ERIC KASHAMBUZI

Written by Eric Kashambuzi, on 23-06-2008 23:14

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In the second article on the NRM successes and challenges which was published in the Weekly Observer, I pointed out that because of imperfections in the functioning of the market forces, governments have had to step in to correct those imperfections or to provide services that do not fall within the comparative advantage of the private sector. I gave examples of such interventions from developing countries.

Some observant readers pointed out that I did not draw on examples from developed countries as well. They asked me to do so if such examples existed in order to have a balanced presentation. This article is designed to do just that with reference to the United States of America and the United Kingdom – the two developed countries that I am fairly familiar with.

When Franklin D. Roosevelt (FDR) became President of the United States, he inherited an economy that had been devastated by the Great Depression of the 1930s. Banks, small businesses and factories had closed. Farm prices had plummeted, falling below the cost of production and transport to the market, leading to the paradox of food rotting in the fields while urban poor populations starved. Unemployment rose from under 500,000 in October 1929 to 17 million or 25 percent of the labor force in January 1933. At that time no tradition had existed of government intervention in the United States economy. The economy corrected itself under the ‘invisible’ hand of the market forces. However, this time, the extent of human suffering particularly of the poor and the vulnerable: the old, the sick and single parent families demanded government’s rapid and effective response. FDR convened a special session of Congress (parliament) that passed laws to speed up economic recovery, provide relief to the victims of the economic hard times and to make reforms in financial, business, agricultural and industrial sectors. The programs under the ‘New Deal’ (a belief in national planning as opposed to an individualistic, intensely competitive, laissez-faire economy) reached directly into the lives of every American as millions received relief, got jobs or aid with credit. The Public Works Administration appropriated $3.3 billion for hiring the unemployed to build roads, sewage and water systems, public buildings, ships, naval aircraft, and a host of other projects.

The Tennessee Valley Authority (TVA) provided assistance for flood control and the construction of dams to generate cheap electricity; soil erosion control mainly through reforestation and better farming methods such as contour plowing; produced fertilizers and introduced education programs. These programs contributed to the economic recovery and had a long term impact on the economy and society. They created jobs, improved the purchasing power and in the process got business going again. As a result of government borrowing, the deficit rose from $22.5 billion in 1933 to $40.5 billion in 1939.

From the 1960s the world economy experienced difficulties which degenerated into stagflation (stagnant economic growth, rising inflation and unemployment) in the 1970s that could not be solved by the Keynesian approach of demand management through deficit financing to achieve full employment. The right wing economists blamed the economic hard times in the 1970s on the Keynesian economics. They proposed that a monetary policy (monetarism) to control the quantity of money in circulation be instituted to ensure non-inflationary sustained growth without government interference. However, governments that followed this advice soon abandoned it in favor of intervention.

When John F. Kennedy became President, the US economy was experiencing difficulties and unemployment was high. Government intervention became necessary to boost the economy through tax cuts and deficit financing. The program was continued under his successor, Lyndon B. Johnson. The economy responded favorably, national output surged, unemployment declined and the gap in the federal budget narrowed as rising national income increased tax payments.

Johnson was succeeded by Richard Nixon who inherited inflation. Consequently, he adopted a tight monetary policy. The result was a recession and unemployment which rose from 3.5 to 6.0 percent of the total labor force. Nixon switched from a restrictive to an expansive fiscal and monetary policy. He became a Keynesian as a result of his intervention in the US economy to correct free market imperfections.

When Ronald Reagan became President, he was determined to tame inflation, curb the role of government in the economy and remove regulations in order to release individual and business energies as the engine of economic growth.

The Federal Reserve (Central Bank) implemented a restrictive monetary policy through high interest rates. Inflation was brought down but the policy caused a steep recession in 1981-82 considered to be the worst in the postwar period. The recession pushed unemployment to a post war peak of more than 11 percent. Alarmed by these developments which were politically untenable, the Federal Reserve dropped its professed monetary policy and together with the Treasury Department adopted a stimulus monetary and fiscal or pro-growth policy characterized by tax cuts and deficit spending to stimulate aggregate demand and economic growth.

The economy responded favorably to Reagan’s intervention growing at an average annual rate of 3.2 percent with low inflation. The excess capacity accumulated over the 1981-82 recession period helped to keep inflation down. For this reason, Dennis Healey, a former British finance minister concluded that it was the Keynesian economics of government intervention rather than the power of the free market (supply-side economics) that led to the economic recovery and sustained growth during Reagan’s presidency. The recovery began when the Chairman of the Federal Reserve relaxed monetary control in 1982.

In Britain Prime Minister Margaret Thatcher declared her determination to control inflation as her first economic priority by reducing the quantity of money in circulation, cut public-sector investments and reduce the role of government in the economy. The steep rise in interest rates that followed the reduction in the money supply led to a deep economic recession from 1979 to 1982. Unemployment rose from 5.4 to more than 12 percent or three million people. The restrictive monetary policy was abandoned in 1983 when it became clear that the relationship between the money supply and inflation hardly existed. Thatcher’s government borrowed 6 percent of Britain’s GNP – one of the highest public debt ratios in the world – to stimulate the economy, create jobs and end the recession.

Before concluding, it is important to remember that in the 1960s and 1970s, African governments pursued a Keynesian approach and intervened in the economy to boost growth and create jobs. However, since the 1980s, the donor countries have regarded the Keynesian economic approach as an obstacle to development and imposed the neo-liberal policy of free trade and private sector as the engine of growth. Having failed to deliver after more than twenty years, structural adjustment or the Washington Consensus has thus been abandoned in favor of an effective and strategic state intervention.

When the NRM came to power in 1986, it inherited an inflation rate in three digits. With advice from foreign advisers, the government assigned top priority to inflation control. The quantity of money in the economy was reduced, hiring in public institutions was restricted and interest rates were raised. With the assistance of huge excess capacity in industry, agriculture and labor market as well as generous donor funding and remittances, the economy grew fast from a low base in areas where peace and security prevailed, the supply of goods and services increased and inflation came down. With excess capacity almost used up and donor funding declining, economic and social strains are beginning to show as witnessed by increasing unemployment and poverty.

To avoid further deterioration, it is high time that the relevant authorities worked out an intervention package of programs to create jobs and stimulate economic growth. The interest rates will need to be managed in such a manner that they permit borrowing by small and medium enterprises to take place. Keeping interest rates so prohibitively high for the sake of low inflation is increasingly becoming counter-productive. The Central Bank needs to be pragmatic especially in view of the fact that the IMF has accepted a reasonable level of flexibility.

It is worth stressing by way that government moderate deficit financing is not necessarily a bad idea provided the resources are invested in productive activities that generate revenue with which to retire the debts. Trouble occurs when the government borrows and spends on consumption or mismanages potentially productive investments.