Macroeconomic policy for inclusive development

In a recent article in The Daily Star, I had mentioned that in a developing country like Bangladesh, macroeconomic stability should not be the goal of macroeconomic policy, rather it should be a means towards attaining the broader goal of inclusive development. In that sense, it would be necessary for macroeconomic policy to have a development orientation. The purpose of the present article is to provide a broad outline of how that could be achieved.
The important elements of inclusive development include:
* Stable and sustained economic growth;
* Reduction of poverty and inequality;
* Improvement in the access to education and health services;
* Greater opportunities for productive employment; and
* Basic social protection floor for all citizens.
Since high rate of economic growth is the first item in the above list and since that is a pre-requisite for attaining the other goals, one should start there. Investment -- both public and private -- is a major driver of growth; hence policies must be geared towards that objective. While interest rate is a major determinant of investment, that's not the only factor -- especially in a country like Bangladesh. Infrastructure, including power, transport, and communication are critical factors. Improvements in these areas are essential, and that would require investment -- especially by the government. Hence, in formulating the fiscal policy, emphasis must be on public investment in infrastructure and creating necessary fiscal space for that.
If the government has to incur a budget deficit -- as is often the case in developing countries with limited internal resources -- it must look for non-inflationary means of financing the deficit. For example, borrowing from the banking system may be inflationary while mobilising private savings would not be. However, instruments necessary for using the latter, e.g., interest on deposits and other instruments of savings, may have an impact on overall interest rates and hence private investment. But as mentioned earlier, interest rate is not the only factor governing investment, and an increase in savings is anyway needed for higher investment.
As for the sustainability of budget deficit, it is necessary to identify the maximum permissible share of interest payment in GDP, and compare the actual with that maximum. If the actual is less than the maximum, fiscal deficit would not be constrained by public debt. Whether this constraint would be binding would depend on the interest rate paid by the government on its borrowing and the economy's growth rate. The former would raise the debt-service ratio whereas the latter would reduce it. From this point of view also, maintaining a high rate of growth would be important.
Reduction of deficit may be achieved by a prudent management of public expenditure rather than through blanket cuts in expenditure. Public investment in infrastructure and expenditure on education and health services must be safeguarded. While the former is essential for creating incentives for further investment, especially by the private sector, the latter is essential for attaining the human development goals.
Monetary policy is important for fighting inflation. But it would be important to examine the components of inflation and their determinants and undertake measures to fight inflation accordingly rather than following the orthodox approach of adopting a restrictive monetary policy at the first sight of inflation. If supply side factors like shortfall in production of some commodities, rise in the prices of imported goods, or a general increase in global market prices, are found responsible for inflation, measures would have to be formulated to address such factors.
In order to maintain equilibrium in the balance of payment and avoid (or reduce) trade deficit, it would be important to let the exchange rate reflect the true price of the domestic currency. This may be done by allowing the exchange rate to change smoothly through "controlled devaluation" (i.e., the adoption of "crawling peg system"). The impact of devaluation on both exports and imports should be monitored carefully to see whether it is producing the desired effects and whether inflation is being imported through higher prices of imports (as depreciation of the domestic currency will increase the domestic prices of imported goods).
What's the current situation in Bangladesh? If the goal of employment is regarded as important, the following numbers will have to be considered. Every year, some 1.8 million people enter the labour force for whom employment is needed (not to speak of the already unemployed and underemployed). Assuming that 500,000 people can find jobs abroad, we would still be left with a minimum of 1.3 million. Add to that the backlog of unemployed and that the goal would be to employ at least 300,000 of them. Thus we would need domestic employment for at least 1.6 million every year.
On the side of demand for labour, every percentage point of GDP growth has been found to create some 250,000 jobs. Hence, in order to generate 1.6 million jobs per year, a GDP growth of 6.4% would be absolutely essential. And if the employment goal includes the transfer of some of the underemployed to better jobs, the required GDP growth would be correspondingly higher. Hence, macroeconomic policies must be geared towards achieving GDP growth of over 6.5% per annum.
Given the current investment requirement per unit of GDP growth, the rate of investment required for achieving a GDP growth of 6.5% would have to be about 26% -- unless of course the pattern of growth changes in such a way that investment requirement will be lower. For example, if more of output growth comes from relatively more labour intensive sectors, e.g., labour intensive manufacturing, construction and low end services, investment requirement may be correspondingly lower. Fiscal and monetary policies could be used not only for achieving the investment rate indicated above but also the desired change in the pattern of growth.
Since the goal of inclusive development includes the implementation of a basic social floor, budgetary provision would need to be made for measures aimed at that goal. There is already a plethora of social safety net measures that cost the government some 2.5% of GDP. One example may serve to indicate the fragmented nature of such programmes and the need for a serious re-thinking of the strategy for social protection. Under the old age allowance scheme, an amount of Tk.300 per month is paid to the old in poor households. The number of people currently covered by the scheme is about 2.5 million -- which is less than 6% of the total number of poor people in the country. And the amount paid per person is not even equal to two days of unskilled workers' wages. The above example should serve to highlight the need for a serious review of the effectiveness of the existing measures, their rationalisation, and adoption of a national framework for social protection for all with a particular focus on the poor. Experiences of some developing countries (e.g., Brazil) indicate that the effective use of cash transfers can contribute significantly to the reduction of poverty and inequality. The budgetary implication for such a comprehensive policy in Bangladesh would have to be worked out, and fiscal policy would need to be geared towards meeting that need.

The writer, an economist, is former Special Adviser, Employment Sector, International Labour Office, Geneva.