MMT and international trade – some further considerations in a degrowth context

One of the undercurrents at the recent UK MMT Conference in Leeds was the apparent unwillingness of MMT economists to acknowledge their mistake in dealing with international trade. In our new book – Modern Monetary Theory: Bill and Warren’s Excellent Adventure (published July 2024) – we devote a chapter to this issue. There are various strands to the criticisms we receive ranging from claims we are simply wrong at the most elemental level to others claiming trade has no part in the MMT framework. All miss the point and I am surprised people have tried to make a ‘career’ (or advance their egos) on this issue. As I have noted several times in the past, the issue is nuanced but the elementary facts are not. I am now working on a section for my new book (with Dr Louisa Connors) on ‘degrowth’ and system viability from an MMT perspective and so I am linking the trade aspects of MMT with this narrative to provide further clarification of how nuanced this area of discussion can be. Here is a little glimpse of that work.

On the claim that the topic of trade has nothing to do with Modern Monetary Theory (MMT), I would only say that the person or persons who continually advance that fiction have no real understanding of what MMT is about.

We discuss that issue in our book too.

For me, MMT is a series of interlinked stories starting with the Money Story that outlines the nature of a currency and the capacities of the currency issuer.

It then traces the consequences of using that currency in various ways and the way in which the non-government sector interacts.

In that latter sense, we have to consider the labour market (where power is exerted and wage outcomes feed into the income and cost structure), the banking sector (where credit originates), the production sector (where technology combines with other inputs, including labour), the household sector (where people make decisions about spending and saving), and the external sector (where the fortunes of other nations impact on the domestic economy among other linkages).

All these individual stories are linked by the currency, laws, custom, institutional structure and more.

MMT is thus a broad macroeconomic framework that combines behavioural theorising with accounting and description to provide a superior lens into the way the government currency issuing capacity works and impacts on the economy.

Understanding the way in which the external economy impacts on all of that is thus an integral aspect of the work that we have done over the last 28 or so years.

Moving on.

As long as I have been a student then academic, the heterodox or progressive economists have been obsessed with the idea that the external sector somehow plays an outsized role in forcing governments into submission.

I would come up against this view regularly at heterodox conferences dating back to the 1980s and during the advanced stages of my undergraduate then honours and masters coursework it was drummed into me that Nicholas Kaldor’s notion of a ‘balance-of-payments-growth-constraint’ (BPGC) mean that fiscal policy was limited not by real resource availability (as in the MMT position) by the export capacity of the nation.

It was claimed that fiscal policy could never push economic growth beyond that allowed for by the export potential of the nation, otherwise imports would become excessive, and the currency would, ultimately, collapse.

British economist Tony Thirlwall was the prominent exponent of this view and I was taught in my fourth year at the University of Melbourne by one of his former doctoral students.

So I understood the message very clearly – yet I rejected it.

When MMT emerged, many heterodox economists could grasp that the government issued the currency and logically could never run out of it, but, still vehemently held onto the BPGC theory which they claimed prioritised the external sector over domestic policy ambitions.

And, of course, I had grown up in a small open economy where the mainstream economists almost uniformly claimed that current account deficits were dangerous and would be punished by currency investors and/or cause inflation.

In my Masters coursework, I was taught by one of the prominent characters advancing the claim that current account deficits were dangerous and unsustainable because ultimately the currency would collapse.

These ideas were thoroughly mainstream and were used as a ruse to justify cutting government deficits and deregulation aimed at reducing the size of government and suppressing trade union wage demands.

I rejected all these claims.

At a pure empirical level, Australia had been running current account deficits of around 3 per cent of GDP since the 1970s and no major currency incident relating to trade had occurred.

That alone suggested there was something amiss with the BPGC theory.

The Australian dollar did fluctuate widely at times as a result of our status as a primary commodity exporters – that is, the sort of products that Australia exports are subject to quite violent and variable terms of trade fluctuations on world markets.

But despite these occasional fluctuations, Australia still become one of the wealthiest per capita nations in the world and the impacts of the exchange rate shifts were barely noticed by anyone.

On December 9, 1983, the Australian government floated the Australian dollar, which finally moved Australia away from the vestiges of the Bretton Woods fixed exchange rate system and meant that the exchange rate would shift if there were imbalances between exports and imports.

The earlier decision to reduce tariffs had also meant Australian consumers could purchase better cars and electronic equipment that were cheaper to import than to make at home.

I was still a university student during this period and it was obvious to me that an external deficit represented a material advantage to Australian consumers, and, while the preferences for our exports might change, a nation that could import more than it had to export should take advantage of that situation for as long as it persisted.

That was the basis of my later perspectives on trade, which Warren and I weaved into the MMT framework in the 1990s.

The ‘modern’ in MMT relates to the new era of fiat currencies that emerged after the Bretton Woods system of fixed exchange rates which had been in place since 1946 finally was terminated with the Jamaica Accords in 1976 following a period when the Smithsonian Agreement had tried unsuccessfully to restore the system after President Nixon has closed down the US dollar-gold convertibility part of the system on August 15, 1971.

The end of convertibility marked the beginning of the ‘fiat monetary system’ characterised by the use of non-convertible state money.

It was now clear that the currency-issuing government faced no financial constraints on its spending.

The focus now could shift away from managing gold and foreign exchange reserves to other priorities, including the universal political goal of full employment, and that the constraints on government spending were now the availability of real productive resources that could be purchased with the currency of issue.

That was a major shift and MMT is the only body of work that recognised it as such and is built upon the understandings that arise from that shift.

Mainstream economics still relies on notions that were developed under the fixed exchange rate system where the external sector constrained what could be achieved domestically by government.

Recognising the shift to fiat currencies and acknowledging that the external economy plays a major role in the availability of real resources via trade, we sought to articulate what that meant in terms of the opportunities facing a nation.

The starting point is the notion that nations produce to consume, and that they trade to increase their respective consumption possibilities.

If we simply consider the fundamentals of that reality – setting aside a bevy of complexities such as national security etc. for the time being – then we can obviously conclude that any country benefits when they import goods and services rather than sending its local production abroad.

This is the starting point of the MMT perspective – exports constitute an opportunity cost because the embodied real resources could have been used domestically rather than being sent for the benefit of foreign consumers.

Conversely, imports constitute a net benefit to a nation because they involve foreigners transferring their real resources to the importing nation, thus preventing their own citizens from using them.

Taken together, a trade deficit provides net benefits to the nation, permits higher material living standards, and is said to thereby increase the real terms of trade for the deficit nation.

Nations that run trade surpluses deprive their citizens of a higher material standard of living – either they are being underpaid, under consuming, and/or working longer than they must, which are consequences of reductions in real terms of trade.

Why then would a nation want to export?

The answer is to generate benefits that are otherwise unattainable, given their domestic resource base.

Thus, the export cost can be seen as an investment to allow imports that expand the domestic consumption possibilities.

It is these fundamental observations that seem to rankle with some people to the point they make videos and give presentations saying that MMT is wrong or a pack of lies or whatever.

At the level I have just presented the narrative I am amazed by these criticisms.

It is self-evident that if you have something at your disposal and you hand it to another nation then you have incurred a ‘cost’ and if that other nation hands you something that they have declined to use themselves then you have gained a benefit.

A trade deficit means that foreigners have given up more real resources (inputs, final goods) than they have received in return.

Pretty simple.

I don’t want to go deeply into the BPCG issues here – you can read a working paper I wrote in 2022 (to be published soon in a book) on the debate – MMT and Trade.

Basically, the proponents of the BPCG idea assume that there must be a trade balance and a constant real exchange rate.

To them, a ‘currency crisis’ is nothing more than exchange rate depreciation.

Additionally, the alleged long-run constraint on growth is not binding because financial flows on the capital account negate the Thirlwall assumption that exports are required to pay for imported goods and services.

In other words, a nation could record permanent trade deficits, without degrading its currency, if the surplus nations desired to continue building their foreign exchange reserves accordingly.

On commentator wrote (reference in above working paper) in the period of ‘modern’ central banking perspective under flexible exchange rates, that:

The current account balance need not … be seen by itself as a reliable indicator of vulnerabilities … The fact that Australia has managed to sustain investors’ confidence is evident in the maintenance of the current account deficit at an average of around 41⁄2 per cent of GDP over two decades combined with a real exchange rate showing no discernible trend over the same period.

There are many institutional features that a nation can use to avoid vulnerability to external shocks – like ‘Stable government, credible and sustainable monetary and fiscal policies, a sound financial system based on efficient regulation and supervision, effective legal and accounting frameworks, and transparent and open markets for factors of production and outputs’ (quote from same commentator).

Further, we have always acknowledged that there are nuances to this starting-point, fundamental insight on the export-import equation.

We acknowledge, for example, that strategic considerations can also weigh heavily on trade decisions.

For example, a nation that imports the needs of its military could find itself unable to provision its military during times of war.

During the recent pandemic, Australia discovered it did not have sufficient medical supplies (PPEs) and was forced to quickly access them from China, which introduced delays and quality problems.

But what about the issue of strategic assets?

From a consumption perspective, imports represent a real benefit while exports are a real cost.

However, this does not mean we should disregard a current account deficit.

Surplus nations build up financial claims in the currency of the deficit nation.

Without restrictions, foreigners could liquidate these claims by purchasing local real estate, which might undermine the prosperity of the residents (for example, through housing affordability issues).

Just think about ‘Londongrad’ – which describes how the wealthy Russian investors have purchased thousands of high-end properties in London in the areas of Belgravia, Lambeth, Brent, Camden, Kensington, Chelsea, Southwark, and Croydon, to name a few places.

The simple remedy is that governments can legislate to hinder foreigners from purchasing such strategic assets.

In Australia, for example, the Foreign Investment Review Board controls what assets foreigners can buy.

What about the issue of currency liquidation?

Nations that run current account surpluses will build up foreign currency reserves as a consequence.

What happens if these foreigners decide to liquidate their local currency holdings by purchasing foreign exchange.

It must be recognised that underpinning the willingness of foreigners to run surpluses against a nation is the desire to accumulate financial claims in the local currency.

While that preference holds, the deficit nations enjoy the favourable terms of trade.

Should that preference decline suddenly then the deficit nation would incur significant adjustment costs depending on the size of the trade deficit.

However, any major liquidation of this type would expose the holders to losses should a significant depreciation result.

Any speculative activity using those currency holdings could also be thwarted by capital controls.

During the GFC, the little nation of Iceland proved that the legislative capacity of the state was more powerful than the large US hedge funds who contested the decision of the government to impose capital controls to protect the nation’s currency as the banking sector collapsed.

The capital controls proved to be very effective in stabilising the currency as the nation recovered from the financial disaster that the neoliberal deregulation had created.

What about the issue of political influence?

Most problematic would be the situation where the foreign interests use their financial clout to influence the outcomes of legislation or manipulate the media to accomplish goals that are not consistent with national well-being.

There is no reason a nation has to accept such manipulation.

Legislative restrictions on campaign funding and media ownership rules could prevent such problems.

What about the issue of deindustrialisation?

It is also argued that persistent external deficits are associated with deindustrialisation (loss of manufacturing capacity), which has the consequence that high-skilled, well-paid employment declines, undermines research and development, and suppresses productivity growth and innovation, and renders the nation dependent on imported goods and services.

The traditional case for protection of the manufacturing sector against import competition – the so-called ‘infant industry’ argument – was based on the need for self-reliance in the event of war.

An MMT understanding allows us to appreciate that there would be no financial impediment for a government building national industries, funding research and development, providing first-class universities and apprenticeship training and the rest.

If a nation with its own currency closes its manufacturing sector, cuts career public sector jobs, and relies on low-paid and precarious service sector jobs for employment creation, then that is a political choice the government has taken and has little to do with running external deficits.

Now let’s turn to the degrowth question

The exports are a cost-imports are a benefit narrative simplifies a complex set of considerations.

These considerations are not the usual complaints raised by critics of MMT in this context.

But they do bear on the work I am doing on degrowth and environmental sustainability and thus represent an advance on the simple MMT perspective.

For a start, that simple perspective assumes a certain homogeneity across the product lines that are exported and imported.

What do I mean by that?

Think about Australia – the latest data from the Australian Bureau of Statistics – International Trade in Goods (May 2024) – reveals that 61.9 per cent of the total goods exported by Australia are from the mining sector – Coal, Oil and Gas Extraction, Metal Ore Mining, and Non-Metallic Mineral Mining and Quarrying.

A legitimate question to ask is: What is the opportunity cost to the citizens of exporting those resources rather than using them ourselves?

The Climate Council of Australia, for example, released a Report in 2015 – Unburnable Carbon: Why we need to leave fossil fuels in the ground – which convincingly argues that:

The inevitable conclusion from the commitment by the world’s governments to protect humanity from climate change is that the vast bulk of fossil fuel reserves cannot be burned. To have just a 50:50 chance of preventing a 2°C rise in global temperature: 88% of global coal reserves, 52% of gas reserves and 35% of oil reserves are unburnable and must be left in the ground. Put simply, tackling climate change requires that most of the world’s fossil fuels be left in the ground, unburned.

The calculus has worsened over the last decade or so since this Report was published.

The point is that we should not be using our coal reserves (for example) in any use – export or domestic – if we are to survive the changing climate and that observation places a different slant on the exports are a cost angle.

I will articulate that position more fully in further writing.

And, consider the imports are a benefit observation.

Clearly, if we evaluate human well-being in terms of materials commanded then that observation is undeniable.

But then if we dig deeper into the sorts of things that a nation imports then it is reasonable to question the quality of the benefit.

And here I am imposing my own judgement or set of preferences, which I acknowledge are not aligned very closely with the mass of consumers.

I shudder when I go to shops like K-Mart or Big W or their equivalents in other nations.

These are the big chain stores that sell very cheap, mass-produced consumer items – that are generally of low quality and do not stand up to use very well.

Mostly plastic junk.

Again, I emphasise that I am not a low-income worker and that gives me much more discretion over what I can buy in the form of consumption goods and services.

So qualify what I am saying here by that reality.

The point is that for a nation that is importing vast quantities of stuff that ends up soon after purchase in the rubbish bin – because it breaks or is otherwise disposable – it is reasonable to question the nature of the benefit arising from these imports.

When we enter a degrowth narrative then those questions become paramount and highly qualify the starting assumption that the primary aim of production is end-point consumption.

The basic rule of macroeconomics is that spending drives output which creates income and employment.

So if we want to change global production patterns then we have to alter our spending patterns.

Which means that cutting back on the ‘benefits’ of those cheap imports and keeping the ‘costs’ in the ground will be a good start.

Conclusion

I will expand on those thoughts in more detail another time.

That is enough for today!

(c) Copyright 2024 William Mitchell. All Rights Reserved.