According to the International Coffee Organization (ICO), the price of coffee has risen for 17 consecutive months and the sector is being hit with sequential shocks, the latest being the Ukrainian conflict, which is having impacts on both the demand and supply sides. I was talking with a friend over the weekend just gone and…
I am hosting a workshop in Darwin today, the first CofFEE event since we established a branch of our research group here at the University in October 2012. The topic is the Economic Prospects for Timor-Leste and the discussion is oriented to broaden the economic narrative beyond the rigid and growth-restricting fiscal rules that the IMF and the World Bank have pushed onto the Timor-Leste government. The aim of my work generally is to develop more inclusive and equitable approaches to economic development, which emphasise full employment, poverty reduction and environmental sustainability. A complete understanding of Modern Monetary Theory (MMT) allows one to see the agenda of the multilateral organisations in a clear light. So while Timor-Leste has a major struggle ahead to achieve its strategic goals of becoming a middle-income nation by 2030, it would be advised to scrap its present currency arrangements and use its massive oil wealth to introduce unconditional and universal job guarantees as the starting point for a more coherent and inclusive development path.
The Workshop Program is as follows:
- 13:00 Introduction and Welcome – Professor Bill Mitchell, CofFEE Director
- 13:10-14:00pm Professor Daniel Kostzer, Senior Economist with the UN Secretariat in Timor-Leste – Topic: The socio-economic structure of the first republic of the 21st Century: Timor-Leste.
- 14:00-14:40 Avelino Maria Coelho da Silva, Secretary of State for the Council of Ministers, Government of the Democratic Republic of Timor Leste – Topic: Evaluating the economic and employment progress of Timor Leste and a proposal for co-operative self-sufficient agricultural development. He is also the Leader of the Socialist Party in Timor-Leste.
- 14:40-15:00 – Afternoon Tea
- 15:00-15:40 – Martin Hardie, Lecturer in Law, Deakin University, former solicitor, barrister and advisor to the East Timorese resistance and government – Topic: Personal reflections on the role of the UNTAET in setting the economic fundamentals of the East Timorese economy.
- 15:40-16:20 – Prof Bill Mitchell – Topic: Currency sovereignty and the need for employment guarantees in developing nations.
- 16:20-17:00 – Panel Discussion and Open Floor
We are trying to stream it live and I will make a link available if that proves to be possible. There will be a full video of the event available in the coming days though.
The struggle against the Indonesian invasion, which resulted in independence in 2002, was very costly in terms of the destruction of real resources in Timor-Leste. The Indonesian army and its sycophantic rebel militias deliberately destroyed a significant proportion of the economic infrastructure in the nation towards the end of 1999 as it became clear that the UN was supporting the independence struggle.
Roads, water supply systems, the power supply, houses and school buildings were targetted as a malicious last act of an illegal colonisation by the Indonesians.
The Government of Timor-Leste has developed a nation-building plan in 2011 – the Strategic Development Plan (SDP) – which aims to fast-track the development of public infrastructure and human capital development. It is a massive task.
It is devoting considerable resources – mainly from the Petroleum Fund – to fulfill this task.
The nation is rich in petroleum resources although the Australian government has been doing its best to deprive the Timorese of what their fair share in the Timor Gap resources should be. Australia has been manipulating its national borders and withdrew from the relevant international jurisdictions, which would have resolved the disputes concerning ownership just before official independence was granted. The cynicism is exemplified because these withdrawals were only on issues concerning maritime boundaries.
Australia’s behaviour with respect to Timor-Leste has been poor from the time that it sided with the Indonesians when they invaded the small nation. This is despite the people of East Timor (at the time) suffering awful consequences from the Japanese during the Second World War as a result of extending succor to Australian troops who were fighting the Japanese invasion throughout the islands.
There is only elementary frameworks in place at this time for gathering meaningful social and economic statistics in Timor-Leste and so it is still difficult to fully document how the economy is travelling.
We know that its non-oil economy has been growing strongly over the last five years as a result of strong public infrastructure spending. There is, however, widespread illiteracy, malnutrition, unemployment and poverty, all interrelated.
The UNDP report – One Instrument, Many Targets: Timor-Leste’s Macroeconomic Policy Challenge – estimated that the “share of people living under the national poverty line increased from 36 per cent in 2001 to 50 per cent in 2007”. it also showed that the “maternal mortality ratio remains unacceptably high” and around a “half of the children are underweight”.
Further, it estimated that in the capital (Dili) “58 per cent of the youth” were unemployed in 2009. Timor also has high rates of illiteracy and very low per capita income.
You can access some summary data for Timor-Leste from the – UN Human Development Indicators.
The following graph presents trends in the UN’s Human Development Index from 2000 to 2012. Timor was moving quickly away from the “Low Human Development” path, prior to the financial crisis but took a substantial hit during the crisis. The strong public infrastructure spending, however, has helped it resume its improvement.
It obviously has a long way to go in reaching its SDP goals, which if successful, would see the nation achieve upper-middle income status by 2030.
The multilateral agencies operating in Timor-Leste, the most influential being the IMF and the World Bank, however, are critical of the pace of government spending.
Inflation has been rising (now above 10 per cent) but this has been mostly due to the falling value of the US dollar (the economy is dollarised) and, to some extent, rising food prices. Timor-Leste is a net importer of food.
What is often not understood when it comes to the inflation generating process in Timor-Leste is that most of it is imported and stems in no small part from its decision to use the US dollar as its official currency. For example, the nation imports a lot of essentials from Australia (food etc) and in the last decade the Australian dollar has soared against the US dollar (doubling in value).
This has had the effect of pushing the prices of imported products from Australia. But the cure for that is not to impose fiscal austerity but rather insulate the economy from imported inflation by allowing the exchange rate to move. That cannot happen at present as a result of the dollarisation. I will return to this again soon.
In February 2012, the IMF published its Article IV Consultation, which is a standard document that results from its consultations with members (usually on an annual basis).
This document emerges out of “visits” by IMF officials to the nation in question. They consult government officials, usually who are already in the “IMF way” and avoid more widespread consultation. The World Bank is also often involved as they were in the most recent visit.
In the latest briefing the IMF say:
The planned investment in infrastructure is welcome, but given double-digit inflation, staff advised slowing the planned increase in capital spending over the next few years to better align with the absorptive capacity of the economy and administrative constraints. In the absence of monetary policy (Timor-Leste uses the U.S. dollar), sound fiscal policy is key to containing high inflation and sustaining strong growth. Staff supported the government’s plan to reduce the non-oil fiscal balance to a sustainable level over the next 10 years, to provide an anchor for fiscal policy.
Timor has massive petroleum resources which allow it to earn significant export revenue – “Petroleum income accounted for about 270 percent of non-oil GDP, as of 2010” (IMF).
It runs a large current account surplus (“over 50 percent of GDP in 2011”), which has allowed it to accumulate over $US9 billion in foreign investments.
The following Table is taken from the UNDP MDG Report (cited above) and shows the importance of oil revenue to Timor-Leste. As the Report notes, “that without oil and gas revenues, the overall fiscal balance will drop to a deficit of 97 per cent of GDP” and that the “oil sector is an enclave that has virtually no linkages to the rest of the economy. It creates no employment for the domestic work force”.
In the short- to medium-term, the oil revenue is clearly massive and provides ample opportunity for the nation to invest in durable assets, the most important being human capital (education and training).
While it is seeking to build the Petroleum Fund up further to ensure that there are funds for future generations once their oil resources start to decline it has more than enough to fund increased capital infrastructure development and short-term imports of food to alleviate the shortages that have developed.
I will return to the problems of the Petroleum Fund later because it bears on the use of the US dollar as the official currency.
Timor-Leste also needs to invest more in agriculture and I will write more about the competing interests on agricultural development in a separate blog. The World Bank, obviously, favours the agri-business type export model whereas there is a strong case to be made that a co-operative system of small scale subsistence agriculture will help improve food availability. I will write about that another day once I have done more research on the question.
The IMF and World Bank, however, does not have a good track record when it comes to agricultural reform. They have an export-market obsession which not only leads to products flooding the world markets and driving down prices so that farmers have trouble even servicing the debts that are pushed upon them in the name of development, but the conversion into export production undermines the sustainable subsistence characteristics of the agricultural sector. Ultimately, it leads to poor outcomes.
The IMF Briefing notes that:
Large infrastructure spending is mainly to be financed by withdrawals from the Petroleum Fund. The government is also considering other financing options such as borrowing and public- private partnerships (PPPs).
First, the Petroleum Fund is now over $US9 billion – around 90 per cent is invested in US government bonds. There is no need for the government to borrow any funds, given that all of the borrowing would have been in the form of foreign-currency loans. The government of Timor-Leste should relinquish the US dollar as its official currency, a point I take up later.
Second, PPPs should be avoided. As I explain in this blog – Public infrastructure 101 – Part 1 – PPPs are another neo-liberal vehicle for transferring and concentrating public wealth into the private sector.
They can only become cheaper than full public provision at the expense of service quality and in the case of an essential service or infrastructure, the intrinsic risk can never be transferred to the private sector.
Further, they have delivered poor outcomes to date around the world and they effectively transfer the planning of public infrastructure to the private sector who are motivated by profit rather than service delivery.
The underlying premises underpinning macroeconomic policy in Timor-Leste, are, however, typical of the neo-liberal leanings of the IMF and the World Bank.
I have noted in the past that the IMF does not have a good track record in developing economies. Please read this blog – IMF agreements pro-cyclical in low income countries – for some data. The following graph, uses data from the World Development Indicators, provided by the World Bank. It shows Gross National Income per capita, which, in material terms is an indicator of increasing welfare.
The overwhelming evidence is that thes IMF structural adjustment programs (SAPs) increase poverty and hardship rather than the other way around. Latin America and Sub-Saharan Africa (which dominates the low income countries) were the regions that bore the brunt of the IMF SAPs since the 1980s.
While the high income countries enjoyed strong per capita income growth over the period shown (since 1980), Latin America (and the Caribbean) has experienced modest growth and the low income countries actually became poorer between 1980 and 2006.
The two trends are not unrelated. The SAPs are responsible for transferring income from resource wealth from low income to high income countries.
During the period when the United Nations Transitional Administration in East Timor (UNTAET) – was steering the creation of the new Timorese nation (from 1999-2002). The IMF and World Bank were also prominent and I will detail more fully the transition in later blogs.
The nation was pressured to adopt the US dollar as its official currency. At the time, I was approached by a lawyer, who had provided legal support for the resistance movement and was also aiding the transition.
He asked me to advise him on the best currency arrangements. Clearly, I indicated that the new nation needed to introduce its own currency from the outset, which would allow them true independence. I strongly urged against the dollarisation of the economy. Obviously bigger voices prevailed.
That decision has been a very poor one for Timor-Leste and as part of its long-term development it should abandon the US dollar as soon as possible.
What are the issues?
First, the dollarisation of the economy is not only unnecessary but it limits the scope of macroeconomic policy making in Timor-Leste. By adopting the US dollar the nation does not have independent monetary or exchange rate policy. It cannot choose its own interest rate and the inflationary implications of that are noted above.
This means that all counter-inflation efforts have to be performed using fiscal policy, which is also entrusted with advancing the economic development, in line with the Millennium Development Goals.
There is a rule in economics that there has to be an equal number of policy tools for the policy targets. How on the one hand can the Timor-Leste government satisfy the development goals when it has to adopt tight spending policies, under the watchful eye of the masters of slash and burn, the IMF?
Any serious attack on inflation via fiscal austerity will be very costly to a nation that desperately needs increases in government spending growth not reductions. And remember that trying to discipline the inflation process, when the origin of that process is mostly due to its currency arrangements (dollarisation) is very costly and, ultimately, doomed to fail.
The solution, from an MMT perspective is clear. Timor-Leste should abandon the US dollar and introduce its own currency and allow it float on the international markets.
Then the nation would de-couple itself from the US monetary policy and exchange rate fluctuations and fiscal policy would be able to target public infrastructure development more fully to not only provide capacity to increase agricultural outputs (reducing its dependency on imported food) but also attract private investment in urban infrastructure (so-called crowd-in effects).
This will also allow the nation to better manage a large-scale public works program to directly address the problem of unemployment and underemployment. That will, in turn, better target poverty reduction.
A newly created central bank would be able to play the dual role of maintaining financial stability (via liquidity management) and acting as a development bank to ensure that private development was adequately funded at stable interest rates.
I will come back to this soon.
Second, the – Petroleum Fund Law 2005 – was drawn up to be consistent with Article 139 on Natural Resources in the 2001 – Timor Leste Constitution. This Article says that all natural resources “shall be owned by the State and shall be used in a fair and equitable manner in accordance with national interests”.
The Petroleum Fund Act in tandem with the dollarisation of the economy undermines that statement of purpose. Articles 14 and 15 of that Act require that 90 per cent of the invested funds be placed in US dollar assets (of various types).
This prevents the Fund from investing in higher yield non-US assets such as Australian government bonds, which are of equivalent no-risk status. So you can see it is also tied in with the fluctuations in the value of the US dollar rather than a true purchasing power measure if the PF was diversified across a range of zero-risk assets (such as the higher yielding Australian government bonds).
This requirement means that the value of the fund fluctuates with the fortunes of the US dollar and during the economic crisis, the Petroleum Fund lost up to 30 per cent of its value as the US dollar depreciated. Clearly, the loss of value is not in terms of the fund’s nominal asset value given it is denominated in US dollars. But in terms of purchasing power the fund is vulnerable from this unnecessary restriction.
The IMF is also promoting what are effectively balanced budgets on the government of Timor-Leste via an unnecessary fiscal rule. In its 2012 Briefing document it stated that:
The government intends to reduce the non-oil fiscal balance to the level implied by the ESI over the next 10 years. Staff supported this goal as an anchor for fiscal policy.
ESI stands for estimated sustainable income, which is defined in the Petroleum Fund Law as “3 percent of Timor-Leste’s total petroleum wealth that is the current Petroleum Fund balance plus the net present value of future petroleum receipts”. There is no economic or financial basis for this 3 per cent rule. It has striking overtones with the 3 per cent Stability and Growth Pact rule that is ruining the Eurozone nations.
It is an arbitrary constraint which prevents Timor-Leste from using the wealth it possesses to advance its development goals. Sure enough there are capacity constraints in the nation that have to be overcome (for example, actually spending the money effectively to ensure all citizens benefit), but the 3 per cent rule is not scaled to reflect those constraints.
It is a typical neo-liberal constraint on government spending. The consequences are predictable and observed by the fact that the vast majority of the population remain in an impoverished peasant state.
The fiscal rules that the Timor-Leste government accepted (crafted by the World Bank and the IMF) force it to justify any withdrawals form the PF beyond the ESI.
So the Government is not only using a foreign currency but is also voluntarily constraining its capacity to use the wealth it possesses to advance the material interests of the population.
The IMF is pressuring the government to spend less when it should be spending more and allowing the other macroeconomic policy tools, which are currently unavailable as a result of dollarisation to lift some of the weight. They are using the inflation bogey to restrict spending when the inflation is mostly tied up with the decision to use the US dollar.
The link between macroeconomic policy and poverty reduction via development (including job creation) is obvious although usually denied by these demands for fiscal balance.
In Making fiscal policy working for the poor, which is a UNDP publication published in 2004, we read:
Macroeconomic policies represent a key ‘entry point’ for the UNDP’s activities to foster human development. In order to present programme countries with viable macro policy options, UNDP seeks to support access to policy advice that presents a menu of feasible options and alternative analyses.
In Timor-Leste’s context, all the notions of fiscal space that the IMF and UNDP wheel out are moot.
The IMF Briefing considered the question of the retention of the US dollar. It said:
Staff supported the authorities’ intention to continue to use the U.S. dollar as its currency. Given the country’s limited capacity for independent monetary and exchange rate policies, the use of the U.S. dollar is appropriate and has provided a nominal anchor. There are no plans to change the exchange rate regime in the medium term, but as indicated in the SDP, the Central Bank plans to study, by 2015, the merits of adopting Timor-Leste’s own currency.
The nation has huge oil reserves and could easily run an independent monetary and exchange rate policy. It is quite different from less developed nations that have large current account deficits and always face currency depreciation.
It is quite clear that the use of the US dollar has not provided a sound nominal anchor. The IMF contradicts its own position here. Earlier in the briefing it argued that the government needs to tighten fiscal policy because high inflation is becoming endemic – that is, there is no effective nominal anchor.
There are hundreds of developing countries that do have currency sovereignty which means they can enforce tax liabilities in the currency that the government issues. It doesn’t matter if other currencies are also in use in those countries, which is common. For example, the USD will often be in use in a LDC alongside the local currency and be preferred by residents in their trading activities. But, typically, the residents still have to get local currency to pay their taxes. That means the government of issue has the capacity to spend in that currency.
So the point is that as long as there are real resources available for use in a less developing country, the government can purchase them using its currency power.
The are hundreds of thousands of people in Timor-Leste who are unemployed. They are real resources which have no “market demand” for their services. The government of Timor-Leste could easily purchase these services with the local currency without placing pressure on labour costs in the country.
Given the oil wealth embodied in the Petroleum Fund, the government could also implement an employment guarantee under existing currency arrangements. But by jettisoning the dollarisation of its economy it frees up monetary and exchange rate policy, which is current hindering development.
Those who might oppose such a development will claim that this policy would place further strain on the food shortage and cause inflation. Given the strength of the current account (as a result of its petroleum exports) it is hard to see any large scale depreciation occurring.
But all open economies are susceptible to balance of payments fluctuations. These fluctuations were terminal during the gold standard for external deficit countries because they meant the government had to permanently keep the domestic economy is a depressed state to keep the imports down.
For a flexible exchange rate economy, the exchange rate does the adjustment. Is there evidence that budget deficits create catastrophic exchange rate depreciation in flexible exchange rate countries? None at all. There is no clear relationship in the research literature that has been established.
If you are worried that rising net spending will push up imports then this worry would apply to any spending that underpins growth including private investment spending. The latter in fact will probably be more “import intensive” because most less developed countries import capital.
But as noted above, the Petroleum Fund gives Timor-Leste an abundance of purchasing power with which it can increase the importation of food without introducing a debilitating currency crisis.
Further, well-targetted government spending can create domestic activity which replaces imports. For example, Job Guarantee workers could start making things that the nation would normally import including processed food products.
Moreover, a fully employed economy with skill development structure embedded in the employment guarantee are likely to attract FDI in search of productive labour. So while the current account surplus might decline from its very heady heights as the economy grows (which is good because it means the nation is giving less real resources away in return for real imports from abroad) the capital account would move into surplus. The overall net effect is not clear but an external deficit in the short- to medium-term is highly unlikely in the the case of Timor-Leste.
Where imported food dependence exists – then there are two considerations. If the nation is not resource rich and cannot generate sufficient export earnings to allow it to import enough food, then the role of the international agencies should be to buy the local currency to ensure the exchange rate does not price the poor out of food. This is a simple solution which is preferable to to forcing these nations to run austerity campaigns just to keep their exchange rate higher.
But Timor-Leste is not in this position. It has sufficient export revenue earning capacity to fund vastly increased imports, including food.
MMT tells us that the reason there is mass unemployment in less developing countries is the same as there is mass unemployment in advanced economies. There are plenty of jobs to do in both types of economies. There is no shortage of work! In fact, in nations such as Timor-Leste there is an abundance of labour intensive work that can be done to improve the public amenity and infrastructure.
The problem is that there is always a shortage of paid work. The solution is to fund the work that needs to be done in all economies. If you have idle labour then that means there is not enough employment funding being injected into the spending system.
The government has the capacity to make up these shortfalls in spending where it is sovereign without imposing higher taxes and without recourse to borrowing. As a starting point it should use its sovereign capacity to buy up all the unwanted labour – that is, introduce an unconditional and universal employment guarantee.
It is clear that skill levels vary and in Timor-Leste there is a paucity of skilled labour. That just means that the public works programs have to be designed in ways that are inclusive to the least-skilled workers.
My work in South Africa (in relation to the Expanded Public Works Program which employed more than a million workers in the first five years of operation) taught me that large-scale public works initiatives can be very successful in alleviating poverty and improving the family dynamic. They are difficult to organise and never “perfect” but they add productive value to the communities and the people that participated in the work.
The other thing it taught me is that there are many ways in which a particular goal can be addressed. My interaction with civil engineers in South Africa was illustrative. The bureaucrats – engineers who had been educated in the US or Britain were horrified that we would advocate labour-intensive road building methods (read: lots of me bashing rocks into the dirt as in the old days). They wanted the best-practice methods that employed hardly anyone per km of road length.
The science indicates that the two methods of road building both produce first-class surfaces that are durable and effective. But for these sort of programs to be successful, they have to be flexible and scale the employment reach to suit the circumstances. So the labour-intensive methods employ more and can be inclusive for the lowest skill workers (who only have to bend their backs!) but they still produce excellent roads.
My experience in these sorts of programs tells me that there are many more examples like this one.
The opponents of universal and unconditional employment programs are usually so obsessed with their erroneous notion of “fiscal room” that they fail to understand the way in which an employment guarantee is part of an overall macroeconomic framework that provides full employment and price stability.
Piecemeal and small-scale employment programs based on some limited international development aid might create a few jobs here and there. Should we be happy about that? Well 1 job is better than none. But in the less developed countries millions of jobs have to be created. In Timor-Leste tens of thousands of jobs are needed in the first instance.
In this context, the problem is a macroeconomic one and the debate has to come to terms with that. The only way that nations are going to be able to successfully create enough jobs is for them to abandon these nonsensical neo-liberal concepts of “fiscal space” and fiscal rules, such as the ESI in Timor-Leste, and come to terms with the fact that most countries do have sovereign currencies and that those that do not should be encouraged and aided to move in that direction.
Once you come to terms with that then you can “think big” and work out structures that are capable of supporting the creation and adminstration of millions of public jobs. Then we might get some distance down the road to fighting poverty.
I will have a lot more to write in the coming period about Timor-Leste as I learn more. I am visiting the nation next week and will have more to write after that visit.
This is just a sketch of some of the issues facing Timor-Leste as it gropes its way forward in its early days of nationhood. It is already being squeezed in the vice-like grip of the IMF and the World Bank and has accepted the neo-liberal line of thinking that unjustified fiscal rules (the ESI) deliver stable outcomes.
In the case of Timor-Leste, all these fiscal rules generate is continued poverty, malnutrition and unemployment. They do nothing to develop the self-sufficiency of the agriculture – and most of Timor-Leste remains a peasant, pre-capitalist economy.
The dollarisation also leave it with little room to pursue the development goals that have been set for it.
That is enough for today!
(c) Copyright 2012 Bill Mitchell. All Rights Reserved.