The year 2025 will be the third consecutive year in which the Brazilian economy experiences sustained growth. During the first two years of his administration, economic expansion was above 3% annually, while the outlook for 2025 is for a slowdown: 2.4%, according to IPEA, one of Brazil’s leading state economic analysis agencies.

Since June-July 2024, during the U.S. presidential election and with the possibility of Trump being re-elected, Brazil, like other emerging economies, faced devaluation pressures. This led to higher inflation due to rising exchange rates and supply shocks caused by climate issues. These issues have reduced the food supply (mainly coffee, eggs, and beans), causing prices to rise.

This macroeconomic instability scenario was reloaded by the Trump-driven trade war, particularly when the 50% tariff on purchases from Brazil was announced under a mix of arguments between commercial (trade deficit), political (preventing Bolsonaro from being judged for an attempted coup d’茅tat and US bigtech鈥檚 regulation), and geopolitical (the advance of the BRICS on a possible replacement of the dollar in commercial relationships).

What was the response in terms of economic policy? The institutionalization of the inflation target led to an increase in the SELIC interest rate from 10.75% in September 2024 to 15% in June 2025, the highest level since 2006. The orthodox argument suggests that raising interest rates reduces the money supply, curbing aggregate demand and reducing inflation. From another perspective, raising interest rates promotes carry trade, which attracts foreign capital through the capital account and allows the exchange rate to appreciate. In this way, the economy partially protects itself from speculative capital outflows and reduces the prices of imports and exports, thus decreasing the inflation.

In contrast, a sharp rise in interest rates deepens the pernicious effects of financialization: it impoverishes indebted families and concentrates income. Are there any other alternatives available? The economic toolbox offers other options. Many observers have noted a striking characteristic of Lula鈥檚 third administration: the absence of open confrontation with Brazil’s powerful financial sector. This is no coincidence. The painful lessons of Dilma Rousseff’s presidency (2011-2016) and her impeachment weigh heavily on current political calculations.

To understand this, we need to analyze the historical lesson of Rousseff’s removal, its macroeconomic causes, and how this experience has limited economic policy options.

On Dilma Rousseff鈥檚 impeachment lessons

Dilma鈥檚 presidencies (2011鈥�2016) were interrupted by what many analysts鈥攊ncluding myself鈥攃onsider a parliamentary coup. The formal justification for her removal from office was the use of financial resources from decentralized public entities (with fiscal surpluses) to pay for central government expenses (a fiscal deficit)鈥攅ssentially, a financial maneuver to ensure the continuity of state expenditures. Ironically, a few months later, Congress approved a law that allowed up to 15% of similar transfers.

While this was a legal argument, the political environment was shaped by broader narratives of corruption surrounding the Workers鈥� Party (PT). Scandals such as the 尘别苍蝉补濒茫辞, the misuse of Petrobras funds, and eventually the Lava Jato operation led by judge S茅rgio Moro (which gained international visibility) all created fertile terrain for political destabilization. The economic slowdown also contributed to Dilma鈥檚 declining popularity and created an opening for her opponents to press for her removal shortly after she won re-election.

While the present government has not directly challenged financial capital as Dilma once attempted, perhaps we could draw a line connecting the lessons of her government to the current dilemmas of the Lula government.

Dilma鈥檚 first administration (2011-2014) faced direct conflict with the financial banking sector. She attempted to lower interest rates from 12.5% to 7% to reduce financing costs and encourage productive capital. However, when commodity prices fell internationally in 2012, this led to reduced capital inflows and a depreciation of the exchange rate (1,69 to 2,03 BRL/USD in a six-month period). Alongside the deregulation of the electrical system, this caused inflation to increase from 6.0% to 7.3% (IBGE).

The increased inflation created widespread discontent and raised doubts about the economic viability of the Workers’ Party’s political projects. The response was to increase the interest rate from 7.25% to 11%, which benefited the financial banking sector and led to fiscal cuts. As lowering the interest rate failed, a new economic plan was introduced to boost (private) investment by giving tax breaks to certain industries. This caused a significant drop in tax revenue, leading to cuts in public spending. As a result, overall demand fell, and private investments did not increase, as expected. There was no expected substitution between public and private investment.

The severe economic crisis increased, with GDP dropping by six points between 2015 and 2016. The crisis worsened Dilma’s reputation and gave the opposition in Congress the opportunity to push for impeachment using false claims, which they did.

Lula 3.0: Strategic trade-off or missed opportunity?

Learning from past experiences, Lula’s new government decided not to confront the financial banking sector or reduce the Central Bank’s interest rate. Instead, they maintained the institution’s independence in monetary policy and partially revived the social agenda based on Lula’s first two terms.

First, they encouraged gradual increases in the minimum wage to boost economic growth and improve income distribution. Second, they renegotiated family debt to ease financial burdens by rescheduling and reducing the debt amounts. Third, they relaunched the housing program, Minha Casa Minha Vida, with subsidized interest rates, which led to a 15% increase in contracts at the beginning of 2025.

Public spending management deserves separate consideration. On the one hand, the institutional framework of fiscal rules was maintained, initially with the spending ceiling inherited from Michel Temer’s administration and its reformulation through the New Fiscal Regime (Novo Arcabou莽o Fiscal), which allows for spending expansion of up to 2.5% annually to consolidate fiscal balance in the medium term. In parallel, several parliamentary amendments were approved to overcome these limits, notably the transitional reform that enabled the reinstatement of the Bolsa Fam铆lia program and the relief spending package for Rio Grande do Sul due to major floods in 2024. The first two years of administration involved a 5% increase. However, a significant contingency and spending freeze is expected for 2025: approximately $2 billion (0.1% of GDP).

From 2023 to 2024, household consumption and exports were the main drivers of Brazil鈥檚 economic growth. Gross capital formation (investments) only began to increase in the final quarter of 2024 and fell again in the second quarter of 2025 (IBGE, 2025). Ultimately, it is unclear whether these fragmented factors will ensure continued growth in the future. Rising interest rates are expected to slow economic growth to less than 3%, possibly close to 2%, with the sole objective of containing inflation. However, it remains unclear whether these factors ensure continuous growth in the long term. The increase in interest rates is expected to slow economic growth to less than 3%, possibly even below 2%, to reduce inflation.

As inflation is not always caused by higher demand, there is debate on whether this will work. Higher interest rates can strengthen the currency, which may lower the cost of imported goods and ease inflationary pressure. However, environmental issues continue to cause supply problems, and maintaining high interest rates incurs social costs. First, private investments decrease because borrowing becomes too expensive, and public investment through SOEs, such as Petrobras, would not be enough to stimulate aggregate demand. Second, higher interest rates increase government bond returns. More public money is allocated to bondholders, leading to regressive income distribution.

The New Fiscal Scheme (NFS) limits public spending by 2.5% per year and does not provide significant room for large-scale projects such as the Growth Acceleration Program (PAC) initiated after the 2008 financial crisis. The only way to create additional fiscal space is through tax increases. As taxing billionaires has not been completely successful, no public investment will be encouraged, and more public money will be in the hands of the wealthiest Brazilian families.

The current debate within the Workers鈥� Party is about the success of its economic plans. On the one hand, they choose not to challenge the financial banking system and its usual beneficiaries. However, they ignored the social demands for more public spending on education, infrastructure, health, and social rights. These issues have long been present in Brazilian democracy, particularly for the most disadvantaged groups.

Lula, Brazilian economy and democratic perspectives

With elections approaching the following year, the question is whether the Workers’ Party government can sustain its political project. Although unemployment is historically low, the achievements of Lula’s third term remain uncertain. Although there has been slight economic growth and income improvement, deep social transformation goals remain unfulfilled.

Trump’s presidency has created international instability and has fostered the approach of Brazil to the BRICS. In this sense, the unilateral imposition of 50% tariffs has been considered a direct attack by dominant nationalist sectors, which has resulted in unexpected support for Lula (particularly, large financial and banking conglomerates). However, this support is likely to be diluted by 2026.

In a previous article, we outlined three possible scenarios for 2026 .

1. Lula鈥檚 continuum: This scenario envisions a continued mandate for Lula or a successor, enabling deeper transformations that significantly enhance the masses鈥� quality of life. However, economic results would ideally follow a path of gradual improvement, partially satisfying the basis of popular support.

2. Great political moderation. In this scenario, the outcome of Lula’s third term fell short of maintaining popular support. This could create a political space for conservative sectors to promote a candidate from the economic and financial establishment that is not necessarily linked to the ultra-right or Bolsonaro movement.
3. Polarization and Discontent: This scenario posits a complete disagreement with the results of Lula’s third term, leading to increased polarization between PT’s ideological supporters and a new leadership emerging from the extreme right, possibly figures such as S茫o Paulo Governor Tarc铆sio de Freitas or members of Jair Bolsonaro’s family.

After Bolsonaro sentenced to 27 years in prison, the involvement of part of the military leadership in the attempted coup d’茅tat, and the Trump effect, the economic and political results seem to be heading towards a bifurcation between scenarios 1 and 2. Recent history reminds us of how quickly unexpected shocks鈥� geopolitical, climatic, or domestic鈥攃an alter this picture.

Sergio Martin P谩ez is a Professor of Macroeconomics and Economic Development at the Institute of Urban and Regional Research and Planning (UFRJ-Brazil). Postdoctoral researcher at the same university with financial support from FAPERJ.

By Jacob Assa and Marc Morgan

鈥淭he purpose of studying economics is not to acquire a set of ready-made answers to economic questions, but to learn how to avoid being deceived by economists.鈥�
鈥� Joan Robinson

Recent years have seen a proliferation of debates on the shrinking of fiscal space in both industrialized and developing countries. In the former, the discussion often takes the form of agonizing over fiscal 鈥樷��, whereas in the latter it is usually presented in the context of 鈥樷��.

In reality, the real black holes, or blind spots, are those found in neoclassical economic models underlying such debates, rather than in the real economy (Table 1). We describe three such neoclassical fiscal black holes, based on our recent paper 鈥樷��.

Table 1. Overview of fiscal black holes in the neoclassical paradigm.

Source: Authors鈥� elaboration. Shaded in black are the black holes of the neoclassical fiscal paradigm.

We show how fiscal space is not the absolute sum of taxes and borrowing, but rather relative in several ways. It depends on macroeconomic conditions, such as unemployment and inflation, countries鈥� degree of monetary sovereignty, and their level of productive capacity. Furthermore, fiscal space is relative to what governments do with it, expanding or contracting depending on the function of public spending.

Neoclassical Black Hole #1:            A Gilded Cage

Mainstream economic models rely on an anachronistic view of public finances dating back to the gold-standard era, or at least to the quasi-gold-standard post-war period of the Bretton Woods system, when the US dollar was pegged to gold, and all other major currencies were fixed vis-a-vis the US dollar.

In that reality, fiscal space was absolute – the sum of tax revenue and government borrowing. This was the case since, while a country could always issue more of its own currency, the peg to gold or another currency forced it to obtain that external currency to protect the agreed exchange rate, or risk depreciation.

This situation ended in 1971, when the United States forfeited the link to gold, making the US dollar a fiat currency, one whose value is determined by decree (fiat in Latin) rather than being based on its relationship to a commodity like gold or silver. All other major currencies were likewise floated and their exchange rates have since been determined by market dynamics.

In a fiat-money world, nothing limits the ability of a currency-issuing government from creating as much money as it needs. Alan Greenspan, chairman of the US Federal Reserve from 1987 to 2006, to a congressional committee. We have seen this in action after the 2007-8 recession, the COVID-19 pandemic, several rounds of quantitative easing, and every time countries go to war.

However, while the public supply of money in a fiat system is infinite, real resources in the economy – labor, capital equipment and nature – are finite. Therefore, how and where the money is spent matters. This leads us to the next two black holes.

Neoclassical Black Hole #2:            The Invisible Private Sector

Mainstream economics is of two minds about the private sector. In theory, it sings its praises as the source of all innovation and growth, positing that the invisible hand of the market can lead to optimal social outcomes. In practice, in modelling fiscal and debt sustainability, it is the private sector itself which is invisible.

This paradox is the result of the twin-deficit theory, which claims that increased public (domestic) deficits lead to larger external deficits, since higher government spending 鈥榗rowds out鈥� private savings. Public spending in this view has to come at the expense of private spending, since money is seen to be a scarce resource, limited by the fixed amount of currency (e.g. US dollars) or precious metal (in the bygone era) a country has.

In reality, the economy has three institutional sectors – public, private and external. Furthermore, the balances of all three sectors must add up to zero by accounting identity. This has been recognized in the , the of Wynne Godley, as well as by leading investment banks such as and .

Looking at the sectoral balances of the US economy (Figure 2) reveals two different aspects of the second black hole of neoclassical theory.

Figure 1. Sectoral balances in the US, 1960-2024

First, holding the external balance constant, the public sector鈥檚 deficit is equal to the private sector鈥檚 surplus. That is, domestic government spending does not simply disappear into a black hole but is spent into the private sector (hiring teachers, doctors, building bridges and roads, and so forth). Accumulated public deficits constitute the public debt, but that is also by definition the stock of private wealth (held in cash, deposits, bonds, or another form of financial or non-financial asset). Looking at only one side of this is incomplete and misleading.

Second, private deficits are the real danger. In contrast to a currency-issuing government which can never run out of its own money, private households and businesses cannot create money to self-finance. Private banks (under license by the government) create money as loans but the new assets (deposits) are equal to the new liabilities (loans) so there is no increase in the private sector鈥檚 net financial position. Private deficits increase private debt and the risk of insolvency. In the lead-up to the 2007-8 crisis this was ignored by most economists (who use neoclassical equilibrium models), except for those using such three-dimensional (3D) . In fact, reducing fiscal deficits (i.e. increasing private sector deficits and debt ceteris paribus) in the US has led in every single case to a major .

Macroeconomic accounting models thus allow us to go beyond the market/state dichotomy, since public deficits fund private surpluses (as long as public spending is not feeding the external account directly), which then translate into profits, investment and .

Let us illustrate this black hole with an example. An absolute approach would likely evaluate a 5% public deficit as too big, passing targets conventionally believed to be good practice such as a balance at 0% or a deficit limit of 3% of GDP. By contrast, the fact that the private sector cannot run a deficit for long determines the minimum public sector deficit as being equal to or greater than the external sector balance (at least over a medium term horizon and conditional on public socio-economic objectives). In other words:

Absolute fiscal space: public deficit 5% > (0% 娄 3%) – too big

Relative fiscal space: public deficit 5% < 6% external deficit – too small

This is true not just for the advanced economies but also for developing economies. A neoclassical twin-deficit view would struggle to explain how China, a country running public deficits in 26 of the last 27 years (Figure 3), could become the workshop of the world. The 3D view of sectoral balances, however, shows the massive benefits to China鈥檚 private sector of these productive public deficits, which increased after the current account surplus declined precipitously following the 2007-8 global financial crisis.

Figure 2. Sectoral balances in China, 1997-2024.

Source: .

Public deficits do only help to create private surpluses, but also affect real economic activities such as production. Thus they impact the general utilization of real resources, affecting the unemployment rate and the rate of inflation. When there are more unemployed (or underemployed) resources, public deficits can stimulate their employment without stoking inflation, compared to an economy with fully employed resources.

Repeating the example above:

Absolute fiscal space: public deficit 5% > (0% 娄 3%) – too big

Relative fiscal space: public deficit 5% < 6% external deficit – too small

Relative fiscal space: public deficit 6% >= 6 % external deficit and low unemployment – sufficient

Relative fiscal space: public deficit 6% >= 6 % external deficit and high unemployment – too small

These were the key insights of and , among others. However, as they were based in and writing about industrialized economies (the UK and US, respectively), we consider this a special case of fiscal relativity, applying only to developed countries. To examine fiscal space in developing countries, we need to to account for their lower levels of productive capacity and monetary sovereignty.

Neoclassical Black Hole #3:            Monetary Sovereignty and Productive Capacity

Compared to the world before World War II, most countries today are politically sovereign having achieved their independence through the process of decolonization in the post-war decades. However, many former colonies are still economically dependent on advanced economies, for several reasons.

First, they have low productive capacity and typically export low-value added raw materials and minerals, while importing high-value added machinery. This leads to negative terms of trade, persistent trade deficits, and high external (foreign-currency) debt.

Second, and related to this, indebtedness in foreign currency is far more complex than domestic currency debt. The former requires the borrowing country to have sufficient foreign exchange reserves, and also exposes it to exchange-rate volatility. If its currency depreciates against the foreign currency of its debt (e.g. dollar or Euro), it owes more in local currency terms. Default in foreign currency is possible and not infrequent.

In contrast, domestic public 鈥榙ebt鈥�, as seen above, is the same as domestic wealth. Where the government sells bonds to private investors, it can always pay the principal and interest without default or exchange rate risks. Most of the more successful developing countries have thus reduced the share of foreign currency debt in their total borrowing over time (Figure 4).

Figure 3. Foreign currency public debt as a share of total public debt.

Source: IMF World Economic Outlook.

Other factors reducing the monetary sovereignty of countries include not having their own currency at all (e.g. the CFA countries in Africa or Euro countries in Europe), fixed exchange rates, a high degree of inelastic imports (e.g. food and fuel imports), and not having a liquid currency. The following chart ranks regions by our .

Figure 4. Monetary Sovereignty Index Across World Regions.

Source: .

One notable finding in this graph is that Euro countries are ranked third from the bottom, below non-CFA African countries. The latter have more monetary sovereignty than the former, since they issue their own currency. The former rely on an external issuer (the ECB) for money creation.

However, European countries have higher productive capacity than African countries, and can thus absorb more public spending before inflation starts to kick in. And again, the level of unemployment in each country matters too. Combining these four elements together we arrive at a general relativity of fiscal space, applicable for all countries, and operationalized in our . Figure 6 shows the five countries with the highest index of fiscal space, and its decomposition.

Figure 5. Fiscal Space Index in the top 5 countries, 2022.

Source: .

An important implication of the relativity of fiscal space is not how much a country has at any particular moment. It is the fact that it can contract or expand its fiscal space depending on what it spends on. This can be seen in several counterintuitive general examples.

In the mainstream interpretation, public deficits are thought to create 鈥榖lack holes鈥� by increasing the public debt to supposedly unsustainable levels. But targeting public spending on utilizing unemployed resources can lead to economic growth which is faster than the growth rate of debt. This in fact would reduce the economy’s debt burden.

Deficits are also expected to increase inflation in the twin-deficit view. But if the spending is directed to creating more productive capacity, especially of food and energy, this would reduce the need to import these strategic inputs. Since global commodity prices of food and energy are volatile, and tend to rise during global crises, such 鈥榩roductive deficits鈥� would reduce the potential for pass-through inflation from abroad, thus enhancing fiscal space for the future.

Another example is choosing to finance infrastructure projects with domestic (deficit) spending rather than with borrowed foreign debt. After spending, the government can sell bonds to drain the additional liquidity created through its spending. This requires a sufficiently developed domestic financial market. Alternatively, the government could just spend and tax the additional liquidity instead of issuing bonds. The newly created domestic 鈥榙ebt鈥� is also newly created private sector wealth in the form of differently held assets and additionally has no exchange rate risk or default risk. By increasing its monetary sovereignty, the country has increased its future fiscal space, despite (or because of) functional deficit spending.

To take a concrete example, let鈥檚 look at China. As Figure 6 shows, China is the country with the fifth highest fiscal space according to our estimates (for 2022). Table 2 breaks China鈥檚 record down further, showing how it scores highly on components that positively impact fiscal space and lowly for components that negatively impact fiscal space. The country has recognized the importance of exercising its sovereignty over domestic policy, meaning it has made institutional choices that has given it the fiscal space to attain its economic objectives – it issues its own currency, it operates a (managed) flexible exchange rate (aided by a tightly regulated capital account), it prioritizes issuing public debt in its domestic currency, it targets a high utilization of resources and a high domestic productive capacity that forgoes excessive dependence on food and fuel imports. There is a blueprint in this record, one in which all the determinants of fiscal space are taken seriously.^[1]

There is also the consideration of international sovereignty over domestic policy, in which institutional choices made collectively by the global community impinge on national fiscal space. Among the variables included in our analysis, this concerns the convention of foreign exchange reserves (dependent on foreign demand for the country鈥檚 production and on the international monetary system more generally – for example the existence of an international central bank operating a global unit of account), and currency liquidity (dependent on foreign demand to hold the country鈥檚 currency, which would be aided by requiring payment of trade in the currency of the importing country or by requiring foreign direct investment into the importing country鈥檚 economy, subject to transparent legal frameworks). China has been acutely aware of these asymmetric interdependencies, hence its strategic moves to not be subject to their worst side-effects (e.g. currency and balance of payments crises). An increasing cohort of smaller developing countries are seeing eye to eye on this, demanding reform to the international monetary system in these directions to better aid their chances at development. 

Table 2. Decomposition of fiscal space in China, 2022

Source: . Shown are the four components of our fiscal space index by the positive or negative impact each has on the overall index, the Chinese values of each component, and how the Chinese values rank compared to other countries, as well as the global weights of each component in the principal component analysis (PCA) for the 150 countries.

These ideas may seem to go against the current of mainstream economic policy, which encourages countries, both developed and developing, to balance their budgets, borrow in global capital markets, and hope for their private sector to fund the public sphere.

This approach is not just cautious; it is incoherent and reckless given the framework presented above. Keeping in mind the three-dimensionality of sectoral balances, their link to the real economy鈥檚 productive capacity, and the global dimensions of monetary sovereignty, the opposite approach – strategic, targeted public spending to achieve concrete developmental objectives – is what should become the new conventional wisdom.

Audentes fortuna iuvat

Jacob Assa holds a PhD in Economics from The New School for Social Research.

is a Research and Teaching Fellow in the Department of History, Economics and Society and the Paul Bairoch Institute of Economic History at the University of Geneva (UNIGE).

Notes

^[1] For comparison, South Africa鈥檚 high fiscal space estimate in Figure 6 is predominantly the result of its excessive unemployment rate of between one quarter and one third of the labour force.

In January 2023, Luiz In谩cio “Lula” da Silva, leader of the Partido dos Trabalhadores (PT), began his third term as the president of Brazil, the largest economy in Latin America. The economic outlook is promising, with steady growth, controlled inflation, and declining unemployment rate. Despite challenges from a difficult Congress, Lula aimed to revive social and economic policies from his earlier terms (2002-2010). Simultaneously, he is pursuing an active international agenda focused on peace in the Middle East and Ukraine, environmental protection, and reforms in global governance. Brazil’s G20 presidency will conclude in November with a meeting in Rio de Janeiro that is expected to introduce new tax measures on billionaires and initiatives to boost environmental conservation. A Global Alliance Against Hunger will also be launched to tackle global issues.

This article explores the potential for necessary changes to meet Brazilian demands, concerns about the macroeconomic trajectory’s sustainability, and political tensions leading to the 2026 elections. The central argument is that Lula’s external strategy is closely tied to strengthening the internal disputes affected by neoliberal institutions. Success in this approach is vital not only for achieving structural improvements, but also for safeguarding the democratic regime, which faced threats just eight days after Lula took office.

FROM THE PLAN TO ECONOMIC REALITY

Lula’s first years in office have demonstrated promising economic results, surpassing market expectations with a growth rate of 2.9% in 2023 and a projected growth of around 3% in 2024, which is significantly higher than the anticipated 1%. This outpaced both Latin American and global growth averages. Key contributing factors include a substantial increase in exports driven by strong soybean and corn harvests and an increase in household consumption. The recovery of income transfer programs, an 8% increase in the minimum wage at the beginning of 2023, and a decline in unemployment stimulated this consumption. Additionally, successful negotiations in Congress allowed for extra spending, facilitating the resumption of the Bolsa Fam铆lia program鈥擫ula’s flagship social transfer initiative鈥攚hich further enhanced the purchasing power of many families.

Inflation has also declined, dropping from 9.3% in 2022 to 4.5% by mid-2024. This reduction can be attributed to the appreciation of the nominal exchange rate and strategic changes in Petrobras鈥檚 pricing policies, a state-owned oil company. A high reference interest rate, maintained between 10% and 13%, has attracted capital inflows, contributing to the nominal appreciation of the Brazilian real, from six to five reais per dollar. This appreciation has helped ease domestic price pressures, while the abandonment of Petrobras鈥檚 import parity pricing has insulated fuel prices from international fluctuations. Moreover, unemployment rates have improved, decreasing from 8.4% to 6.4%, the lowest level since 2012.

Looking ahead, the projections indicate a slowdown in growth and controlled inflation, although several underlying risks remain. Estimates for 2025 anticipate a modest growth rate of 1%, reflecting the challenges within the neoliberal economic policy framework. The expected agricultural export boom may face obstacles owing to a 20% decline in international prices and severe flooding in Rio Grande do Sul, a crucial agricultural region. Additionally, gross fixed capital formation fell by 3% in 2023, particularly for machinery and equipment, signaling a trend toward productive disinvestment.

Specific tensions persist, especially regarding fiscal policy and proposed changes to public spending rules, along with the Central Bank’s focus on inflation targeting in its exchange and monetary policies. The New Fiscal Scheme (NFS) limits public spending by 2.5% per year and does not provide significant room for large-scale projects, such as the Growth Acceleration Program (PAC) initiated after the 2008 financial crisis. The only way to create additional fiscal space is through tax increases. While newly approved taxes on ultra-wealthy investment funds and simplifications to consumption taxes may boost future tax revenues, they are unlikely to generate sufficient fiscal space for substantial economic initiatives. If inflation projections hold, the new formula for adjusting the minimum wage could lead to real improvements in workers’ living conditions, offering a glimmer of hope for economic growth.

Since June 2024, the international environment has prompted capital outflows and pressure for currency devaluation amid a strengthening dollar against emerging market currencies. This has led to an increase in the exchange rate from 5.10 to 5.85 reais per dollar, prompting government intervention. These exchange rate pressures could lead to higher inflation, and the Central Bank鈥檚 inflation targeting policy might necessitate increased interest rates, potentially dampening consumption鈥攖he sole growth vector thus far. The emerging prospects underscore the restrictive nature of neoliberal institutional frameworks. In a deteriorating international scenario, these frameworks significantly limit policies aimed at stimulating economic growth and job creation, likely undermining popular support for the Workers’ Party (PT).

THE DOUBLE FRONT OF POLITICAL DISPUTE

The first 22 months of Lula’s administration were characterized by two primary fronts of political engagement. The first is Brazil’s re-emergence on the international stage, where Lula’s charismatic leadership has brought attention to pressing global issues. The second front involves internal political struggles marked by negotiations with Congress and the “independent” Central Bank president. This internal conflict has necessitated a delicate balance to defend democracy amid rising tensions. Just eight days after taking office, Lula faced an attempted coup in Bras铆lia by right-wing groups reportedly backed by military elements, political parties, and the former far-right president, Jair Bolsonaro. A strong international condemnation, combined with decisive judiciary intervention, has played a crucial role in preserving democratic order.

Initial assessments suggest notable progress on both fronts, although external achievements have outstripped internal ones. Although Bolsonaro鈥檚 disqualification from elections until 2030 weakened the primary opposition, the threat to democracy remained palpable. The municipal elections last October showed enduring popular support for far-right factions. This dual strategy, addressing both international and domestic issues, acts as a cohesive mechanism; the international agenda creates a vital space for internal maneuvering, pressuring progressive institutional changes, such as implementing higher taxes on the wealthiest individuals. Historical experiences from Lula’s and Dilma’s administrations, particularly the parliamentary coup, demonstrate that meaningful transformation requires addressing more than just internal conflicts, as all parties, especially capital and labor, must benefit from these changes.

Confronting the Western neoliberal consensus is critical to preventing societal demands for transformation from being penalized by international financial markets, which can manipulate credit ratings and provoke tensions in exchange rates, inflation, and macroeconomic instability鈥攅lements that could be perceived as a “soft coup” by market forces. The push for a multipolar international system anchored in initiatives like BRICS is gaining traction, with the inclusion of new partners (BRICS+) becoming increasingly significant. A comprehensive strategy for sustainable growth and development has emerged as a priority, earning Lula invitations to key international events such as COP27 and rekindling relations with G-7 economies. This dual approach exemplifies how international relations can expand domestic political maneuvering.

On the local front, tensions in economic policy highlight two critical aspects of the neoliberal institutional framework: (i) fiscal policy and potential adjustments to public spending rules and (ii) the Central Bank鈥檚 exchange and monetary policy, which is heavily focused on inflation targeting. These tools are central to the functioning of the Brazilian state but often hinder democratic efforts to address urgent social needs, such as building larger schools and universities, improving the water supply in drought-affected regions, expanding healthcare coverage, and fulfilling other social commitments. Instead of resorting to street mobilization or constitutional referendums to break congressional gridlock, as seen in Colombia and Chile, Lula aims to foster a new international consensus to counter the global rise of anti-democratic ultra-right and fascist movements.

PERSPECTIVES FOR THE PT鈥橲 POLITICAL PROJECT

Emerging prospects can be framed in three possible scenarios.

1. Advancement of International Patterns: This scenario envisions a continued mandate for Lula or a successor, enabling deeper transformations that significantly enhance the quality of life of the majority. Economic results would ideally follow a path of gradual improvement, partially satisfying the basis of popular support and facilitating continuity through the vote in 2026.
2. Political Blockage: In this scenario, the outcome of Lula’s third term may fall short of maintaining popular support. This could create a political space for conservative sectors to promote a candidate from the economic and financial establishment, not necessarily linked to the ultra-right or Bolsonaro movement.
3. Polarization and Discontent: This scenario posits a complete disagreement with the results of Lula’s third term, leading to increased polarization between PT’s ideological supporters and a new leadership emerging from the extreme right, possibly figures such as S茫o Paulo Governor Tarc铆sio de Freitas, or members of Jair Bolsonaro’s family.

Currently, the trajectory appears to lean between scenarios one and two. However, history reminds us that “unexpected” geopolitical, health, and climatic events can swiftly alter the course of events.

Sergio Martin Paez is Professor of Macroeconomics and Economic Development at the Institute of Urban and Regional Research and Planning (UFRJ-Brazil) and postdoctoral researcher at the same university with financial support from FAPERJ.

The current remarkable surge in inflation is considered to be a nearly global phenomena (Reinhart and Lucker 2022), affecting both developed and developing nations. While there may be common drivers of inflation, such as factors associated with the Covid-19 pandemic followed by Russia鈥檚 invasion of Ukraine, there are considerable variations in the causes of it, especially with reference to developing countries, including Albania. Drawing on Kalecki鈥檚 (1976) Essays on Developing Economies, I argue that there are also domestic factors attributed to the increase in inflation that resides in the structural sectoral imbalances of the Albanian economy.  

Rising prices in Albania sparked protests across the country in March 2022. The protests highlighted the rise in food prices which increased by more than 9% compared to March in the previous year; with the price of bread being the main contributor to such increase. With Albanians spending more than 42% of their total budget on food, rising prices of 鈥榥ecessities鈥� adds more pressure to the poor households to make ends meet. Nearly a quarter of Albanians, 640,000 people, already live in poverty (Kote 2022) and soaring prices in the economy could push people further into poverty. But what is pushing food prices to soar in a country where agricultural land accounts for 24% of overall land, a good Mediterranean climate, and water resources, all of which are crucial for agricultural development? Despite these favourable conditions, the productive capacity of Albania鈥檚 agriculture sector to meet domestic demand for food and feed meets is only one third (World Bank, 2022a). 听

The agricultural sector has always been important for the Albanian economy, in terms of both value added and employability. Even though the country has undergone major economic transformation since the fall of communism three decades ago, the agricultural sector continues to be one of the main contributors to the country鈥檚 economy. The agricultural sector accounts for more than 19% of GDP, as of 2020. However, this is a substantial decline since the mid-1990s, in which the share of the sector in the economy was more than 36%.   

At the same time, it appears the country has bolstered industrial capacity, with the industry increasing steadily since late 1990s with construction being the most important component of the sector. The industry sector has also become the main economic sector in terms of employability growth. As of the end of 2021, the annual growth rate in the industry sector increased by 7.5%, followed by the services sector with the number of employed increasing by 7.2%. In contrary, the annual growth rate of employability in the agriculture sector decreased by 5.3% at the end of 2021. According to the Labour Force Survey (2009), the share of employability for the agriculture sector in 2007 was 47% of total employability of people aged between 15-64 years old. However, the importance of the sector in terms of employability has steadily declined over the last two decades, accounting for around 41% in 2020.

There is a large literature emphasising the vital role the agriculture sector plays in the process of economic growth in developing countries (see for example Johnson and Mellor, 1961; Gollin et al 2002; Storm 1995). However, as well as being central in promoting economic growth, of equal importance is the sector鈥檚 role in maintaining non-inflationary growth. Kalecki (1976) writings on issues of financing economic growth, highlight the importance of the sector in dissuading domestically produced inflationary tendencies. He recognised that a crucial challenge for developing countries is that of increasing the productive capacity in the economy, and whilst he argued that this (expand productive capacity) can be achieved through increasing investment, the latter could potentially induce inflationary pressures. Kalecki鈥檚 short and to the point articles on issues related to development economics argue that then when employment in industry increases, it generates higher levels of income, leading to a higher demand of necessities (which are basic needs goods). On the other hand, if the capacity of the agriculture sector is unable to meet the increased demand, this leads to higher prices for necessities goods. This way, Kalecki is able to illustrate through a simple model, how increased investment could result in bottlenecks in the supply of necessities. It is through this analysis that he explains how the structural characteristics of the economy could potentially lead to inflation being produced domestically.  

Therefore, investment in infrastructure should be accompanied with measures to expand agricultural production with the aim to increase the supply of necessities, in an attempt to avoid inflationary pressures. The alternative of course, is to rely on imports to meet the rise in demand for necessities. Indeed, Albania鈥檚 reliance on imports for food has increased by more than 21% in the period between 2017-2011, with imports reaching ALL130 billion ($1.08billion). Such reliance and exposure to foreign markets and the recent global supply chain disruptions, has inevitably led to higher food prices in Albania – increasing to 14% more than in the previous year, latest data in September 2020 shows.

The productivity of the Albanian agriculture sector has declined in recent years significantly. In mid-2021 the sector increased only by 0.11%, with construction dominating with a 25% increase. The World Bank (2022b) reports that access to finance and land fragmentation are of great concerns and significantly prevent the agriculture sector expanding production. In early 2022, Albanian farmers addressed the severe difficulties the country鈥檚 agricultural sector is facing, and took to the streets to rally against soaring prices of agricultural inputs, calling for more government support. According to the Food and Agriculture Organisation of the United Nations (FAO) report, Albanian farmers receive the lowest government support in the region, receiving only 鈧� 3 million per year in subsidies. The sector also receives the lowest government support relative to the other sectors in the economy. Indeed, agriculture spending accounted for 1.9% of total government spending for the period between 2010-2017. This is considerably lower than what education, healthcare and house building are receiving 10.9%, 9.4% and 6.7% of total government support, respectively.

To sum up, development issues require a multisectoral analysis. The argument provided here is that indeed sectorial imbalances could bring about inflation. In particular, in developing economies, a demand induced by a rise in investment in infrastructure and industry should be associated with a rise in the capacity of production of the agricultural sector. The rise in the production capacity may be achieved by measures such as the provision of cheap bank credit and other forms of assistance such as government subsidies. In light of recent developments, with Albania鈥檚 agricultural productivity at it lowest, increased exposure to foreign goods markets and the global supply chain disruption, it is important for the country to focus on achieving and maintaining agriculture development.

References

Gollin, D. Parente, S. and Rogerson, R. 2002. The role of agriculture in development, American Economic Association, 92(2), pp. 160-164.

Johnston, F.B. and Melor, W. J. 1961. The role of agriculture in economic development, American Economic  Association, 51(4), pp.566-593.

Kalecki,M.(1976) Essays on Developing Economies, 鈥淭he Problem of Financing Economic Development鈥�  and  `Problems of Financing Economic Development in a Mixed Economy鈥� Hassocks, Harvester Press

Kote, Kristo., (2022), Basic products鈥� price jumped 14%-24% in April, Albanian Daily News, 10 May 2022, Accessed on 24 May 2022. Available on: .

Reinhart, Carmen and Clemens Graf Von Lucker, (2022), The return of global inflation, World Bank Blogs, 14 February 2022, accessed on 25 May 2022, available on: .

Storm, S. 1995. On the role of agriculture in India鈥檚 longer-term development strategy, Cambridge Journal of Economics, 19(6), pp. 761-788.

World Bank (2022a), The future of water in agriculture in Albania- A broad sector rethinking, World Bank Group. 

World Bank (2022b), Creating markets in Albania: Taking advantage of new trade and investment opportunities for a more robust private sector- Country Private Sector Diagnostic, World Bank Group, June 2022.

Mimoza Shabani is Senior Lecturer in Financial Economics at the Royal Docks School of Business and Law, University of East London.

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What is at stake?

Let鈥檚 start with a story. A friend asked me what my favourite genre of fiction is. I replied: microeconomics. If you get the joke, you would be laughing. Otherwise, you would be wondering why I said that. Well, that鈥檚 the truth. Take any standard economics textbook, we find ourselves in the fictional worlds of 鈥榣et鈥檚 assume there are two goods鈥� and 鈥榠f we move from point A to B鈥�. It is true and well understood that these assumptions and imaginations are meant to break down complex phenomena. However, this entry point of supply and demand curves with the endless possibilities of hypothetical scenarios is not the only way to study/introduce economics. In this regard, I put forth the relevance of studying Wassily Leontief鈥檚 work and argue that it adds pluralism to economics education at least in three aspects: 1) methodology (philosophical and mathematical approach), 2) the unit of analysis (micro to macro and in between), and 3) ideas at the margins (reading thinkers like Piero Sraffa and other classical political economists). Now we shall deal with these three themes individually.

Today, let鈥檚 not talk about change!

Leontief was highly critical of the dominance of mathematics in the economics field and his words from his presidential address at the eighty-third meeting of The American Economic Association, in 1970 are still relevant to an extent in today鈥檚 context:

鈥淧rofessional journals have opened wide their pages to papers written in mathematical  language; colleges train aspiring young economists to use of this language; graduate schools require its knowledge and reward its use.鈥� (Leontief 1971, p. 2)

One of the reasons behind these criticisms is the irrelevance and inadequacy of these mathematical models to real-world problems. The formal properties of these models are explained by a step-by-step derivation that often runs into several pages, but the empirical validity of the bizarre assumptions behind these modes is null.

Leontief was very critical of 鈥渋mplicit theorising鈥�, mathematical models, and econometric analysis, and believed that economic analysis should be based on the observed facts of the economy.

鈥淭he shift from casual empiricism that dominates much of today’s econometric work to systematic large-scale factual analysis will not be easy. To start with, it will require a sharp increase in the annual appropriation for Federal Statistical Agencies.鈥� (Leontief 1971, p. 5)

Students are introduced to economics with the hypothetical worlds of supply and demand curves and the use of calculus to study these changes and shifts is necessary. As Sraffa points out in the preface of his revolutionary book Production of Commodities by Means of Commodities (PCMC): 鈥淭he marginal approach requires attention to be focused on change, for without change either in the scale of an industry or in the 鈥榩roportions of the factors of the production鈥� there can be neither marginal product nor marginal cost.鈥�  (Sraffa 1960, p. v)

And the subject matter is taught with the notions of supply and demand as if this is the only entry point to understanding the economic phenomenon and introducing economics to students. Further, needless to mention how this framework is accepted as universal truth, irrespective of the context, that students of economics rarely question its validity and relevance. In Aspromourgos鈥檚 words: 鈥淚ndeed that representation of SAD [supply-and-demand curves] became so widely accepted that it came almost to be regarded as mere common sense that any economic fool would know and accept.鈥� (Aspromourgos 2018, p. 2)

To sum up, by studying Leontief we add pluralism in methodology on two fronts viz. philosophical and mathematical. Philosophical in the sense that we become critical of the fact that marginalist economics relies on hypothetical scenarios and recognise that it鈥檚 possible to study economic phenomena without talking about change. In fact, scholars like Sraffa and Leontief help us understand alternative notions of demand and supply contributing to the holistic learning of the students. For instance, in the Spirit of Sraffa鈥檚 critique of marginalist theory, Krishna Bharadwaj builds an alternative approach that is 鈥渇ree from the need to employ marginal magnitudes and does not require hypothetical or potential changes to determine the resting position of the economic variables (Marcuzzo 2014, p. 49).鈥� Further, to study the change in the set-up of marginalist economics, we are predominantly trained in a particular kind of mathematics which is calculus. However, once we give equal importance to other approaches like input-output analysis and the theoretical models developed by others like Sraffa and Marx, it is inevitable that we introduce students to alternative ways of thinking in mathematics along the lines of matrix algebra and other methods that don鈥檛 rely on calculus and optimization. Thus, adding pluralism to economics education on the mathematical front.

I-O analysis: a must-visit on your route to macroeconomics from microeconomics

The core principle of Leontief鈥檚 economic analysis is the idea/concept of understanding the 鈥榚conomy as a whole鈥� and recognising the interdependence between different parts of the economy. And this understanding of inter-industrial relationships is at the heart of the theoretical model behind the input-output analysis. Further, the practical applications of the input-output analysis help us study the direct and indirect effects of changes in demand in one sector and their impact on employment levels in various sectors of the economy. In his recent textbook Macroeconomics: An Introduction, Thomas (2022) highlights the importance of understanding the economy through a 鈥榤eso鈥� approach like the input-output analysis.

Leontief鈥檚 position on policy and planning is very different from other economists of his time. Leontief argues that the role of an economist is to point out the different consequences of the alternative policies instead of following a general objective welfare function that gives precise answers and restricts the elaboration of alternative scenarios. Therefore, Leontief views the input-output approach as the logical way to go about economic policy and planning as it brings detailed knowledge of the structural characteristics of different sectors of the economy.

Here, I would like to highlight that while Leontief endorses and highlights the relevance of a 鈥榤eso鈥� approach in economic analysis. He rejects the aggregate analysis in totality along with a dismal tone towards inferential statistics and econometrics. And rejects conventional fiscal and monetary policies as they rely on a 鈥渞ather sketchy aggregative description and analysis of the economic system鈥� (Leontief 1976, p. 7; as cited in Carret 2022, p. 12).

Anybody who was concerned with the practical application of econometric analysis, I think, is conscious of the fact that in a large number of instances, these aggregative measures are not very useful. Particularly in connection with many problems of policy-making and of economic planning of any kind, aggregative concepts are very limited in their application, because in this type of question we have to deal with concrete, separate industries, with individual prices, or at least outputs and prices of small commodity groups. (Leontief, 1949b: 274; as cited in Carret 2022, p. 8)

Why did Keynes refuse to publish Leontief鈥檚 PhD thesis?

The cost of focusing too much on the methods and courses catered around the dominant approach of marginal analysis is that students have no idea about the other thinkers who contributed to economic thought. In this light it is important to engage with Leontief鈥檚 work for two reasons: 1) Leontief鈥檚 work was always downplayed from a theoretical perspective and 2) Leontief鈥檚 work has certain interesting similarities with the classical political economists and Sraffa.

Leontief maintained a prominent position among government institutions as the input-output analysis was widely used for policy making. However, as Carret (2022) argues, academic economists lost interest in Leontief鈥檚 work. At best, Leontief was seen as an empirical economist, undermining his theoretical contributions. Often his work is presented as a 鈥渧ery crude, though useful鈥� (Gilibert 1998, p. 41) version of the general equilibrium. And whenever the result of his analysis was inconsistent with conventional theory, the result was labelled as a 鈥榩aradox鈥�. Leontief submitted a revised version of his PhD thesis to the Economic Journal and the editor (Keynes) rejected it. While we don鈥檛 know the exact reasons behind the rejection, it is interesting to note that, in his PhD thesis Leontief argues for the substitution of the principle of circular flow for that of homo economicus as the cornerstone of economic theory. Further, his originality was continually called into question. On one hand, in the English-speaking countries, the input-output analysis was considered irrelevant to mainstream economics, and on the other hand, in the German and Russian-speaking countries, input-output analysis was seen as a descendant of Soviet statisticians and Quesnay鈥檚 Tableau.

Often it is incorrectly believed that 鈥榥eoclassical鈥� economics is an intellectual advance from the previous thinkers broadly under the camp of classical political economy. However, Sraffa rejects this view in his book PCMC (1960) and revives the essence of classical political economy in his economic theory. Leontief is closely connected to both early thinkers of classical political economy and Sraffa. It is well documented that 1) the input-output analysis has classical political economy roots (see Kurz and Salvadori (2000)), 2) the fundamentals of classical political economy and Leontief鈥檚 analysis have similarities and differences in interesting ways (see Pressman (1998)), and 3) Leontief鈥檚 and Sraffa鈥檚 early work have interesting connections (see Kurz and Salvadori (2006)) and the later Leontief deviates to deal with the practical issues of input-output analysis.

To sum up, it is important to engage with Leontief鈥檚 work to understand why his contributions are ignored in academic space. Furthermore, by reading classical political economists, Leontief, and Sraffa, I believe that we add pluralism to the economic curriculum in an interesting way. Especially given that the entry points of Sraffa and Leontief, and the fundamentals of classical political economy are often in opposition to the dominant marginalist economic thought.

Towards a more pluralistic economics curriculum

A recent report, Pluralism in Economics Education, by Rethinking Economics India Network (REIN 2022) highlights the hegemony of 鈥榥eoclassical鈥� economics in economics curriculum in India and proposes that a multiplicity of schools of thought is required to make the economic discipline more diverse. To this end, studying Leontief will add pluralism to economics education in India along the lines of the method, meso approach, and representation. Given the diversity of the Indian economy, the meso approach adopted in input-output analysis will be helpful in regional studies and policy making in line with the 鈥榮tructural鈥� features of the local economies.

To conclude, we do not have to be as dismissive of mainstream economics as Leontief. As students of economics, in the spirit of pluralism, it is important to have a holistic understanding of economic theory and that requires us to consciously break free from the shackles of marginalist perspectives. To this end, with all due respect to Leontief鈥檚 interest in economics discipline and economics education, the best we could do is to engage with Leontief鈥檚 work and understand the relevance of the input-output analysis and the reasons behind Leontief鈥檚 reluctance to see any point in inferential statistics and econometrics.

References

Carret, V. (2022). Understanding the Bitterness of Wassily Leontief: Intention and Reception of Input-Output Techniques, 1940s-1950s. Center for the History of Political Economy at Duke University Working Paper Series (2022).

Gilibert, G. (1998). Leontief, Wassily. In H. Kurz., & N. Salvadori (Eds.), The Elgar companion to classical economics (pp. 40-4). Cheltenham: Edward Elgar.

Kurz, H. D., & Salvadori, N. (2000). Classical Roots of input-output analysis: A short account of its long prehistory. Economic Systems Research, 12(2), 153-179.

Kurz, H., & Salvadori, N. (2006). Input鈥搊utput analysis from a wider perspective: a comparison of the early works of Leontief and Sraffa. Economic Systems Research, 18(4), 373-390.

Leontief, W. (1971). Theoretical assumptions and non-observed facts. American Economic Review, 61(1), 1-7.

Leontief, W. (1991) The economy as a circular flow, Structural Change and Economic Dynamics, 2, 1991, pp. 177鈥�212. English translation of parts of Leontief (1928) with an introduction by P. A. Samuelson.

Marcuzzo, M. C. (2014). On alternative notions of change and choice: Krishna Bharadwaj鈥檚 legacy. Cambridge journal of economics, 38(1), 49-62.

Pressman, S. (1998). Input-Output Analysis. In H. Kurz., & N. Salvadori (Eds.), The Elgar companion to classical economics (pp. 415-18). Cheltenham: Edward Elgar.

Rethinking Economics India Network, 2022. Pluralism in economics education: A review of undergraduate programmes in India. Curriculum Reform Project. New Delhi.

Sraffa, P. (1960). Production of commodities by means of commodities (Vol. 1). Cambridge: Cambridge University Press.

Thomas, A. M. (2021). Macroeconomics: an introduction. Cambridge University Press.

Tony Aspromourgos (2018): What Is Supply-and-Demand? The Marshallian Cross Versus Classical Economics, Review of Political Economy, DOI:10.1080/09538259.2018.1537646    

Thair Ahmad is a Teaching Fellow at Krea University, India. He finished his bachelor’s and master’s in economics at Azim Premji University, India. His areas of interest include history of economic thought, economic history, and development economics. He loves to tweet () about economics and politics.

Acknowledgements: Thank you to Alex Thomas, Ashwath R, and Nancy Devpura for their feedback and comments on this blog post..

A stylised fact that characterises modern economies is that part of the installed productive capacity is persistently idle. By productive capacity I mean the productive equipment (mostly fixed capital goods) in existence, together with that part of the workforce which is required to operate it. As we can see in Figure 1, in countries as diverse as Belgium, Finland or Lithuania, the effective utilisation of installed capacity often gravitates below 100%, and around 80% on average worldwide.

Figure 1. Installed capacity utilisation by country (1998Q1-2017Q4).

Source: see Appendix I.

The academic consensus is that there are large margins of idle capacity planned by entrepreneurs. The reasons why entrepreneurs plan to operate with idle capacity vary according to the school of thought considered. At the risk of making a drastic simplification, we can say that while some authors think that entrepreneurs do so in order not to lose market share in the face of changes in demand, others tend to think that there is a rate of utilisation of installed capacity that does not accelerate inflation (Non-accelerating inflation rate of capacity utilisation, NAICU).

For some authors, large margins of idle capacity is the way in which the presence of persistently unused resources manifests itself (Ramey, 2020). When making an investment, entrepreneurs plan the size and intensity of future use of the capital stock over several business cycles – determined precisely by the duration of the stock. This level of utilisation, the expected average level, which the entrepreneur calculates during the investment process, is known as the normal level of utilisation of installed capacity (Ciccone, 1986; 1987).  This level of idle capacity is usually planned taking into account economic fluctuations, mainly in order not to lose market share, among other factors (Lanzillotti, 1958, 1959).

As normal utilisation of installed capacity is a variable that is not usually measured by national statistical institutes, no time series are available. However, it is possible to obtain time series of effective capacity utilisation. In this post, we will use time series of the US economy to explore what mechanisms could explain the tendency towards normal capacity utilisation. 

The tendency towards normal capacity utilisation: the case of the US economy

Although effective utilisation of installed capacity (U) has been on a declining secular trend in the US since the 1950s (Pierce and Wisniewski, 2018), it has remained relatively stable at around 79.5% on average, in line with the global level. In addition, the level of activity – represented here by the level of manufacturing production (MP) – has shown a clear positive trend until stagnating in the late 2000s, as can be seen in Figure 2.

Figure 2. Installed capacity utilisation (dotted line) and production level (2017=100, solid line) in the United States (1948Q1-2021Q1).

Source: see Appendix I.

An interesting question to ask is what happens to the level of capacity utilisation when the level of activity increases in an economy like the US. In this post we carry out two exercises to try to uncover some answers to this question. Firstly, we take the level of manufacturing output (MP) and see what happens to the utilisation of installed capacity (U). As we can see in Figure 3, looking at a 30-quarter period, a persistent increase in the level of activity (MP) – which remains above the initial level, even until the last period – has a transitory impact on the level of utilisation (U). There is a peak in the latter in the second quarter, and the effect slowly diminishes until utilisation returns, around the tenth quarter, to the pre-shock level.

Figure 3. Impact of an increase in the level of production (MP) on the level of output (left) and installed capacity utilisation (U, right) in the United States (1948Q1-2021Q1).

Response of MP to MP shock                                                          Response of U to MP shock

Source: see Appendix I.

Given that the effect of the level of activity on capacity utilisation is transitory, the question is: what is the adjustment variable? If we allow ourselves a great simplification, we can find two main answers in the literature. On the one hand, there are those authors who think that the adjustment occurs on the quantity side (first, private investment and, as a consequence, an increase in the level of productive capacity); on the other hand, there are those who argue that the adjustment operates through an increase in the level of inflation – an acceleration of inflation.

In the first case, when demand for goods increases persistently, entrepreneurs first respond by increasing capacity utilisation and then increase productive capacity. In this case, investment, which is fully induced by the level of production, is a “defensive” response by entrepreneurs in order not to lose markets to their competitors. The adjustment is then through an increase in the share of private investment in output. In the second case, entrepreneurs increase the utilisation of installed capacity, but also persistently change the level of inflation (Corrado and Mattey, 1997).

Secondly, we try to lay the groundwork to begin to understand what the adjustment variable actually is. Using the same methodology mentioned previously, we take the level of production (MP), the level of prices (P) and the level of productive capacity (K). As can be seen in Figure 4, a persistent increase in the level of production (MP) has a positive and persistent impact on the level of prices (P) and also permanently on the level of productive capacity (K).

Figure 4. Impact of an increase in the level of production (MP) on the level of output (left), the level of prices (centre) and the level of productive capacity (right) in the United States (1948Q1-2021Q1).

      Response of MP to MP shock        Response of P to MP shock    Response of K to MP shock

Source: see Appendix I.

Now, what about inflation? Repeating the same exercise, but looking at the level of inflation (instead of the price level), we find that the effect is transitory. In Figure 5, we can observe this result. Although slightly longer lasting than the effect on capacity utilisation – about 5 quarters longer – we confirm a transitory increase in the level of inflation.

Figure 5. Impact of an increase in the level of output on the level of output (left), the level of inflation (centre) and the level of productive capacity (right) in the United States (1948Q1-2021Q1).

Response of MP to MP shock     Response of INFLATION to MP shock     Response of K to MP shock

Source: see Appendix I.

Conclusions

To summarise, the exercises seem to suggest that changes in the level of activity generate transitory effects on capacity utilisation. As for the adjustment variables, the price level rises, but so does the level of productive capacity. Finally, the effect on the level of inflation is transitory. Although this exercise is inherently very limited, and as with any empirical exercise the results should be taken with caution, we will try to provide some tentative explanations.

We can therefore conclude that it is a stylised fact that modern economies operate with margins of idle capacity. In the literature we find that this idle capacity is planned by entrepreneurs. On the basis of the econometric exercises conducted, we can further conclude that:

• When the level of activity rises persistently, the price level also rises. This would be in line with the adjustment through “prices”. This remains to be analysed in depth, but again, being reductionist, we can find two explanations. One possible explanation is that there may be supply constraints that do not allow demand to be satisfied in the short run. From an alternative point of view, given that an increase in activity levels generally brings with it an increase in the level of employment, in the bargaining power of workers and, hence, in wages, the rise in the price level could be explained as a reaction of employers to this process.

• The level of activity also turns into an increase in the level of productive capacity. This would be in line with the idea of adjustment through “quantities”. When entrepreneurs find that the level of demand increases persistently, they increase utilisation in the short run, in order not to lose market share, and adjust their productive capacity in the long run. In this case, investment would be fully induced by the level of output.

• Finally, the impact of an increase in the level of activity on inflation is transitory.

If the economy is demand-driven, any increase in the autonomous components of aggregate demand will affect the level of productive capacity and the price level in the case of the United States. Since the effect on inflation is transitory, these results support the view that the US government should try to pursue full employment policies, as the risks of inflationary episodes are negligible.

References

Ball, L. M. (1999). Aggregate demand and long-run unemployment. Brookings papers on economic activity, 1999(2), 189-251.

Ball, L. M. (2009). Hysteresis in unemployment: old and new evidence (No. w14818). National Bureau of Economic Research.

Blomstr枚m, M., Lipsey, R. E., & Zejan, M. (1996). Is fixed investment the key to economic growth?. The Quarterly Journal of Economics, 111(1), 269-276.

Ciccone, R. (1986). Accumulation and capacity utilization: some critical considerations on Joan Robinson鈥檚 theory of distribution. Political economy, 2(1), 17-36.

Ciccone, R. (1987). Accumulation, capacity utilization and distribution: a reply. Political Economy, 3(1), 97-111.

Corrado, C., & Mattey, J. (1997). Capacity utilization. Journal of Economic Perspectives, 11(1), 151-167.

Deleidi, M., & Mazzucato, M. (2021). Directed innovation policies and the supermultiplier: An empirical assessment of mission-oriented policies in the US economy. Research Policy, 50(2), 104151.

Freitas, F., & Serrano, F. (2015). Growth rate and level effects, the stability of the adjustment of capacity to demand and the Sraffian supermultiplier. Review of Political Economy, 27(3), 258-281.

Girardi, D., & Pariboni, R. (2020). Autonomous demand and the investment share. Review of Keynesian Economics, 8(3), 428-453.

Girardi, D., Paternesi Meloni, W., & Stirati, A. (2020). Reverse hysteresis? Persistent effects of autonomous demand expansions. Cambridge Journal of Economics, 44(4), 835-869.

Lanzillotti, R. F. (1958). Pricing objectives in large companies. The American Economic Review, 48(5), 921-940.

Lanzillotti, R. F. (1959). Pricing objectives in large companies: Reply. The American Economic Review, 49(4), 679-687.

Paternesi Meloni, W., Romaniello, D., & Stirati, A. (2021). On the Non-Inflationary effects of Long-Term Unemployment Reductions. Institute for New Economic Thinking Working Paper Series, (156).

Pierce, J. R., & Wisniewski, E. (2018). Some characteristics of the decline in manufacturing capacity utilization (No. 2018-03-01-2). Board of Governors of the Federal Reserve System (US).

Ramey, V. A. (2020). The macroeconomic consequences of infrastructure investment (No. w27625). National Bureau of Economic Research.

Appendix I. Data.

Capacity utilisation by country (1998Q1-2017Q4). Source: OECD; Business Tendency Surveys; . Quarterly data (1998Q1 鈥� 2017Q4).

Capacity utilisation in the United States (1948Q1 鈥� 2021Q1). Source: Board of Governors of the Federal Reserve System (US), Capacity Utilization: Manufacturing (SIC) [CUMFNS], retrieved from FRED, Federal Reserve Bank of St. Louis; , July 15, 2021. Quarterly data (1948Q1 鈥� 2021Q1).

Manufacturing production index in the United States (1948Q1 鈥� 2021Q1). Source: Board of Governors of the Federal Reserve System (US), Industrial Production: Manufacturing (SIC) [IPMANSICS], retrieved from FRED, Federal Reserve Bank of St. Louis; , July 15, 2021. Quarterly data (1948Q1 鈥� 2021Q1).

Manufacturing productive capacity index in the United States (1948Q1 鈥� 2021Q1). Source: Board of Governors of the Federal Reserve System (US), Industrial Capacity: Manufacturing (SIC) [CAPB00004SQ], retrieved from FRED, Federal Reserve Bank of St. Louis; , July 15, 2021. Quarterly data (1948Q1 鈥� 2021Q1).

Consumer price index in the United States (1948Q1 鈥� 2021Q1). Source: U.S. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: All Items in U.S. City Average [CPIAUCSL], retrieved from FRED, Federal Reserve Bank of St. Louis; , July 15, 2021. Quarterly data (1948Q1 鈥� 2021Q1).

Santiago J. Gahn is a Postdoctoral Research Fellow at Universit脿 Cattolica Sacro Cuore di Milano (CRANEC). He tweets at .听听

A similar version of this post was originally published in “Central de Ideas”, the official blog of the Banco Central de la Rep煤blica Argentina (BCRA). The author would like to thank Ramiro E. 脕lvarez, Ariel Dvoskin and Riccardo Pariboni for their comments, which helped to substantially improve this post.

by Alex M. Thomas, Cambridge University Press, 2021.

This recently published introductory Macroeconomics textbook written by Alex M. Thomas provides a refreshingly novel approach to teaching Macroeconomics to undergraduate students. As the author points out in the Preface, this textbook offers a 鈥�problem-setting approach rather than a problem-solving one, as is the case with most economics textbooks鈥� (Page xvi, emphasis mine). The textbook has nine chapters, and the chapters have enough material to whet the appetite of a broad audience 鈥� Chapters 1,2,6 and 9 deal with the history and philosophy of Macroeconomics, Chapters 3-5 deal with the core economic theory of money and interest rates, output and employment levels and economic growth and Chapters 7 and 8 talk about the macroeconomic policy of achieving full employment and tackling inflation. In this review, I would focus on four issues 鈥� the commitment of the book towards enhancing pluralism in Macroeconomics, the importance given to studying macroeconomic theory, the idea of relating macroeconomic concepts to the context which is being studied and an explicit concern to make Macroeconomics accessible to an undergraduate audience residing in underdeveloped parts of the world.

The chapters dealing with the broader philosophy of Macroeconomics in this book make the case for budding macroeconomists to be widely read and be able to utilize all sources of information at hand 鈥� textbooks, classic papers, newspapers, government reports, historical accounts and even works of fiction to make sense of the context. The picture that best conveys the imagery of a such a well-grounded economist is on Page 3 of Chapter 1 just preceding John Maynard Keynes鈥� famous description of 鈥渢he kind of skills an economist ought to possess鈥�(Page 3). The picture depicts a young economics student who has four hands 鈥� one hand holding a history textbook, one hand engaging with graphs discussing macroeconomic equilibrium, the third hand holds the picture of the Indian Parliament and the fourth hand is held by the student on her chin 鈥� as if wondering in awe about the varied inputs that are required to make sense of the mammoth creature under consideration. This depiction of Macroeconomics made me recall former US President Harry Truman鈥檚 who was widely credited with saying 鈥淕ive me a one-handed economist!鈥�. Clearly, as the author鈥檚 depiction shows, we need to train many-handed economists who would be able to bring in various perspectives while deliberating on issues of policy importance. This might frustrate the policy makers looking for quick actions but would ensure that the policy advise that is being given is well-thought out and has engaged with contradictory pulls and pushes and diverse realities facing our contemporary societies. The readers would be able to better appreciate the book鈥檚 commitment to pluralism by looking at the references section and also suggestions for further reading after each chapter.

This book has a firm commitment to ensuring that undergraduate students in their first course on Macroeconomics learn to appreciate the insights and rigor of economic theory. Economic theory readily gets associated with abstraction for its own sake and tends to earn a bad name especially in today鈥檚 times when the economics profession is taking a turn towards data-driven approaches (interested readers can look at Chapter 6: Why Economic Theory Matters for a detailed discussion). The book uses 鈥渁n economy with free mobility of capital and labor鈥� as the object of analysis at the first level (Page 13). This is not to say that aspects of the 鈥渁ctual鈥� world like immobility of labor in a developing country context like India that happens due to caste, gender and community do not exist. Using the competitive economy as the 鈥渟tandard of reference鈥� is only a first level of analysis abstracting from the myriad considerations of the real world to enable 鈥減recise鈥� statements to be made about the 鈥渆conomic phenomena under study鈥� (Page 14). Even if the theoretical framework employed does not speak to the actual world as a one-to-one mapping, the thought experiment at the first level of analysis greatly enhances the rigor and sharpens the thinking of a budding economist. Talking of economic theory, the author is careful to point out that he 鈥減refers using 鈥榓ctual鈥� to 鈥榬eal鈥� as the theoretical world is also real鈥� (Page 14). The theoretical framework, in turn, creates demand for observables – accounting and data that are needed for analysis. Though economists like Richard Stone working in the middle of the 20^th century on developing national income accounting systems were well aware of the need for theory in empirical measurement (pointed out by the author in Chapter 6), the lesson seems to have been lost on the current fad among economists to only look at big data and rely on data-driven solutions to offer policy advice. The author has a nice quote from Albert Einstein in chapter 6 highlighting the need for theory 鈥� Einstein after attending Werner Heisenberg鈥檚 talk on quantum mechanics in 1926 had this to say, 鈥淲hether you can observe a thing or not depends on the theory which you use. It is the theory which decides what can be observed鈥� (Page 133).

The plea to give due space to theory in economic analysis does not mean that one should ignore the immediate context in which economies are functioning. Chapter 1 of the book distinguishes between different levels of analysis 鈥� macro, meso and micro. The macro approach is what the textbook mostly deals with but is also complemented by meso (a study of different sectors within an economy) and also at times with micro approaches (the way an individual makes economic decisions). While staying true to the core conceptual core of Macroeconomics, the book tends to move away from the narrow compartmentalization of the subject as is found in many conventional macroeconomics textbooks. Even while the student is immersed in learning a Macroeconomic concept, it is not wise to lose sight of the end goal of the study of this subject. As the author points out, 鈥渋t is important to remember that most of us are studying economics not only to understand our economic surroundings but also to better them for all鈥� (Page 16). The task of bettering lives for all cannot be complete unless trained macroeconomists are sensitive to the context in question. This sensitivity to the immediate macroeconomic context is visible in this book in the discussion of the policy application of macroeconomic theories to the Indian context (Chapters 7 and 8). Chapters 4 and 7 raises the issue of the applicability of the Keynesian demand multiplier to the post-independence Indian economy. VKRV Rao, an Indian economist (also a student of John Maynard Keynes at the University of Cambridge) and founder of many great institutions of learning in post-independence India, wrote an article in 1952 in the Indian Economic Review talking about the limited applicability of Keynesian ideas to the Indian context because of the extensive informal sector in Indian economy where wage determination did not take place as in the developed countries and extensive supply-side constraints that the newly independent country faced. Clearly, this indicates a tension between the concept and its application depending on the context and as the author rightly argues, 鈥済ood policymaking needs to take cognizance of both concept and context鈥� (Page 158).

Another major contribution of this book is its accessibility and relatability to the undergraduate audience in developing countries (in the case of this book, the undergraduates in India). The study of Economics, in my view, has faced two major problems. First, most Eurocentric theories have been privileged over the voices from the Global South. Second, even if you accept the argument that students across the world need to be well-versed with Economics as taught in the West, there are barriers of language and privilege that have allowed only a select few 鈥� a representative sample of elite students from the developing countries, as it were, to be able to partake of this Western discourse. Every chapter in this book offers some citations from works of fiction immersed in the milieu of the Indian sub-continent. The author makes this objective clear in the Preface where he mentions that he has tried to infuse the Indian context into 鈥渙ur non-Indian economic contexts鈥� by engaging with fiction pertaining to the themes of 鈥渃aste, ecology, gender or land鈥� (Page xvi). The very first chapter of this book where the history of economics is discussed points out towards the development of economic thought in non-European contexts. This is important so that undergraduates do not leave the classroom thinking that whatever happened in Economics happened in a faraway Western land and their job is just to diligently replicate those theories irrespective of the context they operate in. Closely tied in with this objective of infusing the Indian context into a Macroeconomic context is the concern for making the readings and textbooks available to Indian students who do not have access to 鈥渨ell-stocked鈥� libraries (page xv). In an earlier paragraph I had supported the author鈥檚 view that economics students should be well-read and be able to utilize different sources of information. The author realizes that this normative claim has to be tempered with the harsh material realities of differential access to education in developing countries. Often in the past have I received requests from friends in India looking for books and journal articles which their libraries do not have access to. The author has clearly taken cognizance of this fact and in every chapter where he offers suggestions for further reading, he suggests multiple sources of the same reading material so that accessing it does not become impossible for the less privileged undergraduate student willing to learn Macroeconomics.

When I was taught Macroeconomics as an undergraduate, my course instruction primarily relied on conventional Macroeconomic textbooks written by North American authors with the US context in mind. I knew more about how the Federal Reserve functions after my Principles of Economics course than I knew about the Reserve Bank of India. I certainly learnt the macroeconomic concepts very well but was seldom left thinking how this related to what the local newspaper was reporting about the policies of my own central bank. It is only when I took a course on Money and Financial Markets in my final year that the context of Indian monetary institutions was brought in. This book is clearly different for good and I really hope that it would bring in winds of change in the pedagogy of Macroeconomics and that more such books would be written in the future offering students a holistic approach to the subject.

Mohit Arora is a PhD student in the Economics department at University of Massachusetts, Amherst.

Simply speaking, development macroeconomics can be summarized as the challenge of improving productivity and production capacity in poor countries. This involves the conditions that need to be fulfilled for a development process to start as well as the policy framework and instruments that support it. Heterodox approaches consider the state鈥檚 role in steering productivity growth as essential (Cardim de Carvalho, 1997). Markets may be able to exploit price signals and adjust resource allocation correspondingly. However, they guarantee neither sufficient profitability of key sectors nor the demand for the goods produced. Both the profit rate and effective demand are conditions for investment to take place (Oberholzer, 2020). It is thus up to the government to make public investment in priority sectors and to apply instruments such as taxes and subsidies in ways that simultaneously allow for economies of scale, higher productivity large-scale employment and demand. This is what is generally referred to as industrial policy (see for example Chang, 2006; Oqubay, 2018).

But this is not everything. Policymakers have to pursue such a development strategy in face of an (often permanent) shortage of foreign currency. While domestic currency can be generated via the domestic banking system including public development banks, the availability of foreign currency is limited unless a country is able to increase exports or restrict imports. Since larger export capacity and a higher degree of import substitution are long-term goals, the current account is determined by domestic and foreign economic growth. This insight has come to be known as the balance-of-payments-constrained model or Thirlwall鈥檚 law, respectively (Thirlwall, 1979, 2013): it is reasonable to assume that demand for a country鈥檚 exports grows in income in the rest of the world while imports increase with domestic economic growth because a part of increasing incomes is reliably spent on imported goods. Therefore, stability in the balance of payments requires that imports do not grow faster than foreign exchange earnings via exports allow. A limit to the growth of imports implies a limit to the country鈥檚 economic growth, hence the balance-of-payments-constrained growth rate.

These two essential problems of development macroeconomics can be denoted as the internal and the external constraint. Industrial policy has to remove the internal constraint by developing production capacity. However, overcoming the internal constraint does not necessarily overcome the external constraint of foreign exchange shortage. In other words, even the best industrial policy might become rather modest because it is subject to the shortage of foreign currency, that is, the external constraint.

Unless a country runs a continuous structural current account surplus, a strategy that is logically not feasible for all developing countries simultaneously (Blecker & Razmi, 2008), it almost inevitably features phases of (potentially large) deficits during certain stages of its development strategy. Such deficits may be due to the urgency to relieve the most extreme poverty as fast as possible and also the need to import capital goods that are necessary for technological catch-up. However, as explained by Thirlwall鈥檚 law the balance-of-payments constraint does not allow for deficits because they involve accumulation of foreign debt and often also boom-bust cycles of capital flows eventually giving way to exchange rate depreciation and currency crisis. The external constraint becomes even tighter when ambitious economic policies, which entail public investment, income redistribution and other measures that might be perceived to threaten private profits trigger capital flight, hence an additional loss of foreign currency.

There is a solution to the external constraint, which is rarely discussed in the literature even though it contains many elements of Keynes鈥檚 proposal of an international clearing union suggested in the Bretton Woods negotiations after World War II (Keynes, 1942/1980). Adding insights by E.F. Schumacher (1943) and, notably, Bernard Schmitt (2014), we get to a policy proposal that can be implemented individually by a single country. To briefly explain it, imagine what happens when a resident of a country pays for imports that are not matched by exports of an equal amount: the resident pays in domestic currency while the foreign payee receives a payment in international currency, that is, usually US Dollars. The country thus has to go in debt in order to get access to the Dollars required. At the same time, the payment in domestic currency is lost to the economy because it is just crossed out of the double-entry bookkeeping system (indeed, nobody currently receives these domestic monetary units as a payment). The loss in domestic currency is tantamount to a loss in domestic effective demand and, eventually, a loss in output. Combined with the accumulation of foreign debt this means, in fact, that an international payment is made twice. Deficit countries thus continuously lose economic resources whereas. In a sound system, by contrast, they should have the chance to build up economic resources in order to prevent the accumulation of external debt.

A country may decide to reform its international payment system as follows (Schmitt, 2014; Oberholzer, 2020): first, it sets up a new institution, which may be either independent or linked to the government or the central bank. This institution is responsible for the settlement of all international payments. When an importer gives her bank the payment order, the payment in domestic currency is received by the new institution, which completes the transaction by accessing a foreign loan and paying the foreign exporter in Dollars. We see that the monetary units in domestic currency are not lost anymore. Instead, and this is the second step, the institution can make use of them and spend them for productive investment in the domestic economy, which creates both demand and production capacity. Now, the institution鈥檚 foreign loan is backed by a real asset. It can issue bonds and sell them abroad in order to repay the foreign loan. This implies that neither the institution nor the country is a net debtor anymore. There is no pressure on the exchange rate and the country is able to enlarge the pool of its economic resources to strengthen export capacity and import substitution. It can sustain 鈥榗urrent account deficits鈥� on its growth trajectory without running into currency crisis.

In addition to this blueprint, a unilateral reform of international payments must take into account many institutional and macroeconomic aspects, which are described in more detail in Oberholzer (2020). Moreover, many technical details would certainly arise once a country implements it. Yet, it seems clear that such a reform is a key element of a successful macroeconomic strategy for developing countries. By strongly relaxing, if not removing, the external constraint, it enables industrial policy to be ambitious again such that the internal constraint can be overcome.

References

Blecker, R.A. & Razmi, A. (2010). Export-Led Growth, Real Exchange Rates and the Fallacy of Composition. In M. Setterfield (ed.), Handbook of Alternative Theories of Economic Growth, Cheltenham, UK and Northampton, MA, USA: Edward Elgar Publishing (pp. 379鈥�396).

Cardim de Carvalho, F.J. (1997). Economic Policies for Monetary Economies: Keynes鈥檚 Economic Policy Proposals for an Unemployment-Free Economy. Revista de Economia Pol铆tica, 17(4), 31鈥�51.

Chang, H.-J. (2006). The East Asian Development Experience: The Miracle, the Crisis and the Future. London, UK; New York, USA; Penang,Malaysia: Zed Books and Third World Network.

Keynes, J.M. (1942/1980) The Collected Writings of John Maynard Keynes, Vol. XXV: Activities 1940鈥�1944. Shaping the Post-War World: The Clearing Union, London and Basingstoke: Macmillan.

Oberholzer, B. (2020). Development Macroeconomics: Alternative Strategies for Growth. Cheltenham and Northampton: Edward Elgar.

Oqubay, A. (2018). Industrial Policy and Late Industrialization in Ethiopia. In F. Cheru, C. Cramer and A. Oqubay (eds.), The Oxford Handbook of the Ethiopian Economy, Oxford University Press, (pp. 605鈥�629).

Schmitt, B. (2014). The Formation of Sovereign Debt: Diagnosis and Remedy. Available at 13679.

Schumacher, E.F. (1943). Multilateral clearing. Economica, 10(38), 150鈥�165.

Thirlwall, A.P. (1979). The Balance of Payments Constraint as an Explanation of International Growth Rates Differences. Banca Nazionale del Lavoro Quarterly Review, 32(128), 45鈥�53.

Thirlwall, A.P. (2013). Economic Growth in an Open Developing Economy: The Role of Structure and Demand, Cheltenham, UK and Northampton,MA, USA: Edward Elgar Publishing.

Basil Oberholzer is a macroeconomist working in the field of development macroeconomics, ecological economics and sustainable development who received his PhD at the University of Fribourg (Switzerland). He tweets at .

Photo by听听辞苍听.

In April 2021, Ivan Duque鈥檚 administration presented a tax reform bill labeled 鈥淟aw of Sustainable Solidarity鈥� to Congress. The bill contemplated an increment of the VAT on basic goods in conjunction with an increase in the marginal tax rates on the income of the so-called Colombian middle class. The vast majority of whom earns monthly less than 4,000,000 Colombian pesos (around 1,065 U.S. dollars). Although the bill put on the table contained some crucial elements for discussion, such as implementing a 鈥渂asic monthly income鈥� of 21 U.S. dollars (by far less than the current minimum wage). It contained little or nothing to effectively tackle Colombia鈥檚 high social and income inequality (with an official GINI of 0.526 for 2019).

The tax reform bill was presented in the mid of a severe economic and social crisis that had worsened due to the pandemic and against which the Colombian government has done hitherto little beyond the orthodox recipes. This triggered a general strike and nationwide social mobilizations that have already lasted over more than two weeks without any clarity as to their resolution as yet. The current social protest can be considered a continuation of a general strike that erupted at the end of 2019 and got into a rest due to the pandemic.

Yet, many elements behind the social movement go beyond dissatisfaction with the tax reform bill. Since 2016 after the peace deal between the Colombian government and the FARC, which used to be the oldest and biggest guerrilla in Colombia, the government hasn鈥檛 implemented most of the elements contemplated in the peace agreement. Also, although Colombia has had macroeconomic stability for more than 20 years, an indicator such as the official unemployment rate has consistently been above 10%. The level of poverty before the COVID-19 shock was near 32%.

Thus, the following question arises, what does it mean to have macroeconomic stability to the population? A call to think outside the box on what the government can or can鈥檛 do must be considered under other lenses. In view of the worsening of the social, political, and economic crisis in Colombia and the need to develop economic policy alternatives to the government鈥檚 orthodox position, a group of citizens and academicians wrote the open letter below to respond to those who argue the TINA mantra and believe that there鈥檚 a consensus in economics to support tax reforms amidst the COVID-19 epidemic.

Unemployment rate and public spending by COVID-19, February 2021

Sources: OECD (2021); Elgin, Basbug and Yalaman (2021); own elaboration.

OPEN LETTER

FOR A NEW MACROECONOMIC POLICY IN COLOMBIA
BOGOTA, MAY, 5^th, 2021

In the media discussions about the tax reform, which the government had to withdraw this week due to the massive citizen protest, the idea was spread that there was consensus among the 鈥渆conomists鈥� and that the country would be better off with this tax reform than without it. After its withdrawal, many say that the new proposal should take up the essentials of the previous bills again, although adding some compensatory measures, as they usually advise, to save face, for as long as we can remember.

Over the last four decades, it has been repeated incessantly and with blind faith that 鈥渢here is no alternative.鈥� Those of us who sign this letter believe that there are alternatives and that other economic and social policies are possible, such as those adopted by the countries that have best faced the current crisis, including the United States since the recent change of government. For this reason, we would like to make it clear to the public that there is no such consensus, that the vision questioned by the past financial crisis, discredited by the pandemic, and the lack of pluralism in the discipline exclude other interpretations of economic reality and, in particular, of public finances. Concerning the latter, the more realistic analyses have proposed measures other than tax cuts for the rich and fiscal austerity that have been adopted by governments more sensitive to the needs of citizens. To open the conversation and to let citizens know that there are other policy options, and to inform them of their views, we offer the following points for their consideration.

1. The tax reform proposal, which despite the euphemisms is neither supportive nor sustainable, treats public finances as if they were the household鈥檚 finances or those of the neighborhood grocer. It argues that a country can go bankrupt as a business would go bankrupt, so the State must look for money as a family or a company must look for income. That would be true if the government only spent in dollars, euros, or other foreign currency, but it does not: it also spends in its national currency. Moreover, a country鈥檚 fiscal sustainability should not be a problem when it borrows its own currency. As has been known for decades, taxes do not finance the expenditures of a country with a fiat currency and a flexible exchange rate.
2. The idea of money as something external to the credit system advocated by our most influential economists is what leads us to believe that the government needs to ask for financing. However, money is a debt and not an external object; there is no reason to continue considering currency as a scarce commodity like gold or silver. As Keynes said, 鈥渁nything we can actually do we can afford.鈥� The constraint is not financial but one of real resources.
3. The tax reform bill disregarded the strong regressive income redistribution that has occurred in the last two decades from wages to profits, despite the fact that it was easily observable in the figures published by DANE (National Statistics Administrative Department) and the Banco de Rep煤blica (Colombia鈥檚 central bank). The most visible consequence of this redistribution has been the enrichment of a few and the continuous deterioration of the economic situation and the standard of living of most of the population.
4. The lower share of wages in the economy鈥檚 income and the fall in the standard of living of the population, which worsened in the last year, are the result of the dismantling of the role of the State as the provider of public services and guarantor of economic and social rights promoted by recent governments, the concentration of property and wealth fostered by their policies and the higher profit margins imposed in particular by large companies in the various sectors of the economy.
5. The reform project did not address the underlying problem since it did not touch the growing concentration of property and wealth, nor did it seek to modify the determinants of the income distribution. Therefore, it hardly affected the part of the income received by large landowners and capital owners. The supposed 鈥渟olidarity鈥� with the pandemic victims consisted of redistributing the remaining portion of the income. Redistributing the income of salaried workers, the self-employed, peasants, and small businesses among informal workers, the unemployed and marginal groups, transferring part of the already low income of the working class and the impoverished middle class to the already disadvantaged sectors.
6. Contrary to the orientation of recent governments, the fiscal policy of this and future governments should reduce the margins of banking intermediation in the country, among the highest in the world, as well as the significant market power and the high degree of monopoly of large banks and business consortiums. It should also tax their enormous profits and shareholder dividends so that the government鈥檚 social expenditures help improve the distribution of after-tax income and the situation of the vast majority.
7. The latest DANE report shows that the number of people in monetary poverty increased by more than three million people in 2020, which many commentators attribute to the pandemic. However, this is not the case as it was not a natural phenomenon, and the policies of previous governments aggravated its consequences. Austerity and sound finance policies, promoted and supported by the supposed consensus of economists, have damaged the economy by restricting effective demand. Poverty and unemployment are of great concern (especially for youth and women); as such are a product of austerity measures that hurt the majority of the population. Figure 1 contrasts the size of public spending to address COVID-19, an embarrassing 2.8% of GDP in Colombia, with unemployment rates in some OECD countries, as of February 2021.
8. The policies adopted to face the pandemic affected women to a greater extent, as shown by IMF and World Bank studies. Colombia is no exception. DANE data indicate that the annual unemployment rate for women increased to 19.3% in March 2021. Monetary poverty also affected women more; according to this classification, today, 46.7% are poor, and 17.8% are in extreme poverty. Thus, fiscal policy must be rethought from a gender perspective to address this structural inequality.
9. Public employment and universal basic income programs are the basis of a credible plan for the recovery and stabilization of an economy constrained by demand and low utilization of installed capacity. Labor flexibilization policies must be replaced by actions aimed at maintaining full employment in the economy. Agendas to improve workers鈥� rights and guaranteed employment policies in which the State acts as the employer of last resort should be the basis for reducing poverty and improving income distribution to promote economic reactivation. This should be accompanied by implementing universal and unconditional education and health policies, especially for the country鈥檚 youth.
10. The most severe current problem is unemployment; it cannot be treated with the microeconomic instruments of the 19th century since it is a monetary and macroeconomic phenomenon and requires the 20th and 21st-century macroeconomics techniques. The State must act as an employer of last resort. Faced with a fall in effective demand caused by the collapse of private spending on consumer and investment goods, the only stabilizing agent is the State, resorting, for example, to a public employment buffer, which acts as an automatic stabilizer. Using DANE unemployment figures, we estimate a buffer model whose results show that unemployment could be reduced from 14.2% to 5.2% of the economically active population in four years. The first year starts with 547,997 female heads of household, and in the fourth year, there would be 2,191,989 female household heads in the system. The salary would be 800,000 Colombian pesos (around $217 U.S. dollars) per month, and the fiscal cost would increase from 0.49% of GDP in the first year to 1.5% in the fourth year. The multiplier effects of the buffer would lead to a 1.5% increase in GDP in the last year and an increase in tax revenues equal to 0.24% of GDP.
11. For its part, the fear of losing credit ratings has more to do with panic-mongering to create panic, with no facts to back up that fear. As debt expert Daniel Mun茅var pointed out, 鈥渢he bulk of our debt has fixed interest rates […], and there is no reason why they cannot continue to be so in the future if the government does its job well before international lenders, besides the fact that the Treasury has set a maximum limit on amortizations of 8% of the current total amount of debt. In other words, even if we lose investment grade, the increase in interest rates would eventually only affect new debt.鈥� Thus, the domestic policy seems to be determined by the rating agencies, which, worth remembering, contributed to the 2007 global financial crisis through their bad practices. As Srinivas Raghavendra says, 鈥淭he emerging politics of the present crisis is driven by the coercive power of the rating agencies over the institutions of the state through the delinking of the politics of deliberative democracy from the conduct of economic policy in general and fiscal policy in particular.鈥�
12. To think that income redistribution is achieved with greater 鈥渆conomic freedom鈥� is to ignore the history of developed countries, which relied not only on the 鈥渕arket鈥� but also on the use of State policies as a development tool: the country needs industrialization policies and progressive tax reforms. But in the crisis caused by the pandemic, individuals and MSMEs need immediate support to mitigate or remedy their loss of monetary income as well as clear measures to reduce the effects of conventional policies. However, this requires breaking free from dogmas that impede diligence and efficiency.
13. Central bankers are not benevolent dictators, nor can they continue to promote the idea that monetary policy is a purely technical matter. As James Tobin put it, monetary policy is a political problem. Whatever they may say, the world鈥檚 most important central banks are acting as lenders of first resort to the central government, without in any way denying that the degrees of freedom to finance public spending via central banks must be conditional on the preservation of the central bank鈥檚 effective capacity to manage monetary policy in the event of inflationary dynamics.
14. In a country with high dollarization of its external assets and liabilities in the context of a deep liberalization of its capital account, such as Colombia, it is necessary to accompany these unconventional monetary policies with measures to control capital flows, certainly in a balanced manner to avoid further destabilization of the exchange rate. These measures go in the right direction in an emergency, and it is pertinent to put them into practice.听听

To face a situation of public calamity such as the one suffered by 99% of the population, a tax reform is still an irrelevant alternative amid the pandemic and the economic crisis. Citizens should know that there are other ways of thinking and understanding the economy. Among economists, there is no consensus of the entire profession, as was not the Washington Consensus. Only a well-informed citizenry can press for governments to disregard outdated theories and policies contrary to the welfare they promise.

Gonzalo C贸mbita                    Universidad Nacional de Colombia

Mery C. Garc铆a                       Universidad Nacional de Colombia

Nohora Garc铆a听听听听听听听听听听听 Universidad Nacional de Colombia

Alejandro Garay                     University of Missouri – Kansas City

Cesar Giraldo Giraldo            Universidad Nacional de Colombia

Camilo Guevara                      Universidad Nacional de Colombia

Diego Guevara                        Universidad Nacional de Colombia

Forrest Hylton                         Universidad Nacional de Colombia, Medell铆n

Manuel Martinez Mantilla      Universidade Estadual de Campinas, Brasil

Stanley Malinowitz                Universidad Nacional de Colombia

Hernando Matallana               Universidad Nacional de Colombia

Guillermo Maya Mu帽oz         Universidad Nacional de Colombia, Medell铆n

Carolina M茅ndez                    Pontificia Universidad Javeriana, Bogot谩

Laura Mois谩                            Universidad Nacional de Colombia, Medell铆n

Andr茅s Felipe Mora                Universidad Nacional de Colombia

Fernando A. Morales              Universidad de Bio Bio, Chile

脕lvaro M. Moreno Rivas        Universidad Nacional de Colombia

Manuel Mu帽oz Conde            Universidad Nacional de Colombia

Elizabeth Oviedo                    Universidad Cooperativa de Colombia

Vanessa Ram铆rez Quintana    Universidad de Buenos Aires, Argentina

Liliana Elizabeth Ruiz            Universidad Militar Nueva Granada

Flor Esther Salazar                 Universidad Nacional de Colombia

Rafael Orlando Su谩rez           Universidad Nacional de Colombia

Carlos Suesc煤n                      Universidad Nacional de Colombia

Luisa Fernanda Tovar             Universidad Nacional de Colombia

Iv谩n D. Vel谩squez                  Bemidji State University, Estados Unidos

Pablo Bortz                             Universidad Nacional de San Mart铆n, Argentina

Sonia L贸pez Cer贸n                 Pontificia Universidad Javeriana

Juan David Parra                    Universidad del Norte

Florencia M茅dici                    CONICET/Universidad Nacional de Moreno, Argentina

Camila Ni帽o Fern谩ndez          Estonian Business School Helsinki

Martha Susana Jaimes New School for Social Research, Estados Unidos

Pedro Clavijo                          University of Utah, Estado Unidos

Carlos Mej铆a                           Universidad del Valle

David Cano                             Universit脿 degli Studi di Siena, Italia

Jairo Parada                            Universidad del Norte

Since its publication on May 5th on social media, the letter has been subscribed by 407 signatures of citizens and academics from Colombia and other countries. Sign the letter .

Photo: BOGOT脕, COLOMBIA – 5 MAY, 2021: A protester holds the Colombian flag in a peaceful protest in the framework of the national strike against Ivan Duque government

In his late-night

Yet the Philippine state鈥檚 inadequate institutional capacity to respond to the epidemic goes deeper. Given the national economy鈥檚 position in the hierarchical global economic system, its structural weaknesses impacts on how effective the government鈥檚 response can be. The current mainstream approaches to resolve the pandemic and the multiple crises of capitalism would fail to address the convoluted historical process of maldevelopment of the Philippines. Thus, a radical political strategy with a new economic paradigm for post-pandemic reconstruction is needed.听听听听

The Neoclassical Economic Team and the Missing Keynesians

On economic affairs, Duterte has relied on the 鈥渂right boys鈥� of his cabinet 鈥� notably, Finance Secretary Carlos Dominguez III, newly resigned Socio-Economic Planning Secretary Ernesto Pernia, and former Budget Secretary and incumbent Central Bank Governor Benjamin Diokno. Although they are competent technocrats, being, their faith in market-oriented solutions does not provide the appropriate policy framework to contain the health crisis and economic downturn.

While Duterte鈥檚 political style may be characterized as populism, his administration鈥檚 economic policies are Hence, his to generate funds through any means possible to sustain the beleaguered economy is to be carried out on the terms of neoclassical macroeconomic theory. A core operating tenet of this orthodox economic policy is that (i.e. room in a government鈥檚 budget) is a prerequisite for government spending, even when an expenditure is on purposes such as securing the well-being of citizens during a pandemic. It undermines a basic Keynesian macroeconomic reality that the government generates income through spending — which, in turn, increases the state capacity to provide for the needs of the population. Neoclassical macroeconomics also claims that a government is constrained by revenues, and that the capability of a state is reduced to its financial position. It therefore disregards the possibilities for the state to exercise political will over economic policy instruments and the scope for a government to mobilize the country鈥檚 real resources.听

Unfortunately, voices from Filipino critical, heterodox, or post-Keynesian economists are hardly heard in public debates when their intervention is most urgently needed.听

MMT and Monetary Sovereignty

At this period of great uncertainty with a looming, the Philippine government may test Modern Monetary Theory (MMT) as a viable macroeconomic strategy to manage the pandemic crisis. MMT is applicable to a sovereign state like the Philippines with a central bank that issues the country鈥檚 own currency and a floating exchange rate regime that is fully integrated into the fiat monetary system of the contemporary world-economy. A fundamental principle of MMT is 鈥渕onetary sovereignty,鈥� which suggests that. Hence, the Philippine peso is the creature of the Philippine state.听

The direct transfer of cash to the public and other targeted social support schemes are now being undertaken by state agencies, cities and municipalities across the Philippine archipelago on the basis of local ordinances and the Social Amelioration Program provided for under the. This may be construed as an implementation of insofar as it shows that the government does not face financial constraints when printing and issuing its currency to distribute to the population for local consumption of goods and services.

Contrary to Duterte鈥檚 alarmist pronouncement, the government cannot run out of money for this purpose of transferring or handing out cash to the needy and insecure population simply because the Philippine state has sovereignty over the issuance of the peso and a national central bank (the BSP – Bangko Sentral ng Pilipinas) controlling monetary policy. At the moment, the Philippines also has a and a sustainable level of external debt. Through legislation by the Senate and the House of Representatives, the Executive can instruct the BSP to issue money or credit bank accounts without draining the nation鈥檚 reserves. In today鈥檚 modern monetary system, this may be done.听

By following the MMT, the Philippine government can take the perspective that the state issues — rather than merely spends — money. As such, the state is not like the typical private individual or household, whose spending is limited by its savings. Being the monopoly issuer of its own currency and the sole taxation authority, the state can always credit a bank account to make a domestic payment. The government cannot be insolvent; but it can default if it chooses to do so. An option for the government is to make a self-imposed debt limit, and for a developing country, in particular, it should be strategic with its and avoid piling up external debt burden.听 It is imperative not to deepen unnecessary external indebtedness of the government for expenditures and programs that can be covered in local currency during this expectedly protracted economic hardship. The substantial increase in government debt now due to deficit spending and external borrowings will still have to be addressed in the post-crisis management of the economy. There is a danger that these deficits and debts would be managed through austerity and deep cuts in state expenditures if neoliberal officials are elected in government or appointed in the bureaucracy in the future.

Mobilizing Finance, Real Resources and Labour

In addition to the macroeconomics of MMT, the Philippine government may also implement universal basic incomes and related social protection programmes, notably the provision of food and other needs for subsistence of households while on lockdown and community quarantine, to ensure cash flow for individuals and families, support reproductive life, and encourage both productive and creative work. But these financial assistance would not go far enough. In war-like economic conditions such as the COVID-19 pandemic, Keynes would remind us that the technical problem of finance (i.e., the making and issuance of money to spend for necessary expenditures) can be solved easily. The more crucial problem for the time being is the, when not just the demand- and supply-side problems come in to play, but also where there is an organizational requirement for the government to deliver public services efficiently and effectively.

The key to a strong economy has always been . During the pandemic, the mobilization of finance should come with shifting and mobilizing the country鈥檚 real resources. It is vital that the government鈥檚 pandemic response is comprehensive with a view to the action plan for economic and social changes over the immediate and long-term.

The greatest鈥攜et underutilized鈥攁ssets of the Philippines are the labour of its people. Acting as an employer-of-last-resort, the government should create jobs and facilitate employment in activities that are currently most strategic (e.g., in healthcare, scientific research, farming, education, information technology, retail and food sectors, construction and infrastructure, sanitation and other public services). Give jobs at a living wage up to a point of full employment and open opportunities for livelihood. Legislate labour laws to reduce working time to what is just and socially necessary so as to observe a natural balance between work and leisure.

In essence, this emphasis on the strategy of job creation even in a time of a pandemic comes from a particular sensibility of labour as a creative and productive source of social and economic value. Labour is the lifeblood of the human economy and society; whereas the capitalist system depends its survival and reproduction on the real subsumption of labour to capital and on the market exchange for profits. Here, comes to mind: 鈥淓very child knows a nation which ceased to work, I will not say for a year, but even for a few weeks, would perish. Every child knows, too, that the masses of products corresponding to the different needs required different and quantitatively determined masses of the total labour of society.鈥�

Paradigm Shift for a New Economy

The biggest constraint, however, to any progressive economic response to the pandemic is the longstanding hegemony of neoliberalism that has resulted in the tragic underdevelopment of and tremendous inequalities in the Philippines. From crony capitalism during the Marcos dictatorship in the 1970s鈥�1980s to the succeeding 30 years under different administrations with essentially elitist liberal-democratic institutions, the neoliberalization process in the Philippines has favoured the ideology of trade liberalization over industrialization, localized agricultural innovation, agroecological transformation and food self-sufficiency. For decades, the country鈥檚 economic managers and free-market ideologues have made Filipinos consent to the idea that it is much cheaper to import manufactured goods, rice and other agricultural products than to protect and nurture the nation鈥檚 manufacturing industry, agriculture, farmers and food system.

The macroeconomic techniques offered by MMT and Keynesianism may prove effective for the Philippine government to keep the economy dynamic. But utilizing them requires strict adherence to the principles of democracy and integrity in governance.

On top of adopting the perspectives of state money, labour and democracy, there is need to redefine the role and restructure the responsibilities of the central bank in a way that contributes to a coordinated economic and social reform process鈥攕pecifically to strengthen the domestic industry, manage the terms of trade, and institutionalize redistributive welfare programmes. To this end, should not be BSP鈥檚 primary regulatory function and monetary policy goal. Though central bank鈥檚 independence should be guaranteed, it must not be made immune from democratic accountability.

It is particularly important in the wake of the pandemic that economic policies be used as instruments of social justice to build conditions for a new economy, rather than the recovery of the grossly unjust and highly unequal existing order. The synergy of economic activities between rural and urban areas must be organized sustainably to attain the geographical development objectives of dynamism with equity. Importantly, to genuinely enforce, the government and the active citizenry have to collectively value every labourer鈥檚 contributions to the socio-economy, reassess the ethics of inherited wealth, and dismantle rentier capitalism.

Indeed, the ongoing health, economic and existential crises ought to be taken as an opportune moment to push for a shift in our thinking about the normative workings of the economy, the significance of addressing systemic inequalities, and the moral value of human dignity and every human life.

Paradigm shift now, and change shall come.听

Bonn Juego is a researcher and teacher in international development studies at the University of Jyv盲skyl盲, Finland. He tweets at .

Photo: PCOO EDP