MMP Blog #45: The JG and Affordability Issues with Special Considerations for Developing Nations

By L. Randall Wray

Affordability Issues. As we have seen over the course of the previous 44 blogs, a sovereign nation operating with its own currency in a floating exchange rate regime can always financially afford an JG/ELR program. So long as there are workers who are ready and willing to work at the program wage, the government can “afford” to hire them. It pays wages by crediting bank accounts. If it credits more accounts than it debits through tax payments, a deficit results. This initially takes the form of net credits to the banking system, held as reserves. If the reserve holdings are excessive, banks bid the overnight rate down. The government can then either choose to let the overnight rate fall toward zero (or its support rate if it pays interest on reserves), or it can intervene to sell interest-paying bonds at the desired support rate; this will drain excess reserves. In no sense is the government spending on JG/ELR constrained either by tax revenues or the demand for its bonds.

Nor will spending on the JG/ELR program grow without limit. As discussed earlier, the size of the pool of workers will fluctuate with the cycle, automatically shrinking when the private sector grows. In recession, workers shed by the private sector find JG/ELR jobs, increasing government spending and thereby stimulating the private sector so that it will begin to hire out of the pool. Estimates by Phil Harvey and Wray put net spending by the government on a universal JG/ELR program at well under 1% of GDP for the US; Argentina’s Jefes program (a limited JG/ELR program) peaked with gross spending at 1% of GDP (this figure undoubtedly overstates net spending because in the absence of the Jefes program government would have had to provide more spending on other anti-poverty programs).

As discussed, a floating exchange rate provides the “degree of freedom” that allows the government to spend without worrying that increased employment and higher demand will threaten an exchange rate peg—by possibly increasing domestic inflation and/or increasing imports. Thus, fiscal policy is “freed” to pursue other objectives, rather than being held hostage to maintenance of the peg. By the same token, monetary policy can set the overnight interest rate to achieve other goals, rather than being determined by the rate consistent with pegging the exchange rate.

This is not to imply that the government will necessarily avoid any consideration of impacts on exchange rates while forming fiscal and monetary policy. However, if achievement of full employment is believed to conflict with maintenance of a constant exchange rate, the government in a floating currency regime can choose full employment. On the other hand, on a fixed exchange rate, a government that has insufficient foreign exchange reserves may not be able to “afford” to spend to promote full employment if that might lead to loss of reserves. In the next section we see how such a government could still implement a version of the JG/ELR program.

 The JG/ELR for a Developing Nation. A small developing nation presents several challenges. First, it may produce a small range of commodities and import a large number of types of goods that it does not produce (although many of these may not directly enter the consumption basket of much of the population). Further, its exports might be limited to an even smaller range of commodities. Growth of monetary income could immediately pressure the exchange rate.

Second, the formal sector could be small, with most production and employment in the informal sector—and with a large disparity between wages paid in the formal versus the informal labor markets. Third, the administrative capacity of the national government might be quite limited. Domestic infrastructure might be inadequate to allow significant expansion of productive capacity. And finally, its exchange rate is likely to be pegged.

If a universal JG/ELR program is implemented nationally with a wage equal to the minimum wage in the formal sector, there would be a flood of workers from the informal sector. Monetary incomes would rise and the demand for consumption goods—including most importantly the “luxury” imports that had been beyond reach for most of the population—would increase. The trade balance would deteriorate and the government would quickly lose the international reserves necessary to maintain the peg. Domestic prices would rise (although direct pressures on prices of domestically produced goods would be limited if these were inferior goods, mostly purchased by poor families), but more importantly, import prices would rise as the currency depreciates. An exchange rate crisis would be likely to trigger an economic crisis.

Is there any way to avoid these consequences?

First, let us see how this nation can reduce impacts on prices, the exchange rate, and the trade balance. It will need to limit the program’s impact on monetary demand, which can be done by keeping the program’s monetary wage close to the average wage earned in the informal sector. Thus, rather than setting the wage at the minimum wage in the formal sector, it is set at the wage of the informal sector.

However, poverty can be reduced if the JG/ELR total compensation package includes extra-market provision of necessities. This could include domestically-produced food, clothing, shelter, and basic services (healthcare, childcare, eldercare, education, transportation). Because these would be provided “in kind”, the program’s workers would be less able to use monetary income to substitute imports for domestic production. Further, production by the workers could provide many or most of these goods and services—minimizing impacts on the government’s budget, as well as impacts on the trade balance.

If the program directly provides basic necessities as well as monetary income equal to that previously earned in the informal markets, there will be some net impact on monetary demand. Further, production by JG/ELR workers might require imports of tools or other inputs to the production process. Careful planning by government can help to minimize undesired impacts.

For example, imports of required tools and materials can be linked to export earnings or to international aid. Because production techniques used in a JG/ELR program are flexible (production does not have to meet usual market profitability requirements—as Mat Forstater has shown), government can gradually increase “capital ratios” in line with its ability to finance imports. Further, JG/ELR projects can be designed with a view to enhance the nation’s ability to increase production for export. The most obvious example is the provision of public infrastructure to reduce business costs and attract private investment.

A phased implementation of the program will help to attenuate undesired impacts on formal and informal markets, while also limiting the impact on the government’s budget. Further, starting small will help the government to obtain the necessary competence to manage a larger program. For example, Argentina limited its program by allowing participation by only one head of household from each poor family.

The program can start even smaller than that, allowing each family to register a head of household, but allocating jobs by lottery so that the program grows at a planned pace. The best projects proposed by individual community organizations (for example, at the village level) can be selected to employ a given number of heads of households from the community (again, with selection of workers by lottery).

Decentralization of project development, supervision, and administration can reduce the administrative burden on the central government while also ensuring that local needs are met.

As another example, India implemented a JG only for rural workers, who now have the right to demand 100 days of work. Limiting the program to rural workers helps stop the migration of population to cities in search of jobs, and limiting the program to 100 days of work per year reduces the number of projects to be created (and also reduces disruption in the local agricultural sector that typically needs labor for only part of the year; the program employs workers when they are not employed in agriculture).

International aid agencies can provide some financing for the ELR program, as they did in the case of Argentina’s program. Of course, a sovereign government can always pay wages in the domestic currency. So international aid is not needed in order to pay the wages. However, if imports increase because of poverty reduction, the international aid can provide needed international currency. Further, the program might need some tools or equipment that must be imported. For these reasons, international aid in the form of foreign currency could be welcome in some cases.

However, international borrowing should be avoided unless the JG/ELR program will directly increase exports to service international debt. Some of the output of the JG/ELR program can be sold in domestic and perhaps in international markets to generate revenue. For example, Jefes workers in Argentina produce clothing and furniture that is sold in formal markets. Further, some of the output of the program can substitute for government purchases; for example, Jefes workers produce uniforms for the government. Generally, however, JG/ELR production should not compete with the private sector. And government should avoid building up foreign currency indebtedness that would be difficult to service.

Finally, government can use the traditional methods of protecting its trade balance and exchange rate peg: tariffs, import controls, and capital controls. Remember: JG is an add-on program. To the extent that JG/ELR raises monetary wages and monetary consumption its impact on the trade balance and exchange rates is similar to the impact of domestic growth more generally. The arguments for and against “intervention” in the area of international trade and capital flows are well-known and need no further discussion here. While there has been a strong bias against such intervention, the consensus has shifted somewhat in recent years toward the view that protection is acceptable on a case-by-case basis.