Examine Kalecki’s model of financing development. What relevance does it have for contemporary developing countries?

Kalecki’s model of financing development

Kalecki’s model of financing development may have somewhat to be reviewed in parts due to its historical perspective and being written in the 1960s (Sawyer, 1985), however some of the points of the model, particularly to do with aid, lose little of their poignancy for today’s developing countries. First let us begin by giving an overview of the model.

Kalecki decides to begin by looking at a highly simplified model and then throughout remove assumptions and thus add to the model piece by piece in order to ease the explanation (Kalecki, 1993). Thus Feiwel, 1975, puts them into 6 sections and it is through this methodology I shall explain it.

The assumptions made under the first ‘approximation’ are described below. These assumptions will be disposed of in later stages, recognising that developing countries depend to a great extent on foreign trade and that public expenditure and revenue are important (Kalecki, 1993). The first is that the economy is a closed economy, i.e. an economy with no relations to alien economies and not engaging in foreign trade, with little to no government expenditure or revenue (Kalecki, 1993). Another assumption is of 3 social classes, namely; ‘Capitalists’, ‘Workers’ and ‘Small Proprietors’ of which the ‘small proprietors’ includes the poor peasants, artisans and small shopkeepers (Kalecki, 1993). To simplify the next concept, this group and the ‘workers’ are assumed to consume the entirety of their income and therefore we also assume that all savings are made by capitalists (Kalecki, 1993). First of all we take the economy and split it into 2 sectors: investment goods as Sector I and consumption goods as Sector II, with raw materials and fuels being entered into each according to how they are utilised by each (Kalecki, 1993). The accumulated inventories of each of the goods are included respectively in each aggregate (Kalecki, 1993). In both sectors part of the profits made from the products which are consumed are saved by capitalists and the left over are savings (Kalecki, 1993). The excess of goods in Sector II, i.e. that which is not consumed by the workers and capitalists of Sector II, is consumed by the workers and capitalists of Sector I (Kalecki, 1993) (Feiwel, 1975). The savings of the Sector 2 capitalists is then spent on investment goods of Sector 1 and the savings made by the capitalists there are reinvested (Kalecki, 1993) (Feiwel, 1975). Thus it can be said that Savings  equal Investment and that investment finances itself (Kalecki, 1971) (Kalecki, 1993). However, the crux of the matter is whether inflationary pressures are created at this point due to a failure to expand the consumer goods supply in response to the extra demand (Feiwel, 1975). If Sector II’s capacity is fully utilised but not increased then a ‘price-wage spiral’ will ensue (Feiwel, 1975). Conversely, if the capacity is increased then ‘output of consumer goods… will satisfy increased consumption by workers and capitalists in Sector 1’ (Feiwel, 1975). Basically, inflation is compelled by ‘conditions of consumer good supply’ (Feiwel, 1975).

In the second ‘approximation’ we remove the assumption of there being no public investment, i.e. government expenditure financed by government loans (Feiwel, 1975). The investment is still equal to savings under this relaxation and thus inflation still is determined by the ‘conditions of the consumer goods supply’ (Feiwel, 1975). The fact that public investment doesn’t have to be inflationary is an important point, showing it is not necessarily worse than private investment and the government can ensure investment where perhaps it would not have otherwise occurred or private investment would have been kept low (Kalecki, 1993).

Moving to the third ‘approximation’, we look more at the elasticity of consumption goods and differentiating the departments (Kalecki, Collected Works of Michal Kalecki. Volume V, Developing Economies, 1993) (Feiwel, 1975). Kalecki says that in the developing countries the supply for the industrial consumer goods will be elastic while supply for the agricultural, in particularly foodstuff (the most basic necessity), goods tends to be rigid due to ‘institutional factors’ possibly bringing about the aforementioned price-wage spiral (Feiwel, 1975). Then again the food supply won’t be falling as labour transfers to industry from agriculture but may ‘augment per capita peasant consumption’ or ‘leave a surplus of agricultural surplus to be marketed’ (Feiwel, 1975). This won’t meet the extra demand because Kalecki assumes that urban workers demand more than rural workers (Feiwel, 1975). Where there are higher food prices by which peasants are gaining then there should be an increase in demand for industrial goods which may counterbalance the problem as standards of living rise for peasants and savings accrue once more to pay the higher wages in industrial sector (Kalecki, 1993) (Feiwel, 1975). However if the profits go to landlords, merchants or money lenders then there may be only increased demand of luxury goods (usually imports) and thus no counterbalance (Feiwel, 1975) (Kalecki, 1993). Thus it may be said that inflation can be prevented if food supply is adequate or there is an increase in industrial productivity (Feiwel, 1975). On the other hand this industrial productivity increase may mean less employment and, despite more demand from agricultural workers, a stoppage of the migration of labour to industry which may be seen as undesirable (Feiwel, 1975) (Kalecki, 1993). At this point the distribution of income in industry should be noted, as the degree of monopoly may rise and this will raise the share of profits and lead to prices of industrial good rising and cutting into real wages, affecting demand (Kalecki, 1993).

The fourth ‘approximation’ is the introduction of foreign trade and a look at its effect on the international terms of trade [Feiwel, 1975]. Developing countries will find that the increased demand for capital goods and some ‘raw materials and semi fabricates’ cannot be met by domestic production and so are imported making growth in both parts of the Sector hard to parallel but if they can import these goods then the volume of investment can be allowed to expand (Kalecki, 1993) [Feiwel, 1975]. There may also be importing of food where domestic production doesn’t suffice which can reduce inflationary pressures by increasing the supply of the consumer goods (Kalecki, 1993) [Feiwel, 1975]. The problem is, to fund the imports there should be exports but if the supply of consumption goods isn’t adequate to export then the desired import goods themselves can’t be bought due to lack of foreign currency [Feiwel, 1975]. On top of this, Kalecki sees the problem in deteriorating terms of trade which occurs where entering the foreign markets leading to increased import demand but suggests that there should be a response of ‘restrictions on imports of non-essentials’ [Feiwel, 1975]. Here is a very important part of the model: Kalecki views the solutions to the terms of trade problem often suggested, i.e. grants, loans and/or [foreign] direct investment [Feiwel, 1975].

Kalecki rules out grants due to the policy and political conditionality which often comes with the grants and can affect undesirably the following pattern of growth [Feiwel, 1975]. Of foreign direct investment Kalecki cases that it won’t be made with the longer-term development needs in mind, companies will gain political power which also isn’t in the long-term development interests and furthermore may be a drain later on the Balance of Payments [Feiwel, 1975]. Instead then, loans would appear to be the most viable option, when there is the condition that they are paid back via exports to the lender in specific goods would be most desirable [Feiwel, 1975]. Then again, Kalecki does recognise that the gaining of loans may be difficult due to the risk which may be perceived (Kalecki, 1993). To ‘prevent flight of visible capital and hidden transactions in forms of deflated export prices’ it is suggested that transfer of dividends by foreign enterprises could be restricted [Feiwel, 1975]. Since import of capital within the balance of payments is seen as an improvement of terms of trade, to help with this then export and import duties may be introduced to prevent profit repatriation by increased export prices or a drop in import prices [Feiwel, 1975].

The fifth ‘approximation’ introduces the ability of taxes to partially or fully finance investment, with the savings cut being equal to the ‘corresponding given level of investment’ [Feiwel, 1975] (Kalecki, 1993). The tax should be raised from capitalists (which include landlords) as consumption and savings would only be partially reduced and not cause lower real wages whereas taxation of lower-income groups would [Feiwel, 1975]. It will lead to less demand for imported luxury goods but not wage goods, i.e. it will have a limited effect on domestic demand, and will reduce ‘speculative hoarding’ as liquid assets become less available and turn them to productive investment [Feiwel, 1975]. If the tax were to affect wage goods then it may be used to fight inflation by curbing effective demand [Feiwel, 1975]. This taxing of profits will also help to relieve inflationary pressures [Feiwel, 1975]. Profit taxes should not be a disincentive for private investment as the taxes should only tax away the profits created by public investment in the first place (Kalecki, 1993).

In the sixth ‘approximation’ we consider the banking credit restriction which may be used to depress investment and decelerate the pace of development and thus curb inflationary pressures [Feiwel, 1975]. This is also doable via directly alleviating state investment or some licensing of private investment (Kalecki, 1993). The credit restrictions however, while they may be used to prevent hoarding if used ‘highly selective[ly]’ , if there is no hoarding will only hamper the development process (Kalecki, 1993). This may be ineffective due to the special purpose credits being used for speculative hoarding with the ‘release [of] the firm’s own funds... mak[ing] them available for speculative activity’ (Kalecki, 1993). Another choice is a revaluation of deposits, government bonds and banking credits constantly ‘according to established price indices’ (Kalecki, 1993). However these are not fighting primary but secondary inflation it should be remembered, which may only be prevented by ‘economic policies embracing the whole development process’ and is important in Kalecki’s constant assumption that there will not be taxing or eating up of the real wages of the lower income group (Kalecki, 1993).

Relevance for contemporary developing countries.

Now we come to the question of the relevance of Kalecki’s model for developing countries. The relevance in terms of policy making can be seen in Kalecki’s treatment of aid, control of investment and price stability (Sachs, 1977), and in ‘his ability to see the interplay between politics and economics’ [Sachs, 1977]. However there are some criticisms which also can be levelled at the model.

Kalecki’s model does not recognise totally that exports may be an effective engine of growth (Chakravarty, 1997). For example in countries which have financed development while keeping unequal distribution of wealth such as Brazil. Brazil’s economy is ranked in the world top 10 as one of the richest yet it is also noticeable that the tax system is regressive (Beghin, 2008). It could be pointed out that this does not go against the whole of Kalecki’s model, simply against the assumption of that the poor not paying for investment, however this is a fundamental to the model . Furthermore, the use of taxes has been shifted away from investment and social policies towards paying the interest on debts. So it would seem that without following much of Kalecki’s model in terms of preventing real wages losses they still achieved serious growth  pushed by exports used to fund capital imports (which doesn’t contradict Kalecki but they haven’t developed a home market as the model prescribes (Beghin, 2008) (Kalecki, 1993)). Thus we look at next the role of aid in Kalecki’s model and in terms of today’s developing economies.

‘Kalecki was perhaps correct in his scepticism of finance via grants, loan, and direct investment. Jayati Ghosh points out that in terms of Kalecki’s insistence that foreign cash and capital inflows: led to easing of supply bottlenecks and balance of payments, and; that the increased investment was in appropriate goods (i.e. not luxuries) (Ghosh, 2011). In fact she further says:

‘Even the most cursory examination of the experience of the past two decades will suggest that according to these basic criteria, most of the foreign capital inflow into developing country “emerging markets” in the era of globalisation did not achieve these most obvious goals of development.’ (Ghosh, 2011)

Alesina & Dollar show that aid patterns show that FDI is more likely to flow to countries applying economic liberalisation (Alesina & Dollar, 2000) while Hefeka & Michaelowa show that

‘while conditionality improve the situation of the poor [as would be in line with Kalecki model ] in developing countries if IFIs and donor governments are benevolent, this is no longer ensured if either or both pursue self-interested policies. In particular, if they are pressured by business interests... it can also follow that the poor will actually lose’ (Hefeker & Michaelowa, 2005).

This shows that developing countries today still ought to show some scepticism when it comes to foreign aid, for example there is evidence of donors prescribing policies on Thailand in the 70s (Thandee, 1988) and the evidence of lower growth due to loan problems in the 1980s throughout LDCs (Sawyer, 1985) which further display the relevance of Kalecki’s model.

Pairing this with Kalecki’s views on investment controls, when one looks at China we can see some effectiveness of controlled foreign investment and credits aimed towards investment in accordance with development (Laurenceson & Chai, 2001) and the banks use by the state for infrastructural development. Where agricultural investment is concerned the directed investment can be seen as State owned enterprises dominate the lending of credits (Laurenceson & Chai, 2001). Thus Kalecki’s rejection of the ‘market-failure paradigm’ which assumes that ‘market economies are likely to perform better’, may be pertinent one (Chakravarty, 1997) and be relevant where Laurenceson and Chai say that development banks should not be judged by efficiency as banks in developed countries would be judged (Laurenceson & Chai, 2001). This shows the relevance of Kalecki’s model.

Chakravarty points to some limitations of Kalecki’s model in the context of India, where he says that Kalecki’s understates intersectoral relationships in a developing economy and the ‘strategic importance of self –reproducing capital goods sectors’ which are emphasised in the Mahalanobis model (Chakravarty, 1997). He says that although this is a limitation for the model in terms of large countries such as India the model has actually prevailed, perhaps, since in India the agricultural land productivity per acre has ‘stayed nearly the same’ and the Mahalanobis model has not helped reach a ‘high enough growth path’ (Chakravarty, 1997). In terms of India (and many other emerging economies for that matter), the ‘massive tax evasion’ must also be recognised as a potential limitation to the model (Patel & Chandavarkar, 2006). Furthermore, the East Asia land reforms may well have played the role Kalecki forecasted, although this must be tentatively approached due to ‘extraneous economics’ such as the very high foreign aid per capita rates in South Korea and Taiwan (Chakravarty, 1997). Finally, and agreeing with the original concern of the need to adjust the model to the time of Sawyer, Chakravarty points out that outsourcing of labour is also not recognised in the analysis of Kalecki (Chakravarty, 1997) although this recognition of the importance of historical and political backgrounds is an important strength (Chakravarty, 1997) (Sachs, 1977).

It seems to me that although some parts of the model may need to be updated naturally due to a change over time and the emergence of over models and examples of development, and although some naivety may be suggested at parts of the model due to simplification, it is in Kalecki’s emphasis of the ‘interplay between politics and economics’ and his insightful look at the dangers of aid that may have relevance still for developing countries today.

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