The state-citizen relationship is fundamental for effective economic policies

January 20, 2022, 10:25 a.m.

Last modification: January 20, 2022, 12:34 p.m.

Illustration: TBS


Illustration: TBS

The Covid-19 crisis has more than ever revealed the fractures, the pre-existing structural rigidities and the institutional weaknesses of the economies of developing countries. This called for a rethinking of budgetary and monetary policies, the main vectors of relief, recovery and reconstruction of an economy.

It is therefore essential to examine the obstacles to transformation in developing countries in the wake of the pandemic and to analyze the paths to recovery on the basis of an economic policy-making agenda. This requires understanding how political regimes change and evolve, juxtaposing fiscal and monetary policies and state building throughout history, such as pre- and post-colonial periods, to the current context.

Rashed Al Mahmud Titumir. Illustration: TBS

Rashed Al Mahmud Titumir.  Illustration: TBS

Rashed Al Mahmud Titumir. Illustration: TBS

Because development and transformation are complex, they require the use of an interdisciplinary approach to venture beyond the conventional tendency to explain the state of developing countries by taking into account the experiences of advanced economies. There is a need for a different approach to data, at least at three levels: the aggregate level using global data, the single country context with case studies, and a cross-country assessment for comparative analysis. This cannot be done without having a critical assessment of the relevance of the different schools of thought to provide a nuanced and stimulating theoretical apparatus applicable to developing countries, in addition to allowing for an analysis specific to each country.

State building and economic policy making

The relationship between the nature of the state and the economic policies that flow from it in developing countries has, until now, been neglected. A historical institutional analysis of pre- and post-colonial eras, including the Covid-19 period, grids the transmission mechanisms of realities between the making of economic policies, the concentration of wealth and power and the differential access to markets and resources .

What is needed is a thorough understanding of state formation in developing economies and the nature of capital accumulation. In order to establish a transformation agenda in developing countries, mainly South Asian and African, it is essential to determine whether there is an inherent structural reality that could have led to the creation of rentiers, hindering the development process.

Fiscal and monetary policy making

An understanding of the citizen-state relationship posits that transformational institutions are essential to the functioning of the market and the state. No doubt it is time to question the so-called apolitical approach of a new consensus, of neoclassical monetarists and public choice theorists. The central problem with these schools of thought is the inability to endogenize fiscal policy as an overtly political process. State-citizen-corporate decisions are shaped by formal institutions, subordinated to informal institutions of norms (informal codes) and values ​​(reproduced by society).

In such a context, an alternative diagnostic framework, adopting a historical institutionalism approach, could make it possible to endogenize the intrinsic properties of state-building and economic policy-making. Only such an approach could provide a theory of change.

Tax policy and the state-citizen relationship

There is another important need to break with orthodoxy because the fiscal policy of underdeveloped countries has a different objective than that of advanced countries. Since fiscal policy involves political processes, the process of state building in developing countries needs to be critically understood. The process of state building largely depends on a government’s ability to generate sufficient revenue and then use it effectively. However, how taxation can be used to promote statebuilding has remained an understudied area in the academic realm. For transformation, fiscal policy must accelerate the rate of physical and human capital formation by increasing investment in public and private enterprises and diverting resources from socially less desirable sectors, to achieve full employment and equitable distribution of labor. income and wealth. In the midst of the Covid-19 crisis, the state-citizen relationship must be analyzed on the basis of state directives and the process of distributing tax incentives to the productive sectors of the economy.

Fiscal policy and production capacity

Instruments such as technology acquisition and organizational capabilities determine the level of productivity brought about by the role of fiscal policy. In the context of Covid-19, developing countries can choose to use these instruments to stimulate productive economic sectors and induce effective policy responses to improve productivity.

Productivity is influenced by existing power relations. Political settlement plays a key role in this regard. The endogeneity of the policy affects the progress of the whole process. Within mainstream economics, there had been a general neglect to understand how the state, secured by appropriate political settlement, plays an active role in ensuring and maintaining high investment rates and the shift to acquisition, catching up and deepening technologies leading to higher productivity. .

The productivity of the factors of production – labor, capital and technology – is shown to be driven by the endogeneity of the political establishment or social property relations. Informal institutions play a decisive role and influence the nature and distribution of power in a given society.

Equality, Welfare and the State

There is growing interest in understanding inequality, keeping in mind the growing systemic inequality resulting from low returns to labor relative to capital, known as permanent systemic inequality. Here, an elaborate theoretical distinction can be made between demand, want and need in support of each according to ability, to each according to need, as opposed to neoclassical demand theory – the relationship between the demand of consumers for goods and services and their prices, being willing and able to buy at a given price in a given period of time. The latter is intrinsically unequal.

It is a question of understanding the struggles and aspirations of peoples for equality, human dignity and social justice, and of integrating them into the trajectories of debates on the necessary and sufficient conditions for a lasting and rapid improvement. standard of living, exacerbated by the Covid-19 crisis, towards the formation of a welfare state. This requires a wide range of redistributive fiscal tools to translate normative principles within the framework of development and statebuilding needs.

Monetary policy, growth and employment

There is a growing consensus to challenge the prevailing agreement on currency-inflation trade-off and currency neutrality to present the means by which monetary policy exerts real effects on long-term growth and employment. What is needed, however, is to establish additional channels through which monetary policy augurs credit to sectors that are crucial for long-term growth, job creation and increased productivity.

In order to recover from the economic downturn due to the Covid-19 crisis, monetary policy must ensure that financial conditions are accommodative enough to incentivize capital-intensive investment and deficit-financed spending. Transmissions in such a context are determined by changes in wages and employment outcomes in the real economy. Particular combinations of fiscal and monetary policies, known as fiscal and monetary policy mixes, are important and such that they can enhance long-term stability.

Prices, inflation and monetary policy

The mainstream has pushed central banks to shift significantly in favor of focusing solely on price stability rather than a jobs-centric policy perspective. The mainstream theories behind such a change have major theoretical shortcomings. These theories fail to clarify the inflation experience of developing countries.

Structural and institutional weaknesses provide many opportunities for rent-seeking in the production and distribution process, leading to higher prices for consumers. Pursuing a single inflation targeting objective imposes significant costs on a weak institutional structure.

An assessment of the use of monetary policy instruments and subsequent effects on inflation during the Covid-19 crisis in developing countries calls for linking fiscal policy to monetary policy. There is a need to move towards a functional financial approach as opposed to sound finance, in order to define the appropriate type of fiscal rules to complement monetary policy in order to achieve the objective.

A transformation program

There is an association between state, citizen, fiscal and monetary policies. Since fiscal policy is political, the process of state building in developing countries needs to be critically understood. The ability of governments to interact with society through fiscal policy to provide public goods and meet basic and other development needs are important elements of statebuilding. Monetary policy can also be used effectively to initiate diversification and structural change in the economy, and increase the government’s ability to strengthen the state through functional finance. Nevertheless, it is imperative that the transformation agenda inculcates the values ​​of living in harmony with nature at its core, especially for highly climate-vulnerable countries. Only then can we expect a developing country to follow a development trajectory that reaches the individual at the last mile and enriches the state-citizen relationship.

This is based on summaries of individual chapters from the author’s recent book, “Fiscal and Monetary Policies in Developing Countries: State, Citizenship and Transformation,” published by Routledge. Subtitles are the titles of the chapters.

Dr. Rashed Al Mahmud Titumir is Professor and Chairman of the Department of Development Studies, University of Dhaka and Chairman of Unnayan Onneshan.

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