‘Populist’ macroeconomic policy

Vladimir Popov, Jomo Kwame Sundaram

BERLIN, KUALA LUMPUR: ‘Ethno-populism’ has emerged and spread in recent decades in response to the mixed consequences of neoliberal globalization. It appropriates nationalist rhetoric for narrow ethnic, religious, cultural or other communal ends, typically with a chauvinist, jingoist rejection of selected Others as politically expedient.

Politics of macroeconomic policy

Most elected governments in the world typically rely on the political support of coalitions among different interest groups, including classes. Hence, unsurprisingly, most political platforms involve what are essentially populist coalitions, within a political party or among several such groupings, seeking popular electoral support.

Mancur Olson’s notion of ‘distributional coalitions’ -- i.e., political alliances cooperating to secure shared, complementary, not conflicting demands -- presumed that such populist regimes typically have to raise enough tax revenue for redistribution in response to demands and pressures from interest groups.

Thus, fiscal mechanisms became central for such redistribution by determining not only the sources of state revenue, especially taxation, but also the beneficiaries and consequences of government expenditure.

Alleged ‘macroeconomic populism’ in Latin America has been used to explain its 1980s’ ‘lost decade’ as due to irresponsible fiscal policy. Other factors, such as abuse of the ‘non-system’ after US President Nixon ended the Bretton Woods system, are ignored in this narrative.

Thus, macroeconomic mismanagement, especially fiscal indiscipline, was blamed for the developing country debt dilemmas of the 1980s and the transitional economies’ problems of the 1990s.

Retrospectively, the problems of communist party-run states were misleadingly blamed on both enterprise and national level ‘soft budget constraints’ (SBCs) when, in fact, these were much more pervasive during the problematic 1990s’ transitions of ‘post-socialist’ economies.

Coping with fiscal deficits

Constrained by the unwillingness and inability to raise enough tax revenue, and the desire to redistribute in favour of particular interest groups to remain in power, governments are left with four options to indirectly finance subsidies.

The first is to maintain control over particular prices, i.e., selective price controls. But controls over the prices of non-resource goods still require budgetary subsidies to companies producing the goods and services.

By contrast, price controls for fuel, energy and other resource commodities can redistribute resource rents to consumers. This option, only available to resource rich countries, thus contributes to the popular ‘resource curse’ story.

A second mode of subsidization, when funds are not available, is inflationary government budget financing. The government is said to cause inflation by spending beyond its (revenue) means, i.e., the tax revenue shortfall supposedly causes inflation, i.e., ostensibly ‘imposing an inflation tax’ on everyone.

A third option is debt financing, using either domestic or external borrowings. Debt financing buys some time to maintain subsidies, but debt servicing imposes an additional burden on the government budget to service the debt with payments for both the principal and interest.

A fourth option has been to maintain an overvalued exchange rate, effectively favouring consumers over producers, importers against exporters, and consumption at the expense of savings. Rising consumption, associated with increased imports financed by external borrowings or foreign exchange reserves, can only temporarily ‘kick the can down the road’, before balance of payments problems come home to roost.

There has long been a near consensus that persistent exchange rate overvaluation is detrimental for economic growth and transformation in developing countries. Needless to say, exchange rate overvaluation is favoured by governments collecting taxes in domestic currency having to service external debt in foreign currencies, and import lobbies, i.e., those earning at home and spending abroad.

Macroeconomic populism and deficit budgets

There seem to be two ways to deal with demands for populist redistribution and to ensure macroeconomic stability. First, by eliminating demands for redistribution by reducing inequalities, especially to maintain political support for the ruling distributional coalition.

Second, those leading the ruling distributional coalition in power can redistribute income explicitly via direct subsidies, rather than indirectly. They can also try to reduce the costs of preserving political support by other means.

Research on Latin American and other countries suggests that ‘transitional democracies’ are less effective than either authoritarian regimes or well-established democratic regimes in resisting macroeconomic populism. Hence, some populist distributional coalitions have proved more politically stable and less wasteful than others.

Contrary to prevailing economic mythology, fiscal constraints in socialist economies were harder than in developing countries and no less hard than in most developed countries. SBCs in socialist economies were not pervasive, as widely presumed, but selective, i.e., involving subsidization of some enterprises or industries at the expense of others.

Such selective subsidization is typically part of industrial policy, whether successful or otherwise, but is neither an intrinsic feature of centrally planned socialist economies, nor of fiscal constraints. In many countries, especially in East Asia, such selective subsidies, not pervasive SBCs, have been successfully used to promote export oriented and high technology industries.

With democratization, small and well-organized lobbies, e.g., for resource and military interests, have been able to influence public policies far more successfully than the far more numerous, but typically poorly organized consumers, producers and others amorphously constituting the public interest.

The generally weak post-socialist states were generally unable to resist pressures from influential interest groups. Thus, subsidies and other policies supporting such industries and enterprises increasingly undermined the strict national fiscal constraints under socialism.

Fiscal indiscipline myth

Thus, increasingly widespread enterprise-level SBCs engendered deficit financing, which became associated with permanent government budget deficits, debt accumulation and other macroeconomic imbalances, resulting in high inflation, in turn worsening macroeconomic instability during such transitions.

The combination of weak states and competing powerful interest groups thus caused governments to ‘kick the can down the road’ by accumulating deficits and debt, ‘printing money’ (inflationary financing), keeping domestic fuel and energy prices below world levels and maintaining an overvalued exchange rate.

Deficit spending is just one possible ‘populist’ macroeconomic policy. This was actually rare in socialist countries, but widespread in transition economies, especially the former Soviet republics, and also common to many developing countries, especially in Latin America and Sub-Saharan Africa.

The recent and ongoing rise and consolidation of ethno-populist regimes underscore the need for more rigorous understanding of the socio-economic bases for new distributional coalitions, the conditions enabling their emergence and sustenance, as well as their likely implications.

Myths of soft budget constraints

Vladimir Popov and Jomo Kwame Sundaram

BERLIN, KUALA LUMPUR: In recent decades, many contemporary macroeconomic and financial problems have been blamed on ‘soft budget constraints’ (SBCs), with the term becoming quite popular in the economics lexicon, financial media and political discourse.

Soft budget constraints

Originally coined four decades ago to purportedly describe the economic roots of problems in centrally planned ‘socialist’ economies, it was soon also invoked for ostensibly dirigiste developing countries accused of ‘macroeconomic populism’ and ‘industrial policy’.

It has since assumed a double life, invoked on one (microeconomic) hand to discipline large enterprises not maximising shareholder value by investing too much for the medium and long-term, and on the other (macroeconomic) hand to control ‘irresponsible’ governments running budget deficits.

First formulated by Harvard economist Janos Kornai from Hungary to explain economic behaviour in ‘socialist’ economies said to be characterised by shortage, the term was soon widely used in the literature on economic transitions from centrally planned ‘socialism’ to market capitalism.

The original claim was that state-owned enterprises (SOEs) in socialist countries were not allowed to fail even when unprofitable. According to him, such SOEs were almost always bailed out with financial subsidies or by other means. True, SOEs in socialist economies never went out of business as there were no bankruptcies.

But although such legal bankruptcy provisions were undoubtedly lacking, SOEs were often disciplined by other means in such ‘centrally planned’ economies: national budget provisioning under central planning was almost always strictly limited, managements could be changed, or enterprises required to reform.

Nevertheless, poor enterprise management and losses were blamed on SBCs. With enterprise losses assumed to result in national level budgetary indiscipline, SBCs at both levels were presumed to be related.

Hence, permanent government budget deficits, debt accumulation, high inflation and other macroeconomic imbalances were presumed to be associated with pervasive enterprise level SBCs and losses.

Global neoliberal economic ascendance from the 1980s increasingly invoked SBCs to explain economic problems at both micro and macro levels in non-socialist economies, such as the financial difficulties of US auto giant Chrysler in the 1980s and various macro-financial crises since.

Shortages and SBCs

The SBC notion was directly linked by Kornai to the ‘shortage economy’, another notion associated with him from the 1980s, with both portrayed as characteristic of centrally planned socialist economies.

When a government covers the losses of all unprofitable SOEs with a national fiscal SBC -- a practice presumed to be widespread -- both wages and profits exceed the value of output, causing both consumer and investment demand to exceed supply in such ‘shortage’ economies.

As enterprises are not constrained from increasing demand for resources, shortages emerge. Shortages are inevitable if prices are controlled and cannot rise to clear markets. But SBCs do not inevitably lead to shortages as market price increases can eliminate them.

Due to SBCs, enterprises are presumed to increase investment and production until they encounter non-financial resource constraints in the form of shortages. But no explanations have been offered as to why these should necessarily occur, either in theory or in practice.

Rather, this claim is based on the presumption that SOE managers are primarily, if not solely interested in maximizing output or growth rates. This presumption is widely believed by economists to be realistic, although there is no systematic evidence that this was indeed the case.

Selective industrial policy

Enterprise level losses over several years were also presumed to be due to SBCs, rather than the result of a deliberate policy of selective encouragement of and support for particular sectors, technological initiatives and enterprises.

In fact, such support for strategic industries and enterprises was not widespread, let alone pervasive, and did not cause major government budget deficits. Such selective industrial policy is thus easily, but misleadingly depicted as a classic cause of enterprise-level SBCs.

Such selective subsidization may or may not succeed in accelerating progressive structural transformation, but was certainly neither an intrinsic or pervasive feature of centrally planned socialist economies, and even more misleadingly, a major cause of pervasive SBCs.

In East Asia, promotion of export-oriented manufacturing and new high-tech industries contributed to successful catch-up growth and structural transformation. But such targeted subsidization conditional on meeting performance criteria did not involve national level or macroeconomic SBCs.

The problem in the USSR and East European countries was not subsidization per se, but rather, indefinite, even increasing protection through higher domestic prices for manufactures -- as part of import substituting industrialization policy -- perpetually protecting manufacturing SOEs not effectively compelled to become more competitive.

Budget constraints in ‘socialist’ economies

In the Soviet Union after the Second World War, from the 1947 monetary reform until the 1987 Gorbachev perestroika reforms, budget deficits and debt were kept low and transparent. Open and hidden annual inflation rates remained in the single digits, often lower than in Western countries.

In fact, budget constraints in ‘socialist’ economies were ‘stricter’ than in most developing countries, and no less ‘hard’ than in many developed countries. SBCs in ‘socialist’ economies were not all-pervasive, as often claimed, but selective, e.g., involving subsidization of some enterprises or industries at the expense of others.

Budget constraints under central planning were mostly much stricter than in market economies at similar levels of development. SOE losses could contribute to government budget deficits, but were mostly modest under ‘socialism’, with both open and hidden inflation relatively low.

Various political factors shaped macroeconomic policy choices during the 1990s’ transitions. Previously ‘hard’ budget constraints ‘softened’ dramatically in many East European countries and former Soviet republics, resulting in fast growing budget deficits and high inflation.

The new combination of weak states facing rivalrous powerful interest groups caused governments to ‘kick the can down the road’, with deficits, debt, inflationary financing, overvalued exchange rates as well as domestic fuel and energy prices below world levels.

Hence, SBCs were just one type of economic policy, rare in ‘socialist’ countries, but found in many developing countries, especially in Latin America and Sub-Saharan Africa, and ironically, in transition economies, especially in the former USSR, from the 1990s.

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