With modern money theory (MMT) receiving impressive attention, the implications this theory has for developing countries have also been discussed more intensely. Emphasizing both its strengths and gaps provides a great chance to further develop macroeconomic strategies for poverty reduction and environmental sustainability.
In brief, the theory starts from the statement that money is issued by the government and brought into circulation via its expenditures. The government does not rely on taxes to fund expenditures when it is itself the source of money. Therefore, money can be created upon demand, is not limited, and can be used by the government to finance all expenditures it considers necessary to achieve policy goals such as full employment or a Green New Deal. The reason why agents in the economy accepts this money only consisting of numbers without any intrinsic value is the obligation to pay taxes. Since the state has the power to impose taxes, individuals need to get hold of money as this is the only way to meet their obligations; this is how the currency is accepted as a means of payments. The government thus has the power to run unlimited deficits because the fact that money is needed to pay taxes guarantees its acceptance even if those taxes do not cover expenditures. In fact, the government should run deficits because it creates the demand required for full employment while a balanced budget constrains it. The government cannot go bankrupt because there is no lack of currency it issues itself. The conditions identified by MMT for the system to work are the following: 1) the country must be sovereign of its own currency and 2) inflation needs to be kept under control. Once the latter starts accelerating due to increased nominal demand stemming from government expenditures, taxes can be increased in order to withdraw money from circulation. However, as long as full employment is not achieved, prices are argued to remain stable.
Criticism of MMT has come from both mainstream economics as well as other heterodox strands. While the former tries to dismiss the theory in order to maintain the claim that there is no alternative to balanced budgets, the latter take a more sophisticated stance because apart from the disagreements, MMT is itself also rooted in heterodox economics.
It has been argued, mainly by the post-Keynesian school, that many of the central claims of modern money theory are not really modern because they are not new. True, the insight that money is endogenous and as such is the product of loan issuance was developed decades ago. Moreover, opposition to balanced budgets and harmful austerity has also been shared by many theoretical approaches for a long time. Therefore, heterodox approaches may know why they did not end up with the proposals now made by MMT. Yet, these critical points are not proof of MMT being mistaken.
There are further objections regarding a lack of clarity of what is part of MMT and what is not. For instance, there is disagreement on whether public sector employment programs is supposed to keep wages down and help curb inflation or whether it is an essential tool to drive up the wage share.
More serious obstacles are issues like the difficulty to fine-tune an economy such that full employment can be guaranteed via demand created by government expenditures while the private sector is just complemented instead of being compromised (buffer stock employment). It is hard to imagine such fine-tuning in a developing country’s weak institutional setting. Moreover, MMT acts on the assumption that the government’s treasury and the country’s central bank are just two departments of the same institution where the treasury can get what it needs from the central bank. This, if wishful, may not be an insurmountable barrier but so far, the reality of developing countries’ public institutions is usually different.
A definitely fundamental issue to be debated is the impact of unlimited government spending on inflation. It is fair to argue that unemployment and spare capacity counter inflationary pressure. However, the question is where the additional monetary units brought into circulation by the government eventually go. While in post-Keynesian theory endogenous money is associated with the production process, the monetary circuit and hence with output, the same is not true when the government tries to drive demand by deficit spending. To the extent of the budget deficit, there will be money left in circulation that will drive up prices. Higher inflation may be acceptable when it comes with the pursue of other macroeconomic goals. However, it has to happen within limits. Emission of government bonds and debt management may extend this constraint a bit. According to MMT, inflation can be curbed by raising taxes and lower the amount of money in the economy. However, the sooner inflation becomes an issue, the higher taxes have to be raised and the more the demand stimulus of government expenditures is eliminated.
Not only post-Keynesian scholars but also Marxian thinking finds issues of concern in the theory. What if a demand stimulus is insufficient to achieve full employment because there is a lack of profitability in the economy? Higher demand will not trigger additional investment if that investment is not sufficiently profitable. In that case, the result is not more output but inflation. To the extent that a fall in the profit rate explains long-term stagnation, government expenditures may be powerless. The same applies to developing countries where most likely not only demand is missing but also profitability, which is why the many calls for private sector engagement have shown poor results so far. With supply constraints being tighter in poor countries, inflation is even more an issue than in advanced economies.
After all, the most important criticism raised against MMT with regard to developing countries concerns the issue of monetary sovereignty. Which countries are sovereign of their currency? There is the US which enjoy the privilege of issuing the global reserve currency. Apart from other regional key currencies, almost all countries, and notably developing countries, face the balance of payments constraint. This means that they rely on foreign currency to pay for imports. The higher national income, the more imports grow and the greater the need for foreign currency. The resulting current account deficits involve exchange rate depreciations, imported inflation and foreign debt accumulation all of which can result in banking and currency crises. Following Thirlwall’s law, a developing country’s sustainable growth rate is limited by the growth rate, which is in line with a balanced current account.
MMT has an answer to several of these critical arguments: the government acts as an ‘employer of last resort’ by providing a job guarantee program. Hence, it eliminates unemployment by itself hiring people whose job consists, for example, in implementing the Green New Deal (for instance the installation of solar panels). Indeed, this is a very valuable proposition. To create employment, exerting additional demand is most likely not enough so spending is more effective if it does not merely go into consumption but into productive investment and production. Unlike the private sector, a public job guarantee program does also not rely on profitability. In line with demand, it is able to enlarge supply capacity and helps to keep inflation in check. To the extent that economic growth induced by a job guarantee still involves a current account deficit, the problem might be solved by directing investment in sectors, which either 1) rely less on imports, 2) are able to replace imports, or 3) promote exports to compensate the increase in imports.
The challenge a job guarantee program faces is definitely not a lack of money. It would, however, be wrong to believe that thanks to MMT, a job guarantee can be easily implemented. The administrative and institutional challenge is non-monetary but nonetheless very significant. This means that once we arrive at the core of the issue, we are back to development macroeconomics, which deals with the struggles of technology transfer, establishment of value chains, realization of productivity gains, import substitution and export promotion, and many more. Endogenous money is an important and useful vehicle to this purpose, but it is not a solution in itself.
Many of these institutional and technical steps tend to get in conflict with the balance of payments constraint. For example, establishing new industries requires the import of capital goods and hence a period of current account deficits. Is there a way to ensure macroeconomic stability despite external imbalance? To get a step ahead, we should think about the mechanics of the current international payment system and reform them in a way that provides a stable current account. It is an ambitious endeavor but a necessary one to relieve economic policies within countries from a tight constraint. It is only in such a stabilized environment that the issues of low productivity, profitability and demand can be tackled by public sector investment and employment can be fully exploited in the interest of poverty reduction and ecological transformation.
Basil Oberholzer is a macroeconomist working in the field of environmental economics and sustainable development who received his PhD at the University of Fribourg (Switzerland). He is also the author of Development Macroeconomics: Alternative Strategies for Growth. He tweets at @basiloberholzer.