Inflation paranoia threatens recovery

Anis Chowdhury and Jomo Kwame Sundaram

SYDNEY and KUALA LUMPUR: Inflation hawks are winning the day. The latest ‘beggar thyself’ race to raise interest rates has begun. This ostensibly responds to the spectre of runaway inflation, supposedly retarding economic growth and progress, and thus threatening central bank ‘credibility’.

Inflation fetish

The ‘one size fits all’ policy of raising interest rates to contain inflation is being touted again, the world over. This will surely kill national efforts to revive economies reeling from COVID-19 pandemic slowdowns.

Central banks in many emerging market and developing economies (EMDEs) – such as Brazil, Russia and Mexico – began raising policy interest rates right after inflation warning bells were set off after mid-2021. Indonesia and South Africa have since joined the bandwagon.

International Monetary Fund (IMF) Managing Director Kristalina Georgieva has warned that US interest rate rises would “throw cold water” on global recovery, especially hurting struggling emerging markets.

An earlier IMF blog had urged EMDEs to prepare for earlier than expected US interest rate hikes. The Fund has lowered its growth projections as the inflation bogey induces monetary and fiscal tightening.

Inflation paranoia

Inflation hawks denounce price increases, claiming – without evidence – that it impedes growth. Former World Bank chief economist Michael Brunoand William Easterly refuted these popular, but false prejudices.

Using 1962-1992 data for 127 countries, they found, “The ratio of fervent beliefs to tangible evidence seems unusually high”. They also found extremely high inflation – over 40% yearly – mainly due to very exceptional circumstances, e.g., Nicaragua after the Sandinista takeover.

Bruno and Easterly concluded that inflation under 40% did not tend to accelerate or worsen. They concluded, “countries can manage to live with moderate – around 15–30 percent – inflation for long periods”.

Bank economists Ross Levine, Sara Zervos and David Renelt confirmed a negative inflation-growth relationship to be exceptional, and due to a few extreme cases.

Rudiger Dornbusch and former IMF Deputy Managing Director Stanley Fischer came to similar conclusions. They too found moderate inflation of 15–30% did not harm growth, emphasizing “such inflations can be reduced only at a substantial short-term cost to growth”.

Citing IMF research, Harry Johnson also argued that while very high inflation could be harmful, there was no conclusive empirical evidence of the alleged inflation-stagnation causal nexus.

Even monetarist guru Milton Friedman acknowledged, “Historically, all possible combinations have occurred: inflation with and without development, no inflation with and without development”.

Thus, the Fund and the Bank have no sound bases for promoting draconian policies to eliminate inflation above, say 5%, by citing a few exceptional cases of very high, runaway inflation and low growth.

Inflation misdiagnosed

Friedman’s sweeping generalization that “inflation is always and everywhere a monetary phenomenon” ignored other factors possibly contributing to inflation.

Without careful consideration of inflation’s causes, the same old policy prescriptions are likely to fail, but not without causing much harm. Prices tend to rise as demand outstrips supply. This can also happen when demand rises faster than supply, or if demand does not decline when supply falls.

The IMF attributes the current inflationary surge to supply chain woes, higher energy prices and local wage pressures. While demand has been boosted by pandemic relief and recovery measures, where existent, supply shortages remain vulnerable to disruptions.

Rising food costs are also pushing up consumer prices. Extreme weather events – droughts, fires, floods, etc. – have affected food output. More commodity price speculation – e.g., via indexed futures – has also raised food prices.

Although wages have risen in some sectors in some countries, economy-wide wage-price spirals are unlikely. Employment suffered during the pandemic while unionization is at historically low levels.

Labour’s collective bargaining powers have declined for decades, especially with technological change, casualization and globalization lowering the labour income share of GDP.

As the profit share of income continues to rise, rising mark-ups and executive remuneration also push up prices. With more market monopoly powers, price gouging has become more widespread with the pandemic.

Understanding what causes particular prices to rise is critical for planning appropriate policy responses. Although devoid of actual diagnoses, inflation hawks have no hesitation prescribing their standard inflation elixir – raising interest rates.

Raising interest rates may help if inflation is mainly due to easier credit fuelling demand. But tighter credit is unlikely to effectively address ‘supply-side’ inflation, which typically requires targeted measures to overcome bottlenecks.

Interest rates harm

Higher interest rates increase borrowing costs, squeezing investment and household spending. This hits businesses, hurting employment, incomes and spending, and can result in a vicious downward spiral.

Higher interest rates also increase governments’ debt burdens, forcing them to cut spending on public services including healthcare and education. Incredibly, elevated interest rates – harming investments, jobs, earnings and social protection – supposedly benefits the public!

The adverse spill-over impacts of rising interest rates are also considerable. Raising rates in major advanced economies weaken EMDE capital inflows, currencies, fiscal positions and financial stability, especially as sovereign debt has ballooned over the last two years.

Indeed, the interest rate is a blunt weapon against inflation. How can raising interest rates curb food or oil price increases? While supply blockages persist, essential consumer prices will rise, even with high interest rates.

Higher interest rates may even aggravate inflation as businesses cut investment spending. Thus, supply bottlenecks, especially of essential goods, are likely to be more severe, pushing up their prices.

Most people are indebted, with the poor often borrowing to smoothen consumption. Thus, the poor are hurt in many ways: losing jobs and earnings, coping with less social protection, and having to borrow at higher interest rates.

Hence, the standard medicine of higher interest rates has massive social costs. Meanwhile, the principal beneficiaries of using higher interest rates to lower inflation are rich net creditors and financial asset owners.

Toxic prescription

Premature reversal of expansionary fiscal policy has been largely due to debt hawks’ successful fear mongering. Thus, debt paranoia nipped in the bud the ‘green shoots’ of robust recovery following the 2008-2009 global financial crisis.

In the early 1980s, inflation paranoia led to interest rate spikes, triggering debt crises, stagnation and lost decades in much of the world, especially developing countries. Now, inflation hawks are poised to derail global recovery, stop adequate climate action and otherwise undermine sustainable development.

Policymakers the world over, but especially in developing countries, must reject the inflation hawks’ paranoid screeches. Instead, they must identify and address the sources, causes and nature of the inflation actually faced. And then, take appropriate measures to prevent inflation accelerating to harmful levels.

There are a host of alternative policy measures available to policymakers. They must reject the lie that they have no choice but to raise interest rates – widely recognized as a blunt weapon, with deadly ‘externalities’.

While all available policy options may involve trade-offs, policymakers must seek and achieve socially optimal results. This requires robust, resilient, green and inclusive recoveries – not fighting quixotic windmills of the paranoid mind.

Related IPS commentaries

Inflation Bogey Blocking Recovery. 19 Oct. 2021. https://www.ipsnews.net/2021/10/inflation-bogey-blocking-recovery/

Central Banks Must Address Pandemic Challenges. 3 Aug. 2021. http://www.ipsnews.net/2021/08/central-banks-must-address-pandemic-challenges/

Debt Hawks Detract from Urgently Needed Fiscal Recovery Efforts. 13 Aug. 2020. http://www.ipsnews.net/2020/08/debt-hawks-detract-urgently-needed-fiscal-recovery-efforts/

Fight Pandemic, Not Windmills of the Mind. 28 Jul. 2020. https://www.ipsnews.net/2020/07/fight-pandemic-not-windmills-mind/

Robust Global Economic Recovery Needs Coordinated Policy Response. 14 Apr. 2016. http://www.ipsnews.net/2016/04/opinion-robust-global-economic-recovery-needs-coordinated-policy-response/

Austerity Bad for Recovery. 6 Jun. 2013. http://www.ipsnews.net/2013/06/oped-austerity-bad-for-recovery/

Climate inaction, injustice worsened by finance fiasco

Jomo Kwame Sundaram

KUALA LUMPUR: Many factors frustrate the international cooperation needed to address the looming global warming catastrophe. As most rich nations have largely abdicated responsibility, developing countries need to think and act innovatively and cooperatively to better advance the South.

Climate action

The world is woefully offtrack to achieving the current international consensus that it is necessary to keep the global temperature rise by the end of the 21st century to no more than 1.5°C (degrees Celsius) above pre-industrial levels two centuries ago.

The last Intergovernmental Panel on Climate Change (IPCC) report warns that temperatures are then likely to exceed 2.2°C. Many climate scientists fear many underlying interactions and feedback effects are still little known or poorly understood. Hence, they have not been factored enough into current projections.

Although the threat of global warming was scientifically recognized almost half a century ago, there has been much foot ragging since. Contrary to widespread belief, industrialized nations – the earliest and biggest greenhouse gas emitters –have actually held back much more adequate responses to the climate threat.

Although the UN’s 1992 Earth Summit in Rio de Janeiro secured the international community’s commitment to sustainable development, actual progress since has been modest at best. Undermining multilateralism – particularly since the end of the Cold War around the same time – has certainly not helped.

By effectively killing the Kyoto Protocol, the US has undermined the UN system and other multilateral initiatives not in its own interest since the first Cold War’s end. Consequently, most other signatory rich nations have not even tried to meet the Kyoto Protocol obligations they had signed up to.

Unsurprisingly, then Vice-President Al Gore – who presided over the US Senate’s 95-0 vote against the Kyoto Protocol – did not stress climate change in his 2000 presidential campaign. His public advocacy against global warming only began after his political ambitions ended with his controversial loss to George W. Bush.

Likewise, President Obama did little against global warming during his first presidential term – e.g., at the 2009 Copenhagen UN Framework Convention on Climate Change (UNFCCC) Conference of Parties (COP) – before the US actively shaped the 2015 Paris Agreement.

But, unlike Kyoto, the Paris deal is voluntary – i.e., not binding. Nonetheless, climate action was dealt yet another blow when President Donald Trump withdrew the US in early 2017 before President Joe Biden brought the US back in 2021.

Climate finance

To induce developing countries to accept binding new obligations at the 2009 Copenhagen COP, the European Commission President, French President Nicolas Sarkozy and UK Prime Minister Gordon Brown all pledged US$100 billion of climate finance annually – far from enough, but still a decent start.

But not even half this grossly inadequate, originally European commitment has actually been delivered. Other rich countries have generally given even less than the Europeans. All this is far short of what developing countries need to cope, worsened by requiring more aid to donor country export sales.

Most concessional climate finance since has been to mitigate climate change, with much less for adaptation. Worse, almost nothing has gone to help the typically impoverished victims of global warming for their cumulative ‘losses and damages’!

Sustainable Development Goal (SDG) 13 seeks to combat climate change and its impacts. Meanwhile, current global warming continues to worsen the effects of accumulated greenhouse gas emissions by industrialized countries.

In December 2015, the Paris COP reached agreement on a range of voluntary promises. Yet, climate scientists agree that neither the binding Kyoto Protocol nor the voluntary Paris Agreement can keep global warming by the end of the century under 1.5°C.

Economic damage to developing countries due to global warming so far is currently assessed at more than double the better documented adverse impacts on rich nations. But its victims get little help adapting to the daunting consequences of climate change, let alone ‘compensation’ for irreversible ‘losses and damages’.

Meanwhile, ostensible climate finance book-keeping involves considerable ‘creative accounting’. Thus, such resources have been exaggerated in various ways – e.g., by citing numbers for ‘blended finance’ and other dubious arrangements.

Thus, official ‘overseas development assistance’ or aid funds have been abused to subsidize ‘greenwashing’ public-private partnerships – e.g., by ‘de-risking’ profit-seeking private investments presented to the public as ‘climate-friendly’.

Climate justice

More recently, ‘climate justice’ is increasingly being demanded, especially of Western nations – instead of mere ‘climate action’. Although the climate action approach claims to treat all countries equally, by ignoring existing inequalities and disparities, climate action inevitably deepens them.

Invoking justice implies equitable actions are needed to redress the unequal implications of climate actions – e.g., reducing energy generation and use – for the poor and the rich – both people and countries. Thus, without addressing the need for equitable sustainable development, climate action often worsens inequities.

Hence, while claiming to offer seemingly fair solutions, some climate action measures – e.g., simply raising carbon prices, and thus, fuel costs for all – will be unfair in impact. Instead, climate justice measures must equitably address global warming and other climate change challenges.

The challenge – from a sustainable development perspective – is to address climate change while improving living standards equitably, especially for the worse off. This requires widespread generation and use of affordable renewable energy – instead of using fossil fuels – to slow global warming.

But markets are not going to do so on their own. Hence, novel, including hybrid means and much more affordable transfer of relevant technologies are needed to rapidly promote renewable energy use and ecological adaptation to global warming without adversely affecting the worse off.

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More progressive taxation needed for social progress

Jomo Kwame Sundaram

KUALA LUMPUR: Governments must innovatively develop progressive means to finance the large-scale social spending needed to improve lives and livelihoods, especially following the COVID-19 pandemic. More egalitarian tax reforms should enable governments to equitably mobilize desperately needed revenue to advance sustainable development for all.

Fiscal policy challenges

To respond to the pandemic and its economic fallout, massive resource mobilization has been necessary to protect people’s health and livelihoods, stem economic decline and stagnation, and ensure sustainable progress.

Fiscal policy involves governments harnessing and deploying resources. But modes of state financing and spending impact economic inequalities. Monetary policy measures can be supportive, but they cannot replace fiscal efforts.

However, the economic slowdown requires much more state spending, largely financed by sovereign debt, i.e., government borrowing. This has undoubtedly been necessary to deal with the pandemic, but fiscal policy should be consistently countercyclical: expansionary to counter downturns, and conservative in good times.

Rich countries have generally been fiscally bolder by running deficits to spend since the global financial crisis, but especially in response to the pandemic. Massive economic relief and recovery packages have tried to protect incomes and failing businesses, albeit unevenly.

Taxation regressive

Regressive colonial taxes were levied on subject populations, but tax incidence became more progressive after independence in most, though not all post-colonial societies. In the last four decades, most governments have reformed tax policies for the worse, reducing tax revenue shares and shifting the tax burden from the better off to the public at large.

Policy advice from international financial institutions and political pressure from powerful elites and foreign investors have reduced taxation’s progressive aspects. With Trump, laughable arguments such as Arthur Laffer’s curve – without any sound theoretical or empirical bases – are still being invoked to justify regressive tax reforms.

Rich corporations and individuals paid less and less in direct taxes, as the public paid more and more in indirect taxation, typically on consumption. Most countries still tax income, but tax rates on corporate income, high income individuals, property and inheritance have declined in most countries in recent decades.

The wealthy’s assets are mainly held as stocks, shares and real property. Their incomes are mainly from such assets, rather than earned as wages. Taxing excess profits and wealth can raise considerable revenue to finance development policies and measures, besides narrowing gaps between the beneficiaries and others.

Instead, wealth is typically taxed at low rates, while huge loopholes allow such assets to be hidden, typically abroad. Many trillions are hoarded in often secret accounts in tax havens, both off- and on-shore. All this has accelerated wealth concentration and economic inequality.

Making taxation more progressive

Governments mainly get fiscal resources from tax revenue or by borrowing. Taxation is undoubtedly the most sustainable, effective and accountable means for states to raise funds. Progressive taxation and government expenditure can both reduce inequalities, albeit in different ways.

Windfall profit taxes

A few individuals and businesses are reaping huge rewards from the pandemic while most have been hurting. Many billionaires have reportedly become much more affluent, with the ten richest more than doubling their wealth from US$700 billion to US$1500 billion since March 2020!

Windfall taxes at high rates are easily justified. After all, most who have gained much owe their newfound wealth to circumstances largely not of their own making. Windfall incomes or profits during the pandemic can be ascertained by comparing recent with previous profits. Such gains should be heavily taxed for the same reason.

Wealth taxes

Wealth taxation has diminished significantly in recent decades due to successful lobbying by the rich. The introduction or reintroduction and extension of progressive wealth taxation will raise considerable revenue if loopholes can be closed, not only domestically, but also internationally.

Perhaps even more than income taxation, wealth taxes are a progressive means to raise revenue. They also have greater potential to address other inherited privileges and inequalities, including those associated with culture, lineage, ethnicity and gender.

Conditional support

Government spending – including subsidies and relief measures – should not benefit businesses paying taxes abroad or not paying them at all. Many companies resort to tax havens and other loopholes to pay less tax where they operate and profit from.

More progressive systems

Tax systems should get much more from those most liable and able to pay. Concretely, this should include:

• Introducing or increasing taxes on assets like real property, wealth, inheritance and investment income (‘capital gains’).

• Raising the rates and progressivity of personal and business income taxes.

• Shifting relative reliance from indirect taxes – e.g., on value-added or sales or consumption – which tend to be regressive to more progressive direct taxation.

• Cracking down hard on tax avoidance and evasion – especially by the wealthy, however politically influential.

• Enhancing international cooperation on taxation to enhance and distribute tax revenue progressively.

Such systemic reforms are essential for progressive fiscal redistribution, e.g., by financing sustainable development in the medium and long-term. Of course, an immediate priority in the near term is financing a forward-looking recovery from the pandemic and its aftermath.

Coordinating fiscal policy

Governments are expected to raise enough revenue to finance the services, goods, facilities and infrastructure they are supposed to provide, i.e., to fulfil public expectations of citizens’ entitlements. The popular presumption is that tax incidence is not only progressive, but has also become increasingly so, although the converse is more likely to be true.

Taxation is widely expected to reduce, if not remedy inequalities. If well-designed for effective implementation and enforcement, the international record suggests this is achievable. In line with the public’s progressive redistribution expectations, the government is expected to be Robin Hood-like, i.e., to take from the rich to give to the poor.

Of course, whether taxation is progressive depends on how it is collected and spent. Hence, tax and spending policies should be considered together. But it is now clear that some pandemic relief packages have mainly benefited influential businesses, with crumbs going to the most needy.

International cooperation is needed to for appropriate tax reforms in this age of financial globalization, and to prevent increasing capital outflows from developing countries. For the time being, minimizing tax evasion depends on equitable and effective international cooperation on terms fair to all, rather than conditions imposed by the rich countries, as has been the case.

Selected IPS articles

Progressive Taxation for Our Times Sep 21, 2021

http://www.ipsnews.net/2021/09/progressive-taxation-times/

Myths, Lobbies Block International Tax Cooperation Jun 29, 2021

http://www.ipsnews.net/2021/06/myths-lobbies-block-international-tax-cooperation/

Powerful States Push Tax Race to the Bottom Jun 15, 2021

http://www.ipsnews.net/2021/06/powerful-states-push-tax-race-bottom/

Only Multilateral Cooperation Can Stop Harmful Tax Competition Apr 13, 2021

http://www.ipsnews.net/2021/04/multilateral-cooperation-can-stop-harmful-tax-competition/

Urgently Needed Deficit Financing No Excuse for More Fiscal Abuse Dec 08, 2020

http://ipsnews.net/2020/12/urgently-needed-deficit-financing-no-excuse-fiscal-abuse

Countercyclical Fiscal Policy Needed to Counter Global Economic Downturn Oct 01, 2019

http://www.ipsnews.net/2019/10/countercyclical-fiscal-policy-needed-counter-global-economic-downturn/