Modern Monetary Theory (MMT) is increasingly gaining traction in today’s public discourse. While there is huge literature available regarding MMT, it is often ridiculed by statements claiming to explain the theory, such as “money printer gone brrrr”. It is important to know that MMT doesn’t advocate for money printing. To borrow from L Randall Wray, a pioneer of the field, MMT argues that a sovereign government that issues its own “nonconvertible” currency cannot become insolvent (in terms of its own currency). It cannot be forced into involuntary default on its obligations denominated in its own currency. It can “afford” to buy anything for sale that is priced in its own currency. Here sovereignty is defined in monetary terms in that a state has monetary sovereignty when it issues its own currency, taxes its people in that currency, accepts that currency in payment of the imposed obligations, and issues debt in its own currency. Along with this, a fifth consideration, according to Wray, is to have a floating exchange rate regime (which is what “nonconvertible” currency means); so that it provides more fiscal space for the government.
MMTers argue that their descriptions and prescriptions equally hold for the developing nations as for the developed nations. While this is largely true, there are however some constraints with regard to the developing countries.
The first such constraint is the need for a developing country to accumulate foreign currency, especially the international reserve currency - the dollar. One major factor that leads to this accumulation is the necessity to import various types of goods (which could be for various reasons). So, with the accumulation of external debt, the demand for foreign currency also increases because it leads to higher debt service obligations and also because it increases risk perception as there is greater exposure to currency mismatch. The accumulation of foreign debt means that the balance of payments becomes a major limitation on the policy front for a developing country. In the current account of the balance of payments, a trade deficit (imports > exports) is compensated by positive capital inflows (which leads to a surplus in the capital account). That is, a current account deficit must be balanced by the sum of the capital account. Randal Wray once wrote that “MMT makes no claim that floating rates eliminate current account deficits, indeed, MMT does not argue that elimination of current account deficits is even desirable”. But, the said balancing does not mean that a country can sustain any level of the current account deficit, over time. There is ample evidence available that the higher the current account deficit, the less likely that it can be sustained. What all this means is that the current account deficit chips away the monetary sovereignty of developing countries and thus the validity of MMT in such countries becomes uncertain.
A second issue, which is related here is that Wray suggests that in a floating exchange regime a government does not need to fear that it will run out of foreign currency reserves (or gold reserves) for the simple reason that it does not convert its domestic currency to foreign currency at a fixed exchange rate. Indeed, the government does not have to promise to make any conversions at all. But a developing country necessarily concerns itself with the capital flows not because of the issue of convertibility of currency, but because it needs to pay for its imports (or some sort of short-term obligation). All this is to say that a developing country may very well face the risk of foreign debt default.
Fadhel Kaboub, another MMT economist, identifies three broad areas from where a trade deficit arises. It arises because the developing country lacks food sovereignty, energy sovereignty and they essentially export low-value goods and import high-value goods. He says that this is a trap, in that a trade deficit leads a country to accumulate foreign currency. To do this, domestic resources are diverted from the areas of the government’s priority to areas that earn foreign exchange for the country. For instance, a government may prioritise the needs of foreign tourists as they spend the foreign currency or the government may announce tax concessions with the hope to attract foreign investors and end up losing revenue which could otherwise be used to develop local government. So, his advice to developing countries is to invest in sustainable agriculture to reach a level of self-sufficiency, to invest in renewable energy production that allows the countries to set their priorities, to invest in education, and to prepare an industrial strategy to move up the value chain from producing low-value-added goods to high-value-added goods. All these will provide resilience for a country from external shocks that a country may face.
A third important constraint is inflation. MMT argues that while a sovereign can never default, there are limits as to how much it can spend; that is, there are certain limits on the fiscal deficit a sovereign runs. These limits are in the form of constraints on the part of real resources in an economy. If a government spends more than what these real resources could absorb, it risks the possibility of price hikes, i.e. inflation. MMT’s prescription to this problem is that the government could increase tax rates so that the purchasing power of the economy as a whole falls and thus inflation could be arrested (note that MMT also says tax revenue does not pay for anything but gives several other reasons for justifying the taxes). Now, in developing countries, there are two main problems with this. First, the tax base is lower in developing countries. Therefore, even when taxes are increased there might not be the desired effect of reducing purchasing power and thus controlling inflation. The prevalence of the informal economy on a large scale is also a constraint in this context.
It is true that developing economies face certain constraints that the MMT approach has not fully gauged. For instance, a developed country might not have constraints of fiscal space due to the current account of the balance of payments (and due to implications thereof). However, it can also be argued that it is precisely the understanding and the implementation of MMT that is required for the developing countries to overcome these constraints. The primary focus of MMT on real resources can be an important takeaway for developing economies because the development of real resources (in part) entails huge investments in developing human capital, green resources, and health resources. Despite many constraints, MMT also opens many doors for the developing economies.
Subscribe to The Pangean
Get the latest posts delivered right to your inbox