State-citizen relationship foundational to effective economic policies
The Covid-19 crisis has unmasked the fractures, pre-existing structural rigidities and institutional fragilities in the economies of developing countries more than ever. This has called for a rethinking of fiscal and monetary policies, the main vehicles for relief, recovery and reconstruction of an economy.
It is, therefore, essential to examine the barriers to transformation in developing countries in the wake of the pandemic, and to analyse the pathways to recovery based on an economic policymaking agenda. This necessitates the understanding of how policy regimes shift and evolve, by juxtaposing the fiscal and monetary policies and state-building throughout history, such as the pre- and post-colonial periods, to the present-day context.
Since development and transformation are complex, it requires the use of an interdisciplinary approach to venture beyond the conventional inclination to explain the state of developing countries by considering the experiences of advanced economies. There is a need for having a different take on data, at least at three levels: the aggregate level using world 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 on the relevance of different schools of thoughts to provide for a nuanced, thought-provoking theoretical apparatus applicable to developing countries, besides allowing to comprehend a country-specific analysis.
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State-building and economic policymaking
The relationship between the nature of state and consequential economic policies in developing countries has, to date, been neglected. A historical institutional analysis of pre- and post-colonial epochs, including the Covid-19 period, grids the transmission mechanisms of the realities between economic policymaking, concentration of wealth and power, and differential access to markets and resources.
What is needed is a thorough understanding on the state formation in developing economies and the nature of capital accumulation. For laying out an agenda for transformation in developing countries, primarily South Asian and African ones, it is indispensable to find out if there is any inherent structural reality that may have led to the creation of rentier, impeding the developmental process.
Framing fiscal and monetary policies
A comprehension on the citizen–state relationship posits that transformational institutions are key to a functioning market and state. Undoubtedly, this is the time to question the so-called apolitical approach of a new consensus, neoclassical monetarists and public choice theorists. The central problem with these schools of thoughts is the failure to endogenise fiscal policy as an overtly political process. The decisions of state–citizens–firms are shaped by formal institutions, contingent upon informal institutions of norms (informal codes) and values (reproduced by society).
Against such backdrop, an alternative diagnostic framework, taking a historical institutionalism approach could allow for endogenising intrinsic properties of state-building and economic policymaking. Only such could provide for a theory of change.
Fiscal policy and the state-citizen relationship
There is an another important need to break away from the orthodoxy as fiscal policy in under-developed 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 the capacity of a government to raise sufficient revenue and then to utilise it in an efficient manner. However, how taxation can be used to promote state-building has remained an under-studied area in the academic arena. For transformation, the fiscal policy has to accelerate the rate of physical and human capital formation by expanding investments in public and private enterprises and by diverting resources from socially less desirable sectors, to achieve full employment and the equitable distribution of income and wealth. Amid the Covid-19 crisis, the state-citizen relationship has to be analysed on the basis of state directives and the distribution process of fiscal stimulus to the productive sectors in the economy.
Fiscal policy and productive capacity
Instruments such as technology acquisition and organisational capabilities determine the level of productivity contributed by the role of fiscal policy. Under the context of Covid-19, developing countries may choose to use these instruments to boost productive economic sectors and induce effective policy responses to improve productivity.
Productivity is influenced by existing power relations. The political settlement plays a key role in this regard. The endogeneity of politics affects the advancement of the whole process. Within mainstream economics, there had been a general negligence to comprehend how the state, underwritten by appropriate political settlement, plays an active role in ensuring and maintaining high rates of investment and the shift to higher productivity-inducing technology acquisition, catching-up and deepening.
It is demonstrated that productivity in factors of production — labour, capital and technology — is brought about through the endogeneity of political settlement or social property relations. Informal institutions play a decisive role, and have a bearing in terms of the nature and distribution of power in a given society.
Equality, welfare and state
There is growing interest in understanding inequality, being mindful of systemic escalating inequality arising out of low returns on labour vis-à-vis capital which has come to be known as permanent systemic inequality. Here, an elaborate theoretical distinction can be made between demand, want and need in support of each according to their ability, to each according to his/her need, as opposed to the neoclassical theory of demand — the relationship between consumer demand for goods and services and their prices, being willing and able to buy at a given price in a given time period. The latter is intrinsically inequalising.
What is needed is to comprehend people's struggles and aspirations for equality, human dignity and social justice, and factor it into the trajectories of debates on the necessary and sufficient conditions for sustained and rapid improvements in living standards, exacerbated by the Covid-19 crisis, towards formation of a welfare state. This necessitates a wide range of redistributive fiscal tools for translating normative principles as a part of developmental needs and state-building.
Monetary policy, growth and employment
There is a growing consensus to challenge the mainstream accord concerning the money–inflation trade-off and the neutrality of money to present ways through which monetary policy exerts real effects on growth and employment in the long term. What is, nevertheless, required is to establish additional channels through which monetary policy augurs credit to sectors that are crucial for long-term growth, employment creation and productivity augmentation.
In order to recover from the economic slowdown due to the Covid-19 crisis, the monetary policy should seek to ensure that financial conditions are sufficiently accommodative to incentivise high-capital investments and deficit-financed spending. The transmissions under such a context are driven by variations in wages and employment outcomes in the real economy. The particular fiscal–monetary policy combinations, known as fiscal–monetary policy mixes, are important and such that this can reinforce long-term stability.
Price, inflation and monetary policy
The mainstream pushed the central banks to shift significantly in favour of solely focusing on price stability rather than on a policy perspective centring on employment. The dominant theories behind such a shift have major theoretical shortcomings. These theories fail to clarify the inflation experience of developing states.
The structural and institutional weaknesses provide widespread opportunities for rent-seeking in the production and distribution process, leading to higher prices for consumers. Following a single-minded inflation-targeting objective imposes significant costs on a weak institutional structure.
An assessment of the use of monetary policy instruments and the subsequent effects on inflation during the Covid-19 crisis in developing countries calls for linking fiscal policy to monetary policy. There is a need for moving towards functional finance approach as opposed to sound finance, to delineate appropriate kind of fiscal rules to complement the monetary policy to achieve the purpose.
An agenda for transformation
There is an association amongst 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 the society by means of fiscal policy to provide public goods and meet basic and other development needs are important components of state-building. Monetary policy too can be effectively used to initiate diversification and structural change in the economy, and increase the state-building ability of the government through functional finance. Nonetheless, it is imperative that the agenda for transformation inculcates values of living in harmony with nature at its core, particularly for countries with high climate vulnerabilities. Only then may we expect a developing country to traverse on a trajectory of development that reaches the individual at the last mile and enriches the state-citizen relationship.
This is based upon the abstracts of different chapters of the author's recent book, "Fiscal and Monetary Policies in Developing Countries: State, Citizenship and Transformation," published by Routledge. The sub-headings are the chapter titles.
Dr Rashed Al Mahmud Titumir is professor and chairman of the Department of Development Studies, Dhaka University, and chairperson of Unnayan Onneshan.
