While drafting my PhD dissertation, I often mentioned Schumpeter economic paradigm. To be honest, I didn’t read enough most of the time and was lucky I didn’t get difficult questions on that. It was only afterwards that I read and understood better the implications.
The Trade and Investment Report 2008 by UNCTAD is out now on this topic. It claims that developing countries are reversing their current accounts and changing their external balances. They can be divided into two groups: firstly, A countries, who are exporters of manufactures export capital; secondly, B countries, who import food and energy.
The development path for A countries is diversification and industrialization, which cannot be achieved without capital formation and skills acquisition. For this, investment is critical, needing domestic monetary policy and local financial systems. Internal capital is mainly built though reinvestment of company profits.
Such countries are open to a global environment of uncertainty (this word has the highest density in Schumpeter texts). The subprime mortgage crisis has thrown some lessons learned. It has spread the impact of risky investments and it has also proved that current exchange-rate policies are open to speculation, which brings profits for a limited period of time but creates uncertainty on the long run. Speculation typically exacerbates price trends originating from changes in fundamentals.
The most affected sectors are energy and agriculture, very interrelated though biofuel and financial markets. Oil is stabilizing its market price but the index of non-fuel commodity prices has increased by 41.9% (May 07 to May 08). The price stabilization mechanisms of the past have proven unsuccessful in the new century. Uncertainty kills planning, makes management more difficult and has an economic cost.
What is the situation in A countries? Today, for sustainability, national institutional arrangements are in construction (or existing) as buffers between international prices and domestic earnings. In addition, grants and international compensatory finance schemes are only applied in critical moments.
Since 2003, commodity prices and better trade are reversing current accounts. In fact, developing countries are net exporters of capital. For manufacturers, this reversal is driven by real-exchange-rates, whereas for commodity-dependant economies, terms-of-trade are the main factor. Exchange rate has been manipulated, but the world is slowly learning that overvaluation has too often driven to crises.
Schumpeter helped move from the idea that savings drove economy to the idea that decrease in savings can drive to reinvestment of company profits. This works under the assumption that entrepreneurial decisions are not based on savings but in profit expectations. Then the Keynes-Schumpeter model emphasizes the need for a reliable and affordable financing for enterprises.
Empirically, domestic resources are more important that foreign ones. From a policy perspective, interest rates need to stay low and individual projects need to contribute to the economy as a whole. Only in critical situations it is recommended to accept foreign capital inflows and ODA.
Official Development Aid (ODA) has been considered the solution for B countries, where, after substantial increase of disbursements, there is evidence that aid effectiveness is not increasing. Among the many possible reasons, it depends on institutions and policies. It is a fact that good governance and accountability reduce transaction costs.
ODA is perceived as a tool for the achievement of Millennium Development Goals and part of it is used for health, education and emerging social issues. Social and economic aid need to get the right balance. Not too much implemented, during last decade, a best practice to improve ODA effectiveness is to leverage ODA with domestic financing. By reducing the credit risk, local project have access to financing and generate much higher impact.
ODA is mainly a less uncertain source of financing for development. From this perspective, giving access to developing countries to international financial markets makes them vulnerable to their volatility and liquidity crises. This is only partially tackled through a number of innovative debt instruments aiming at reducing this risk, such as external debt in domestic currency.
I guess this was the message in my dissertation without being very aware: Development and prosperity is better achieved following the A road. The WorldBank focuses on debt relief but this has little impact without investment at the firm level. Maybe, probably, perhaps, … focus could shift to mechanisms for speedy resolutions of debt crises and fair burden-sharing among creditors and debtors, improvement of creditor’s risk assessment and reforming the monetary and financial system.
Oslo has announced that Nobel Peace prize has been given to Martti Ahtisaari, former president of Finland and UN envoy.
