Interview with Robert Pollin, June 16, 2006

You propose that monetary and fiscal policy should be more expansionary, while advocates of tight monetary and fiscal policy claim that austerity is better for attracting investment. How would expansionary policies affect business confidence?

Robert Pollin: Over the past decade, the African National Congress-led government in South African has embraced a program of "inflation-targeting." This macro model is similar to those implemented throughout the world, especially in developing countries. These programs are usually implemented under the auspices of the International Monetary Fund. But in the case of South Africa, the ANC-led government developed their inflation-targeting model on their own.

Inflation targeting in South Africa means that the Treasury has set as the government's fundamental macroeconomic target that inflation should remain within the range of 3-6 percent. Fiscal and monetary policies are designed for the economy to hit that inflation target. The primary tool for maintaining inflation within this low range is for the central bank to raise the country's short-term interest rates. With relatively high interest rates, this then slows private investment spending, which in turn means that private businesses will be slow to increase the number of workers they hire. In other words, the country is sacrificing growth in private investment and jobs in order to maintain a low inflationary environment.

Now, of course, this isn't the whole story by any means. The proponents of inflation targeting don't just want to maintain low inflation for its own sake. They also believe that, by maintaining a low-inflation economy, this will also establish a stable overall macroeconomic environment that will be attractive for private investors, both foreign and domestic. According to their reasoning, therefore, maintaining low inflation will be the catalyst that encourages more private investment, and that through this channel, there will be a growth in employment--especially a growth in good jobs--that will be solid and sustainable over a long period of time.

So there is a consistent internal logic to the advocacy of macroeconomic austerity and inflation targeting, in South Africa and elsewhere. But the evidence to date on this logic is that it isn't working. Simply having a low inflation rate, and more generally, a "stable macro environment"--including low fiscal deficits and a trade balance--is not enough to stimulate private investors. This is especially true if private investors face high interest rates, in the range of 10 - 11 percent, and weak aggregate demand--with government spending being tight and private businesses investing at a slow rate. However, even given all of that, the model could still work if there were strong demand being injected into the economy through exports. However, South Africa has not been especially successful in expanding their export markets. And a major reason this is so comes back to the logic of the inflation-targeting model: the high real interest rates that are the main tool for inflation control also keep the value of the rand high. But a relatively high rand makes it difficult for South Africans to succeed in export markets.

Our alternative approach is certainly more expansionary than what follows from the inflation-targeting approach. But we are also very careful in the ways that we propose the government pursue a more expansionary approach. For example, the government now projects for the next few years fiscal deficits in the range of 2 percent of GDP. We advocate that, on average, the structural deficit should rise to somewhere around 3 percent of GDP (and by "structural deficit," I am referring to a deficit that arises during business cycle expansions. During recessions, the cyclically-driven deficit should be permitted to grow beyond the structural deficit). This isn't a dramatic increase in favor of an expansionary fiscal program. But it does mean that the government would have an additional 14 billion rand per year to spend on employment growth and poverty reduction, without creating significant problems in terms of government interest payments or inflation. That's something like $45 per year per person in South Africa, which is not a trivial sum considered in this way.

We do favor a substantially more expansionary monetary policy, specifically that the central bank should allow nominal interest rates to fall from about 11 percent to about 7 percent--i.e. four full percentage points--and to hold rates at that lower range over a sustained period of time. We believe this will stimulate investment and economic growth. It will lead to some more inflation, but not a dramatic inflationary push. In short, we think this expansionary monetary policy will help create more jobs without creating serious negative side effects like excessive inflation.

Overall, we think that a modest increase in the structural deficit and significantly lower interest rates will actually be positive for business confidence. Businesses will be able to borrow at significantly lower costs. This will in turn inject more spending into the economy. Meanwhile there will also be more government spending in the economy. Overall demand in the economy will therefore expand. All of these things will promote business confidence. It is important that inflationary pressures remain moderate here. And we have also outlined measures to prevent inflation from getting too high.

You advocate subsidized credit and other social support for small-scale agriculture. To the extent that small-scale farming is conducted for subsistence, how would this affect economic growth? Furthermore, if growth occurs via increased agricultural productivity (thus freeing up labor for other uses), what implications does this have for employment?

RP: We advocate very large credit subsidies for small-scale agriculture, but for other areas as well, including small- and medium-sized businesses, worker cooperatives, and large-scale businesses that can demonstrate their ability to promote significant increases in employment relative to their total spending. This is one of our key positive policy proposals. It is a kind of hybrid policy measure, combining employment and credit subsidies for businesses to hire more workers. We advocate this policy on a large scale, covering something like 20-25 percent of all new investment in the South African economy. We have tried to be careful in estimating the costs of credit subsidies of this magnitude. What we found is that, even if we assumed that the government were to guarantee up to 75 percent of loans within this subsidy program, and that the default rate on the loans were as high as 15 percent, the measure would still cost the government no more than about 1-2 percent of its current level of fiscal expenditures. When the government guarantees 75 percent of a loan made by a private bank, this means that the bank will charge interest rates well below current market rates--in the range of 5-6 percent, for example, as opposed to 11 or 12 percent. This reflects the dramatic reduction in risk assumed by the banks. At the same time, the banks still have money on the line in such an arrangement, and will therefore be careful in the management of their loans, which is an important positive. We go through the details of how to calculate an appropriate subsidized interest rate relative to government bond rates and private sector unsubsidized rates.

Now, specifically, to the subsidies for small-scale farmers that we advocate: we think that these subsidies will allow farmers to stay afloat and become more productive. To be more specific here, we spend lots of time talking about building linkages between different sectors of the South African economy to promote employment. If small farmers could increase their operations, they could also then provide raw materials to agro-processing firms, in areas such as biofuels. These agro-processing firms would also be eligible for subsidized credit because their operations would generate large employment effects through their links with the local farmers.

The living standard of small-scale farmers will therefore rise through such developments, which also translates directly into reducing poverty. It also means that farmers will not be migrating out of agriculture--at least not as rapidly--and then trying to find employment outside of agriculture. Thus, the pressure on unemployment will be relieved.

Overall, then, in terms of living standards as well as fighting unemployment, it is a positive to significantly increase opportunities for small-scale farmers to succeed where they are, as opposed to having them feel compelled to leave their farms. We think that giving farmers large credit subsidies will be a major factor contributing toward this end.

How does your subsidized credit program ensure that new employment will be in the formal sector and thus will contribute to tax revenue for the government and to benefits and better working conditions for workers?

RP: The very fact that people are applying for, and obtaining, subsidized credit puts them in the formal economy. All of the businesses getting subsidized credit--whether they be large- or small-scale, agriculture, manufacturing or services, privately-owned or cooperatives--will need to establish a formal relationship with their lenders, and the lenders will have to accept monitoring by the government to be eligible to receive guarantees on their loans. So the program creates incentives for businesses to become formalized. This in turn has the benefit that you suggest--an increasing share of businesses getting formalized will mean that a higher share will also be paying taxes, even a small amount.

As for working conditions, the credit subsidies themselves do not address the issue of labor standards--either of wages, workplace conditions, or the rights of workers on the job. The main aim of the credit subsidies is simply to create more demand for businesses to hire workers. At the same time, if the government concurrently promotes decent work standards, in terms of the minimum wage, workplace conditions and basic rights, these will mesh well with the expansion of demand for workers in the formal economy that should come both from the credit subsidies that we propose and the more expansionary fiscal and monetary policy.

I should also add here that, although we don't specifically focus how to improve labor standards, we do focus on the importance of not making labor standards worse. I am referring to the idea that one way of increasing employment in South Africa is to cut wages. We spend a lot of time showing that cutting wages to make workers more attractive to businesses is neither desirable, nor workable on its own terms, in the contemporary South African situation. We do advocate that unions do not push for wage and benefit increases that outstrip productivity growth. But that doesn't mean that cutting wages--and thereby worsening labor standards--is a solution to mass unemployment.

The benefits of government subsidies of employment, as opposed to transfer payments to the unemployed, seem clear. But what is the advantage of government subsidies to employers over increasing public sector jobs?

RP: We support large-scale increases in employment both in the public and private sectors. The government is already pursuing a program of increasing public sector employment, through its "Expanded Public Works Program." This initiative primarily entails measures to increase the labor intensity of existing public works programs such as road building, road maintenance, and social service programs. We completely support the principle of this program. In fact, the main criticism we have of the program, as it is currently operating, is that it is operating on too small a scale. At the level it is operating, there is no chance that it will make a significant dent in unemployment. In fact, even if the program is doubled in its scope--that is, even if all the public works programs now operating in the country were to become twice as labor intensive as they are today--it still wouldn't make a significant dent in unemployment. For this reason, we advocate two additional major steps in fighting unemployment: first, that the government significantly increase its level of spending on labor-intensive public works, and not just increase the labor-intensity with a given amount of spending; and secondly, that it stimulate the private economy to expand employment also. In our view, only this kind of combination will make it possible for the government to reach its goal of cutting unemployment in half in what is now less than a decade.

What motive, other than altruism, exists for development banks and private banks to offer subsidized loans? How do the profits from subsidized lending compare to profits from unsubsidized lending?

RP: An important part of the subsidized credit program we designed is that it is a good deal for private bank--they should be able to profit off of the program, while at the same time, the program will benefit working people and the poor by substantially expanding employment opportunities. The way the banks will profit is that they will be able to make loans with far less risk than they now face. For example, if we assume that the loan guarantee will be 75 percent of the principle on a loan, that means that on a loan of 1000 rand, the private lender will only face a loss of 250 rand if the borrower ends up defaulting. The government will pay the bank 750 rand to cover the bank's loss on this loan. This should make the profitability on even a high-risk loan comparable to the profits on a loan to a big, established company. But then there is an added benefit to the banks here: their market for profitable loans has just expanded dramatically, since businesses that were previously too risky are now very viable as lending opportunities. The point here is to encourage the private banks to pursue lending within the country, and specifically give credit at low interest rates to businesses that will rapidly expand employment in South Africa.

As for the country's public development banks, their job--as their name implies--is precisely to promote development, not simply to make profits. And by "development" in South Africa today, it is obvious that we must focus on employment expansion and poverty reduction, not merely on increasing GDP, without considering how GDP growth might affect the country's unemployment and poverty crises. The public development banks in South Africa have been too cautious in their approach to promoting development. But I have been very encouraged by a recent major initiative by the Industrial Development Corporation, South Africa's largest development bank, to pursue a much more aggressive approach to linking their lending policies with employment creation.

The study emphasizes that one hazard of implementing this employment-targeted program is a sell off of rands by foreign investors, and you discuss South Africa's history of capital management techniques. Haven't South Africa's governments since 1994 tended to shy aware, as much as possible, from the policies of the apartheid and earlier eras? What are the political implications of asking the government to revisit these policies?

RP: There is an important irony here. The previous, apartheid government did very well in managing the flows of investment funds in and out of the country. Part of the economic program of eliminating apartheid was to give wealthy individuals and businesses in South Africa more freedom to move their money out of the country as they wished. We are not advocating that the government go back to its apartheid-era practices in terms of managing inflows and outflows of funds. However, some management of funds is crucial for preventing speculative movements of capital, which prevent the government from pursuing employment-targeted measures in a serious way.

The scenario could be something like this: the government decides to reduce lending rates from, say 11 to 7 percent. But in response, wealthy South Africans decide to take their money out of the country. They start selling their bonds, and this leads to a panic run against the rand. This could choke off an expansionary monetary policy before it even has a chance to get started and demonstrate its benefits, including benefits for investors in South Africa.

Other middle income economies, such as Malaysia and Chile, have utilized capital management techniques with considerable success. As we note in the study, even the IMF has recently been softening its opposition to such measures, at least in part in recognition of their successful implementation in places such as Malaysia. In the case of South Africa, the fact that these policies have been successfully utilized in the past, and the fact that the relevant laws remain largely in place, means that there is a high probability that these measures can be utilized successfully now. Remember, there is, of course, a huge difference between what we are advocating now and what went on under apartheid: we are advocating some management of capital movements into and out of South Africa in order to support a program to dramatically stimulate employment opportunities and poverty reduction. Under apartheid, these same techniques were used to maintain a system of oppression.

Apartheid has left South Africa with a dramatic skills gap, as you note in your paper. African and Coloured South Africans don't have the skills to compete for higher-wage jobs. How does this set of policies set South Africa on a course towards greater equity in economic opportunity?

RP: Apartheid was about denying opportunities to Blacks and Coloured people--in terms of education, skill-specific training, the chance to open a business, and employment itself. The program we have designed focuses on creating jobs now and on giving more credit to the types of farms, small businesses, and cooperatives led by Blacks. It seems to me that this is a crucial step toward eliminating the terrible legacy of apartheid, and thereby, promoting economic opportunity. But other initiatives must also be taken, including dramatically improving opportunities for education and skills-training. We don't focus on this in our study, but such measures are certainly completely consistent with what we propose. Moreover, it is important to keep in mind that, even if South Africa were to invest heavily in education and skills upgrading--as has been and should continue to do--if this occurs without a rapid expansion of opportunities for both employment and new businesses then the benefits resulting from education and skills training alone will be very disappointing to lots of people who made the effort to receive this training.

You write that this policy framework is, in adapted forms, applicable to countries around the world that are struggling with dramatic levels of unemployment and poverty. In South Africa these problems are being faced by a relatively stable government and democratic system. How can pro-poor policies take root in countries facing rampant corruption, such as Kenya, or growing internal unrest, such as Somalia?

RP: The approach we have developed for South Africa is certainly adaptable, with appropriate modifications, to other country settings. James Heintz and Jerry Epstein have already developed a similar program for Ghana. James and I, along with three other co-workers, are now developing something similar for Kenya. Leonce Ndikumana is working on similar questions in his current project with the United Nations Economic Commission for Africa. In general outline, these programs are also very much in line with what the UNDP has long advocated, and continues to advocate forcefully, throughout the developing world. The term the UNDP uses is "pro-poor macroeconomic policies." The general thrust of the program is to utilize conventional, time-tested tools of economic policy--such as expansionary monetary policy, development banking and credit subsidies, and moderate capital management interventions--to create a developmental state that has a good chance of successfully fighting mass unemployment and poverty. Our approach draws substantially from the older developmental state models that were eclipsed by IMF-style neoliberalism in the 1980s. The main innovation in our approach relative to the earlier models is that we have adapted the broad goals and the specific policy tools to make them workable within the contemporary realities of globalization.

Now, of course, even if we allow that pursuing such policies can achieve more in fighting poverty and unemployment than IMF-type policies, we still do face a significant problem: can we assume that governments can implement these policies successfully? If the government is corrupt, or if there is social chaos, how can these policies possibly have a chance to succeed? My answer is that these policies cannot succeed in a situation of severe corruption or chaos. But it is also true that no other policy measures, including IMF-type policies, could succeed either under such circumstances. Indeed, we have seen very well in Kenya that, since the 1980s, combining a corrupt government with IMF-style policies have led to a collapse of economic growth and significantly worsening poverty. And when economic growth collapses, this in turn generates a vicious cycle that encourages more social tensions, and therefore more corruption and chaos.

The urgent need is therefore to create social conditions that are conducive to economic growth and expanding economic opportunities. A big part of that is certainly to implement measures that are capable of fighting corruption--but this is a subject for another discussion. However, an equally big part of the story is to implement economic policies that are feasible today and that will create opportunities both in the short- and long-term, for workers, the unemployed, the poor, as well as businesses. That is the core principle of the program we have outlined. And to the extent such policies are successful, they should also encourage a virtuous cycle that supports social solidarity.