Late developers are nowadays confronted with the problem of having to earn foreign currency to finance structural transformation under extremely unfavourable conditions. The dependency on forex is rooted in the international financial architecture and represents a major pitfall for countries trying to catch up. However, this structural impediment to transformation is not paid much attention to by the dominant development economics.
Poverty as choice
According to the World Bank, the IMF and most mainstream economists, the main man-made cause for ‘underdevelopment’ is clear: bad institutions rooted in bad policies, which is often referred to as ‘bad governance’ (see e.g. World Bank 2017). Poor countries are still poor because they had a succession of corrupt governments since independence, which implemented policies unfavourable to the market. Differences in governance cause some nations to fail whilst others flourish (see e.g. Acemoglu and Robinson 2008; Dequech 2006). It is hence up to governments to decide whether they want to rule a country where poverty and weak jurisdiction prevail and nepotism can exist unabatedly; or in a country where good institutions foster economic development. In this context, financial sector liberalisation and financial inclusion have been promoted as development policies that can boost prosperity and reduce poverty. What is left out here though, are the inescapable facts of the global economic system which pose the most severe problems for current late developers, i.e. the institutional structure on a global level.
Development against the backdrop of a forex crunch
One such global institutional constraint is the dependence on reserve exchange that developing economies face, necessary to pay imports, redeem foreign debt and conduct exchange rate stabilisation measures. This dependency constitutes the choice between two evils or both of them: 1) increasing exports or 2) foreign borrowing in order to satiate the need for foreign exchange. In the case of the first option, it has to be considered that the terms-of-trade for primary commodities (the main export of many developing economies) deteriorate vis-à-vis imported manufactured goods. As primary commodity prices are low and extremely volatile, they are a poor source of export revenues and hence forex. What is more, monetary policies such as undervaluation of the national currency to improve competitiveness stand in the way of imports of capital goods necessary for structural transformation. If the second option is chosen and foreign currency is borrowed, the results are more often than not postponed and later show up as aggravated balance-of-payment difficulties and debt overhangs.
Ethiopia as an illustrative case
Ethiopia is one of the late-developers whose experience demonstrates the dilemma the international structure poses for low-income countries trying to catch up. It is celebrated as one of the new PINE-tigers (Philippines, Indonesia, Nigeria and Ethiopia) with at times two-digit growth rates in the past two decades. During the early 1990s it liberalised its financial sector, leading to a massive increase of formalised banking. It here followed an example set by the Asian Tigers, i.e. tentative liberalisation with strong government interference in the form of governmental credit control and allocation (e.g. for Korea: Kim 1995: 107). The growth spurts financed by the domestic banking sector were one of the factors behind increased imports making foreign exchange increasingly necessary. This led to a persistent forex crunch imperilling prospects of sustained structural transformation and growth.
The Eurobond issuance in 2014 securing 1 billion US-Dollars, bilateral loans from China and the United Emirates as well as a diaspora fund did little to ease Ethiopia’s incessant need to find foreign exchange. The prime minister Abyi Ahmed hinted that the problem is unlikely to be solved without the private sector which can be interpreted as a prospective opening up of Ethiopia’s capital account. If Ethiopia allowed foreign inflows of private financial capital, it could follow the experiences of many Asian and Latin-American countries since the end of the Bretton-Woods-system: erratic and pro-cyclical capital in- and outflows, subsequent debt crises and extremely high fluctuations of interest rates. In fact, the East-Asian financial crisis, identified as the ‘first crisis of globalisation’ by some (Lever-Tracey 2000: 66), was ignited by a real estate sector inflated by foreign capital inflows made possible by liberalisation (Tracy 2000: 52) – not an unlikely scenario for Ethiopia where the real estate market is already skyrocketing. It here becomes clear that common policy recommendations for developing economies such as financial liberalisation can exacerbate the problem.
Aid, FDI or financial inclusion as solutions?
Some might counter that the problem of foreign currency crunches can be solved by international aid or investments. Aid as well as foreign loans come with the danger of the Dutch disease, i.e. the appreciation of the domestic currency due to the sudden capital inflow, hence endangering export potentials – or overindebtedness if the aid consists of concessional loans. Other adverse effects of aid have been assessed in Moyo’s Dead Aid (for the argument that the scope of aid matters see Sial 2018). Structural change is hard if not impossible to achieve by increasing the inflow of international productive capital in the form of FDI (cf. Akamatsu 1962: 7) – and subject to sudden change. FDIs originating in industrialised countries for instance are increasingly being repatriated, as advances in automation make the labour share in production costs less relevant.
In this context, policy recommendations such as financial inclusion, or access to credit and financial services for unbanked communities, appear to be missing the point. Banking the unbanked in Ethiopia does not address the core constraints to structural transformation. Providing individuals with access to savings and credit in an economy with high unemployment rates, low productivity and low value added production does not address the cause of widespread poverty.
As identified by Eichengreen et al. (2003), the original sin, i.e. the inability of peripheral countries to borrow (at affordable rates) in their own currency, makes it extremely difficult to circumvent the perpetuating problem of forex dependency. This can only be resolved by reforming the international financial architecture (for reform suggestions see Akyüz 2013). Without such reforms, the catching up of developing economies is rendered extremely hard if not impossible under current global conditions. This goes against the notion that with financial sector liberalisation, the means to finance structural transformation can be mobilised.
A strong domestic banking sector might help gain access to foreign exchange but the problem of debt sustainability remains. Such finance is not only erratic and particularly pro-cyclical, but the profitability of investments in late-developers is also questionable in the face of tendencies towards stagnation in advanced capitalism, as predicted by Kalecki and Schumpeter (see Menon 2018).
Akyüz, Y. 2013. The Financial Crisis and the Global South: A Development Perspective. London: Pluto Press.
Eichengreen, Barry, Ricardo Hausmann, and Ugo Panizza. 2003. ‘Currency Mismatches, Debt Intolerance and Original Sin: Why They Are Not the Same and Why It Matters’. Working Paper 10036. National Bureau of Economic Research.
Kim, Kwan S. 1995. ‘The Korean Miracle (1962-80) Revisited: Myths and Realities in Strategies and Development’. In Asian Industrialization and Africa, edited by Howard Stein. New York: St. Martin’s Press.
Lever-Tracy, Constance. 2000. ‘Mismatch at the Interface: Asian Capitalisms and the Crisis’. In Chinese Business and the Asian Crisis, edited by David Fu-Keung Ip, Constance Lever-Tracy, and Noel Tracy. Aldershot, Hampshire, England; Burlington, Vt., USA: Ashgate Pub Ltd, p. 66–86.
Moyo, Dambisa. 2010. Dead Aid: Why Aid Is Not Working and How There Is Another Way for Africa. London: Penguin.
Tracy, Noel. 2000. ‘The East Asian Financial Crash: Causes and Consequences’. In Chinese Business and the Asian Crisis, edited by David Fu-Keung Ip, Constance Lever-Tracy, and Noel Tracy, first edition. Aldershot, Hampshire, England ; Burlington, Vt., USA: Ashgate Pub Ltd, p. 48–65.
This blog post is a part of the blog series Inclusive or Exclusive Global Development? Scrutinizing Financial Inclusion, in which a new perspective on financial inclusion is published every #FinanceFriday of February, March and April 2019.