Report urges poorest countries to adopt macroeconomic policies which support development of their productive bases

Expansionary fiscal policies and public investment are not only good for crisis but for also sustainable growth, Least Developed Countries Report 2009 says

Geneva, 16 July 2009 -- Governments of the world´s 49 poorest countries should strive to ramp up public investment not only in response to the global crisis but as a long-term spur to stable economic growth, UNCTAD´s Least Developed Countries Report 2009(1) recommends.

The report, released today, notes that the policy myths of the self-regulating market and minimalist government have, in both developed and developing countries, been buried under the mounting economic debris of the financial crisis. It says the so-called LDCs should focus their macroeconomic policies long-term on boosting the productive capacities of their economies and on establishing the infrastructure -- such as roads, bridges and electricity supply -- that empowers such progress. It adds that they should nurture and steer their fledgling private banking sectors into investing in productive activities instead of government portfolios and real estate.

Significant stimulation measures have been taken by governments in developed countries in response to the financial crisis. As the crisis spreads across the globe, many less-wealthy nations lack the resources to take similar corrective action, the report notes. For most LDCs, the worldwide recession is compounding a pre-existing chronic squeeze on credit which has restricted business development and stymied economic diversification.

A central claim of the LDC Report 2009, which is subtitled The State and Development Governance, is that managing the crisis and establishing a new path of sustained growth and poverty reduction will require LDCs to adopt more expansionary macroeconomic and financial policies.

For the last three decades macro-economic policies in the LDCs have been strongly influenced by the recommendations of international financial institutions such as the International Monetary Fund (IMF) and the World Bank, and bilateral aid donors. Typically, they have focused monetary policy on containing inflation, while the role of fiscal policy has been to ensure that budget deficits remained moderate. Public investment has generally not been seen as having an important role in promoting economic development.

Under this approach, government spending has been cut independently of cyclical conditions and long-term needs, the report says. But this strategy has failed to deliver the invigorating investment climate promised by its neo-liberal proponents. The report says LDCs now need to refocus their macroeconomic policies on developing productive capacities -- that is, the abilities of their economies to produce more varied and more sophisticated products. LDC governments also should accelerate structural change towards more productive activities.

For most LDCs, the required change means adopting expansionary fiscal policies and accommodating monetary policies, as well as managing exchange rates and capital flows.

Public investment is essential for development, the report argues. Such investment directly expands the productive capacity of an economy. By investing in productive sectors such as agriculture and infrastructure -- as well as in health and education -- the state contributes to establishing basic growth fundamentals. These investments can draw in private investment and raise labour productivity, and also can play an important role in demand management, including counter-cyclical effects such as the stimulation measures many countries are now using to combat the global recession. In addition, public investment allocates resources to combat poverty, generate employment, reduce inequality, and diversify economic structure.

To raise public investment to appropriate levels, states need to be able to mobilize fiscal revenues, the report says. In recent years LDCs have not made sufficient progress. Tax revenues rose marginally (to just 12% of GDP in African LDCs) in 2000-2006, despite strong economic growth. The feeble rise resulted from the generalized introduction of value-added taxes (VATs) and a marginal expansion in direct taxes only partly compensating for falling trade taxes (due to trade liberalization). To strengthen their fiscal bases, LDCs should refrain from further trade liberalization, increase VATs on luxury goods, improve the effectiveness of taxation of high incomes and corporations, and strengthen property taxes, the report recommends.

Official development assistance (ODA), an important source of revenue for many LDCs, has often been misdirected and has acted as a substitute for domestic fiscal revenues, the study says. During the current crisis, ODA levels should be maintained (or possibly raised) and debt relief intensified, and aid should be increasingly used to strengthen the economic infrastructure and the capacity of LDC states to raise revenues domestically.

Currently macroeconomic management in LDCs places too much emphasis on monetary policy to the detriment of fiscal and exchange-rate policies, the report contends, and the main objective of monetary policy has been to combat inflation rather than promote growth, employment and exports. Inflation has certainly fallen. The average consumer price index inflation rate during 2005-2007 for the LDCs as group was just 9.8%. However, the restrictive monetary policies and high real interest rates have rendered much investment unviable. Between 2004 and 2006, 27 out of 49 LDCs had high real interest rates (that is, above 6% per annum, and exceeding 15% in seven countries), while in most developed countries they were mostly below 4% per annum.

Monetary policy in many LDCs is hampered by underdeveloped financial markets and institutions and by prematurely open capital accounts. The fledgling private banking sector that has emerged typically has not performed the function of channelling savings into productive investments, the report says. Rather, it concentrates on lending at high interest rates to the government or on supporting more speculative investments in high-risk sectors such as real estate.

The report advises LDCs to manage their capital accounts in a way that will allow them to deal more effectively with two major problems: capital flight and short-term capital volatility. LDCs also should manage their exchanges rate to maintain the competitiveness of their exports, for example by means of a managed float (a market-determined rate, but with occasional interventions by the central bank) or by using a loose peg to foreign currencies which is readjusted periodically.