By LUIZ CARLOS BRESSER-PEREIRA*
The short-term vision of both governments on the left and on the right generates deficits in the current account, creating a perfect harmony between the populism of politicians and economic orthodoxy
Once upon a time there was a country that saved and invested 18% of its GDP, when countries that grow quickly and do the “catch up” save around 30%. On the other hand, the country's current account deficit was 2% of GDP, that is, the country spent more than it collected and its external debt increased. “What to do?” asks the government. The solution quickly reaches anxious ears: it is to borrow and grow with external savings. Ten years later, however, what happened? The investment rate remained the same and the country continued to grow little, very little.
The newspaper's excellent correspondent Economic value in Geneva Assis Moreira presented on February 29th some of the information that the Human Development Report 2023/2024 from UNDP/UN will present in the coming days. The sad story is that the countries, much like our story in the previous paragraph, are heavily in debt and semi-stagnant. “Out of 59 developing economies examined, 32 have credit ratings rated below 'non-investment' grade. At least 36 are classified as at risk or at high risk of debt”. Worse: “Among 22 of the poorest countries, debt service payments represent more than 20% of their income.” And, according to the IMF, it represents 59,1% of these countries’ GDP.
To avoid doubt about the absurdity of the situation, “the UNDP estimates that low-income countries spend 2,3 times more on average on interest payments than on social assistance for their population, 1,4 times more than on domestic spending with health or 60% of what they allocate to education”.
Sorry for the quote, but here are the data of a tragedy that is always happening – a continuous tragedy that gets worse from time to time. And that confirms a more general thesis that I defend: the more a country gets into debt, the less it grows.
I know I'm going against the current – against established knowledge. I am saying that countries should avoid current account deficits as much as possible and therefore should not go into debt in foreign currency.
A frequent behavior of finance ministers in developing countries is to seek to reduce the public deficit to obtain credit abroad and, thus, be able to count on foreign savings. Being fiscally responsible is great, but not for this reason. With the exception of some special cases, the main one is that the country is already growing at a miracle pace. Then, the marginal propensity to consume falls, the marginal propensity to invest increases, and the substitution rate for domestic savings falls, and foreign savings add to domestic savings. Outside of this situation, countries should not seek external savings to grow, because external savings simply replace internal savings, while the country becomes indebted.
They should not try to grow with external savings for two reasons that occur successively. The first of these is one of the basic ideas of “New Developmentalism”. When a country tries to grow with external savings, that is, with current account deficits financed by loans or direct investments, the country's exchange rate appreciates in the long term (as long as more dollars are coming in than are going out due to deficits), the Industrial companies lose competitiveness, and the country, instead of industrializing, deindustrializes. This fact already has a large number of empirical proofs.
The second reason is divided into two. First, there is the high weight of public external debt service on GDP, the recent data we saw above. How can the State invest if 20% of its revenue is used to pay interest abroad? Not to mention the cost of internal debt. Second, there is the risk of the country going bankrupt, entering a balance of payments crisis.
Such a crisis is likely in low-income countries, but it also happens in middle-income countries, as is the case in Argentina since the government of Mauricio Macri. And it can even happen in rich countries, as was the case in the United Kingdom in 1976. It harms a country's growth for many years.
Rich countries ignore the first reason, but they cannot ignore the second. Faced with the threat of a financial crisis in the most fragile countries, they could limit their loans to these countries to export their capital – not the direct investments of multinationals that are not the cause of a balance of payments crisis because they have no maturity date.
Instead, however, they found a “solution”. John Williamson, in the 1980s (the decade of the great external debt crisis), formulated the concept of the “fundamental equilibrium” exchange rate, which I prefer to call the “external debt equilibrium” exchange rate. It's a simple concept: a country can borrow in foreign currency as long as its current account deficits relative to GDP are not greater than GDP growth. In other words, as long as the external debt/GDP ratio does not increase, there will therefore be no problem of excessive interest burden, nor the threat of a balance of payments crisis.
There is a formula that allows orthodox economists to calculate this “equilibrium” exchange rate and propose it as the path of development for the periphery of capitalism. This policy, however, implies exchange rate overvaluation (which is already terrible) and what's more, if the country is careless about the limit of its external debt balance (which is very common), it will see the cost of debt service increase or enter into crisis. of balance of payments.
These considerations lead me to say that current account deficits are always bad, even if they are financed by direct investments, because they always appreciate the exchange rate. And also foreign currency loans are always bad not just for the first, but for the two reasons already discussed.
Why, then, do peripheral countries insist on taking on debt? Because in the short term, as long as negative motives do not operate, loan capital inflows can increase the growth rate. And because governments, whether right or left, in addition to thinking only about the short term, prefer current account deficits and an exchange rate because this increases the purchasing power of salaries and they are re-elected. As you can see, there is a perfect harmony here between the populism of politicians and economic orthodoxy.
* Luiz Carlos Bresser-Pereira Professor Emeritus at Fundação Getúlio Vargas (FGV-SP) and former Minister of Finance. Author, among other books, of In search of lost development: a new-developmentalist project for Brazil (FGV Editor).
Originally published in the newspaper Economic value.
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