Category Archive: Analysis

1. Desenrola Brazil

   April 25, 2024 6:49 am Comments Off on Desenrola Brazil

   Credit in Brazil—and particularly consumer credit—is expensive, but ubiquitous. Exclusion from the credit market, where basic needs not covered by wages are increasingly financed, is now a threat to the very social reproduction of the working classes. Accordingly, the massive expansion of access to banking services, known as “financial inclusion,” has made working-class and poor Brazilians key players in the creation of financial wealth—the indebted counterparts of a booming creditor ecosystem.

   Over the last few decades, there has been an accelerated and continuous increase in the number of people in debt and the amount of disposable household income spent paying it off. According to the Central Bank of Brazil,¹ at the end of 2020 there were around 85 million people in debt to the financial sector, roughly 46 percent of the adult population, with just over 8 million designated as “at-risk debtors.”² Nearly 9 million have defaulted.

   In the wake of the Covid-19 crisis, the situation has continued to deteriorate. While the number of borrowers expanded at the expected rate, surpassing 105 million people, the number of people in risky debt has practically doubled—reaching 15.1 million in March 2023.³ An attendant explosion in defaults has taken place, affecting tens of millions of people who together carry debt worth R$350 billion (US$70 billion).⁴ Meanwhile, the debt poor⁵—those who fall below the poverty line due to the amount of income lost to loan payments—are another growing part of the increasingly complex landscape of Brazilian inequality.

   The scope and impact of this problem affects millions of lives and, by inhibiting the consumption of working families, acts as a brake on the reheating of the domestic economy. Looking to address the urgency of the situation early in his third term, in July 2023 President Luis Inácio Lula da Silva launched an ambitious social program focused on debt renegotiation. Desenrola Brasil—“unroll” or “untangle” in English—offers conditions so that people who have been denied credit can renegotiate their debts, reduce their degree of financial vulnerability, and reestablish their creditworthiness. The program began as a campaign promise, but has become a lifeline for tens of millions of Brazilians who are in arrears.

   It is also a lifeline for their creditors. The Central Bank acknowledged that the high leverage of household debtors, and the growing losses that this leverage imposed on the financial sector, had resulted not only in a retraction of the supply of credit to families, but also in a limit to banks’ profitability.⁶ The latter is explained by the fact that 65 percent of credit is in the hands of families, whose loan arrangements generate the majority of credit interest for the banking sector—73 percent—from consumer credit.

   The aim of this article is threefold. First, to contextualize the development of chronic indebtedness among Brazilian families. Second, to situate and map previous public policy initiatives that, reflecting the power of creditors in the Brazilian economy and the acute crisis caused by the Covid-19 pandemic, have chosen debt as their object of treatment. And finally, to reflect on the implications of household debt becoming an explicit and institutionalized dimension of public policy with the creation of Desenrola Brasil.

   From mass financialization (1995–2015) to the profitability crisis (2016–2021)

   The process of financialization in Brazil began after the end of the “economic miracle” (1967–1973) and can be divided into two phases. The first phase, which we call “elite financialization,” took place from 1981 to 1994 and was marked by the context of the foreign debt crisis and rising inflation. During this phase, the banking system implemented indexing mechanisms that guaranteed financial gains for a small, privileged clientele. In these years, where income from financial securities grew, productive investment stagnated.

   The second phase, called “mass financialization,” lasted from 1995 to 2015. This period saw a reduction in inflation and real interest rates, accompanied by a notable increase in credit operations. At the institutional level, this period was marked by a regime that reconciled the expansion of social policies—particularly cash transfers⁷—with the expansion of financialized accumulation. During these years, the country moved from a period of stagnation in productive investment, characteristic of the first phase, to the consolidation of a process of deindustrialization and low economic growth.

   

   The expansion of the credit market in the second phase is visualized in the above chart, showing data from a representative basket of the financial-banking sector for the period between 2000 and 2023.⁸ The graph shows the variables net profit (dotted line), credit revenue (highlighted by the red line), and revenue from securities (or TVM,⁹ represented by the blue line). As illustrated, the financial-banking sector’s net profit, driven by credit and securities revenues, grew almost uninterruptedly. In the mass financialization phase, operations in the credit market overtook debt securities as the main source of growth. Unlike the first phase, in which the debt securities market was central, the increasing importance of income from operations in the credit market now stands out.

   Against this backdrop, this section proposes an analysis from the perspective of financial cycles. To do this, we discuss two points: first, a fall in the two main banking revenue streams appeared as a trend before the Covid crisis and, for this reason, we can consider that decline to have a more structural dimension; second, the state played a key role in restoring the sector’s profitability.

   Analyzing the period of the profitability crisis also reveals interesting characteristics. Given the decline in dominant sources of income from 2016 to mid-2021, the banking sector’s strategy to boost and stabilize net profit growth was based on increasing the margin applied to credit operations, i.e. the spread. The spread represents the amount effectively retained by the banking sector in credit operations, calculated as the difference between credit income and funding costs. In other words, the spread represents the banks’ reaction to the fall in revenues.¹⁰ Using their power in the credit market to increase their rents, banks transferred the burden of the crisis to borrowers.

   Among borrowers, that burden fell mainly on households.¹¹ The credit data show that at the end of 2016, for the first time in the historical series, the balance of credit to households surpassed that of credit to non-financial companies, and has remained dominant until the present.¹² It is those households, therefore, and particularly those on lower incomes, who are bearing the brunt of the prohibitive interest rates.

   

   The above chart shows the recent evolution of the average interest rates charged by the financial sector, comparing the Selic rate and the IPCA.¹³ It highlights the centrality of the Selic rate in understanding how the banking sector’s revenues are recovering whereas household indebtedness is increasing. It is clear that, as of 2021, following the accelerated rise in the Selic rate, interest rates for common household credit registered a significant jump. Low-risk payroll loans rose on average from 19.98 percent per year in May 2020 to over 25.81 percent in May 2023, while free resources loans, which include all types of loans to families, moved from 25 to 38.22 percent per year on average over the same period. In May 2023, the month prior to the launch of Desenrola, with inflation at around 4 percent, the interest rate on the balance of loans to families was almost 7 percentage points higher than that on the total balance of loans.

   On the credit supply side, as of 2012, 90 percent of new credit concessions relate to non-real estate credit, i.e. consumer credit, which is not used to accumulate assets as part of a risk prevention strategy.

   The Selic rate is also a crucial variable for understanding the expansion of the Brazilian credit market. This relationship can be seen in Graph 3 below. The ratio between securities and credit income (represented by the red line) shows a negative correlation with the nominal Selic rate (represented by the dotted line). This correlation indicates that the banking sector expanded its credit operations in line with changes in monetary policy: the more the Selic rate fell, the more the sector came to depend on credit income.

   

   According to Graph 3, the lowest value of this ratio was more than 0.9 in 2002, when the nominal Selic rate was, on average, above 20 percent. A value of 1 indicates that the two incomes have the same weight for the Brazilian banking sector. The highest value recorded was 3.1 in December 2021, when the Selic rate reached a historic low (2 percent per year) and was negative in real terms. It is also worth noting that, with the increase in the Selic rate in 2022, the ratio returned to its 2004 level, reaching 1.3. With regard to 2021, as Graph 1 above shows, the year stands out for reversing the downward trends in both revenues. A very plausible explanation, based on a combined reading of the two graphs, is that the Selic rate played a crucial role in this reversal. Brazil’s monetary policy diverged from other central banks when, from 2021 onwards, the BCB prematurely adopted a contractionary approach and raised the Selic rate to 13.75 percent in August 2022, putting the country back at the top of the list of the highest real interest rates in the world.¹⁴ Only with the intervention on the Selic rate was the profitability of the financial-banking sector restored.

   One interpretation of these developments supports the framework of a financial-rentier class coalition, whose preferences guide Brazilian monetary and fiscal policy decisions.¹⁵ It is possible to infer that a downward trend in revenues caused these actors to intensify rentier channels in the debt securities market, in favor of raising the Selic rate. In a situation of declining revenues, it becomes not only preferable but imperative for the financial sector to secure the state as a debtor, as opposed to budget-constrained families and firms.

   It is in this context, of a financial cycle in a contractionary phase, and with the state playing the role of “revenue guarantor of last resort,” that the Desenrola program was born, interpreted here as one of the pillars for the inauguration of a new financial expansionary cycle.

   However, before explaining the context that led to the creation and implementation of the program, it is worth examining the changes caused by the Covid-19 crisis and how they impacted the relationship between debtors and the financial system.

   Covid-19 and the social crisis

   During the coronavirus pandemic, which led to lockdowns and other forms of social isolation, emergency measures were adopted to alleviate the suffering of families and prevent companies from closing their doors or massively laying off their workforce. Unlike the Great Financial Crisis of 2008, the bailout of families prevailed as a centerpiece of global initiatives dealing with the economic, social, and health crisis caused by Covid-19. In all latitudes, various income and employment guarantee programs were implemented, with the common goal of giving cash to those unable to work, at higher levels than existing social protection systems could achieve.

   Brazil was no exception, and it adopted a suite of ad hoc programs: emergency aid to people in situations of vulnerability; an emergency benefit for formal employees; an emergency benefit for maintaining employment and income; and emergency financing to cover payroll expenses. These emergency income guarantee programs consumed 63.5 percent of the “war budget” spent in 2020.¹⁶

   The generous Covid tax relief packages laid bare the folly of the fiscal and monetary orthodoxy that had previously restricted public spending and reduced the redistributive and risk-mitigating power of social policies. After four decades of neoliberalism, austerity policies had dismantled the provision of public services, encouraging privatization and financialization in their stead. Chronic indebtedness is a symptom of this shift, a fact that became clear with another set of measures adopted during the Covid crisis: the temporary suspension of payments on household debt.

   Debt suspension programs were necessary because of the explosion of private household debt that characterized the decade prior to the pandemic and that now comprises a considerable portion of households’ disposable income. As incomes dropped violently with the pandemic shutdowns, already record-high default rates ran the risk of spreading throughout the country’s financial system.

   The United States, the United Kingdom, Argentina, Spain, Italy, and many other countries all adopted similar temporary measures—combining generous cash transfers with the temporary suspension of debt repayments and sanctions previously applied to defaulters or those in arrears. Once again, Brazil was no exception. In parallel with the implementation of Emergency Aid, which covered 67 million people for eight months, some debts were suspended, such as students’ debt with FIES, for example.¹⁷ However, the July 2020 law restricted this favor to debtors who were up to date with their payments or less than 180 days in arrears,¹⁸ and offered significant discounts to those who agreed to renegotiate their debt while the law was in force. No federal provisions were passed to suspend the payment of debts from mortgages, rents, or current account payments.

   What we saw across national contexts in the midst of the Covid crisis was a sharp reduction in the occurrence of defaults. This happened by way of fiscal stimulus guaranteeing relatively high liquidity for families, and through debt payment suspension measures and other related administrative instruments, which stimulated a wave of debt renegotiation with clear leadership from private banks. The reduction in defaults and arrears was accompanied by an increasing credit balance that deepened the ties between households securing their consumption through debt and the financial institutions whose profits are guaranteed by that debt.¹⁹

   In Brazil, the process of restoring families’ debt capacity took place outside of coordinated state action—in other words, it was the initiative of the banking sector itself.²⁰ Thus, the most vulnerable families and workers covered by the emergency cash transfer program began to seek out banks to renegotiate their debts.²¹ Banks and other financial institutions spent around 60 billion reais (12 billion USD) on debt extension programs between March and December 31, 2020 without renegotiating interest rates, which at the time were in free fall.

   With regard to the repayment of mortgage loans, the National Monetary Council recommended that financial institutions suspend mortgage installments for up to 120 days, later extending the recommendation to 180 days. This was aimed at borrowers who were in default or who were no more than two installments in arrears. There was no interest forgiveness, which continued to apply to the remaining installments. On the other hand, for borrowers of the housing access program Minha Casa Minha Vida,²² track one of which is 90 percent financed by public funds,²³ it was necessary to pass a specific law to suspend these installments, not least because in December 2020 defaults of more than 360 days had already reached 33.2 percent of contracts. The bill (795/2020) passed the Chamber of Deputies, but is still being processed in the Senate. In the meantime, the percentage of defaulters over a year in arrears reached a record high in December 2022: 45 percent of borrowers in Band 1 of the program.²⁴

   Individual debts were handled on a case-by-case basis—meaning that they may not have been fully favorable to the debtor—leading to a reduction in the principal and interest rate. It is estimated that, during the Covid crisis, in a context of extremely high unemployment and rising levels of severe food insecurity, the option left to the population with “survival debts” was to ensure their ability to remain in debt in order to meet their most immediate needs.²⁵ This indicates that “financial inclusion” has become the unavoidable material basis of social inclusion for a large number of households, even in the face of high financial vulnerability.

   Debt renegotiation reappeared in 2023, but this time as federal public policy. Designed by the Ministry of Finance, Desenrola was marketed as one of the founding milestones of the Lula 3 administration.

   Is Desenrola an ad hoc rehash of a successful one-off initiative implemented by banks during Covid-19, now with the participation of the state? Or is it meant to regulate the credit market in order to support a new cycle of financial expansion, and by so doing transform debt management into a full-fledged social policy?

   A focus on defaults over debts

   Victorious in the 2022 federal elections, the Workers Party brought forward the Desenrola Brasil bill in June 2023, which was voted into law in September with a large majority. The bill’s main objective is to open a channel for debt renegotiation between defaulters and institutional creditors (banks, financial institutions, and public service providers) under the tutelage of the state, in the form of guarantees.

   Initially, the government planned to help up to 32 million people,²⁶ restricting itself to those registered with credit bureaus who had defaulted on debts issued between 2019 and 2022. Given the very heterogeneous profile of debtors and defaulters, the program is structured into two bands. Band 1 targets 21 million defaulters with  incomes not exceeding two times the minimum monthly salary, equivalent to R$2,824 (US$656)—encompassing the majority of borrowers (66 percent). Band 2, on the other hand, includes those with monthly earnings of above two times the minimum wage all the way up to incomes of R$20,000 (US$4,036), which corresponds to a potential universe of eleven million defaulters. 

   The legal framework means that, in Band 1, the state assumes a significant portion of risk: in the event of a repeat default, it guarantees the bank’s payment of the principal (stipulated after the debt has been renegotiated), adjusted by the Selic rate. For Band 2, the risk is entirely borne by the financial institutions. In contrast to Band 1, the incentive to renegotiate Band 2 is purely regulatory in nature: renegotiated debts generate “presumed credit,” reducing banks’ minimum capital requirements and providing greater liquidity. The renegotiation of Band 2 began in July 2023. Band 1 began to be serviced in September 2023.

   In Band 1, renegotiation takes place through the Desenrola Brasil digital platform, accessed through a government portal. This platform was developed by the company PdTec with the aim of consolidating debts and strengthening the relationship between creditors and debtors. This company has know-how in the area of digital collections, working to recover defaulted debts through electronic summons. On the platform, creditor firms take part in an auction, offering discounts on the value of debts, which are defined by the creditors on a case-by-case basis. The liability for defaulted debts was initially estimated at R$150 billion (US$30 billion). According to the Ministry of Finance, the auctions organized by the creditors ended up facilitating the significant discount of R$126 billion (US$25.2 billion), reducing the defaulted debt to be renegotiated to just R$24 billion (approximately US$5 billion). The average discount was expected to be 60 percent, but ended up at 83 percent.

   The program covers debts from consigned and nonconsigned loans, as well as nonbank debts. Debts secured by real guarantees or linked to rural credit, real estate financing, and operations involving third-party risk, are not eligible for renegotiation. In short, the program prioritizes consumer credit.

   In Band 1, the state grants a guarantee exclusively to debts that do not exceed the R$5,000 (US$1,000) mark, in aggregate totaling around R$13 billion (US$2.6 billion). It’s expected that the main debts renegotiated will be those related to consumer bills, such as water, electricity, telephone, retail, and bank obligations. The rules offer the option of paying in cash or through bank financing, without the need for a down payment. Interest for Band 1 is a maximum of 1.99 percent per month, equivalent to an annual rate of 26.68 percent per year, with the first installment due after a maximum of sixty days. The minimum payment installment will be R$50 (US$10) and the payment term is between two and sixty months, with decreasing installments. In real terms, the ceiling for charging interest is high, which makes the renegotiated debt more expensive, since the IPCA stood at 4.68 percent in 2023. In 2024, inflation is expected to be even lower, at 3.25 percent.

   The guarantee offered by the National Treasury comes from the Operations Guarantee Fund (FGO), a program originally launched in 2009, in the context of the Great Financial Crisis. In terms of the legal framework, therefore, the Desenrola Brasil FGO is nothing new, but it extends the existing framework from legal entities to individuals. The government initially made R$87.5 billion (US$17.50 billion) available to the National Treasury to make up the FGO for Band 1.

   For debts addressed under Band 2, each financial institution has the autonomy to renegotiate through its own channels or together with its partners, in an approach similar to that adopted during the Covid-19 crisis. In order to participate in the program, individuals with debts that can be renegotiated under Band 2 must  go directly to their creditor institution.

   Unlike Band 1, Band 2 does not have a FGO or a digital platform, and the discounted debt is to be paid in cash. But given slow growth in demand, the government decided to review the rules for Track 2 and permit defaulted debt to be paid in installments. Regulatory incentives are offered to encourage financial institutions to increase the supply of credit for the program, while the incentive for the bank is that the value of the renegotiated debts generates “presumed credit.” As Minister Fernando Haddad explained: “If the discount for the person is R$7,000 (US$1,400), the [presumed] credit for the bank will be R$7,000 (US$1,400).”²⁷ Therefore, when renegotiating debts, banks have a “presumed credit,” freeing up liquidity for investment.

   To summarize the main differences between the structure and state backing of the two bands: in Band 1, there is fiscal support, namely the Operations Guarantee Fund (FGO), whose principal is covered by the Treasury and adjusted by the Selic rate in the event of default on the initial debt renegotiated; Band 2, meanwhile, encourages renegotiations via an accounting incentive, whereby banks gain presumed credit in equal value to the renegotiated debts.

   With Desenrola underway, the federal government decided to extend its scope of action. Its target audience now includes MEIs (individual micro-entrepreneurs) as well as FIES-funded students in default, covering loans that were taken on up to 2017 and which were in default in June 2023—comprising about 1.2 million students. The channels for renegotiation are Banco do Brasil, Caixa Econômica, and the Ministry of Education (MEC), indicating that it is exclusively up to the government—the creditor of the student loan—to define the renegotiation rules, without requiring the participation of private institutions. Three different debt refinancing profiles were created, which can be paid in installments (from fifteen to 150 months), with different percentages of principal discount (ranging from 77 to 99 percent) or charges (100 percent). The path to refinancing depends on the condition of the debtor, whether they are registered with CadÚnico and/or a former Emergency Aid beneficiary, as well as their accumulated time in arrears.²⁸

   Unraveling knots

   At the end of 2023, the Ministry of Finance acknowledged that the targets achieved by the program had fallen short of what had been planned. While about eleven million people across both bands had benefited (against estimates of more than thirty-two million potential debtors), only 1 million people (5 percent of the target audience) in Band 1 were able to renegotiate and pay off their debts, which collectively amounted to R$5 billion (US$1 billion). Under Band 2, 2.7 million people paid off debts of R$24 billion (US$4.8 billion) through direct negotiations with financial institutions. By the end of 2023, R$29 billion (almost US$6 billion) had been renegotiated. The same occurred with Desenrola FIES, with only 14 percent of defaulting students having renegotiated their debts by the end of December 2023.²⁹

   But the seven million people who were taken out of the default list via Desenrola were registered as defaulters with debts of less than R$100 (US$20). Forgiveness for these small sums was off the table—debt is to be paid, whatever the amount and whatever the conditions that led to it. By way of illustration, it is worth pointing out that the renegotiation of the individual debt of R$100 (US$20) of seven million defaulters, if maintained in full without discount, would correspond to a maximum of R$700 million (US$140 million), which represents just 0.2 percent of the total credit revenue obtained by banks in 2022, according to data recorded by the Central Bank.

   With the program still under development and subject to adjustments, and which has already been extended twice, a full accounting of its impact would be premature. But some crucial elements can still be assessed—starting with the justifications for a federal government program to reduce defaults.

   The resumption of growth is a primary objective of the third Lula administration, and credit to families appears to be a crucial strategy in pursuit of that goal given the existing policy framework. In 2023, Congress approved the New Fiscal Framework (NAF), which consists of new rules for public spending. In short, primary public spending (excluding interest payments) can only grow up to 70 percent of the previous year’s tax revenue. If this growth reaches above 3.57 percent per annum, an additional clamp is imposed on public spending, limited to an annual real increase of no more than 2.5 percent. Health, education, and social security spending are exempt, in compliance with the Constitution, but other social spending will likely be heavily repressed to meet the requirements of the NAF.³⁰ As Pedro Bastos has pointed out, if this rule is not complied with, “the punishment is for spending to grow the following year at a rate 50 percent lower than the rate of revenue growth.”³¹ Within this framework of fiscal austerity, in which the lever of growth can only be wielded by private capital, maintaining demand becomes even more heavily dependent on household consumption financed by credit.

   The other flagship policy of the administration is the New Industry Brazil (NIB), a policy launched in January 2024 to reverse the process of reprimarization of the economy by fostering a cycle of reindustrialization. It will take time for the resulting productivity gains and raised wages to appear. In the meantime, massive household indebtedness will compensate for the absence of public investment, fulfill the expected transition to a virtuous cycle of growth with rising real wages, and, by expanding the credit market, boost the optimism of private investors.

   Therefore, cleaning up a situation of extremely high default rates is a task for yesterday. Not least because, if, as the Finance Minister says, the resumption of growth will be based on public-private partnerships (PPPs), we need to reduce the risk that household defaults may jeopardize the prevailing development financing model. Reducing defaults without tackling indebtedness in some way reflects a de-risking strategy, insofar as it ensures that, via loans, families are able to pay for the services charged by private investors in the event that family income does not cover all needs. These are mostly institutional investors, operating in the area of social and urban infrastructure, notably health, energy and sanitation. In these sectors, the price of consumer tariffs tends to increase in real terms to ensure a good return on investment.

   But the causes of default remain unaddressed. Desenrola has failed to offer mechanisms to protect families from chronic indebtedness, which today amounts to approximately R$3.5 trillion (US$670 billion or 32 percent of GDP). While the sum may seem low in comparative terms, it is worth noting this is debt taken on for short-term consumer needs—to finance basic social reproduction.

   It’s worth remembering that, in 2021, following strong mobilization by consumer protection bodies, a law was passed to establish an extrajudicial legal framework for renegotiating debts. It covers the same debt profile covered by Desenrola—debts related to consumption or linked to financial institutions—but its target audience is over-indebted people, regardless of whether they are in default. Eligibility is extended to anyone in good faith who has accumulated what debts are necessary to meet their basic needs and does not have enough income to pay them off without compromising what the program calls an “existential minimum.” The minimum acts as a safeguard, stipulating that the monthly payment of debts cannot compromise more than 35 percent of the over-indebted person’s income. The law also includes criteria that financial institutions must observe, such as preventing abusive practices when granting credit and collecting debts that could threaten vulnerable social groups.

   The Over-indebtedness Law was not enough to reverse, over two years, the spread of overindebtedness. But the federal government scored a goal by inserting into the Desenrola law a cap on the repayment of credit card debts. Under the law, accumulated interest cannot exceed the principal, putting an end to outrageous percentages that reached interest rates above 430 percent per annum at the end of 2023. This is an important step, even as it exemplifies the same logic that has stimulated family indebtedness as a driver for rentierism, as removing the threat of default is essential to the stability of the financial system.

   The idea of making the Desenrola program permanent, as has been announced, offering a legal framework for renegotiating defaulted debts for low-income families, suggests that FIES Desenrola may also be here to stay, considering that a new expansion of FIES to finance access to private and paid university education is already on the table of the Minister of Education. The Minister of Entrepreneurship, Micro-enterprise and Small Business, would also like a Desenrola to call his own. In whatever new forms it takes, this program represents the adoption of an unprecedented institutional and legal framework for debt management via public policy, rearticulating the relationship between the government and financial institutions, while placing family debt at the center of current attempts to restructure the Brazilian economy.

   The government has renewed the program, from December 2023, to March and now May 2024, for those covered by Band 1. Similarly, in order to reach more debtors who have not rushed to make use of the program, the government made access to its digital platform more flexible through partnerships with the post office, additional financial institutions, and companies like Serasa—a private consultancy, credit granting, and debt recovery firm which has built a national reach by lending at exorbitant rates to those excluded from formal credit. With these expansions, coverage has improved, but barely hit 50 percent of the target population. According to the most recent figures from the Ministry of Finance on the program, up to mid-March of this year, about 14 million people across both Bands 1 and 2 have renegotiated R$ 50 billion in debt. It remains to be explained why this ambitious, highly-publicized program has failed to attract the poor, defaulting population it was designed for, and who seem indifferent to their debts.

   In this way, the government’s claim that Desenrola would reconfigure the frameworks of social policy by easing the burdens of defaulters loses its strength. What was the amount previously paid as debt service before the default, and what criteria did the financial sector adopt for discounts and auctions? How did the government act so that, in addition to defaulters, highly indebted Brazilian families could escape the spiral of persistent debt refinancing in order to survive? In place of answers to these fundamental questions, there seems to be a functional strategy that supports mass consumption via indebtedness for the purposes of rentier accumulation. The novelty lies in the fact that the state is taking on debt management as a way of confronting the contradictions that rentier accumulation itself engenders—thereby turning debt management into a novel dimension of social policy. 

   Financialization in Brazil is advancing by searching for profitability in the public debt securities market and in the credit market, depending on what is most lucrative. This status quo has a new partner in Desenrola Brasil. In twenty years, Brazil has gone from a society without much credit to a nation where debt rollover is part of the struggle for survival—a trend that, by the looks of things, is here to stay.

   This article was translated from Portuguese by André Lucena.

2. The Origins of Conditionality

   April 18, 2024 6:07 am Comments Off on The Origins of Conditionality

   Contemporary debates around the governance of the global economy often center on the role of the International Monetary Fund (IMF), arguably the most powerful international organization that—among other responsibilities—provides loans to countries in economic crisis. The most recent iteration of these debates took place in Marrakesh in October 2023, where IMF member-states agreed on increases to its lending capacity, while preserving the current allocation of votes, which overwhelmingly favors large Northern economies. This perpetuated the widespread perception that the IMF is the enforcer of creditor countries, a concern bound to reemerge at the IMF and World Bank Spring Meetings, taking place this week in Washington, DC. While the IMF’s loans carry low interest rates, their true cost for debtor countries is the obligation to implement far-ranging economic reforms. 

   IMF loans were not always tied to such obligations. The IMF was established at the Bretton Woods Conference in 1944 to regulate the international financial system. Its key responsibilities were twofold: the now defunct role of overseeing a system of pegged exchange rates, and a role as the world’s lender of last resort to countries that have trouble financing necessary imports or servicing their external debt. Initially, the IMF provided loans without any conditions attached—consistent with the view of John Maynard Keynes, representing the British government at Bretton Woods. By contrast, its other chief architect, Harry Dexter White of the US Treasury, was ultimately successful in his push to mandate the implementation of policy reforms in return for financial assistance, a practice known as conditionality. 

   But why rely on conditionality in the first place? There are two main rationales: first, to purportedly ensure that funds are actually repaid to the IMF, and second, to avert “moral hazard,” the risk that countries continue to adopt unsustainable policies if they can always anticipate yet another IMF bailout with limited strings attached. The former concern is overblown: countries rarely ever don’t repay the IMF, and the few failures of repayment are generally temporary in nature. The second argument neglects the fact that many countries fall into economic crisis because of external shocks over which they have little control. The Covid-19 pandemic was case in point, as increased government spending to fund the recovery left many countries with unsustainable debt repayments.

   The introduction of conditionality was a controversial move. Britain advocated a lenient approach where loans would just need to be paid back at a relatively low interest rate, whereas the United States pushed for expansive conditionality. The Bretton Woods approach to placating these positions was for the final agreement to be vague on the specifics of conditionality, an issue to be worked out at a bureaucratic-technical level once the IMF was already established. Thus, the precise terms and conditions of the IMF’s loans were left to be worked out in its initial loans, and then remained remarkably consistent up until the 1970s. 

   In these early years of the IMF’s operations, its staff demanded that borrowing countries met a set of aggregate economic targets, like reaching budget balance, increasing international reserves, limiting domestic credit expansion, or eliminating exchange restrictions. All were intrusive measures that borrowers often objected to, but they were limited and predictable, as well as temporary and reversible. A government might have balked at reducing civil servant wages, implementing a hiring freeze or reducing public investment, but it was free to increase spending in the future, when it was no longer under IMF tutelage and when economic conditions were more amenable.

   In the 1980s, however, the nature of conditionality dramatically changed. As the 1982 debt crisis engulfed the developing world, the IMF—at US initiative and insistence—began to change the ways in which it provided support to borrowers. In line with the neoliberal Zeitgeist in ascendance at the time, government intervention was seen as a key determinant of economic problems, and expanding the remit of markets was the prescribed solution. The ensuing set of reforms became known as “structural adjustment” policies, and they are often very difficult to reverse—this is indeed part of their appeal to the IMF. For example, once a natural resource is privatized, re-nationalizing it is extremely challenging. Structural adjustment policies remain the cornerstone of IMF lending today. 

   How IMF conditionality has shaped the world we live in

   Conditionality matters. For borrowers, the implications are direct and obvious. The arrival of IMF staff to a country’s capital to “negotiate” a loan marks the beginning of a usually long period of political and social turmoil, as the IMF team examines the nature of economic problems and puts forth a range of reforms to address them. These reforms seek to fundamentally alter key parameters of the borrower’s economy, like the role of the state, the remit of markets, and the degree of international integration. 

   A closer look at the IMF’s application of conditionality reveals the scale of the organization’s engagement in the reshaping of domestic political economies. Figure 1 presents a world map showing the total number of conditions applicable in all IMF loans between 1980 and 2019. The countries shaded black have the highest number of conditions over the period, where the total number of conditions is greater than 1050. The countries shaded in light grey have the lowest conditions, at 350 or less. Countries without any shading had no conditions at all during the period. Armenia, Kyrgyzstan, Malawi, Pakistan, Romania, and several West African countries emerge as countries with highest overall conditionality burdens: all have received repeat loans that carried a high degree of conditionality. 

   Figure 1: Total IMF conditions, 1980–2019

   

   Countries have clearly had diverging experiences with IMF conditionality. For example, Mauritania had IMF programs active for thirty of the forty years covered, carrying a total of 1,175 conditions. Other countries had only brief encounters with the Fund, reflected in relatively limited conditionality. For instance, South Africa only had a one-year loan carrying eleven conditions between 1982 and 1983. Lithuania, with 417 conditions, held the median number of conditions for IMF borrowers. Most high-income nations did not have any conditions during the period covered because they did not borrow from the IMF, although Cyprus, Greece, Iceland, Ireland, and Portugal are notable exceptions.

   Of course, even though suggestive, there are limits to such aggregate condition counts. Not all IMF conditions are the same, and common criticisms that the IMF advocates for “one size fits all” policies are often exaggerated. Each IMF program is different in the precise mix of policies it seeks to reform, and this differentially impacts borrowers. The program typically contains a highly formulaic conditionality element that applies to all borrowers (for example, the commitment to not incur new debts), as well as a tailor-made element comprising structural reforms across a range of policy areas. 

   Three types of reform merit specific attention. First, privatization measures directly target state involvement in the economy. The targets of these policies are commonly state-owned enterprises, which have been set up by many countries to create or nurture markets, often meant to ensure that the exploitation of natural resources yields public, rather than private, profits. Similar to their private counterparts, these enterprises are often mismanaged or stay uncompetitive. However, while badly-run private sector firms can go out of business, state-owned enterprises continue to be subsidized by the public budget and accrue major losses. The IMF’s standard response has been to advocate for their privatization, which can yield some income for a cash-strapped state but takes areas of economic activity out of public hands. Investors buy these state-owned enterprises at a low cost, as the economic downturn suppresses their valuation and currency devaluations make them more attractive to holders of foreign currency. Often, these investors are foreign multinational companies, who are then protected by international trade law and other legal arrangements from possible future policy reversals. 

   Second, economic deregulation allows market forces to operate with fewer regulatory requirements set by state bodies. Its proponents argue that the market, rather than the public sector, is best equipped to allocate resources efficiently. Yet, economic deregulation typically favors the interests of large corporations—for example, through changes in the tax code—while neglecting the needs of small-scale companies and the labor force. Indeed, deregulation of labor markets has been a staple IMF policy. Such reforms affect both public and private sector employees: the former commonly see their numbers reduced, their salaries frozen, and any new hiring suspended; and the latter witness the dismantling of collective bargaining arrangements, along with the overall flexibilization of employment conditions, including on hiring and firing and dismissal compensation.

   Finally, trade liberalization measures entail reductions in tariffs and nontariff barriers to trade in order to facilitate integration into the global economy. Although such measures can stimulate economic growth, gains from trade liberalization are typically distributed unevenly to highly specialized labor rather than to poor households. These measures can also expose domestic industries to international competition before they are able to compete, essentially preventing global South firms from receiving the kind of state support that nurtured global North industries at earlier stages of their development process. 

   The IMF’s conditions aspire to no less than fundamental overhauls of countries’ political-economic arrangements, creating domestic winners and losers in the process. Once in place, these reforms create self-reinforcing dynamics, as policy areas that are marketized are difficult to re-regulate and increased international economic integration is difficult to reverse. 

   But IMF borrowers are not the only ones affected by conditionality—countries in the global North are indirectly impacted as well. IMF calls for deregulated labor markets, low taxation, and increased economic openness in a developing country grant firms in the North new opportunities to take their production offshore, thus cutting jobs and investment in their country of origin. Economic liberalization and deregulation in the global South have follow-on effects for the global North; consequences which have contributed to the current wave of skepticism vis-à-vis globalization. 

   Conditionality in the present

   The IMF has taken center-stage in dealing with fiscal and debt pressures since the onset of the Covid-19 pandemic. Excluding emergency pandemic-era loans, forty-seven countries have turned to the IMF for conditionality-carrying loans since 2020. The majority of these loans are for three- or four-year lending programs that stipulate extensive policy reforms. Not only does this include some of the world’s poorest countries like Afghanistan, Chad, and the Democratic Republic of Congo, but also middle-income countries like Argentina, Egypt, and Seychelles. 

   The comparative experience with these loans suggests that austerity is on the rise. Uganda provides a case-in-point, entering a three-year IMF program in June 2021 to support the response to the Covid-19 crisis and improve debt sustainability. The IMF called for a steep decline in the primary budget deficit: from 7.1 percent of GDP in the 2020–21 fiscal year to 3.4 percent of GDP for 2021–22, with further reductions scheduled in subsequent years. These objectives were underpinned by quarterly performance criteria on the primary budget balance of the central government and a structural condition requiring the Ministry of Finance and Uganda Revenue Authority Commissioner to adopt a revenue strategy implementation plan. These cuts disproportionately hurt poorer households and undermined the ability of Uganda to invest in its climate adaptation and mitigation strategies.

   In Bangladesh, the IMF called for a decline in the primary budget deficit from 3.8 percent of GDP in 2023–24 to 3.3 percent of GDP by the end of the three-year program, to be achieved through energy subsidy reductions. While the IMF claimed that subsidies would be phased out in a way that protects the poor by sustaining public investment spending and supporting poverty reduction, it offered no specifics for how this would be achieved, prompting scrutiny from civil society groups. Indeed, the IMF has a track record of not coupling the elimination of energy subsidies with sufficient energy access or other forms of social protection for those most affected by them, as shown by recent protests in Pakistan and Sri Lanka. 

   The IMF claims it now cares about the negative consequences of austerity, often citing how social spending is protected from cuts through conditions that stipulate spending floors. Yet, an Oxfam analysis of seventeen recent IMF programs found that for every $1 the IMF encouraged these countries to spend on social protection, it told them to cut $4 through austerity measures. The analysis concluded that social spending floors were deeply inadequate, inconsistent, opaque, and ultimately failing.

   Is there a better way?

   IMF lending programs and their associated conditionality are intrusive and cumbersome, and countries tend to avoid them for as long as they can. In some cases, countries build up foreign reserves to support their currencies in case an economic crisis arises. This is a helpful tactic, but it cordons off funds that could be used in more productive ways, thereby limiting governments’ fiscal space. Or, deterred by strict conditionality, countries avoid requesting IMF assistance until the very last moment, when a crisis might have intensified, necessitating greater degrees of economic consolidation. 

   Reforming the IMF’s lending practices so that they deliver more effective and timely advice is necessary for the organization to live up to its promise. With this in mind, at the top of the agenda—especially during this year’s Spring Meetings—is the need for the aims and ambitions of conditionality to be revisited, not just in terms of reducing the number and scope of conditions included in a program, but also challenging the underlying logic of austerity. The austerity agenda is, at its core, only a short-term and short-sighted solution to fiscal problems. It frees up resources for governments to repay debt, but damages people’s lives and livelihoods in the process. In the longer term, austerity is neither socially nor economically sustainable, as meeting pressing challenges— like climate change and rampant inequalities—will require public investment. 

   A common talking point of the IMF is that sound public finances are a necessary condition for development. We do not disagree with this logic, but we argue that it is not a sufficient condition for sustainable development. Without social protection policies to maintain livelihoods and stimulate economic demand, public finances will ultimately suffer and development will falter. In other words, austerity is self-defeating and profoundly costly in social terms. It cannot remain the primary policy response to instability and crisis.

   This piece draws on Alexandros Kentikelenis and Thomas Stubbs’s recent book, A Thousand Cuts: Social Protection in the Age of Austerity (available from Oxford University Press).

3. New World Order?

   April 17, 2024 8:52 pm Comments Off on New World Order?

   

   We live in a dysfunctional system in which money flows out of the countries that need it most and into the coffers of the wealthiest. In 2023, the private sector collected $68 billion more in interest and principal repayments than it lent to the developing world. International financial institutions and assistance agencies extracted another $40 billion, while net concessional assistance from international financial institutions was only $2 billion—even as famine spread. The result is that as developing economies make exorbitant interest payments to their creditors, they are forced to cut spending on health, education, and infrastructure at home. Half of the world’s poorest countries are now poorer than they were before the pandemic. 

   At The Polycrisis we have been tracking the whipsaw of the global financial system amid private finance mantras, interest-rate hikes at the Fed, and the explosion of debt in the global South. In our dispatches on IMF meetings, the Paris conference on debt and climate, the BRICS summit, Barbados, Brussels, Ukraine, and Pakistan, we have sought to throw light on the political economy of financial distress. Who is in need? What do they get from whom, and under what conditions?

   The polycentric financial “order”

   The World Bank boosted its lending in the wake of the Covid pandemic, but is still well short of meeting the financing needs of developing countries. At the Spring meetings of the IMF and World Bank this week, the question of who adds capital for development, climate resilience, and the energy transition is high on the agenda. 

   Long-term finance is one thing, but in a crisis, it’s liquidity that counts most—and it can be key to warding off the kind of panic that drives investment away.  

   In all this, the dollar remains king. Want to make payments? Send an invoice? Store your wealth? Borrow across borders? Chatter about any replacement of the dollar as the dominant reserve currency is overblown. No other contender is willing to run the current-account deficit necessary to be a global reserve issuer. And when a storm arrives, liquidity flows to those with “safe assets” closest to the imperial core, while the burden of “structural adjustment” falls on the poorest and weakest shoulders in each society. 

   But even so, with US spending stymied by domestic politics, a new set of global players is fronting the cash for states in need of liquidity. Something resembling a polycentric financial patchwork has slowly emerged. We track that emergence here by focusing on the providers of liquidity, the so-called “global financial safety net.” 

   The global financial safety net is a bricolage, not a formal framework. It consists of central bank swap lines, IMF lines of credit, and regional financing arrangements (RFAs) whereby a group of countries pool their reserves. The fourth component is countries’ own international domestic reserves—sovereign holdings denominated in foreign currency.

   Swaps

   In a crisis, the Fed effectively becomes the world’s central bank and is the “lender of last resort” for those countries fortunate enough to be in the inner circle, documents Aditi Sahasrabuddhe. First in line sits the “gang of five,” made up of the European Central Bank, the Bank of England, the Bank of Canada, the Bank of Japan, and the Swiss National Bank. In this top tier, dollar liquidity is provided in exchange for a central bank’s respective currency—it is unconditional, unlimited, fast, and accessible daily. Next in line, nine countries constitute the second tier; Australia, New Zealand, Singapore, Denmark, Norway, Sweden, Mexico, South Korea, and Brazil—their access to liquidity is unconditional but limited in quantity. For the rest, terms and conditions apply.

   

   Interest rate decisions made by the five central banks in the top tier create shockwaves for countries lower down. After 2021, rising interest rates attracted foreign and domestic capital toward the top. Lower-tier economies were hit by currency depreciation, surging dollar outflows to import costly commodities (thus fueling their inflation), and soaring borrowing costs. The IMF estimates that capital outflows from emerging markets exceeded $300 billion between late 2021 and July 2022 when the Fed began its current hiking cycle. 

   Currencies of G20 countries, not just the G77, were sold off and weakened against the dollar in 2021–2023. Even top-tier countries such as Japan are now upset about the strong dollar and are remonstrating at the G20. As John Connally, the US Treasury secretary under Nixon, famously said in 1971: “The dollar is our currency, but it’s your problem.”

   The IMF

   As Herman Mark Schwartz’s schema (above) indicates, for all the countries in the periphery of US dollar swaps, the standard pathway for liquidity is the IMF. By some measures the Fund has stepped up since Covid: its lending is at an all time high of $151 billion (denominated in Special Drawing Rights), although that remains a fraction of its total lending power of a trillion dollars. 

   Its outstanding loans tell a geoeconomic story. The African countries most in need are far down the list. Much of the IMF’s liquidity flows to the countries at the faultlines of the new cold war. Argentina, by far the IMF’s largest borrower, single-handedly holds 30 percent of the IMF’s credit, dwarfing IMF lending to all sub-Saharan countries combined. The second largest borrower, Egypt, got a fresh tranche of $5 billion in March to help Sisi’s regime deal with the blowback from Russia’s and Israel’s wars. Then there is the $15.6 billion lent to Ukraine—the IMF’s seventh largest program in its history. Because of its extremely high rate of borrowing, Ukraine is now facing various surcharges on top of its 3.5 percent interest rate, and the Economist estimates that, all told, its rates could total as much as 8 percent once the war is done—another impending disaster awaiting the country. If this weren’t bad enough, the IMF also wants Ukraine to introduce fiscal reforms—a rather difficult order as Russian bombs continue to fall.

   

   The IMF’s practice of requiring governments to introduce harsh austerity measures in exchange for liquidity have driven many countries to try and shield themselves from needing to engage with the Fund at all.

   Self-insuring

   The biggest part of the aggregate safety net remains self-insurance—that fourth category of hard currency FX reserves accumulated by individual countries. Some emerging-market countries have built up their own rainy day funds of safe assets issued by the “gang of five” since the 1990s. Korea, India, Indonesia, and other Asian countries that suffered in the region’s financial crisis reorganized their growth models to boost export revenues, aiming to protect their sovereignty against IMF prescriptions.​​ Moreover, they began to borrow in their local currencies and increased domestic food and energy production, hoarding their scarce dollars to avoid a balance of payments crisis.

   

   
   This self-insurance of international reserves, however, remains very unevenly distributed. Of the $14 trillion in international reserves, IMF chief Kristalina Georgieva said last year that more than $10 trillion was held by advanced and “strong emerging market economies.” She added: “the rest of the world relies on pooled resources of international institutions such as the IMF.”

   Alternatives

   In their own geoeconomic sphere, the Gulf kingdoms have established themselves as lenders of last resort. Camile Lons and Hasan Alhasan at the International Institute for Strategic Studies examined Gulf bailouts to twenty-two African and Asian countries and concluded that they were “unmatched in scale by traditional Western and multilateral donors.” Over the last sixty years, Saudi Arabia, the UAE, Qatar, and Kuwait have disbursed an estimated $363 billion to countries, most of which are in the Middle East North Africa region. The largest recipients were Egypt, Iraq, Pakistan, and Jordan, with bailout packages kicking into overdrive after the Arab Spring threatened the Gulf Kingdom’s allies, and again when distress in the region grew after Russia’s invasion of Ukraine. In contrast, the IMF has, over the same period, given out $162 billion (in constant 2020 USD) in loans to those same countries. 

   

   The IMF’s recent bailout package for Egypt was done in coordination with the UAE, which pumped in a record $35 billion into the cash-strapped country, including prime real estate purchases on the Mediterranean as Sisi sells off his country’s crown jewels. 

   Much has been made of China’s lending for infrastructure projects over the past fifteen years. Chinese lending for Belt and Road projects is often construed as a novel form of “debt trap diplomacy,” but it more closely resembles familiar and ill-conceived foreign investment fads that other wealthy countries have undertaken before them. 

   In lockstep with infrastructure and trade, China’s liquidity provision—PBOC currency swap lines and emergency loans by Chinese state banks to countries in the Belt and Road Initiative—has surged in the last decade.

   

   A report by AidData sought to quantify and categorize China’s various “lender of last resort” provisions to other countries (although data availability was an issue). The authors warned that China’s becoming a major liquidity provider could lead to a less transparent global financial architecture. But looking at the present global financial safety net suggests coherence has long been in short supply. 

   Argentina has been making use of Chinese swap lines for years. It first formalized a swap line with the People’s Bank of China in 2009, and since then the arrangement has evolved and expanded, as detailed by Vincient Arnold. The Argentine Central bank has drawn on the facility to buy dollars, to buy imports and protect its scarce dollars, and most recently, to directly repay IMF debts. 

   Countries less entangled with the IMF than Argentina also strike swap deals with China. In her paper “It Takes Two to Swap,” Aditi Sahasrabuddhe looked at the political and economic motivations of over 40 countries that signed swap lines with China. She found that for countries that did not have active loans with the IMF, the bilateral swaps with China functioned as a substitute for going to the IMF—a very useful service indeed.

   There are even more direct routes to the dollar hierarchy for powerful middle-income countries: India has avoided IMF programs for more than 30 years and hasn’t received Fed swap lines, but as of 2019, it can go to the Bank of Japan for swaps denominated in US dollars.

   Regional alliances

   Several formal alliances have been created out of dissatisfaction with the IMF, including the Arab Monetary Fund, the Chiang Mai Initiative by ASEAN countries and China, Japan and Korea, the Eurasian Fund for Stabilization and Development, the European Stability Mechanism, the Latin American Reserve Fund, and the BRICS contingent reserves. Some of these RFAs are “aspirational as opposed to operational.” Despite a lending capacity almost as large as the IMF, they have only disbursed about $1.5bn in loans in the first ten months of the Covid crisis and activated $550m worth of currency swaps. The IMF provided $88bn in the same period. Most RFAs were created in the aftermath of regional crises: the ESM after the 2010s European crisis, and ASEAN’s Chiang Mai Initiative after the 1998 Asian financial crisis. 

   Conspicuously absent from most of these arrangements, whether formal or informal, are Sub-Saharan African countries. Lacking reserves earned through exports, they are largely subject to the IMF’s tender mercies. They are considered not strategically important enough to warrant special measures from larger countries higher up the currency hierarchy. Nor do they trade enough with each other or have enough regional wealth to form an RFA—although new ideas are being proposed (Ghana proposed that countries keep 30 percent of their reserves in African currencies; a facility to improve the liquidity and attractiveness of African eurobonds has launched, but without the G20 support that was originally envisaged). Without powerful friends, financial engineering alone is inadequate.

   Polycentrism?

   World money has always been geopolitical, as political economist Mona Ali has argued. The global dollar system, headquartered in New York and London, is a “money-military matrix backed by legal armature.”

   Most of the non-US arrangements amount to workarounds that are still in service of dollar-based obligations; extending them a little further than US politics would allow for, and with a few less strings than the IMF might demand. The dollar system’s solidity is largely based on the preferences and needs of global elites. Flexing underneath and against that system is likely to continue to be of a limited and ad-hoc nature—more about shielding from disaster and protecting interests than about upending the financialized global dollar system.

4. The Electric Vehicle Developmental State

   April 11, 2024 2:39 pm Comments Off on The Electric Vehicle Developmental State

   In the late 1970s, Western markets were flooded with Japanese cars from then-unfamiliar brands like Toyota, Mazda, Datsun, and Honda. The combination of a high quality product, efficient fuel consumption, and a low price tag made these brands very popular in the US and Europe in the aftermath of the 1970s oil shock, resulting in a decline in market share for domestic manufacturers and complaints of unfair competition from entrepreneurs and trade unions.

   The “Japan Shock” soon engendered a protectionist policy response. The US and the UK negotiated voluntary import quotas with Japan to limit competitive pressure on their car industries, and European countries adopted similar measures. But this was only the first step in a deeper transformation of Western industry. Desperately seeking avenues to regain international competitiveness and quell heightening domestic labor unrest, companies in the global automotive sector and beyond began to emulate their Japanese rivals. The “Toyota method,” expounded by the company’s leading industrial engineer Taiichi Ohno, became a must-read for any serious industrial manager, while North Atlantic business schools started teaching Kaizen and Kanban methods of “just-in-time” production. This cultural shift, sometimes described as part of a broader process of “Japanization,” served to catalyze the embrace of what sociologists came to call post-Fordist management strategies, which focused on flexibility and cost-cutting while rejecting the vertically integrated production models of 1950s US and European auto leaders. 

   Nearly fifty years after the “Japan shock,” today’s global automotive industry confronts a far more systemic upheaval—what we could term the “Chinese electric vehicle (EV) shock.” Until recently, China’s automotive industry was dismissed as a low-quality copy of Western or Japanese models. However, it has since achieved impressive quality and price competitiveness in the strategic section of electric vehicles—in 2023, the Chinese giant BYD overtook Tesla as the largest producer of electric cars with 3 million New Energy Vehicles (NEVs).¹ That year, China’s export of NEVs grew by 64 percent. Together with good Internal Combustion Engine (ICE) sales and Russian demand induced by Western sanctions, China has already overcome Japan as the world’s largest auto exporter overall. 

   Figure 1: EV quarterly sales (2018–2023)

   

   How Western governments will respond to competition in an industry long considered the test of economic prowess is a question of central concern to the twenty-first century. In both the US and EU, the rise of Chinese EVs has been condemned as the result of unfair practices. Announcing a probe into Chinese EVs and state aid in September, Ursula Von der Leyen asserted that their competitiveness was a result of “market manipulation.” Joe Biden has similarly pledged to prevent Chinese EVS from “flood[ing] our market,” and Donald Trump described the impact of Chinese electric cars as an economic “bloodbath.” 

   Underlying these incendiary remarks, however, is an industrial transformation no less significant than that of Japanese automakers in the 1980s. The rise of the Chinese EV industry has been enabled not only by generous government subsidies but also by profound changes in strategy and organization, and in particular by a distinctive revival of vertical integration—at both individual firm and national levels. The approach is perfectly exemplified by BYD, which has sought to bring virtually all aspects of the value chain under its control: from battery technology—which was its initial core business—to microchips and even expanding to ownership of lithium mines and car carrier ships. Further, exploiting significantly lower labor costs in China compared to countries like Japan, Germany and the US, the firm has availed itself of a massive army of factory workers with a significantly more labor-intensive production process than its competitors. This neo-Fordist approach has allowed BYD to drive down costs while coordinating and accelerating the innovation of different key components during a pivotal phase in the industry’s evolution. Additionally, it has enabled the company to mitigate operational uncertainties and address shortages of various input factors and services, like the ongoing chip shortage since 2020.

   In parallel, the Chinese government has been pushing for vertical integration at the national level, ensuring that 80 percent of the EV value chain is contained within the country through the “Made in China 2025” plan, which has the aim of minimizing the effects of disruptions and setting the conditions to reinforce and maintain technological supremacy. While the model is likely to shift as labor relations evolve, this turn towards “re-integration” and “re-internalization” carries important lessons about the future of economic organization and industrial policy. 

   The electric vehicle revolution

   American management theorist Peter Drucker famously called the automotive industry the “industry of industries”—for over a century, car manufacturing has represented the ultimate test of industrial development due to the complexity of input factors, range of supplementary industries, and high capital and knowledge requirements. Cars depend on mining, chemical, steel, and electronics sectors, armies of technicians and production workers, and expensive machinery and plants. Car production has enormous barriers to entry and involves major entrepreneurial risks; this is why relatively few countries can claim membership in the exclusive club of auto-manufacturing. These challenges are even more pronounced with electric vehicles. 

   Like other green technologies, such as solar panels, electric vehicles are not entirely new. At the turn of the twentieth century, some of the first automobiles were powered by primordial lead-acid batteries; a third of the cars in 1900 New York were electric. But at the time, gasoline-powered vehicles outperformed electric ones due to their higher range and speed as well as their lower operating costs thanks to cheap and abundant oil. This balance has dramatically changed in recent years.  Besides boasting sportier performance (contrary to popular perceptions), EVs offer lower operating costs, lower maintenance and repair costs, greater convenience in daily use, and less noise. The savings in operating costs are particularly impressive, with recharging EVs projected to “reduce the energy costs of a vehicle by 50‒80 percent through 2030 relative to a comparable gasoline vehicle.” Of course, as technology and infrastructure develop, significant disadvantages remain in higher up-front costs, a limited range, long charging times, and, in many countries, the scarcity of recharging points. 

   Electric batteries are what economists specializing in innovation would describe as the “enabling technology” of EVs, but they are also their structural bottleneck. The lithium-ion battery (LIB) invented in 1991 offered a smaller and more capable substitute for its nickel-cadmium predecessor to power all sorts of battery-powered products that were previously unthinkable: from smartphones to tablets, robot vacuum cleaners, and the so-called “micro-mobility” of electric bikes and scooters. However, its application to automotives promises to have the most revolutionary consequences. Since the invention of LIB, their energy density has increased threefold while the cost per kilowatt-hour has dropped by more than 90 percent. Thus, the same technology that in the 1990s backed Nokia and Motorola phones can now power cars and even buses. Moreover, improvements via the lithium-iron-phosphate (LFP) variant, already used by BYD for its blade batteries, and a shift in LIB from liquid to solid electrolytes, could significantly increase capacity and provide faster charging.

   The centrality of battery technology to the EV sector also explains the importance attributed to the construction of so-called “giga factories”—enormous manufacturing plants that can produce batteries whose total storage is billions of watt-hours—and why access to lithium has now become so strategic. This alkaline metal is not scarce on the earth’s crust. However, only a few places around the world enjoy a degree of concentration sufficient to make the extraction of lithium economically viable, with Chile, Argentina, and Australia being the most endowed nations. To guarantee themselves security of supply, some EV companies are now entering the lithium mining business directly, either as shareholders or sole owners.

   The new Henry Ford

   The rise of the Chinese automotive industry has generated an estimated 140 different EV brands, but only a few of them are on the same order of magnitude as BYD, which in 2023 surpassed Tesla as the largest EV producer in the world. The firm was founded in Shenzhen in 1995 by Wang Chuanfu, an orphan from the poor rural region of Anhui who studied chemistry and material science. In many ways, the company’s operations closely resemble an electric revival of the Fordist logic of mass production, with a highly labor-intensive production process, a vast army of factory workers, and Taylorist methods of scientific organization of production. 

   Above all, BYD echoes the Fordist emphasis on vertical integration. Just as Ford acquired iron and coal mines to produce steel; rubber plantations in Brazil to produce tires (before the invention of vulcanization eliminated the need for natural rubber); white silica sand mines to churn out the car’s windscreens, windows, and mirrors; and even forests to build the car’s wooden parts, BYD has moved to control the production and assembly of battery cells; the manufacturing of the electric powertrain; the semiconductors and electronic modules; and now even the mining of lithium. It also builds its cars’ axles, transmission, cockpits, brakes, and suspensions “in-house.” And, just like the Fordist giant plants of Highland Park and River Rouge, BYD has built enormous industrial plants to produce batteries and other critical components, and for the assembly of cars. Four of them are located in BYD’s hometown, Shenzen, and twenty elsewhere around China, while several new plants are currently being built abroad, from Hungary to Brazil.   

   In the first part of twentieth century, vertical integration enabled Ford and other firms to reduce intermediation costs, control production, and coordinate innovation across different stages of manufacturing, from the procurement of rubber and steel to the standardization of parts and suppliers. High productivity and high wages in an oligopolistic market secured stable profits in an expansionary macroeconomic environment, i.e. the golden era of Fordism, between the end of World War II and the end of the 1960s. The oil crisis of the 1970s revealed the rigidity of this industrial model, as wage inflation and demand for more efficient vehicles made US automakers uncompetitive. Western industrialists then took inspiration from just-in-time flexible manufacturing achieved by Japanese firms like Toyota, which relied on a network of external suppliers and contingent labor to absorb market shocks, spinning off the production of components. Japanese car makers broke the assembly line into islands of production manned by quality teams, co-opting unions into corporate objectives. This business organization logic was conducive to a more efficient disciplining of the workforce and the disorganization of trade unions, whose bargaining power collapsed when they could no longer threaten work stoppages across stages of production.

   Outsourcing went hand in hand with offshoring much of the value chain to countries with lower wage costs. Economist Raphäel Chiappini argued, “Since the end of the 1980s, carmakers in Europe, Japan and the US, such as General Motors, Ford, Toyota, Honda, Volkswagen, Audi and Daimler Chrysler, have outsourced an increasing share of automotive production to emerging countries to benefit from lower production costs.” This has led to an “international division of labor” or, more negatively put, “international fragmentation,” namely a situation in which various countries specialize in distinct stages of the supply chain where they accrue a competitive advantage. While intending to improve quality and reduce costs, this shift has also made car manufacturers vulnerable to supply chain disruption, which is becoming a growing risk in these unstable times. 

   The return of vertical integration

   The weaknesses of global supply chains have become ever more apparent in the aftermath of the pandemic and within the context of heightened security competition. As a result, the language of “onshoring” and “in-house” has crept into policy debates. In this regard, BYD presents a fascinating example of the contemporary “re-internalization” of national production and its relationship to the broader drift of new industrial policies. The firm follows the typical structure of the vertically integrated conglomerate, with the central company (BYD Company) controlling various subsidiaries: BYD Auto, BYD Electronics, BYD Semiconductors, BYD Transit Solutions, and BYD FinDreams (the arm responsible for producing batteries and various car components). While vertical integration is common to other EV competitors such as Tesla, BYD has achieved a far greater degree of integration than Musk’s firm, which purchases around 90 percent of its batteries from firms such as Panasonic and CATL. 

   Battery production was BYD’s original core activity, ensuring high competency in the production of the most critical and potentially innovative component of EVs. Through its subsidiary BYD Semiconductors, the company also controls the production of microchips, which proved an important advantage during the post-2020 microchip shortage resulting from the trade war between China and the US. Chuanfu’s company also produces its own metal and plastic parts, has bought shares in China’s leading lithium miner Shengxin Lithium Group, and is shopping for mines in Brazil. BYD has thus achieved unparalleled control over its production cycle—according to the firm, only the tires and windows are entirely outsourced. A report by the New York Times highlighted that, in the manufacturing of the hatchback Sedan Seal, BYD produces internally a whopping three-quarters of all components—compared to just one-third for a comparable Volkswagen electric car, giving it a 35 percent cost lead. 

   BYD is also increasingly active in the “downstream” part of the car industry, namely sales and service. It has recently entered the shipping sector with BYD Explorer 1, a Ro-Ro vessel able to transport 5,000 cars, which is expected to be the first of an expanding fleet, guaranteeing BYD better control of the delivery of its products. Like the Fordist model, BYD’s vertically integrated strategy is labor intensive. The company’s employees have doubled in just two years, reaching 570,000 workers in 2023 (just under Volkswagen’s 670,000 and significantly above Toyota’s 370,000). Bucking the Japanese model of highly automated production involving expensive machinery, BYD has instead long relied on comparatively cheap manual workers performing a myriad of small tasks. Such lower “capital intensity” has thus far proven an excellent recipe for expanding revenues and profits—but this may change as labor costs rise due to competition between automotive companies.

   Figure 2: Total assets and the number of employees of major automakers (2023)

   

   Learning from China’s industrial policy

   BYD’s success, however, is the product of sustained industrial policy. Though its longstanding efforts to achieve “intensive development” in the automotive industry had repeatedly ended in disappointments, eventually, China has been able to exploit what Alexander Gerschenkron called the “advantage of backwardness.” Taking lessons from other East Asian countries like Japan and Korea, China has pursued developmental state policies to move from low-end to high-end manufacturing, with “green technologies” assigned particular importance. 

   New energy vehicles first earned a policy mention in the tenth Five Year Plan (2001–2005). However, it was only in the aftermath of the 2007–2008 financial crisis that they “were designated as a strategic emerging industry, along with solar and wind power.” An important turning point in industrial policy for EVs was the launch in 2015 of the “Made in China 2025” plan announced by Xi Jinping and Prime Minister Li Keqiang. The plan declared that “manufacturing is the core of the national economy, the root on which the country is established, the tool for national invigoration, and the foundation for a strong country.” EVs featured among ten key sectors seen as pivotal for the country’s future success, besides integrated circuits, aerospace equipment and new materials. Notably, the plan recommended that 80 percent of all necessary input factors for the EV industry be sourced in China to guarantee a high degree of “independence” in the production of EVs. This push for domestic sourcing enormously shaped the production strategies carried out by domestic firms.

   China now finds itself in a place of seemingly unassailable supremacy in this industry: 60 percent of all EVs produced in 2023 were made in China. Furthermore, Chinese firms have a formidable cost advantage over legacy competitors, estimated at around 25 percent for BYD, according to Swiss Bank UBS. Like all countries, China must import some raw materials, especially lithium carbonate from Chile and Argentina and cobalt from Congo. But it also controls key elements of the supply of critical materials: over half of the Lithium world production, over 60 percent of Cobalt production, and 70 percent of rare earth materials. Furthermore, the Chinese industry accounts for over 70 percent of the cell components of batteries and the production of battery cells. Two-thirds of global battery production is located in China, with CATL and BYD accounting for over 50 percent of the global output. This push to develop an independent and largely self-sufficient value chain has proven far-sighted in anticipating the disruptions faced by global supply chains because of extreme weather, war, and growing inter-power rivalry. A high share of the EV value chain gives China a significant comparative advantage vis-à-vis competitors while also providing the conditions to defend the supremacy in innovation and intellectual property that China is likely to achieve in coming years. 

   The Chinese government promoted these developments through generous science and technology funding, such as with the famous 863 Program. Under the tenure of automotive engineer Wan Gang (2007–2018), the Ministry of Science and Technology has been strongly supportive of the EV sector. Through joint ventures like SAIC-Volkswagen and acquisitions of Western car suppliers, the Chinese government pursued technology transfers from foreign companies. It also offered grants or loans to car firms for, among other things, the creation of manufacturing plants and bankruptcy prevention. The key policy instrument, however, has come in the form of subsidies.

   It is estimated that the Chinese government spent $60 billion in subsidies on electric vehicles between 2009 and 2017. Consumer subsidies have been more generous than the $7,500 tax credit offered by Biden’s Inflation Reduction Act, with national tax credits compounded by local government tax credits. The twenty-three local authorities (nineteen provinces and four metropolitan areas) are responsible for around 70 percent of public spending. These local governments conduct their industrial policy by championing local producers through grants, cheap credit, bailouts, and land supply, and by targeting procurement on local enterprises (for example, by sourcing the local taxi fleet with cars from the local automotive company).

   Additionally, Chinese state-owned enterprises (SOEs) include many automotive firms. Centrally owned SOEs are coordinated through the State-owned Assets Supervision and Administration Commission of the State Council (SASAC) and are expected to contribute to the implementation of government objectives. Some automotive SOEs such as SAIC, BAIC, and Chery are instead owned by provincial authorities, which are known for supporting loss-making industries to protect jobs and manufacturing capacity. 

   Political support for “local champions” by provincial authorities, combined with stimulus interventions from the central government, is known to lead to structural overcapacity, as was the case of the steel-making sector in the mid-2010s when the central government was eventually forced to impose closures and consolidation. While overcapacity can be seen as economically wasteful, it engenders a Darwinian struggle for entrepreneurial survival and technological innovation, which nurtures internationally competitive export champions. This is what is now in store for the EV sector, which is affected by severe fragmentation. The incipient price war will become fiercer as subsidies are progressively scaled back and domestic demand in China continues to be weak. However, offering the eventual winners greater economies of scale, this moment of reckoning is likely to make Chinese EVs even more competitive internationally. 

   The embrace of state-guided industrial policy and vertically integrated production by BYD and the Chinese government more broadly reflect a remarkable, if nascent, tendency within the global economy. While this tendency is echoed in Biden’s subsidy-fueled industrial turn, the EU still clings to a post-Fordist vision and to a nostalgic hope to revive globalization and its long supply chains. The ongoing EU investigation on Chinese EVs will likely recommend a hike in import tariffs, which are currently a third of US tariffs at a modest 9 percent. In March 2024, the EU started registering Chinese EVs at customs, meaning these tariffs could be applied retroactively. Import tariffs will offer little solace, however, without a deeper reflection on the changing structure of global production. Western countries should realize that in many sectors such as EVs, they are—for the first time in modern history—in a technological catch-up mode vis-a-vis a more advanced competitor, which they also consider a key geopolitical rival. Instead of focusing their attention on increasing military spending and drumming up fears of global war, Western countries ought to take China’s  technological and industrial challenge seriously. 

5. Inflation as Distributive Struggle

   April 5, 2024 12:29 pm Comments Off on Inflation as Distributive Struggle

   Lea este artículo en español aquí.

   On January 24, 2024, Argentina’s General Confederation of Labor (CGT) called for a twelve-hour general strike—the first in almost five years—just forty-five days into President Javier Milei’s term. This action was a direct response to the first measures proposed by the new administration which threatened to dismantle the pillars of workers’ rights. A week after the strike, union leader Pablo Moyano warned of future intensified actions in response to debate around the “Omnibus Law” in Congress.¹ The CGT is “more united than ever” after the strike, he stated, signaling a strengthened and highly alert unionism.

   Since Néstor Carlos Kirchner’s victory in 2003, Argentina has become increasingly polarized politically. Néstor Kirchner and his wife, Cristina Fernández de Kirchner, governed from 2003 to 2015 with a clear bias towards workers. The ruling coalition led by the Kirchners was defeated in 2015 by Mauricio Macri, a businessman who imposed a pro-capitalist “gradualist” agenda. In 2019, Macri was defeated by a coalition led by Alberto Fernández as president and Cristina Fernández de Kirchner as vice-president, returning the government to a more pro-labor orientation. Milei’s victory continues this cycle of alternations, but with increasing volatility, as his government presents itself as a pro-capitalist “shock.”

   In the early days of his term, Milei appointed former Macri government officials  as ministers and advisors: Luis Caputo (former JP Morgan executive and ex-Minister of Finance), Federico Sturzenegger (former Central Bank head), Patricia Bullrich (former Minister of Security).² And just a few days after assuming the presidency, the Oral Court of Corrientes (one of the Argentine provinces where Milei’s party won) granted parole to the repressor Horacio Losito, who had three life sentences for crimes against humanity committed during the last military dictatorship. After his inauguration on December 10, Milei emphasized the need to reduce the fiscal deficit by 5 percent of GDP, the burden of which would fall on the “state and not on the private sector.” The adjustment, then, would result from a reduction in spending rather than an increase in taxes, with public employees bearing the largest impacts.  

   Milei’s diagnosis is that inflation is driven by the fiscal deficit financed through currency issuance. This is a consensus view in the Argentine mainstream, and arguably supported by the IMF. For Milei, inflation is a monetary phenomenon, an excess demand created by irresponsible politicians whose only solution is a shock adjustment. But this diagnosis is deeply flawed: capacity utilization rates in Argentina barely reach 65 percent, and there is no excess demand in the economy. The most probable result of Milei’s adjustment is a deep recession. 

   An alternative diagnosis

   Growth rates in Argentina have been low for several years. Total registered employment and economic activity have remained stagnant since 2011. Real wages have been declining since at least 2017, as chronic inflation reached 276.2 percent year-on-year by February 2024. The population living below the poverty line has reached 40 percent. Alternating governments have been unable to address these economic burdens.  
   
   Argentina’s low growth rates result from its low foreign reserves. The country needs $5 billion per month for imports but has today around just $28 billion in reserves; net reserves are negative. As a consequence, there is limited economic policy space to boost domestic demand without deepening the balance of payments crisis. Because most machinery and equipment needed for increased production in Argentina is imported, any domestic expansion that induces investment requires foreign exchange. Like other countries with an incomplete productive structure—and without access to external financing—exports must increase to finance these capital goods. When this does not happen, the central bank begins to lose international reserves. Without outside financing to provide foreign exchange, it must adjust its exchange rate. But increasing the price of foreign currency results in an increase in domestic price levels—both imported and exported products (whose price is international) become more expensive in the local currency. Given that wages are paid in local currency, workers see a decline in real purchasing power, reducing labor’s share of the national income and creating a recession. This phenomenon has long been understood and is referred to as “stop-and-go” cycles.³

   In this diagnosis, high inflation is not explained by “aggregate excess demand.” Rather, rising prices and costs result from conflict between classes over the distribution of real income.⁴ In Argentina, there is constant pressure from the agricultural and industrial exporting sectors to depreciate the currency to reduce real production costs. But with strong labor union foundations, Argentine workers and non-exporting capitalists want to protect the domestic market—which is comprised predominately by wage earners. Workers try to raise money wages to defend their real income and living standards, raising costs at the expense of profit. Thus, inflation becomes a conflict.

   In an economy with high inflation, multiple factors influence prices, among them wages, profits, basic service fees, and the exchange rate, which determines prices of imported and exported commodities.  Amidst a balance of payments crisis in Argentina, wages and exchange rates are the most consequential.  

   The wage level depends on a subsistence basket for workers—a de facto minimum wage. But it is also determined by whether the organization of the labor market enables workers to defend or advance their standard of living in the struggle for surplus distribution. In Argentina, unions are relatively strong; they have the power to veto the government.

   But so do agrarian rentiers. Represented by the Argentine Rural Society, these exporting interests have the power to delay or stop the sale of grains for export if the central bank’s reserves decline. When this happens, exporters of agricultural commodities force a depreciation of the central bank’s exchange rate, so that the amount of local currency they earn through export earnings increases. The depreciation of the nominal exchange rate allows exporting rentiers to reduce their domestic costs in terms of the export revenues. This also increases the price of imported goods—both consumer products and production-related equipment—in local currency, giving workers less purchasing power. With exported goods and their derivatives—meat, flour, electricity—all more expensive in the local currency, the cost of the basic consumption basket rises, leading to a decrease in real wages.  The struggle for income distribution is fought between workers who want higher real wages and agrarian/capitalist exporters.⁵

   Twenty years of inflation

   Argentina is a commodity-exporter, and commodities—directly or indirectly—determine the basic consumption basket. Commodity prices increased dramatically in the late 2000s: in September 2006, the price of soybeans was $200 per ton. By August 2012, it had reached $622 per ton. As the price of food increased, so did the cost of the basic consumption basket.

   In 2007, Néstor Kirchner reinstated collective bargaining agreements, granting unions the ability to negotiate their nominal wages. This measure was extremely important for improving the income distribution, but it also opened the door to inflation caused by distributional conflict as exporters retained the power to take back through depreciation whatever workers won through collective bargaining. Guided by a powerful fiscal policy, the economy grew steadily in the mid-2000s, and the unemployment rate dropped from 20 percent in 2003 to 7 percent in 2008.⁶ The incipient distributive struggle pinned workers and capitalists concerned with the internal market against exporters of agricultural and industrial products.

   By 2015, this struggle produced an inflation rate in Argentina of approximately 25 percent per year. The situation worsened under Macri. When he began his term in 2015, the exchange rate was 9 pesos per dollar; four years later it was 59 pesos per dollar, a sixfold increase. Exchange-rate adjustment increased prices, and workers negotiated higher nominal wages in wage agreements.⁷ In 2019, the annual inflation rate had grown to over 50 percent.

   In Argentina, each increase in the nominal exchange rate—or the international price of commodities—also increases the local price of commodities. This in turn raises the price of the consumption basket, leading workers to demand higher nominal wages to maintain their purchasing power, which can further raise prices. Through this mechanism, successive rounds of the exchange rate-prices-wages struggle leads to persistent and chronic inflation, and in the context of dollar scarcity, can lead to hyperinflation. Like Macri, President Alberto Fernández failed to halt this dynamic between the nominal exchange rate and wages. Inflation reached 100 percent by 2022.

   Milei’s first policies

   In his first significant economic policy, Javier Milei depreciated the local currency (in real and nominal terms) by almost 100 percent, shifting the official exchange rate from 400 to 800 pesos per dollar. Additionally, his government introduced a package of measures to cut public spending and cut subsidies for basic services. The substantial real depreciation of the local currency significantly impacted price levels, as demonstrated by the Consumer Price Index (CPI) monthly increases: 25.5 percent in December, 19.6 percent in January, and 13.2 percent in February. These increments cumulatively represent a compounded 70 percent price increase over the three-month period, highlighting the immediate and profound effects of the currency’s depreciation on the economy. Substantial declines in real wages and the share of wages in national income are expected, as historical trends show that real depreciations are often accompanied by reductions in real wages. Figure 1 illustrates how the workers’ share in income is essentially a mirror of the real exchange rate. Of course, the IMF supported these measures (see the IMF Managing Director’s X post below).

   Figure 1: Real Exchange Rate and Wage Share in Argentina (1946 – 2024)

   

   Figure 2: Kristalina Georgieva’s official X account

   

   The real depreciation of the exchange rate will benefit commodity-exporters and their related industries with dollar-denominated incomes. As the wage share falls, the profit share increases. This is the case, for example, for soybean exporters and industrial exporters, who will see an improvement in their expected profitability.

   The real wage decrease, coupled with the planned reduction in government spending, will lead to a collapse in activity levels.⁸ With falling production, the quantity of imported inputs necessary for production will also decline. This will enable the central bank to continue the policy of accumulating international reserves, which is crucial for stabilizing the nominal exchange rate and, consequently, the price level. As seen in Figure 3, the reserve accumulation process has already begun.

   Figure 3: . International Reserves (in millions of $US)

   

   The measures taken by the Milei government will, in the short term, lead to a decline in real wages and the share of wages in income distribution, while increasing the capital share in the national income. A decrease in real wages and real public spending will lead to fall in production and employment. Consequently, the quantity of imports will decline, allowing the central bank to accumulate reserves to anchor the nominal exchange rate and attempt to curb inflation driven by the exchange rate.

   The great unknown

   Despite its impact on spending and wages, it is unclear how Milei’s economic policies will achieve their own objective of reducing the fiscal deficit. A reduction in public spending would decrease economic activity and domestic demand, resulting in lower private employment and investment, and in turn, a drop in public revenue.

   This makes a fiscal surplus implausible. In some provinces and municipalities in Argentina, 90 percent of the budget is spent on wages—spending reductions necessitate lowering wages, with negative effects on consumption and demand. While the government can choose how much to spend at the beginning of the year, the deficit depends on revenues which are a function of activity level. 

   Reducing the deficit does not guarantee stabilization of the nominal exchange rate without international reserves accumulation. External factors, such as the nominal exchange rate, affect the pursuit of a fiscal surplus, and the Milei government is intent on further depreciating the peso. While the government aims to achieve a monthly crawling-peg exchange rate of 2 percent, which would allow the 80 percent nominal interest rate (see Figure 4) to offer substantial gains in dollar terms, such a shift depends on the accumulation of international reserves, which in turn, depends on the interest rate.

   Figure 4: Central Banks of Argentina’s Monetary Policy Rate (Nominal Interest Rate)

   

   After a 100 percent depreciation of the peso with an inflation rate exceeding 200 percent, participants in the foreign exchange market will likely expect further depreciation. If the expected depreciation remains high, current interest rates may not be sufficient to convince market participants. Moreover, during March, the central bank decided to reduce the Monetary Policy Rate to 80 percent. Why doesn’t the government increase interest rates? There are a few possible explanations. Several important members of Milei’s political coalition benefit from low rates relative to the expected evaluation. Alternatively, the government could be pushing the economy into hyperinflation in order to set the stage for a dollarization regime in the future.⁹

   The distributive struggle

   The main challenge of Milei’s economic agenda, however, is confronting the ongoing distributive struggle over inflation.  Stabilizing the price level in Argentina requires stabilizing the nominal exchange rate through international reserves. Although Milei publicly declared a wage freeze for public employees, implementing this policy may not be as straightforward as it seems. In response to proposals targeting workers’ rights and pursuing the privatization of public enterprises, the CGT launched a resistance plan, with participation from other trade union federations. The government will struggle to manage new demands from unions for nominal wage adjustments. The teachers’ unions, for example, are in the midst of negotiations for higher wages, after dismissing the national government’s offer and planning a “National Day of Protest.”
   
   In Argentina, the power of formal workers lies with labor unions, who negotiate with a variety of political parties and governments. Since the 1940s, the emergence of Peronism forged a symbiotic relationship between unions and the state, assigning unions a pivotal role in politics and the distribution of social benefits. The establishment of union-run healthcare systems during Onganía’s dictatorship in 1970 marked another significant milestone, solidifying unions as an essential support for workers’ welfare. Argentina’s  high rate of union membership—27.7 percent— is a testament to their power.¹⁰

   Figure 5: Relationship between real wage change and general strikes

   

   Milei’s relationship with the unions will determine the fate of his government. In his messianic new year’s message, he foreshadowed, “If our program is obstructed by the same people who want nothing to change, we will not have the tools to prevent this crisis from turning into a social catastrophe of biblical proportions.” The ability to determine the nominal exchange rate through the central bank is the main tool at his disposal to discipline workers—beyond this lies the state’s monopoly of force. Milei could pursue hyperinflation, as he calls it, a “social catastrophe of biblical proportions”—and blame union leaders for its effects, as he has threatened in the past. Or he could choose to tactfully manage a price and wage agreement with great political flexibility, but this is at odds with the proposed agenda. If Milei’s proposals are not approved by Congress, hyperinflation could be the next agenda item.

   The challenge of every Argentine government is how to accumulate international reserves in order to stabilize the nominal exchange rate while simultaneously managing political demands. The government’s proposed solution for the shortage of dollars is cutting spending and reducing real wages, but it’s unclear if this path will be politically sustainable. From 1999 to 2001, the government of Fernando De La Rúa attempted to reduce public spending in order to reach a fiscal surplus, but his term ended prematurely with the 2001 social crisis. The problem then concerns the political sustainability of the government in front of these demands. Growing poverty rates, real wage reductions and public spending cuts have the potential to generate significant social unrest.

   Carlos Menem’s administration successfully implemented a similar adjustment in the 1990s after hyperinflation, but the national and international political context was very different: the Washington Consensus was at its peak, and unions participated in the negotiations. Today, the political consequences of such an adjustment are higher. Given the failure of Macri’s “gradual” approach to the fiscal adjustment, it’s unclear how a “shock” government would see different results.  Historically, democratic governments that failed to negotiate with the labor unions either resorted to institutional violence against popular sectors or experienced hyperinflation. In either case, their tenures in executive power were short.

6. The Debt Poor

   April 3, 2024 3:12 pm Comments Off on The Debt Poor

   The 2008 financial crisis was an unprecedented demonstration of financialization in capitalism today. In the US, the collapse of real estate values revealed how formal credit channels—imagined as mechanisms of wealth creation—had brought unsustainable levels of household indebtedness down into new layers of American society. But if the experience showed how central household credit had become for low-income families to access housing in the US, it serves as just one example of how credit and debt shape not only business but household life globally. This is particularly evident in Brazil, where the cost of debts and debt service make up a growing share of annual household income. 

   Adjusting household income to include the burden of debt service shows that debt in Brazil is pulling an increasing share of the population below the poverty line. The temporal analysis below shows this clearly in two distinct movements. Between 2009 and 2018, the expansion of social-insurance programs coincided with a dramatic decline in poverty over all. At the same time, debt has grown persistently. Family budgets’ debt-service commitments have led to an increase in Brazil in what the economists Steven Pressman and Robert H. Scott refer to as the “debt poor”—those families whose total or disposable income does not qualify them as poor, given whatever income threshold, but whose disposable income net of debt service falls below that threshold.¹  

   The Brazilian case thus exemplifies the social effects of financialization: by eliminating a barrier to the expansion of credit to low-income people—the lack of collateral—the increasing coverage of cash transfer benefits has coincided with new financial services and products aimed at socially vulnerable layers of the population. Observing the effect of this growth of household debt on living conditions requires adapting our economic and social measurements. But doing so allows us to see how the nature of poverty is changing, as debt—rather than lack of income alone—becomes an important vector for its incidence. 

   Credit as a structural component of the Brazilian economy

   The importance of debt in contemporary capitalism is not only a result of its quantitative growth; debt reflects a a series of transformations brought about by financialization. Favorable macroeconomic conditions and financial innovations in the early 2000s drove lenders to extend credit downward to middle- and low-income layers of the population, a trend celebrated domestically as “financial democratization” following the political democratization of the 1980s and 1990s, and echoed in the US today among claims of “democratizing finance” by retail securities brokers. 

   Lenders’ most prominent innovation in this period was the payroll loan—a form of consignment credit in which interest and principal installments are deducted directly from the paycheck. Reducing risks of late payments and default, the payroll loan allowed much lower interest rates. According to data available from the Central Bank of Brazil, the main clientele for this type of credit is public servants, retirees and pensioners in the public social-security system—all those whose monthly income is the responsibility of the public sector. The state becomes the guarantor of debt, especially for retirees and pensioners, a process Lena Lavinas has described as “the collateralization of social policy.”

   This process relates to yet another transformation: the expansion of debt into new socioeconomic spheres, including those in which debt previously had only marginal involvement. Debt is now a determining factor in access to goods and services, entering spheres previously delegated to social policy and de-mercantilized forms of social provision. The design of social policy has begun to promote debt, to the extent that payment is now necessary for social reproduction.

   Through financial innovations such as securities and synthetic bonds—which transform regular payment flows into financial assets traded on secondary market—household debt has also been integrated into global financial markets. These debts then become the target of financial speculation and a source of profit.²

   

   The expansion of household debt in Brazil (Graph 1) began at a time of growth in Gross Domestic Product (GDP), employment and income—and, consequently, a fall in poverty.³ Credit was instrumental in maintaining this growth, higher during the period between 2003 and 2014 than in previous decades. On the demand side, the main factor in GDP expansion was consumption rather than investment. The increase in consumption was due to the rise in income, but also to credit.⁴ According to one study, “free credit” for individuals (as opposed to “directed credit” subject to laws and regulations) accounted for 45 percent of the growth in consumption and one third of the growth in GDP between 2004 and 2013.⁵

   From 2014 onwards, however, the situation reversed. In 2015–2016, the business cycle turned and Brazil fell into recession. Indebtedness fell momentarily during the slow and virtually stagnant recovery. But in the recovery of 2017–2018 credit growth resumed, even as income growth, employment, and poverty reduction all performed poorly. The growth of credit in this extremely unfavorable economic context indicates its structural role in the Brazilian economy; its obligations persist well after its contributions to GDP. 

   “Debt poverty” in Brazil

   The use of income measurements alone do not take into account this structural role of household debt in the standard of living across the population. As debt rises, an increasingly significant portion of disposable income is not actually disposable. If income must be spent on servicing past debts, it is not available for spending that contributes to current household well being. To capture more accurately what portion of households fall above or below a given consumption threshold—the standard method of defining poverty—Pressman and Scott advocate an alternative definition of income for poverty indices: “uncommitted disposable income.” This measure is defined as disposable income (i.e. net of taxes) minus debt-servicing costs.⁶ 

   Since the establishment of a poverty line is related to a socially acceptable minimum standard of living, uncommitted disposable income is a more comprehensive and accurate measure of whether households are able to afford that standard. By deducting debt-service from income, we can see how debt contributes to the incidence of poverty over all. It also makes visible a specific social group: those whose disposable income is above the poverty line but who fall below it when debt-service is deducted. This group is known as the “debt poor.”

   The Pesquisa de Orçamentos Familiares (POF or Family Budget Survey), carried out by the Instituto Brasileiro de Geografia e Estatística (IBGE or Brazilian Institute of Geography and Statistics) allows one to construct statistical series of disposable income and uncommitted disposable income for families in Brazil. Using this series, one can measure the share of the population (in this case, families) that falls below any given income threshold. Using the two income thresholds for existing poverty definitions—the Bolsa Família eligibility line, approximately R$ 200.00; and the World Bank’s international poverty line of around R$ 596.00—a comparison of these two series between 2008–2009 and 2017–2018 shows a picture of both the reduction of poverty in Brazil and the effect of indebtedness in pulling people into poverty.⁷

   Graph 2: Monetary poverty rate based on disposable income and uncommitted disposable income

   GRAPH TK

   First, note that the change in the definition of income does not alter the downward trend in either poverty threshold over the period considered. Debt, despite increasing, was not able to reverse the overall trend of poverty alleviation in Brazil. Graph 2 shows the evolution of the poverty rate in the two income series (disposable and uncommitted disposable) for the two different thresholds considered.

   However, there is a clear increase in the impact of indebtedness on poverty. As Figure 3 below shows, between 2008–2009 and 2017–2018 the number of debt poor—those whose disposable income places them above the poverty line but whose uncommitted disposable income pulls them below it—increased as a share of the impoverished population for either poverty threshold. In other words, the number of people whose debt-service commitments brought them below either poverty threshold increased. In absolute terms, there are 475,000 more debt poor people at the R$200.00 poverty line and 1.5 million more debt poor people at the R$596.00 poverty line.⁸

   Graph 3: Difference between poverty rates based on disposable income and uncommitted disposable income

   GRAPH TK

   Adjusting our poverty metrics to account for the debt poor allows us to estimate the additional monetary resources that would be needed to eradicate poverty, all else equal, beyond the monetary transfers already in place—notably Bolsa Família, social security and welfare benefits, unemployment insurance, etc.. This measure includes both the debt poor and those who would already be in poverty even without debt, but whose income is reduced by debt service payments. As can be seen in Graph 4, the transfers necessary to raise debt-poor incomes above the poverty threshold increases with the passage of time and the growth of this population. Looking initially at the poverty line of R$200.00 in 2008–2009, the inclusion of debt represents an additional need of R$10.5 billion; in 2017–2018, R$18.2 billion (73 percent more). For the R$596.00 poverty line, the figures were: R$67.7 billion in 2008–2009 and R$115.6 billion in 2017–2018 (71 percent more). 

   Graph 4: Difference between the amount of additional monetary resources to eradicate poverty when debt is taken into account (in R$ million 2021)

   GRAPH TK

   In summary, the evolution of poverty in Brazil between 2009 and 2018 includes two distinct movements: a fall in poverty, but a rise in the effects of indebtedness on poverty, reflected by an increase in the number of debt poor and the share of those in poverty due to debt. Although Brazil has reduced poverty, conventional measures fail to capture actual incomes as debt obligations increase. Both the size and intensity of real poverty should be increased accordingly by using uncommitted income rather than disposable income. 

   But beyond identifying this neglected layer of the population, an analysis of the effects of indebtedness on poverty also shows macroeconomic correlations. If the share of the debt poor has risen overtime, then further increases in indebtedness may further increase poverty. 

   The fact that a significant population entered poverty as a result of their debts demonstrates that credit to meet needs is not a silver bullet. This becomes even more pressing when this credit is accompanied by austerity in the public sector, which forces households to approach the market for their means of social reproduction, such as health, education and housing. Neglecting the direct effects of indebtedness on income obscures a key dynamic of financialization in Brazil: when the coverage and value of monetary benefits and the public and universal supply of goods and services are inadequate, loans become the last lifeline.

7. The Visible Hand

   March 29, 2024 8:21 am Comments Off on The Visible Hand

   China has transformed into a leading force in science, technology, and innovation (STI). With rapidly rising research and development (R&D) expenditure, a larger and increasingly high-quality talent pool, and impressive scientific publication and patenting statistics, the country is set to become a global STI superpower.            

   The evolution of the Chinese STI sector has been widely conceptualized through a Schumpetarian perspective which emphasizes market-oriented economic development, enterprise behavior, and the enterprise-centered innovation system. The managerial and innovative capabilities of outward-looking Chinese firms have been most commonly attributed to driving China’s technological development.           

   We challenge this conventional wisdom by underscoring the role of policies, politics, institutions, and the state in promoting China’s STI growth. Behind China’s innovation, we argue, is the “visible hand” of the Chinese government. Correctly conceptualizing the origins of Chinese technological development is crucial for understanding its future prospects.¹ If its present achievements are to be lasting, China must preserve the institutional capacity to achieve high-priority, national-development objectives. Above all, it must more efficiently transform R&D advancements into innovation.      

   Drawing on a close inspection of China’s recent innovation policies, we identify three challenges to China’s existing STI infrastructure. First, though it has hugely increased expenditure in R&D, total investment remains insufficient and poorly allocated in internationally comparative terms. Second, recent government restructuring has weakened key agencies and obscured their decision-making power; its effectiveness remains to be seen. Finally, the structure of investment in scientific research has shifted away from government funding to enterprise-driven investment, with unpredictable results. Such challenges bear significant consequences for China’s future as a global leader in innovation.

   State intervention

   In pre-1978 China, the state was responsible for all scientific research funding, and the central government appropriated funds through a centralized system. Beginning in 1985, however, a profound reconstitution of China’s science and technology (S&T) system altered the mechanism of appropriations and prioritized changes to government appropriations. The State Council, or the cabinet, gave the State Science and Technology Commission (SSTC) the power to administer all operating expenses for civilian science. The SSTC and the Ministry of Science and Technology (MOST), which succeeded the SSTC in 1998, distributed funding to agencies under the State Council and affiliated research institutes. In 2000, funds became directly channeled to department budgets, while MOST managed national S&T programs.

   The reform was a hallmark in China’s overall post-1978 transition from central planning to a socialist market economy. Though it coincided with the period of market reform, it was government restructuring rather than markets which encouraged the rise of China’s STI sector.

   Despite its clear advantages, the new system exhibited important flaws. It suffered from the absence of unified planning, ineffective coordination, and a lack of transparency in fund distribution and spending accountability. As a result, it was reorganized once more in 2014, when central funds were directed exclusively into five streams—the National Key R&D Programs; the Mega-Science Programs; the Nation’s High-Tech R&D Program; the National Key Technology R&D Program; the Industrial Technology R&D Fund; and Special Funds for research in public sectors. The trend towards recentralization continued until 2018, when MOST was transformed into a “super” department which received allocated funding directly from the Ministry of Finance for distribution.² 

   However, in 2023, the Central Committee of the Chinese Communist Party restructured China’s S&T system again, this time with major implications for central S&T and R&D funding. Under the new reform, MOST would become an office of the Central Science and Technology Commission, a new party organization responsible for formulating S&T strategy, focusing on a top-level design, unified planning, and interagency coordination. Policymaking and S&T budgeting functions related to specific sectors would be redistributed to mission-critical agencies.³

   China and the US

   According to the US National Science Foundation, in purchasing power parity terms, China was the world’s second largest R&D spender in 2019, accounting for about 22 percent of the global total, behind the US, whose global share was 27 percent. A 2020 report from the American Academy of Arts and Sciences observes that China “was passing the United States in research and development investment at purchasing power parity.” In May 2021, US President Joe Biden remarked: “We used to invest more in research and development than any country in the world and China was…number nine. We are now number eight and China is number one.”                

   Indeed, China’s R&D investment has skyrocketed in recent decades. The central research funding reform has released the original public resources to the market, while the market-oriented reform has activated the vitality of firms and research institutes. In 2023, China’s gross expenditure on R&D (GERD) reached some RMB 3.33 trillion, three times that of ten years ago and seventy-one times that of 1995. In 2023, China’s total R&D spending as a share of GDP—or R&D intensity—reached 2.64 percent, more than triple the average of the EU member states, which together managed 2.15 percent in 2021. Although China fulfilled the R&D intensity target set for 2020 (2.5 percent) in 2022, two years later than planned, it has retained the momentum to help transform the nation’s economic structure and stimulate the next stage of STI-driven socio-economic development.

   These accomplishments, however, look less promising in comparative terms. In 2019, US GERD was $657 billion, more than twice China’s $321 billion.⁴ The most recent data from the OECD show that in 2021 government-financed GDP on R&D was 0.69 percent for the US and 0.46 percent for China. America also led China in total R&D investments, which include public, private, and nonprofit investments. R&D intensity was nearly 3.4 percent for the US and about 2.44 percent for China in the same year.

   Total R&D spending in the US surpassed 3 percent of GDP for the first time in 2019. In June 2021, the US Senate passed the historical Innovation and Competition Act of 2021, displaying its determination to significantly increase government spending on R&D. China’s current goal is to achieve the R&D intensity target of 2.8 percent by 2030, making it impossible for China to surpass the US in this critical statistic in the immediate future.⁵ Slow economic growth in China may also negatively affect the sustainable growth of R&D funding, despite the fact that the Chinese government has not reduced its investment in S&T.

   The quality of R&D expenditure statistics itself cannot be taken for granted. In the US, the federal government’s contribution to GERD is provided by the Office of Management and Budget, and by various S&T mission-oriented agencies. Such detailed agency-level R&D expenditure statistics are unavailable in China, and estimates for central government expenditures may have major inaccuracies. 

   It is also likely that measures of China’s R&D expenditure are inflated. The OECD forecast is based on the domestic purchasing power of the Chinese currency, but most research equipment, chemical reagents, basic data, and journal access are purchased on international markets. Additionally, Chinese enterprises may overstate spending on R&D to meet the “official” criterion to qualify for tax credits and other favorable policies, and to elevate their executives professionally.

    It is not just the quantity of expenditure that matters for innovation—the form that this expenditure takes is crucial as well. China has continuously spent a relatively low share of R&D expenditure on scientific research—devoting approximately 16 percent to basic and applied research and the rest to experimental development. In other words, instead of acquiring or generating new scientific or practical knowledge without any use in view, China’s R&D in the twenty-first century has been oriented towards experimental development—producing new products or processes and improving existing products or processes. From the early 2000s until 2022, anywhere from 5 to 6.57 percent of expenditure was devoted to basic research, with roughly 11 percent in applied research. This is a dramatic decline from a standard of 26 percent share applied research expenditure in 1995, and concerningly low in comparison to the US and Japan, which spent some 30 percent of respective R&D expenditure on applied research. With no new knowledge from scientific research, the generation of new products or processes depends on international technology transfers.

   The sources of innovation

   The sources of funding have also changed. Since 1995, the growth rate of enterprise R&D funding has significantly exceeded that of the government’s spending. Today, the proportion of the GERD contributed by enterprises has increased to 78 percent, while the share of government spending fell to about 19 percent. The trend is consciously undertaken by the Chinese government: since 2021, manufacturing enterprises have received a 100 percent tax deduction for R&D expenses, thereby increasing total tax deductions from RMB 360 billion in 2020 to RMB 440 billion in 2021. With respect to research funding, the enterprise has emerged as the primary actor of innovation. 

   This high share of enterprise funding is atypical. Internationally, the proportion of government funding in GERD during industrialization was generally between 30 and 50 percent, with  enterprises accounting for 40 to 60 percent of investment. The US federal government had been the leading sponsor of the nation’s R&D for many years, funding 67 percent of all US R&D in 1964. Though this share has since significantly declined to 20.89 percent in 2021, it remains higher than China’s 18.96 percent. 

   For basic and applied research, the government remains the key actor—being the sole funder of the former, and contributing 85 percent of funding for the latter. This, too, is atypical: in 2021, the US business sector was not only a substantial performer (34.62 percent) and funder (32.53 percent) of basic research, but also the largest performer (61.06 percent) and funder (56.3 percent) of applied research. While the government ought to invest more in research funding, then, firms should focus on basic research in addition to experimental development.

   Given that the government constitutes the key funding source for basic and applied research, the low share of government funding in GERD has led to a relatively low share of R&D expenditure on scientific research. China’s local governments spend more on S&T than the central government, but this expenditure also includes spending on non-R&D activities. 

   An additional challenge to China’s R&D sector comes in the form of organizational structure. From 2000 to 2014, reforms of the S&T budgeting system, departmental competition, and the establishment of Mega-Engineering Programs led to the diminishing role of MOST in China’s national innovation system. The 2018 reforms returned more power to MOST, and the latest 2023 reform would strengthen MOST’s role in coordination, though it may be at the expense of the ministry’s budgetary functions by moving some of its organizations to mission-oriented agencies.

   Unlike the National Natural Science Foundation of China (NSFC), which funds basic research and mission-oriented research projects through competitive and peer-review processes, MOST, which until the 2023 reform administered a much larger share of the government S&T appropriation, was criticized for being non-transparent in its distribution of funds. The lack of coordination and transparency has led to redundant spending across ministries and agencies, thus wasting scarce S&T resources. Now, MOST administers over the NSFC by macro-management, coordination, supervision, and evaluation, allowing the NSFC to operate relatively independently.⁶

   The future of innovation

   Understanding the role of the state in promoting China’s historical advancements in STI illuminates current obstacles and carries important implications for paths forward. Key among the necessary reforms is to expand sources of R&D funding. For example, the government could create tax incentives encouraging enterprises and entrepreneurs to donate towards scientific research. Organizational reforms are also necessary—the 2023 MOST reform could make the agency and the Ministry of Finance responsible for allocating the R&D budget accordingly. While the Ministry of Finance, MOST, the National Development and Reform Commission (NDRC), the State Administration of Taxation, and the Ministry of Education have been important in the formulation of indigenous innovation policy since 2006, only MOST has played a major role in budgeting.⁷ 

   In OECD countries, budgets have moved from being fiscally oriented to policy oriented. Fiscally-oriented budgeting emphasizes cost controls and ensures balance in the financial system. Policy-oriented budgeting emphasizes cost-effectiveness and cost-efficiency with evaluation geared towards the result-oriented nature and quality of budget applications. In the US, for example, every policy act has a corresponding budget plan, and the two are closely integrated. In developing countries, budget decisions are still distinct from policy decisions and national plans. China is no exception. Most Chinese STI policies do not follow with a clear budget, and it is also not clear as to whether the R&D budget corresponds to specific policy objectives.

   The NDRC is responsible for important economic regulations and strategic resource allocation; its S&T role is confined to making policies related to industrial technology, and it therefore has a limited role in the S&T budgeting process. Given its prominence in the Chinese government hierarchy, the NDRC should have an expanded and integrated budgeting and policymaking function. Similarly, other agencies with a critical S&T mission and therefore a larger S&T budget also should actively participate in policymaking to harmonize S&T-related policymaking and budgeting. While there is still a long way for China to align R&D budgeting with related policies at the agency level, the scientific and political leadership understands the significant role of R&D expenditure in promoting scientific research and stimulating innovation, as well as the urgency in effectively and efficiently utilizing rising but often scarce financial resources.

   Schumpeterian perspectives are valuable in providing a theoretical foundation for national innovation-driven development and policymaking. But as the Chinese state’s active creation of the market mechanism shows, Schumpeter’s ideal market is only an abstraction. Though the government has made enormous strides in advancing the STI sector, it should not lose sight of its critical role in cultivating future growth. 

8. The First New Deal

   March 28, 2024 8:51 am Comments Off on The First New Deal

   In 1933, four years into the Great Depression, Congress enacted the National Industrial Recovery Act (NIRA) in close cooperation with the Roosevelt administration. The central action of the statute was to facilitate price coordination across a given market or industry.¹ Its rationale was to contain the destructive competition and below-cost pricing that were exacerbating the problems already roiling the economy as a result of the initial stock market crash, and subsequent cascading credit and liquidity crises. In addition to addressing the credit crisis directly through banking and monetary reform, the Roosevelt administration thus sought to buoy up purchasing power by stabilizing prices.² NIRA also systematized and federalized the existing patchwork of legal support for collective bargaining between workers and business firms, in an effort to stimulate and stabilize wages.³ The idea of boosting demand and ultimately production through a floor on wages was not new; it had had currency for decades thanks to the influence of institutionalist economists, policymakers, and many business leaders.⁴ Still, NIRA at that time represented the most ambitious and broad-ranging effort to put that idea into practice. 

   In discussions of economic law and policy today, the “First New Deal” is understood as a major experiment in “planning” that displaced “markets.” This characterization is broadly endorsed by mainstream antitrusters, legal progressives, socialists, and most others too. Beyond that point of convergence, the normative valence attached to each—as well as the political meaning of “planning” within a broader political project—diverges, with some endorsing “markets” over “planning” or vice versa, and with some seeing “planning” as key to a broad emancipatory project, and others seeing it as simply a backstop for the continuation of a fundamentally inegalitarian economic system. 

   What these often bitterly divergent viewpoints have in common, though, is a failure to grasp just how intrinsic the activity of economic planning is to markets themselves. This is not in the mere sense of bare-bones public and legal market management mechanisms (such as contracts and property law), though indeed those mechanisms frequently enable significant degrees of economic planning that obviously displace competition (think for example of long-term output or requirements contracts). In Patrick Atiyah’s magisterial history of English contract law, he suggested that a major reason for the rise of contract law in the nineteenth century, and specifically for the modern emphasis on the will of the parties and on expectation damages, was that the legal form facilitated economic planning—and economic planning was necessary for the growth of markets and capitalism.⁵ 

   The economic planning facilitated by the law and by public choices about it runs even deeper, however. A tapestry of economic coordination systematically weaves itself between the private and public spheres, centrally including the business firm itself. The point here is not merely that ideal theory never quite fits the world perfectly. To be sure, the real world is always a bit messier than our categorical representations of it—a necessary consequence of any theory, indeed of any thought. But the problem isn’t that reality doesn’t quite stay within the lines of the broadly shared picture of markets as unplanned competition; it is rather that this picture has the wrong shape altogether. 

   If we don’t see this, we are quickly led down the garden path of downstream debates that are variations on the following themes: When is planning (and/or coordination between market participants) justified by sufficiently-systematic or structural “market failure”? What is the cause of market instability, falling margins and/or below-cost pricing, either generally or over some long historical period and across sectors? Such questions and debates aim at an unwarranted level of generality, which unfortunately follows naturally from the wrong-shaped picture of markets that infects our thinking across the political spectrum. The consensus view seems to be that the paradigm market (or really, set of interlocking markets in an economy) is, first, devoid of economic planning, and second, runs on a set of generally applicable, interconnected motive forces that result in successfully calibrating prices and costs, and ultimately in employing all available resources in the service of existing human needs (and desires). Planning or “intervention” are justified if and only if the mutual operation of those motive forces for some reason breaks down. Whether one believes that breakdown is more or less frequent, the paradigm largely retains its force as a normative and analytic baseline for legal and policy thinking, and indeed for social theory. 

   If, instead, planning and coordination are understood as intrinsic to markets—and typically have an essential role in pricing decisions, in cognizing and managing costs, and in regulating the economic rivalry that affects both prices and costs—then we should probably not seek to understand specific pricing problems, nor conditions of chronic instability, as symptoms of either special or general breakdown of the ideal market mechanism. Rather, since avoiding these outcomes is generally what planning, or economic coordination mechanisms, seek to do, we might look to see if and why those particular mechanisms may have broken down. (Certainly, we’d also look for specific explanatory empirical conditions relating to costs, demand, or rivalry—but without attributing any particular norm or baseline to any of those dimensions of markets, instead understanding them as characterized by empirical variety). 

   These are general points, but the public price coordination experiments undertaken in the early 1930s United States furnish a helpful entry point. Two significant home-grown tributaries flowed into what became NIRA and its family of price coordination experiments: the Progressive planning tradition and the antitrust tradition.⁶ Today, NIRA is commonly counterposed to antitrust (both in principle and in terms of the historiography of the New Deal). But at the time, the antitrust camp had little truck with the self-coordinating market ideal. Resistance to public price coordination experiments, meanwhile, particularly among conservative jurists, was also not based on a preference for unplanned markets, but instead on ideas of freedom of contract—which were in many respects inconsistent with the unplanned market ideal. And the Supreme Court’s ultimate rejection of NIRA as unconstitutional was not even based upon freedom of contract (much less an embrace of unplanned markets), but instead upon the conclusion that the scheme did not involve enough planning. Ironically, it was ultimately the Progressive planning tributary to NIRA—rather than the antitrusters and rather than the courts—that did the most to bring the self-coordinating market ideal to the center of American law and policy. That is, the Progressive planners inaugurated the tradition, still with us today, of asserting special exceptions to unplanned markets as the justification for specific instances of economic planning. In so doing, they helped to elevate the self-coordinating market ideal to its vaunted position. 

   The competition that kills

   The price coordination experiments of the first New Deal are conventionally counterposed to the antitrusters, the “neo-Brandeisians,” and the second phase of the New Deal. While some degree of divergence between camps identified in these terms is undeniable, the idea that they map onto a clear conflict of principle on the questions of competition or planning is at best greatly exaggerated. First, even the association of key figures of the second New Deal with Louis Brandeis or with antitrust itself appears to be overstated.⁷ Second, Brandeis’ own work, in promoting trade associations and other forms of economic associationalism, formed a key precedent for NIRA.⁸ If NIRA was about containing ruinous competition, Brandeis had long been writing about “the competition that kills,” seeking to contain it through decentralized forms of coordination and, once on the Court, promoting toleration for it under antitrust law.⁹ And thirdly, this advocacy on Brandeis’ part was not a personal quirk or a novel departure, but was instead consistent with the antitrust tradition of the earlier Populist era, which had always aimed to cultivate dispersed forms of economic coordination while targeting those forms—such as “the trusts”—that concentrated economic planning in a few hands.¹⁰ Perhaps surprisingly, the Brandeisian antitrust tradition was far less tied to the ideal of unplanned competition than the Progressive planning tradition was.

   So, while the unplanned market ideal undoubtedly came to eventually influence American antitrust, it was not yet associated with the antitrusters. This ideal was, in the first place, birthed in the matrix of classical political economy, then refined and purified in the still relatively recent “marginal revolution.” In this ideal competitive state, competition (or potential competition) allocates economic resources to their optimal uses. In a textbook competitive market, economic coordination is either not present or invisible. It’s not present in the sense that coordination between firms is nonexistent, by assumption. Any coordination that does exist is presumed to occur only within firms, i.e., via the entrepreneurial function of coordinating the various factors of production within the production process. The implications of this idea, therefore, pertain not only to public planning as such but, more precisely, to any proposed economic coordination mechanism outside the firm, be it notionally private cooperation (or “collusion”) or public regulation. 

   Importantly, the competitive ideal has little to do conceptually with the existence of economic rivalry, an idea with which it is frequently conflated—even, sometimes, within the very thought traditions that birthed the competitive ideal, and certainly within many policy and legal applications of those traditions. As none other than Friedrich Hayek lucidly explained the distinction: 

   Perhaps it is worth recalling that, according to Dr. Johnson, competition is “the act of endeavouring to gain what another endeavours to gain at the same time.” Now, how many of the devices adopted in ordinary life to that end would still be open to a seller in a market in which so-called “perfect competition” prevails? I believe that the answer is exactly none. Advertising, under-cutting, and improving (“differentiating”) the goods or services produced are all excluded by definition—“perfect” competition means indeed the absence of all competitive activities.¹¹

   Instead, ideal competition might be best described as the optimization of welfare through the sorting and aggregation of preferences and their matching with available resources and goods, a state in which even technical differences or improvements—the most common folk justification for ‘competitive markets’—are assumed away from the basic analytic apparatus.¹²

   Brandeis and the antitrust tradition up to this point were simply not rooted in the competitive ideal of the self-coordinating market. Brandeis understood competition as rivalry, and he had no interest in welfare maximization in the technical sense, preferring to directly articulate the normative goals of policy. He also understood economic rivalry to be necessarily conditioned by legal rules, making the choice of these rules both unavoidable and essential to ensure that competition actually served pro-social aims.¹³

   This position is distinct from a vague endorsement of tempering competition with coordination or planning. It implies a conception of competition in which there are basic, qualitative differences between forms of competition, beyond any differences in degree. That is, at any given time firms may compete in one dimension (say, product quality) and not another (say, labor costs). Legal rules as well as prevailing market settlements channel competition (and economic activity) along various dimensions. For an obvious example, the law channels competition away from overt violations of property rights. (The National Cash Register Company at one point had a “knockout squad” that employed competitive strategies such as surreptitiously dropping sand in rival cash registers while on sales calls.)¹⁴) While that result may seem obvious, the boundaries of property rights (and business torts) are often not. From this alone it should be evident that there will always be some social contestation—and social choice—regarding the appropriate channels of competition. But the markets of ideal theory have little space for these facts, conceiving of competition at best in terms of magnitude rather than qualitative difference. Importantly, this is just as true for imperfect competition theory as for perfect competition.

   Indeed, the position of Brandeis and other Progressive-era antitrusters (like Henry Martin of the Antitrust League), and of Populist critics of monopoly before them, is different to anything resembling “imperfect competition theory,” which does continue to pay fealty to the self-coordinating market ideal as a normative and analytic benchmark, regardless of its adherents’ beliefs about the frequency with which actual markets depart from that ideal. On the other hand, embracing economic rivalry as one good among others (as the antitrusters of the time generally did) does not imply any commitment to the self-coordinating market. For Brandeis and fellow travelers, economic coordination and markets went together like a horse and carriage: they were complements, not substitutes. You don’t need to demonstrate a “horse failure” to introduce the use of a carriage. In fact, you need a working horse to use a carriage, just as, for the Populists and for Brandeis, markets generally required working mechanisms of economic coordination. 

   NIRA directly built upon Brandeis’ life-long project of dispersed coordination as a driver of stability and sustainable pricing. Its basic goals were to set prices at a level, relative to business costs, that would ensure a margin sufficient for the business to reproduce itself according to socially defined criteria and to meet other specific social and economic goals. To do this, accounting for production costs was a key task facing the NIRA trade groups and the federal agency. As participants in this experiment have detailed, it was a practical problem that NIRA largely failed to solve. Here, the operational reason for failure largely harmonizes with the constitutional failure that lawyers are most familiar with: a lack of uniform, substantive standards.  

   Before his years on the Supreme Court, Brandeis had expended significant energy on the issue of cost accounting among smaller and mid-sized businesses, in an effort to prevent “the competition that kills.” He identified below-cost pricing as itself an antitrust harm (for instance when used by dominant firms against smaller ones with less capacity to absorb losses) and promoted legislative, administrative, and private efforts to systematize the accounting of costs across markets in order to prevent such practices.¹⁵ He also promoted minimum price coordination across firms as a mechanism of maintaining sustainable pricing, living wages, and independent enterprise. His idea was that legitimating coordination beyond firm boundaries provided a source of stability that could obviate the need for stabilization through corporate consolidation and domination. Whatever its failures, and however it otherwise diverged from Brandeis’ vision, NIRA built upon these efforts. 

   The planners

   “Make no small plans, for they have not the power to move men’s souls,” said Rexford Tugwell. Tugwell was an original member of Roosevelt’s “brains trust” and—alongside his direct role as an administrator in landmark New Deal agricultural programs—also a “key architect of NIRA.”¹⁶ When he signed the Act into law, Roosevelt channeled Tugwell and other adherents of the high-wage doctrine (who believed that underconsumption had caused, or at least exacerbated, the Depression) by emphasizing the program’s promise to raise the “ purchasing power of the public.”¹⁷ This was to be achieved not only through the collective bargaining provisions in the statute but also through the price floors themselves, which would help to secure internal investment, wages, and jobs. 

   Tugwell emphasized the continuity between public planning and the extensive planning that already pervaded the economy through the mechanism of business firms themselves: 

   National planning can be thought of-in a technical rather than a political sense-merely as normal extension and development of the kind of planning which is a familiar feature of contemporary business . . . We have many illustrations of the extension of central office control over numerous units of the same industry, and even over various units of different industries which contribute to one product, such as motors, tires, telephones, or radios.¹⁸

   Public planning was therefore a change in form, not substance. In these terms, NIRA effectively outsourced pricing decisions from individual firms to bodies composed of representatives from industry, organized labor, and the public.

   Tugwell had been a student of Simon Patten’s at Wharton—an influence he celebrated, writing a long, affectionate account of Patten’s life and ideas.¹⁹ Tugwell emphasized the institutionalist bent of Patten’s economic ideas; like others of his generation, he had sought out advanced study in Germany, where he discovered his dissatisfaction with the English economists’ pervasive emphasis on scarcity, eventually coming to champion an economics of “abundance” while also adopting his German teachers’ “inductivism” and interest in the “facts of industrial life” over pure theory.²⁰ That said, it is remarkable that Patten still adopted many of the analytical devices of marginalism, notably his own version of the marginal utility concept.²¹

   Such flirtation with the analytical framework of marginalism, and with the accompanying framework of the self-coordinating market, was common to many Progressive institutionalist economists. For Patten (and Tugwell), that did not seem to directly involve the conceptual framework of relative prices and allocative efficiency itself. But many others, notably many of the most influential Progressive planners, cognized the basis for economic planning quite precisely in terms of specific breakdowns of the self-coordinating market. As such, this current ran through the planning tradition as inherited by NIRA.  

   Recall that according to the basic logic of the self-coordinating market, phenomena such as overproduction, under-employment, and insufficient rates of return can only be brief, passing readjustments. But the various crises and perceived crises—depressions, mass unemployment, falling profits—of the late nineteenth century (coinciding with the rise of big business and the rapid geographical expansion of markets) challenged the applicability of the competitive ideal. Progressive economic thought and debate was greatly shaped by the backdrop of these phenomena—even as it was also shaped by recent analytical refinements of the self-coordinating market idea in the form of marginalist economic thought. 

   This combination of influence produced the basic form of argument in which many influential Progressive thinkers argued that specific exceptions and breakdowns in the operation of competition were the reason and the justification for economic regulation or planning—whereas an earlier generation of lawyers and jurists largely assumed that markets were publicly ordered generally speaking, whether for egalitarian or hierarchical ends.²²For example, key Progressive figures argued that market equilibria broke down when faced with the high fixed-cost production brought on by rapid industrialization.²³ A central common theme across much Progressive-Era thought was that the cause of disequilibration lay in industries at the leading edge of technological development and thus in investment in physical assets, which were often also the industries boasting large firms and concentrated markets.²⁴ Where costs decreased with increasing production, firms would tend to grow in size in order to capture these economies of scale. However, the high degree of investment in fixed, physical assets implied by this industrial pattern was said to create a tendency toward destructive competition, or pricing below actual costs. Investments in large-scale industrial production (fixed costs) effectively created a situation in which firms were held hostage by their own investments, and thus were driven to both overproduction and underpricing.²⁵

   While commentators have broadly tended to characterize this constellation of influential economic and regulatory thought in terms of its opposition to “the classical model of the competitive market,” as Sklar called it, at a more fundamental level this movement of thought in fact affirmed the underlying cogency of that theory, arguing that its descriptive power was disrupted only through the appearance of a set of contingent (and new) facts, namely high fixed-cost industries. Aside from the fact that this failed to account for extant patterns of destructive competition at the time (which were just as, if not more, common in industries characterized by relatively low fixed costs and numerous small firms), this also did nothing to contest the place of ideal competition as a normative and analytic baseline. In a world where almost no one else was asserting the self-coordinating market ideal as a basis for working out law or policy in the first place, Progressives erected the greater part of their justification for planning and regulation on the basis of exceptions to that ideal.

   Planning in the courts

   This comes into particular relief when we examine the major Supreme Court cases that considered NIRA and other policies in its orbit. Nebbia v. New York (1934) upheld a state-level policy to stabilize milk prices. The case sheds light on the primary arguments against policies of public price coordination in play at the time. Schechter Poultry (1935), which famously held NIRA to be unconstitutional, is notable for not taking up any of those arguments against public market coordination, instead holding that Congress failed to meaningfully articulate the substantive standards by which public market coordination will occur. Finally, Appalachian Coals (1933), which evaluated a joint venture among coal operators to stabilize prices, illuminates the central role of the business firm in the emerging self-coordinating market ideal. 

   Freedom of contract

   The decision in Nebbia v. New York dealt with a program coordinating milk prices engineered by the New York legislature. The state’s efforts began in 1932 with an extensive one-year research program spanning thirteen public hearings, 2000 pages of testimony, and numerous reports from industry and state officials. The basic problem was that milk prices were depressed below average costs, posing an existential threat to producers and to other actors along the supply chain. As with all farm products at this time, deflation in milk prices exceeded economy-wide deflation—which meant that farmers’ costs had not fallen as much as the prices of their products. (The federal Agricultural Adjustment Act proceeded on the basis of a similar finding.) 

   Numerous factors contributed to this scenario. First, as the committee observed and the Court agreed, milk has an especially short shelf-life.²⁶It is plausible that this alone strengthens deflationary pressures, relative to other commodities. (Notably, in an early draft fragment from what became the General Theory, Keynes speculated that a reason for a structural tendency to deflation rather than inflation—other things equal, and absent stimulus—is that goods in general are more susceptible to spoliation than currency.²⁷) Second, there was no way to quickly adjust productive capacity to lowered demand—you already have the cows you have—resulting in persistent oversupply.²⁸ 

   The New York legislative committee found that a specific exacerbating factor in the local market was the practice of maintaining “surplus milk” in order to meet variable demand of a basic foodstuff.²⁹ Larger milk distributors maintained surplus milk, which they obtained at a lower price, while smaller distributors did not maintain such reserves and obtained their milk at a “blended” price (between the ordinary and the surplus price paid by larger distributors).³⁰ This meant that smaller distributors could persistently underprice larger ones, causing much of the milk on the market to be priced below (the larger distributors’) cost.

   The actual holding in Nebbia was concerned with the limits of the “public interest” in a business. This category had formed the traditional legal justification for regulation extending to prices. Thus, the disagreement between the majority and the dissent was mainly about the breadth of the category of businesses affected by “public interest”—with the majority holding that milk distribution is a business “which public interest demands shall be regulated” and the minority taking a narrow view of the “public utility” exception. What makes Nebbia interesting for our current purpose, however, is not its primary holding, but how clearly it distills the rationale or framework that “public interest” or “public utility” are meant to be a departure from.

   It’s often assumed that freedom of contract arguments and self-coordinating market arguments fit together seamlessly as a basis to attack “planning.” This is not true, and Nebbia helps to illustrate why. As an initial matter, the courts of the so-called Lochner era emphasized liberty of contract far more than they ever emphasized a self-coordinating or “competitive” market, which largely entered in as an afterthought or a gloss, if at all. The idea of a self-coordinating competitive market was emphasized far more by the Progressive policy-makers and technocrats who did battle with the courts, albeit largely by asserting special exceptions to it. The New York legislative committee did essentially this, resulting in the conclusion that “the ordinary play of the forces of supply and demand, owing to the peculiar and uncontrollable factors affecting the industry” were not sufficient to “right” the “evils” of underpricing.³¹ Once again, the idea that ordinarily the “play of the forces of supply and demand” set prices (at an ideal level) on their own was supplied by the legislative and administrative “planners” and technocrats—not by the old-fashioned courts in the thrall of laissez-faire.

   While not exactly missing altogether from court opinions through the preceding decades, this idea of a self-coordinating market—resulting in prices that ideally allocated productive resources to their optimal use—was simply not dominant among American jurists. In Nebbia, as elsewhere, it emerged in the majority opinion only via the arguments of the reformerswho wanted to engage in price regulation. Notably, it is largely missing altogether from the Nebbia dissent—which wanted to strike down the price regulation—and which instead emphasized freedom of contract and the privacy of pricing decisions. 

   The business challenging the New York statute had argued that its constitutional due process rights (the main doctrinal vehicle for freedom of contract arguments in such cases) were particularly implicated because the regulation constituted “direct fixation of prices.”³² While noting that “the due process clause makes no mention of sales or of prices any more than it speaks of business or contracts or other incidents of property,” the Court’s majority did acknowledge that:

   The thought seems nevertheless to have persisted that there is something particularly sacrosanct about the price one may charge for what one makes or sells, and that, however able to regulate other elements of manufacture or trade, with incidental effect on price, the state is incapable of directly controlling the price itself.³³

   The Court then went on to deny this proposition—but only by expanding the category of businesses or property “affected with a public interest” that would justify price regulation.

   The Nebbia opinions (the majority and the dissent) did not invoke the self-coordinating market ideal, except in quoting the New York legislative committee. The debate was about freedom of contract, as embodied in constitutional due process rights, and the limits upon those rights worked by the public interest category. Still, the Nebbia dissent did cite one earlier decision in which, rarely for this period, the Court had invoked competitive markets. In that case, the Court had struck down a state price discrimination statute aimed at agricultural buyers, on the ground that “Buyers in competitive markets must accommodate their bids to prices offered by others, and the payment of different prices at different places is the ordinary consequent.”³⁴ (This, of course, should not be true in a single“competitive market”; the Court may have meant that the different “places” constituted different markets, or it may be further evidence for how distant the concept of an ideal market still was from jurisprudence.) 

   Still, the idea surfaces one of the tensions between the freedom of contract rationale and the self-coordinating market rationale, as bases for undermining price regulation. Under conditions in which the laws of supply and demand are working as “the classical theory” prescribes, there is only one market price. There are no choices about prices for firms to make, at all. Firms may choose how much to make or sell, but they don’t choose the price at which they sell. As such, the dynamic process of adjusting bids, and the “payment of different prices at different places” does not happen when supply and demand are in equilibrium. Again, Hayek explained this point: 

   What the theory of perfect competition discusses has little claim to be called “competition” at all … if the state of affairs assumed by the theory of perfect competition ever existed, it would not only deprive of their scope all the activities which the verb “to compete” describes but would make them virtually impossible.³⁵

   Therefore, if there are choices about prices to make, if there is any meaningful liberty to interfere with, then the market is by definition not in equilibrium and there is no basis to say that government regulation is pulling it further away from equilibrium. The freedom of contract objection and the self-coordinating market objection (to a policy of public price coordination like NIRA, or like the New York Milk Control Board) cannot meaningfully coexist in the same case. If the former applies—if there is any actual choice that a firm is able to make about pricing—the market is by definition not in equilibrium. But if it is, then there is no freedom to choose a price, no freedom that can be interfered with. This isn’t the only logical tension between the freedom of contract and competitive market frameworks,³⁶ but it is one that disputes over price regulation particularly surface.

   Why care about this now? Because the two-step invocation of the competitive ideal and freedom of contract as the basis of attacks on public market coordination is very much still with us, even though the relative prominence of the two ideas has changed. In the early decades of the twentieth century courts predominantly emphasized freedom of contract, while the competitive ideal was at best ambiguously in the background. Courts today invoke the competitive ideal as a benchmark much more directly and frequently against particular instances of “regulation.” Yet, invocations of textbook competitive markets would have little normative pull—particularly in the broader public sphere—without their affective association with the freedom of contract idea.

   The chickens come home to roost

   The Supreme Court’s decision in Schechter Poultry, which famously held NIRA to be unconstitutional and thus marked the end of the “first New Deal,” did not reject public market coordination at all.³⁷ Instead, it implicitly embraced the possibility of such state action while rejecting the way NIRA went about it—broadly tracking internal criticisms of NIRA in the process. This further undermines the facile opposition between “the planners” and the “neo-Brandeisians” as a framework for understanding the internal dynamics of the New Deal.

   As an initial matter, the opinion affirms the obvious continuity between the “fair competition” concept in NIRA and its earlier appearance in the 1914 Federal Trade Commission Act. That continuity is evident from the statutory text, which expressly referred to the FTC Act and which empowered the FTC—an agency created by Congress in 1914 to implement antitrust law and policy—to enforce the new industry codes to be created by the federal agency administering NIRA. This basic continuity between the statutory schemes undermines the idea that NIRA (while indeed entailing certain exemptions from the Sherman Act) was fundamentally at odds with the broader antitrust or antimonopoly project. Moreover, the Schechter decision in no way contested this continuity, only pointing out that the statute’s reference to the FTC Act did not itself supply the missing content for the concept of “fair competition” that NIRA otherwise failed to provide. And this much was surely right, in that NIRA’s concept of fair competition necessarily went beyond whatever was already contained in the FTC Act, even though it built upon it. 

   As already noted, the problem of below-cost pricing that NIRA centrally concerned itself with was one of the primary economic ills emphasized by Brandeis himself—a figure who towered over the framing of the FTC Act and who was more broadly the primary voice of antitrust in the Progressive Era. Below-cost pricing was also investigated by the FTC in the 1920s across several industries. And as a tactic of gaining market dominance, it was already well-recognized in pre-FTC antitrust law, including in the landmark Standard Oil decision, as a violation of section 2 of the Sherman Act.³⁸

   But perhaps most importantly, Schechter would be an odd marker for the judicial rejection of experiments in public price coordination—since it didn’t reject that project at all. The Supreme Court never even reached the constitutional “due process” question, within which liberty of contract was housed, nor did that idea enter in through some other doctrinal door. The Court certainly did not invoke competitive markets or the competitive ideal in the abstract. Instead, the nub of the decision was to reject the particular arrangement for market coordination before the Court insofar as it lacked substantive governing standards at the legislative level. That is, Congress failed to supply its invocation of “fair competition” with much, or any, meaningful content. 

   The specific legal argument of the decision was that Congress may not constitutionally delegate its law-making power to the executive. At a minimum, the Court said, Congress should specify some substantive standard that the executive may then interpret, implement, apply and enforce. Whatever the reasonable boundaries of that constitutional imperative are—and although a conservative judiciary today threatens to weaponize it as a broad attack on federal administration as such—it is not particularly controversial that NIRA far outstripped them. Indeed, in this respect it’s worth noting that the Supreme Court’s rejection of NIRA was, in essence, on all fours with one of the most lucid internal criticisms of NIRA—namely that the absence of a meaningful system-wide standard led to chaos, with codes following very different methodologies, leaving them especially vulnerable to capture by powerful corporate actors.

   Those criticisms were well laid out by one Herbert Taggart, an accounting expert intimately involved with the administration of NIRA.³⁹ While a certain skepticism about the whole enterprise does infuse his functional criticisms, they are still well worth considering by those who are themselves more optimistic about the project of public involvement in price coordination. Taggart’s criticisms spanned the two main types of standard-setting used by the codes to quell destructive below-cost pricing: standards that attempt to define below-cost pricing across firms, and those that simply prohibit firms from pricing below their own costs. (According to conventional theory, these should of course be one and the same).⁴⁰

   Taggart’s objections to setting minimum cost levels across an industry or market include internal workability concerns as well as more basic concerns about too much market stability. The more basic concerns were common ones: Taggart—like critics dating back to at least Adam Smith—worried about standardizing costs to the extent of disincentivizing innovation, and more generally incentivizing production/production methods that no longer matched the moment for whatever reason.⁴¹The workability issues, on the other hand, arose because in order to be meaningful, the prohibition on below-cost pricing must be per-unit, while Taggart argued that per-unit cost comparisons are effectively impossible in the vast majority of cases. This is because: 1) consistency in accounting practices across firms is difficult even in case of truly identical or comparable products, given the difficulty in consistently allocating overhead costs;⁴² 2) truly identical products are rare, in that almost all markets display some level of product or service differentiation (even extending to the “bundle” of goods and services that’s actually being sold); and 3) inter-industry comparisons of costs are particularly intractable. 

   One might suppose that rules aimed at preventing individual enterprises from pricing below their own costs would fare better, but Taggart convincingly argued that such rules pose unique problems of their own. On the one hand, such a rule avoids the basic cost commensurability problems. On the other hand, it introduces its own problems—because at least in an inter-firm system, a common minimum price is eventually set, by hook or crook, and subsequently known to all. In the single-firm system, there is no common minimum price, which means that the basic problem of allocating overhead costs leads to basic compliance uncertainty. According to Taggart, ultimately “all of the cost accounting proposals approved by NRA contained loopholes of such magnitude that almost any price above labor and materials could be justified.”⁴³

   The issues raised by Taggart are important in their own right, and they also help to reveal the distance between the Schechter decision and any embrace of a self-coordinating market ideal. The central point about Schechter for the current purpose is that it did not oppose public market coordination as such, nor did it rely on the freedom of contract or self-coordinating market rationales as a basis for opposing NIRA. In fact, the non-delegation holding in a basic sense embraced the possibility of public market coordination: the whole problem was that Congress did not take the reins enough, not that it took them at all. 

   Imagine what a substantive statutory standard for fair competition might have looked like if Congress had decided to articulate one. Whether it dealt with cost accounting standards or not, it would have had to state that some means and methods of competition were legitimate, while others were not. This is hardly the stuff of the self-coordinating market ideal. The Court not only didn’t endorse that ideal, its prescriptions pulled directly away from it. 

   This is further highlighted by the fact that the constitutional delegation problem was not only about the executive branch, but also about private firms:

   Would it be seriously contended that Congress could delegate its legislative authority to trade or industrial associations or groups so as to empower them to enact the laws they deem to be wise and beneficent for the rehabilitation and expansion of their trade or industries? Could trade or industrial associations or groups be constituted legislative bodies for that purpose because such associations or groups are familiar with the problems of their enterprises?⁴⁴ 

   That is, the Court was expressly concerned that Congress was, in effect, delegating law-making power to private firms by empowering groups of firms to legislate market rules. In the foregoing passage, the Schechter decision echoes many in the nineteenth-century who worried about private associations trampling upon the state prerogative to order markets. This is a precise inversion of an endorsement of self-coordinating markets. The legal problem the Court identified with NIRA was, in part, an inappropriate privatization of a public function—not a problem with public market coordination as such. 

   A diamond in the rough

   Though it did not deal with NIRA directly, the 1933 decision Appalachian Coals v. United States rounds out our exploration of early New Deal experiments in price coordination through the eyes of the Court. As one antitrust commentator noted, “the scholarly consensus has been that Appalachian Coals was a temporary Depression era loss of faith in free markets in which the Court endorsed a price-fixing cartel, abandoning the per se rule against price-fixing until it came to its senses . . .”⁴⁵ That scholarly consensus, of course, fits comfortably with the opposition between planners and antitrusters in New Deal historiography. However, it is incorrect as a matter of the development of antitrust law: Appalachian Coals displays substantive continuities with many earlier and later legal developments. It is better seen as the apotheosis of a significant and not-yet-integrated minor strain in twentieth-century competition policy—one that predated it and that is still with us.

   The simplistic consensus also does not adequately capture the dynamics of the decision itself. The case arose from a joint selling agency in an industry—bituminous coal—that was formed to cope with a tendency toward unstable and unsustainable prices that far predated the Depression. In fact, those issues had been the subject of a Federal Trade Commission study and report in the early 1920s—again reinforcing that below-cost pricing was already a traditional competition policy concern. Experiments in various forms of private market coordination were nothing new to the industry. As Branden Adams has lucidly explained, an effective contest to manage the bituminous coal market unfolded over decades, involving three essential players: the coal operators, the mineworkers union, and the railroad corporations that transported the coal.⁴⁶

   By the early 1930s, the market was suffering from reduced demand for reasons that went beyond the general downturn: there had been an expansion of production capacity in response to an earlier spike in demand (triggered by the First World War), followed by the development of other energy sources and by the increasingly efficient extraction of energy from coal itself.⁴⁷ This mismatch between capacity and demand was exacerbated by various other conditions. One of those conditions was the prevalence of a method of production that essentially required the production of other sizes and shapes of coal in order to meet orders for a given type (such as stove coal, egg coal, lump coal, and the like). This led to systemic production of “distress coal”—recalling our “surplus milk”—which further depressed prices.”⁴⁸ Finally, the district court had found that coal buyers were large entities and often highly organized, adding to the downward pressure on prices.⁴⁹

   For all these reasons, the Court decided the coal operators’ joint selling agency was a reasonable measure and did not violate antitrust law. The Appalachian Coals Court cited the earlier, famous Chicago Board of Trade (a Brandeis opinion), which had upheld what was essentially a form of price-fixing in the context of a commodities exchange for the express purpose of stabilizing and rationalizing trading.⁵⁰ Now, the Court held that the coal operators’ association (which also featured a research department to increase energy efficiency) appeared reasonably designed to “make competition fairer,” to “promote the essential interests of commerce,” and in essence to help a struggling industry recover from crisis.⁵¹ In an observation that might today be controversial, the Court also noted that the “interests of producers and consumers are interlinked.”

    When industry is grievously hurt, when producing concerns fail, when unemployment mounts and communities dependent upon profitable production are prostrated, the wells of commerce go dry.⁵²

   Repeatedly, the Court invoked “fair” competition, and affirmed that “reasonable” (above-cost) prices were desirable. 

   Yet what most distinguishes Appalachian Coals is not so much any of the foregoing—all of which were quite ordinary ideas in previous decades, even if increasingly challenged by the Progressive embrace of self-coordinating market benchmark—but its demonstration of the emerging role of the firm as a kind of invisible anchor of the competitive ideal. The Court noted that the simple fact that the coal operators coordinated between themselves on prices could not condemn the arrangement, given that it would be uncontroversial that such coordination would be protected if “the defendants had eliminated competition between themselves by a complete integration of their mining properties in a single ownership.”⁵³ The Court went on: 

   We know of no public policy, and none is suggested by the terms of the Sherman Act, that in order to comply with the law those engaged in industry should be driven to unify their properties and businesses in order to correct abuses that may be corrected by less drastic measures. Public policy might indeed be deemed to point in a different direction.⁵⁴ 

   Rejecting the idea that “the formation of a huge corporation” should “be considered a normal expansion of business, while a combination of independent producers in a common selling agency should be treated as abnormal—that one is a legitimate enterprise while the other is not”— the Court concluded that antitrust law did not contemplate such an “artificial” distinction.⁵⁵ While Appalachian Coals made the point even more explicit, this rejection of “the firm exemption” is entirely consistent with Brandeis’ observation a couple of decades earlier that the German steel cartel was a superior arrangement to US Steel because it rationalized prices while retaining independent centers of decision-making (the latter being a standard antitrust concern, then as well as now). 

   Like Brandeis’ earlier advocacy and writings, Appalachian Coals endorsed “fairness” in competition, an idea that, among other things, encompassed “reasonable” prices, i.e., prices that sustain the reproduction of industry, employment, and living wages. The decision is especially important for revealing the basic connection between a strong embrace of “the firm exemption” and the self-coordinating market ideal. When economic coordination is limited to firms—and when firms are viewed as indivisible entities rather than groups of people engaged in planning—then the myth of the self-coordinating market can begin to flourish. Appalachian Coals is significant not only because it expressly embraced price stabilization as a goal of law and because it allowed an inter-firm coordination mechanism to go forward partly on that basis, but also because it rejected the primacy of the business firm as the sole acceptable engine of economic planning. If there is a single element that unifies the various moments of the second New Deal, it is the movement toward precisely this anointing of the business firm that Appalachian Coals resisted. It is no accident that the policies associated with that period—alongside their very tangible egalitarian effects—also inaugurated the legal and policy developments that would eventually usher in the primacy of the self-coordinating market framework. (That, though, is a story for another day.)

   Rivalry and planning

   Any too simple distinction between planning and competition does little to help us understand the price coordination experiments of the early New Deal. Nor does it help us think about a forward-looking program of economic governance. 

   The conceptual distance between economic rivalry and the self-coordinating competitive market is highly relevant here, because only the latter is inconsistent with planning as such. Acknowledging the value of economic rivalry, in itself, in no way forecloses economic planning. A belief that economic rivalry can, other things being equal, conduce to social and economic benefits does not imply the existence of a unique welfare maximum that planning would distort. (Both perfect and imperfect competition theory, however, do carry this implication; that the latter provides for exceptions where planning may compensate for some other distortion does nothing to change its acceptance of the underlying rule.) The specific views of Brandeis and the earlier populists make this logical possibility—an endorsement of both rivalry and planning—concrete.

   That rivalry and planning are not mutually exclusive does not mean that there aren’t political and institutional choices to be made, and also further deliberations on the economic governance to be pursued. Planning and rivalry exist together like a controlled burn. The fire may die down to nearly an ember in some cases but never quite disappear; conversely, anything called a market has a fire-keeper, no matter how big and chaotic the fire may sometimes burn. And crucially, along with the degree of control, we have to ask who the fire-keepers are. Who is tending the burn of competition? In any given case, is it an individual dominant firm, a group of firms, labor organizations, government agencies, or some other group of people? 

   Once we accept the inevitability of some level of market-wide price coordination, we can recognize the valuable lessons from the public price coordination experiments of the 1930s. Taggart’s cost accounting questions may seem technical, but they lead to a profound and basic inquiry about how to value the things we value, and how to then measure them against the costs of our collective endeavors. His criticisms of NIRA can perhaps be summarized under two major headings. The first is the familiar discomfort with too much stability, which may dampen performance, innovation, and other productive or desirable outcomes. The second is the apparently technical, but actually quite profound and substantive set of questions about how to accurately measure business or production costs, and then how to standardize that measurement across firms or production units and across industries. 

   Both are valid concerns that an affirmative program for economic governance will need to grapple with. Concerns about the costs of stability have, for the most part, been overemphasized in recent decades. Historically, plenty of highly coordinated and stabilized production environments in fact led to a high degree of technological innovations, including quite revolutionary innovation. (The medieval craft guilds—favorite target of the early classical economists—are one such example; the regulatory environments  of well-capitalized mid-century firms, which functionally limited payouts to shareholders and executives and incentivized reinvestment, are another.) That said, we need not deny that too much stability can dampen effort, innovation, and dynamism. It does not follow, though, that unlimited instability leads to maximum innovation. Indeed, it seems plausible that some core stability is necessary for competition to work in a virtuous way—the controlled burn. The problem is that this rather prosaic fact is simply not recognized, much less synthesized, in any working account of competition policy. At best, it is outsourced to other areas of law (such as labor law and social welfare policy). Much left-wing thought, too, counterposes markets and planning without really questioning the mainstream theory of markets and competition or providing a distinct account.

   The question of how to consistently measure costs and make that measurement commensurate across firms and products, meanwhile, is key. Such a task is particularly difficult in the shadow of a theory of markets that may even encourage us to think of costs as deductively derivable from other variables, rather than the most irreducible, ground element of price-making. This, I believe, is one area where new thinking is genuinely needed. Digging into the details of NIRA—as well as other case studies of price-making mechanisms, whether they be public, private, or somewhere in between—can help guide our work moving forward. 

   One final, important point about measuring costs is not quite made explicit by Taggart. Any benchmark for costs will necessarily involve a social determination of appropriate returns—to labor, but also to other input providers. Further, that social process of decision-making involves a normative determination that cannot be reduced to any purely “material” factors—though it is surely intertwined with the material. Far too many thinkers on the left assume that there is some objective amount that labor produces and thus should receive in return, but such assumptions make the same errors as mainstream theory. There is no escaping the open-ended social determination of appropriate returns to workers, a determination that necessarily implicates questions of fairness. False certainties will not help us, but perhaps shedding them will encourage a greater embrace of planning, moving us towards the means of realizing the world we desire.

9. Offshore Treasure

   March 21, 2024 2:17 pm Comments Off on Offshore Treasure

   Lea este articulo en español / Leia o artigo em português.

   Since the discovery of some of the world’s largest oil reserves in 2015, Guyana has entered a period of economic and geostrategic reconfiguration. According to the Energy Information Administration (EIA), Guyana holds the sixth-largest oil reserves in the Americas and the nineteenth largest in the world. With high quality product, below average production costs, and low local consumption, the reserves have enormous export potential—per capita, Guyana has quickly become the highest producer of oil in the world. 

   It remains to be seen whether Guyana can capitalize on this historic opportunity. The existing agreement signed between the Guyanese government and ExxonMobil favors the American multinational, allocating only 54 percent of revenues to Guyana and burdening the government with taxes and development costs. In July 2017, the IMF’s Fiscal Affairs Department wrote in a restricted report that the contract was “too generous to the investor” and contained “a series of loopholes,” stating that the “existing production sharing arrangements appear to have royalty rates well below what is observed internationally.”

   In order to take advantage of its resource wealth, the Guyanese government must navigate a complex web of international and domestic pressures. The oil discovery has reignited longstanding imperial tensions and introduced new ones. Territorial disputes with Venezuela and regional rivalries between the US, China, and Russia have aggravated domestic instabilities. As production expands, Guyana has again become a battleground for geopolitical ambitions.¹

   Great power struggle

   Guyana is located near the Atlantic Ocean and the Great Caribbean, in close proximity to the Panama Canal. It shares a border with Brazil, Venezuela, and Suriname—the latter two of which have persistently engaged in territorial disputes. Prior to the oil discovery, Guyana operated as a minor agricultural economy, highly dependent on export revenues from sugar, rice, gold, timber, and bauxite. Despite its location and mineral reserves, it remains the second poorest country in South America, with one third of the population living below the poverty line.² 

   American interests in Guyana date back to the nineteenth century, when geopolitical thinkers like Alfred Mahan characterized the Caribbean Sea and Gulf of Mexico as the “American Mediterranean.” Mahan argued that control over the region, particularly through the construction of the Panama Canal, would grant the US navy easy mobility between the Atlantic and Pacific, allowing it to quickly assemble its fleets without dividing them between two oceans, offering a safe commercial route for exports, and enabling it to block entry for military and economic rivals. 

   In the postwar period, this perspective was revived by Nicholas Spykman, who argued that South America is divided from “the American Mediterranean” through the Amazon Forest and Andes Mountains. Included in this conception of American territory was a large portion of Mexico, island chains along Central America, and northern South American countries like Venezuela and Colombia. With its proximity to the bi-oceanic choke point, Guyana was at the heart of this territory. It was in the US’s imperial interest to ensure that the state remained entirely dependent economically and militarily. It’s no coincidence, then, that along with Honduras, Aruba and Curaçao, El Salvador, Colombia, and Suriname, Guyana has long been forced to act as a military base and a defender of US regional interests.³ The discovery of oil has only exacerbated these imperial aspirations. 

   The US is not the only power invested in the future of Guyana. Guyana and Brazil share a 1605 kilometer porous land frontier in the Amazon. In the late nineteenth and early twentieth centuries, Brazilian military commanders like Mário Travassos and Carlos Meira Mattos viewed Guyana as a platform to access ports across the north of the continent, the Caribbean, and the South Atlantic. Guyana was seen as the ideal point from which to defend against US encroachments into South America. The rich strategic resources of the Amazon, it was held, would attract “external greed,” thereby necessitating close integration between the Amazon countries. In more recent decades, Brazil has acted on these goals through the promotion of a transnational development pole between Brazil, Guyana, and Venezuela. This aim, too, has been amplified by the oil discovery.

   Venezuela’s highly contested relationship to Guyana revolves around a territorial dispute over the Essequibo and maritime zones dating back to 1841, when British colonial powers invaded this rich territory. Though the dispute was nominally resolved in 1899 through international arbitration, it was never fully laid to rest. Venezuelan thinkers like Ruben Castillo presented the territorial loss as a disaster for Venezuela’s security and economy. In the 1960s, a new Venezuelan reading of the 1899 case led to renewed complaints filed to the United Nations (UN) in 1963 and 1965, holding that the earlier arbitration was skewed by British tampering with cartographic evidence and an imbalanced composition of the court. The result, according to Venezuelan legal theorists, was a “compromise obtained by extortion.”

   Following a commission of inquiry in 1966, Guyana and Venezuela signed the Protocol of Port of Spain, which suspended any claim to sovereignty over the territory for the following twelve years. Under the government of Hugo Chavez, a spirit of cooperation and integration ensued—including the forgiving of Guyanese debts with Venezuela and, under subsequent administrations, the exchange of rice and oil under the PetroCaribe agreements signed in 2009.⁴ 

   Exxon steps in

   With limited state capacity for extraction, processing, or regulation, research and exploitation of Guyana’s oil resources have been largely conducted by foreign companies—prominently American ones. ExxonMobil’s interest in Guyana dates back to the mid-1990s, when the company identified the country’s deep waters as an “area of interest for oil” after completing a series of geological surveys. In 1999, a subsidiary signed an agreement to drill, in a vast offshore concession. For years the company accomplished little, mainly because of the maritime border dispute between Guyana and Suriname, which began in 2000 and was resolved in 2007, paving the way for Exxon to restart exploration a year later. 

   In May 2015, Exxon announced its first major discovery in Guyana: the Liza 1 field. By 2020, Exxon had invested around $5 billion in Guyanese oil production; thus far, eighteen wells in the Stabroek block have been found, located about 200 kilometers off the coast of the capital Georgetown, in waters between 1500 and 1900 meters deep, the reserves approximately 3.6 kilometers below the seabed.⁵ Most of the wells are in the eastern territory of the Guyanese coast, outside of the Essequibo region. 

   Thus far, Guyana has not been able to meet the technological or skilled labor requirements necessary to develop its energy industry. Nonetheless, aspirations to build state capacity and increase investment have been the driving force behind domestic policy over the past decade. In 2018, the government announced its intent to form a national oil company and apply a local content policy, creating logistics centers and specialized scientific and technological institutes in addition to formulating appropriate tax legislation. Raphael Trotman, then minister of natural resources, made such plans explicit, while the ministry drafted local content policies. But no progress has been made; the prospect of a national oil company was last mentioned by the government in 2020.⁶ Faced with a major lack of capacity, the Guyanese government took on a $20 million loan from the World Bank in 2019, directed towards developing administrative and regulatory capacities in the oil sector, which currently depends on skilled laborers from neighboring countries like Trinidad and Tobago, Venezuela, Brazil, and the US.⁷ Unsurprisingly, Exxon and other large, private oil companies have been able to exploit the nascent stages of the industry by co-opting and influencing domestic politics. The existing ethnic and political divisions in the country have offered an ideal environment for such outside interventions. Since Guyana gained independence from the UK in 1966, the Indo-Guyanese population, making up 40 percent of the country and represented by the People’s Progressive Party (PPP), has contested power with A Partnership for National Unity (APNU), which represents the Afro-Guyanese population, who make up 30 percent of the country.

   In May 2015, the opposition APNU party, led by David Granger, won the Guyanese general elections, ending the PPP’s twenty-three-year cycle of incumbency. The APNU’s coalition government held a fragile majority, leading by only one seat. Just nine days after the election, ExxonMobil announced the success of Stabroek oil discoveries. The following year, Granger’s government signed a new contract with ExxonMobil that revised and amended the 1999 agreement. Despite some additional earnings for Guyana, the contract overwhelmingly favored the oil company. Many Guyanese citizens objected to the lack of transparency surrounding the contract. A clause granting an $18 million bonus to the government upon the contract’s signing generated even more suspicion. 

   When the contract was finally released to the public, it revealed enormous missed opportunities. Open Oil, a German analytics company, estimated that Guyana would absorb no more than 54 percent of the contract’s economic resources. For comparison, Ghana’s deal for offshore oil granted it 64 percent. A thorough analysis of the contract points out that in terms of area, the Guyana lease is more than 100 times larger than the US lease on the Gulf of Mexico. The Guyanese government will pay taxes on behalf of the contractor and is responsible for reimbursing all development costs in order to gain access to investment revenues, estimated at $20 billion by 2024. A contractual provision also prohibits Guyana from unilaterally renegotiating, amending, or modifying the agreement. 45 percent of the stakes in the Stabroek block are held by a consortium composed of a private US company called Hess Guyana Exploration and the state-owned China National Offshore Oil Corporation (CNOOC); the contract requires that the consortium be indemnified if any government action impairs the accrued economic benefits.

   Commercial production in Stabroek began in late 2019. Exxon was already producing 98,000 barrels of oil per day at Liza 1 in July 2020, aiming to reach 120,000 barrels the following month, and 750,000 barrels per day by 2025. If successful, these numbers would make Guyana the sixth-largest oil producer in the Americas.⁸ However, the Guyanese government recently estimated that the consortium produced and sold 31.8 million barrels in 2020 (87,000/day), its first full year of production, failing to meet the annual target of 100,000 barrels per day.⁹

   Some estimates suggest that future production has the potential to quadruple the country’s current GDP, with annual inflows of $15 billion; government revenues could reach $5 billion by the end of the next decade. Bolder estimates suggest that extraction could yield between $7 billion and $27 billion in gross revenues per year over the next thirty years.¹⁰ The excitement over the discovery was so great that Neil Chapman, a member of Exxon’s board of directors, called it “a fairy tale.”¹¹ Later in 2018, Rex Tillerson, ex-CEO of Exxon and former US secretary of state, claimed that the discoveries made it possible to “make our hemisphere the undisputed center of global energy supply.”¹² 

   These expectations have thus far shown to be over-ambitious. Exxon’s 25 percent return to investors in 2012 dropped to 6.5 percent in 2019, while its market capitalization dropped from $527 billion in 2007 to $150 billion today. With Exxon recently announcing that it would cut investments, the project in Guyana has become the key strategic asset for the company as it struggles to maintain investor confidence. 

   The return of empire

   In the meantime, the discovery of oil has also reignited century old global and regional disputes—such as tensions between Guyana and Venezuela. In 2007, Exxon cleared the way for its initial forays into Guyana just as Hugo Chavez nationalized projects managed by British Petroleum, Exxon, Chevron, Conoco Philips, Total and Statoil—projects constituting 25 percent of Venezuela’s oil production with more than US $17 billion in investments. Exxon soon entered into extended legal disputes against the Venezuelan government around oil exploration only to be defeated in court, suffering large financial losses.¹³ In October 2013, a Venezuelan navy ship intercepted an oil exploration vessel owned by the Texas company Anadarko Petroleum, escorting it and arresting its crew, which included five Americans. Opposition to the US and greater appropriation of oil revenue had been cornerstones of Chavez’s platform since the CIA-backed attempted military coup in 2002.

   Following Exxon’s 2015 discovery, the Venezuelan Navy declared an “integral defense zone” covering the maritime area in dispute with Guyana. The Guyanese government, supported by Colombia and Suriname, rejected this claim, promising to take the issue to the UN, Organization of American States, Caribbean Community (CARICOM), and the Commonwealth.¹⁴ The case was once again submitted to the International Court of Justice, with Guyana’s lawyers paid through Exxon profits. 

   Rising territorial disputes with Venezuela pushed Guyana even further into US hands, tying Guyanese defense with the economic interests of Exxon. The US has closely allied with Guyana to defend its strategic access to resources and preserve relations with an amicable government hostile to Venezuelan interests. In 2019, between May and August, the US Southern Command of the Armed Forces promoted the annual New Horizons military exercise in Guyana, providing training for its troops in engineering, construction, and medical care, involving a military apparatus disproportionate for the claimed purpose of humanitarian civic assistance. During the closing ceremony, General Andrew Croft, commander of the Southern Air Force, stated that Guyana is in a strategic location at the edge of South America and the Caribbean.¹⁵ Analysts have noted that the US military presence in Guyana is a maneuver to encircle Venezuela, adding to the US’s military presence and bases west of the country in Colombia.

   The US “war on drugs”—which has ensured a permanent pretext for military action in Latin America—has also extended to Guyana. The country falls under the Caribbean Basin Security Initiative (CBSI), formed by the US to combat drug trafficking in the region.¹⁶ The 2017 US National Security Strategy, as well as the US Bureau of Western Hemisphere Affairs’ 2020 US Strategy for Engagement in the Caribbean, determine the policy of engagement to combat drug trafficking and transnational crime in the Caribbean. 

   US militarization has been met by the increased economic and military presence of external powers allied to the Maduro government, notably China and Russia. The “oil for loan” model committed about half of Venezuelan oil revenues to China and Russia. Although it has a marginal participation in oil exploitation in Guyana, China is nonetheless a crucial actor in the global power dispute and in South America. In July 2018, the government of Guyana signed a memorandum of understanding with China to join the Belt and Road Initiative (BRI), with several projects aimed at transforming the Guyanese city of Lethem into a major commercial center. The Chinese state oil company CNOOC is the third largest operator of the Stabroek block.¹⁷ Guyana could be considered another potential target for China’s growing need to locate natural resources outside of its borders. 

   Between these competing developments, northern South America has again transformed into a battlefront for the great powers. While the US and EU dominate in Guyana and Suriname, Venezuela is host to China and Russia. As the competition over resources intensifies, the Greater Caribbean will continue to be a strategic region for American power—one in which the US government is willing to employ its vast global military presence. 

10. 100 Days of Milei

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    Lea este artículo en español aquí.

    Javier Milei’s election to the Argentine presidency in November sent shockwaves throughout the country. While the media personality was not altogether an outsider, his party La Libertad Avanza (LLA), formed in 2021, fundamentally lacked political experience. Until Milei’s inauguration in December, the LLA had no governors or representatives in the Senate, and only three seats in the Chamber of Deputies. 

    The long agony of Argentina’s stagnation, impoverishment, and inflation explains the success of Milei’s dystopian vision. Argentina ended 2023 in the red, marked by a 78 percent devaluation of the peso and a 1.8 percent decline in GDP. The average salary ($320 per month) was the lowest since the great crisis of 2001, with 44 percent of the population living below the poverty line. The country lacked financial reserves to deal with a suffocating external debt, and had an annual inflation rate of 160 percent and counting. Amid the successive crises of neoliberalism and the decline of progressive Latin American projects, Milei seized the presidency wielding a chainsaw and promising cuts, austerity, and collective suffering. 

    In the months since the election, many analysts have speculated about the types of policies the self-proclaimed libertarian capitalist might dare, and ultimately manage, to pass. Milei’s two most prominent proposals, the Urgent Necessity Decree (Decreto de Necesidad de Urgencia, DNU) and the “Omnibus” Bill, have been caught in limbo for weeks amid political disputes with the LLA’s opponents, and even some former allies. After the first one hundred days at the helm, what has Milei managed to achieve? And what does this herald for the years to come?

    A hectic agenda

    In his first week in office, Javier Milei formed a cabinet by co-opting some opposition leaders while keeping his distance from the political factions that had supported him in the runoff election (known as balotaje in Argentina). With precarious political alliances that he never ceased to regard with suspicion, Milei began to frenetically dominate the political agenda. Within days of assuming office, he presented his proposal for the DNU. Should it pass, it would involve the  privatization of several state-owned companies, the deregulation of price controls, the flexibilization of labor law, and the liberalization of real estate, energy, tourism, pharmaceutical, communication, and healthcare markets, among others.

    In its scope and dimensions, the DNU aims to reshape the entire social fabric of the country based on an ultra-capitalist dogmatism. In a similar vein, and quick off the block, Milei introduced an Omnibus Bill to Congress consisting of over 660 articles, symbolically named the “Law of Bases and Points of Departure for the Freedom of Argentinians.” Given its breadth and depth, the bill was practically a constitutional reform. Additionally, it included two points that raised alarms among both the political class and various social forces.

    The proposal called for declaring a public emergency with regard to economic, financial, tariff, energy, and administrative matters, which would grant Milei “extraordinary powers” to decide on these issues without Congressional approval for almost the entirety of his term. The law promoted a security code aimed at penalizing any form of social protest, such as imposing fines on organizations participating in protests or banning traffic interruptions, with penalties of up to five years for those who “lead, organize, or coordinate a meeting or demonstration” that obstructs urban circulation.

    Milei did not have much luck with either initiative. On the same night as the decree was announced, protesters filled the streets of Buenos Aires. Even more powerful was the call for a general strike at the end of January. At the same time, the judiciary responded to requests for precautionary measures presented by civil associations and union centers, ultimately deciding to declare the unconstitutionality of several points of the decree. This led to various amendments including scaling back proposals that deregulated labor laws, limited the right to strike, and relaxed the contractual indemnity regime.

    When it came time to pass the bill through Congress, the government encountered unexpected opposition from liberals and conservatives alike, including many of those it saw as  potential allies. After two weeks of unsuccessful sessions, the LLA failed to secure the necessary votes to approve the law in the Chamber of Deputies, though this was largely due to the party’s parliamentary inexperience and the executive branch’s intransigence.

    One week later, Milei opened a new front of the conflict with lawmakers, sparring with provincial governors over the distribution of taxes and national resources. This had the effect of triggering something of a rebellion among the governors, reviving the historical dispute between federalism and centralism. Why Milei opted to provoke both  governors and political factions that had supported him in the runoff election remains unclear. Was it a strategy to monopolize all right-wing votes or simply an effort to take advantage of the honeymoon period of the first one hundred days of government, pushing through as many reforms as possible? The possibility that the decision was simply a consequence of Milei’s political ineptitude in building alliances should not be underestimated.

    Of course, governing effectively requires engaging with the different political functions of state and social forces. The LLA only holds thirty-eight out of 257 seats in the Lower House, and seven out of seventy-two in the Upper House. It holds no gubernatorial or mayoral seats, nor does it have its own political structure in the provinces. With this weak political base, governability depends on the support of other political forces. In a country with a long tradition of social organization, during a social crisis that shows no signs of improvement, government action is never disconnected from the streets. 

    The adjustment

    The complete deregulation of prices, the removal of energy subsidies, and the 100 percent devaluation of the Argentinian peso against the dollar have all contributed to the inflationary momentum, resulting in a nearly 50 percent increase in prices in December and January alone. It should not be imagined that this is not a substantive part of Milei’s economic plan. From the outset, the anti-inflationary policy essentially consisted of eroding wages and pensions and inducing a brutal self-imposed recession.

    This has involved significant spending cuts. According to data published by the Congressional Budget Office, total expenditures of the National Administration in January recorded a real year-on-year decline of 11.9 percent; social programs were the hardest hit with a nearly 60 percent cut compared to the previous year. The situation is dire. 

    In such circumstances, there has been a significant loss of purchasing power of formal wages. While Argentina still maintains a high level of unionization compared to other Latin American countries, providing some level of protection through wage negotiations and labor struggles, Milei’s government has taken particular aim at labor and is clearly working to weaken its remaining power. The situation is different for informal workers and self-employed individuals, who account for 45 percent of Argentina’s workforce and depend on the daily level of economic activity.

    Middle-class households have also been hit, as the cost of private education, healthcare, vacations, and fuel have increased above the average inflation rate, and there are no savings instruments to protect against these rising costs as a result of low interest rates.

    While the crisis is certainly hitting hardest in the lower-income sectors, its impact is even more pronounced for women. The “feminization” of poverty deepens as each crisis intensifies income inequality, unequal access to the labor market and, with it, unequal distribution of caregiving responsibilities. It’s worth noting that, along with women, transgender, transvestite, and non-binary individuals—who are absent from public statistics—record the highest levels of informal employment.

    Equally alarming is the situation of retirees and pensioners, a sector that has been severely affected by the two previous administrations but has now become the primary variable for adjustment to achieve the desired fiscal surplus: the reduction in pension spending, through a fierce reduction in pensions, accounts for 1.5 percent of the projected reduction in the fiscal deficit for this year.

    This combination could pose a problem for Milei, who found support among all these sectors during the election. It also marks a crucial point for a government that so far seems unwilling—or perhaps unable—to translate that popular support into institutional strength. Economic signals are also unclear, and the president seems more focused on polarizing the electorate against the amorphous enemy, which he calls the “establishment,” than on managing the state, forging alliances, alleviating the social crisis, and charting a comprehensible economic model.

    The Milei chapter

    For the time being, polls show that Milei continues to enjoy high support among those who voted for him, although he has not managed to gain new supporters in an increasingly polarized society. As time passes and the crisis worsens, patience for Milei’s “anti-establishment” government is likely to wane. On the night of December 20, following the announcement of the DNU via national broadcast, protests erupted at the gates of the National Congress. The chosen date carries significant symbolic weight due to the events of December 19–20, 2001, when nationwide uprisings erupted in response to the government’s efforts to pass its so-called Anti-Picketing Protocol. Those protests ultimately led to the resignation of the president, thirty-nine deaths, and the beginning of a political crisis that would give rise to a new historical cycle. Security forces were deployed at the access points to the City of Buenos Aires; police officers filmed passengers and checked their belongings on public transportation, while station loudspeakers broadcasted intimidating messages. The government aimed to assert its stance against some of its main political enemies—social organizations—and thus solidify its policy of controlling, disciplining, and persecuting social protests.

    Forty-five days into his term, Javier Milei faced a multisectoral general strike: social movements, feminist collectives, cultural organizations, and recently reactivated neighborhood assemblies joined with labor unions, turning the strike into a genuine cross-movement protest against the Omnibus Bill and the DNU. It is still too early to tell if such strike activity will continue, but the alarm bells are ringing. In March, the start of the school year and conflicts over salary negotiations in the education sector coincided with the two most important mobilizations in the country: the 8 March feminist strike and the march for human rights, scheduled for March 24.

    Following the parliamentary defeat of the Omnibus Bill, the government insists on almost daily provocations to different sectors: defunding cultural organizations, announcing changes in immigration laws, statements about repealing the abortion law, and closing human rights-related agencies. This is a strategy of opening multiple simultaneous fronts to generate wear and tear and, consequently, lower levels of mobilization.

    This poses a strategic challenge for popular organizations, which must respond to each specific government attack. Nonetheless, Argentina’s powerful tradition of grassroots resistance remains the greatest threat to Milei and his government. Milei may well be trying to reshape the social fabric of Argentina, but after his first 100 days in government, whether or not he’ll be able to do so remains unclear. 

    This essay was translated from Spanish for Phenomenal World by Maria Isabel Tamayo.