Navigating Economic Sustainability: Global Dynamics and Institutional Barriers
Balance of Payments Part I of III
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In our last post, we examined the relationship between interest rates, inflation, and the term structure of prices. Today, we'll embark on a three-part exploration of the balance of payments from an MMT perspective. It really deserved a series of its own, but it is also a part of this series hence the change in format. In this first part, we'll delve into the role of politics and power dynamics in determining a country's ability to utilise MMT principles in managing its external sector. We'll also explore historical examples of countries that have navigated foreign transactions under the lens of MMT, providing valuable insights into the successes and challenges faced by different nations in various contexts.
Navigating Economic Sustainability: Global Dynamics and Institutional Barriers
Introduction
Modern Monetary Theory (MMT) has gained significant attention in recent years as an alternative economic framework for addressing various domestic and global socioeconomic challenges. While much of the focus has been on the potential of MMT for domestic policy, its implications for managing foreign transactions and international relations warrant further exploration. This article delves into the historical, political, and institutional aspects related to MMT and foreign transactions, highlighting the interplay of these factors in shaping a country's approach to implementing MMT principles (Mitchell, Wray & Watts 2019).
We begin by discussing the political balance of payments approach put forth by Cline and Tankus (Cline & Tankus 2020), which emphasizes the role of politics and power dynamics in determining a country's ability to utilize MMT principles in managing its external sector. Building upon this foundation, we examine historical examples of countries that have navigated foreign transactions under the lens of MMT, including Latin American experiences and cases from India, Indonesia, and Malaysia. These examples provide valuable insights into the successes and challenges faced by different nations in various historical, political, and institutional contexts (Cline & Tankus 2020).
In our analysis, we also consider the role of international relations factors, such as trade agreements, global economic trends, and geopolitical considerations, in shaping the application and effectiveness of MMT principles in foreign transactions. Furthermore, we explore the importance of institutional capacity and currency denomination in determining a nation's ability to manage its foreign transactions using MMT principles (Mitchell, Wray & Watts 2019).
In light of recent developments in the global economic landscape and a case study of Sri Lanka, we provide context-specific policy recommendations for countries considering the implementation of MMT principles in managing foreign transactions and addressing domestic socioeconomic challenges. By examining the interplay of historical, political, and institutional factors in the application of MMT principles, this article aims to contribute to the ongoing discourse on the potential of MMT for promoting sustainable and inclusive growth in an increasingly interconnected world (Mitchell & Muysken 2008).
Historical Examples of MMT and Foreign Transactions: Relevance for Australia
Tankus and Kline (Tankus & Kline 2020) highlight three key differences between Latin American countries and the U.S. in fiscal and monetary policies: private versus public foreign debts, fiscal and bureaucratic capacity, and the establishment of national currencies.
Latin America's colonial heritage led to political and fiscal fragmentation, reliance on private foreign debts, and weaker fiscal and bureaucratic capacity compared to the U.S. and Western Europe (Cline & Tankus 2020). National currencies and central banking arrived late in Latin America, often under foreign influence (Helleiner 2003).
In contrast, the U.S. and Great Britain built substantial tax and administrative capacity, with military events boosting their fiscal states (Daunton 2001). Their importance in international trade made foreign actors more willing to accept their debt (Eichengreen 2011).
Building upon this analysis, we examine case studies of India, Indonesia, and Malaysia, which provide valuable insights into the application of MMT principles in foreign transactions, given their geographical proximity and historical ties to Australia. We focus on these countries because their experiences with balance of payments constraints, economic policy-making, and financial crises hold important lessons for Australia in an increasingly globalized world (Arora 2012).
India (post-1991 economic liberalization)
India's balance of payments has been significantly impacted by its colonial history under British rule, like Australia (Chandrasekhar & Ghosh 2002). After gaining independence in 1947, India pursued socialist economic policies aiming for self-reliance but continued to face balance of payments crises due to reliance on essential imports (Panagariya 2008). Economic liberalization in 1991 improved India's access to foreign capital, but its balance of payments remains vulnerable to capital flows and trade deficits (Kletzer 2004). Given their common British colonial history, India's experience highlights how legacies of foreign rule can limit a country's fiscal and monetary sovereignty, creating reliance on external financing (Chandrasekhar & Ghosh 2002). As Australia seeks to strengthen economic ties with Asia, understanding India's balance of payments constraints provides a useful context.
To achieve economic sustainability, India needs to develop further its tax and administrative capacity, which remains limited by its colonial history (Chandrasekhar & Ghosh 2002). Ensuring policy space and flexibility through administered capital controls or limiting foreign-denominated debts may also help address India's balance of payments vulnerabilities, as shown by its 1991 crisis (Patnaik & Chandrasekhar 1995). However, capital account policies should not reduce incentives for export-orientation, foreign direct investment, and economic diversification to maintain sustainable growth over the long run (Panagariya 2008).
Indonesia (post-Asian financial crisis, late 1990s)
Like Australia, Indonesia's balance of payments depends heavily on commodity export revenues and foreign investment inflows (Soesastro & Basri 2005). The 1997 Asian financial crisis exposed the vulnerabilities of this reliance, leading to economic collapse, political instability, and a severe balance of payments crisis (Krugman 2000). To improve its resilience, Indonesia pursued IMF-backed reforms to open its economy, restructure debt, and strengthen its financial system (Lindgren et al. 1999). However, reliance on commodity exports and foreign capital continues to create constraints for Indonesia in achieving economic sustainability (Hill 2000).
Given Australia's proximity to Indonesia and its position as a major trading partner, Indonesia's experience provides important insights. Reliance on natural resources and foreign capital inflows increases susceptibility to external shocks that limit a country's fiscal and monetary sovereignty (Stiglitz 2002). As Australia seeks to develop its export sector further, Indonesia's case study highlights the need for economic diversification and policies that curb speculative capital flows to strengthen the balance of payments and enable greater policy flexibility (Soesastro & Basri 2005). During crises, capital controls may help stabilize financial systems but should be accompanied by efforts to reduce external vulnerabilities over the long run (Krugman 2000).
Malaysia (Asian financial crisis and capital controls, 1997-1998)
Malaysia's small, open, and diverse economy, like Australia, makes it dependent on international trade and foreign capital flows (Athukorala 2001). During the 1997 crisis, Malaysia imposed capital controls that enabled a quicker recovery by limiting currency speculation and raising policy flexibility (Kaplan & Rodrik 2001). However, reliance on exports and foreign investment continues to create balance of payments constraints for Malaysia in achieving economic sustainability (Jomo 2001).
Given this similarity, Malaysia's experience is highly relevant for Australia. Capital controls during crises can stabilize financial systems and boost policy space for countries with strong economic ties to international markets (Kaplan & Rodrik 2001). However, reducing underlying vulnerabilities is necessary for long-term balance of payments sustainability. Malaysia's development of export industries, foreign direct investment policies, and ongoing promotion of political stability highlight the need for Australia to diversify its economy, foster productive foreign investment, and build strong institutions (Jomo 2001).
These historical case studies highlight both the constraints countries face in adopting MMT principles to achieve economic sustainability as well as potential policy responses, providing important lessons for Australia as it seeks to strengthen its balance of payments position and navigate increasing global economic uncertainty. Comparing their experiences underscores the role of economic structures, institutions, political systems, and historical events in shaping a country's fiscal and monetary sovereignty capacity for sustainable development (Helleiner 2003). Building upon Tankus and Kline's analysis, Australia can look to India, Indonesia and Malaysia's experiences adopting MMT principles in foreign transactions to inform policies that enhance its balance of payments flexibility and resilience in an era of greater global interdependence (Tankus & Kline 2020).
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