humble economists should be.

THE FIRST SCHOOLS OF ECONOMIC THOUGHT The distinction between developmentalist and liberal economic theories is central to ND. According to the developmentalist perspective, the coordination of economies and the allocation of factors of production are the result of market competition and corrective state intervention – a more realistic perspective than the view that market forces coordinate economic systems optimally. The original schools of thought – mercantilism, classical political economy, and Marxist political economy – developed between the sixteenth and nineteenth centuries, when capitalism was on the rise. The first two schools of thought were influential in promoting industrialization and development, and the third offered a systematic and acute view of capitalism while critiquing it. I will briefly discuss these three theories and mention two other schools: the physiocratic school, which had an influence on France in the eighteenth century, and the German historical school, which played a crucial role in the industrialization of Germany in the nineteenth century. The Mercantilist School This is the first school I will discuss. It was the dominant school of thought in the seventeenth and eighteenth centuries, and its final part coincided with the Industrial Revolution in Britain. At this time, European societies began their capitalist revolution by building the first national markets. Economics or political economy (they were the same thing until the end of the 19th century)

4

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was the science of markets – how markets coordinate economic systems. Therefore, it could only arise when the markets became national. Before mercantilism, what was meant by economic theory was the management of the local economy; it was not a science, it was just a practice. Mercantilist economists had precursors in the Renaissance.4 The mercantilists were Italian, Dutch, and British. In England, along with merchants, they enjoyed the support of monarchs, beginning with Queen Elizabeth I (1558–1603). Mercantilism as an economic theory was born in response to the economic successes of the Dutch Republic, which was the leading capitalist country in the seventeenth century. Josiah Child (1630–1699) and James Steuart (1712–1780) were leading British mercantilists. Jean-Baptiste Colbert (1619–1693) headed the French mercantile school, while Antonio Genovesi (1712–1769), an Italian economist and philosopher, was transitioning to classical political economy. The most important Italian mercantilist was Antonio Serra, who lived in the eighteenth century and published his major book, A Brief Treatise on the Wealth of Nations, in 1613.5 According to Erik Reinert, Serra was “the first economist to produce a theory of uneven development.” He argued that the Venetians, unable to cultivate the land like the Neapolitans, were forced to rely on industry to make a living, taking advantage of the increasing returns to scale offered by manufacturing activities.6 The mercantilists were developmental, not liberal economists. At the time when the modern state and the market – the two central institutions of capitalism – were being constructed, mercantilists recognized the precedence of politics over economics, of the state over the market. They saw the prosperity of nations as a result of the association of the monarch and his court with the rising mercantile and financial bourgeoisie and the achievement of trade surpluses from their relations with the other nations. As Amintore Fanfani (1908–99), a prominent Italian centre-left Christian Democrat put it in 1955, the main difference between classical orthodoxy and economic development theory is that “while scholasticism thinks of an order of equilibrium, mercantilism thinks of an order of growth.” Like modern developmentalism, mercantilism asserted that economic development was essentially the development of the manufacturing industry. Following this line of thought, Reinert and Reinert ([2005] 2011) argue that the main difference between orthodox economics (a form of scholastic economics) and mercantilist economics was that “mercantilist policy recommendations were highly context-dependent – protecting manufacturing might be the right thing to do in one context, while free trade might be right in another, whereas the recommendations of neoclassical economics are independent of context.”7

The method and the schools

5

Classical School of Political Economy With the publication of The Wealth of Nations in 1776, Adam Smith (1723–1790) can be seen as the founder of economic liberalism and classical political economy. This dual role – ideological and theoretical – made him the most important economist of the eighteenth century, just as Karl Marx and Alfred Marshall would be in the nineteenth century. His theory represented progress in that it defined the wealth of nations not as a trade surplus and the volume of gold reserves a country possessed, but as production: what we now call gross domestic product (GDP). It also saw the increase in a country’s productive capacity as the result of the division of labor and the use of new techniques. Other prominent political economists were Thomas Malthus (1766–1834), Jean-Baptiste Say (1767–1832), David Ricardo (1772–1823), and John Stuart Mill (1806–1873). These economists lived during the epoch of capitalist revolutions in their own countries. They adopted the historical method to develop their theories. However, in the works of David Ricardo, we can find the seeds of the hypothetico–deductive method, and at a certain point in his life, Stuart Mill considered its adoption to make economics “accurate”, although upon publishing his Principles of Political Economy in 1848, he continued to use the historical method. They also adopted the labor theory of value: “value” being defined as the amount of labor used to produce the good. Prices vary around this amount according to the demand and supply of the good or service. Karl Marx, who can also be considered a member of the school of Classical Political Economy, also adopted the labor theory of value, but used this concept to define the rate of exploitation in capitalist societies – the “rate of surplus value,” defined as the ratio of the total amount of unpaid labor (surplus value) to the total amount of wages paid (the value created by labor alone). Adam Smith created the metaphor of the “invisible hand” to explain how competitive markets work and how they ensure the most efficient allocation of factors of production. From this concept, Ricardo would derive the law of comparative advantage. This powerful and misleading syllogism was to become the main tool that liberal imperialism adopted to persuade or pressure developing countries not to protect their infant industry. I say “liberal imperialism” because economic liberalism is the main ideological tool that powerful nations use within the framework of “informal imperialism” – the kind of economic imperialism that became dominant after World War II. With the wars of independence waged by the colonies, formal imperialism became economically unviable. Informal or soft-power imperialism then used economic liberalism as its main tool to prevent low-wage peripheral countries from industrializing and competing in international markets.

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New developmentalism

Marxist School of Political Economy While the mercantilist school was abandoned due to the rise of the classical school of political economy, and the latter yielded to the rise of the neoclassical, the Marxist school has remained alive, and modern Marxism has made a decisive contribution to the understanding of capitalism today. It inspires heterodox non-Marxist schools, including ND. Marx analyzed and critiqued capitalist societies and their dynamic, contradictory and unjust character with a depth never before reached by an economist or philosopher. Marx failed when he foresaw the collapse of capitalism in his lifetime, and the Marxist school lacks a proposal for policymaking, because it sees capitalism as a permanent crisis. Still, the historical method he adopts – and his radical critique of capitalism – explains why he continues to be influential. The Marxist school of thought is the only original school that remains alive.8 Combining political economy, sociology, and history, it offers a broad and critical view of capitalism and its historical development.

NEOCLASSICAL ECONOMICS Neoclassical economics was born around 1870, when a group of economists simultaneously proposed a new theory of value to define prices. Léon Walras (1834–1910), William Stanley Jevons (1835–1882), and Karl Menger (1840–1921) adopted the hypothetico–deductive method and developed the concept of marginal utility and a related subjective theory of value that would allow for the progressive mathematization of all economics. This did not represent progress for economics; it represented a significant regression. At its core, economics has ceased to be a science of how economic systems work and has become an ideological justification of economic liberalism and an abstract theory of economic decision-making. The leading economist of this school was Alfred Marshall (1824–1918), who, with the publication of his monumental Principles of Economics in 1890, changed the name of our science from political economy to economics. A contradictory man, he praised the historical discussion of economic problems and policies, but the concepts and figures of his microeconomics were purely deductive. Because this microeconomic system is highly abstract – ahistorical – current microeconomics textbooks do not differ much from Marshall’s Principles. In this book, I will call “liberal orthodoxy” not the theories but the policies that neoclassical economists usually advocate, while I will use the expressions neoclassical economics, conventional economics, and liberal-orthodox economics interchangeably. The Austrian school is also liberal – radically liberal. Some of its members, such as Ludwig von Mises (1881–1973), advocate meth-

The method and the schools

7

odological individualism; others, such as its main representative in the twentieth century, Friedrich Hayek (1899–1992), were also liberals but thought more historically, rejecting the methodological individualism that is the twin brother of the hypothetico–deductive method. By any measure, Hayek was a great economist. Thus, I do not regard this school as just another orthodox school of thought, but as a heterodox but liberal school. The neoclassical school has been the dominant school of economic thought in the departments of economics at leading UK and US universities since the time of Alfred Marshall. The stock market crash of 1929 and the Great Depression of the 1930s demoralized this school and the economic liberalism it preached, making room for Keynesian critique. From the mid-1940s to the mid-1960s, neoclassical economics lost its dominant position to post-Keynesian economics, but in the late 1970s, it returned to that position. The profound attraction that orthodox-liberal economics exerts on economists is due to the belief that markets can coordinate economies without the intervention of human beings and because it can be expressed in the form of a mathematical system of equations. Humans were fascinated by Plato’s idealistic philosophy, which held that reality is a projection of the human mind. Idealist philosophy rejects the dualistic perspective, which opposes the reality of the idea and affirms the primacy of consciousness, which would be the origin and prerequisite of existing phenomena. In modernity, important philosophers such as Descartes, Kant, and Hegel were idealists, and virtually all of them thought logically–deductively. The exception is Hegel, whose genius allowed him to combine induction and deduction dialectically. In antiquity, Aristotle and Thomas Aquinas were realist philosophers, as were Hume, Marx, and Peirce in modernity. I only understood philosophical idealism when, critically studying neoclassical economics, I realized that its scholastic and idealist character derived from the adoption of the hypothetico–deductive method. Using this method, neoclassical economists “solved” the problem of truth. Truth became a matter of logical consistency that did not need to be verified by its adequacy for reality – a complex and contradictory reality that only allows the social sciences to make provisional and imprecise generalizations. Today’s neoclassical economists – those who believe in the Walrasian general equilibrium model and the theory of rational expectations – insist on the importance of empirical research. Still, when the facts disprove the theory, they conclude that the problem lies in the facts and not in the axiomatic character of the idea, which is logical and therefore true. We generally see the history of science as a process of continuous, sometimes contradictory, progress. In the case of economics, however, the neoclassical and Austrian schools did not represent progress, but rather a regression or a deadly deviation. Neoclassical economists changed the name of economics because the new name (economics) suggested that economics had

8

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become a “pure” science, while the old name (political economy) indicated that economic science mixed economics with politics. The adoption of the hypothetico–deductive method allowed the construction of a totally abstract theory and, therefore, supposedly more scientific. But what happened was the opposite. Economics has lost touch with economic reality. It has become a system of economic syllogism of a normative character, not the analysis of how economic systems actually work. Economics should help economists understand the economic systems of the present and the past. By adopting a method suited to the methodological sciences but not to the substantive sciences, and radically assuming liberal ideology, liberal orthodoxy hinders rather than helps economists to do their jobs. There are some economists in the United States and Britain who are brilliant and progressive, but who do not criticize the core of neoclassical economics. I think of academics like Dani Rodrik or Paul Krugman. I explain that they are competent and experienced economists who use practical models that do not depend on the core of neoclassical economics: the general equilibrium model and the theory of rational expectations. There is also the case of many academics who publish research papers in economic journals using econometrics and algorithms to test projects and public policies. They were educated at universities that teach neoclassical economics, but they are not neoclassical economists. We could say that they are part of a school of project evaluation and public policies. They are interested in evaluating relevant specific policies and projects, not economic systems. They are essentially pragmatic economists. Since the global financial crisis of 2008, orthodox economics, which serves as a justification for neoliberal reforms and neoliberal ideology, has once again faced serious problems. The crisis of 2008 was milder than that of 1929 because governments immediately adopted sound Keynesian (heterodox) countercyclical fiscal policies. In 2016, with the election of a right-wing populist in the US, Donald Trump, and the Brexit referendum in Britain, neoliberalism faced a political crisis. The collapse happened in 2021 with the Covid-19 pandemic and the election of Joe Biden as US president. Thus, since 2021, we have witnessed a “developmental turn”, unlike the “neoliberal turn” of 1980. The state is back, and state intervention is no longer the problem but the solution. It should be noted, however, that the developmentalism that is emerging is conservative, not progressive, as it was in the “golden age of capitalism” after World War II.

POST-KEYNESIAN ECONOMICS The post-Keynesian school of economics is the most important heterodox school. It was born in the 1930s with the contributions of John Maynard Keynes (1883–1946) and Michał Kalecki (1899–1970). It is a theory critical

The method and the schools

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of the liberal orthodoxy that founded macroeconomics and that advocates moderate state intervention in the economy. Given ND’s assertion that economic theories are developmentalist or liberal, post-Keynesian economics is a developmental economics. He uses primarily, or should use primarily, the historical–deductive method, not the hypothetico–deductive method. Keynes and Kalecki did not start from axioms, but from the observation of the economic systems of their time – mainly the United Kingdom and the United States. By the 1930s, Keynes was part of the mainstream and had more influence than Kalecki in changing economics. Keynes was a professor at Cambridge, while Kalecki was a Polish economist who taught at Cambridge and Oxford for some time – an outsider. Together, they made a revolution in economics. The crash of 1929 and the Great Depression of the 1930s demoralized neoclassical economics and economic liberalism, before the founding documents of post-Keynesian economics were published between 1934 and 1939. From the 1940s to the mid-1970s, neoclassical economics lost its position in mainstream economics to post-Keynesian economics, which succeeded in promoting growth and full employment in the core countries. In the late 1970s, the elections of Margaret Thatcher and Ronald Reagan and the economic crises in Britain and the United States paved the way for the neoliberal turn of the 1980s – the transition from Keynesian to neoclassical economics in universities and from a socialist economy and a democratic and developmentalist ideology to conservative market fundamentalism. Post-Keynesian economics was born in the 1930s, when liberal orthodoxy was in crisis and economics departments in universities were relatively open to heterodox thinking. Beginning in the 1980s, the core of neoclassical economics – the general equilibrium model and the theory of rational expectations – became “absolute truth,” and economics departments closed their doors to heterodox economists. Before the Keynesian revolution, economics was a microeconomics that started from the concept and determination of value and prices. In philosophical terms, post-Keynesian economics is a realist theory, not an idealist theory, as is conventional economics. This realism made economics operational – it allowed economists to formulate and implement stabilization and growth policies. Prior to this, economics was a scholastic construct and an ideological tool for justifying economic liberalism. Governments should do nothing to make national economies more stable and grow faster. Governments were realistic enough to understand that this laissez-faire did not make sense to them. Politicians had to ignore economics when they adopted active stabilization and growth policies. In accounting terms, ex-post, aggregate supply is equal to the sum of wages and profits, which in turn is equal to aggregate demand in terms of consumption and investment. Classical political economists turned this identity into a theory, Say’s law, which states that supply creates demand – which

10

New developmentalism

Keynes rejected in the first chapter of his book General Theory (1936). Such an identity is false because economics deals with monetary economies, not barter economies. This is because capitalists and employees can always decide to “value” their dividends, interest and real estate rents, or their salaries and wages – they can put their money “under the mattress” or deposit it in the banks. On the other hand, post-Keynesian economics holds that investments do not depend on prior savings, they depend on the expected rate of profit minus the interest rate. Full employment is not the “normal” condition of monetary economies; it is an exceptional condition that can derive from disorderly or active macroeconomic policies. Men and women are not the all-knowing, entirely rational agents assumed by orthodox-liberal economics. They are flesh-and-blood people who follow routines and make decisions based on inevitably uncertain predictions. This explains why uncertainty plays a central role in Keynes’s macroeconomics. Keynes and Kalecki had different intellectual backgrounds. Keynes was a disciple of Alfred Marshall and was originally a neoclassical economist, while Kalecki had Marx’s political economy behind him. Thus, Keynes had a harder time than Kalecki in getting rid of the hypothetico–deductive method and neoclassical economics. Kalecki’s Marxist background helped him to think historically and to see the economy as part of a larger, more complex capitalist society. Keynes limited his analysis to the short term, leaving the study of economic development to his followers. At the same time, Kalecki was also one of the founders of structuralist developmentalism, as well as being one of the founders of macroeconomics. Here, I’m highlighting Keynes and Kalecki’s original contributions to macroeconomics, but as Marc Lavoie notes, “Post-Keynesian Economics is much more than a modernized version of the economics of a single collaborator – Keynes.”9 We can distinguish four branches within the post-Keynesian school. Considering only the economists who are part of history today, we had the Cambridge school of Joan Robinson (1903–1983), the Kaleckian school, the Keynesian-institutionalist school of John Kenneth Galbraith (1908–2006), and the American school of Sidney Weintraub (1914–1983).10 Today, post-Keynesian economics is a complex and dynamic school of thought that attracts heterodox economists interested in policies aimed at full employment.11 But it is a theory that shows little interest in developing countries.12 Modern monetary theory is a recent theoretical development associated with post-Keynesian economics. It originates from the banking school of Thomas Tooke (1774–1858), who criticized the quantity theory of money and advocated the reverse position: that the quantity of money in circulation was endogenous and determined by prices, rather than prices being determined by the quantity of money in circulation. Modern monetary theory updates these

The method and the schools

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views. I will discuss this theory in Chapter 6, when I analyse the reaction of economics to austerity. Conventional macroeconomics and its monetarist theory of inflation face a crisis because of their association with liberal orthodoxy and their poor results. This crisis was already evident on the periphery of capitalism in the early 1980s, when a group of Brazilian economists developed the theory of inertial inflation in which the money supply was endogenous and only validated ongoing inflation.13 In the early 2000s, it was not the crisis in the Global North, but the quasi-stagnation in Latin America, which made room for new developmentalism as a tributary of post-Keynesian economics and classical structuralist developmentalism.

NOTES 1.

The word economics cannot simply be translated as “economy”. The better translation is “economics,” which I use in this translation for the Portuguese of this book. Peirce (1877); Popper (1934). 2. Bresser-Pereira (2009; 2017). 3. 4. Among them, Giovanni Botero (1544–1617) and Antonio Serra (dates of birth and death unknown), who published his most important book in 1613. 5. The dates on which Serra was born and died are unknown. We only know that he published a pioneering book in 1613. Reinert (2007: 7) Fanfani was quoted by Reinert. 6. 7. Reinert and Reinert (2005: 5; 10). Choosing some of the leading Marxist economists of the recent past in a some8. what arbitrary way, we have, in Germany, Ernest Mandel (1923–1995) and Andre Gunder Frank (1929–2005); in France, Samir Amin (1931–2018); in the United States, Paul M. Sweezy (1910–2004) and David Gordon (1944–1996); in Great Britain, Maurice Dobb (1900-1976). Immanuel Wallerstein (1930–2019) and Giovanni Arrighi (1937–2009) for their approach to the World System. Among the current Marxists, we have Shaikh, Anwar, François Chesnais, David Harvey, Gérard Duménil, Dominique Levy, Michael Hudson, Leda Paulani, John Bellamy Foster, and Alfredo Saad Filho. Lavoie (2014: 43). 9. 10. Considering only the founding economists, we also have: (1) in the Cambridge school, Roy Harrod (1900–1978) and Nicholas Kaldor (1908–1986); (2) in the Kaleckian school, Joseph Steindl (1912–1993); (3) in the Keynesian-institutionalist school, John Kenneth Galbraith (1908–2006), and (4) in the American school, Sidney Weintraub (1914–1983), Hyman Minsky (1919–1996), Paul Davidson (1930), and Fernando Cardim de Carvalho, (1958–2018). 11. Today, among the leading post-Keynesians, we have Jan Kregel, James Galbraith, Victoria Chick, Philip Arestis, Malcolm Sawyer, Eckhard Hein, Engelbert Stockhammer, Marc Lavoie and Robert Blecker. 12. Among its key representatives, Jan Kregel, who worked for several years at UNCTAD, is an exception. 13. See Bresser-Pereira (2012b).

2. The developmental schools and anti-imperialism There are two developmentalist schools: classical structuralist developmentalism and new developmentalism (ND). ND can also be called the new developmental theory to make clear its theoretical character. What they have in common is the historical method, a critical stance towards conventional economics, the defence of a moderate intervention of the state in the economy, and a national perspective that does not exclude international cooperation. His economics is associated with Keynes and post-Keynesian economics, and his political economy is associated with Marx. In this chapter, I will discuss classical structuralist developmentalism and ND – the two main schools that focus on developing countries.1 I will compare these two schools with post-Keynesian economics – the most complete heterodox school of thought – and refer to the French school of regulation, modern monetary theory (MMT), as well as some important sociological contributions to the theory of economic development.

CLASSICAL STRUCTURALIST DEVELOPMENTALISM In the 1940s, when some economists began to study underdeveloped countries, a new school called development economics was born. But this is an excessively general expression. I call it classical structuralist developmentalism. It is based on a political economy that discusses the capitalist revolution, the developmental state, class coalitions, and is based on an economics in which we find the “big push model”: the identification of economic development with industrialization or structural change; the transfer of labor to manufacturing as a way of increasing productivity; the critique of neoclassical economics based on the tendency of deterioration of the terms of trade; the argument of the constraint on the balance of payments (which can only be overcome by industrialization) and the rising yields existing in manufacturing. Classical structuralist developmentalism is associated with capitalist revolution, economic development, and the rise of modern empires with the reduction of the populations of Asia and Africa to a colonial and underdeveloped condition. Classical structuralist developmentalism defined economic development as the historical process of capital accumulation with the incorporation 12

The developmental schools and anti-imperialism

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of technical progress and the raising of a population’s standard of living. It is a relatively self-sustaining process because investments in machinery and technology – the modernization of companies that compete in the market – become an essential feature of every national economy. Classical structuralist developmentalism originally saw the world as divided into industrialized countries and underdeveloped countries. Soon, however, the term “underdeveloped countries” was replaced by “developing countries”, probably because the international agencies dealing with the problem of development were uncomfortable with the term underdeveloped – it would be too pessimistic. So, “developing” became the dominant expression, and I have been using it for a long time, but as time went on it became clear that underdeveloped was a more realistic term. All countries that have had contact with the Global North have experienced some growth, but only a few have grown fast enough to catch up with and improve the standard of living of their population. Rosenstein-Rodan’s (1902–1985) 1943 big-push model was the main founder of the new school. It showed that developing countries did not count on the positive externalities that lowered production costs in rich countries. The 1949 model of the trend towards the deterioration of the terms of trade was proposed by Raúl Prebisch (1901–1986). The model rejected the conventional assumption that increasing productivity in rich countries would lower prices; instead, it caused wages to rise in these countries, and the benefits of productivity were not transferred to the entire world, as conventional economics held. Prebisch also formulated the original model of balance-of-payments constraint, which showed that while the income elasticity of consumption of primary goods in the Global North was less than 1, the income elasticity of consumption of manufactured goods in developing countries was greater than 1. In 1968, Nicholas Kaldor (1908–1986), following a long tradition dating back to Antonio Serra’s 1613 book, argued that manufacturing involved increasing returns, not diminishing returns, as neoliberal orthodoxy assumed.2 These four models justified state intervention in developing economies. Classical structuralist developmentalism assumed that a developmentalist class coalition, associating the national bourgeoisie, workers, and the public bureaucracy, would control industrialization. We can see this socio-political vision in the studies of the Economic Commission for Latin America and the Caribbean (ECLAC) – especially in the contribution of Brazilian nationalist intellectuals at the Higher Institute of Brazilian Studies (ISEB), particularly Hélio Jaguaribe (1923–2018)3 – and in Peter Evans’ doctoral dissertation on the “triple alliance.”4 The essential contribution of classical structuralist developmentalism was the assertion that economic development is industrialization or “structural change.” Its policy was national developmentalism: in order to industrialize, countries had to plan their economies and adopt the model of industrialization

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by import substitution. The developmentalists did not get far with planning – in capitalist economies planning is only possible for infrastructure and the primary inputs of industry – but their import substitution strategy worked. Import tariffs on manufactured goods was the basic industrial policy they adopted. Larger countries, such as Brazil and Mexico, were the most successful because economies of scale were less restrictive. Governments set tariffs for the different industries, starting with consumer goods, gradually expanding to the primary input and capital goods industries. By using import tariffs, they were not inventing a strategy. All industrialized countries, such as late arrivals like the United States and Germany, but also the United Kingdom, protected their industry with import taxes. Alexander Hamilton (1757–1804), George Washington’s Secretary of the Treasury, originally developed the “infant industry” argument that legitimized this policy. While living in the United States, the German economist Friedrich List (1789–1846) authored the book The National System of Political Economy ([1841], 1999), in which he vigorously elaborated on this argument. List criticized the law of comparative advantage, which led liberal economists to disparagingly define him as “the theorist of protectionism.” But import tariffs only become “protectionist” when they are maintained after the respective industry is no longer reasonably defined as an “infant industry”. The import-substitution model of industrialization has been successful in Latin America and extraordinarily successful in Brazil. Yet, in 1963, the prominent developmental economist Maria Conceição Tavares, when considering the provisional intrinsic character of the model of industrialization by import substitution, revealed in an influential paper her concern with its future decline.5 This was an internal critique of classical structuralist developmentalism that she later revised. When, in the 1980s, Latin America fell into a tremendous economic crisis, liberal economists immediately attributed the economic stagnation, which would define this decade, to the import-substitution model. The critique did not make sense. The real cause of the crisis was the great foreign debt crisis of the 1980s, resulting from the policy of growth with external debt adopted in the 1970s by the countries of Latin America and Africa. In the 1930s, they had to abandon this policy because their international credit was suspended with the 1929 crash and the following moratoriums. In the 1970s, the credit was restored, and the countries immediately resumed the equivocated policy of growth with foreign savings.

SECOND GENERATION DEVELOPMENTALISM In the 1980s, all the countries of Latin America, and many of Africa and Asia, faced a major economic crisis: the foreign debt crisis of the 1980s. At that time, the rich nations, led by the United States, made the “neoliberal turn”, moving

The developmental schools and anti-imperialism

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from the “golden age” of a developmental and progressive capitalism to the “neoliberal years”. In the post-war years, the Global North viewed the import substitution strategy with some discomfort but accepted its developmentalist ideas and policies. That changed in 1980. The neoliberals immediately attributed the foreign debt crisis to the industrializing import substitution strategy and the “protectionism” involved. Import tariffs in this strategy were high, but not just protectionist. They were also a means to neutralise pragmatically the Dutch disease. The causes of the stagnation that heavily indebted developing countries faced in this decade stemmed more from borrowing by developing countries in hard currency to “grow with foreign savings” and the brutal rise in US interest rates than from domestic inefficiencies. In the context of the great foreign debt crisis of the 1980s, classical structuralist developmentalism faced its own crisis, which Albert Hirschman (1915–2012), one of the pioneers of this school, immediately recognized.6 But this crisis had already begun in the late 1960s with the emergence of “associated dependency” – the dominant version of dependency theory that paradoxically rejected import substitution and advocated the association of Latin American countries with the Global North. All versions of dependency theory rejected the existence of a national bourgeoise and were critical of the nationalist or developmentalist class coalition involving the working class, the public bureaucracy, and the national bourgeoisie itself. But while the original Marxist version proposed by the theory’s founder, André Gunder Frank, was also critical of imperialism, the associated dependent version preached “association” with the empire. This argument will be further developed at the end of this chapter. While Latin America literally stopped in the 1980s and has been almost stagnant since the 1990s, East Asian countries have continued to adopt a developmentalist approach to growth and have now become wealthy countries. There are three main books that originally looked at this extraordinary growth: Chalmers Johnson’s 1982 book on Japan, Alice Amsden’s 1989 book on South Korea, and Robert Wade’s 1990 book on Taiwan. They talk about the importance of investment in education and infrastructure and also discuss macroeconomic policy but emphasize industrial policy. Erik Reinert and Ha-Joon Chang followed suit. In the turn of the century, they studied the history of economic development in the core countries and demonstrated that the same policies and institutions that the neoliberal consensus sought to prohibit from developing countries adopting were the same policies and institutions that they themselves had used when they were at the same stage of economic development. This historical institutional inconsistency plagued the Washington Consensus. In 2013, Mariana Mazzucato published her book The Entrepreneurial State with a definitive research on the fundamental role of the state in economic growth, not in obvious countries like South Korea or China, but in the US.

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Using a wealth of data, she showed how rich countries, despite their neoliberal rhetoric, continued to intervene in their economies. The American state was entrepreneurial – that is, innovative, risk-taking, and directly involved in technological development. We can only explain the enormous development of the Internet and the rise of corporations like Google and Apple if we consider the role that the state has played in developing the basic technologies behind its growth. However, if we compare this era with the “golden age”, we see that neoliberalism inhibited the economic creativity of the state in the neoliberal years. This was one of the causes of the poor economic performance of rich countries after the neoliberal turn of 1980.

NEW DEVELOPMENTALISM In the 1980s, developmentalist governments in Latin America failed to overcome the foreign debt crisis, their developmentalism weakened, and in the 1990s, they dived into the new truth coming from the Global North. They engaged not only with the inevitable structural adjustment policies led by the IMF – inevitable due to the defaults – but also with the neoliberal reforms, now coordinated by the World Bank, which made a neoliberal turn at the cost of an identity crisis.7 Not surprisingly, trade and financial liberalization has failed to make these countries resume growth. Instead, we have seen increased financial instability, low growth rates, and deepening inequality. In the 2000s, some developmentalist governments returned to power in Latin America, but the economic results were no better, essentially because they did not reinstate the import tariffs that neutralized the Dutch disease, and also tried to grow with foreign debt. Fiscal populism also happened, but it was not the main cause of the failure of countries to overcome the quasi-stagnation that characterized the neoliberal years in this region. Classical structuralist developmentalism and post-Keynesian economics did not identify these two problems, nor did they have the policies to overcome them. ND was the answer. ND is a theoretical framework that explains why Latin American countries have been almost stagnant since the 1980s, while East Asian countries continue to grow rapidly. Rather than just generically criticizing neoliberal reforms, as classical structuralist developmentalism often does, ND has shown that these reforms have been instrumental in causing quasi-stagnation. By opening up their economies without considering that import tariffs on manufactured goods were a way to neutralize the Dutch disease, Latin American countries fell into a trap: not the “middle-income trap” but the “liberalization trap.”8 We will discuss this in Chapter 13. In this context, a growing group of economists began to construct a macroeconomics of development and a political economy, which came to be called

The developmental schools and anti-imperialism

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new developmentalism. The first contributions were made in 2002, but the first work that drew attention was a comparison between ND, neoliberal orthodoxy and populist forms of developmentalism (Bresser-Pereira, 2006). In this and the following three years, with the publication of the 2008 article on Dutch disease and two books,9 we can say that the new economics was defined. In my 2007 book, Macroeconomics of Stagnation: A Critique of Conventional Orthodoxy in Brazil, I studied the quasi-stagnation of the Brazilian economy while building the basic models for ND. Globalization and Competition was the first book to present ND’s economics and the new political economy.10 In the 2008 article on Dutch disease, we have two equilibrium exchange rates: the current equilibrium, which balances the country’s current account intertemporally, and the industrial equilibrium, which makes the production of non-commodity tradable goods and services competitive by companies using the best technology available in the world. Thus, ND uses the concept of equilibrium, but not in the neoclassical sense, as the price freely established by the market, but the prices consistent with the proper functioning of the economy. A price is in equilibrium when, for example, it balances one thing, or makes another competitive, or is compatible with price stability, etc. In the early 1980s, 20 years before ND was developed, Yoshiaki Nakano and I developed the theory of inertial inflation that I believe should be considered part of ND. This theory distinguishes the factors of acceleration, maintenance, and sanction of inflation. It states that excess demand or supply shocks is the accelerating factor of inflation, the formal or informal indexation of the economy is the sustaining or inertial factor of inflation, and the quantity of money is the sanctioning factor of inflation. As money is endogenous, when the inertial inflation is high, the money supply increases to keep the economy’s real liquidity stable, allowing its normal functioning.11 In 2010, a group of 81 academics discussed and signed the “Ten Theses on New Developmentalism”.12 In 2014, José Luis Oreiro, Nelson Marconi and I published the book Developmental Macroeconomics, which was the first systematization of ND’s macroeconomics and discussion of Brazil’s quasi-stagnation.13 In 2020, I published an article in the Cambridge Journal of Economics summarizing the entire theory.14 The present book is the most complete formulation of ND’s economics and political economy. ND’s political economy originates from Marx’s political economy, while its economics and policy recommendations originate from post-Keynesian economics and classical structuralist developmentalism. It considers economic development as a priority objective for countries – a goal that is in tune with, but not in conflict with, the other political objectives of modern societies: national autonomy; safety; individual freedom; social justice and the protection of the environment. It argues that two complementary institutions coordinate the economy: the state and the market. It asserts that developmentalism

18

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and economic liberalism are the two forms of economic coordination of capitalism. While the market coordinates the competitive sector of the economy from above, the state coordinates the non-competitive sector (infrastructure and basic inputs), in addition to coordinating some strategic industries such as aeronautics, the health industrial complex, and innovative industries in which the socialization of risks for radical innovation requires the direct participation of the state. As a political economy, ND asserts that in order to develop, each nation-state must rely on a developmentalist class coalition, the developmental state, and economic nationalism. In its microeconomics, ND holds that supply factors are crucial for development, although they can only promote growth if they are combined with macroeconomic policies that ensure that the level of interest rates is low and the exchange rate competitive. In macroeconomics, ND assumes that markets are incapable of securing the “right” or “correct” macroeconomic prices (interest rate, exchange rate, wage rate, inflation rate, and rate of profit). The “correct” or “right” here has no relation to the neoclassical term “right prices.” It is not the price by the market, but the prices that ensure financial and price stabilization, encourage investment, distribute income evenly, etc.15 In its development macroeconomics, ND defends fiscal deficits when they are countercyclical and rejects current account deficits. In contrast, neoliberal orthodoxy rejects fiscal deficits and is complacent about current account deficits. ND assigns high importance to the current account, which must be balanced, thus rejecting the growth with foreign debt. The exceptions are the rare moments in which the economy grows very fast to the point of causing the marginal propensity to consume to fall and the rate of replacement of domestic for foreign savings to also fall. ND sees the exchange rate as a strategic macroeconomic price and argues that there is a tendency towards cyclical overvaluation of the exchange rate in developing countries, caused by the growth with foreign debt policy – a misguided policy generally adopted by developing countries that does not lead to an increase in the investment rate, but to an increase in consumption. When a country has the Dutch disease, we have a second cause for the long-term overvaluation of the exchange rate – not the general exchange rate, but the relevant exchange for competitiveness of the manufacturing industry. ND sees climate change as a significant threat to humanity and understands that economic growth is a tool, not a burden, which allows countries to finance the substantial investments needed to replace carbon dioxide emitters with renewable energy sources. The state should control this effort by taxing carbon emitters while encouraging green and carbon-free technologies.

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COMPARING WITH CLASSICAL STRUCTURALIST DEVELOPMENTALISM New developmentalism, classical structuralist developmentalism, and post-Keynesian economics are associated – especially the first two. We could see ND not as a new school, but as part of classical structuralist developmentalism. But I prefer to think in terms of a new school because ND makes some criticisms of the school from which it originated and adds new ideas. ND and classical structuralist developmentalism agree that: • development is industrialization or structural change or even productive sophistication (synonyms); • the state must intervene moderately in the economy in order to achieve development; • the external constraint stems from two perverse income elasticities: while in rich countries the income elasticity of imports of primary goods is less than one, in developing countries the income elasticity of imports of manufactured goods is greater than one; and • imperialism – or the Global North – seeks to prevent developing countries from industrializing; it prefers to keep the unequal exchange system, exporting goods with high value added per capita and importing from the Global South commodities with low value added per capita. ND makes criticisms to classical structuralist developmentalism: • while classical structuralist developmentalism is a development microeconomics focused on the supply factors that determine investment and growth, post-Keynesian economics pays greater attention to short-term demand. ND thinks from the outset of macroeconomics as a macroeconomics of development, and its major instrument for this, besides stimulating investment, are the management, although relative, of the five macroeconomic prices; • the main objects of study of classical structuralist developmentalism are pre-industrial countries that begin to industrialize, while ND focuses on middle-income countries that have already carried out their own capitalist revolution; • classical structuralist developmentalism was pessimistic about the export of manufactured goods, adopting the model of industrialization by import substitution and legitimizing the corresponding import tariffs with the argument of infant industry. ND is more optimistic, defends an export-led strategy and legitimizes import tariffs with the neutralization of the Dutch disease argument;

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• ND counts with an original model of Dutch disease that has great relevance for the growth of commodity-exporting countries, classical structuralist developmentalism does not;16 • while classical structuralist developmentalism ignores the Dutch disease, ND attaches great relevance to it in determining the industrialization or not of commodity-exporting countries; • to neutralize the Dutch disease and be able to industrialize, ND advocates two policies that can be combined: a variable export tax on the commodities that give rise to it, or a tariff reform that differentiates the well-known import tariffs from a single import of manufactured goods tariff for all manufactured goods. In one case, the tax, in the other, the tariff, will vary according to the price of the commodities that the country exports. In the case of tariffs, they only neutralize the Dutch disease internally. In order for the industry to also be competitive abroad, a variable subsidy must be added; and • classical structuralist developmentalism advocates the growth with foreign indebtedness policy or with foreign savings, while ND rejects this policy for middle-income countries on the grounds that it overvalues the national currency in the long run. ND recommends balancing the current account or, when the country faces the Dutch disease, achieving a surplus, not ignoring that such a policy depends on the existence of countries with current account deficits.17

COMPARING WITH POST-KEYNESIAN ECONOMICS ND basically adopts post-Keynesian economics but makes some additions and change of focus. • ND is from the start an open and dynamic structuralist macroeconomics of development – a macroeconomics of development – while post-Keynesian economics is originally closed and short-term; • it focuses on the analysis of the five macroeconomic prices, which are not explicitly considered in post-Keynesian economics; • it focuses on the exchange rate and current account policy that many both developing and rich countries adopt, while post-Keynesian economics pays little attention to the exchange rate and ignores current account policies; • it has a theory of exchange rate determination that depends on two variables that are present in all theories (differential interest rate and exchange ratios), adds the current account deficit or surplus policy, and replaces the PPP with the value of the foreign currency related to the comparative unit labor cost index;

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21

• it criticizes the policy of growth with external indebtedness, which, instead of increasing the rate of investment, causes the appreciation of the exchange rate in the long run that discourages investment, while at the same time causing an artificial (unsustainable) rise in the wages and incomes of rentier capitalists, thus stimulating consumption; and • it states that in developing countries there is a tendency towards a cyclical and chronic overvaluation of the exchange rate, attributing it to governments failing to neutralize the Dutch disease, to the usual growth with external debt policy, which is turned real by high long-term interest rates aimed at attracting foreign capital to finance the deficit.

ANTI-IMPERIALISM Among ideologies, one of the least studied is nationalism. For a long time, one of the few essays on this topic was Ernest Renan’s famous 1882 essay, What is a Nation? He says that a nation is a history of efforts, sacrifices and commitments, whose existence is ensured by a “daily plebiscite”. In the last 50 years, an academic literature on the subject has emerged and Ernest Gellner made a classic contribution to it in 1983.18 He argued that nationalism is the struggle for congruence between the nation and the nation-state. That is why I say that nationalism is the ideology of nation-state building. Significantly, however, none of the authors in this literature – all of whom come from rich countries – speak of developing countries and anti-imperialism. Economic nationalism and developmentalism are associated. In order to grow, a nation must be able to assert and defend its own interests; it must use the state, which already regulates the economy, as an instrument of economic development. Modern economic nationalism was the reaction of the developing countries to imperialism. Classical structuralist developmentalism and ND are economically nationalist. The Global North criticizes imperialism and economic nationalism, “forgetting” that they themselves were, and continue to be, nationalist countries, as they defend the interests of national capital and national labor. The industrialized countries were nationalist and developmentalist when they formed their nation-state and industrialized; they remain nationalists today when they defend the interests of their companies that compete globally and oppose the industrialization of the periphery of capitalism. They oppose it because they want to maintain the developing countries exporting commodities while they continue to export manufactured goods. It is true that their multinational companies invest in the manufacturing industry of developing countries, but this is a policy of the companies, not of the rich countries and their governments. Although nationalistic, the governments of the central countries and their economists have made the word “nationalism” pejorative, associating it with

22

New developmentalism

fascism and populism. That is why I always talk about economic nationalism. Ethnic nationalism quickly turns into xenophobia and is the source of wars, fascism and genocide.19 The economic elites of rich countries had already abandoned nationalism to the extent that they adopted economic liberalism. Globalization has weakened still more nationalism because such elites – a rentier–financier class coalition – could now earn dividends, interest and real estate rents are realized in many countries. They have lost the idea of the nation and its commitment to growth. However, the working class of these countries, as well as the industrial entrepreneurs, remain nationalists, and their politicians defend the national interests so that they can be re-elected. The two developmentalist schools, classical structuralist developmentalism and ND, are anti-imperialist. They see the Global North as opposed to industrialization on the periphery of capitalism, hence the development of the Global South. The main representatives of classical structuralist developmentalism did not speak of imperialism, but of “centre-periphery.” Raúl Prebisch, the founder of classical structuralist developmentalism, did that in ECLAC and criticized the “unequal exchange” – developed countries exchanged sophisticated goods with high value-added per capita for primary goods in which value-added per capita was small and wages were low. He was aware of imperialism, but centre-periphery was enough for him to elaborate his main argument. As Joseph Love has noted, Prebisch “has earned for himself a prominent place in the history of the theory of imperialism, even if ‘imperialism’ is not part of ECLAC’s vocabulary.”20 In his 1961 book, Development and Underdevelopment, Celso Furtado (1920–2004), who worked with Prebisch, argued that underdevelopment was not a phase that preceded industrialization and economic development; it was rather the result of the strategies that the centre adopted to grow. Like Prebisch, Furtado did not attribute underdevelopment to imperialism – a word that did not fit in the United Nations – nor did he explain the wealth of rich countries as a function of the exploitation of developing countries, but he was critical of the centre-periphery relationship to the extent that it impeded the growth of developing countries. He knew that economic liberalism was the soft power that imperialism used to curb the industrialization of developing countries and convinced them to adopt liberal economic policies. ND argues that the countries on the periphery of capitalism must be nationalist to grow because it is practically impossible for them to develop if they do not have economic independence. Only by being autonomous will they be able to reject the liberal policies that the Global North pressures them to adopt using the weight of their ideological hegemony.

The developmental schools and anti-imperialism

23

TWO CURRENTS OF DEPENDENCY THEORY Dependency is an expression and a theory that emerged in the 1960s, in Latin America. Instead of talking about imperialism and focusing on the imperial interests of rich countries, Marxist economists focused on the alienated, dependent elites existing on the periphery of capitalism. The defining feature of dependency theory, regardless of its version, is the radical rejection of the existence of a national bourgeoisie in developing countries. This is a mistaken view. Latin American industrialists are nationalist at certain times and dependent at other times, especially when they feel threatened by the left. They are contradictory and ambiguous; they are nationally dependent. There are two main currents within dependency theory: the original and radical current of André Gunder Frank (1929–2005) and Ruy Mauro Marini (1932–1997), and the associated dependency theory of Fernando Henrique Cardoso and Enzo Faletto (1935–2003). Frank founded the theory with the article “The development of underdevelopment” (1966).21 He was in Brazil shortly after the military coup of 1964, saw that the coup had the support of industrial businessmen, and then authored his essay. At that time, in the context of the Cold War, similar coups of state took place in Argentina (1967) and Uruguay (1978). Most Latin American intellectuals accepted the view of the associated dependency and interpreted these coups as the confirmation of the dependency theory thesis of the “impossibility” of a national bourgeoisie constituting itself in developing countries. Dependency theory’s radical version, which remained Marxist, asserted dependency but was anti-imperialist; the associated dependency, founded by Cardoso and Faletto’s book Dependency and Development in Latin America ([1969] 1979), ceased to be Marxist and defended the association of Latin American countries with the United States. This version soon became dominant in the region, including on the left, because it was critical of authoritarian regimes and the growing inequality that military regimes were deepening. This dependency’s interpretation saw the investments in the manufacturing industry of the multinational corporations investing in the industry of Latin American countries as “proof” that the centre-periphery opposition was false. Naturally, the governments of developed countries and U.S. academics welcomed the theory of associated dependence, as Cardoso acknowledged.22 Accepted by intellectuals and supported by the United States, the associated version of dependency theory undermined in the long term the economic nationalism of Latin American countries. In the late 1980s, after ten years of the foreign debt crisis, it was one of the causes of the rejection of the nationalist developmentalist policies that had been behind the region’s economic growth from World War II until the 1980s. Since then, these countries have embraced

24

New developmentalism

the neoliberal reforms – liberalizing trade and finance – that have been the causes of the region’s quasi-stagnation ever since. By opening up trade and radically reducing import tariffs on manufactured goods, they failed to neutralize the Dutch disease, and the region’s industry faced a significant competitive disadvantage compared to competitors abroad. ND’s response in the 2010s was to define developmentalism as an anti-imperialist theory, to reject that developing countries had fallen into the middle-income trap, and to affirm that they had fallen into the “liberalization trap.”23

THE REGULATION SCHOOL AND MODERN MONETARY THEORY Among the heterodox schools of thought that have emerged in the last 50 years, one of the most relevant to ND is the French regulation school. This school originated in Marxism and offered major contributions both to the analysis of the post-war Fordist class coalition of the “golden age of capitalism” and to the understanding of finance. Its most important representatives are Michel Aglietta and Robert Boyer. Another important and more recent school is the modern monetary theory (MMT) school, derived from the endogenous theory of money defended by post-Keynesian economics. It took up the ideas of the German economist George Friedrich Knapp (1842–1826), who, in his 1905 book, The State Theory of Money, created chartalism. For him, money would have a political nature and that its establishment and use would occur from an act of power of the state when it chooses the unit of account and the means of payment. Money, therefore, is not a commodity, but a medium of exchange created by the economy and guaranteed by the state, which accepts it to pay taxes. In the 1940s, Abba Lerner, with his macroeconomic functionalism, gave a Keynesian interpretation of the theory. Another contribution, now post-Keynesian, was the theory of endogenous money, which I will discuss in Chapters 7 and 8. MMT is behind other distinguished economists such as Hyman Minsky (1919–1996) and Wynne Godley (1926–2010), who developed the “sectoral balances macroeconomics” that has become influential in recent years. MMT’s leading economists are Warren Mosler, L. Randall Wray, Stephanie Kelton, and Richard Koo. MMT received a lot of attention after the 2008 global financial crisis, when the central banks of major central countries engaged in so-called “quantitative easing.” This involved a huge injection of money into their economies to increase liquidity, reduce the interest rate even more than the market had reduced, and stimulate economies that were almost stagnant. This policy was possible because the central economies fell into the Keynesian liquidity trap and traditional monetary policy was ineffective. Quantitative easing has been

The developmental schools and anti-imperialism

25

relatively successful in reinvigorating economies and has not caused inflation. This attention was redoubled when, in the face of the Covid-19 pandemic, the same countries financed a large part of the expenses involved through the purchase of new government bonds. Thus, the purpose of central banks with quantitative easing was not only to increase monetary liquidity by buying old treasury bonds and private bonds, but to finance the state spending involved, or to reduce in practical terms (not in accounting terms) public debt by buying new treasury bonds. Quantitative easing represented a further refutation of the monetarist theory of inflation (which I will discuss in Chapter 10).

SOCIOLOGY OF DEVELOPMENT I conclude this analysis of developmental schools by mentioning the contributions to the theory of economic development of some social scientists who have used the historical method. I am thinking of the progressive sociologist C. Wright Mills (1916–1962) and the conservative economic historian Walter Whitman Rostow (1916–2003) in the post-war period. In 1982, the political scientist Chalmers Johnson (1931–2010), discussing Japan, defined the concept of the developmental state, and, since the 1980s, the sociologist Peter Evans, who is part of the “bring the state back” group, has been working on the developmentalism theme, emphasizing how the high bureaucracy in rapidly growing developing countries has become embedded with the businessmen in mutual development projects. In 1985, when they published the book Bringing the State Back In,24 they were reacting to the rational-choice school, which in association with neoclassical theory had become at the time hegemonic in political science and was also seeking to appropriate sociology.25 The “neoliberal years of capitalism” were the years of these schools of thought. Today, after the global financial crisis of 2008 and the Covid-19 pandemic of 2020, they have been profoundly shaken.

NOTES 1.

2. 3.

I know that the term “develop” that I often use is an understatement, but alternative words also have problems. The term assumes that developing countries are developing and catching up with the core countries, which is not true. All countries that have had contact with the industrial West and learned to use some of its institutions and technologies have experienced some growth, but only a few have grown fast enough to catch up with and improve the standard of living of their population. Kaldor (1968). Neoliberal orthodoxy is a mixture of market-oriented reforms and fiscal austerity, which uses Neoclassical Economics as its “scientific” justification. A group of nationalist intellectuals who formed the ISEB (Higher Institute of Brazilian Studies) in 1955. This group studied the industrialization of Brazil

26

4. 5. 6. 7. 8. 9. 10.

11. 12. 13. 14. 15. 16. 17. 18.

19. 20. 21. 22. 23. 24. 25.

New developmentalism

and the developmentalist class coalition that supported it under the leadership of President Getúlio Vargas. Hélio Jaguaribe was its chief political scientist, Alberto Guerreiro Ramos its leading sociologist, and Ignacio Rangel its most important economist. Evans (1979). Tavares (1963). Hirschman (1981). Bresser-Pereira (1995). This argument and the empirical justification can be found in Bresser-Pereira, Araújo and Peres (2020). Bresser-Pereira (2008; 2010); Bresser-Pereira, Oreiro and Marconi (2014) Bresser-Pereira (2007) Macroeconomics of Stagnation was translated into English under the title: Developing Brazil: Overcoming the failure of the Washington Consensus. The book Globalization and Competition (2010) was a first systematization, but some fundamental problems, such as the theory that explains why the exchange rate is a determining variable of economic growth, would only be developed in the next three or four years. Bresser-Pereira and Nakano (1984). For a history of the theory, see Bresser-Pereira (2023a). “Ten Theses on the New Developmentalism”. Two years later, we published the Portuguese version of this book, which is substantially superior to the original English edition. (Bresser-Pereira, Oreiro and Marconi, 2016). Bresser-Pereira (2020). While for neoclassical economics the “right prices” are the prices set in a competitive market, for ND the macroeconomic “right prices” are the prices compatible with economic growth. In 1958, in a report on Venezuela, Furtado was close to developing a Dutch disease model, but the report remained for 50 years in the ECLAC archives, and Furtado didn’t use this model in his later works. For example, China’s systematic current account surpluses since opening its economy have only been possible because the US has run large current account deficits since the 1960s. Eric Hobsbawm, Ernest Gellner, Miroslav Hroch, Benedict Anderson, Anthony D. Smith, and Michael Mann. Selected texts from these and a few other authors are in the excellent book edited by Gopal Balakrishnan, Mapping the Nation (1996). Otto Bauer (1881–1938) was an exception. Love (1980: 65). Frank (1966). This influential newspaper circulated in Latin America in 1965. Cardoso (1977), with a certain irony, entitled this short essay, “The Consumption of the Dependency Theory in the USA”. Bresser-Pereira, Araújo and Peres (2020). Evans, Rueschemeyer, and Skocpcol, eds. (1985) In the “bringing the state in” group were Peter Evans, Dietrich Rueschemeyer, Theda Skocpcol, and Fred Block (1985).

3. The capitalist revolution and the developmental state To understand the world we live in, we must know how the Capitalist Revolution radically transformed the economic, social, and political life. It began in the time of mercantilism (which Marx called primitive accumulation of capital in the fascinating chapter 24 of Capital). Since then, the main question economists have asked themselves is: what makes nations prosperous? The synthetic answer I offer is the Capitalist Revolution – the transition that each people must make in order to become a nation, form a nation-state, and realize their industrial revolution, thus experiencing economic development. The leading European countries surpassed the great civilizations of Asia when they jointly carried out their capitalist revolution. This Revolution can be considered to have been accomplished at the world level from the 18th century to mid 19th century, when the countries that originally developed formed their nation-states and industrialized.1 This radical transformation occurred on the basis of the development of technology and the emergence of a national bourgeoisie. It marks the beginning of the historic process of economic development. Each nation-state must carry out its own industrial and capitalist revolution to develop. In the words of Walt Whitman Rostow, this is the moment when national economies take off.2 Each take-off lasts about 50 years and is the most visible and strategic period of the transition to capitalism. When this transformation is consummated, we can conventionally understand that the formation of the nation-state and the industrial revolution are over, and the capitalist revolution itself can be considered “complete.” In the nineteenth century, the bourgeoisie of the countries that first “completed” their respective capitalist revolutions became liberal but remained authoritarian. If all citizens had the right to vote, the rich feared that the working class would expropriate them, and so they opposed universal suffrage. It was only when, in the end of the 19th century, they realised that the social-democratic political parties that could win elections did not have that intention or that power. Thus, they accepted democracy, minimally defined as the guarantee of the rule of law and free elections. Marx taught that in capitalism capital generates profits that materialize from the exchange of labor power for wages, but there was one condition: capitalists must already own capital. That is why the existence of a primitive 27

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accumulation of capital was logically necessary. It involved various forms of violence in addition to the formation of monopolies and cartels: the enclosure of communal areas, the confiscation of Catholic Church lands, wars and piracy promoted by the state. Only after that, the new ruling class – the bourgeoisie – would be able to make profits on the market by paying wages to labor power reduced to a mere commodity.

THE DEVELOPMENTALIST AND THE LIBERAL FORM Celso Furtado explained the structural change that led to capitalism and economic development with the concept of economic surplus.3 He noted that the accumulation of capital, the source of increased labor productivity, became systematic and necessary only under capitalism. In pre-capitalist regimes, empires spent the economic surplus on building temples and financing wars. In mercantilist societies, there was a breakthrough because commercial capitalists invested in stocks, mules, and ships to transport luxury goods in long-distance trade. Investment in machinery to increase productivity only became systematic under capitalism. John K. Galbraith ([1967] 2007) argued that capitalism involved shifting the strategic factor of production from land to capital. With the industrial revolution, the reinvestment of profits ceased to be an alternative and became a necessity. This revolution was associated with technological progress and the formation of national markets, so the capitalists had to reinvest their profits and modernize their factory in order to survive in a competitive context. Economic development has become relatively self-sustaining. The capitalist revolution is associated with three historical transformations: firstly, we have the decline of patrimonialism, when the people ceased to identify the state with the power and patrimony of the king. Secondly, the state ceased to be absolute, the power of the monarch ceased to be arbitrary and became constitutional, and the state assured the rule of law. Third, the state gradually ceased to be mercantilist and became liberal and nationalist – a contradiction that was at the heart of the formation of nation-states. For ND's political economy, developmentalism is the default form of economic coordination of modern economies. The alternative is economic liberalism. It is the default form because capitalism was born within the framework of mercantilism, which was the first developmentalism, insofar as the first industrial and capitalist revolutions have taken place under mercantilism. It was only from then on, that economic development began to occur – the historical process of capital accumulation with the incorporation of technical progress that leads to increased productivity and an improvement in the population's standard of living.

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I realized some time ago that I needed a word to designate the alternative to economic liberalism and that word that did not exist yet. There was the socialist alternative, but socialism is not an alternative to economic liberalism, it is an alternative to capitalism. So, I decided to use the word “developmentalism.” I have therefore made a deliberate semantic enlargement. Now, in addition to economic liberalism or the liberal form of economic coordination, which seeks to reduce state intervention in the economy to a minimum, we have developmentalism or developmentalist form of economic coordination, in which the state intervenes moderately in the economy and adopts a national perspective of defence of national labor and capital. In Latin America, economists were already using this word in the 1960s, but it had no international circulation.4 Chalmers Johnson made the word known in 1982 when he called the highly successful Japanese state the “developmental state”. A national society and its respective nation-state is therefore primarily developmental or liberal. It will be developmental if the state intervenes moderately in the economy and adopts a national perspective, and it will be liberal if the state only guarantees property rights, contracts, and keeps the fiscal budget balanced. All capitalist countries have experienced a capitalist revolution which has invariably taken place within the framework of a developmental state. There are good reasons for this. To transform an agrarian economy into an industrial one, the state always has the first word. It must build a developmentalist class coalition and formulate and implement a national development project – something we cannot expect from the market. This was necessary for the central countries and proved even more necessary for the peripheral countries, which had to overcome the obstacles imposed by imperialism. Not only formal, colonialist imperialism, but also informal imperialism, exercised through the pressures and ideological hegemony of the central countries that impose the use of the law of the comparative advantages of international trade to prevent them from industrializing. An important question is whether agrarian elites participate in developmentalist class coalitions and are involved in the capitalist revolution of their countries. In South Korea and Taiwan, they joined industrial entrepreneurs in the process of industrialization. The same can be said of the German agrarian elites whom Bismarck successfully brought into his class coalition. Instead, in Brazil, it is often argued that agrarian elites opposed industrialization and the developmental state, both in the pre-industrial period and today. One possible explanation for this difference is if the country is primarily a commodity exporter. If so, this country will face the Dutch disease, the neutralization of which involves the adoption of export taxes on these commodities or import tariffs and export subsidies on manufactured goods – two policies that these elites believe will be harmful to them.5

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By understanding developmentalism as a form of economic coordination of capitalism, we can distinguish the phases of capitalist development as developmental or liberal; we can identify each government as developmentalist or liberal; and we can compare the general phases of capitalist development with the periods of development of each country. First, however, I would like to examine briefly the various historical forms of social organization, the respective political–territorial units and the coordinating institutions of these forms of society that preceded capitalism and in capitalism itself.

FORMS OF SOCIAL ORGANIZATION History can be seen as a historical sequence of forms of social organization or society. Adopting Marx and Engels’ modes of production with the addition of aristocratic societies, I distinguish five historical forms of society: primitive, slave-owning, feudal, aristocratic, and capitalist. Each form of society is defined by its technology and the dominant form of property. Moreover, each form has its respective political–territorial unity: in primitive societies this unity was the tribes; in ancient civilizations, the empires; in feudalism, the fief; in aristocratic societies, absolute monarchies, and in capitalism, the nation-state. I say ‘political–territorial unity’ because classical empires were too heterogeneous to be called societies and fiefdoms were too small to individually constitute a political system. As we can see in Table 3.1 – built with European societies in mind – for each form of society there is a main political–territorial unit and two coordinating institutions. Religion is or was a powerful institution present in three of the four historical forms of society. Religions were polytheistic in primitive and slave-owning societies, while in later, more developed societies they tended to be monotheistic. In capitalist societies, the religious institution is not among the two most relevant coordinating institutions because religion has lost much of its political influence and has become a matter of personal faith. In China, religion has always played a secondary role, having been replaced by Confucianism – a bureaucratic moral philosophy. The state would be present in three forms of social organization if we did not distinguish the ancient and very small state, led by an arbitrary oligarchy, from the modern state, in which a public bureaucracy and a system of formal laws are its basic characteristics. The market only appears as a relevant institution under capitalism. Institutions regulate and coordinate societies. The state is the main institution in capitalist societies, followed in importance by the market. The state is a normative institution, it is the system of laws and an organizational institution that enforces the law: the public administration. All institutions have some power to make their norms binding, but only the state has the power of life and death. For this reason, Max Weber defined the state as the institution that

The capitalist revolution and the developmental state

Table 3.1

31

Historical forms of societies and coordinating institutions

Forms of social

Territorial political

organization

societies

Coordinating Institutions

Primitive societies

Tribes

Tradition

Religion

Slave societies

Classical Empires

Religion

Ancient state

Aristocratic societies

Absolute monarchies

Modern State

Religion

Capitalist societies

Nation-states

Modern State

Market

has “the monopoly of legitimate violence.”6 Institutions are central to the four forms of society. The market is the institution that coordinates only capitalist societies through competition between economic agents, whether companies or individuals. Before capitalism there were markets, but they were mainly local fairs, not national markets that set prices at the national level, and then at the world level as is the case today.

THE FORMATION OF NATION-STATES Ernest Gellner noted that an essential element distinguishes nation-states from ancient empires. In the classical empires, the oligarchy of soldiers and priests possessed a “superior culture” but was not interested in transferring it to the peoples they had reduced to the status of colonies. They maintained a military force in the territory, associated themselves with part of the local elites, and collected taxes, not interfering in the religion or other institutions of the dominated peoples. Instead, nation-states are, or seek to be, integrated societies. Their goal is economic development, and their governments have created the public education systems needed to increase productivity.7 England was the first country to form its nation-state and carry out the industrial and capitalist revolution. The construction of the English nation-state began in 1534 when King Henry VIII created the Church of England. In the seventeenth century, two revolutions reflected the rise of the bourgeoisie, the new social class that would lead the capitalist revolution: the bourgeois and puritanical revolution of Oliver Cromwell (1643–1651) and the aristocratic Glorious Revolution (1688–89), which made England the first nation-state to guarantee the rule of law and civil liberties.8 Nation-states become more robust and independent as they grow. The formation of the nation-state was a precondition for the industrial revolution in each country. The new nation-states that initially emerged in Europe were large and had relatively secure domestic markets in which the new industrialists could massively sell their relatively cheap manufactured goods and make profits. Once the industrial revolution was accomplished, we can consider that the country has completed its capitalist revolution.

New developmentalism

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GREAT DIVERGENCE, THE STATE, AND IMPERIALISM As long as tribes and the ancient empires covered the land, there was no increase in productivity and the people were poor except for a small military and religious elite. Productivity, however, began to increase in Europe in the eighteenth century and economic development became a historical reality. The basic reason was this region experienced the capitalist revolution – a historical process that began in the fourteenth century in the commercial cities of northern Italy, gained a global dimension with the great navigations and mercantilism, and materialized with the formation of the first nation-states and their respective industrial revolutions. This transformation was accompanied by the emergence of two social classes: the bourgeoisie, which would only become the ruling class in the nineteenth century, and the working class. From the enormous development that took place in the West during the capitalist revolution while the rest of the world remained stagnant if not decaying, came the Great Divergence, which we can see in Figure 3.1.

Source:

Angus Maddison (2007), p. 382.

Figure 3.1

Per capita growth 1500–1950 of Western European countries, Japan, China, and India

Why did the capitalist revolution originally take place in Europe? Various schools of thought offer answers. The new institutionalism argued that Europe

The capitalist revolution and the developmental state

33

protected property rights and contracts, while China and India did not. But this is a mistaken explanation, because institutions are endogenous, and there is a high correlation between the level of economic development and the quality of institutions. It makes more sense to say that the capitalist revolution, which set the historical divergence between Western Europe and the rest of the world – resulted from a set of propitious events that added up in Europe from the eleventh century to the national and industrial revolution in the original countries, Britain, France and Belgium, and the rise of modern imperialism. Among these factors, the greatest was the formation of nation-states that integrated large territories and allowed the construction of large internal markets. Recently, reading Giovanni Arrighi, this view has been confirmed and enriched. He argues that “interstate competition was a crucial component” of capitalist expansion and that “the greatest material expansions only occurred when a new dominant bloc amassed enough world power to remain in a position not just to circumvent interstate competition.”9 Arrighi credits Fernand Braudel with the correct understanding of the relationship between capitalism and state power. For the great historian, the emergence of capitalism was absolutely the expansion of state power.10 In Braudel's words, “capitalism only triumphs when it identifies itself with the state, when it is the state.”11 Imperialism completed the scenario of the “Great Divergence”. The first European countries to carry out the capitalist revolution became wealthy and militarily powerful and subjected the rest of the world to their domination, thus building colonial empires. The great Asian civilizations faced collapse. China, which only in the eighteenth century ceded to England the status of the richest country in the world, faced decadence and widespread poverty. The Chinese call the period 1850–1949, “the century of humiliation”. After World War II, when the reduction of peoples to colonial status became politically unfeasible, the centre – or Global North – resorted to economic liberalism. The central countries did not adopt this path when they were carrying out their own industrial and capitalist revolutions, but they did not hesitate to demand that the peripheral countries carry out the neoliberal reforms. In this way, premature deindustrialization has become the norm in peripheral countries that have submitted to the Global North.

THE DEVELOPMENTAL STATE In coordinating capitalist economies, the modern state takes two primary forms: the developmentalist form and the liberal form. A state that leads the formation of a developmentalist class coalition and promotes industrialization is a developmental state. In general, it became developmental after main historical transitions. For example, using the US as a reference for these transitions, after the Great Depression of the 1930s and World War II, there

34

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was the transition back to developmental capitalism, which I call the “second developmentalism”; around 1980, there was the “neoliberal turn” and the transition from social-democratic developmentalism to neoliberal rentier–financial capitalism, but in 2021 – after the 2008 crisis, and after the Covid-19 pandemic of 2020, neoliberalism collapsed and there was the second historical return to a developmentalist regime. This is the third developmentalism that today begins to be dominant. Chalmers Johnson offered a detailed definition of the developmental state. It is the state that: • has economic development as its primary objective; • intervenes in the economy not only through regulation but also directly; • has a small and highly qualified public bureaucracy to which real powers are attributed, leaving the legislature and the judiciary in the background; • controls its commercial and financial accounts abroad and therefore it controls the exchange rate; • protects the domestic industry from foreign products; • facilitates the importation of machines; • separates foreign technology, in which the bourgeoisie has a strong interest, from foreign capital, in which interest is limited; • creates state-owned financial institutions; • adopts credit and tax incentives, but always on a temporary basis, subject to constant evaluation; • adopts a consolidated public investment budget; • offers strong government support for science and technology; and • avoids detailed laws, leaving room for companies to take the initiative, with discretionary guidance from the public bureaucracy.12 Peter Evans drew attention to two characteristics of the twentieth-century developmental state: its bureaucratic capacity – the ability to implement law and public policy – and its embeddedness – the way in which public bureaucracy is enmeshed in society and the business community.13 Johnson and Evans attribute to the public bureaucracy a strategic role in the developmental state, which is reasonable, although industrial entrepreneurs also have a decisive role to play in it. These are excellent definitions of the developmental state, but we can and should define it more broadly. The state will be developmental if: (a) it considers economic development as its primary objective; (b) intervenes moderately in the market, planning the non-competitive sector of the economy and adopting strategic industrial policies; (c) conducts an active macroeconomic policy that seeks to keep the five macroeconomic prices, especially the exchange rate, correct (compatible with growth and stability); (d) advocates countercyclical

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35

public deficits and rejects any current account deficit, and (e) is politically supported by a developmentalist coalition made up of businessmen, workers, public bureaucrats and sections of the former ruling class – a coalition that adopts a national development strategy, as opposed to a conservative or neoliberal coalition made up of sections of the pre-industrial ruling class, rentier capitalists and financiers. In developing countries, within the framework of rentier capitalism, conservatives have also been in neoliberal coalitions that have associated themselves with international liberal elites and have therefore been practitioners of economic liberalism. According to Evans, the modern state can be “predatory” when it “does not have the capacity to prevent individual incumbents from pursuing their own goals. Personal bonds are the only source of cohesion and individual maximization takes precedence over the pursuit of collective goals.”14 Predatory states are common in pre-industrial countries that have not yet had their industrial and capitalist revolution. Its rulers call themselves liberals, but they are only opportunists. In middle-income countries, there are still politicians and civil servants dedicated to rent-seeking, but only exceptionally can these countries be called predatory states. We cannot see as predatory the rich and middle-income nation-states that have recently been under right-wing populist governments – such as the administration of Donald Trump in the US and Jair Bolsonaro in Brazil – even though those governments have been predatory administrations.

FOUR TYPES OF CAPITALIST REVOLUTION Considering the position of the country – at the centre or on the periphery of capitalism – as well as the moment of the revolution, it is possible to distinguish four types of capitalist revolution that lead to four models of the developmental state: (a) the original capitalist revolutions that led to the first central developmental countries that industrialized in the eighteenth and early nineteenth centuries, such as England and France; (b) the late capitalist revolutions in the original latecomer central countries that were not colonies but carried out their industrial revolution later on, such as Germany and the United States; (c) the independent peripheral capitalist revolutions that were colonies or quasi-colonies of developed countries, but which achieved a high level of national autonomy, industrialized, caught up, and became rich, such as Japan, Taiwan and South Korea, or became middle-income countries, such as China, India, Malaysia and Thailand, and (d) the national-dependent peripheral countries that made a capitalist revolution, but, after the great foreign debt crisis of the 1980s, lost part of their national autonomy and began to grow at a very slow pace, like Brazil and Mexico.

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Central Countries of Original Development We have already discussed the model of the developmental state of the original central countries – the first model. They were not called developmental states back then because that term did not exist. Their industrial revolutions began in the mercantilist phase, in which there was a developmentalist coalition of classes with the participation of the absolute monarch and the big bourgeoisie. While the monarch and his court of aristocrats and patrimonial bureaucrats lived off the treasury of the state, the emerging commercial and financial bourgeoisie paid taxes in exchange for the monopolies that the monarch granted them. With this money, the monarch waged wars that expanded the borders of the nation-state and created the internal market for its industrialization. Central Countries Lagging Behind In the 1960s, the economic historian Alexander Gerschenkron analysed the European countries that developed in the second half of the nineteenth century and found in them a high degree of state intervention.15 These late capitalist countries of the second model had to contend with the industrial imperialism of England and France, which, as Friedrich List wrote in 1846, tried to “kick down the ladder” of Germany.16 In that country, the developmental state was called Bismarckian. The German industrial revolution, led by Otto von Bismarck (1815-1898), combined state intervention and investment banks served as an example for other latecomer central countries. In 1962, Hélio Jaguaribe, writing about the Bismarckian development strategy, observed that in this strategy the internal market was reserved for national industry and that the state played the role of arbiter between the conflicting forces.17 Although the domestic market of the United States was also reserved for domestic manufacturers, the decisive role of the state is not so clear, because liberal ideology was so prevalent there that the role of the state in the industrialization of the country was systematically obscured. Its first Secretary of the Treasury, Alexander Hamilton, was not only one of the three great federalist philosophers, but also a developmental economist and, indeed, the doyen of developmental economists. In his classic “Report on Manufactures” (1792), Hamilton, then George Washington’s Secretary of the Treasury, defended the use of import tariffs on manufactured goods on the grounds of infant industry. In this way, he launched a lasting and consistent policy of industrial promotion that only ended in 1939, when the United States finally lowered its customs tariffs, which had been very high until then.18 According to Paul Bairoch, import tariffs in the US from the 19th century through the 1930s ranged from 35 percent to 48 percent, making the country, in Bairoch's words, “a bastion of protectionism.”19

The capitalist revolution and the developmental state

37

Independent Peripheral Countries The third model of the developmental state is the independent peripheral model. The Meiji Restoration of 1868 – the Japanese nationalist revolution that freed the country from Western tutelage – led Japan to the strategy of copying Western technology and institutions. Rapid industrialization took place over the next 40 years, under the direct control of the Japanese state.20 The copying of technology and institutions took place from 1868 to 1910. Between 1908 and 1910 the Japanese administration decided to privatize companies in competitive sector, which at the time were run by samurai turned bureaucrats.21 Privatization had no ideological roots: the Japanese simply copied the Western institutional model, which, in the case of competitive firms, assigned the market the role of economic coordination. They remained, however, developmental. Classic works on independent peripheral development include those of Chalmers Johnson on Japan, Alice Amsden on South Korea, and Robert Wade on Taiwan. These books clearly show the importance of state intervention for the development of these countries. What they lack, with the partial exception of Robert Wade's book, is a deeper analysis of the active macroeconomic policy they adopted. In each of these countries, the state guaranteed the general conditions of capital accumulation (microeconomic conditions such as education, investment in infrastructure, good institutions, and a national financial system), and macroeconomic conditions such as sustained demand and access to demand through a competitive exchange rate. They avoided current account deficits and limited external indebtedness to keep the exchange rate competitive, limited the entry of multinational companies into strategic sectors; adopted industrial policies; adopted a macroeconomic policy aimed at maintaining a satisfactory rate of profit, leading companies to invest; and kept the inflation rate reasonably balanced. In this effort to realize the attainment, Asian policymakers had a major advantage over their Latin American counterparts: they did not export commodities and therefore did not need to neutralize the Dutch disease. Asian countries behaved according to the metaphor of flying geese, originally proposed by Kaname Akamatsu;22 they developed in flocks from the Japanese model. The first flight involved South Korea, Taiwan, and Singapore; the second, Malaysia and Indonesia; the third, China, and the fourth, Vietnam. China, having fallen under Western imperialism since the mid-nineteenth century, had its national, and supposedly socialist, revolution in 1949. The national revolution was completed by the industrial revolution, which was divided into two parts: the first from 1949 to 1978 under the leadership of Mao Zedong (1893–1976) and the second from 1989 to 2010 under the leadership of Deng Xiaoping (1904–1997). Mao thought he was carrying out the first

38

New developmentalism

phase of the Chinese socialist revolution, when in fact he was carrying out the first phase of a capitalist and managerial revolution. With Mao at the helm, China asserted itself as a genuinely independent nation-state, educated its population and developed basic infrastructure —activities that the state typically conducts effectively and with reasonable efficiency. Capitalist reform took place in the 1990s. The second phase of the Chinese industrial revolution involved privatization and diversification of production. The first phase was statist, the second developmental. At this stage, as had happened with Japan, the competitive sector of the economy was privatized and left mainly to the market, while the state maintained political control, adopted industrial policies for the competitive sector, planned the investments of the non-competitive sector, and executed an active macroeconomic policy to ensure the equilibrium of the five prices, mainly the exchange rate. In this second developmental phase, China has experienced the most extraordinary economic development ever, surpassing even the previous example of Japan, and achieving an average annual growth rate of 10% for 30 years. National-dependent Peripheral Countries The fourth model of developmental state – the national-dependent peripheral model – was not as successful as the other three. The countries in this group developed enough to carry out their industrial revolutions but were unable to maintain rapid growth rates from 1980 onwards. In Brazil, per capita income growth fell from almost 4 percent per year during the industrial revolution (1930−1980) to 0.8 percent per year from 1981 to 2020. This is versus 1.5 percent and 3.0 percent per year for the central countries and all developing countries, respectively. Much the same thing happened in Mexico. In analysing the developmentalism of the two countries in this period, Ben Ross Schneider found that their developmentalism had four basic characteristics: profits and investments dependent on the State; a developmentalist discourse dominated by the need to industrialize and the role of the State in promoting industrialization; the exclusion of the majority of the population and a highly institutionalized public sector bureaucracy.23 These are typical features of a developmentalist strategy, to which I add two positive policies – a nationalist approach and the use of import tariffs on imported manufactured goods – and a negative policy – the self-destructive attempt to grow the economy with foreign loans, which ended up financing consumption much more than investment, and which was the central cause of the crisis and the demise of developmentalist nation-states in the end of the 1980s. In contrast, East Asian countries avoided current account deficits and excessive external indebtedness. In the early 2020s, after more than 30 years of high growth, China was a creditor country.

The capitalist revolution and the developmental state

39

In addition to the four types of capitalist revolution discussed in the previous section and the respective models of the developmental state, after the Second World War, in the “golden age”, we had a fifth model of the developmental state. In these years, the most developed countries experienced a second developmentalism – the developmental social-democratic state. The latecomer central countries and peripheral that adopted active industrialization policies were also developmental. The first developmentalism occurred with mercantilism and the third is occurring now with the collapse of neoliberalism.

NOTES 1.

This revolution at world level I write capitalizing each word, the individual revolutions, with small letters. Rostow (1960) 2. 3. Furtado (1961: chap. 3.) In 2014, Pedro Cezar Dutra Fonseca surveyed the Brazilian economic literature 4. on developmentalism and found that the first two authors to use this word were Hélio Jaguaribe (1962) and Bresser-Pereira (1963). I will discuss Dutch disease in Chapter 14. 5. 6. The state is an institution. The nation-state is a form of society with a population, a state, and a territory. Gellner (1983). 7. Arrighi (1994: 13). 8. 9. Arrighi (1994: 10). See also Wallerstein (1991: chaps. 14–15). 10. Braudel quoted by Arrighi (1979: 229–230). 11. Johnson (1982; 1989). 12. Evans (1992). 13. Evans (1992: 12). 14. Gerschenkron (1962). 15. The expression “kicking away the ladder” was originally employed by Friedrich List in 1846 to describe the behaviour of England, which sought, using the arguments of classical economic liberalism, to convince the Germans not to industrialize. The argument describes the current behaviour of rich countries in relation to developing countries. Ha-Joon Chang (2002); He took the expression and applied it very appropriately. 16. Jaguaribe (1962). 17. According to William A. Lovett, Alfred E. Eckes Jr., and Richard L. Brinkman (1999), the U.S. made 621 concessions in a 1938 agreement with the United Kingdom that amounted to 457.8 million U.S. dollars and accounted for 37% of durable goods imports. 18. Bairoch (1993: 40; 51). 19. By “West,” I mean the group of rich countries around the North Atlantic, plus Australia and New Zealand, which today are better referred to as the Global North. 20. Angus Maddison's data suggests that the Japanese industrial revolution happened around the time of World War II, but the ability of this data to detect industrial revolutions is limited. Japan was only able to attack Russia in 1905, China in

40

New developmentalism

1936, and the United States in 1942 because it had already developed a powerful industrial sector. 21. In the Meiji Restoration, the Samurai participated in a military capacity. The Samurai then became a middle class of bureaucrats who ran the manufacturing companies that the state had created. Finally, between 1808 and 1810, they became private entrepreneurs of the privatized companies. 22. Akamatsu (1962). 23. Schneider (1997). As far as public bureaucracy is concerned, this view applies more to Mexico than to Brazil. In a classic book on the Brazilian public bureaucracy, Schneider (1991) showed that this bureaucracy was relatively informal, but firmly professional.

4. Forms and phases of capitalist development Nation-states have been developmentalist since they were constituted as such within the framework of mercantilism and industrialised. They became developmentalists again in the post-war social-democratic years. Now, after the recent collapse of neoliberalism, the state is back, it intervenes in the economy through industrial policy and macroeconomic policy, it is again developmental. These are the three phases and forms of capitalism that I will discuss in this chapter. Economics is the science of markets, but they only become relevant when they are national, not mere fairs, when they coordinate national economies and then the international economy. However, this only happens within the framework of the nation-state, when the state regulates and intervenes in the economy, that is, when the market is supported by the state. Thus, it is more accurate, therefore, to say that economics is the science of how markets and the state coordinate the economy. Economic theories are associated with the phases of capitalist development. Neoclassical theory was born to justify economic liberalism. With the collapse of its radical form, neoliberalism and neoliberal orthodoxy entered into crisis, but in a different form from the crisis they faced in the 1930s. At that time, Keynesian economics emerged; in the 2020s we do not see a new economics emerging. ND is a new theory, but it focuses on middle-income countries. It does not have the breadth of the Keynesian revolution.

TWO INSTITUTIONS, THE STATE AND THE MARKET The state coordinates the whole of society, the market coordinates only the economic system. Considering these two institutions, we have already seen that there are two forms of economic coordination of capitalism, the developmental form and the liberal form. For economic liberalism the market fully coordinates the economy, while the state merely ensures the proper functioning of the market. For developmentalism both institutions are relevant to the coordination of capitalism. The market coordinates the competitive sectors of the economy, the state coordinates the non-competitive sectors and, more broadly, coordinates the whole of society. The neoliberal condition is never achieved, 41

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but liberal governments often adopt misguided policies to achieve it, such as austerity. When state intervention is moderate and the country has a national perspective, it will be developmental, but to be successful it will have to rely on good government or administration. When intervention is maximum, we no longer have capitalism – we have statism. With the failure of statism in the Soviet Union and China, most people took statism for socialism and ceased to see it as an alternative to capitalism. Now we would be doomed to capitalism and liberalism. It was a hasty conclusion. Statism was really the existing socialism, and the hope of countries achieving in the short-term is not realistic. They may choose economic liberalism or developmentalism, and a progressive or a conservative developmentalism. From my point of view, a social-democratic, republican and green developmentalism is a fairer and more coherent economic and political regime for the survival of humanity than economic liberalism and liberal democracy. Using the word developmentalism in this broader sense – as a form of economic coordination of capitalism – we can say, for example, that before the “neoliberal turn” of the 1980s, in the post-war years, advanced capitalist societies were not liberal economies, but social-democratic and developmentalist economies. The default form of capitalism is developmental because the industrial revolutions in Britain, France and Belgium took place in the context of mercantilism – the first historical form of developmentalism. In the US, unlike in Europe, there are no social-democratic political parties, and the country is less progressive and less green than the advanced countries of Europe. In the US, the Democratic Party is more progressive than the Republican Party, but it cannot be considered social-democratic. Probably for this reason, the country's progressives are called “liberals.” In this book, I use the word liberal with its classical meaning. Liberals were only progressive in Europe from late eighteenth century until the mid-nineteenth century. Neoliberals are the radical liberals who emerged after World War II, becoming dominant in the 1980s. Recently, neoliberalism collapsed, and the rich world is in transition to a third developmentalism. The case of the US is interesting and perhaps surprising to many. Despite the large role that entrepreneurs played in its development and the importance of the American domestic market, the US economy was developmental until 1980. It was only in 1939 that the US opened up its economy by lowering import custom tariffs on manufactured goods, which were high. American economic historians do not have an explanation for these custom tariffs; they label them “protectionist.” In the first 40 years of the twentieth century, the “infant industry” argument, which legitimized import tariffs on manufactured goods, was no longer applicable, but American policymakers rejected the liberal prescription because they rightly believed, first, that their nation's economic growth required it to industrialize, and second, that industrialization

Forms and phases of capitalist development

43

depended on custom tariffs. Thus, they adopted import tariffs pragmatically. They were right because the U.S. had the Dutch disease – market failure in commodity-exporting countries – that the tariffs neutralised. A country faces the Dutch disease when it can export commodities profitably at an exchange rate that is substantially more appreciated than the exchange rate that manufacturing companies, using the best technology available in the world, require to be competitive. The simplest and most traditional way to neutralize or counteract this market failure is to impose custom tariffs on manufactured goods. This was done in the US until 1939, despite the fact that import tariffs are the industrial policy that liberal economists most vehemently reject. By adopting import tariffs, American capitalism was developmental, not liberal. While opening up its economy with reduced import tariffs, the US remained developmental in the New Deal, like European social democratic countries in the “golden age of capitalism”. People believe that economic policy of the US was always liberal, but it was developmentalist until 1980. With the “neoliberal turn”, the United States embraced economic liberalism with poor results. The market is an efficient institution that satisfactorily coordinates the competitive sectors of the economy, while in monopolistic sectors, in which there is no real competition, the state must be the coordinating institution. Moderate state intervention in the economy means that a country respects the principle of subsidiarity: the larger, higher-ranking body, the state, should not perform functions that can be performed more efficiently by a smaller, lower-ranking body: the market.

POLICIES DEFINE THE DEVELOPMENTAL STATE In economic terms, each phase of capitalist development will be developmental or liberal, depending on the degree of state intervention that the country adopts. Capitalism was born in each nation-state during a developmental phase – the mercantilist phase – in countries such as Britain and France, which were the first to build national markets and which went through all the phases of capitalist development. Capitalism was also developmental in backward countries such as Germany and the United States, which made their industrial revolutions in the second half of the nineteenth century. A moderate state intervention in the economy is the defining character of the developmentalist form of capitalism. The State intervenes moderately when it: • adopts industrial policies in competitive industries; • regulates uncompetitive or naturally monopolistic industries; • manages the two macroeconomic accounts: the fiscal account and the current account; and

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• keeps the five macroeconomic prices correct: interest rate, exchange rate, wage rate, inflation rate, and rate of profit. Today, we must add that it is the developmental state that fights poverty, seeks to reduce economic inequality, and protects the environment. Within the framework of democracy – which has become the proper political regime of advanced capitalist societies – it is impossible to ensure long-term growth without listening to the demands of the people. And fighting climate change is a condition for humanity's survival. The second element that defines a developmental policy regime is a national perspective. The peripheral countries need, firstly, to recognize that it is not only companies but also nation-states that compete at the global level, secondly, they must understand that major nation-states are imperialist nations that pressure developing countries to adopt liberal policies aimed at blocking their industrialization. Thus, they must be economically nationalist and be anti-imperialist.

PHASES OF CAPITALIST DEVELOPMENT In discussing the history of capitalist development, we can distinguish four phases: two of them predominantly developmentalist and the other two liberal. Since 2008, neoliberalism has faced a major crisis, and in the early 2020s, after the Covid-19 pandemic, neoliberalism collapsed, and developed capitalist economies are in transition to a new phase – a managerial and developmental phase. With the capitalist revolution, world history ceased to be the narrative of the splendor and decay of ancient empires and civilizations to become a social construction – a social project aimed at economic and human development, to be carried out in the context of nation-states. Auguste Conte, like Marx and Engels, understood this well and proposed phases of capitalist development. Today, capitalism already has a long history, which we can better understand if we divide it into phases that vary according to the criteria we adopt. These phases must not be confused either with Kondratieff's well-known “long waves” to which Schumpeter subscribed, nor with David Gordon’s “social structures of accumulation” – long period of relatively rapid economic expansion followed by decay and period of stagnation and instability before the beginning of a new cycle.1 Both long waves and social structures of accumulation are cyclical phenomena that end with an economic crisis, while phases can be longer and do not necessarily end in crisis. I am aware that reducing history to phases suffers from overgeneralization and a certain arbitrariness that historians resist, but I prefer to take a chance, hoping that our understanding of capitalist development can be improved by this simplification.

Forms and phases of capitalist development

45

Fernand Braudel ([1979] 1987b: 62) was not afraid of periodizations and divided the history of capitalism in Europe – with their respective central points in parentheses – into four secular tendencies or cycles: the Northern Italian cycle from 1250 (1350) to 1507; the Dutch cycle from 1510 (1650) to 1733–43; the British cycle from 1733–43 (1817) to 1896; and, with Arrighi, the American cycle that began in 1896. In the index of Braudel’s book, the first and second cycles have cities at their core – Venice and Genoa in the first cycle, Amsterdam in the second – while the third and fourth secular cycles, which are specifically capitalist, have two nation-states at their core, the United Kingdom and the United States. Following a similar perspective, Giovanni Arrighi, in The Long 20th Century, used the hegemonic country as a criterion and saw four “systemic cycles of capital accumulation”: • the Genoese Cycle, from the fifteenth century to the beginning of the sixteenth century; • the Dutch Cycle, from the end of the sixteenth century to the middle of the eighteenth century; • the English Cycle, from the last half of the eighteenth century to the beginning of the twentieth century; and • the American cycle, during the twentieth century.2 He called the first cycle “Genoese” because in the sixteenth century the Genoese were financing Spain, the dominant country at the time. He speaks of “systemic” cycles because they always end with a period when finance is dominant. Following Marx and Braudel, Arrighi notes that periods of material expansion are followed by periods of financial expansion. I’m not comfortable with dividing history into cycles, because history does not repeat itself, and I have a hard time understanding the idea of an eternal return. I prefer to think in terms of stages or phases rather than in terms of cycles. It is true that Arrighi’s cycles do not imply repetition. Each one, in its own way, recovers and re-signifies elements from previous cycles and then combines them with new elements. In this sense, the cycles are progressive.3 Arrighi, following Braudel, identifies as cyclical regularity the tendency to financialization at the end of each cycle. This is an interesting observation, because we saw this regularity repeated at the end of the last phase – the neoliberal phase. Periodization involves the adoption of a classification criterion. At another time, I studied the phases of capitalism according to the types of technical progress (capital-costly, neutral, and capital-saving) and their effects on the distribution of wages and profits.4 In this book, I will work with four phases, based on the form of coordination of the economy, and the ruling class, which commands the process of accumulation and innovation of capital. These are

New developmentalism

46

Table 4.1 Dates

Phases and forms of capitalist development and growth rates Phases

Form of

Annual growth

coordination

rate (%)

1600 – 1839

Mercantilist

Developmental

0.21%

1840 – 1929

Industrial (entrepreneurs’)

Liberal

1.32%

1930 – 1939

(Crisis)

-

0.63%

1940 – 1970

Managerial developmentalism

Developmental

2.68%

1971 – 1979

(Crisis)

-

2.00%

1980 – 2020

Neoliberal (rentier–financiers’)

Liberal

1.80%

Source:

Maddison Historical Statistics.

presented in Table 4.1, in which, in addition to the name of the dominant faction (merchants, entrepreneurs, managers, and rentier–financiers), we have for each phase its developmental or liberal character and the average growth of per capita income. I could have included a phase before mercantilism – the epoch of the bourgeois city-states of northern Italy: Venice, Florence, and Genoa – but at that time we did not have capitalism in the strict sense: private ownership of the means of production, wage labor, and capital accumulation. However, in Braudelian terms, it was a place for the realization of extraordinary profits based on the appropriation of economic and political power. There was still no wage labor, no systematic increase in productivity, no nation-states with large domestic markets, no industrialization: the defining characteristics of capitalism. These city-states were involved in long-distance trade and for some time were strong enough to defend themselves against the feudal lords as well as the Pope. This time was a precursor to a phase, rather than a phase, of capitalist development. As Maurice Dobb (noted, we should not call it the “birth of capitalism” because capitalism requires the direct subordination of the worker to the capitalist for the production process. It requires the institution of wage labor.5 When discussing capitalism historically, I use as a reference Britain, France, and Belgium, which have gone through all the phases of capitalist development and have had a significant influence on the rest of the world. From the third phase onwards, I added the USA, which, after the First World War, became hegemonic, replacing Britain in this role.

THE MERCANTILIST PHASE The mercantilist phase, from the beginning of the seventeenth century to the end of the nineteenth century, was not the failure portrayed by liberal econo-

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47

mists since Adam Smith. Rather, it was a phase of development in which our three original countries – Britain, France and Belgium – carried out their capitalist revolutions and became rich, powerful and capable of building colonial empires. The mercantilists founded economics, and there were among them some prominent economists. I consider Alexander Hamilton to be a patron of developmentalism, for in 1792, as George Washington’s Secretary of the Treasury, he developed the concept of “infant industry”, thus legitimizing import tariffs. In late Germany, which also made its industrial revolution within the framework of developmentalism, this developmentalism was not mercantilist, but Bismarckian, named after the statesman who united Germany and promoted its industrialization. In Germany, Friedrich List, who learned from Hamilton, is a second patron of classical and new developmentalism. Capitalism was born developmentalist in the mercantilist phase. The industrial revolutions in the first countries to industrialize took place within the framework of mercantilism. Liberal economists, under the influence of Adam Smith, slammed mercantilism. Mercantilist economists were the founders of economics and political economy and their theory deserved criticism, but the policies they sponsored were a prosperous economic arrangement that led the first countries to start their industrial revolutions. Mercantilism was the first historical form of developmentalism – an economic system in which the state acted on the criterion of subsidiarity to intervene when markets were unable to do their job. As for the political regime, this was the time of the absolute state. Capitalism became liberal only after the 1840s, when the United Kingdom finally opened up its economy. The state has never been fully liberal, because it has often been called upon to intervene internally and has played a central role in the violent creation of empires. The state intended to reserve these markets for its capital, sophisticated manufactured goods, as well as for the supply of oil and raw materials. The seventeenth and eighteenth centuries were the era of the absolute state, of the primitive accumulation of capital, of the formation of the first nation-states, and finally of the moment of the Industrial Revolution in England – the economic revolution that definitively gave rise to capitalism and modernity. It was the moment of the configuration of what Immanuel Wallerstein (1980) called “the world system”. Mercantilism was the epoch of the first developmental capitalism, insofar as it was based on a developmentalist coalition formed by the monarch, the aristocrats around him, and the emerging big commercial bourgeoisie. For Amiya Kumar Bagchi, “the first developmental state in our sense to emerge since the sixteenth century was that of the northern part of the Spanish Netherlands which, after the reconquest of the southern part by Spain, evolved into today’s Netherlands.”6 The mercantile bourgeoisie originally derived their wealth from the long-distance trade of luxury goods, but with the rise of manufacturing, they soon became interested in the formation of a secure

48

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and broad domestic market, which would make possible the mass production of the cheap industrial goods that defined the Industrial Revolution. With this medium-term goal in mind, reaping short-term gains from the mercantilist monopolies granted by the monarch, they financed the wars initiated by the monarch – wars that defined the territorial space of the first nation-states and paved the way for the industrial revolutions in each country. In mercantilism, the ruling class coalition associated the big bourgeoisie with the monarch and their patrimonial court. As for the economic criteria, mercantilism was the first developmentalism, as the state actively intervened in the economy. Mercantilism and the absolute state were key institutions in the transition from feudalism to capitalism. The absolute monarchs, the merchants and the great financiers founded capitalism; mercantilist economists founded economics and political economy. This was a period of active state intervention and the formation of the first nation-states, those sovereign territorial societies that would define capitalism. Long-distance trade remained the central economic system, but now, with the technological progress of navigation initiated by the Portuguese, the colonies in the Americas, and the colonial trading centres in Asia and Africa, long-distance trade has transformed into a “world economy” in the words of Fernand Braudel, or a “world system” in the words of Immanuel Wallerstein.7 As Braudel put it, “mercantilism is an insistent, selfish, and therefore vehement impulse of the modern state,” and continues, now quoting Daniel Villey, “it was the mercantilists who invented the nation-state.”8 In fact, the mercantilist system involved (a) a kind of national development project led by the absolute monarchs, responsible for the wars aimed at expanding the borders of the state, (b) a coalition of classes associating the monarch and his court with the big merchants, and (c) state intervention in the economy. These three characteristics made mercantilism the first developmentalism. In 1776, Adam Smith published his Wealth of Nations, criticizing the mercantilist system that was at its peak at the time. His book was a revolution in economics, but it was not until 1846 that England transformed his theory into practice, a liberal policymaking, with the complementary theories of David Ricardo.

THE INDUSTRIAL (ENTREPRENEURS’) PHASE The liberal phase of industrial entrepreneurs lasted from the industrial revolutions of the central countries to the trade liberalization of Britain, in 1846. This was the capitalism that Marx had known and analyzed. It was a time of modest per capita growth rates, high instability, and great inequality. The growth was, however, enough to allow the first industrialized countries to acquire military power and build colonial empires. The political regime ensured the rule of law, but not universal suffrage, and thus remained authoritarian.

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49

Schumpeterian entrepreneurs who knew how to innovate and invest led this industrial phase. It was a liberal phase both in economic terms because the state had no direct role in production, and in political terms because the new ruling class guaranteed civil liberties and the rule of law, not the universal suffrage, thus remaining authoritarian. But the state did not become fully liberal, because it continued to intervene in the economy in various ways. As Pierre Rosanvallon (2011) observed, at the end of the nineteenth century, the fragility of the liberal state provoked a revival of ideas that favored greater state intervention in the economy. When, for example, the great financial crisis of 1893 happened in the United States, the state was called in to help. But state intervention was sufficiently limited in the original countries that it is reasonable to say that economic liberalism was dominant. The liberal capitalism of the entrepreneurs was characterized by enormous urban poverty and displacement, which led the workers and popular classes to organize trade unions and to establish socialist political parties demanding universal suffrage and socialism. They did not achieve socialism, but they won the battle for democracy at the turn of the twentieth century, when the advanced countries, in which civil liberties were already guaranteed, adopted universal suffrage. Within the framework of liberalism, the original industrial countries experienced modest growth rates (between 1 and 1.5 percent per capita per year), which, however, were sufficient to make them more powerful, which in turn allowed them to build important colonial empires in Asia and Africa. It was the time of the gold standard, the popular classes turning into proletarians, terrible working conditions, lack of job security and increasing inequality. Marx had said that the first crisis of capitalism, sensu stricto, happened in 1825. Several crises followed: in 1873, liberal capitalism faced a major financial crisis that Carlos Marichal calls “the first world financial crisis,” and just 20 years later, capitalism entered a new crisis, centred in the US.9 In every crisis, profit rates fell, corporations asked for state protection, the state intervened, and liberals accused policymakers of “neo-mercantilism.” Meanwhile, the latecomer advanced countries, such as the United States, Germany, and Italy, underwent their industrial revolutions, adopting a definite developmentalist strategy – in the case of Germany, the Bismarckian state. The capitalism of the industrial entrepreneurs was the time of colonialism, or modern imperialism. Modern imperialism arose during the era of liberal capitalism – an imperialism of industrial capitalist countries led by the United Kingdom and France in the nineteenth century.10 The industrial revolutions made these two countries powerful enough in economic and military terms to reduce the population of Asia and Africa to colonial status – something that could not have been done in the mercantilist period, when local empires were strong enough to resist colonization.

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As for the Latin American countries, by the beginning of the nineteenth century they had gained independence from Spain and Portugal, and imperialism assumed the form of ideological hegemony or soft-power, firstly, under the leadership of Britain and, after World War II, under the leadership of the US. Modern imperialism is essentially characterized by the rich countries “occupying” the peripheral markets with their capitals and by unequal trade, counting on the cultural and political dependence of local elites.11 In Asia, in the nineteenth century, this occupation took place through war. In the twentieth century, the Global North ideologically subjected the third world political and economic elites to neoliberal “truth,” even though the Global North had not adopted the recommended policies when they themselves had experienced the corresponding phase of development. In 1902, John Hobson made an analysis and critique of imperialism arguing that imperial expansion was driven by the end of investment opportunities in Europe and the search for new markets and investment opportunities abroad.12 In the turn of the century, the Second Industrial Revolution and what I call the “organizational revolution” originated the great corporations and the private managerial class.13 From 1930 to 1945, capitalism faced the Great Depression followed by World War II. In 1933, Franklin Delano Roosevelt launched the New Deal, and in 1936, Keynes published The General Theory. The rich world left behind economic liberalism and turned developmental and social-democratic.

THE MANAGERIAL DEVELOPMENTAL PHASE The Wall Street Crash of 1929 and the following Great Depression paved the way for the managerial phase of capitalism. This was a phase in which the techno-bureaucrats associated themselves with the dominant entrepreneurial capitalists. After the war, it also became a social-democratic phase, defined by compromise between the new ruling class and the working-class. Its managerial character derived from the “organizational revolution” at the turn of the twentieth century, and its social-democratic character derived from the “democratic revolution” and the demands of the popular classes, also at the turn of the twentieth century. The “organizational revolution” was characterized by the emergence of private corporations, the growing separation between control and ownership, the replacement of entrepreneurs by managers in their management, and the replacement of knowledge by capital as a strategic factor of production. These were all new historical facts. Moreover, it pushed the new middle class of public and private managers to associate themselves with the capitalist class. The managerial phase was developmentalist because economic liberalism had failed; because the managerial class tends to be developmentalist to the

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extent that it prioritizes economic planning; because the state is continually called upon to intervene in the economy; and because growth is rapid and financial instability falls whenever developmental politicians and economists are competent managers and policymakers. This was also a great moment for social democracy, it was the “golden age of capitalism”. In this phase, people with a republican spirit who won civil liberties in the liberal phase, and political rights at the turn of the twentieth century – beside universal suffrage – won social rights: universal public education, universal health care, basic social security, and social assistance programs. It was a time of reduced inequality because taxation became highly progressive, and the welfare state became a reality. Mercantilism was the first developmentalism, the “golden age of capitalism” was the second. A broad coalition of developmentalist classes was then formed, consisting of businessmen, the new managerial class and the working class. This was the time of a political–social pact whose first relevant book was by Andrew Shonfield.14 It was a phase that the French school of regulation called “Fordism”. It was the time of “indicative planning” in France, the rise of state-owned enterprises, high growth rates, financial stability, an increase in the tax burden, the adoption of progressive taxation and some reduction in inequality. These years were the years of corporatist capitalism, whose classic analysis was made by Philippe Schmitter in 1974, with reference to the countries of northern Europe.15 This was the moment when the political centre moved to the left, and the common political goal was to create a social or progressive capitalism, regardless of the political party in power. In Germany, for example, the conservative Christian Democratic Party proposed a “social market economy” that was essentially developmental, corporatist, and democratic. With the student revolution of 1968, the “golden age” faced a political crisis. This revolution was intended to be the beginning, but it marked the end of an era. In the 1970s, there was a succession of critical events: the defeat of the United States in the Vietnam War; the abandonment of the Bretton Woods Agreements; the end of the last vestiges of the gold standard; the Organization of the Petroleum Exporting Countries (OPEC) oil shock of 1973; falling rates of profit; stagflation in the U.S. and growing competition from developing countries. Together, these problems defined the 1970s crisis of the managerial, social-democratic, and developmental capitalism. While rentier capitalists replaced entrepreneurs in corporate ownership, neoclassical and neoliberal intellectuals, dissatisfied with the dominant condition of Keynesian economics, seized the opportunity offered by the crises of the 1970s to construct a new narrative: neoliberal ideology. This new ideology

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was persuasive in dismantling the Fordist class coalition and in achieving the neoliberal turn, while neoclassical economics returned to the mainstream.

THE RENTIER–FINANCIER NEOLIBERAL PHASE The neoliberal rentier–financier phase of capitalism began, legitimized by the neoclassical and Austrian schools of thought and by the neoliberal ideology. In this book, I pay special attention to this regressive phase and its close class coalition of rentier capitalists and financiers. On the domestic side, the project of the advanced capitalist countries was now to reduce real wages directly by changing labor contracts, and to reduce them indirectly by dismantling the welfare state. On the international side, the project was to transform globalization into an imperial project of the United States, was to persuade or press all countries to adopt neoliberal reforms. In the short term, after the collapse of communism, the U.S. was able to reimpose its single hegemony, but it was short-lived. Under the coalition of the rentier–financier class, the managers remained part of the ruling class coalition, but this made the coalition internally conflictual because, after all, the shareholders were challenging the power and autonomy of the top executives. Neoliberal rentier–financier capitalism represented a major regression both economically and politically. It began to end with the global financial crisis of 2008, followed by its political crisis of 2016, when far-right populism materialized in the election of Donald Trump and Brexit. This populism did not reflect a crisis of democracy – which was alive and strong in the face of the populist onslaught – but was a reaction against the radical individualism and the competition of all against all that characterized neoliberalism. It did not reflect the failure of democracy, as many feared, but it did reflect the failure of neoliberal capitalism to secure the interests of the white lower middle class, squeezed between the prosperity of the rich and the relative rise of the Hispanic and black middle classes, in the case of the US, and in Europe, of the immigrants. There was some growth in the advanced countries, especially in the United States, but it was modest and unstable; wages for the lower classes have stagnated, and inequality has risen sharply. World figures showed a significant reduction in poverty, but this was due to the growth of Asian countries, especially China. The neoliberal years of capitalism were the time when capitalism globalized and became financialized. It was also the time when the countries of East Asia opened up their economies without harming their manufacturing industry, because, contrary to what happens and is happening in Latin America, they do not have the problem of the Dutch disease, did not submit to the neoliberal project of the Global North, and continued to develop.

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THE GROWING ROLE OF THE MARKET Once a country completes its capitalist revolution, the market assumes a greater coordinating role, but the state continues to intervene moderately in the developmental economy. State intervention in the economy has only become more moderate because markets have become more developed and the state (the law and the organization that guarantees it) has become stronger and more legitimate. On the other hand, the continuous increase in economic complexity has a paradoxical effect: on the one hand, it confirms that the market must coordinate the competitive sectors of the economy, but, on the other hand, it requires the state to continue to intervene in the economy because the market cannot cope with so much diversity and complexity. The market is a more suitable institution when it comes to coordinating diversified competitive activities that involve creativity and innovation, but creativity and innovation always rely on the support of the state to be successful.16 Therefore, it can be predicted that once a country’s industrial revolution is complete, market-based coordination will gain ground over state-based coordination, while the economic role of the state will change. It becomes even clearer that the economic role of the state is very large, without prejudice to the role of the state. The role of the state is: (a) to keep the five macroeconomic prices correct; (b) to plan and invest in infrastructure, the basic input industries, the social area, and climate change; (c) to regulate tightly the large banks that are “too big to fail” and rely on the participation of public banks; (d) promotes strategic industrial policy; (e) to foster scientific and technological development; and (f) to intervene strongly in the services of the welfare state (education, health care, social security, and social assistance); and (g) to counteract climate change. These are roles of the state to which the private sector may contribute. A basic problem facing both developmentalist and liberal governments is the political and economic competence of their leaders. Successful developmental states have always relied on Republican-minded nationalist politicians and pragmatic economists who know that their primary job is to ensure economic stability and develop policies that contribute to their country's industrialization or productive sophistication.

SUMMING UP The economic development of a developing country is a historical process of increasing productivity and wages that results mostly from the transfer of workers to activities that generate higher added value per capita. Economic development is the result of a class coalition that brings together politicians

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and public bureaucrats with business entrepreneurs and workers. In this context, the developmental state has historically been and must continue to be the central institution focused on development, because it is the state that guarantees and regulates the other equally fundamental institution: the market. The scope of the state is much larger than that of the market. The state is the instrument par excellence for the nation to achieve the five main political objectives of modern societies: security, freedom, economic well-being, social justice and protection of the environment – objectives that must be constantly the object of compromises or the principle of reasonableness in the light of perceived or actual short-term conflicts with each other. Economic development is necessarily the result of a national development strategy that arises when a strong nation shows the ability to build an equally strong or capable developmental state. Nations are formed and remain alive and strong only when they are the product of a constantly renewed national agreement. If this social contract that unites them is not solid enough, and if the social classes that constitute it do not maintain basic bonds of solidarity when they compete internationally, these nations will not be true nations. The country will be much more vulnerable to Western hegemony, and economic nationalism will lose strength, as happened in Latin American countries after the great crisis of the 1980s. The developmental state, which lies between the liberal state and statism, is a higher form of capitalist economic and political organization. Within the framework of developmental regimes, the coordination of the state and the market can be sensibly and pragmatically combined in capitalist economies. Every industrial revolution took place within the framework of developmental nation-states, after a group of nationalist politicians successfully formed a nation-state and industrialized it. This phase is always dominated by the state. The State is able to create or regulate the most efficient markets to coordinate the activities of the competitive sector of the economy, now more diversified, and which involves more creativity and innovation. But the state needs to remain developmental – and it usually does – because it is responsible for coordinating the non-competitive sector of infrastructure and basic industry; to implement an active macroeconomic policy (including an exchange rate policy); to reduce economic inequality and to protect the environment. This is a set of roles that the market cannot fulfil.

NOTES 1. 2. 3.

Gordon (1978). Arrighi (1994: 6). I owe this observation to Alexander Abdal.

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See Bresser-Pereira (1986; 2018). In this book I show the kinds of technical progress: when it uses capital, the productivity of capital or the product–capital ratio falls; when it saves capital, the productivity of capital increases; when it is neutral, the causes which make the productivity of capital increase or decrease compensate for each other, and the capital–output ratio is constant. Most models of economic development assume neutral technical progress. 5. Dobb (1963). Bagchi (2000: 399). 6. 7. Wallerstein (1980). 8. Braudel (1979: 484). 9. Marichal (2010: Chapter 1). 10. This long period (1830-1929) can be divided in two (before and after the 1870s) because it was around this decade that wages in England and France ceased to be at the subsistence level and began to increase with productivity. It is also after the 1870s that European countries and the U.S. became strong enough to impose their colonial rule. I do not emphasize the distinction between the two periods in this essay, because it is not necessary for the argument I am developing. 11. Note that this cultural dependence has proven to be much stronger in Latin America than in Asia. 12. Hobson (1902). 13. Organizational Revolution because, at that time, the basic unit of production ceased to be the family enterprises and became the great private organizations. 14. Shonfield (1969). 15. Schmitter (1974). 16. In this respect, the industrialization of Japan in the late nineteenth century is an interesting case. It was carried out almost entirely by the state. Around 1910, however, a rapid and radical process of privatization took place. The Japanese did not aim for neoliberalism, they just embraced market coordination for competitive industries.

5. New developmentalism’s microeconomics In the last chapter I finished presenting the main points of what I call the political economy of ND; from this chapter to the end of the book I will discuss its economics. Economic theory is the science that discusses how the state and markets coordinate economic systems, ensure stability and growth, and reduce inequality. It includes microeconomics, in which economic agents (producers and consumers) compete in the market that coordinates actions and achieves a certain equilibrium; it deals with the behaviour of agents, the allocation of factors of production, and, more broadly, the efficient coordination of economic systems. And it includes macroeconomics, in which the units of analysis are national income, production, and consumption, and a developmental macroeconomics, in which it is not the short but the medium and long term that are relevant. In synthesis, political economy defines the roles of the state and the market, microeconomics, the coordination of the economic system by the market, while macroeconomics analyses economic aggregates, consumption, investment, and income, and development macroeconomics studies the economy in the medium and the short term. For a long time, what we now call microeconomics was all of economics. The classical political economists, the neoclassicals, and the Marxists did not have what we now call macroeconomics. At the heart of economics was value and price theory – prices, because they ensure the coordination of the economy, and value, because the value of each good or service, plus its demand and supply, explain prices. Since Alfred Marshall published his Principles of Economics in 1890, microeconomics has become “Marshallian”, while neoclassical theory has replaced classical political economy. Classical political economists and neoclassical economists start from the behaviour of economic agents, but for the former this was only a starting point, for the latter, it became the fundamental principle; the theory ceased to combine the historical with the hypothetical–deductive method, and became an abstract mathematical model detached from reality.1 Microeconomics doesn’t have to be a system of models that explain the market only deductively. ND sees microeconomics as the study of the economic system based on the behaviour of individuals but seeks to understand how eco56

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nomic agents actually behave in the market, how they are not always rational, to what extent the market is able to efficiently coordinate economic action, and under what circumstances it should resort to coordination complementary to that of the market. In this sense, ND microeconomics combines historical models and economic syllogisms. And its degree of generality or abstraction is naturally lower than that of neoclassical microeconomics. The debate between developmentalism and economic liberalism is part of microeconomics. While economic liberalism recognizes the existence of market failures, it asserts that state failures are worse and has nothing to offer in policymaking except recommending antitrust actions, widespread privatizations, and market liberalization. ND believes that the market is an excellent institution, but it does not agree that it is enough for the state to reduce market failures, and everything is solved. The market has more than flaws, it has limits. There are many things besides monopolies and negative externalities that it is not able to maintain coordinates efficiently. Moreover, the assertion that when the state intervenes to solve one problem, it ends up creating more problems, is false. When state intervention in the economy is prudent and capable, the results are superior, often far superior to the results obtained by the “free market”, as the experience of several countries in many circumstances has shown. Economics was created not just for us to understand how economies work, but to guide policies and make them better. In ND, macroeconomics is substantially more developed than its microeconomics. ND adopts the microeconomics of classical political economy which is centred on the relationship between value and prices and on the tendency to equalization of profit rates – a simple model that assumes competition and the tendency to equilibrium of relative prices that, of course, is never achieved because the economy and its processes of monopolization are always in motion. ND adopts post-Keynesian economics, to which it makes some additions. As for the theory of growth, it uses Marx, post-Keynesian economics and classical structuralist developmentalism. In this chapter, I will summarize microeconomics and begin to introduce ND macroeconomics.

CLASSICAL AND NEOCLASSICAL MICROECONOMICS Classical political economists, from Smith to Marx, were interested in increasing productivity or the optimal allocation of factors of production. They started from the assumption that national markets are competitive and therefore efficient institutions. In this framework, prices ensure the optimal allocation of factors of production. Their reasoning was simple. Companies are profit-oriented and work in competitive markets. In this scenario, in order to survive and grow, companies must invest in more efficient machines and tech-

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niques, and assuming competitors do the same, this will maintain their share of the economy’s total profit. The fundamental principle is that of the tendency to the equalization of the profit rates or the equilibrium relative prices. The discussion of value and price completed this theory of economic coordination via competitive prices. All goods and services have a value and a price. The value covers the cost of production plus a reasonable rate of profit – the defined satisfactory equalized rate of profit that the market sets. Price revolves around the value according to the demand and supply of the good or service. There is, however, a problem: costs involve prices, and so we measure prices with prices. To address this, classical political economists developed the concept of value and assumed that only labor created value. They argued that value corresponds to the socially required labor embodied in the good or service. Capital, on the other hand, was understood as accumulated labor, which is transferred to the value of the good or service. ND subscribes to the microeconomics of classical political economy by Smith, Ricardo, and Marx. Marx used the theory of value, which he had slightly modified, to formulate the concept of “surplus value.” Surplus value or profit is the result of an exchange of equivalent values in the market.2 Workers sell their labor power to companies for their value (the amount necessary to ensure the subsistence and social reproduction of labor power) and receive wages in return. The value of labor and wages are equivalent because wages correspond to their values in the market, but as firms only hire labor if the wages are less than the additional revenues, profit results, Marx understood the surplus value as unpaid labor or exploitation. Marx’s model of surplus value is formally correct, but in capitalism profit is a condition of its very existence. According to the satisfactory rate of profit constraint, which is central to ND, firms only invest and produce if the expected rate of profit is satisfactory, if it motivates them to invest and produce. Therefore, the condemnation of profits only makes sense if there is an alternative to capitalism in the short term. The economists associated with capitalism were unhappy with the thesis of exploitation that Marx had deduced from the labor theory of value. They then proposed a new theory, a subjective theory of value, in which prices depend exclusively on the market – on demand and supply – and not on an “external” variable such as labor. They then proposed, in the second half of the nineteenth century, the concept of marginal utility and the marginalist theory of value, thus giving rise to the neoclassical school. Marginal utility is the additional satisfaction of the consumer with an additional unit of a good or service. The most useful goods, such as air and drinking water, are very useful but relatively inexpensive. Their usefulness drops as the consumer begins to have too many of them. The utility of a good, or the satisfaction it generates, is proportional to the number of items that the economic agent has. Thus, while utility cannot explain the value of a good or service, marginal utility can. The neoclassical

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proposal is based on a psychological assumption: the utility of a given good is constant, while its marginal utility falls as the consumer consumes the good or service, or, in Marshall’s more concrete terms and using his scissors metaphor, demand is determined by utility and supply is determined by production costs. Because scale returns are constant over the long run, marginal cost is constant, and supply curves are horizontal: they set price. Neoclassical theory built a beautiful microeconomic model of how markets work, deduced the demand and supply curves, the mean curves and the marginal cost curves, etc. graphically and mathematically. It thus constructed a radically deductive theory, and economics became pure rationality based on a curious inconsistency – a theory in which, after all, prices explain prices. Nevertheless, this theory is a syllogism – a beautiful and complex syllogism – in which the conclusions are already present in the premises. Instead of sticking to neoclassical abstractions, classical structuralist developmentalism and ND start from a relatively competitive market structure in which rich countries push for economic liberalism, from a state that intervenes in the economy responding to the consensual objectives of growth, price stability, and financial stability, to the interests of class coalition in office, the demands of the people, and the interests of the Global North. From this more realistic approach, where history is part of the game, economists can better understand the economic system they are studying and can propose more sensible policies.

CLASSICAL STRUCTURALIST MICROECONOMICS Post-war classical structuralist developmentalists studied economic development from a microeconomic, not a macroeconomic, perspective. Its units of analysis were the individual agents – the firms, the capitalist entrepreneur, the managerial middle class, and the workers. When they argued that economic development is structural change or industrialization, and crucially involves education and technical progress, they were referring to the composition of production between the primary sector, industry, and services, as well as to the methods of production adopted: two microeconomic problems. When they proposed the big push model, in which a large sum of planned investment would create positive cross-externalities that would turn unprofitable firms into profitable ones, the concept of externalities is micro, not macroeconomic. When they favoured the shift of the labor force from low-income-per-person to high-income-per-person activities, from the production of less sophisticated goods to the production of more sophisticated goods, they were taking a microeconomic approach to economic development. When they discussed the role of institutions in economic growth, they were adopting another microeconomic concept. When they advocated economic planning or investment, they were

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microeconomists. When they criticized the law of comparative advantage, we could say that they were dealing with the theory of international trade, although this theory also uses mainly microeconomic concepts, not macroeconomic ones. In all these cases, they were developmental economists because they believed that markets did not ensure economic development, because they advocated moderate state intervention, and because they recognized the frequent lack of coherence between national interests and the interests of the Global North, which were always presented as consistent with the interests of all. Classical structuralist developmentalists understood that the state should plan the economy. They based their thinking on the initially successful experiences of the Soviet Union and the “indicative planning” of France. However, with the passage of time, they realized that planning in a market economy is only impossible in a non-competitive environment, where there is no market. For that reason, ND’s microeconomics distinguishes between the competitive and non-competitive sectors of a nation’s economy. The state must plan investments in the non-competitive sector, while for the competitive sector, it must promote industrial policy and ensure the general conditions of accumulation, microeconomic and macroeconomic.

ND’S MICROECONOMICS The microeconomics of ND adds little to the microeconomics of classical political economy and classical structuralist developmentalism. Like the latter, it advocates moderate state intervention in the economy and economic nationalism, and sees industrial policy as usual and necessary for all countries that develop successfully. On that matter, see, for example, the contribution of Lazonick and Mazzucato on the United States, and Yuen Yuen Ang on China.3 The ND contribution refers to the division of an economy into a competitive sector and a non-competitive sector, which adopt or should adopt almost opposite policies regarding the role of the state and the market. I became aware of this separation in 2011 when I was visiting China. The Chinese have divided their economy into these two sectors. They did not do so formally and explicitly, but pragmatically: the non-competitive sector, the monopoly side, is dominant; the rest of the economy is reasonably competitive. For the competitive sector, the organizing principle is simple: it is up to the market to coordinate it, and it is up to the state to ensure the general conditions of accumulation. For internationally tradable goods, competition means not only domestic competition, but also the ability to export. For the non-competitive sector, the organizing principle is the reverse: the state should coordinate the sector, preferably keeping the respective companies under the control of the

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state. The main industries in this sector are the infrastructure and the basic inputs industry, as well as the large commercial banks that are “too big to fail”. A sector is competitive when it is made up of multiple companies, with no major barriers to entry to protect companies from competition within the country or internationally (assuming the country’s economy is open). The sector is uncompetitive when the industrial sectors that comprise it are made up of a single or a few companies and the barriers to entry are very high. Thus, in this regard, it is assumed that the State follows the principle of subsidiarity. The state should not coordinate everything that a competitive market can coordinate. The left criticizes this principle, which is central to the social market economy, the moderately conservative German school of political economy that influenced the construction of the welfare state in post-war Europe.4 A social-democratic vision that is close to ordoliberalism, definitively conservative, and more theoretically developed. Ordoliberalism is distinguished from economic liberalism in that it pragmatically advocates state intervention; however, it is often confused with neoliberalism because it is based on the neoclassical and Austrian schools. In the neoliberal years, neoliberal governments privatized monopolistic or quasi-monopoly state-owned enterprises located in infrastructure and “made them competitive.” To do this, they divided them, when that was possible, or else created regulatory agencies whose main role is to set prices as if the market exists. In this way, they “invented” markets that were far from being markets or competitive by ensuring some competition between oligopolistic firms. For example, take the case of landline telephony. When, in 1995, the Brazilian government decided to have private operating companies, it divided the concession of services into three regions, each to be served by a few incumbent companies. The government assumed that this was enough to turn the industry into a competitive market. Another example is energy distribution, which is monopolistic, but governments have created a kind of energy market that has allowed them to call the sector competitive. ND is radically critical of these privatizations through which the private sector gains a lot because it pays cheaply and then raises prices or reduces the quality of services. Financiers, lawyers, and other consultants who charge dearly for their professional services also win. Neoliberals claim that private companies are more efficient than public ones, but this is not true when there is no competition. They also argue that the state does not have the resources to make private investments, but many of these companies are profitable and self-financing.

THE FIVE MACROECONOMIC PRICES Macroeconomics deals with economic aggregates – income or production, consumption, investment, savings, exports, imports, fiscal balance, and current

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or foreign account balances – while microeconomics deals with individual economic agents and their reasonable rationality. That is a well-known difference, but there is another difference that ND highlights: while microeconomics deals with a myriad of individual prices of each good or service, macroeconomics works with only five macroeconomic prices: the rate of profit, the interest rate, the wage rate, the inflation rate, and the exchange rate. These prices must be “right” or correct but this does not mean that they are market-set or market-equilibrium prices. Rather, correct prices are the prices consistent with the well-functioning of the economy, with a growing and stable economy that encourages capital accumulation, growth, and reduction of inequality. Instead, which are the prices that we see developing countries? • The profit rate of the manufacturing industry is usually unsatisfactory, it doesn’t meet the satisfying rate of profit condition, it doesn’t motivate companies to invest, because the exchange rate is often overvalued and makes it uncompetitive. • The interest rate is usually higher than the international interest rate plus the country’s risk. Because it is set to attract foreign capitals and attend to the interests of rentiers and financiers. • The wage rate tends to increase less than the rate of increase in the productivity of labor during the time that Arthur Lewis’s unlimited supply of labor is maintained. After that, it should grow with productivity and be consistent with a satisfactory rate of profit. • The inflation rate is usually high, not so much because of fiscal indiscipline, but as a consequence of cyclical financial crises followed by exchange rate depreciation. As for the episodes of high inflation combined with recession, new developmentalism brings back the theory of inertial or indexed inflation. • The exchange rate is often overvalued due to chronic current account deficits and a non-neutralised Dutch disease and so, not competitive, especially for the manufacturing industry, even if it utilizes world-class technology. The right exchange rate is the rate that makes companies with administrative and technological capacity competitive. To keep the exchange rate competitive and the external account balanced, ND proposes that developing countries do not run irresponsible fiscal deficits, reject the use of the exchange rate as an anchor against inflation, and reject the policy of growth with external debt. In addition, the government may have to adopt capital controls. In principle, if the country has a zeroed or surplus current account, it will not need capital controls, but financial markets are highly unstable and speculative, and the possibility of controlling capital

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inflows and outflows should always be open. In 2016, for example, despite its huge reserves and persistent current account surpluses, China faced a considerable capital outflow and adopted capital controls. The most strategic of all macroeconomic prices is the exchange rate. Conventional economics assumes that economies that use the best technology are necessarily competitive, but this statement assumes that the exchange rate, while volatile, fluctuates around equilibrium. Instead, ND argues that the exchange rate may be overvalued or undervalued for long periods. When it is overvalued, the rate of profit will not be satisfactory, and companies will not invest.

NOTES 1. 2.

3. 4.

It is, however, fair to say that Marshall’s original microeconomics was much more empirical and less formalized than today’s microeconomics. I remind you that the rate of profit and surplus value are synonymous expressions, but while the rate of profit is equal to the return on capital, R/K, the rate of surplus value corresponds to the functional distribution of income between the totals of profits and wages, R/W. Lazonick and Mazzucato (2013) Ang (2016). The main author of the social market economy was Alfred Müller-Armack (1901–1976), whose views were associated with, but more progressive than, those of Walter Eucken’s ordoliberalism (1891–1950). Ludwig Erhard (1897–1977), who ruled Germany at this time, was an active builder of the European welfare state and mainly followed the principles of the social market economy.

6. Macroeconomics and austerity ND basically adopts post-Keynesian economics. This means that it adopts an economics that (1) rejects Say’s law that supply creates its own demand and affirms the crucial role of effective demand in determining full employment and growth; (2) asserts that capitalism is not just an exchange economy mediated by money, but a monetary economic system in which money is not only a medium of exchange but also a store of value, and therefore money can be acquired; at times when households spend less than they usually do and companies do not invest the extra savings thus available, the production–income– expenditure circuit is broken and the economy faces insufficient demand; (3) rejects that a sustainable demand can be achieved and maintained without the state being permanently engaged in fiscal and monetary policy to manage demand; (4) rejects the idea that savings precede investment and reverses the causal relationship on the assumption that firms borrow to invest; and, finally, (5) rejects that the increase in the money supply is the cause of the acceleration of inflation and attributes it to excess demand. The main goal of macroeconomics is to keep the economy around full employment. The concern is not with the growth of installed capacity, but with the level of productive capacity. Development macroeconomics is concerned with increasing installed capacity and, therefore, with economic development. Uncertainty is a central concept in Keynesian economics; there is an uncertainty about the future. An uncertainty that cannot be reduced to probabilities. That is why economics is always precarious, and it must be modest. Another essential concept is the preference for liquidity. Economic agents to maintain high liquidity at the expense of investment in order to take advantage of special economic opportunities that may occur, or to face unexpected and deep crises. In the previous paragraphs, I have radically summarized what I mean by post-Keynesian economics. I did this because this is not a book about macroeconomics, but a book about ND – about ND’s eventual contributions to economics and political economy.

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What are the differences between Keynesian and new-developmental macroeconomics? 1. ND’s macroeconomics is open from the start. You do not first build a closed economy, and then gradually open it up to understand imports and exports, the exchange rate, and capital flows. 2. It is also, from the outset, a development macroeconomics. Textbooks on macroeconomics follow the tradition of starting with simplifying hypotheses (closed economy and no growth) and then discarding the simplifying hypotheses one by one. I’m not saying this method is wrong. Keynes was only able to make a complete revolution in economics because he acted in this way. It would be impossible to deal with so many complex economic variables and build a consistent model if it made it open and dynamic. Today, however, from the extensive theoretical framework already developed, we can build a dynamic and open macroeconomics, and an operating economic model from which it is possible to derive macroeconomic policies. There are, of course, short-term problems such as the problem of a sudden recession or the growth of inflation that post-Keynesian economics already satisfactorily addresses, making ND’s contributions marginal. 3. ND systematically combines macro and microeconomics through the use of the five macroeconomic prices. I discussed them in the last chapter. 4. ND asserts the satisfactory rate of profit constraint: profit rates must be kept within a band that companies view as satisfying and motivating. 5. ND adds a sixth general condition of capital accumulation. Let’s take a brief look at these conditions that motivate companies to invest. Firstly, microeconomic conditions: education, health care, institutions that ensure the proper functioning of the market, investments in infrastructure, and a domestic financial system to finance investment. Secondly, macroeconomic conditions: the existence of demand, to which ND adds a sixth general condition of capital accumulation: access to demand, which only a competitive exchange rate can ensure. Whereas the Keynesian condition was imposed by the historical tendency to insufficiency of demand, the new developmentalist condition derives from another historical tendency: the fact that the exchange rate in developing countries is not only volatile but behaves according to an exchange rate cycle. It remains overvalued for several years between financial crises. 6. ND understands that a country is developmental if it acknowledges and manages two basic macroeconomic constraints – the fiscal constraint and the current account constraint. 7. ND rejects the liberal orthodoxy argument against fiscal deficits and the respective finance that crowds out private investment and cause inflation. There is no crowding-out or inflation as long as there is unemployment.

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However, before a country reaches full employment, fiscal deficits tend to cause an increase in demand for imports leading to current account deficits, which will lead to a long-term appreciation of the national currency and the resulting ills, besides causing excess demand and inflation. In other words, fiscal constraint needs to be recognized because it is an underlying condition for obedience to the current account constraint. 8. The current account must be balanced, if not exhibit surplus. I will discuss this last point in Chapter 12. 9. ND criticizes the policy of growth with external indebtedness – incurring current account deficits (“foreign savings”) and financing them with loans or foreign direct investments. Government authorities often use the “foreign savings argument” – that foreign savings are added to domestic savings – to justify their exchange rate irresponsibility, but what happens is not an increase, but a substitution of domestic savings for foreign savings. This critique is highly counterintuitive because it seems “logical” or “natural” for capital-rich countries to transfer their capital to capital-poor countries, but ND argues that this thesis is generally false. Additional capital inflows keep the exchange rate overvalued in the long run, while the current account deficit remains. The resulting overvaluation of the exchange rate, coupled with a generally high marginal propensity to consume, increases the purchasing power of wages as well as the incomes of rentiers and increases consumption while discouraging investment.1

FISCAL POLICY When we read the newspapers, we get the impression that only one thing really matters: the government’s fiscal policy. And the mainstream media has no doubts – the government must be responsible, it must be austere, it must keep the fiscal account balanced, it must respect the neoliberal orthodoxy. If the government disagrees and indulges in fiscal deficits, the government is either “populist” and believes that a chronic public deficit is the best remedy to sustain effective demand, or it is “developmentalist” and intervenes in the economy and builds the “big state”. In both cases, the fiscal crisis and inflation loom on the horizon. I am not exaggerating. What we have is the age-old struggle of social order against disorder, of truth against evil, of right against left, as if we could reduce economics and economic policymaking to this caricature. In this chapter, I discuss fiscal policy, the myth of fiscal crises, austerity as a syndrome and as a practice and, above all, as the foundation of the social order. For the Greeks, economics was the management of the household. In the seventeenth century, with the rise of capitalism, it became a science, a systematic and relatively complex analysis of the relations of production and

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distribution existing in modern societies. But this change was not radical. The economy retains some simple rules that flow from the management of household budgets. This is the case with fiscal policy. The simple and obvious rule is that the accounts of the state – the public budget – must be balanced. This is not austerity, but common sense. Common sense, however, is often simplistic and misguided. Keynes created a revolution in economics when he persuasively demonstrated that when a country faces a recession, the right fiscal policy is not a balanced budget but a deficit. An economic crisis is usually a crisis of effective demand, and it involves a fall in the expected rate of profit and a fall in investment. The approach to tackling the crisis is not to cut public spending and wait for rising unemployment to cause wages to fall – so that the rate of profit rises again and investment resumes – it is for the state to increase public spending in a countercyclical manner and create demand that gets the economy out of the crisis. Today, this is universally known and practiced. It was the main instrument that all countries used to fight the great financial crisis of 2008. The 2008 crisis would have been much more severe if all countries had not become involved in huge fiscal deficits to finance public investment and, in the case of the US, to finance bank takeovers.2 Keynes, however, never favoured chronic public deficits. He did not differ from his fellow economists, who believed that the budget should be balanced. Keynes, however, thought freely and innovatively, and was able to realize that at certain times fiscal responsibility is not to avoid the deficit, but to incur it. He did not share the populist argument that insufficient demand is a permanent feature of capitalist economies and requires chronic deficits. Economic development depends on investments, which must be both private and public. Experience shows that in developing countries, public investment should account for between 20 and 25 percent of total investment. To finance public investments, the state must make public savings. The state cannot incur a chronic deficit that leads to negative public savings. On the other hand, expectations regarding fiscal sustainability influence the perception of sovereign debt risk and affect both the interest rate and the exchange rate. I know that some of these negative effects reflect a deep-seated and orthodox belief in fiscal balance, but there is little doubt that fiscal waste is a dangerous practice. Fiscal responsibility – which is not synonymous with austerity – has a broad economic logic. It is a way of securing the economic order, and of securing something close to the social and political order.

FISCAL CRISIS OR FINANCIAL CRISIS? Liberal orthodoxy demands balanced budgets and is always warning against “the risk of a fiscal crisis” – warning that the public deficit is too high, or the

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public debt has risen too much, and the country is heading for a fiscal crisis. It’s what I call “the fiscal crisis myth.” I am not aware of any country at any time that has fallen into a purely fiscal crisis. Excessive fiscal deficits or public debt can lead to financial crises, which are the real crises. Rich countries fall into banking crises in which banks fail to honour their debts – the last case was in the United States, in 2008, with the bankruptcy of Lehman Brothers. And many developing countries fall into balance-of-payments crises – another name for currency crises. These are real crises because countries become insolvent and lose the ability to pay their obligations. Japan is supposed to have a public debt of 260% of gross domestic product (GDP), but no financier dares to speculate against the yen because Japan’s debt is in yen and the Japanese state can always pay its debts.3 A balance of payments financial crisis (currency crisis) does not always have a fiscal cause. External debt may not originate from high fiscal deficits that cause excess demand. It may originate from the country adopting a policy of growth with current account deficits, while the government keeps the fiscal account under control. This is what happened in the great East and Southeast Asian crisis of 1997, which involved South Korea, Indonesia, Thailand, Malaysia and the Philippines. These countries were adopting sound fiscal policies, but their growth with current account deficits was far from sound. The Asian financial crisis of 1977 revealed the region’s vulnerability to capital flows. Banks and corporations borrowed massively and cheaply in US dollars, often in short terms. The huge capital inflows greatly increased the value of national currencies; current account deficits and external debts increased; the creditors lost confidence and suspended the rollover of debts; economic agents promoted the outflow of foreign capital, and the financial crisis exploded: the currencies of the countries depreciated sharply and made many borrowers of foreign currency insolvent. Governments spent billions trying in vain to prop up their currencies by raising interest rates. Indonesia, South Korea and Thailand turned to the IMF, which provided nearly US$120 billion in bailout funds. According to the Asian financial authorities, the 1977 crisis was due to the overvaluation of currencies. In fact, countries had opened up their finances, central banks had stopped controlling capital inflows and outflows, and countries had gone into a frenzied process of trying to grow with foreign savings. Its external debt (mainly private) skyrocketed, doubling between 1993 and 1997. The IMF and the World Bank – which had supported the financial liberalization of countries following neoliberal principles – recognized that fiscal policies maintained a positive primary surplus and kept inflation under control, but they saw no problem with current account deficits, and thus maintained their support. As Robert Wade and Frank Veneroso noted in 1998, “The IMF and the World Bank lavished praise upon the governments of the region through

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1997, including on the Korean authorities as recently as September 1997.”4 At the end of the year, the financial crisis claimed their rights. The real cause of the Asian financial crisis was the adoption of the policy of growth with current account deficits and the ensuing increase in foreign indebtedness. This was a misguided policy for two reasons: first, because current account deficits necessarily increased the value of the national currency, causing countries to lose competitiveness; second, because such policy often leads to balance-of-payments crises. In the case of the Asian crisis, the collapse came so quickly that it averted the evils of loss of competitiveness in the medium-term. With the Asian crisis, the fiscal explanation for the financial crises has been shown to be wrong. In a 1998 essay, Paul Krugman acknowledged that “nobody anticipated anything like the current crisis in Asia. True, there were some Asia skeptics – including myself – who regarded the claims of an Asian economic miracle as overstated and argued that Asia was bound to run into diminishing returns eventually.”5 In the canonical models of balance of payments crises, the crisis is always caused by fiscal irresponsibility.

THE AUSTERITY SYNDROME, A CONDITION NOT A POLICY Fiscal crises per se are rare, or simply non-existent, but fiscal discipline or fiscal responsibility are the virtues required of capable economic policymakers. It should not, however, be confused with austerity or the austerity syndrome, which characterizes neoliberal orthodoxy and was behind the global financial crisis of 2008. Today austerity is a basic explanation for the economic difficulties that Germany is facing, as The Economist itself stated on August 19, 2023.6 The austerity syndrome is the belief that capitalism faces a fiscal crisis – a “dreadful” crisis, though never defined – and the only remedy for it is for the state to refrain from spending. Practice austerity in any circumstance. This is the form of crisis that capitalism has faced since the 1970s – a crisis that at the time James O’Connor (1930–2017) called “the fiscal crisis of the state”. He was viewing the crisis not as the outcome of a policy, but as a condition of contemporary capitalism. In the 1980s, I authored several papers and published a book attributing the economic stagnation of Latin American economies in that decade to the fiscal crisis of the state.7 What I was doing with the concept of the fiscal crisis of the state was explaining the crisis, not as over expending, but as a condition of capitalism that today I call the “austerity syndrome”. This was (and still is) characterized by negative public savings, low public investment, and low growth.

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There is a pleonasm in the expression “fiscal crisis of the State”. We do not need the word “state” – a fiscal crisis is necessarily a crisis of the state. I was aware of this fact, but I deliberately used the phrase to relate it to the crisis theory of capitalism that is at the heart of James O’Connor’s 1973 book, The Fiscal Crisis of the State. I saw the fiscal crisis of the state as a historical manifestation of the crisis of capitalism, which corresponds to the historical concept of austerity today. In his book, O’Connor distinguished two sectors in the American social formation – the monopoly sector and the competitive sector – and argued, first, that “the state sector and state spending are increasingly functioning as the basis for the growth of the monopoly sector and total production”, and, second, that “although the state has socialised more and more capital costs, the social surplus (including profits) continues to be privately appropriated … that creates a fiscal crisis or a ‘structural gap’ between state expenditures and state revenues.”8 More recently, William Lazonick and Mariana Mazzucato developed this idea, analysing disruptive innovations that they called the “risk–reward nexus.”9 Armin Schäfer and Wolfang Streeck, for their part, in the introduction to their book, Politics in the Age of Austerity, argued that “many mature democracies may well be approaching such a situation as they confront fiscal crisis”. For nearly three decades, OECD countries have incurred and accumulated deficits. Whichever parties come to office will have their hands tied to previous decisions. In some articles prior to the ones just quoted, Pierson outlined what he calls a “regime of fiscal austerity.” Schäfer and Streeck are not far from O’Connor, but they are referring not to him but to Paul Pierson, a noted analyst of the welfare state who, for the first time, defined the modern historical concept of austerity. In his article “Coping with permanent austerity: welfare state restructuring in affluent democracies”, Pierson stated: The welfare state now faces a context of permanent austerity. Changes in the global economy, the sharp slowdown in economic growth, the maturation of governmental commitments, and population ageing all generate considerable fiscal stress. There is little reason to expect these pressures to diminish over the next few decades. If anything, they are likely to intensify.10

Pierson could not have been more right. We can see austerity in historical terms as a condition of contemporary capitalism or, alternatively, as a liberal-orthodox policy and as a vice.

AUSTERITY AS A VICE To discuss the intellectual history of austerity as an economic policy, Mark Blyth goes back to Locke (1632–1704). I think it would be more appropriate

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to refer to David Hume (1711–1776) and his Essay III – Of Money. The great philosopher was also an economist and was the first to formulate a quantity theory of money: the purchasing power of money is determined by the quantity of money in circulation. Since then, the monetarist theory of inflation has become ingrained in people’s minds, and austerity is seen as the solution. In Chapter 8 we will discuss the rate of inflation and show how wrong the monetarist theory was, so wrong that it has recently been discarded by neoclassical orthodoxy itself. Austerity is an orthodox practice, but it is also a syndrome; it is the belief that a country’s economic system, if not the world’s, is in permanent fiscal crisis or on the verge of rising inflation. The practice and the syndrome together make austerity a kind of vice and result in irrational policies. It is unjustifiable, for example, that in June 2010, in Toronto, the finance ministers of the G20 countries, after less than a year of countercyclical fiscal expansion, retreated to austerity. Blyth tells the story of this event competently and vividly.11 Only Germany – where ordoliberalism, a conservative alternative to neoliberalism, where the state must provide the structural conditions for the functioning of the market – and a dogged European Central Bank, whose president almost led Europe into a major crisis in 2012 – had opposed the big fiscal commitments that all countries made in 2009 to defuse the crisis.12 But a year later, in Toronto, the new slogan that dominated the meeting was “fiscal consolidation.” The backlash was led by Germany, whose finance minister, Wolfang Schäuble, invented an oxymoron, “expansionary fiscal consolidation” – immediately followed by Britain and Canada. As another example, when Lula was elected president of Brazil for the third time in 2022 (the two previous elections were in 2002 and 2006), he said he would change the constitutional amendment that fixed state spending in real terms. Neoliberal economists and the local financial market deplored the new government’s lack of austerity and predicted that inflation would skyrocket, but this is not what happened.13

AUSTERITY AND SOCIAL ORDER Why are conservatives so adamant about advocating austerity when we now know that the public deficit only causes inflation when the economy reaches full employment? Why is austerity a kind of religion for neoclassical orthodoxy? The new-developmentalist explanation is that neoclassical economics is conservative, and the logic of conservatism is order: social order, political order, and economic order. It is no coincidence that Germany is the birthplace of austerity and ordoliberalism. German elites are liberal, but their priority is social order. Some time ago, I proposed the central difference between centre-left and centre-right: the left can risk social order in the name of social

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justice, while the right never risks social order.14 This is a priority so radical that it takes a country out of the realm of reason and condemns it to dogma. The reaction to austerity was also radical at the hands of modern monetary theory (MMT). MMT criticizes orthodox monetarism and the association of fiscal deficits with inflation. The banking system creates money (money is credit), but the state can generate or stimulate the creation of money.15 The reasonable economic limit to public spending is not the spending that is written in the budget, but the point at which aggregate demand becomes excessive relative to supply; only then does inflation accelerate. This reasoning gained relevance after the 2008 global financial crisis, when the central banks of rich countries engaged in a massive increase in the money supply (quantitative easing). The purchase of public and private bonds was made with the aim of increasing the liquidity of national economies, maintaining a low interest rate and stimulating the economy. There was also the goal of reducing the public debt, which, especially in Japan, was very high. Thus, the greater the issuance of money, the more the public debt was reduced. Governments, however, have never admitted this objective for several reasons, the main one being that the official rules of national accounts do not allow the state’s debt to the central bank to be deducted from the public debt.16 When, at the beginning of 2020, the Covid-19 pandemic threatened the world, the same central banks did not hesitate to continue with the policy of quantitative easing, this time to finance the large expenditures required of the state. Brazil and other developing countries did not follow, but that was a mistake. Countries that have embraced monetary financing have felt free to spend more to save more lives. They were running huge fiscal deficits that added to the public debt, but the increase in central bank credit compensated for the increase in the money supply that would happen when they sold government bonds. The increase in the money supply did not finance additional spending, but was aimed only at increasing liquidity, keeping the interest rate low, and stimulating the economy. There was also the objective of reducing the public debt, but this was considered irregular. Thus, the public debts of Japan, the United States, the United Kingdom, Switzerland, Sweden, and Eurozone countries have officially remained higher than they actually were. Accountants and economists love fiction; the former because they need rules and resist new situations, and the latter because they want to discourage “irresponsible public spending”. In fact, the rules that put central banks outside the state were only realistic and reasonable early in the history of central banks, when private banks took over the role of central banks. Today, these rules must be revised. But international national accounting rules change more habitually than through official agreements, and we will have to wait, but critically.17 The fact that monetary financing of public spending does not cause inflation – unless there is excess demand over supply – does not mean that governments

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can spend at will. This limit is not always clear, and there is no reason to take unnecessary risks. Only in special circumstances, and always in a transparent manner, can monetary issuances finance state expenditure. In Brazil, in 2021, Nelson Marconi and I made a concrete proposal following this guideline. Whereas the Brazilian economy had been almost stagnant since the 1980s, and public investment had fallen from 7.8 percent of GDP per year in the 1970s to 2.0 percent per year in the 2010s, and whereas public savings, which were positive in the 1970s, became negative as early as the 1980s, and also considering that, politically, Brazilian governments would not be able to recover public savings, we proposed that the Federal Government be authorized to annually finance public investments up to the limit of 5 percent of GDP. This authorization would be conditional on the National Monetary Commission releasing the cash disbursement every three months after verifying that the economy was not at full employment and that there was no risk of an increase in the inflation rate.18 Orthodox economists – and not only them – reject monetary financing. They believe that the only alternative to finance state expenditures that are not covered by current revenues is the state’s indebtedness to the private sector. The state must always be incurring debt and paying it. This is wonderful for rentiers and financiers; it is their ideal world. Quantitative easing confirmed the claims of MMT, a theory that radically contradicts neoliberal orthodoxy. MMT holds that there is no financial constraint on government spending if a country is a sovereign issuer of currency. The state treasury can always borrow money from the country’s central bank without charging interest. They believe that the orthodox claim that excessive fiscal deficits can bankrupt the state is false. The state can always print money and pay its debts. Actually, they go too far. Printing money is not intrinsically wrong, nor intrinsically right. Printing money is not a last resort, but it is a resource that should be combined with prudence. But policymakers must be realistic. Monetary financing, whether to finance much-needed expenditures or to ensure the liquidity of the economic system, must follow the rule of prudence, which should not be confused with irrational conservatism.

NOTES 1.

See the empirical research that confirms this counterintuitive inverse relationship between foreign savings and domestic savings, and thus between current account deficits and growth: Bresser-Pereira and Nakano (2003), Bresser-Pereira and Gala (2007), Bresser-Pereira, Araujo and Gala (2014). See also Feldstein and Horioka (1980), which economists call a “puzzle” but is only the empirical confirmation of the substitution of foreign savings for domestic savings, as is also the case with empirical studies on “savings substitution”: Sinn (1992), Coakley, Kulasi and Smith (1996).

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2.

Robert Skidelsky, Keynes’s biographer, wrote a full-length book commemorating “Return of the Master” (2009). I say “supposed” because a large part of this debt exists only in accounting terms, not in real terms. Quantitative easing helped to annulate most of such debt, but the accounting rules do not permit the country to deduce from its fiscal debt what is a debt to the central bank. Wade and Veneroso (1998). Krugman (1998). The Economist, August 19, 2023. Bresser-Pereira (1992). O’Connor (1973: 8–9). Lazonick and Mazzucato (2013). Pierson (2001: 411, emphasis added). Blyth (2013). That incompetent president of the ECB was Jean-Claude Trichet. Mario Draghi, the new president, averted the crisis by saying the bank would do “whatever it takes” to turn the eurozone crisis around. Inflation is now (September 2023) under control, at around 3.5 percent per year. Bresser-Pereira (2000). At present, L. Randall Wray is the leading economist of this theory. Part of this accounting rule is correct, because central banks are increasing their debt to the public treasury in order to maintain domestic monetary adjustment targets. But what the governments of the rich countries have done is much more than that. Today, there is the problem of distinguishing the short-term monetary issuances that central banks usually make just to keep the interest rate on target from quantitative easing issuances. This distinction should be made to make tax accounts more realistic. Bresser-Pereira and Marconi (2021).

3.

4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16.

17.

18.

7. The interest rate The interest rate is the price of money. As with other macroeconomic prices, a country’s “right” interest rate is not the market interest rate; for ND it is the average interest rate that prevails in developed countries plus country risk. The basic reference is the US: the Federal Reserve rate. Country risk, in turn, refers to the risk and uncertainty associated with investing in a particular country. This risk may arise from political and economic factors and includes the risk of sovereign default. A second criterion for setting the correct interest rate is to investigate whether the rate harms the country’s competitiveness or not. But this criterion, unlike the first, does not give a precise answer to the question. From the point of view of economic development, the interest rate is the price that entrepreneurs or companies pay to the owners of capital (the rentier capitalists) for the loans of their capital to finance investment. The basic interest rate – the rate that central banks set to lend money to commercial banks, also called the “repo” interest rate – must be low relative to the expected profit rate, in order for the company’s profit rate to be satisfactory. More precisely, the level of the basic interest rate, around which the central bank makes its monetary policy, should be low. The interest rate is relevant for determining three of the four remaining macroeconomic prices. It is relevant for the determination of the exchange rate, because, as we will see, the differential of the interest rate is one of its determining variables. It is relevant for determining the expected and satisfactory rate of business profit, which is the final macroeconomic constraint for ND. It is relevant in controlling the rate of inflation, in that it is the main tool that central banks rely on to achieve their inflation targets. However, the interest rate has limited relevance in relation to the rate of wages.

THE DETERMINATION OF THE INTEREST RATE Neoclassical economics holds that the main determinants of the interest rate are in the real economy. The interest rate balances the demand for investments with the supply of savings. Keynes disagreed. For him, the interest rate is determined in the financial system, in the money market. The equilibrium interest rate is the rate that equals the demand and supply of money. This view is similar to Marx’s theory of the interest rate. Marx argued that the interest rate is determined in the money capital market, but, as in the case of commod75

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ity prices, it has a centre of gravity that he calls the “natural rate.”1 Eckhard Hein, who has studied the problem in depth, concluded that “there are broad consistencies with post-Keynesian monetary economics, at least with a major part in this school of thought, the horizontalist view”.2 People hold money for three reasons: transaction demand, precautionary demand, and speculative demand. Keynes emphasized the third reason, that people hold money in their portfolio waiting for a good application, although this money does not pay interest. While transactional demand for money depends on income, speculative demand depends on the interest rate. People retain less money in their wallets when the interest rate is high and more money when it is low. Having money in their portfolios allows them to speculate and profit from the expected changes in interest rate and bond yields. It is necessary to distinguish the short-term interest rate from the long-term interest rate. While in the short run the interest rate is the tool that central banks rely on to set the base rate, in the long run, the money market does this work. It is also necessary to distinguish the nominal interest rate from the real interest rate. In the short term, both are equal, but in the long term, they are not. Many factors influence the interest rate, among which some are more relevant than others. In the case of the nominal interest rate, inflationary expectations are the most important determinant. As for the real interest rate, the country risk is the most relevant. A body with a solid credit rating, such as the European Investment Bank, will be able to attract savings at much lower interest rates than corporate issuers of “junk bonds”. Countries with high debt levels may have to pay higher rates on state loans than countries with a lower risk of default. The same logic applies to the sustainable – or unsustainable – character of the debt trajectory. The supposed guarantee that “sovereign debt” will be repaid at maturity often allows governments to borrow at negative real interest rates. Since the financial crisis of 2008, from which negative basic interest rates became commonplace, central banks began to implement a policy of quantitative easing, which I discussed in the previous chapter. Fiscal crises are rare but financial crises are common and recurring. Among financial crises, rich countries fall into banking crises in which banks stop servicing their debts, while developing countries fall into currency or balance of payments crises. They are real crises because countries become insolvent, and growth is hampered for several years. For orthodox economic theory, the causes of the financial crisis are exogenous because they result from more than simple market failures. They are usually failures of politicians in office who spend more than would be sensible to be re-elected. But financial crises are often endogenous, they are the result of the speculative dynamics of capitalist development. The causes of the 2008 crisis were definitely endogenous.

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INTEREST RATES IN DEVELOPING COUNTRIES The definition of the “right” interest rate is only of relative interest among developed countries, but it is highly relevant in developing countries. The literature on this subject is scarce. Instead, the literature criticizes the country that keeps the financial sector closed, arguing that if capital flows and exchange rates are free, the interest rate will be lower. However, in a country like Brazil, interest rates became extremely high for many years after the 1991 agreement with the IMF that involved financial liberalization. This was a green light for a coalition of rentiers and financiers to raise interest rates. I began this chapter by saying that the correct interest rate in each country is the average interest rate of developed countries plus country risk. Among developed countries, correct interest rates will vary little because country risks are small and other variables are unlikely to generate substantial differences. The same, however, is not true for developing countries, where the interest rate – including the basic interest rate set by the central bank – is usually much higher than the international rate plus the country risk. In October 2002 the base interest rate set by the Central Bank of Brazil was 19.05 percent and the real base interest rate was 10.95 percent a month (!). Nakano and I then wrote one of ND’s founding papers criticizing this absurd rate.3 The criticism was obvious, but it surprised most Brazilian economists, including the IMF, who believed that Brazil needed that rate to fight inflation. We did not have a precise number for the country risk, only the Standard & Poor rating (the Brazil risk was BB–), but when compared with other countries, it was clear that the Central Bank could not justify such a high interest rate with the existing country risk. Today, country risk assessment has developed enormously and there are several well-correlated quantitative measures.4 Recently I returned to the theme together with Luis Fernando de Paula and Miguel Bruno. In our article, we began by saying that “this article takes up and develops the hypothesis of the existence of a pro-conservative monetary policy convention in Brazil, formulated by authors such as Bresser-Pereira and Nakano (2002), Erber (2011) and, more recently, Lara Resende (2017).”5 The Central Bank has set stratospheric interest rates in Brazil for many years, but it has not done it alone. The local financial sector pushed for it to follow this line. Well-behaved economists say, “the financial markets, not the Central Bank, define the rates”. It is true that financial markets are part of the process of setting the key interest rate, but market forces would never set rates so high when country risk is low. Country risk has been low in Brazil since price stabilization in 1994 – which ended 14 years of high inflation – and even lower since the early 2000s, when a commodity boom allowed the country to liquidate its foreign debt and accumulate huge international reserves.

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ND understands that the case of Brazil was extreme, but in many middle-income countries, the base and average interest rate are above the international rate plus the country risk. Three perverse causes lie behind this fact. First, the rentier capitalists and financiers easily form a coalition of classes to support such a policy. Secondly, the close link between the financial market, the central bank, and the national treasuries makes the latter hostage to the financial market for the purpose of issuing and rolling over public debt. Third, the governments and central banks of emerging countries use interest rates to attract foreign capital and accept the corresponding current account deficits on the wrong assumption that foreign savings will finance investment and growth. Later, I will discuss this perverse cause. The criticism of the “strategy of growth with external indebtedness” is a central theme of ND. The formation of neoliberal class coalitions in the financial sector makes the National Treasury thus aimed at allowing them to “legally” appropriate public assets, this is often present in middle-income countries. It is a sophisticated form of corruption in countries that have a domestic financial market. It is the use of the law against republican rights – the right of every citizen that public property be used for the benefit of the public interest.6

MONEY As already mentioned at the beginning of this chapter, the interest rate is the price of money. Monetary policy, which we will cover briefly to close this chapter, is the sum of policies that use money as an instrument. To be an effective instrument of policy, money must be exogenous so that central banks define the amount of money in circulation. The problem is that money is an endogenous variable and not an exogenous variable. In inertial inflation theory, the money supply is a factor that sanctions inflation; money is therefore endogenous. The claim that money is endogenous has a long history, with its roots in mercantilism. John Law (1671–1729) and Sir James Steuart (1721–1780) have already defended this thesis. In 1971, neoclassical economist Lionel Robbins critically described Steuart’s book, Inquiry into the Principles of Political Economy, as a “kind of compendium of all antiquantitative theories concerning money.”7 Keynes thought that the money supply was exogenous. For Victoria Chick, this reflected the development of the banking system in Keynes’ time, when banks were still for savings deposits. It was only after the suspension of dollar convertibility in 1971 and the development of interbank lending mechanisms that liability management gradually became the guiding criterion of banks’ behavior, and they were able to expand credit.8 The Italian economist Paolo Sylos Labini, who was originally not post-Keynesian, was probably the first

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economist in the twentieth century to define this clearly. In a 1949 article, he argued that the “production of the means of payment does not depend on the mines or, respectively, on the monetary authority, nor on the banks, but on the companies. It is not true that companies cannot produce money: they can and do produce it: not directly, but through the banks”.9 J.E. King says that Kahn and Joan Robinson “were the first English economists to develop the post-Keynesian notion of endogenous money.”10 Nicholas Kaldor – one of the founders of the English version of post-Keynesian economics – vigorously defended the endogenous character of money. The monetarists assumed a stable monetary function, but Kaldor argues that not only money, but also consumption, investment, wealth, and the wage bill correlate with the increase in nominal GDP. The increase in the money supply does not cause an increase in income, but, according to him, the relationship is reversed. The money supply is chiefly the result of the banks’ accommodating response to the demands of the borrowers. The money supply, however defined, correlates with the money GDP—so does everything else: consumption, investment, wealth, the wage bill, etc. An increased demand for money evokes an increase in supply. The money supply “accommodated itself” to the needs of trade: rising in response to an expansion, and vice versa… The explanation for all the empirical findings on the “stable money function” is that the “money supply” is “endogenous”, not “exogenous”.11

In 1963, when the Brazilian economy was facing rising inflation combined with recession, Ignacio Rangel, whose works are only in Portuguese, was probably the first economist to explain inflation using the concept of endogenous currency. He argued that the money supply was increasing, but given the recession, which was not the cause of inflation. Instead, inflation is a defense mechanism of the economy. Inflation causes a drop in the real money supply. Money issuances and corresponding fiscal deficits were a pragmatic policy to keep the real liquidity of the economy stable and avoid recession.12 The endogenous nature of money only became the dominant position of post-Keynesian economics after the contributions that Basil Moore presented in several articles and in a 1988 book.13 Moore defended the traditional view that banks’ money-making process depends on the reserve-to-bank deposit ratio. Central banks must control the amount of bank deposits and therefore the stock of money, determining the size of the high-power base. But if that were true, Moore asks, how do we explain the recent failure of monetary targets and the rise in inflation targeting across the Western world? In fact, companies determine the amount of money by borrowing from banks. The changes in bank loans show in detail the changes in monetary aggregates. However,

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Moore argues that an endogenous money supply means that central banks are passive and cannot affect monetary growth. An endogenous money supply simply denotes that the money supply is determined by market forces. Central banks are able to administer the level of the short-term interest rates within a substantial range… Even though the supply of credit money is endogenously credit-driven, ex-post, the high-powered base multiplier will always appear to be fully confirmed.14

In the early 1980s, when developing the theory of inertial inflation, Nakano and I did not know Moore’s work, but we knew that the endogeneity of money was a topic that had advocates. We consider Rangel’s view and formulate our own explanation of what we call the “sanctioning” role of money in inflation. Given the exchange equation, and assuming relative stability for the velocity of money, the inertial increase in prices necessarily leads to an increase in the money supply. The alternative is a possible attempt by the government and the central bank to freeze it. With high inflation – the reality of the Brazilian economy at that time – the real amount of money in circulation would fall, and a liquidity crisis would lead the economy into recession. To avoid this, the economic system defends itself by increasing the nominal supply of money, either directly, through an expansionary monetary policy, or indirectly, through the automatic mechanism of the financial market. Even though the central bank refused to participate in the process, the economic system still managed to defend itself by increasing credit and increasing the speed of circulation of money. The endogeneity of money is not consensual among post-Keynesians. Victoria Chick, for example, argues that the claim that money is totally endogenous is extreme. The monetary authority does not always provide money to banks on the assumption that it must maintain the liquidity of deposits. Still, to the extent that the monetary authority seeks to maintain a stable interest rate, the money supply is endogenous. Chick asks for a compromise: “Money is neither purely exogenous nor endogenous.”15 J.E. King is more critical. He argues that “Moore never really faced the implicit contradiction that the supply and demand of money are interdependent... Moore’s horizontal money supply curves and the descending money demand curves are mere metaphors.” King proposes that the idea is the inverse of Say’s law: that aggregate supply determines demand. The comparison is not fair, but King is a moderate and competent historian of post-Keynesian economics and acknowledges that “by the early 1980s, there was a broad agreement among post-Keynesian monetary theorists that the money supply was (in some sense) endogenous; that was sufficient to undermine the neoclassical synthesis in general and the IS–LM

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model in particular”.16 Somehow, everyone became horizontalists – favourable to the thesis of the endogenous character of money. Currently, the greatest proponents of the endogenous theory of money are the participants in modern monetary theory—a subsidiary theory of post-Keynesian economics that has its origins in Chartism, a nineteenth-century school of thought led by L. Randall Wray, Keynes, and Minsky. I will discuss this theory later in Chapter 11, in the framework of alternatives to investment financing.

MONETARY POLICY OR INTEREST POLICY? Monetary policy assumes that governments and central banks implement it by controlling the money supply. This was never entirely true, but it was assumed that in order to control the money supply, the central bank conducted open market operations. The central bank buys or sells treasury bonds to regulate the supply of money in reserve in banks. In 1971, when the U.S. suspended the convertibility of the dollar into gold, money increasingly became a purely fiat value, with no collateral behind it except the credibility of the issuing country. And central banks have gained more and more power to set the interest rate of the national currency, regardless of open market operations. Around 1990, when the inflation-targeting regime became the usual practice, this power became more evident. So today, instead of a monetary policy, countries have an interest policy. Central banks continue to operate in the open market, but the weight of central banks in determining the interest rate is overwhelming. The transmission mechanism through which central bank interest rates influence market rates today is unclear. Variations between different national economies and regions result from differences in corporate funding sources, the level and structure of corporate and household debt, and the degree of competition in the financial services sector. We have already shown and discussed the reasons why the interest rate in middle-income countries tends to be higher than the international interest rate. Interest rate policy is now associated with inflation-targeting policy. New developmentalism has nothing to add to what post-Keynesian economics already says and proposes about it. ND naturally shares the rejection of austerity policies, which liberal orthodoxy often adopts. It acknowledges, however, that even when the acceleration of inflation is not caused by excess demand, but by supply problems, the central bank may have no other path but to adopt a policy of demand restriction. In this case, my understanding is that one cannot speak of “austerity”.

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NOTES 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16.

Marx (1894: 358-69). Hein (2002: 114). I refer to Bresser-Pereira and Nakano (2002). Among the indices, J.P. Morgan’s Emerging Markets Bond Index (EMBI), which evaluates 19 countries, is probably the most widely used quantitative country risk index. Bresser-Pereira, Paula and Bruno (2020: 2/21). Italics added by me. Bresser-Pereira (2002). Law (1705); Steuart (1767); Robbins (1971: 102). Chick (1985). Labini (1949: 240). King (2002: 161). Kaldor (1970: 8–9). Rangel (1963). Moore (1979, 1988a, 1988b). Moore (1988a: 384). Chick (1983: 236). King (2002: 174).

8. Inflation and the limitations of economics Inflation – the systematic increase in prices – is probably the most studied of the five macroeconomic prices, remembering that the others are the rates of profit, interest, wage and exchange. A country’s inflation rate is “right” or correct when it is approximately equal to the international inflation rate. The old structuralist idea that the inflation rate should be higher in developing countries only makes sense when the country is starting to industrialize; when the national market is poorly developed; when the economy is closed to foreign trade; or when supply does not respond adequately to changes in demand. Today, no economy in Latin America, where this structuralist view was popular, is underdeveloped enough for this thesis to be useful. In principle, a chapter on inflation would not be necessary in a book focused on economic development, but in developing countries inflation has been a major obstacle to growth. Among inflation theories, none except the theory of inertial inflation offers policies that do not involve the short-term sacrifice of the growth rate, but this is true only when inertial inflation is high enough to justify the adoption of mechanisms for its neutralization, be it a price freeze combined with an accounts payable conversion table, or through an indexed currency as was successfully used in Brazil in 1994. Heterodox economists criticize monetarist theory for the recession and falling wages that its policies have caused. They are right, because liberal orthodoxy often adopts remedies like fiscal adjustment and raising interest rates, even when inflation isn’t driven by demand but stems from short-term bottlenecks in supply. The best policy in this case is some patience. We must, however, recognize that the complementary mechanisms that the heterodox propose have little effect, and when the fight against inflation is effectively urgent, the policymaker has no alternative but to swallow the bitter pill of fiscal and monetary adjustment. Several theories explain inflation, but I believe we can reduce them to three: the orthodox, the post-Keynesian, and the inertial theory of inflation. The first two theories, which purport to be general, should be the opposite of each other, offering alternative explanations for inflation and different policies. They would be opposite if orthodox theory remained monetarist, but the failure of monetarism has become so evident in the last 30 years that liberal orthodoxy 83

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has ceased to see inflation as a consequence of the increase in the money supply and has adopted a demand-driven approach – similar, therefore, to Keynes’s approach. On the other hand, post-Keynesian economic theory was originally demand-driven, but today post-Keynesians adopt complementary concepts such as cost–push inflation, the endogeneity of money, and the inertial component of inflation. I could list other theories of inflation, such as that of cost–push inflation, but I prefer to consider them as additions to the broader theory of inflation – the post-Keynesian one. When there are temporary bottlenecks in the supply of certain goods or services, or when corporations or unions exercise monopoly power and raise their prices, or when the harvest of a particular food fails and prices rise, we can say that these are forms of supply inflation, but one cannot speak of a theory of supply inflation. I replaced the monetarist with the orthodox theory of inflation because the neoclassical economists themselves have already abandoned the monetarist explanation. Today, the post-Keynesian theory of inflation is the most comprehensive theory in that it includes several variables that enrich it. Inertial inflation theory, on the other hand, explains the concomitant existence of inflation and recession and, for this, distinguishes the accelerating factors from the factors that maintain and sanction inflation. I see this theory as part of new developmentalism (ND) because I was deeply involved in its formulation in the 1980s.1

ORTHODOX THEORY OF INFLATION The orthodox theory of inflation has changed over time. Originally, in Irving Fisher’s (1867–1947) traditional quantitative theory of inflation, the money supply determines inflation, and the theory was called monetarist. Irving Fisher’s traditional monetarist theory started from the “equation of exchanges” based on the definition of the velocity of money, V – the number of times in a year that a unit of money changes hands. V ​= (QP) / M 

(8.1)

where Q is real income, P is the price level or inflation, and M is the money supply. Thus, the equation of exchanges, which is a simple identity, is: MQ ​= TP 

where T is transactions.

(8.2)

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From this identity, Irving Fisher, following a belief widespread in the population, formulated the quantitative theory of money or original monetarist theory of inflation. He assumed that the velocity of money is constant – which often does occur – and concluded that the increase in the money supply is the cause of inflation. He claimed that the theory had been confirmed by empirical tests, ignoring that research generally shows a high correlation between money supply and inflation, but the causal relationship may be reversed: inflation requiring and endogenously causing the increase in the nominal money supply to keep the real money supply stable and the economy functioning well. Before Keynes, neoclassical theory had no macroeconomics. Say’s law – supply creates its own demand – was a macroeconomic assumption of classical political economy, which does not amount to macroeconomics. After World War II, Milton Friedman (1912–2006) saw the opportunity to use this law and Fisher’s theory to develop a macroeconomic alternative to Keynesian macroeconomics. Friedman slightly altered the equation of exchanges, replacing (QP) with national income, Y. VM ​= Y 

(8.3)

Thus, in addition to a theory of inflation, he now had macroeconomics. The velocity of money income continued to be constant, the money supply continued to be exogenous, and the nominal quantity of money remained the sole cause of inflation. However, after Keynes, it was impossible to build macroeconomics without considering aggregate demand, so he made a compromise, not in relation to prices but in relation to income. Later, Friedman incorporated the Phillips curve model (which had previously been adopted by Keynesians), in which wages and prices depend on employment and the latter depends on aggregate demand. But he rejected cost inflation and the interpretation of the Phillips curve as reflecting the bargaining power of unions. Instead, he opted for the alternative interpretation of demand-driven inflation that post-Keynesians originally used. Friedman, however – who was always ready to criticize the Keynesians’ assertion that fiscal and monetary economic policies would ensure full employment – in 1975 was already interested in rational expectations and kept the Phillips curve in his system only in the short term, making it vertical in the long term, thus independent of employment and therefore demand. The discussion of inflation and the Phillips curve involved a debate about determining nominal wages. In a 1977 article, Francis Cripps criticized Friedman’s “augmented Phillips curve” and his atomistic model of competition in the labor market, which rejected the role of wage bargaining in determining wages. He argued that any attempt to raise wages above inflation

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would result in more inflation. Cripps showed that empirical research rejected this view.2 In fact, it makes little sense to ignore the importance of wage bargaining when one considers that it is of interest not only to trade unions, but also to employers, who are interested in maintaining their relative position in monetary terms vis-à-vis competing firms. What we do know is that, historically, wage bargaining has played a key role in ensuring that wages rise with productivity, not less than with productivity. As in Keynes’s macroeconomics, income also depends on changes in the money supply. Friedman turned theory into politics—a simple, if not simplistic, policy. Assuming that the usual growth rate in the United States hovered around 2.5 percent per year, and that inflation of 2.5 percent would be compatible with full employment, he argued on several occasions that if the government could keep the money supply growing permanently at around 5 percent per year, we would be in the best of all possible worlds. In the early 1980s, after the “neoliberal turn”, Friedman’s monetarist theory became the dominant theory of inflation. However, this dominance was short-lived. During the 1980s, when central banks were trying to follow monetarist theory and prescriptions, they failed to increase the money supply at a stable rate (after all it is endogenous). On the other hand, the correlation between the money supply and nominal income was not as strong as Friedman’s theory had hoped. Recognizing that the monetarist hypothesis did not work, central bankers were the first to pragmatically abandon it; policymakers followed, and finally academia. The use of inflation targeting was the result of central bankers’ discontent with monetarist theory. Now they didn’t really have a theory, but the freedom to use whatever was necessary to control inflation. Soon, neoclassical economists tried to co-opt the new practice by giving it an orthodox garb with the help of rational expectations. But eventually, the orthodox theory of inflation became a totally demand-driven theory and more “Keynesian” than that of the post-Keynesians. The so-called “new consensus macroeconomics,” which became dominant in the early 2000s, was orthodox macroeconomic theory that included a simplified theory of demand inflation.

POST-KEYNESIAN THEORY OF INFLATION In Keynes’s works there is no complete theory of inflation. The claim that he was not interested in inflation is false, although in his General Theory (1936) he hardly addressed the subject. Keynes was more interested at that time in unemployment and deflation. We can, however, say that for Keynes inflation occurs when the economy reaches full employment; it is an inflation of demand whose thermometer is employment. The excessive money supply only materializes when the demand is greater than the supply in conditions of full

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employment. As Victoria Chick noted, “Keynes assumed the need for price increases as concomitant with any expansion in the short run...”3 The first American post-Keynesian economist to seriously discuss inflation was Sidney Weintraub (1914–83), seen by J.E. King as “the founding father of Post-Keynesian Economic Theory in the United States.”4 With the support of his student Paul Davidson, Weintraub formulated a theory of inflation that combined cost–push and demand–pull approaches. Driven by costs because nominal wages are the main cost that determines inflation; driven by demand because he considered the productivity–wage nexus as a determining factor of consumer demand. At the same time, he criticized neoclassical theory for its inability to simultaneously determine the price level and employment. He developed an equation to replace the exchange equation and called it the “wage–cost–margin” (WCM) equation – also an identity:5 PQ ​= kwN 

(8.4)

where k is the markup or profit margin, w is the average salary and N is the level of employment in the business sector. Based on this identity (8.4), Weintraub formulated his WCM theory of inflation expressed in the relation: P ​= (w/A) (cw + c r λR' + θ') (N/Nc ) 

(8.5)

where A is the productivity of labor; cw is the propensity to consume of wages; cr is the propensity to consume of profits; λ is the pay-out rate (λ = R/wN), where R is the profits and N is the employment in the business sector; θ are unemployment transfers and pensions, where θ'= θwN. Weintraub, assuming that the cost–wage markup k is approximately constant, resumed his theory with equation (8.6), in which inflation is caused by changes in average wages divided by the productivity of labor, i.e., caused by the nominal increase in the unit cost of labor: P ​= k (W/A) 

(8.6)

Weintraub rejected the criticism that he was adopting a theory of rising costs and concluded: As this theory rests wholly on demand relations, the formula should also expose the canard that ‘cost–push’ can be isolated from ‘demand–pull’. Both have a common origin. Both are a manifestation of the interdependence of cost and demand phenomena in the macroeconomic economy.6

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Thus, the concept of cost increase is part of Weintraub’s theory of inflation on wages–costs–margin. As he said in a later paper, WCM theory is a double-edged theory in which there are two blades: a demand blade and a cost blade.7

COST INFLATION Inflation is cost-effective when corporations or unions, endowed with some monopoly powers, raise their prices in real terms regardless of existing demand. It is an incentive to profit when corporations are the agents that can increase profit margins. It is a wage pressure on the part of unions that raise their wages at a time when there is no full employment. Depending on the case, one or another type of cost inflation will be emphasized. Weintraub, for example, focused his theory on the inflation component of wage costs. Economists generally understand cost–push inflation as a theory of inflation. I prefer to see it only as a component of the post-Keynesian inflation theory. The same thing applies to the mentioned structuralist component of inflation. The concept of cost–push inflation is related to the thesis of the endogeneity of money, which today is part of the post-Keynesian theory of inflation and the theory of inertial inflation. Money would be exogenous if central banks had no difficulty determining the amount of money in circulation – the idea behind the monetarist theory of inflation. In fact, the amount of money is endogenous: the central bank can only influence the amount of money by setting the basic rate of interest which is basically exogenous. Variations in the demand for corporate credit, in investments, consumption, and consumption and investment expenditures of the state are determinants of the demand for money and the demand for goods and services. They are the real cause of inflation whenever the supply of goods does not keep up with demand because the economy is operating around full employment.

INERTIAL INFLATION AND EXPECTATIONS In the early 1980s, a group of Brazilian economists originally developed the theory of inertial inflation, for which in certain circumstances inflation is independent of employment and demand. Inflationary inertia—the fact that economic agents raised their prices autonomously, indexing them formally or informally to past inflation—was not a new idea. In the previous decade, in the US, stagflation was a case of inertial inflation. But it was up to Brazilian economists to develop the theory, probably because inflation in the country was extremely high and persistent, making inertial inflation easier to understand. In a 1983 article and a 1984 book written by Yoshiaki Nakano and myself, we distinguished the accelerating, maintaining, and sanctioning factors of

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inflation, and I believe that with the paper we founded the theory of inertial inflation. In a 1984 column, André Lara Resende formulated a new way of neutralizing inflationary inertia through the provisional adoption of an indexed currency.8 Previously, Mário Henrique Simonsen (1970) and Felipe Pazos (1972) made pioneering contributions to the theory of inertial inflation.9 Conventional theories of inflation start from zero inflation and, in seeking its causes, look for the causes of the acceleration of inflation. The theory of inertial inflation, on the other hand, starts from a certain level of inflation and, in addition to looking for the causes of the maintenance of this inflation at this level (the maintaining factor), it seeks the factors that accelerated it (supply or demand shocks) and the factors that validate or sanction it through the nominal increase of money in circulation. In this type of inflation, there is always a distributive conflict between economic agents, some trying to increase their share of income, others seeking to defend themselves. In other words, the former unbalancing the equilibrium of relative prices, the latter seeking to rebalance them. The theory of inertial inflation holds that inflation is a real phenomenon (a distributive conflict) with monetary consequences. In this conflict, if there is an exogenous economic shock, agents seek to increase their share of income by raising prices, and inflation will accelerate. If, however, the agents are only seeking to maintain their share of income (rebalancing of relative prices), the consequence is to keep the inflation rate at the same level. This is the “normal” behavior of economic agents when inflation is inertial. Suppose that in a country inflation is around 10% per month and there are only three economic agents – A, B and C. From there, agent A increases its prices inertially by 10% on the first day of the month, B increases prices on the 10th day and C on the 20th day of the month, always by 10%. We will thus have inertial inflation at the level of 10%. No one knows which of the agents started the process, but each agent knows that if he does not increase his price according to the prevailing inflation rate, he will suffer a loss – he will see his share of the income fall. So, this inflation cannot stop. When, on the contrary, we are considering the accelerating factor of inflation, the first agent to raise its prices will be trying to increase its share of income. If others follow, the attempt will fail, no one will increase their share of income, but inflation will accelerate to a new level at which it will return to being chronically or inertially stable. The same phenomenon may be caused by some other supply or demand shock. In this way, inertial inflation accelerates from level to level, each level being a plateau. In this process, expectations naturally have a role (there is no economic theory without expectations), but they are based on real phenomena, not on the rational expectations produced by the government and embodied by the agents.

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In his model of inflation, Milton Friedman made a distinction between accelerating and sustaining factors of inflation, terming the latter as an inflationary “trend.” However, because he understood inflation as an essentially monetary phenomenon, he attributed the acceleration of inflation directly to the money supply and, indirectly, to expectations regarding this supply. With this, the distinction between accelerating and sustaining factors was lost, because the same cause, the money supply, explains everything. On the other hand, by reducing the whole problem of inflation to the money supply, the monetarists – and especially the followers of the theory of rational expectations – have turned inflation into a problem of expectations and therefore into a psychological problem. The determining factor for inflation would be the expectations of economic agents regarding the money supply, not the distributive conflict, nor the constant imbalance and rebalancing of relative prices. Since inflation is an economic problem and economic theory is a social science, it is tautological to say that inflation is based on the expectations of individuals and their attempts to face uncertainty and make the most of the profits or wages they receive, because all human action is based on expectations. But it is far from clear that economic policy can easily change expectations. Nor is it clear that the expectations of economic agents influence their behavior as strongly as the theory of rational expectations supposes; people know that many expectations never come to fruition. Albert Hirschman once defined disappointment – such a common phenomenon – as a “misguided expectation.” He added: “It's much more common for expectations to outweigh reality than for reality to outweigh expectations.”10 Economic agents need to at least maintain their share of income. Thus, they know they need to be realistic and cannot take their expectations too seriously – and certainly not as radically as the theory of rational expectations claims. Nevertheless, orthodox economists continue to place increasing importance on expectations. They believe that governments can change expectations through changes in the “economic policy regime.” Once governments adopt these changes, often cutting spending, they believe that economic agents will behave rationally and show confidence, and the problem will disappear at a much lower cost than would be anticipated. But economic agents are not as foolish as this theory supposes. Monetarists underestimated the tendency of economic agents to defend their share of income and, to do so, by basing their expectations on past inflation – which is concrete – rather than acting on expectations of falling future inflation, which after all may not be confirmed. There is a divergence in this regard between the neostructuralist theory of inertial inflation, which is based on real distributive conflict including the equilibrium of relative prices, and the theory of rational expectations, which uses the idea that inflation is a psychological

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phenomenon that depends on how economic agents change their expectations in terms of changes in the economic policy regime. The higher the inflation, the clearer the effects of rising prices become on the income of all economic agents. The monetary illusion disappears. As a result, distributive conflict becomes more acute, and inflation becomes increasingly inertial. In cases of hyperinflation – the study of which was important for the formulation of the theory of inertial inflation – the inertial component of inflation becomes so dominant that it ultimately becomes irrelevant. As inflation accelerates with each demand or supply shock and maintains the new level inertially, the inflation rate increases and price corrections that were monthly become weekly, narrowing the gap between price corrections. When the lag becomes a day if not an hour, we are in hyperinflation. The desynchronization of price increases becomes minimal, and price increases become almost simultaneous and instantaneous. The differences between peak prices and actual average prices almost disappear. Therefore, any significant exogenous factor – such as monetary reform accompanied by external loans guaranteeing the fixing of the exchange rate, as happened in the countries of Central Europe after the First World War – allows the immediate elimination of inflation without the need for the use of a mechanism to neutralize inertial inflation. I finish this summary of the analysis of inflation theory with post-Keynesian economists Philip Arestis and Malcolm Sawyer. In a 2004 book, they argue that: In our perspective on inflation, demand and changes in demand have a role to play, but there are other important ingredients, notably the role and distributional pressures, imported inflation, the size of productive capacity and endogenous money.11

They focused on the critique of new consensus macroeconomics, listing three factors, in addition to excess aggregate demand, which determine inflation: the role of endogenous money, the determination of prices, and the determination of wages. It is the best contemporary text on inflation and, not coincidentally, is influenced by Sidney Weintraub.

LIMITATIONS OF ECONOMIC THEORY Thus, ND follows post-Keynesian economic theory in discussing inflation, in emphasizing the complementary role of inertial inflation theory, while criticizing orthodox inflation theory for having only partially severed its links with the original monetarist theory. I personally take this view, knowing that post-Keynesian theory is not always accurate and clear because it takes into account many variables. Its main quality is to be pragmatic and consider its

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numerous components that are not always internally consistent. As Bradford DeLong recently said, commenting on Alan Blinder's book: There has been neither linear development nor much “progress” in figuring out how to manage modern economies in the interest of macroeconomic stability. Instead, Blinder describes “wheels within wheels, spinning endlessly in time and space…[with] certain themes…waxing and waning…monetary versus fiscal…the intellectual realm…the world of practical policy making…the repeated ascendance and descendance of Keynesianism”. The underlying story is driven, ultimately, by historical contingency. Problems appear and are either solved or not solved.12

In discussing the theories of inflation and particularly the ways to control it, the imperfections or limitations of economic theory become even clearer. As with the other social sciences, the predictive capacity of the models that form economic theory is poor. This suggests that economists and their schools should be modest and ready to reformulate models because they conflict with reality. On the other hand, adopted policies often conflict with or ignore theory. Take, for example, the policies that governments and their central banks adopted in the face of inflation in 2022, whose dominant components were not excessive demand, but supply shocks and inflationary inertia. Despite this, central banks have raised interest rates. The Federal Reserve Bank held out for some time, waiting for the moment when supply factors would lose steam. But inflation did not fall, and the Federal Reserve had no alternative but to raise interest rates. Governments and central banks have a limited number of policy alternatives, and sometimes the best thing to do – if not the only thing – is to calibrate interest rate hikes.

NOTES 1. 2. 3. 4. 5. 6. 7. 8.

9. 10. 11.

Bresser-Pereira (2023). Cripps (1977: 107–110). Chick (1983: 278). King 2002: 105. Weintraub (1974: 169; 1968: 43–53). Weintraub (1974). Weintraub (1978: chapter 3). Bresser-Pereira and Nakano (1984); Bresser-Pereira and Nakano ([1984] 1987); Resende (1984). See also Resende and Arida ([1984] 1985); Francisco L. Lopes (1984) made the first “orthodox” contribution to the theory of inertial inflation, ignoring previous contributions. Today, this theory is in macroeconomics textbooks. For an account of the formulation of the theory of inertial inflation, see Bresser-Pereira (2023). Simonsen (1970); Pazos (1972). Hirschman (1982:13). Arestis and Sawyer (2004: 73).

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12. DeLong (2022). Alan Blinder’s new book is A Monetary History of the United States, 1961–2021 (2022).

9. The profit rate and the wage rate In this chapter, I will discuss the rate of profit and the wage rate. For this I will discuss the three types of technical progress and the phases of capitalism according to this technical progress and the rate of profit. The rate of profit is the most important of the macroeconomic prices because, in a capitalist economy, the logic of capital accumulation and economic growth are subordinated to the logic of profits. The rate of profit is correct when, given the interest rate, it is satisfactory – it is sufficient to motivate the competent enterprises of the country to continue investing; it is coherent, therefore, with economic development. It is satisfactory when it is equal to or greater than the sum of (a) the basic interest rate and (b) the average risk of the companies – financial, operational, commercial, compliance, technological.1 The focus on the long run or the satisfactory rate of profit is logical from the point of view of the owners of capital. Not only dividends and legal reserves, but also the amortization of long-term financing to support the company's growth depend on the company's ability to generate value and profits. As for the wage rate, raising it in the medium term is the main reason why we value economic development. Progressive and new developmental economists are interested in real wages, and therefore consumption, growing. The wage rate is correct when it is consistent with economic growth, but for this it must be consistent with a satisfactory rate of profit. It is also correct when it makes room for social policies that reduce or mitigate economic inequality and for investments.2

TYPES OF TECHNICAL PROGRESS Marx formulated the theory of the tendency to the falling profit rate. He predicted this fall because, at that time, technical progress was expensive of capital, and therefore the product–capital ratio or the productivity of capital was falling. He knew there were countertendencies, but he believed they would not be strong enough to keep the rate of profit from falling. The substitution of capital for labor made production highly capital-intensive, i.e., increased the technical composition of capital and reduced the product–capital ratio, thus leading to a fall in the productivity of capital and the rate of profit. His prediction, however, has not been confirmed by history, probably because countertrends prevailed. In the original central countries, the United Kingdom, 94

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France, and Belgium, since about 1870, technical progress did not remain capital-using, but became neutral, while the rate of profit remained satisfactory. Only in a specific historical phase, the “Marx phase” (1815–70), was technical progress capital-using and the rate of profit fell from the high level that prevailed during the Industrial Revolution to the satisfactory level that would prevail in the Great Depression of the 1930s.3 By definition, technical progress happens when labor productivity is increasing. If we do not consider the total productivity of factors (which has its own problems) there is no other way to measure the productivity of the entire economy except in this indirect way – such as the growth of per capita income. The difference between the rate of growth of the labor force (which, to put it simply, we assume is equal to the rate of population growth) and the rate of growth of GDP is equal to the growth of per capita income and labor productivity. The increase in the productivity of labor occurs while changes in technical progress or in the productivity of capital as measured by the product–capital ratio occur.4 In economic theory, we have three types of technical progress. If the productivity of capital is decreasing, technical progress will be costly to capital—we will have “mechanization.” If the product–capital ratio is constant, technical progress will be neutral. And if the productivity of capital is increasing, technical progress will be capital-saving. In the case of costly technical progress of capital, in which the productivity of capital is decreasing, production or GDP will be increasing at a rate less than that of the capital stock: ​   ​ ​  ​     ​K   ˆ ​​

Y  _​ ˆ​  Y

ˆ

(9.3)

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Table 9.1

Assuming the Profit

Given a constant profit rate, consequences of technical progress on the wage rate and distribution and Technical Progress Is

Rate is Constant…

and Output–Capital

…the Wage Rate Will

Ratio Is

Be

R/K→

Capital-using

Y/K↓

W/L→

R/K→

Capital-using

Y/K↓

W/L↓

R/K→

Neutral

Y/K→

W/L↑

R/K→

Capital-saving

Y/K↑

W/L↑

Source:

Bresser-Pereira (1986).

When technical progress is capital-using and the productivity of capital or the product–capital ratio is falling, we have falling wages or else diminishing returns. When technical progress is a substitute for capital, new and more efficient machines are replacing old machines, and we have increasing returns that make it possible to raise the wage rate, keeping the rate of profit constant at the satisfactory level. These two basic types of technical progress can compensate for each other, and we have neutral technical progress in which the weights of the two mechanisms are approximately equal and the productivity of capital is constant. The change of these two weights depends on the stage of the development process. The relationship between wages, technical progress, and functional distribution of income is shown in Table 9.1. Suppose the functional distribution of income between profits and wages is constant (R/Y→) or the rate of profit is constant (R/K→). Considering the latter, we see in Table 9.1 that we have four alternatives: in the first and second rows, technical progress is expensive capital, the product–capital ratio is falling (Y/K↓), and the wage rate will be indeterminate (it will be constant W/L→ or declining W/l↓). In the third line, technical progress is neutral (Y/K→) and the wage rate will be rising. Finally, in the fourth line, technical progress is the capital saver (Y/K↑), and the wage rate will also be increasing (W/L↑). In the third line, in the same proportion as the increase in productivity; in the fourth, at a faster pace. Given these three forms of technical progress or variation of the product– capital relationship, we have different behaviors from the other central economic variables: the rate of profit, the wage rate, and the functional distribution of income. These variables are related to each other following a simple identity: R/K= ​_RY ​ ​ _KY ​​

(9.4)

where R/K is the rate of profit, R/Y is a measure of distribution (which can also be expressed as R/W, since R/Y = 1/(1+W/R), and K/Y is the capital–output relation.

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The distribution of income between wages and profits therefore depends on the rate of profit and the type of technical progress. It is an important measure, but it does not consider the distribution between high wages and bonuses of the upper middle class and the wages of workers, employees and middle-level managers.

OKISHIO’S THEOREM A preliminary problem that has long challenged Marx’s theory of the falling rate of profit was raised in 1966 by Nobuo Okishio (1961, 1977). According to his theorem, it would be irrational for companies to adopt a technology that leads to a fall in the product–capital ratio and the rate of profit. By making reasonably rational investment decisions, companies would not adopt technologies that involve a decreasing product–capital ratio and end up reducing their rate of profit. There is, however, a flaw in this reasoning that does not make companies irrational for adopting a technology that, after all, will reduce their rate of profit. In the 1980s, Anwar Shaikh and I independently developed the same argument disproving Okishio’s Theorem. Shaikh published an article in 1978, while my argument was the subject of my dissertation presented in 1984 and published in 1986.5 Companies always seek to adopt new techniques or buy new machines that reduce their costs. Whenever the costs involved in buying and operating a new machine are lower than the costs associated with the old machine, the company will replace the machine, labor productivity will increase, and the company that introduced the new machine will have an extra profit derived from innovation. Therefore, companies will first invest in the most efficient machine that replaces a certain type of work; then they will buy a second better machine, which replaces a different kind of labor and is less efficient than the first; and so on, until it reaches the point where there are no more new kinds of machines that, up to that point, are worth thinking about buying and replacing labor.6 In this process of purchasing machines, production costs decrease for companies as different types of labor are successively replaced by different techniques associated with machines with decreasing productivity. The company makes these purchases, its profits increase, but competitors soon follow and the rate of profit of the innovative company falls again. The result is a fall in the productivity of capital. This is an unforeseen consequence, outside the control of each individual company; it is a perverse but rational effect of mechanization or the adoption of capital-intensive technical progress. Take, for example, the choice of techniques in an economy that has only agricultural production, and which has replaced all possible labor with a highly efficient machine, the tractor. Then comes another new machine, which reduces costs for companies – a harvester. All farmers must buy it to maintain

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competitiveness, but since the cost–benefit ratio of the harvester is lower than that of the tractor, after the replacement is completed the product–capital ratio of the economy will fall, even if its costs have been reduced, and the average rate of profit will fall.

PHASES ACCORDING TO TECHNICAL PROGRESS AND RATE OF PROFIT In Chapter 4, I defined four phases of capitalist development: mercantilist (1600–1839), industrial or liberal (1840–1929), managerial developmentalism (1940–1970), and neoliberal financial–rentier (1980–2020) using as a criterion production and ruling class coalitions. We have a different but similar phase system if we use as criteria the type of technical progress and the rate of profit. We have it like this: • In the capitalist revolution (1750–1815), technical progress was neutral and the rate of profit constant at a high level. • In the Marx phase (1815–1870), technical progress was capital-using, and the rate of profit declining (there being room for this fall without making the rate of profit unsatisfactory). • In the industrial phase (1870–1960), technical progress was neutral and the rate of profit constant at a satisfactory level. • In the neoliberal phase (1975–2020), technical progress was again costly in capital. Nevertheless, the rate of profit did not fall because the large private corporations became increasingly monopolistic and increased their profit margins.

AN OPTIMISTIC BUT MISGUIDED PREDICTION In writing Profit, Accumulation, and Crisis (1986), my hypothesis was that around 1870, technical progress became neutral and real wages began to rise with increasing productivity. However, while writing in the late 1970s and early 1980s, bearing in mind the rising wage rate in the “golden years of capitalism” and the high degree of development of the Global North, I assumed that technical progress was becoming capital-saving and wages would rise above the growth of labor productivity, while the rate of profit would remain satisfactory. The incredible progress in the computer industry, new and more efficient machines replacing the “old” computers, was an indication that technical progress had become capital-saving. As a result, wages would rise above the increase in productivity and the rate of profit could remain constant and satisfactory, which would continue to stimulate firms to invest.

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That optimistic prediction was wrong. Some economists, considering the Internet giants that were born with little capital, speak today of “a capitalism without capital,” which would reinforce the shift to capital-saving technical progress. They are also wrong. The internet giants – the so-called Big Tech (Google, Amazon, Meta, Apple and Microsoft) and some large Chinese corporations (Tencent and Alibaba) have made massive investments in fixed assets, which are consistent with the fact that technical progress has not become capital-saving, but rather capital-costly. Today, thanks to the research of Marxist economists, we know the effective behavior of the product–capital relation; it did not increase, but fell, that is, technical progress did not save capital, but consumed it.7 However, the rate of profit did not fall correspondingly.

DISTRIBUTION BETWEEN WAGES AND PROFITS When Marx developed the theory of the tendency of the profit rate to fall, he considered the possibility of countertendencies: increasing the intensity of labor, policies aimed at reducing wages, relative cheapening of the elements of constant capital, concentration of capital, and use of monopoly power, etc. In the model I return to here, the long-run constancy of the rate of profit is the result of such countertendencies, which are strong because a satisfactory or reasonably constant rate of profit is a condition for the survival of capitalism. Since, at the moment, there is no alternative to capitalism, the capitalist class ends up obtaining the cooperation of the other social classes in the construction of institutions that protect the rate of profit and the process of capital accumulation. The most recent countertrends to the falling rate of profit have been the incessant mergers and acquisitions that have increased the monopoly power of corporations and allowed for increased profit margins.8 The process of investing abroad also saw corporations increase their profit rates. While the degree of monopoly of leading companies (usually located in developed countries) increased, so did competition between suppliers (developing countries).9

WAGE RATE In the 1986 book, Profit, Accumulation, and Crisis, which focuses on Marx’s theory of the falling rate of profit and the phases of capitalism, I assumed that, except in the Marx phase (1815–1870), the product–capital relationship, although changing during business cycles, was basically constant. Why does it make sense to assume a constant rate of profit? First, because a satisfactory rate of profit is a condition for the existence or survival of the capitalist eco-

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nomic system; thus, as long as a better economic alternative to capitalism is not yet available, the rate of profit must remain at a satisfactory level. I conclude this chapter with a discussion of the tendency for the wage rate to increase in the long term. The capitalist system can only survive if a rate of profit, a rate reasonably above the interest rate, is assured to enterprises. The profit constraint therefore limits the increase in real wages. Second, although capitalist economies and societies are characterized by instability and class struggle, they are, within each nation-state, dialectically cooperative enterprises. The existence of nation-states presupposes broad political agreement. Capitalists strive for profits, but they know that a reasonable wage is essential for political stability and the support of aggregate demand. Similarly, workers are constantly asking for higher wages, but they know that their wages cannot reduce the rate of profit below a certain level without endangering capital accumulation, the process of growth, and employment. Thirdly, the countertendencies to the fall of the rate of profit mentioned by Marx, particularly technical progress, the monopoly power of enterprises, and the existence of institutions which protect the rate of profit over the expenditure of labor will always be at work when the satisfactory rate of profit is threatened. For classical political economy, the theory of the functional distribution of income between profits and wages assumes that wages are constant at the subsistence level, while profits and the wage rate are the residue. Using different theories, Ricardo and Marx assumed that productivity would fall in some way (by falling productivity of land or capital) and predicted the tendency to stagnation. It turns out, however, that the wage rate in rich countries has historically increased as productivity has increased. My theory of functional income distribution inverts the classical relationship. I assumed that the rate of profit is constant in the long run (something that is reasonably true when we examine the history of wages) and concluded that wages are the residuum. Therefore, the wage rate can grow in real terms – almost stagnant technical progress is neutral or capital-saving, as we saw in Table 9.1 – something that history has demonstrated empirically. Since classical political economists believed that the productivity of capital would decline in the long run10 and assumed that the wage rate would remain constant, they concluded that the rate of profit would fall in the long run. However, to the extent that this prediction was not confirmed, I proposed an alternative in the 1986 book: the rate of profit tends to remain constant, fluctuating in a range of satisfactory rates of profit. I argued that in the case of capital-saving technical progress, a rising rate of profit in the long run makes no sense, even when the corporation is monopolistic or the companies in the sector form a cartel, because there are social and political controls that block this practice. On the contrary, given that the economy is still growing (it has not reached the stagnation that is always on the horizon), wages will tend

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to increase more than productivity, allowing workers to keep a share of the economic surplus.

WAGES AND THE EFFECTIVE COST OF REPRODUCTION I believe it is now clear that given a satisfactory rate of profit in the long run, wages and economic growth go hand in hand. In the short and even medium term, profits may increase more than wages, but in the long run they tend to grow at the same rate, essentially because the classical political economists erred in two positions: the rate of profit did not fall as Ricardo or Marx believed, and wages did not stay at the subsistence level as they believed but have grown with the increase of productivity. Classical political economists used the labor theory of value to predict the stagnation of capitalism. They foresaw, in the long run, the fall of the rate of profit and the stagnation of the capitalist economy, because they predicted or assumed constant wages at the level of subsistence and diminishing incomes from land (Ricardo) or capital (Marx). Both predictions failed. Economic history has taken it upon itself to demonstrate that there have been no diminishing returns – on the contrary, it is now increasingly clear that technical development implies increasing returns. As to wages, in the more advanced countries, the value of labor – the amount of abstract labor necessary for the reproduction and maintenance of workers – did not prove constant at the “subsistence level” as classical political economists believed, but it grew. Marx had already realized this fact in his time and said that this level has changed historically – it has been socially determined. But for him, the value of labor was still associated with the subsistence of the worker. Since the mid-nineteenth century wages have grown at roughly the same rate as productivity. In fact, the logic of capitalist development demands a real increase in wages. Thus, we must exclude the level of subsistence from the concept of the value of labor and move to the concept that it corresponds to the effective cost of reproduction of labor power. To continue associating the level of subsistence with the cost of reproduction of labor power we would have to give such an elastic meaning to “socially defined” that it would mean nothing. Redefined in this way, as the effective cost of the reproduction of labor power, the value of labor will be substantially greater than the mere subsistence level. The replacement of the subsistence level by the effective cost of reproduction of labor power is necessary to understand the evolution of capitalism, why companies are effectively paying wages higher than the subsistence level without compromising a satisfactory rate of profit. The rate of profit can be constant in the long run, while national economies and wages grow in real terms. Capitalists pay wages to workers for their edu-

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cation, formal and informal, at school and at home. These costs are included in the value and price of the goods and services they produce and sell. The cost of the labor value of the different types of labor varies according to the degree of education and training required. The costs of training workers, employees, technicians, managers of various levels and advisors of all kinds involved in capitalist production demand more and more spending on higher education and graduate studies and therefore lead to an increase in the value of labor and wages. Thus, the companies that employ this labor force do nothing more than pay their cost of reproduction in the form of wages and salaries. However, contrary to what the classical economists thought, this cost of reproduction proportional to the value added is not the cost of subsistence, but a cost that involves a high investment in human capital and provides substantially higher wages or salaries to the individuals benefiting from the investment. The wage worker continues to produce more than his cost of reproduction, and therefore the capitalists continue to appropriate surplus value. What changes is that the capitalist class and the high techno-bureaucracy do not appropriate all the surplus, as political economists including Marx supposed, but part of it. Since we define the value of labor power in these terms, wages revolve around that value according to the supply and demand of labor, as with any good or service. And, also, according to the bargaining power of the workers. When an economy, in its cyclical process of growth, experiences high and sustained rates of growth, the wage rate will tend to increase in proportion to the increase in the cost of reproduction of labor (which is higher than the cost of subsistence because it includes the costs of education), and this increase will be consistent with a satisfactory rate of profit. Theoretically, the wage rate can rise until such time as the economy reaches a hypothetical stage of abundance, that is, to the point where people have full freedom to choose between income and leisure and decide overwhelmingly for the latter. The condition is that the rate of profit remains satisfactory. When countries face recession and unemployment, governments adopt countercyclical policies. It lowers the interest rate and increases investments in public spending. When the economy recovers and real wages rise again faster than the rate of profit, this will not be a problem as long as the economy is growing rapidly and the rate of profit remains satisfactory. Still, in the long run, governments can act to reduce wages regardless of where the country is in the business cycle. This happened in the “neoliberal years” (1980–2020). This policy satisfied the greed of rentiers and financiers, but was associated with low growth and severe political distortions, which became evident in the US and UK in 2016 with the rise of right-wing populism. Ignoring that their stagnant living standards were mainly due to the economic failure of neoliberal rentier capitalism, racist white workers and the lower-middle class of the

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Global North attributed their problems to immigration and supported far-right populists.

NOTES 1. 2.

3.

4.

5. 6.

7. 8. 9. 10.

I note that the average business risk is different from the country risk I discussed in Chapter 7. A November 2022 study, “Finance for Climate Action” (Report of the High-Level Independent Expert Group on Climate Finance) calculated that emerging markets and developing countries, except China, will need to spend about $1 trillion a year by 2025 (4.1 percent of GDP) and about $2.4 trillion a year by 2030 (6.5 percent of GDP) on specific investments needed and spending priorities. Bresser-Pereira (1986). By Industrial Revolution with capital letters I mean the industrial revolutions in the countries that originally industrialized and completed their capitalist revolution: the United Kingdom, France, Belgium, and the Netherlands. In this 1986 book, I used the concept of product–capital relation, Y/K, which Marx called the “technical composition of capital,” avoiding the use of the concept of “organic composition of capital” that complicates rather than simplifies the argument. In the literature on growth, the capital–output ratio is most commonly used, but I prefer its inverse, the product–capital ratio, because when it is said that this relation is increasing, it means that the productivity of capital is increasing. Shaikh (1978); Bresser-Pereira (1986). This curve is similar to Keynes's marginal efficiency of capital. The difference is that in the marginal efficiency of capital the vertical axis shows the expected rate of profit, while in the curve of investment opportunities that I am suggesting, we have the cost reductions related to the different techniques that replace different types of work. See Duménil and Lévy (1993; 2002); Lapavitsas (2013); Roberts (2016); Chesnais (2020). For research on the great increase in the monopoly power of corporations, see Van Reenen (2018). Milberg and Winkler (2013). Not all classical economists predicted the prospect of long-term stagnation, but this is clear from Ricardo, Malthus, and Marx.

10. Determining the exchange rate1 New developmentalism (ND) places the exchange rate at the centre of its macroeconomics. It argues that the exchange rate determines the rate of investment and therefore determines economic growth. It also states that there are two models associated with the exchange rate that are central to ND: the Dutch disease model and the critique of growth policy with foreign indebtedness or current account deficit. In this chapter, I will synthesize the new developmentalist view on the determination of the exchange rate. Of the five macroeconomic prices, the exchange rate is the least studied variable. The exchange rate literature assumes that markets determine the exchange rate competitively; that it is volatile in the short term; that it cannot remain overvalued or depreciated in the long run – it “cannot” because in the long term the deviations from the equilibrium will be smoothed and the exchange rate will fluctuate sweetly around the current equilibrium. This conventional literature adds that as capital flows have grown enormously in the context of globalization and financialization, the exchange became unpredictable. This is the best of all possible worlds, it is Doctor Pangloss’s world, which, of course, does not correspond to reality. Objectively, we see that the real exchange rate can remain overvalued or depreciated for several years. Thus, the exchange rate is not just a short-term variable; it is also a long-term variable, so when companies make their investment decisions, they also consider the long-term exchange rate, because investments only make sense when we consider the future. The determination of the long-run equilibrium of the real exchange rate is one of the most controversial and little discussed subjects in economic literature.2 Neoclassical economics assumes that the long run is characterized by little or no rigidity or constraint. Therefore, when market forces are free to operate, they will ensure full employment and exchange rate equilibrium in the long run. Heterodox literature is more realistic because it verifies that the market is not strong enough to lead economic agents to the long-term equilibrium of the exchange rate compatible with full employment. Under this assumption, economic policy management and market regulation play a decisive role in defining the conditions for growth. The core of conventional exchange rate theory is purchasing power parity (PPP). This theory defines the real exchange rate as the relative price of a common basket of goods traded by the country and its main competitors, all 104

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converted into the same currency. In the absence of price rigidities, transportation costs, trade barriers, or other short-term disturbances, this ratio should be equal to 1. If this relationship does not remain so, an arbitrage operation will equalize the prices of goods and services between the two countries. The country with “low” prices will attract buyers who demand its currency, appreciating its exchange rate, and the reverse occurs in economies with “high” prices. Thus, international trade will re-establish the role of the exchange rate in balancing the trade balance. Capital flows have no clear role in the PPP. While this is intuitively appealing as an explanation of the long-run real exchange rate, this theory performs poorly.3 Rudiger Dornbusch offered another well-known conventional model. This model incorporates the interest rate parity equation discovered in the IS–LM framework to determine the exchange rate.4 John T. Harvey’s main criticism of Dornbusch’s model is that he assumes that expectations of exchange rate movements are exogenous. In this sense, the exchange rate always moves to meet the expectations of economic agents. Therefore, there is no permanent role in capital flows.5 In the ND model, capital flows are part of the game and are associated with the policy of growth with current account deficits adopted by the country. The post-Keynesian approach assumes that currency prices are determined in the market, but the combination of capital flows and trade flows do not tend toward balance. It is further assumed that income effects are more important in determining the current account than are price effects. In the real world, where capital flows dominate international transactions, monetary authorities interfere in the foreign exchange market to minimize the impact of exchange rate volatility on domestic prices. However, financially integrated developing countries – which should observe the uncovered interest rate parity – constantly violate it, and thus the PPP ceases to function. Harvey proposes a post-Keynesian model for determining the real exchange rate that adds to the post-Keynesian model for determining aggregate demand.6 The main feature of his model is to consider a prediction of exchange rate movements, which, along with Hyman Minsky’s investment theory, explains why the discovered interest rate theory does not hold up in the real world. In this chapter, I discuss the determination of the exchange rate. I will briefly survey the literature and, in the following four sections, discuss the four key variables that determine the exchange rate: (1) the value of foreign currency given by the comparative unit labor cost index; (2) the terms of trade; (3) the current account and the corresponding net capital inflows or outflows, and (4) the interest rate differential. I close the chapter by criticizing John Williamson’s concept of the “fundamental exchange rate.”

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THE VALUE OF THE FOREIGN CURRENCY I now turn to the ND alternative. Instead of using PPP, I propose to use the value of the foreign currency as the primary reference. The PPP is just a pragmatic way of understanding the exchange rate, while the concept of the value of the foreign currency is based on sound economics; its reference is the classical theory of value. Robert Z. Aliber, in the first edition of The New Palgrave Dictionary of Economics, distinguished four approaches to explaining the level of the exchange rate and changes in the exchange rate: purchasing power parity, elasticities, portfolio equilibrium, and the asset market approach.7 The mere existence of so many different methods indicates how poor the PPP is at explaining the long-run exchange rate. The “absolute” PPP is the exchange rate that equals the cost of the same basket of goods and services in two countries with different currencies. For example, if the price of a basket of goods in Brazil in reais (say R$ 90.00) is equal to the price in dollars of the same basket of goods in the United States (say US$ 30.00), the absolute PPP will be R$ 3.00 per US dollar. PPP theory assumes that goods are homogeneous and that the real exchange rate fluctuates around a constant long-run level, which also implicitly ensures current account balance. In this scenario, the “law of the single price” prevails, defined by the country’s representative company. Homogeneous goods must be priced the same in different countries, and any difference is solely due to the nominal exchange rate. This may make sense in countries with similar cultures and similar levels of economic development. But it does not make sense when, for example, one country is developing while the other is rich, or when one country is in the West and the other in the East. Even among similar countries, national tax systems can vary, resulting in countries with quite different relative prices. And then there is the problem of what goods and services to include in the basket. In countries with the Dutch disease, commodity prices will be low relative to other tradable goods. PPP theory does not consider any of these factors. Instead of using PPP, I go back to classical political economy and argue that foreign currency, like any other goods and services, has a value and a price.8 Currencies are not formed by goods and services. Still, they have a value because they represent the value of goods and services that the base country’s money can buy in another country. Classical political economy teaches that the value of a good is equal to the amount of labor socially necessary to produce it. This concept requires a second step – turning value into price – which has been the subject of long academic debate. My understanding is that we also may have a value for the foreign currency, the price of the foreign currency or the exchange rate (they

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are the same) floating around the value. In this case, a first definition that the value being equal to the weighted average exchange rates of the other countries plus a reasonable profit rate. Or, in other words, the value of the foreign currency is the sum of money in the country’s own currency that covers the cost of production plus a reasonable profit. The price of the foreign constraint, the exchange rate, revolving around the value. I came to the concept of the value of the foreign currency or the exchange rate when discussing the Dutch disease in my 2008 paper.9 I then said that the industrial equilibrium exchange rate was a “necessary price”. However, prices are not necessary; they are what they are. Instead, the value of the exchange rate is necessary, it is a definitional value that expresses the cost of production of the good plus a reasonable profit. To calculate it considering this definition, we would try to find the value of the exchange rate empirically, but this would require enormous work. A simpler way is to use the concept of internal exchange rate for a group of countries as was done in the 2010–2015 Euro Crisis. You divide the base country real exchange rate (REER) by a basket of countries – the ones that most compete with the base country (REER*), or you divide the unit labor cost of production of the base country (ULC) by unit labor cost of the same basket of countries, and you will reach a comparative unit labor cost index (CULCI), in this index being present all countries considered. If you divide ULC of the base country by the individual unit labor costs, you will have the misalignments indicating which currency is overvalued or depreciated. This was what Duwicquet, Mazier, and Saadaoui did in a 2018 paper.10 There is an inverse relationship between the CULCI and the value of the foreign currency. When this comparative index rises, it means that wages increase more in the base country and/or productivity increases less in the base country than in the basket of countries, and therefore the exchange rate will have to depreciate to keep firms competitive. When the CULCI is falling, it means that wages are increasing less in the base country or productivity is increasing more in the base country, and the base country will have to value its currency to keep the current account balanced. When the country adopts the policy of current account surpluses systematically, the consequent devaluation of the currency increases its exports and stimulates investments, even at the cost of impoverishing everyone in the country – except the exporters. The wages of the workers and the dividends, interest, and real estate rents of the rentier capitalists will lose purchasing power relative to the wages and other revenues of competitors, with the result that the same amount of money will buy fewer goods and services. This is what is behind the Balassa–Samuelson effect.11 This is also the reason why European economists used the “internal exchange rates” (the exchange rate that would balance each country’s current account) to explain

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the 2010–15 Eurozone crisis. All Eurozone countries have a single currency; they do not, therefore, have different exchange rates that coordinate their trade and economy with each other, but each has its own internal exchange rate.The Balassa–Samuelson effect and the concept of internal exchange rate become clearer when we have the concept of the value of the foreign currency and then we have the CULCI behind these two ideas. Note that this model expresses prices in real terms and is an alternative to the PPP approach. It could be argued that the determination of the exchange rate by the value of the foreign currency defined by the CULCI is like the PPP equation adjusted for productivity, in that the unit cost of labor is its main determinant. The two concepts are similar, but while PPP is simply a comparison between the prices of two baskets of goods in two countries, the value of the foreign currency is solidly based on theory. When we say that the exchange rate is in equilibrium or is competitive, and that it is permanently varying according in the base country and the other countries. When we say that the exchange rate corresponds to the value the terms of trade are irrelevant, and the value of the exchange rate just reflects variations in the CULCI. While the value of the foreign currency is stable, because changes in wages and productivity are small and gradual, the current equilibrium is volatile in the countries that export commodities due to the instability of commodity prices.

THE FOUR OTHER VARIABLES The Terms of Trade The second determinant of the exchange rate is the terms of trade. Considering a well-behaved market – in which the exchange rate floats around the value of the foreign currency and the current account is in equilibrium – changes in the terms of trade will cause a deficit or surplus in the current account and compensatory variations in the exchange rate, so that after a lapse of time, the current account balances again. Supply or demand shocks that impact international prices are the main cause of changes in the terms of trade. These shocks are stronger in commodity-exporting countries because commodity prices are more volatile compared to the prices of manufactured goods and services. Changes in the volume of remittances of profits to rich countries, or of remittances of income from immigrants to their countries of origin, will also have similar effects, although they will tend to be more gradual. Capital Flows The third long-term determinant of the exchange rate is the net capital flows. They have become exceptionally large over the past 40 years and have made

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the exchange rate more volatile and more associated with speculative bubbles. But this does not justify the widespread belief that the size and variability of such flows make it impossible to determine the exchange rate theoretically. Contrary to this belief, capital flows do not make the exchange rate unpredictable. Capital flows are determinants of the exchange rate because they have a direction or a direction that is given by the net capital flows, which will be positive or negative. In the first case, the net supply of foreign currency will appreciate in the domestic currency, and this overvaluation will remain as long as the deficit persists. The reverse occurs when capital outflows exceed capital inflows, causing a depreciation of the national currency. Interest Rate Differential The fourth determinant of the exchange rate is the interest rate differential. The interest rate of developing countries is generally higher than the international interest rate plus country risk.12 The central banks of many developing countries set the interest rate above the international rate plus the country risk for three reasons: because the central banks and the governments believe the country can grow with foreign savings or foreign indebtedness and set the interest rate high to attract capital; because rentiers and financiers capture the central banks to earn higher rates; and to control inflation. The first reason emanates from a mistaken view; the second, from the greed of rentiers and financiers; and as to the third reason, there is no reason why countries need to use the exchange rate as an anchor. It is curious that liberal-conservative austere policymakers – who rightly criticize the use of SOE prices to control inflation – often do not hesitate in adopting a worse policy: to use “the price of the country”, i.e., the exchange rate, to achieve the same goal. The interest rate differential is a determinant of the exchange rate to the extent that many developing countries use the interest rate to attract capital flows. The exchange rate depends on the policies adopted by developing countries, as well as the interest rate policy of other countries, particularly the United States. Local financial markets pay close attention to their monetary policy. They know that if the Fed raises the base rate of the US dollar, other currencies will depreciate, and if the Fed lowers the base rate of the US dollar, other currencies will appreciate, but search to control inflation with an overvalued currency, which is a big mistake. Current Account Policy ND argues that countries may either have or don’t have a current account policy. They have a policy when they show chronic current account surpluses or deficits. They don’t have when the exchange rate floats around the current equilibrium. If a country presents a recurrent current account deficit and so,

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they have a policy, the exchange rate will remain appreciated until the policy holds. The inverse is true in the case of a country that show recurrent current account surpluses.

NOTES 1. 2. 3.

4. 5.

I had the participation of Carmen Feijó and Eliane C. Araujo to write this chapter. See, for example, Blanchard and Milesi-Ferretti (2011). Harvey (2009:16). According to Harvey, the most tested model is the “monetary model,” which incorporates PPP theory into the quantity theory of money. But, in his words (p.19): “... While it may be suggestive in terms of long-term movements, it is a poor guide to politics over the time horizon in which we live our lives.” Dornbusch (1976). According to Harvey (2009: 90): The problem with the neoclassical version of interest rate parity is that it assumes complete reliance on forecasting ($/FX). If, because they are insecure, agents are less eager to ‘put their money where it is’, then it is very likely that the capital flows that serve as adjustment mechanisms will not occur in sufficient volume to define the two sides of the dispute as an equal equation. In fact, given the level of uncertainty in the market, such a complete adjustment would be the exception rather than the rule.

6. 7. 8. 9. 10. 11. 12.

Harvey (2009: chapter 5). Aliber (1987: vol.2: 210). Bresser-Pereira (2013); Bresser-Pereira, Oreiro and Marconi (2016). Bresser-Pereira (2008). Duwicquet, Mazier, and Saadaoui (2018). In other words, the Balassa–Samuelson effect says that when a country’s productivity increases more than in other countries, the equilibrium exchange rate appreciates, thus keeping the current account balanced. Lending to a sovereign country is not always safe.

11. Growth and stagnation We can define economic growth or development as the process of capital accumulation with the incorporation of technical progress that causes a sustained increase in labor productivity, per capita income, and the standard of living of the population. I could add to the accumulation of capital with the incorporation of technical progress education, without which there is no development, a national development project, and good institutions even if these are largely endogenous. Thus defined, economic growth is a historical process that dates back to the capitalist revolution. England, which was the first nation to become capitalist, completed its capitalist revolution in the second half of the eighteenth century. Before capitalism, there were periods when societies were prosperous, but we cannot identify these periods with economic development.1 They were just times of prosperity with no prospect of long-term continuity. It was only after each national society had made its industrial and capitalist revolution that capital accumulation, technical progress, and rising living standards were sustained in the long run.

Source:

Broadberry et al. (2015); Our World in Data.

Figure 11.1

Growth per capita of England/Britain, 1270–2016 (log.) 111

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The economic literature usually distinguishes growth, which would only be an increase in per capita income, from economic development that would involve structural change, but there are rare cases in which a sustained increase in productivity and per capita income does not involve structural change and an increase in people’s standard of living. Some include the reduction of inequality in the historical process of economic development, but if we were to accept this definition the most extraordinary cases of economic development, as was the case in China between 1980 and 2020, would have to be discarded. When we discuss a historical process, we must not confuse reality with our own morality.

DEVELOPMENT AS PRODUCTIVE SOPHISTICATION In defining economic growth, I related it to the industrial revolution or industrialization. Neoclassical economists reject this association. For them, the market and, more specifically, the law of comparative advantages of international trade will be in charge of identifying the industries that will develop. The market “maximizes” the use of its productive resources, regardless of the nature of each industry. That is why Gabriel Palma often says, jokingly, that for orthodox economists there is no difference between producing “potato chips or microchips”. Figure 11.2 shows the close correlation between industrial output per capita and GDP per capita. This close correlation first led classical structuralist developmentalism and particularly Arthur Lewis to defend industrialization as a way of transferring labor to sectors with higher value added per capita. Second, it led Raúl Prebisch and Hans Singer to develop the thesis that in commodity-exporting countries there is a structural tendency for the terms of trade to deteriorate, to the extent that rich countries transform productivity increases into wage increases instead of just lowering prices in all countries so that industrialization would not be required for growth. Third, it led Nicholas Kaldor to argue that industrialization, not the production of primary goods, involves increasing returns. When we say that economic growth involves industrialization, we are saying that it involves the transfer of labor from low to high value added per capita. Or, given that the production of some services involves sophisticated technology and highly skilled personnel, it is more appropriate to say that economic development involves productive sophistication. This is not an original approach. It has been known for centuries. The English King Edward III already knew this, and in the distant year of 1336 he forbade the export of raw wool; he wanted wool production to be supplemented by clothing production, thus increasing the value added by English workers. However, neoliberal orthodoxy has not learned from this.

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World Development Indicators; data organized by Paulo Gala.

Figure 11.2

Industrial GDP per capita (2014) and GDP per capita (PPP, 2011)

The increase in labor productivity and the increase in value added per capita are equivalent expressions. They are the result of the accumulation of capital in machines, new methods of production, and education. Companies make investments that save labor and lead to increased labor productivity. The transfer of labor from low to high productive sophistication activities directly causes an increase in labor productivity. There must be only one restriction: there must be educated workers who are capable of learning how to perform the new tasks. For developing countries, this second way of increasing productivity is more effective than the first, because they are not at the frontier of technological knowledge.

GROWTH MODELS Although economic development or the wealth of nations was the goal shared by all economists, it was not until the 1940s that a school of thought emerged to explain why some countries became rich while others remained underdeveloped. To answer this question, classical structuralist developmentalism criticized neoliberalism, that presupposed full employment and sustained growth – two unrealistic assumptions – and relied on Keynes’s revolutionary contribution to economics. In the 1930s, Keynes challenged the full employment hypothesis and gave rise to macroeconomics; in the following decade, classical structuralist developmentalism explained the problem of underdevelopment

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and the policies to overcome it. In the remainder of this chapter, I discuss an abstract model of growth considering the thought of Marx and Keynes. Whereas economic growth is basically equal to the rate of increase in per capita income, i.e., it is equal to the increase in income divided by income (y' = Δ Y/Y) and if we consider that the growth rate: • • • •

of the population is (n'= Δ N/N); of the labor force is (l' = Δ L/L); of labor productivity is (q'= ΔP/ΔE); and that production and income are always equal ex-post (P = Y);

we will conclude that, in the long run, the rate of economic growth is equivalent to the increase in labor productivity (y'= q'). The fundamental question is what determines long-term growth? The basic answer is that growth or increase in productivity depends on the rate of investment, given the efficiency of that investment or the productivity of capital i​​σ. ​y  ​=  i σ​

(11.1)

Why does economic growth depend on the rate of investment? Essentially because, assuming that there is no full employment, capital accumulation is a desired addition by the country to the capital stock (I = ΔK) that increases its productive capacity by a greater percentage than the country’s population, resulting in increased productivity or economic growth. ΔK/K > ΔN/N The growth model of equation (11.1) corresponds to the production function of the model of Roy Harrod (1900–1978) and Evsey Domar (1914–1997). The two English post-Keynesian economists were interested in building a model of equilibrium on a razor’s edge in which the economy is intrinsically unstable – it cannot deviate from this single equilibrium that markets do not guarantee. In the model where (ex-post), i = s (I/Y = S/Y), and the product–capital ratio is​ i  =   s​σ. Thus, we have equation (11.1) above. The neoclassicals were not satisfied with the Harrod–Domar model. They were right to assert that in the model we must consider labor and allow the substitution of labor by capital and vice versa. The solution found was Solow’s model.2 It was assumed that growth depended on capital and labor, with the total substitution of one for the other factor of production. ​Y   ​=   AK​α(11.2)

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In which, Y is GDP, K and L are capital and labor, A is technology, α is the elasticity of capital, and 1-α is the elasticity of labor and technology. In this function of production, production is expressly the result of capital, labor, and technology that increases the productivity of labor. I do not believe that a growth model should present a single equilibrium, as proposed by the Harrod–Domar model (we know objectively that capitalist economies are unstable), nor do I agree that the Solow model shows that the economy is at full employment and can remain at full employment and grow indefinitely. Neoclassical economists say that this model predicts that an economy will always converge to the equilibrium condition – a condition in which the growth of output per worker is determined only by the rate of technological progress. A model cannot show something like that. Models are ways to understand how economic relations (in this case, economic growth) happen, not to make economic variables act as we want. Nevertheless, Solow’s model was a breakthrough. In addition to explaining growth, it led to the definition of the concept of “total” productivity, to be used in place of the productivity of labor or capital: total factor productivity (TFP). It is the difference between the growth rate and the growth rates of the labor force and capital stock, weighted by their respective shares. It is a measure of productivity in which the inputs are heterogeneous, and the “difference” is the residue of the production function. While total productivity is often used, classical labor productivity is the most widely used and most legitimate way to measure productivity.

ND’S GROWTH MODEL The ND template is a basic guide to development policies. It states that the most important development policy is to increase and maintain the rate of investment at a high level. Few economic relationships have been as consistently verified empirically as that of the close correlation between the rate of investment and the rate of growth. i' = y' Secondly, since investments are equal to savings, the model shows the importance of savings. Keynes understood savings as dependent on investment, but this is only true in the short term; in the long term, we should consider savings as a stand-alone variable and encourage their increase, particularly in the form of savings funds set up by the state. S ​≠​ i s is autonomous from i

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Thirdly, it says that technical progress, which is embodied in machines or people, is an essential variable in explaining economic development. It appears in equation (11.1) in the productivity of capital, and in equation (11.2) it is in 1-α – the elasticity of labor and technology. y' ​= i, s, σ, 1-α(11.3)

THE INVESTMENT RATE From the previous discussion, we can conclude that the investment rate is the main determinant of economic growth. The next question is: what is the main variable that explains investment decisions? And the answer is simple. The rate of investment depends on the firm’s expected rate of profit (r*), minus the interest rate (j). i ​= (r* - j)(11.4)

From this point on, for simplicity’s sake, I will only use the expression “expected rate of profit”, but I will refer to the expected rate of profit of the company. Marx, in Volume III of Capital, made it clear that investment depends on the expected rate of profit. As he argued, interest is simply the price that capitalist entrepreneurs, whom he calls “functional capitalists,” pay for the money borrowed from rentier capitalists—the “owners of capital.”3 Keynes followed this simple line of thought. He developed his investment theory in Chapter 11 of the General Theory. Here, he analysed the concept of “marginal efficiency of capital,” which he defined as “the discount rate which would make the present value of the series of annuities given by the expected returns of the capital good during its lifetime exactly equal to its supply price.”4 Some prominent post-Keynesian economists have duly noted the similarity of Marx’s and Keynes’s views on the decision to invest with Michał Kalecki as an intermediary.5 In the post-Keynesian literature, an alternative model is often adopted: the Kaleckian model, in which the rate of investment depends not only on the expected rate of profit, but also on the rate of utilization of installed capacity. We can add this and many other variables that determine the rate of investment, but the most straightforward and convincing model considers investment to be dependent on the expected rate of profit. The other possible factors, particularly the rate of utilization, are built into the expected profit rate. When this rate is high, firms infer that demand for the goods they produce is high, the rate of utilization is high, and expect higher rates of profit.

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This does not mean that the capitalist entrepreneur maximizes their rate of profit. They want the greatest possible profit, but they also seek their personal fulfilment, they aim to innovate, to build an empire, and they know that maximum profit is a goal that is in contradiction to these personal goals. As Herbert Simon demonstrated long ago, all it takes is a satisfactory rate of profit for companies to invest.6 The convention on what is a satisfactory rate of profit varies from country to country. It will be higher in developing countries than in rich countries because the risk of investing in underdeveloped countries is higher. It will also be higher than the expected average rate of profit in sectors perceived to be riskier. We cannot simply say that the higher the expected rate of business profit, the higher the rate of investment. In the real world, this relationship is not linear. Companies invest when the expected business rate of profit is satisfactory. A convention established by the companies of each country and sector at a given time will define a satisfactory range of expected rate of profit. When it gets to that range, companies will invest. As we can see in Figure 11.3, in which the vertical line is the expected rate of business profit (EPR) and horizontal line is the curve of the investment rate over time that grows but at a decreasing rate until it reaches a plateau. In the long term, the interest rate is not equal to the rate of profit, as neoclassical economics proposes, but is a constant line, always below the investment rate curve.

Figure 11.3

Expected profit rate and the investment rate

THIRWALL’S MODEL Given its normative character and the rigid assumptions of non-market (a single good being produced, fixed proportions of capital and labor,

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government-defined private investment), conventional economics and policymakers, in basing their theory of international trade on the law of comparative advantage, ignore all the assumptions that make it valid. They forget that the law is short-term and economic development occurs in the long term, they forget that the law presupposes full employment. Post-Keynesians, on the other hand, focused on Thirlwall’s law or balance-of-payments constrained growth, which is an extension of Harrod’s foreign trade multiplier and a formalization of Prebisch’s model of the two perverse income elasticities.7 With this model, they made development dependent on demand – essentially exports. That was a breakthrough. We have already seen that the development of middle-income countries is in principle export led. The internal market is essential for development, but it can only drive growth at the beginning of industrialization, when the import substitution model is required or legitimate. Thirlwall’s assumption is that the current account should remain balanced over the long term. Thus, GDP and exports are expected to grow at the same pace. This is what is assumed in Harrod’s foreign trade multiplier, in which the assumptions are that the current account is also balanced (and exports are the only autonomous component of aggregate demand (investment or state spending are not autonomous). As income and the share of income, m is equal to imports divided by income, we have the multiplier of foreign trade, where we see the close association between exports and income: Y = M+Im=Ml / Y. ​Y   =   X  /  m M​

(11.5)

This was a static model. Thirlwall’s 1979 model is dynamic. It is a growth model in which the exchange rate is also constant, and the three variables are defined in dynamic terms. The growth rate of per capita income ​y​replaces ​Y​, the rate of increase in exports x​  ​replaces ​X​, and the income elasticity of demand for imports ​π ​replaces​ m.​ ​y  =    ​_π x ​​

(11.6)

When Thirlwall came up with his model, he showed it to his University of Kent colleague Charles Kennedy, who correctly noted, “this looks like a dynamic version of Harrod’s static foreign trade multiplier.”8 The key variable here is the income elasticity of demand for imports that comes directly from Prebisch’s external constraint, but Thirlwall’s contribution was not only the formalization of Prebisch’s model. In a fascinating 2011 essay, “Models of constrained balance of payments growth: history and overview”, he adopts views similar to those espoused by ND. Take, for example, the defence of mercantilism against liberal critique; the praise of the great mercantilists for whom the important thing was not the size of the treasury

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but keeping the cost of borrowing low; the defence of industrialization since Antonio Serra and his vision of increasing returns to scale; and the wonderful quote from Keynes (apud Donald Moggridge) “what I want is to do justice to the schools of thought that the classics have treated as imbeciles for the last hundred years, I want to make the critique of David Ricardo whose theory of commerce is a real theory related to the reallocation of real resources through trade that ignores the monetary aspects of trade.”9 Keynes also criticizes the modern orthodoxy that ignores the balance of payments or, as I prefer to say, the current account. And it explains why: orthodoxy assumes that the balance of payments, like the entire economic system, is self-balancing. In this way, the policymaker has nothing to do but keep the fiscal account balanced, because it is exogenous to the system.10

Source:

Thirlwall (2011), p. 18.

Figure 11.4

Exports, imports and GDP growth

Thirlwall used Figure 11.4 to present his model. GDP growth is on the horizontal axis and export and import growth on the vertical axis. Export growth (x) is autonomous, while import growth (m) is a function of GDP growth (y), according to the income elasticity of demand for imports (π). The GDP growth rate consistent with the balance of payments equilibrium YB is defined where the x and m curves intersect. The larger the x curve and the flatter the m curve, the higher the equilibrium growth rate. Thirlwall acknowledges the contributions of post-Keynesian economists such as Nureldin Hussain, John McCombie, Ricardo A. Araújo, and Gilberto

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T. Lima, who developed a disaggregated multisectoral version (2007), and Juan C. Moreno-Brid, who included interest payments in the model. They and several others have detailed and refined the analysis of the model. Thirlwall immediately tested his model, and the results were good. He applied the model to a selection of developed countries during the periods 1951–73 and 1953–76 and found “a remarkable correspondence.” Many others have also tested the model, with increasingly sophisticated econometrics, and the results have been good. The model sets a limit to economic growth: export growth adjusted for the income elasticity of demand for imports. Would it work in the case of China’s extraordinary growth? Yes, according to a study by Yongbok Jeon.11 The model’s adjustment to reality is not surprising, since export growth alone is already well correlated with GDP growth, and with the intelligent correction of import elasticity the correlation had to increase. And there is sense in the causality. Export growth is autonomous, while import growth is a function of GDP. As Thirlwall notes, when compared with investment and state spending, exports “are the only component of demand that can pay for the imported content of other components of demand, such as consumption, investment, government spending.” These other variables may have some impact on growth, but he understands that exports are by far the most relevant variable.12 There is, however, a preliminary question: what determines exports? Thirlwall does not have a clear answer to that question. He knows the relevance of investments, but he is not interested in increasing the rate of capital accumulation – a central issue for ND. He does not discuss that investments and competitive exchange rates are fundamental for the increase in exports. He is really interested in the scarcity of foreign exchange, i.e., foreign currency. In 1982, Thirlwall and Nureldin Hussain conducted a study in which, according to Thirlwall, they found that “the difference in growth of three percentage points between Asian growth of 6.6 percent per year and African growth of 3.6 percent is explained by the difference in export growth—not differences in the effect of capital flows or movements in the terms of trade.”13 The result is impactful, but where are the investments? Can a country export without increasing its rate of capital accumulation? Thirlwall is so enthusiastic about his remarkable model that he seems to forget the rest. The main reservation I have with the model is in relation to capital inflows or the policy of growth with foreign savings. Thirlwall assumes that the balance of payments is in balance. More than that, he criticizes countries like Germany and China, which have only current account surpluses, but is not as critical of countries that have chronic current account deficits. After realizing that a number of developing countries had run current account deficits for

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considerable periods, in the 1982 paper with Nureldin Hussain they extended the model to include capital inflows. In this article, they begin by arguing that developing countries can resort to capital inflows, but “most cannot earn enough.” They add that “there are only two factors that can cause a country’s growth rate to deviate from this rate: first, changes in the actual terms of trade, and second, capital flows,” which often work in the opposite direction “to compensate for each other.” And they don’t have much doubt about the benefit of capital inflows. With some understandable disdain, they say: “It must be acknowledged, however, that developing countries are often able to accumulate growing current account deficits financed by capital inflows (which are then written off!) that allow these countries to grow permanently faster than would otherwise be the case.” They then construct the model with the inclusion of capital inflows and arrive at equation (17) in which the constrained growth rate of the balance of payments “is the weighted sum of export growth due to exogenous growth of income outside the country, and the growth of real capital flows, divided by the income elasticity of demand for imports.”14 Thus, the way to circumvent the external constraint is the policy of growth with external indebtedness. This is a serious mistake.

THE TWO-GAP MODEL The two-gap model is more of a normative planning model than an economic model. Chenery, a prominent developmentalist who for years headed the World Bank’s economics department, and Bruno built a model based on the Harrod–Domar model, which was already being used for economic planning, and Prebisch’s concept of external constraint. Growth depends on investments or ex-post savings. Thus, developing countries face a “savings gap” to the extent that there is not full employment, or, more correctly, when Arthur Lewis’s “unlimited supply of labor” prevails, typical of developing countries, and desired (planned) investments are greater than domestic savings after deducting interest payments (net savings). While at the World Bank, they observed that developing countries were also facing a “shortage of dollars” – they were always facing current account deficits and asking the bank to provide the dollars – “to finance investments”, as if it were possible ex-post to know what the loans actually financed. And he concluded that there was a second gap – the “exchange rate gap” – faced with a low-income elasticity of demand for their exports in industrialized countries and a high income elasticity of demand for imports, they fell into chronic current account deficits and, since before 1971 the financial sector was not open to them, a “lack of dollars”.15 A “structural deficit”, many developmentalists said, and the solution was expressly present in the model of the two gaps:

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resort to foreign savings and the savings gap would be covered by net capital inflows. Yes, there was a shortage of dollars, but it was not due to the external constraint, but to the current account deficit policy that countries adopted. A few years later, a major foreign debt crisis impeded the growth of the highly indebted countries. It resulted directly from the policy of growth with external indebtedness legitimized by the two-gap model. And in the early 2000s, we would learn that this policy additionally reduced the international competitiveness of developing countries.

NOTES 1. 2. 3.

4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15.

The economic literature usually distinguishes growth, which would only be the increase in income per person, from economic development that would involve structural changes. Solow (1956; 1957). In the words of Marx ([1894] 1981: 460), “the part of the profit paid in this way is called interest, which is nothing more than a particular name, a special title, for that part of the profit which the capitalist actually works to the owner of the capital, instead of pocketing it himself.” Keynes (1936: 135). Hein (2002); Lavoie, Rodríguez and Seccareccia (2007). Simon (1957; 1959). Thirlwall (2011); Feldman (2021). Charles Kennedy quoted by Thirlwall (2011: 17). Keynes cited by Thirlwall (2011) apud Moggridge (1992). Thirlwall (2011: 6–8). Jeon (2009: 23(2): 135–146). Thirlwall (2011: 20). Idem (2011: 27) Thirlwall and Hussain (1982: 498–500; 500–501). The international financial system had been closed to developing countries since widespread defaults in the 1930s. It began to be inaugurated in 1971, with the end of the convertibility of the dollar, and the supply of foreign exchange became abundant with the first oil shock in 1973 and the rise of the petrodollar market.

12. Policy of current account deficit ND places great importance on the exchange rate and the current account – two interdependent variables. Figure 12.1 shows the relationship between them: the larger the current account deficit, the more appreciated the currency, and the larger the current account surplus, the more depreciated the currency. Thus, there is a correspondence between the current account balance and the exchange rate. When a country runs chronic current account deficits, net capital inflows become equal to at least the deficit. They could, of course, be higher than this if there are additional net inflows of direct investments and loan capitals. Net capital inflows represent a greater supply of foreign exchange and appreciate the country’s exchange rate.

Figure 12.1

The current account balance and the exchange rate

Conventional economics generally ignores this inverse relationship between the current account and the exchange rate. ND emphasizes it and maintains that countries often adopt the current account deficit policy out of mere exchange rate populism. This is true for both developing and rich countries. The current account operationalizes this populism. The governments of these countries adopt the policy of running current account deficits in order to increase the 123

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value of the exchange rate, increase the purchasing power of workers and rentiers, and facilitate the re-election of politicians. Latin American countries and the U.S. do this habitually. This is one of the reasons why the economic performance of Latin American countries has been so poor and why, over the past 43 years, the U.S. has lost the competition with China, East Asia and Germany, which adopted the opposite policy. Countries that run persistent current account deficits do not recognize that they are being populist. They claim that they seek to “grow with foreign savings”, therefore, with external indebtedness. Running current account deficits is the way to get foreign savings that they say would increase domestic savings and increase the country’s investment rate – something the ND has amply demonstrated to be false. What proves that these countries have current account policies? The answer is persistent deficits or surpluses, which can only happen if there is a policy behind it. If it did not exist, the exchange rate would return to the current equilibrium. The role of the exchange rate is to balance the country’s current account. The current account balance sign determines the direction of capital flows that affect the exchange rate. In the long run, countries’ current accounts must balance. If the market is fulfilling its role, we would only have short-term deficits or surpluses that would respond to temporary shocks to the demand or supply of foreign currency. Why do Germany and most East Asian countries run current account surpluses? Because these countries prefer a competitive exchange rate and a competitive industrial sector to increasing the purchasing power of wages and rentier revenues (interest, dividends, and real estate rents). Moreover, considering Germany, its policymakers, as well as its population, have strongly rejected any inflation since the hyperinflation of the 1920s, and orthodox policies aimed at keeping prices in check are seen as legitimate. Thus, workers and rentiers are willing to accept the relative loss of purchasing power of wages and incomes, as they all believe that the high levels of international competitiveness achieved by their manufacturing industry will mean increased exports and eventually higher wages, rents, interest rates, and dividends in real terms. The US, for its part, has systematically run current account deficits since the 1960s, probably because Americans believe they benefit from the famous “exorbitant privilege”: the US dollar is the universal currency, and the US borrows only in dollars.1 In fact, there is a cost to this policy, because the current account deficit involves net capital inflows that value the dollar and make American industry less competitive. However, I am not aware of any debates that attribute the failure of the United States to compete with China to the overvaluation of the dollar as a consequence of current account deficits. In the case of Latin American countries, governments have a policy of running current account deficits because they believe that capital inflows,

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in the form of direct investments or external loans that finance specific investment projects, are an indication that the country “is growing with foreign savings.” Not so. Capital flows are pouring into the country rather to finance consumption, than to finance investment. However, liberal orthodoxy, left-wing economists, post-Keynesians, and international financial agencies – in short, mainstream economists – support this policy, and it is up to ND to radically critique this policy, as we will see later in this chapter. By adopting a policy of growth with external debt, politicians are not following a development strategy, they are practicing exchange rate populism. They are meeting the demands of workers and employees for greater purchasing power of their wages, as well as the demands of rentier capitalists and financiers for greater purchasing power from their dividends, interest, and real estate rents. On the other hand, liberal orthodoxy has good reasons to support the policy of growth with external debt, because it reproduces the interests of rich countries, always interested in exporting their goods and services, as well as exporting capital.

THE RATE OF SUBSTITUTION OF DOMESTIC SAVINGS FOR FOREIGN SAVINGS The growth-with-a-foreign-saving policy is apparently right. It seems reasonable for capital-rich countries to transfer their capital to capital-poor countries. Economists of all denominations – orthodox and heterodox, international agencies and neoliberal orthodoxy – share this belief. ND’s criticism is counterintuitive; it requires economists to rethink economics. I have no doubt, however, that, except in specific circumstances, which I will discuss below, this policy is wrong. Since capital inflows are related to the appreciation of the exchange rate in the long run, the policy of growth with foreign savings causes an increase in consumption, while at the same time harming investment. It increases the consumption capacity of both the poor and the rich, while making internationally tradable non-commodity companies uncompetitive and blocking their investments. In addition to this simple explanation, we must also consider that foreign savings do not add to domestic savings but replace them. Ex-post investment equals savings, which is equal to domestic savings plus external savings: I ​= S ​= Sd +Sx

(12.1)

where I is the investment, S, total savings, Sd, the internal savings, and Sx is the external savings. On the other hand, total savings (S) are equal to domestic savings (Sd) plus foreign savings (Sx), and ex-post, are equal to investment (I).

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Foreign savings are equal to the current account deficit – which, in turn, corresponds to imports of goods and services minus exports of goods and services (trade balance) – plus net revenues sent abroad: CAD ​= (Mg + Ms ) – ( Xg + Xs )(12.2)

where CAD is the current account deficit, and Mg and Ms are the imports of goods and services, respectively, and Xg and Xs are, respectively, the exports of goods and services. We could conclude that when a country is receiving foreign savings, investments and the rate of investment would increase. However, from the relationships described above, this is a wrong conclusion. These are not economic relations, and they are not really economics, but arithmetic identities. In fact, foreign savings do not add to domestic savings, they replace them. We have already seen that the larger the current account deficit, the more appreciated is the national currency, and the larger the current account surplus, the more depreciated is the national currency. Given this relationship, I will now work with the exchange rate at certain periods, rather than working with it every moment, and explain why foreign savings replace domestic savings rather than add to them. Let us assume two periods: t0, in which the current account is in equilibrium and foreign savings are zero, and period t+1, in which the current account is in deficit and the exchange rate appreciates (or there is a surplus, and the exchange rate depreciates). We can now have an equation (12.3) that expresses the rate of substitution (z) of domestic savings for foreign savings; the extent to which foreign savings displace domestic savings. z ​= dSx/ dSd

(12.3)

z ​= ( ΔSx/GDP) / (​∇​Sd/GDP)(12.4)

z ​= μ/¢(12.5)

where z is the rate of substitution of domestic savings for foreign savings, μ is the rate of increase in the rate of foreign savings (ΔSx/GDP), and ¢ is the rate of decline of the rate of domestic savings relative to GDP (​∇​Sd/GDP). As equation 12.3 shows, an increase in the foreign savings rate can cause a fall in the domestic savings rate. If the two rates are equal, z is equal to 1. If ΔSx/GDP ​= ∇ ​ ​Sd/GDP → z ​= 1(12.6)

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What determines z? It depends on the revenues and marginal propensity of workers (wages), middle employees and managers (wages), and rentier capitalists (dividends, interest, and real estate rents) to consume, minus their marginal propensity to invest, the two values added up to 1. Suppose the country’s current account deficit to GDP ratio (ΔCA/GDP) rises and the exchange rate appreciates (or falls, if we measure the exchange rate as the national currency per US$1). As a consequence, the purchasing power of the three recipes falls. But what is relevant in assessing the rate of substitution of domestic savings for foreign savings is what happens with marginal propensities. If the country experiences a period of extraordinarily rapid growth, the opportunities to invest and obtain high rates of profit will increase, the marginal propensity to invest will also increase, and the marginal propensity to consume will fall. The greater the increase in the marginal propensity to invest, the lower the propensity to consume. If the marginal propensity to invest increases by 100 percent, the rate of substitution of domestic savings for foreign savings (z) – which is equal to 1 minus the ratio between the two propensities – will be equal to zero (z = 0).

EXCEPTIONS ND criticizes growth with a policy of external indebtedness, but in certain periods middle-income countries have developed with foreign savings. This was the case in the United States at the end of the nineteenth century, South Korea in the 1970s, and Brazil in the “miracle” of 1968–1973. In periods like these, the rate of substitution of domestic savings for foreign savings is not as high as we are assuming, but it is very low. The explanation for this fact is simple. When a country is growing at a fast pace, really at a fast pace, the opportunities for profitable investment increase, and the marginal propensity to invest of people and businesses increases, while the marginal propensity to consume decreases. In this way, external savings are added to internal savings instead of replacing them. Even so, it is interesting to note that both Japan and China have refused to run current account deficits. In the case of poor countries, there is another exception. For them, who still do not have an export sector that allows the country to start accumulating capital and create a domestic market and industrialize, investments, including foreign ones, aimed at the export of commodities, contribute to the country’s development. Naturally, these exports cause the Dutch disease. However, at this early stage of development, the possibility of the country developing a manufacturing industry is small, restricted to a limited number of goods. And the Dutch disease can always be neutralized by setting import tariffs on these goods. It is too early to create a variable tax on commodities, especially

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minerals, as I will discuss in Chapter 14, because this measure will make all manufactured goods more expensive. An example of the relative success of the policy referred to in the previous paragraph are major oil exporters such as Saudi Arabia, which is now a middle-income country. The country does not know what the Dutch disease is and adopts export taxes only for fiscal purposes, so it has not industrialized. But its huge current account surpluses were used relatively wisely in education, health and infrastructure and the country developed. In addition to this country, the United Arab Emirates, Qatar and Botswana are also exceptions, but relative exceptions: the financing of their oil investments was done in part with export resources, not with foreign direct investments.

THE EXCHANGE RATE CYCLE The ND states that the exchange rate in developing countries follows a trend of cyclical appreciations and devaluations.2 For two reasons: first, because many countries adopt a policy of external indebtedness, or current account deficit policy, and second, because many are commodity-exporting countries and are subject to cycles of rising and falling commodity prices. The result is the currency cycle that will be more pronounced if the two conditions are combined. This cycle usually ends in a currency crisis. Besides the exchange rate cycle, when the exchange rate remains highly overvalued for several years, the country will be less competitive, with difficulty to industrialise and catching-up. The role of the exchange rate is to balance a country’s current account and ensure its external balance. But when the country adopts a policy of growth with a current account deficit and incurs chronic current account deficits, the exchange rate ceases to play its balancing role and follows a cyclical pattern of ups and downs, which, in countries with the Dutch disease, is naturally more pronounced. The exchange rate cycle is depicted in Figure 12.2, in which the full curve represents the observed real exchange rate, and the three dotted curves represent the current equilibrium, the industrial equilibrium, and the exchange rate with a current account deficit. The three equilibria curves – the relatively constant industrial equilibrium curve, the current equilibrium, and “equilibrium” with current account deficit – remain more depreciated than the observed exchange rate. In the phase in which the exchange rate is falling or appreciating, starting from the highly devalued peak, the exchange rate first crosses the industrial equilibrium curve but still maintains a current account surplus. At that moment the country has reached normality, and the crisis seems to be over, but this is not the case. The government, in order to “grow with foreign savings”, insists

Policy of current account deficit

Figure 12.2

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The exchange rate cycle

on the policy of current account deficit or increase of external debt, and the country plunges into the area of current account deficits. But the exchange rate curve doesn’t stop there. It continues to appreciate and reaches the equilibrium cum current account deficit. It could stay there, but exchange rate populism does not cool down and the country finally reaches rock bottom, which reflects the lowest exchange rate that the most efficient commodity exporters can tolerate. It then remains at this unstable level for a few years, while external debt indicators continue to worsen. Finally, the creditors lose confidence once and for all, and the new crisis explodes. It should be noted that the whole process may take less time if the ratio of current account deficit to GDP increases, and financial markets behave as if the country is on the verge of default. This is what happened in the Asian Crisis of 1977. The country is thus unable to pay the amortizations of the external debt and the interest that is due each month and enters into an undeclared moratorium. In this circumstance, it is left with no alternative but to adopt a severe fiscal adjustment to reduce the country’s demand for foreign currency, while keeping the interest rate high so that capital inflows return to liquid.3 After some time, macroeconomic adjustment works with unemployment, falling wages, and rising poverty and inflation falls. This calms the financial markets abroad and at home, and the exchange rate gradually falls, the currency gradually depreci-

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ates, and the exchange rate curve reaches current equilibrium, and then there is a brief period of external equilibrium. In any case, the exchange rate cycle and currency crises are the result of the policy of growth with external indebtedness and the deviations from the current account of equilibrium that commodities can cause. The three actors in this comedy – the middle-income countries and their politicians and economists, the neoliberal orthodoxy represented by the international agencies and the mainstream economists – are optimistic and believe that the cycle will be avoided. It is true that these actors learn, but it is only partially, and the currency cycle starts again. Before closing this section, I note that with the foreign debt crisis of the 1980s, the United States and the IMF learned that they could and should avoid currency crises, that the crises not only cost the indebted countries dearly, but also put the big commercial banks at risk. Thus, they stopped imposing excessive conditions to help the indebted country, acted quickly and, in some cases, avoided the crisis. This occurred, for example, in Brazil in 1999 and in Argentina in 2018. As a consequence, balance-of-payments crises involving defaulting countries have become less frequent. However, the evils associated with overvalued currencies continued to discourage private investment and block growth.

NOTES 1. 2. 3.

Former French President Giscard d’Estaing, while a minister under General Charles de Gaulle, said the U.S. had an “exorbitant privilege” of being able to finance its current account deficits with its own money, the US dollar. For recent empirical confirmation, see Bresser-Pereira et al. (2022) and Marconi et al. (2022). Overt moratoriums, such as the Brazilian moratorium of 1987, are rare.

13. Foreign exchange, investment and growth In order to keep the exchange rate competitive, ND macroeconomics states that the state must have a policy of maintaining: (1) a relatively balanced fiscal account, and (2) a balanced, if not surplus, current account. To achieve these two results, the government should, at the fiscal level, (a) adopt a countercyclical fiscal policy, (b) keep current expenditures balanced, (c) finance public investment with public savings complemented by monetary financing (purchase of new treasury bills by the central bank) whenever full employment is absent and inflation is under control; and at the exchange rate level, it should (a) control domestic consumption and public spending, and (b) stimulate exports. By rejecting chronic current account deficits, ND rejects the policy of growth with foreign savings or external indebtedness. This is the most counterintuitive of the policies advocated by new developmentalism. Middle-income countries often adopt current account deficit or surplus policies. However, both the chronic current account deficits of Latin American countries and the United States, as well as the equally chronic current account surpluses of East Asian countries and Germany, can only be explained if there is an explicit or implicit policy of current account deficit or surplus. Were it not for these policies, the market would pull the current equilibrium around the exchange rate, around the current equilibrium, albeit volatilely. ND rejects a precept that seems obvious: capital-poor countries should rely on capital-rich countries. In this regard, ND notes that current account deficits and the resulting external indebtedness should be avoided, because current account deficits make the country’s currency overvalued, take away the competitiveness of good firms, and discourage if not impede private investment.1 These negative effects of deficits are, however, ignored by conventional economics. Not by countries like Germany and those in East Asia that adopt the policy of current account surpluses – something unfair to competitors, but which keeps the national currency more than competitive. It is worth noting that if the country that has the Dutch disease manages to neutralize it, it will have a current account surplus because it will move from the current balance to the industrial one, which is, by definition, more depreciated than the balance 131

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that zeroes the country’s current account.2 In this case, there can be no talk of a current account deficit policy.

THREE EQUILIBRIUMS Considering the other variables constant, the larger a country’s current account deficit, the more appreciated the exchange rate will be, the higher the surplus, the more depreciated it will be. The main role of the exchange rate is to balance the country’s current account. Therefore, the current equilibrium is the general equilibrium towards which the exchange rate tends. But we have two more equilibriums in ND: the industrial equilibrium that is relevant when the country suffers from the Dutch disease, and the current account deficit equilibrium adopted by countries that have a current account deficit policy. The first is a legitimate equilibrium, the second, a false equilibrium that does not interest the developing countries. The industrial equilibrium corresponds to the exchange rate that makes the country’s industry competitive or, more broadly, productively refined production, which implies higher value added per capita and better wages. The current account deficit equilibrium, which I originally called the “external debt balance” and neoliberal orthodoxy calls the “fundamental equilibrium”, is one that results from an explicit or implicit current account deficit policy. This “equilibrium” takes away the competitiveness of competent companies and easily leads to currency crisis, but it attracts the politicians in the government and the population, who have happily accommodated themselves to it. We can see these three equilibria in the ordinate of Figure 13.1, in which I assume a neutral relationship between the current account and the exchange rate, which is expressed as a neutral slope (45 degrees), but of course this slope will vary depending on the country and the other variables that affect the exchange rate. Using the example of Brazil, we can make it more practical to understand these three balances. I estimate that in Brazil today, (a) the industrial equilibrium is R$5.30 per dollar, satisfactory for the industry, corresponding to a surplus; (b) the current balance, R$4.80 per dollar; and (c) the balance with the current account deficit is equal to R$4.50. In the case of current account equilibrium, the R$5.30 per dollar assumes that net capital inflows are around zero. In the case of industrial equilibrium, net capital inflows will be negative because the country will have a current account surplus. Finally, in the case of the equilibrium cum current account deficit, net inflows will be positive to finance the deficit. The exchange rate of approximately R$4.50 will correspond to the current account deficit of about 2.5 percent of GDP. This equilibrium cum current account deficit is supposed to keep the external debt/ GDP ratio constant.

Foreign exchange, investment and growth

Figure 13.1

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Current account and equilibrium exchange rate

MANAGED FLOATING EXCHANGE RATE According to conventional economics, the exchange rate regime can be floating or fixed. In practice, however, it is or should be floating, administered. This is an oxymoron, it is not logical, but reality and economic policies are not always as logical as we would like, and contradictory expressions can help us understand reality and formulate policies. Conventional economics has always seen the exchange rate as a short-run variable. Volatile, always varying around the current equilibrium. In this case, the theory concludes that it cannot be a determinant of investment. It determines investment because it is a variable that can remain overvalued or depreciated in the long run. It was from the observation of this fact that ND built a theory of investment in which the exchange rate plays a relevant role. Conventional economics always sees the exchange rate as a short-term variable discussed in international trade theory and macroeconomics. So the classic discussion was “fix or float?” (fix or float). But for some time now, that view has changed. The IMF, for example, began to adopt contradictory policies, depending on the country and its conditions. In 1997, it urged Asian countries to devalue or float their currencies, while in 1998 it lent billions to Russia and Brazil to try to help those countries keep their exchange rates at a fixed level. In fact, the two exchange rate regime alternatives are not exclusive. According to neoclassical economics, in a world in which capital is increasingly mobile, countries would not be able to fix or manage their exchange rate

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and at the same time maintain an independent monetary policy. According to the well-known Mundell–Fleming model, countries must choose between the confidence and stability provided by a fixed exchange rate and the control over monetary policy offered by a floating rate.3 In the “neoliberal years of capitalism”, countries were pressured to choose monetary policy and let the exchange rate float. In the days of the gold standard, the fixed regime was the norm. The fluctuation of the dollar in 1971 made room for floating regimes, and currency crises became frequent. The floating exchange rate regime leads countries to the exchange rate cycle, that is, to cyclical balance of payments crises, as we saw in the previous chapter. These crises have real economic costs. Additionally, fluctuating and volatile rates can reduce investor confidence in the currency, discouraging investments and making it harder to fight inflation. To get the best of both worlds, some middle-income economies have tried a hybrid approach, tying their exchange rate to a single foreign currency, or to a basket of currencies. Today, many academics agree to a “limited flexibility,” which is a good compromise, while others continue to believe that a choice between the two regimes is necessary. Policymakers are more realistic and pragmatic and know that they have to live with a relatively floating rate regime, but the exchange rate regime must be pragmatic: it must be a “managed floating” exchange rate regime. For neoclassical economists, misalignments are inevitable. For Keynesian economists, the misalignments are more pronounced. In the past, this volatility was a consequence of sudden changes in the terms of trade that are common in commodity-exporting countries. Today, this high volatility stems additionally from capital flows, which are enormous. As a result, many believe that the exchange rate has become unpredictable. ND diverges from this view. As we saw in Chapter 10, considering capital flows, many countries have a stable exchange rate performance. In general, rich countries are capital exporters and have negative net capital flows, while many developing countries adopt a growth policy with foreign savings and have positive net capital inflows.

ACCESS TO DEMAND THEORY The ND specific theory that explains why the exchange rate determines investment can be called “access to demand theory.” In 2001, when I started building ND, my basic assumption was that the exchange rate was a determinant of both the rate of investment and the rate of growth. At that time and still today, the exchange rate is absent from all textbooks on economic development. Not even one section paid attention to this macroeconomic price. In the early 2000s, there was only one empirical study from 1997 showing that the exchange rate was a key variable in the development process, but that study,

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as well as my 2003 work with Yoshiaki Nakano, did not explain why the exchange rate determines investment.4 Further studies followed and confirmed this role of the exchange rate.5 But the studies also did not offer a theory to explain the empirical findings.6 Finally, in the 2012 paper “The exchange rate at the centre of economic development theory,” I came to the theory after discovering a metaphor I had been looking for for a long time. In 2010 – the last year of Lula’s government in Brazil – I used to say in my lectures that I “envied President Lula, who easily used new metaphors in his speeches.” The following year, I came across the metaphor: the exchange rate is like a switch that turns competent companies on or off from their demand. Based on this idea, the access to the demand theory boils down to the assertion that the exchange rate determines investment under one condition: the country presents chronic current account deficits or surpluses; investment does not have as one of its determinants the exchange rate when it fluctuates around the current equilibrium. In other words, the exchange rate has this power when a country adopts a current account surplus or deficit policy that results in recurring deficits or surpluses. Current account deficit or surplus policies, whether explicit or, as is more common, implicit, result from a sum of previous policies, especially contractionary or expansionary fiscal policies, which lead to the desired deficit or surplus. They are the consequence of a practice that countries consider favourable to them as long as there is no threat of a currency crisis. I adopted the name access to demand theory in 2014, when I proposed a new way of presenting the theory in the paper “Access to Demand”.7 An exchange rate is competitive and determines investment when it guarantees access to existing demand for companies using the best technology. The condition is that in that country the exchange rate is chronically overvalued, and therefore there is a policy or accommodation by the government. As long as the exchange rate remains appreciated, companies or entrepreneurs will only consider the average exchange rate around which the exchange rate fluctuation occurs. And since this rate is non-competitive, they will not invest. The exchange rate becomes a determining variable in the process of capital accumulation. Or, in other words, the non-realization of the investment. Thus, the exchange rate is the variable that gives or denies competent firms access to demand. For current account deficit countries, the limit to such policy is the currency crisis that can result from the increase in the external debt / GDP ratio. For the opposite alternative, there is no limit, except the possible dissatisfaction of the population with its relatively depressed income, or the aggressive response of competing countries in the face of the unfair trade practice involved. Germany and most East Asian countries stimulate investment by adopting a policy of surplus, while Latin American countries discourage if not make

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investment unviable. When a company realizes that there is internal or external demand and formulates an investment project, it calculates its likely return. In the case of the country with a constantly appreciating currency, the company will use this exchange rate to make its calculations and will not invest, or invest only enough to modernize the factory, not to expand production. If the country does not have a current account policy, letting the exchange rate fluctuate around the current balance, then the exchange rate will not be a determinant of the investment. Given the volatility of the exchange rate, this volatility can also discourage investment. Conventional economics is well aware of this problem, and there is ample empirical literature on it.8

ECONOMIC POPULISM Populism is a word that originally belongs to the vocabulary of political theory. In its original sense, populism identifies politicians who manage to establish direct contact with the population without the intermediation of political parties and ideologies. It is a relatively authoritarian political practice that can serve nationalist leaders who stand up to the Global North and industrialize the country, as was the case with Getúlio Vargas in Brazil. Ernesto Laclau (1935–2014) saw populism as an appeal to the people against the established power structure and dominant ideologies.9 Of course, low-quality politicians can also practice populism. Or else, far-right political leaders may practice it, as we have seen recently with Donald Trump.10 In the 1980s, economists also began to use the term “populism,” but in a different meaning. In 1991, Rudiger Dornbusch and Sebastian Edwards edited a book on economic populism in the United States, while I also published an edited book in Brazil on the same topic. The titles were almost the same, and although the authors edited them independently, several of the articles coincided.11 There was an important difference between these two books. I distinguished fiscal populism – the only form of economic populism that the US book discusses – from exchange rate populism. Whereas in fiscal populism the public sector expands more than it should and runs public deficits, in exchange rate populism the nation-state spends more than it should and runs current account deficits. In a number of cases, fiscal deficits are legitimate, while ND maintains that only exceptionally is a current account deficit a responsible policy – in most cases, it is just exchange rate populism. Fiscal populism is a practice of politicians on the right and left who seek to win the votes of the working class and the poor. Exchange rate populism also aims to win the vote of the rentier middle class and the rentier rich. The interest of rentiers in having an exchange rate appreciated by some developmentalists

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who were against depreciation in Brazil at a time when the exchange rate was strongly appreciated (2012), because it would harm the poor. In fact, depreciation reduces the purchasing power of the poor, but it further reduces the purchasing power of the rich. When a currency depreciates, the poor lose purchasing power from their wages alone, while rentiers also lose purchasing power from their incomes and their wealth in national currency. After a while, the exchange rate returns to current equilibrium if there is neither a current account deficit nor the Dutch disease, and the loss of the poor is reduced. In fact, it is temporary, because once the exchange rate becomes balanced in terms of ND, employment grows again and, a little later, wages also grow. Thus, it is no coincidence that neoliberal economists, who tend to represent the interests of rentiers and the rich, do not talk about the exchange rate. They prefer to talk about interest rates and fiscal deficits, not about devaluation of the exchange rate. Innocent developmentalists can also make the same mistake of not paying attention to the exchange rate. They have another argument for this, that of external restraint, which implies less demand from rich countries for their commodities and greater demand from them for more sophisticated exports from rich countries. They conclude that current account deficits are “structural” and inevitable, which is not true: they are avoidable if politicians and the country’s own population abandon populism and accept to consume less for a while. Let’s take a closer look at the exchange rate populism that is behind the currency cycle. I believe I was the first economist to write about exchange rate populism, but the idea (not the denomination) I learned from the noted Argentine economist Adolfo Canitrot (1928–2012) who, in his 1975 paper “The populist experience of income distribution,” showed how governments use exchange rate appreciation to get re-elected.12 To implement this policy, countries increase their fiscal spending and run irresponsible public deficits.13 Another reason for current account deficits is the populist policy of using the exchange rate as an anchor to control inflation. In cases of hyperinflation, this exchange rate anchor complemented by foreign resources and concrete measures that reveal fiscal responsibility can be effective in controlling hyperinflation. This is what happened in Europe after World War I. However, this policy is often adopted by countries that are not in hyperinflation and can lead the country into a major crisis, as we saw in Argentina in 1979 and Chile in 1982. It is curious, however, that the neoliberal orthodoxy, which rejects price controls by state-owned enterprises to control inflation, happily accepts the exchange rate anchor policy. After all, the exchange rate is “the price of the country” and, with it, you cannot and should not mess around.

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THE COST OF THE EXTERNAL CONSTRAINT A number of classical structuralist economists reject the idea of a current account policy and claim that current account deficits are “structural,” associated with external constraint. In fact, in commodity-producing countries, this restriction is real: while the income elasticity of imports of manufactured goods is greater than one, in industrialized countries the income elasticity of imports of primary products is less than one. But the cost of external restraint for developing countries is not the current account deficit and the dollars shortage that are intended to be caused by it, because the exchange rate exists to balance it. The rebalancing may not happen because the government maintains the deficit policy and the population continues to consume more than is compatible with the country’s growth, because economic populism remains dominant. The real cost lies in the fact that the country will have to import less than it would if it did not have the restriction, and the standard of living of the population will fall. It is also in the fact that the national labor force and its production are depreciated, while the labor and production of other countries is valued.

NOTES 1. 2. 3. 4. 5.

Bresser-Pereira and Gala (2008). Bresser-Pereira (2008; 2020a). Mundell (1963). I refer to Razin and Collins (1997) and Bresser-Pereira and Nakano (2003). Gala (2006); Rodrik (2008); Rapetti, Skott and Razmi (2012); Missio, Jayme Jr., Britto and Oreiro (2015). 6. Rodrik (2008: 366), for example, has argued that “why overvaluation is so consistently associated with slow growth is not always explicitly theorized, but most accounts link it to macroeconomic instability.” And he adds: “[T]hese findings suggest that more than macroeconomic stability is at stake,” dwell on this point. Bresser-Pereira (2012b; 2014). 7. 8. See, for example, Vieira and Damasceno (2016). 9. Laclau (2005). 10. This was the case of Getúlio Vargas in Brazil. 11. Dornbusch and Edwards, eds. (1991); Bresser-Pereira (1991). 12. Canitrot (1975). 13. In the case of surplus countries, they can only pursue growth with a current account surplus if the state is sufficiently capable and the government legitimate enough to make workers and rentiers accept a short-term sacrifice with the prospect of higher employment, wages, and revenues.

14. The Dutch disease and its neutralization The Dutch disease is the chronic overvaluation of a country’s exchange rate. It is caused by the export of abundant and cheap resources whose commercial production is compatible with an exchange rate substantially more appreciated than the current equilibrium exchange rate. And it is even more appreciated when our reference is the industrial equilibrium exchange rate. The Dutch disease is a structural phenomenon that blocks industrialization and growth. If a commodity-exporting country, which for a certain time neutralized this disease and industrialized, decides to suspend this neutralization policy, it will soon deindustrialize. This has been the case in Latin America since the 1990s. The Dutch disease is a market failure that implies the existence of a difference between the exchange rate that balances the current account and the industrial equilibrium exchange rate. It puts the country at a major competitive disadvantage. The Dutch disease is an age-old problem. It got its name because it was only identified in the 1960s, when economists in the Netherlands found that the discovery of natural gas and its export were appreciating the exchange rate and thus threatened to destroy the entire industry. In the 1970s, a noted Argentine economist, Marcelo Diamand, understood the dynamics of the Dutch disease when he realized that the overvaluation of the peso originated from exports of wheat, soybeans, and beef. At that time, the expression “Dutch disease” had not yet been coined, but he defined it as “unbalanced productive structures.” Following Dvoskin and Feldman (2015: 221), “…two or more sectors operate under considerably different levels of productivity…which cannot be eliminated by standard devaluations of the exchange rate”1 In a 1972 article, Diamand explained the problem. Taking South Korea, the United States, and Italy as points of reference, he argued that: In each of the countries, the exchange rate is precisely at a level necessary for the price of industrial products to be translated into dollars equal to the international price. In Argentina, the fact that the exchange rate is fixed on the basis of the most productive sector becomes the central determinant of the lack of industrial exports and starts the chain of events that culminates with the crisis and the Argentine stagnation.2

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In other words, the more the commodity sector in Argentina exported, the more the country’s currency appreciated. Thus, companies producing non-commodity tradable goods that were considering their investment projects, made their calculations and gave up the projects because they weren’t profitable. Diamand did not consider that the appreciation only affected industrial companies. And he argued that simply devaluing the national currency would not solve the problem. He reasoned that, first, devaluation would cause inflation; second, it would have a short-term contractionary effect, because it would reduce the purchasing power of wages and other incomes; and third, it “will represent an unjustifiable transference of income to the agricultural sector” (p.6), supply would increase, and the international price of the commodity would fall. These are real problems that make devaluation a bitter medicine. How can a devaluation be carried out once and for all? Or, in other words, how can the Dutch disease be permanently neutralized?

TWO MODELS In 1982, two leading international trade economists, Max W. Corden and J. Peter Neary, published the first model of the Dutch disease.3 In 2008, within the framework of ND, I published my article on the subject, which I understand to be the second model.4 In between, some authors have published empirical studies, to which I will refer below, based in some way on the model of Corden and Neary. The two models divided the economy into the same three sectors – a commodity-exporting sector, a tradable non-commodity sector, and a non-tradable sector, primarily services. Both agreed that the overvaluation applies to the tradable non-commodity sector. In practical terms, this means that the manufacturing industry suffers from this overvaluation of its products and makes the exchange rate applied to it uncompetitive. But the models diverge because, first, Corden and Neary’s model limits the Dutch disease to commodity booms, while the new-developmentalist model adds a long-run factor – Ricardian rents – which can maintain the Dutch disease even in years when there can be no talk of a commodity boom. Second, they diverge because, in the model, I define three equilibria, as we saw in the previous chapter, whereas in the Corden and Neary model these equilibria do not exist or are not explicit. Third, they diverge because the ND model places the exchange rate and its appreciation at its centre, while the other model focuses on the three sectors. Fourth, in one model it is possible to immediately derive policies to neutralize the Dutch disease, in the other there is no mention of this topic. Finally, the Corden and Neary model seeks to obey the principles of neoclassical economics, while mine is structuralist, new-developmentalist.

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EXTENDED DUTCH DISEASE Dutch disease exists in a country when it mainly exports commodities. We then have, in addition to the current equilibrium, the industrial equilibrium that corresponds to an exchange rate that is substantially more appreciated than the exchange rate that companies in each specific industry – using the best technology in the world to produce tradable non-commodity goods and services – need to be competitive. In order to have the full concept of Dutch disease, we must add a third equilibrium – the current account deficit equilibrium or external debt equilibrium that “balances” the exchange rate when the country incurs a chronic current account deficit – countries that are generally underdeveloped. It should be noted that here the assessment relates only to non-commodity tradable goods. If a country has the disease, it will have three equilibrium exchange rates: the current equilibrium exchange rate; the industrial equilibrium exchange rate; and the current account deficit. Originally, I practically defined Dutch disease as the difference between industrial equilibrium and current equilibrium. Recently, however, I realized that this definition does not show the full appreciation of the exchange rate caused by the Dutch disease, because it does not take into account the equilibrium with the current account deficit. I then proposed the concept of extended Dutch disease,5 equal to the difference between industrial equilibrium and equilibrium with a current deficit.

Figure 14.1

Two Dutch disease concepts

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Going back to the example related to Brazil that I presented in Chapter 13, the extended Dutch disease is equal to the difference between $5.30 and $4.50 and therefore $0.80 per dollar, while the original Dutch disease is equal to the difference between $5.30 and $4.80 per dollar; it is therefore equal to $0.50 per dollar. Therefore, the Dutch disease is more serious than we originally thought. We can see the original and extended Dutch disease in Figure 14.1, which is the same as Figure 12.2 with the the curve of the industrial equilibrium exchange rate, which varies less than the current account equilibrium exchange rate.

THE DUTCH DISEASE AND THE NATURAL RESOURCE CURSE The Dutch disease is an economic problem that must be clearly distinguished from the “natural resource curse.” Initially I claimed that the two denominations could be considered synonymous, but I was mistaken. Both problems have the same origin – the fact that the country is a commodity exporter – but the former is an economic problem, while the latter is a political and moral problem. Both the natural resource curse and the Dutch disease give rise to Ricardian rents and rents derived from commodity booms. The two phenomena differ in their nature and consequences. While the Dutch disease implies the long-term appreciation of the national currency that harms the industry, the natural resource curse implies the widespread corruption of individuals and groups of politicians and businessmen who seek to appropriate the revenues derived from the export of commodities. While the curse of natural resources transforms the state into an extractive state in which the government and the economic and political elites are oriented not towards production but towards the capture of rents, the Dutch disease blocks the industrialization of the countries that do not neutralize it, or else leads to the deindustrialization of the countries that have already neutralized it. but, persuaded by economic liberalism, they failed to neutralize it. While Dutch disease is an economic problem, it is a competitive disadvantage created by an overvalued currency, the natural resource curse involves immoral behaviors of politicians and businessmen. While the Dutch disease is one explanation why the country’s economy is barely growing because an appreciating exchange rate for manufacturing makes competent firms uncompetitive, the natural resource curse attributes low growth to the fact that in poor countries, politicians, businessmen and their associates do not think about producing but about appropriating a part of that income. Among political scientists, this idea is, for example, found in Terry Lynn Karl (1997) and Jeffrey Frankel (2010).6 Among economists and geographers, Richard Auty initiated this misguided approach to the problem.7

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While the Dutch disease is of no interest to rich countries and their politicians and economists who prefer that developing countries remain commodity producers, the curse of natural resources is of great interest to them because they can blame all the poor performance of these countries on themselves, rather than on both developing and rich countries. They prefer that they remain producers of primary goods and thus do not compete in the export of manufactured goods. In addition to preferring that developing countries do not industrialize, they have difficulty understanding what the Dutch disease is, which only became relatively easy to understand after my (little-known) 2008 model. It is not easy to counteract, but there is a clear way to do so. The curse of natural resources, on the other hand, is easy to understand (“they’re all rent-seekers”) and practically impossible to solve. Corruption is an endogenous problem in relation to no solution other than developing the country and making it more contractual. Moral preaching and incentives for honesty are ineffective. The central countries defend the political–moralistic solution and entrust an important international agency, the World Bank, to study corruption and propose solutions. I have a PhD student living in Mozambique, Tomás Heródoto Fuel, who set out to draft a thesis on how to neutralize the Dutch disease derived from the recent oil gas exploration in the north of the country. For this he did an internship at the University of Ghana, in which there would be great knowledge of the Dutch disease and wrote a very informative report. In fact, no such knowledge exists. African countries have been the focus of much of the studies on the natural resource curse that are identified with the Dutch disease. The researchers studied the cases of Nigeria, Gabon, Angola, Equatorial Guinea, Chad, Cameroon, Sao Tome and Principe, Mozambique and Ghana. They are scholars from the Global North who quickly transfer their misguided knowledge of Dutch disease to African economists. These international consultants do not know what Dutch disease is, and they do not seem to be interested in knowing. Terry Lynn Karl was clear in showing this disinterest when I met her at a conference on the problem. They want to explain the lack of industrialization of African countries with rent-seeking. So, the North has nothing to do with the problem. It is a problem of the South, for which the North can offer guidance on how to solve it. It is imperialism for hegemony, soft power, in action. In 1995, Jeffrey Sachs and Andrew Warner published an influential working paper from the National Bureau of Economic Research (NBER), which begins with a basic finding: “resource-poor economies often vastly outperform resource-rich economies in economic growth”.8 They did not use Corden and Neary’s 1982 paper, but proposed a model in which there are also three sectors, and they state that “the greater the natural resource endowment, the higher the demand for non-tradeable goods [services], and consequently the

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smaller the allocation of labor and capital to the manufacturing sector…The shrinkage of the manufacturing sector is dubbed the ‘disease’”.9 But that’s not really a Dutch disease model. Sachs and Warner are assuming a full employment economy – a neoclassical assumption – that is not realistic for developing countries and are defining the Dutch disease as a consequence of the allocation of labor and capital in the manufacturing sector in an economy that has no room for it. This is not the Dutch disease.10

NEUTRALIZING THE DUTCH DISEASE Although only recently defined, Dutch disease is a problem as old as capitalism and international trade. Once economic historians take the disease into account, they will have to change their long-term historical analyses. For example, they are likely to conclude that the main cause of the decline of Spain and Portugal from the seventeenth to the twentieth century was the Dutch disease that originated in the gold, silver, and sugar cane of their colonies. Their currencies remained overvalued in the long run, making industrialization and growth impossible, while manufacturing developed in France, England, and Belgium. Another example is related to industrialization by import substitution. The respective high import tariffs were not necessarily protectionist; They were also a way of neutralizing the Dutch disease in the domestic market, creating a level playing field for industry. Industrialization was only possible in the United States because, until 1939, it maintained high import tariffs on manufactured goods. So, this country neutralized the Dutch disease pragmatically, without having a clear idea of what the problem was. The severity of the Dutch disease originating from oil and gas exports depended on the difference between its cost of production and its international price, because the greater this difference, the greater the severity of the Dutch disease. ND presents two methods of neutralizing Dutch disease that can be complementary. The best method is for the country to set a variable export tax on exported commodities. This export tax should vary according to the average price of the main commodities exported. The law that promotes the exchange rate reform should have a table with the average prices in real dollars (adjusted for inflation) and the respective tariffs, which should be zeroed when prices fall to a certain level. The neutralization process is simple. Given that the demand for the good is inelastic relative to the country’s exchange rate (the demand curve is vertical), an export tax increases the cost of producing the commodity, the supply curve (S1) shifts to the left (S2), and, as we see in Figure 14.2, the current account equilibrium exchange rate will converge to the industrial equilibrium exchange rate.

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An export tax neutralizes the Dutch disease by shifting the supply curve

Here’s a simple example: suppose the Dutch disease in a country Z at a given time is Z$0.80 per dollar. An export tax of the same amount would neutralize the disease. An interesting series of events concerning an export tax took place in Argentina after the great financial crisis of 2001. The government created a hold on commodity exports, not to counteract the Dutch disease, but only for fiscal reasons. Although it was a fixed tax, it neutralized the disease. Reindustrialization took place, high growth rates were achieved, and the country experienced a current account surplus. Then, in 2007, inflation spiked, and the government decided to use the exchange rate as an anchor against it. As a result, the current account surplus evaporated, the peso appreciated, the growth rate appreciated, and growth lost momentum. There is, however, a second method to counteract the Dutch disease: an import tariff and an export subsidy on tradable non-commodity goods and services, also variable according to the average price of commodities exported by the country. This was the method that many countries adopted pragmatically, intuitively. They adopted this method when their policymakers did not know about Dutch disease, even though they were developmentalists and knew that for a country to grow, it had to industrialize. It turns out that the World Trade Organization limits the size of import tariffs and prohibits any type of export subsidy. This international organization, which resulted from the transformation of the former GATT (General Agreement on Tariffs and Trade), was created at the height of the “neoliberal years of capitalism” (1994) and aimed to limit the political space of developing countries. With the recent collapse of

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neoliberalism and as governments led by the US and President Joe Biden bring back the state, this entrenched belief in free trade is losing steam and countries will be freer to decide their own policies. The reform that sets import tariffs should establish two tariffs for each type of good or service: a regular tariff, which varies according to the type of good or service, and a single tariff, which is levied on the import of all goods and services, and which should be called the “Dutch disease tariff”. As with the export tax, the Dutch disease tariff must be variable. I believe that this alternative should be considered by countries such as Brazil and Argentina, where the origin of Dutch disease lies more in the export of soybeans than oil, where the number of agribusiness farmers is very large, politically liberal-conservative, and rejects any tax. What should the country do with the revenues from the new tax or tariffs? The only strictly rational use is the creation of a sovereign wealth fund, such as Norway’s sovereign wealth fund. Other taxes should have the fiscal purpose of financing the state. Only the fund’s revenues would enter the country’s public budget. Contrary to common belief, the fund would not neutralize the disease (this is done by export tax or import tariff), but it would prevent inflows of hard currency from re-appreciating the national currency. For a rich country like Norway, this is possible. It is not so reasonable for developing countries, which will have to come to some kind of compromise. There is a third method to counteract the Dutch disease: the creation of multiple exchange rate regimes. In the 1950s, when Brazil did not have a well-defined tariff law, the government created multiple exchange rate regimes. In one, the government classified goods into five categories – from goods that should be taxed more to those that should be taxed less – and held regular dollar auctions for importers in each category, offering each auction an amount of dollars that, given expected demand, would put the dollar roughly at the desired price. This is not a good method, it made the exchange rate confusing, but at that time it worked.

THE SECOND ARGUMENT FOR IMPORT TARIFFS The Dutch disease tariff is a second legitimate argument for import taxes – taxes that were essential to the industrialization of many countries and that continue to be essential today. However, in an age of ideological hegemony of neoliberal capitalism, the persistent critiques of liberal economists have led many developmentalist policymakers to desist from adopting them. The classic argument legitimizing import tariffs was the infant industry argument, proposed by Alexander Hamilton in his Report on the Subject of Manufactures (1791) and followed by Friedrich List.11 It is an excellent argument, but it is a valid argument only as long as each country’s industry was

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a nascent sector. Or when new technological advances have occurred in the sector that the country has not kept up with and, if the country understands that it must conserve and develop this sector, it is once again an infant. But after an industry ceased to be nascent, many countries continued to levy import taxes to continue to industrialize – or to avoid deindustrialization – even though policymakers lacked a good argument. Now, we have this argument, “the argument for neutralizing the Dutch disease.” For example, the U.S. has had a severe Dutch disease problem since it started exporting oil from Texas, and Latin American countries have always been commodity exporters. Both countries maintained high import tariffs – the US until 1939, Latin American countries until about 1990 – and continued to industrialize, even though the infant industry argument had already lost its validity long before those dates. But policymakers knew that development required industrialization and that if tariffs were eliminated as the liberals wanted, there would be premature deindustrialization. Thus, many countries have pragmatically adopted the argument of neutralizing the Dutch disease. Another example: in 1968, when much of the manufacturing industry had already matured in Brazil, the government created a subsidy for the export of manufactured goods, and from 1969 to 1990 it experienced a huge increase in exports of manufactured goods. In 1965 manufactured goods accounted for only 6 percent of total exports, and in 1990 they accounted for 62 percent! After 1990, when the subsidy was suspended, exports of manufactured goods fell to half of what they represented as a percentage of total exports, and at the same time the country’s degree of technological sophistication fell. Therefore, the US and Latin American governments did not know what the Dutch disease was, but they relied on policymakers who adopted high import tariffs pragmatically and intuitively because they believed that industrialization would grind to a halt if the tariffs were cancelled. If they had known what the Dutch disease is and had adopted the new argument, they would have had more ammunition to defend the industrialization of their countries. In Latin America, developmental economists who defended industrial policy would have continued to advocate import tariffs which, in the history of economic development, are the most important industrial policy. Who will win and who will lose when the disease is neutralized? The goal is for industrial companies to win by becoming competitive. Wage earners, managers, rentiers and financiers will pay because the purchasing power of their revenues will fall. Commodity exporters, even when they pay taxes, will not pay anything in net terms after all because what they pay in taxes, they get back due to the depreciation of the exchange rate. Companies indebted in foreign currency will suffer, but they have taken a risk they should not have taken. And they had at their disposal risk protection mechanisms, the cost of which led them not to adopt. It is natural, therefore, that they pay for it.

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Liberal economists are not interested in discussing tariffs that they consider a “cardinal sin.” It was less comprehensible, however, that some of the developmental economists allowed themselves to be influenced by the ideas that became dominant and no longer spoke of import tariffs, although they continued to defend industrial policies.

NOTES 1. 2. 3. 4. 5. 6. 7.

Dvoskin and Feldman (2015: 221). Diamand (1972: 9–10). Corden and Neary (1982); Corden (1984). Bresser-Pereira (2008). Bresser-Pereira (2023b). See, for example, Karl (1997); Frankel (2010). Auty (1990). Several economists, including Lederman and Maloney (2007), have followed this line. Sachs and Warner (1995: 2). 8. Matsuyama (1991) Sachs and Warner (1995: 6). 9. 10. Sachs (2007: 191) recommended that “How to handle the macroeconomics of oil wealth”) recommended that “oil earnings are invested in ways that enhance productivity, and thereby raise rather than lower production in the non-oil traded–good sector”. He also considered pegging the national currency to the dollar but acknowledged that such a policy would require substantial foreign exchange reserves. And he came close to solving the problem when he considered the possibility of subsidizing exports of manufactured goods that contribute significantly to improving the technological sophistication of the economy. 11. Hamilton (1791); List ([1841] 1999) National System of Political Economy. List was modestly influential in Germany because he wrote his book in the US and was not part of the German historical school. He was the first economist to adopt a national perspective in the nineteenth century and was highly influential in Brazil in the 1940s and 1950s.

15. Green and social In this book, I discuss new developmentalism as an economic and political theory, but the social sciences always convey values. Its theme – economic growth or economic development – is already a value. It is one of the five ultimate goals that humanity has set for itself in the last three hundred years alongside security, freedom, social justice, and protection of nature. More than that, economic growth – while once in conflict with these goals – is now essentially a means to achieve progress in each of them.

CLIMATE CHANGE AND ITS CONSEQUENCES Until the middle of the twentieth century, the protection of nature was not a problem discussed by economists; it was a topic that was in its infancy. It was only with the United Nations Conference on the Human Environment in Stockholm in 1972 that the environment finally became a major issue. Today, with the threat posed by climate change, the protection of nature has become a condition for the survival of humanity. The big problem associated with protecting nature is climate change. Today, this problem is scientifically defined and is being addressed by many scientists associated with the United Nations Intergovernmental Panel on Climate Change (IPCC). The consequences of climate change are well known: the extinction of animal and plant species; reduction of biodiversity; changes in the frequency and intensity of rainfall, interfering, for example, with agriculture; a rise in sea level that will submerge the coastal lowlands and the population that lives there; and the intensification of meteorological phenomena such as severe storms, floods, windstorms, heat waves and prolonged droughts. A warmer planet is becoming a place of extremes. In terms of short-lived events, the worst that the weather can offer is a world hit by tropical hurricanes or typhoons. A single hurricane can cause more than US$100 billion in damage, as Hurricane Harvey did when it hit Houston, Texas in August 2017, or kill thousands, as Maria did the following month in Puerto Rico. Several studies predict that people living in the place where they have historically always lived will see these areas push climate boundaries as the world gets warmer. Due to the rise in temperature by 2070, many areas where people live today will develop climates unlike any in which people have lived before. Some econometric analyses based on interannual differences suggest 149

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that, in general, higher temperatures lead to lower labor productivity and more violence. A long-term change refers to sea level. Sea rise comes from three different mechanisms: the expansion of the oceans as they absorb more heat; the addition of meltwater from the shrinking of glaciers to the land; and the physical breakdown of ice sheets, such as those in Antarctica and Greenland. The first two factors are currently leading to a sea level rise of about 1 cm every three years and are expected to do so at a similar rate in the twenty-first century, even if global warming is kept well below 2°C. The time it takes for seawater to heat up gives the process significant inertia. Such elevations will erode coastlines and increase flooding, especially when they are pushed inland by the undertows produced by intense storms. A high probability of drought and crop failure; changes in regional climates that disrupt entire economies; storms that are more destructive due to wind and rain; seawater submerging beaches and seeping into aquifers – what is known about the impacts of climate change is already quite worrying. The “known unknowns” add to this anxiety – not just the question of ice sheets, which creates a great deal of uncertainty.

DEVELOPMENT PROTECTS THE PUBLIC PATRIMONY Nature is a public or common heritage that the State has an obligation to protect. According to the principle on which republican rights are based, the assets that are part of the public patrimony can only be used for public purposes. For this reason, the protection of nature is a republican right that the State must ensure.1 Yet, for a long time, the law has ensured the abuse of nature or was silent about it, and its depredations have been immense. The challenge we have today is more than just protecting the environment, it is restoring it. We cannot and should not privatise nature. For historical and practical reasons, land is private, but the subsoil, the air, the atmosphere cannot be privatized, and the use of land must be regulated by the state in the interest of the public good. Human development is a collective effort associated with happiness. Collective, because there is no individual happiness – happiness is achieved within communities: families, friends, professions, cities, civil society, and nations. Collective, because within the framework of nation-states – the most complex and advanced form of political-territorial society built to date – the common good is called the public interest. Collective, because freedom is not what an individual desires, it is the ability to defend the public interest, even when that interest is in relative conflict with our own individual interests.

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But what is the relationship between those four goals, or the higher goal of happiness, and the fifth: well-being or economic development? Many environmentalists became critical of economic development, and some economists advocated degrowth. GDP would be another name for the destruction of nature. Does this mean that advocates of economic development, as in my case, have chosen a wrong path? ND does not distinguish economic development from growth, but it does distinguish it from progress or human development. While economic development is only a long-term increase in productivity and living standards, progress comprises all the political goals that modern societies set for themselves. ND adds that, despite the contradictions, economic development is the most important means to achieve the other goals. Let us look at what happened to developed countries in relation to the other four policy goals: security – developed countries are the safest; freedom – in developed countries, civil rights and, more broadly, human rights are better defended; social justice – in developed countries there is less inequality; environmental protection – in developed countries, nature is better protected than in other countries. In fact, in the old days, industrialization caused great environmental destruction, but at that time there was no concern for the environment. Thus, in the concept of economic development, raising living standards is a means rather than an obstacle to human progress. However, sensible environmentalists have come up with the concept of sustainable development. According to the United Nations’ 1987 Brundtland Report, Our Common Future, sustainable development is “the development that meets present needs without compromising the ability of future generations to meet their own needs”.2 It is an effort to combine increasing productivity, reducing inequalities and protecting nature.

MAJOR INVESTMENTS TO CURB CLIMATE CHANGE Reducing greenhouse gas (GHG) emissions will require large investments. All the major ways to curb climate change involve investments: • The first of the eight goals is to keep fossil fuels in the ground. The more that is extracted and burned, the worse climate change will be. To this end, investments in renewable energy are at the top of the list of measures: investments in wind and solar energy and in biofuels. • Secondly, there is a need to switch to sustainable transport. The shift to electric cars and buses is underway, although the problem of planes and ships has not yet been resolved. • Third, build “green” homes that save energy.

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• Fourth, to change the food we eat, and to encourage diets that cut or drastically reduce meat consumption and, in the end, become vegan. • Fifth, protect forests like the Amazon from occupation for agriculture and cattle ranching. • Sixth, restore nature that absorbs more carbon by planting trees in the right places or returning land to nature through reforestation schemes. • Seventh, to protect the oceans from overfishing. The oceans also absorb large amounts of carbon dioxide from the atmosphere, and this helps keep our climate stable. • Eighth, to reduce unnecessary consumption. Luxury goods should be taxed, especially plastic ones. The first two measures – keeping fossil fuels in the ground and switching to sustainable transport – involve large investments and will only be possible for countries that have experienced economic development. It is for this reason that the financing of climate change investments in developing countries has become a central issue for the world. In November 2012, the UN Climate Action High-Level Champions conducted a survey, with the support of Vivid Economics, on the costs involved. By 2050, US$125 trillion in climate investments will be needed to meet net zero carbon emissions, with investments from now to 2025 needing to triple – compared to the last five years – to put the world on track. These investments are job creators and nature protectors: they reduce the impact of growth on nature and make production more efficient in terms of damage to nature. How can we discourage companies from making investments that use nature? Everyone knows that the best thing to do is to tax these investments, but these taxes are limited because people do not like taxes. And because if one country raises its taxes on tradable goods, other countries must do the same to maintain a uniform level of taxation. This would require international agreements that are not on the agenda. The alternative that presented itself was the creation of carbon markets. Companies are allowed to emit more carbon than the country’s regulations allow, as long as they buy carbon credits from other companies – a commercial carbon credit being equal to one tonne of carbon dioxide, or the equivalent amount of another reduced, sequestered or avoided greenhouse gas. It is a smart system. Instead of paying taxes, they pay by buying carbon credits. Since they were instituted, carbon credit prices have been increasing and encourage some companies to produce them, mainly by planting trees, and then sell them at a profit. However, the system has drawbacks. As with all markets, carbon markets are legally created and regulated and depend on authorized emissions standards. In addition, many carbon credits would be produced anyway. Since the 2015

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Paris Agreement, progress has been made towards establishing agreements on the processes and methodologies that countries need to follow to access carbon markets, but according to a report by the United Nations Development Programme (UNDP) Climate Pledge, “there are also serious concerns, including issues related to double-counting GHG emission reductions, human rights abuses and greenwashing (where companies falsely market their green credentials, e.g., misrepresentations of climate-neutral products or services).”3 One alternative that is working very well is subsidies. All countries subsidise investments in renewable energies – namely wind and solar energy – and progress is enormous, not only in energy production, but also in technical progress that reduces costs. According to the International Energy Agency (IEA), during the period 2022–2027, renewables are expected to grow by almost 2,400 GW. That is equal to all of China’s installed power capacity today. This represents an 85 percent acceleration from the previous five years, prompting the IEA to revise its projections upwards. Renewables are expected to account for more than 90 percent of global electricity capacity expansion over the next five years. Electricity from wind and solar power generation will more than double over the next five years, providing nearly 20 percent of global power generation by 2027 and surpassing coal-fired power generation. In addition, global biofuel demand will increase by 35 billion liters per year, or 22 percent, over the period 2022–2027. The US, Canada, Brazil, Indonesia, and India account for 80 percent of the global expansion in biofuel use, as all five countries have comprehensive policy packages that support growth.4 In 2021, Raghuram Rajan made the best and most original economic proposal to advance the fight to control GHG emissions. He argued that it is generally accepted that a carbon tax is the best solution, but it is not feasible at a global level due to the free-riding effect. If some countries decide to tax GHG emissions while others do not, the competitiveness of those who do so will fall. Rajan’s proposal to solve this problem of justice was to leave the policies to each country and create a fair system of financing the investments needed for the carbon economy. How unfair it is for one country to work hard to reduce its emissions while another continues to extract as much oil as possible: There is profound inequity in asking a country that emitted just 0.13 tons of carbon dioxide per capita in 2017 to bear the same burden as the US or Saudi Arabia, with their respective per capita emissions of 16 and 17.5 tons.

The solution proposed by Rajan is to create Global Carbon Incentive (GCI). Every country that emits more than the global average would pay annually

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into a global incentive fund, the amount calculated by multiplying the excess emissions per capita by the population and the GCI. If the GCI started at $10 per ton, the US would pay around $36 billion, and Saudi Arabia would pay $4.6 billion. Meanwhile, countries below the global per capita average would receive a commensurate payout (Uganda, for example, would receive around $2.1 billion). This way, every country would face an effective loss of $10 per capita for every additional ton that it emits per capita, regardless of whether it started at a high, low, or average level. There would no longer be a free-rider problem, because Uganda would have the same incentives to economize on emissions as the US.5

He says the incentive is self-financing. Right. The countries with the highest per capita emissions will pay – which is why, for the time being, the proposal is not being discussed as seriously as it should be. Giulio Guarini and José Luis Oreiro recently proposed a distinction between a green and a brown manufacturing sector. With this differentiation, it would be possible to “integrate the ecological approach to the new developmentalism”. They understand that in a country facing the Dutch disease (mainly oil exporters), given the increasing production of soybeans and meat, there is no alternative to marginal producers but to expand the land used by this kind of production to the borders of the Amazon. The economic solution to the problem is to reduce the profitability of such kind of activities by adopting the export tax over primary goods, which also would contribute to the neutralization of the Dutch disease.6 There are many other actions that are part of the fight for the protection of the environment. In defence of biodiversity, Inger Andersen, director of the United Nations Environment Program (UNEP), recently declared that the “five horsemen of the apocalypse” are climate change, pollution, invasive species, overexploitation of natural resources and, most important of all, the conversion of forests to agriculture and livestock. Protecting the Amazon and other tropical forests is essential for mitigating climate change and defending biodiversity.7 The change in consumption habits, especially the sharp reduction in meat consumption, is another relevant change that is happening. When some time ago a young man told me that he was going vegan, as a contribution to the protection of nature, I thought that this kind of individual action was admirable, but it would not make a difference, but I changed my mind, because the number of people who are reducing their meat consumption is increasing everywhere. The time to prevent global temperatures from rising more than 1.5°C above pre-industrial averages is fast approaching. Decisions made now will determine whether that goal will be met or whether the world will exceed it by the

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middle of this century and have to deal with severe weather extremes before trying to lower the thermostat again in the second half of the century. These are the warnings from the Intergovernmental Panel on Climate Change (IPCC) in April 2022. The panel offers a comprehensive menu of possibilities for how humans can stabilize the climate and avoid catastrophic global warming while meeting the commitments made in the 2015 Paris Agreement. The aim of this pact was to keep average global warming between 1.5°C and 2°C above pre-industrial levels. Achieving these goals is the greatest challenge facing humanity today. Efforts are being made and progress so far has been great, but far from sufficient. Failure will be bad for everyone, but particularly bad for the poor who live in the regions most vulnerable to climate change – the coastal areas of every continent and the tropical semi-desert regions of Africa. It is important to believe that failure will be avoided. Isabella Teixeira, former Minister of the Environment of Brazil (2010–2016), in an interview with Daniela Chiaretti, said that at the time of the Paris Agreement, what existed was climate denialism, and this had already been overcome. Now you have to overcome the feeling that there is no way out. The same journalist asked Mary Robinson, former president of the UN High Commissioner for Human Rights, if she agreed. She replied: She’s right. There are people who say that this problem is too big and that, since nothing can be done, it is better to move on with life. We have to encourage people not to do that. I tell everyone that you have to do three steps. The first is to make the climate crisis personal in everyday life and that means recycling more carefully, changing our diet, changing the way we get around. Walking more, cycling more is good for weather anxiety. The second thing is getting mad at whoever has more responsibility and isn’t doing what they should. It’s governments around the world, cities, local authorities, businesses. The third step is the most important – by 2030 we have to cut emissions in a way that lets nature breathe. We have to imagine greener cities, rural areas with more water, reforestation. And we have to get excited because that’s the only way people will be motivated.8

In the same interview, Mary Robinson repeated what Pope Francis said in a conversation with former UN Secretary-General Ban Ki-Moon: “God forgives everyone. Sometimes we forgive others. Nature, never.” Faithful to this quote, he delivered a beautiful encyclical letter Laudato Si’ – On the Care of Our Common Home in which he quoted St. Francis: “Praise be to You, my Lord, for our sister, Mother Earth, who sustains and governs us, and who produces various fruits with colourful flowers and herbs,” ending with: “This sister now cries out to us because of the harm we have inflicted on her by our irresponsible use and abuse of the goods with which God has endowed her.”9

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GROWING INEQUALITY At the height of capitalism, the neoliberal years were a time of radically rising economic inequality: the rich got much richer, while the poor did not get poorer, but their incomes stagnated.10 If we consider only the richest 1 percent of the United States, in 1930 they controlled 23 percent of total disposable income. In 1980, as a result of the “Golden Age of Capitalism”, this share fell to 9 percent, but in 2017 it returned to 22 percent. Rising inequality is an essential feature of neoliberal rentier capitalism, a social formation in which rentier capitalists, financiers, and corporate top executives are the big winners, along with a few young professionals who have become entrepreneurs who have made fortunes from startups associated with the information technology revolution. Today, the world is richer than it was in the 1970s, but it is also more insecure and more unequal. Demand for unskilled workers and middle managers has declined, while demand for skilled workers, managers, and higher-level consultants has increased. Employment contracts have been “made more flexible”, that is, they have become more precarious. On the other hand, firms have been able to maintain a satisfactory rate of profit despite low demand and falling capital productivity because they have been able to increase monopoly power. Thus, as Alain Lipietz pointed out in 2001, “the progressive reduction of the guarantees offered to unemployment has weakened workers and the lower middle class but has increased the income of managers and directors.”11 All the researchers involved in the study of income inequality knew that the “neoliberal turn” implied a large increase in productivity. Anthony Atkinson, Thomas Piketty, Branko Milanovic, Gabriel Palma and James Galbraith, in particular, have made it clear that, after the reduction of inequality after WWII, the concentration of income in the hands of capitalists and top professionals from 1980 onwards increased again as a consequence of wages’ quasi-stagnation.12 The depth of this rise in inequality has been definitively proven in three notable books: Thomas Piketty’s Capital in the Twenty-First Century (2013); Atkinson’s Inequality: What can be done? (2015); and Branko Milanovic’s Global Inequality: A New Approach to the Age of Globalization (2016). In Piketty’s book, two figures, which I reproduce here, are significant. The figure on inequality in the US, 1910–2010, shows that the share of the highest decile of national income, which was about 45 percent, drops sharply to about 33 percent in 1940–1944. It remained at this level until 1978, when, during the neoliberal years, it began a vertical growth that only stopped in 2008, when it reached 50 percent of the national revenue. The numbers are entirely consistent with my analysis in my book on neoliberal financial rentier capitalism.13

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Piketty (2013), p. 52.

Figure 15.1

Income inequality in the US 1910–2010

In the case of France, however, there has been no increase in inequality since 1978. Democratic resistance to rising inequality was strongest in France.14

Source:

Piketty (2013), p. 429.

Figure 15.2

Income inequality in France 1910–2010

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Similar results for the US and Britain are shown in Atkinson’s book. He works with the Gini coefficient rather than the highest decile and shows that Gini values for the US and Britain fell until World War II, remained stable until about 1979, and began to rise until 2013. And he comments: “In the 1980s, [inequality] skyrocketed. This was the ‘Inequality Turn’ in the United States. Between 1979 and 1992, the Gini rose by 4.5 percentage points; and since 1992 it has increased by another 3 points”.15 Thus, the neoliberal turn happened at the same time as the inequality turn. They were reflecting the fundamental shift in the political regime from a social and developmental regime to a neoliberal regime. Milanovic’s discoveries go in the same direction, with one particularity: he tests Kuznets’ inverted U-curve. In his 1954 presidential address to the American Economic Association, Kuznets asserted that inequalities first rise with the onset of industrialization, eventually stabilize over time, and then begin to fall during the later stages of development. In fact, with a country’s industrial revolution, inequality tends to increase because productivity increases faster than wages. This is because, according to Arthur Lewis, an unlimited supply of labor keeps wages close to subsistence levels, but once this labor reserve is exhausted, and as long as workers organize themselves into unions, wages tend to rise with productivity, and the distribution of income levels out again. In a third phase, inequality would fall without reducing the rate of profit below the satisfactory level because, as I argued erroneously in the early 1980s, the information technology revolution was causing the productivity of capital or the product–capital ratio to increase.16 Testing the Kuznets curve in several wealthy countries, Milanovic (2016: 53; 72) found that industrialization and urbanization “increased inequality, beginning at the time of the Industrial Revolution to a peak that occurred in the late nineteenth or early twentieth century.” Inequality remained high for the next 30 years, falling only in the 1930s. The Gini remained low until the 1970s, defining the “Great Leveling.”17 In the 1980s, however, contrary to the Kuznets curve, inequality increased in the United States and Britain. According to Milanovic, “Kuznets’ original hypothesis is consistent with data up to 1979, but it does not explain the increase in both inequality and income that has occurred over the past forty years.” Thus, he also recognizes that the inequality turn happened at the same time as the neoliberal turn – the two turns are the same thing. This confirms the argument that the neoliberal years were a reactionary retrogression. Another impressive set of information regarding these two turns is in Figure 15.3, where we see the increase in productivity and the real wage rate in the US between 1948 and 2014. While both rates grew at the same rate between 1948 and 1973, after this period, a major gap emerges: productivity continues at roughly the same pace, while wages remain virtually stagnant. In the latter

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Note: Data are for average hourly compensation of production/non-supervisory workers in the private sector and net productivity of the total economy. “Net productivity” is the growth of output of goods and services minus depreciation per hour worked. Source:

Economic Policy Institute, Washington, DC.

Figure 15.3

Productivity and wage rate in the US 1948–2014

period, while productivity grew by 72.2 percent, hourly wages grew by 7.2 percent. Similarly, a survey conducted by the Economic Policy Institute and distributed by the Congressional Research Service shows that “in the US, between 1979 and 2019, the richest 1.0 percent saw their wages grow by 160.3 percent, and the wages of the richest 0.1 percent grew more than twice as fast, with a spectacular increase of 345.2 percent. By contrast, the poorest 90 percent had their annual salaries increased by 26.0 percent from 1979 to 2019.” In 1979, executive pay was 39 times higher than that of the average worker. By 2000, that ratio had increased to more than 1,000 times!18 Social mobility in the US has also fallen vertically. According to a 1998 survey by Perruci and Wysong (2008), 23 percent of adults who were born in the poorest 20 percent of the population reached the fifth highest quintile. In 1998, that percentage dropped from 20 to just 10 percent. In another rich country, France, where the degree of inequality is considerably lower, the trend towards income concentration is also strong. Between 1998 and 2005, while the income of the richest 0.1 percent grew by 32 percent and that of the richest 10 percent grew by 19.4 percent, that of the poorest 90 percent grew by only 4.6 percent. This concentration is explained in part by the

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sharp increase in the value of this wealth, but the most important factor was the increase in wages and salaries: the wages of the richest 0.1 percent increased by 29 percent, while the wages of the poorest 90 percent increased by only 4 percent.19 While capitalists remain prosperous, the striking correlation between rising incomes and wages shows that today the big winners are members of the techno-bureaucratic class.

WHY IS INEQUALITY INCREASING? Marx’s Capital was the most important book of economics and political economy published in the nineteenth century for the depth of its analysis of capitalism. Keynes’s General Theory was the most significant book on economics in the twentieth century for having created macroeconomics and, at the present time, Thomas Piketty’s Capital in the Twenty-First Century is the most relevant book for the depth of his research and its critical character. Theoretically, Piketty’s book is not sophisticated. The two laws he presents are not really new. The first law reproduces the first equation that Marx used to formulate his theory of the fall of the rate of profit model (α = r × β), while the second law that Piketty presents reproduces the Harrod–Domar model (β = s/y). But, as Robert Solow noted in an excellent review of the book,20 there is a third theoretical proposition that underlies the whole book (τ>γ) – the rate of profit is generally higher than the rate of growth per capita.21 Only in the period 1910–1950, Piketty notes, was the rule not followed, probably due to the two World Wars. Apart from that, if the state does not intervene correctively, income will be concentrated all the time. In addition to this general explanation, I add more specific economic and political reasons for the enormous increase in inequality that has occurred in advanced countries since the late 1970s. Two are associated with the information technology revolution. The first reason is the increased demand for skilled labor, while the demand for unskilled labor has fallen. The second reason is more difficult to understand at first glance. It is the fall in the productivity of capital or the increase in the capital-output ratio. The information technology revolution involved a major substitution of labor for machines: an increase in the capital-labor ratio. We discuss the theory of this question in Chapter 9. Private corporations compensated for the drop in profitability caused by this technical change by engaging in mergers and acquisitions, increasing monopoly power, and increasing profit margins. On the other hand, these were the neoliberal years: a time when the ideological hegemony of the rentier–financier class coalition was enormous. With the support or legitimization of neoliberal orthodoxy, there have been many policies that have led to an increase in inequality. Tax reforms have made the tax system more regressive; the adjustment of the minimum wage due to inflation

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was postponed; reforms made employment contracts more flexible; there have been huge increases in top executive salaries, bonuses, and stock options; and there has been a relative reduction in social spending. All these causes could be summed up in a single cause: the dominance of rentier finance neoliberal capitalism and the ideology of neoliberalism. Behind the rise of neoliberalism and the relative stagnation of wages, there is a new historical fact that threatened the rate of profit in the rich countries: competition from low-wage developing countries that exported manufactured goods – the Asian tigers, China, and now Vietnam and India. In the 1970s, Brazil was together with the tigers, threatening the Global North. But in the 1980s, not only Brazil, but all of Latin America experienced a massive foreign debt crisis. By 1990, all of these countries had submitted to neoliberal pressure to open up their economies. Thus, they stopped the neutralization of the Dutch disease with import tariffs – and, in the case of Brazil, with subsidies for the export of manufactured goods – and, since then, they have deindustrialized and their economies have almost stagnated. New developmentalism was born to face this problem.

NOTES 1. For the concept of “republican rights”, see Bresser-Pereira (2002). 2. See https://www.are.admin.ch/are/en/home/media/publications/sustainable​ -development/​brundtland​-report​.html 3. UNDP Climate Pledge, “What Are Carbon Markets and Why Are They Important?”, blog posts, May 18, 2022. IEA, 2022 Report. 4. Rajan (2021). 5. 6. Guarini and Oreiro (2022: 249). 7. Andersen (2022). Chiaretti in Valor (04/10/2021); Robinson in Valor (26/10/2021). 8. 9. Pope Francis (2015: 3). 10. The neoliberal years began in 1980, under the governments of Margaret Thatcher in the United Kingdom and Ronald Reagan in the United States, went through a crisis starting in 2008, and ended with the Covid pandemic in 2020. 11. Lipietz (2001: 25). 12. Atkinson (1999); Milanovic (2002, 2007); Atkinson and Piketty (2004); Palma (2006, 2009); Galbraith (2011). 13. Bresser-Pereira (forthcoming) The Rise and Fall of Neoliberal Rentier Capitalism, Oxford University Press. 14. Piketty (2013: 52; 429). 15. Atkinson (2015: 17–19). 16. Bresser-Pereira (1986). As I discussed in Bresser-Pereira (2016), the Information Technology Revolution is causing not an increase but a fall in the productivity of capital. 17. The Great Leveling was a period of relatively reduced inequality in Europe and the U.S. from World War I until the 1970s.

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18. Congressional Research Services, December 28, 2020. http://​bit​.ly/​3PnyxXQ 19. Landais (2007). 20. Solow (2014). 21. Where α is a relation, r the profit rate, and β the capital-product relation (the inverse of the product-capital relation we used in Chapter 11).

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Index phases of capitalist development 44–6 policies defining developmental state 43–4 rentier–financier neoliberal 52 state and market 41–3 summary 53–4 technical progress and rate of profit 98 capitalist revolution and developmental state 27–8 developmental state 33–5 formation of nation-states 31 Great Divergence, state, and imperialism 32–3 liberal form 28–30 social organization, forms of 30–31 types of capitalist revolution 35–9 carbon markets 152–3 Cardoso, Fernando Henrique 23 ‘centre-periphery’ 22 central banks 79–80, 81, 86, 88, 92, 109 Chenery, H.B. 121–2 Chick, Victoria 80 China 37–8, 60–61 city-states 46 classical and neoclassical microeconomics 57–9 classical political economy 5, 100, 101, 106–7 classical structuralist developmentalism 12–14, 15, 19–20, 22, 113–14 classical structuralist microeconomics 59–60 climate change 18, 149–50, 151–5 collectivity 150 colonialism 49 comparative unit labor cost index (CULCI) 107–8

access to demand theory 134–6 agrarian elites 29 anti-imperialism 21–2, 44 Arestis, Philip 91 Argentina 139–40, 145 Arrighi, Giovanni 33, 45 Asian financial crises 68–9 Atkinson, Anthony 156, 158 austerity 69–73 Austrian school 6–7 authoritarianism 27 balance of payments crises 68 Balassa-Samuelson effect 107–8 banking crises 68 Blinder, Alan 92 Blyth, Mark 70–71 bourgeoisie 15, 23, 27–8, 31, 32, 36, 47–8 Braudel, Fernand 45, 48 Brazil 14, 17, 38, 73, 77–8, 79, 80, 132, 136, 142, 146, 147, 161 Bresser-Pereira, Luiz Carlos 16–17, 69–70, 73, 77, 80, 89, 98–9, 99–101, 134–5, 136, 137, 140, 141–2 capital 94–6, 97–8 capital accumulation 27–8, 44–5, 65, 99 capital controls 62–3 capital flows 68, 105, 108–9, 120–21, 122, 123, 124–5, 132, 134 capital-saving technical progress 98–9 capitalist development, forms and phases of 41 growing role of market 53 industrial 48–50 managerial developmental 50–52 mercantilist 46–8 177

178

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competitive and non-competitive sectors, division between 60–61 Corden, Max W. 140 corruption 142, 143 cost inflation 88 countercyclical policies 102–3 country risk 75, 76, 77–8, 109 coups 23 Covid-19 pandemic 72 Cripps, Francis 85–6 currency cycle 128, 137 current account 20, 123, 131–3 access to demand theory 135–6 balanced 118, 119, 124 deficit equilibrium 132–3, 141 deficits 18, 66, 68–9, 120–21, 123–30, 137–8 and external constraint 138 policy 109–10 surpluses 107, 124, 126, 128 custom tariffs 43 DeLong, Bradford 92 democracy 27, 49 dependency theory 15, 23–4 devaluation 140 ‘developing countries’ 13 developmental state see capitalist revolution and developmental state Diamand, Marcelo 139–40 Dornbusch, Rudiger 105, 136 Dutch disease 16–17, 18, 19–20, 43, 127–8, 139–40, 154 extended 141–2 import tariffs 144, 145–6, 146–8 models 140 and natural resource curse 142–4 neutralizing 144–6, 147 East Asian countries 15, 37, 52, 124 economic crises 67 foreign debt crisis (1980s) 14–15, 16, 38, 122, 130, 161 economic growth/development 111–12 development as productive sophistication 112–13 growth models 113–16 investment rate 116–17

role of state 15–16 sustainable 151 Thirwall’s model 117–21 two-gap model 121–2 economic liberalism 5, 9, 22, 28–9, 41–2, 49, 57 economic nationalism 21–2, 23, 44 economic populism 136–7 economic thought, first schools of 3–6 economics, nature of 41 Edwards, Sebastian 136 effective cost of reproduction of labor power 101–2 England economic growth/development 111 formation of nation-state 31 entrepreneurs 48–50 equilibrium 17 Evans, Peter 25, 34, 35 exchange rate 18, 20–21, 62–3 access to demand theory 134–6 and current account 123–4, 126–7, 128–9, 130, 131, 132–3, 138 cycle 128–30, 134 determining 104–10 managed floating 133–4 multiple regimes 146 populism 123, 125, 129, 136–7 see also Dutch disease expectations 90–91 expected profit rate 116–17 export subsidies 145, 147 export tax 20, 144–5, 154 external constraint 138 externalities 59 Faletto, Enzo 23 falsificationism 2 financial crises 68–9, 76 global financial crisis (2008) 8, 24–5, 67 fiscal crisis 67–8, 69–70 fiscal deficits 18, 65–6, 67, 72 fiscal policy 66–7 fiscal populism 136 Fisher, Irving 84–5 floating exchange rate 133–4 foreign currency, value of 106–8 foreign debt crisis (1980s) 14–15, 16, 38, 122, 130, 161

Index

foreign savings 66, 124–7 forms of capitalist development see capitalist development, forms and phases of France, inequality 157, 159–60 Frank, André Gunder 23 French regulation school 24 Friedman, Milton 85–6, 90 Fuel, Tomás Heródoto 143 functional distribution of income 96–7, 100 Furtado, Celso 22, 28 Galbraith, John K. 28 GDP per capita 112, 113 Gellner, Ernest 31 Germany 36, 47, 71, 124 Gini coefficient 158 Global Carbon Incentive (GCI) 153–4 global financial crisis (2008) 8, 24–5, 67 globalization 52 Great Britain economic growth/development 111 inequality 158 Great Divergence 32–3 greenhouse gas (GHG) emissions, reducing 151–4 growth see economic growth/ development Guarini, Giulio 154 Hamilton, Alexander 36, 47 Harrod-Domar model 114, 115 Harvey, John T. 105 Hayek, Friedrich 7 Hume, David 71 Hussain, M. Nureldin 120–21 hyperinflation 91, 137 hypothetico–deductive method 5, 6, 7–8, 10 imperialism 5, 19, 33, 49–50 anti-imperialism 21–2, 44 import substitution 14, 15 import tariffs 14, 15, 16, 20, 36, 42–3, 144, 145–6, 146–8 industrial equilibrium 132–3, 139, 141–2 industrial phase of capitalist development 48–50

179

industrial revolutions 31, 47 industrialization 13–14, 15, 19–20, 29, 112, 139, 144, 146–7, 158 inequality 156–61 inertial inflation 17, 83, 88–90, 91–2 infant industry argument 146–7 inflation 83–4 cost inflation 88 and exchange rate 137 expectations 90–91 hyperinflation 91, 137 inertial 17, 83, 88–90, 91–2 limitations of economic theory 91–2 and money supply 79, 80, 84–5 orthodox theory of 84–6 post-Keynesian theory of 86–8 rate 62 targeting 81, 86 information technology revolution, and inequality 160 institutions 30–31, 32–3 interest policy 81 interest rate 62, 75–8, 81, 109 Internet giants 99 investment 67, 114, 115–17, 134–6 Japan 37 Johnson, Chalmers 34 Kaldor, Nicholas 13, 79 Kalecki, Michal 8–9, 10, 116 Keynes, John Maynard and Keynesian economics 8–10, 65–6, 67, 75–6, 78, 86–7, 113–14, 116, 119 see also post-Keynesian economics King, J.E. 80–81 Knapp, George Friedrich 24 Kuznets curve 158 Labini, Paolo Sylos 78–9 labor productivity 95, 98, 113, 114 labor theory of value 5, 58, 101–2 law of comparative advantage 5 liberalism, economic 5, 9, 22, 28–9, 41–2, 49, 57 liberals, use of term 42 List, Friedrich 14, 146 macroeconomics 56, 61–3, 64–6

180

New developmentalism

managed floating exchange rate 133–4 managerial developmental phase of capitalist development 50–52 Mao Zedong 37–8 Marconi, Nelson 73 marginal utility 58–9 market 3–4, 5, 17–18, 31 failures 57 growing role of 53 and state 41–3, 53 Marshall, Alfred 6 Marx, Karl and Marxism 5, 6, 23, 58, 75–6, 94–5, 99–100, 101, 116, 160 meat consumption, reducing 154 mercantilism 3–4, 118–19 mercantilist phase of capitalist development 46–8 methodological sciences 1, 2 Mexico 38 microeconomics 56–7 classical and neoclassical 57–9 classical structuralist 59–60 new developmentalist 60–61 Milanovic, Branko 156, 158 modern monetary theory (MMT) 10–11, 24–5, 72, 73 monarchs 4, 30, 31, 36, 48 monetarism 83–6, 90–91 monetary financing of public spending 72–3 monetary policy 81 money 64, 72, 76, 78 money supply 78–81, 84–5, 86, 88, 90 Moore, Basil 79–80 Nakano, Yoshiaki 17, 77, 80, 89 nation-state formation of 27, 31 see also capitalist revolution and developmental state nationalism, economic 21–2, 23, 44 natural resource curse 142–4 nature protection 149, 150, 151, 152, 154, 155 Neary, J. Peter 140 neoclassical economics 6–8, 9, 58–9, 112 ‘neoliberal turn’ 14–15, 16 neoliberalism 8, 9, 24, 51–2, 102–3 and exchange rate 137

and inequality 156, 160–61 and privatization 61 Netherlands 47–8 new developmentalism (ND) comparing with classical structuralist developmentalism 19–20 comparing with post-Keynesian economics 20–21 concept of 1 development and summary of 16–18 O’Connor, James 69–70 oil exporters 128 Okishio’s Theorem 97–8 ordoliberalism 61, 71 Oreiro, José Luis 154 ‘organizational revolution’ 50 orthodox economics, criticism of 2 Paris Agreement 155 Peirce, Charles 2 phases of capitalist development see capitalist development, forms and phases of Phillips curve 85–6 philosophical idealism 7 Pierson, Paul 70 Piketty, Thomas 156–7, 160 planning 60, 121–2 political economy classical 5, 100, 101, 106–7 Marxist school of 6 Pope Francis 155 Popper, Karl 2 populism 52, 102–3, 136–7 exchange rate 123, 125, 129, 136–7 post-Keynesian economics 8–11, 20–21, 64, 80–81 exchange rate 105 growth 118–21 inflation 83–4, 86–8, 91–2 investment 116 Prebisch, Raúl 13, 22 predatory states 35 prices 57–8, 59, 62–3 privatization 61 product–capital ratio 94, 95–6, 97–8 productive sophistication 112–13

Index

productivity 94–6, 97, 98, 100–101, 113, 114–15, 158–9, 160 profit rate 58, 62, 94 and cost of reproduction of labor power 101–2 expected 116–17 long-run constancy of 99–101 Okishio’s Theorem 97–8 and phases of capitalist development 98 and technical progress 94–7, 98–9 progress 151 public bureaucracy 34 public patrimony 150 purchasing power parity (PPP) 104–5, 106, 108 quantitative easing 24–5, 72, 73 Rajan, Raghuram 153–4 Rangel, Ignacio 79, 80 rational expectations 90–91 reality 1, 2–3, 7 regulation school 24 reinvestment of profits 28 religion 30, 31 renewable energy 153 rentier–financier neoliberal phase of capitalist development 52 Ricardo, David 5, 48 Robinson, Mary 155 Rosenstein-Rodan, Paul 13 Sachs, Jeffrey 143–4 satisfactory rate of profit 117 Saudi Arabia 128 savings 66, 115, 124–7 Sawyer, Malcolm 91 Say’s law 9–10, 85 sciences 1, 2, 3 sea level rise 150 second generation developmentalism 14–16 Serra, Antonio 4 Smith, Adam 5, 48 social democracy 50, 51 social order, and austerity 71–3 social sciences 1–3 societies/social organization 30–31

181

sociology of development 25 Solow growth model 114–15 South Korea 37 state 17–18, 25, 54 formation of nation-state 27, 31 intervention, desirability of 57 and market 41–3, 53 planning 60 role of 15–16, 53 see also capitalist revolution and developmental state statism 42 Stuart Mill, John 5 subsidiarity 61 subsidies exports 145, 147 investments in renewable energies 153 substantive sciences 1, 2 substitution of domestic savings for foreign savings, rate of 125–7 surplus value 58, 102 sustainable development 151 syllogisms 2, 3, 5, 59 Taiwan 37 Tavares, Maria Conceição 14 taxes exports 20, 144–5, 154 and nature protection 152 technical progress 94–7, 116 capital-saving 98–9 Okishio’s Theorem 97–8 and phases of capitalist development 98 terms of trade 108 Thirwall growth model 117–21 total factor productivity (TFP) 115 truth 1, 2, 7 two-gap model 121–2 ‘underdeveloped countries’ 13 underdevelopment 22 United States (US) 14, 15–16, 23, 36, 42–3, 52, 124, 144, 147, 156–7, 158–9 utility 58–9 value 58

182

New developmentalism

wage–cost–margin (WCM) theory 87–8 wage rate 62, 94, 100–101 wages 85–6, 88, 96–7, 98, 99, 101–2, 158–60

Warner, Andrew 143–4 Weintraub, Sidney 87–8 World Trade Organization (WTO) 145