David Rabkin, ContributorDURING MY recent trip to Africa, I had the opportunity to attend a conference for potential overseas investors. The first morning I was seated next to the governor of the central bank of one smallish African nation. Recalling that this man's nation had experienced healthy growth over the last several years, I asked him how he felt about the state of his country's economy.
"We've kept inflation below one per cent for the most recent year," he answered. "That is, if you take out food items, alcohol and tobacco. The prices of those items have been increasing, but we can't figure out why."
I asked whether the bank had observed any increase in domestic savings or investment, or whether his country had had any significant foreign investments over the past year. He replied that it had not.
"Could it be, then, that your growth spurt has put a little money in people's pockets and that they are using some of that money to buy more or better food and, perhaps a cigarette or a drink?"
"No," he replied "I don't think that's it."
I tried my question a different way, to make sure I had been clear, but again the central banker rejected my hypothesis.
ECONOMICS
To be clear, I am not an economist, but I will never forget the lesson of an economics professor of mine who asked the following question: "if you give a room full of children $100 of play money each and then auction off an exciting toy, what will be the price of that toy?"
The answer: $100. "Now, if you give each child $200, what will be the auction price of that same toy?" The answer: $200. That is inflation.
It must be concluded, therefore, that if prices are going up on items that are not scarce, more people must be purchasing those items.
John Maynard Keynes, the intellectual architect of the International Monetary Fund (IMF), explained a central macroeconomic relationship:
Nat'l Income = Consumption + Investment + Government Spending
Simply put, a country's GDP (National Income) is the sum of how much individuals spend, how much is invested in the country (by locals or foreigners), and how much Government spends. Therefore, if GDP is rising, one of those other three categories must be moving, too. In the case at hand, unless the Government is stocking up on liquor and cigarettes, consumers must mathematically speaking be spending more on basic items. This, as my professor will tell you, means the prices on those items will rise.
WHAT IS SUCCESS?
This episode troubled me deeply, and continues to plague my thoughts. There is, of course, the obvious concern that a nation has entrusted its finances to a man who appears to be under-prepared for his task. Unfortunately, as disturbing as this is, it is not uncommon to find a senior public servant who is less skilled than one would hope.
What has really been troubling me, is that this man chose to focus his answer on inflation and inflation alone. He didn't say "boy, we're doing great: we've really had strong growth" or "it's very exciting to see the rate at which we are reducing poverty" or "the country has created x or y new jobs in the last few years". In his case, all of these things are true, and the overall rate of inflation (even with the rise in the items mentioned above) is still low. But the banker had his eyes squarely on the price.
None of this is to say that inflation is unimportant. Indeed, it is one of the key variables in the fundamental economic equation. High and rising inflation, and the uncertainty it creates, can be a serious problem for a business or an economy.
A central banker should clearly be concerned about inflation. But is low inflation an end unto itself?
JOSEPH STIGLITZ AND THE IMF
You might think so if you pay close attention to the IMF or to many in the central banking fraternity across the developing world.
As the fictional auction demonstrates, the more money there is in an economy, the higher prices will go. Growth by definition means there is new money in the economy and, therefore, it is often accompanied by inflation.
If you agree that growth is a good thing for an economy and I argue that without it there can be no long-term prosperity then you must be prepared for a bit of inflation. If managed, this is not a bad thing.
Joseph Stiglitz, the Nobel-prize winning former chiefeconomist of the World Bank, argues that the developing world has become obsessed with inflation, to the exclusion and detriment of all else. He puts the blame squarely on the shoulders of the IMF, whose managers he claims have adopted the perspective of the one group for whom inflation is always a bad thing: international lenders.
The more inflation, the less likely it is that international creditors will be able to recoup the full value of their loans plus interest. International creditors, of course, include financial institutions, influential private investors, and the IMF itself.
While these groups do need to get repaid for the system to work, the ultimate goal of growth must be achieved for the whole exercise to have been worth the time.
THREE PATHS
I know of three basic macro-economic strategies for creating growth, all of which come straight from Keynes' formula. There is consumption-led growth, such as that experienced in the United States, where consumer spending is seen as the key driver.
There is government spending-led growth, such as was observed
in many Asian success stories, where Government investment led to long-term economic expansion.
Finally, there is investment-led growth, including the foreign direct investment strategies that many Caribbean economies are pursuing as their path to prosperity. This last strategy was also the impetus behind the African investor conference I attended.
All of these strategies get easier in an environment of stable prices. Yet never have I heard of a country that grew simply by reducing inflation.
Unfortunately, Stiglitz argues, the IMF has imposed loan conditionalities, as well as decades of public relations, that have led to this mono-maniacal focus on limiting price expansion.
Ironically, the strategies the IMF has espoused are quite unlike the strategies followed by their own creditor nations: the United States, European Union, and Japan; and not at all consistent with the views of Keynes himself.
Alan Greenspan, the U.S.'s reigning economic maestro, is a perfect example: the inputs into his decisions are drawn from the full spectrum of economic events and his ultimate goal is always long-term growth.
Greenspan has done a remarkable job at managing inflation, but his legacy will undoubtedly be his stewardship over the longest economic expansion in U.S. history, not the fact that he kept inflation under control. Sometimes it is hard for us normal folk to understand what he's saying, but I'm pretty sure I'm reading Greenspan right on this one.
CREATIVE TENSION
It has been argued that it is useful for central banks and governments to be focused on different goals. While the central bank worries about price stability (inflation/deflation), the Govern-ment can worry about growth. This argument is deeply flawed.
The central banker controls interest rates, which are the single most significant determinant of local investment, one of the most significant determinants of foreign investment, and inextricably linked to Government's ability to spend.
More than one central banker has squashed a recovery or induced a recession by raising interest rates to avert inflation.
A more appropriate place for tension, I suggest, is between the developing world and the so-called international economic consensus. It is bad enough that so many impoverished nations have, as their stewards, bureaucrats who lack the ability to perform their impossibly complex jobs (I certainly wouldn't want the responsibility of setting interest rates, let alone money supply).
This problem becomes endemic when the international aid institutions designed to encourage global stability and economic growth are pushing bad advice.
Let me say it clearly: the ultimate goal of any central bank must be economic growth for its nation. This does not negate that the objective function of a central bank is to steady prices, but it does mean that this objective must be tempered with the broader goal for which stable prices are just one component. Only through growing its economy, can a nation hope for its citizens to be lifted out of poverty and into productivity and, finally, prosperity. Any other goal is either an input into the growth equation or just plain wrong.
Many of the ideas in this article have been inspired by "Globalization and its Discontents" by Joseph Stiglitz.
Both the children's auction and Keynes equation assume a closed economy (no exports or imports). In an open economy, foreign trade would have to be factored into the equation. In the case at hand, the economy has a very low and relatively stable level of external trade, meaning that the equations hold up fairly well without further adjustment.
Export-led growth is actually a microeconomic strategy, which can be thought of as foreigners leading a local economy's consumption often enabled by increased investment in the economy from at home or abroad.
David Rabkin is Project Director of the Jamaica Cluster Competitiveness Project, sponsored by the Jamaica Exporters Association. Mr. Rabkin is a Vice-President in the Boston-based advisory firm, OTF Group. He can be reached at: drabkin@onthefrontier.com
