The limits of conventional macroeconomics: Why one needs to focus on structural transformation and inclusive development

By Iyanatul Islam (ILO) and Anis Chowdhury (UN-ESCAP)1,2

Conventional macroeconomics as applied to developing economies is part of an overall framework that has a rather narrow conceptualization of economic stability based on certain thresholds: low, single digit inflation (usually less than 5%), fiscal deficits of less than 3% of GDP, debt to GDP ratio of 40% or less, and foreign exchange reserves that can meet at least three months of import coverage. It is argued that sustaining these thresholds engenders ‘market confidence’ that is key to fostering investment, growth, employment and poverty reduction. This template provides the motivation for the observation in the World Bank’s 2013 World Development Report (WDR) on Jobs when it claims that macroeconomic stability is one of the ‘fundamentals’ of growth and employment and even suggests that counter-cyclical fiscal policy is ineffective in developing countries.

The IMF’s 2013 Jobs and Growth Report (JGR) complements the 2013 WDR by observing that “one element of the approach on which there is little disagreement is the critical importance of macroeconomic the essential foundation for any growth strategy”. Macroeconomic stability is then defined in terms of ‘low inflation and sustainable public finances and external positions’.

The widespread practice of targeting low, single digit inflation was first initiated by the monetary authorities in New Zealand in 1990. Two years later, the Maastricht Treaty became the most famous example of both inflation targets and fiscal rules that were formally adopted by the members of the Eurozone.
Although the rules and targets pertaining to macroeconomic management were led by policy-makers in the developed world, they continue to influence the design of macroeconomic policy in developing countries. This is evident, for example, from the convergence criteria of currency unions and regional economic groups in Africa. This proclivity to stick to rules and targets persists even among the Bretton Woods institutions despite disappointing findings from their in-house research.

For example, the World Bank’s Lessons from the 1900s (2005, p. 95) concluded: “Macroeconomic policies improved in a majority of developing countries in the 1990s, but the expected growth benefits failed to materialize, at least to the extent that many observers had forecast. …(They) were symptoms of deficiencies in the design and execution of the pro-growth reform strategies that were adopted in the 1990s with macroeconomic stability as their centerpiece.”

The IMF-World Bank Development Committee in its 2006 interim report noted: “In a development context, fiscal policy serves both as an instrument of macroeconomic stabilization and as an instrument to achieve growth and poverty reduction objectives. In many developing countries, however, fiscal policy focus[ed] largely on the goal of stabilization. Correspondingly, growth and poverty reduction objectives were under-emphasized.”

It further noted: “The fiscal deficit is a useful indicator for purposes of stabilization and for controlling the growth of government liabilities, but it offers little indication of longer term effects on government assets or on economic growth.” It also observed that countries reduced their fiscal deficit to stabilize their economies “often by cutting public capital formation significantly, despite its potential negative impact on growth and poverty reduction.”

In light of these observations, it is not surprising that the IMF has made the following acknowledgement: “there is no simple relationship between debt and growth. In fact, our …analysis emphasizes that there are many factors that matter for a country’s growth and debt performance. Moreover, there is no single threshold for debt ratios that can delineate the ‘bad’ from the ‘good’.”3

It would be foolish to argue that macroeconomic stability does not matter. Hyperinflation and out-of-control debts and deficits kill growth. On the other hand, the restoration of stability will not automatically engender self-sustaining growth. More importantly, upholding the entirely appropriate principles of price stability and fiscal sustainability should not be reduced to some simple and restrictive targets.

In understanding the limits of conventional macroeconomics, one needs to reiterate the customary distinction between growth and development. The latter is best characterized by a process of structural transformation in which resources shift from low to high productivity sectors. It is this process of structural transformation that occupied the attention of ‘first-generation’ development economists. They recognized that it is possible to have the ‘wrong’ kind of structural transformation or growth without structural transformation.

Even if a country experiences sustained per capita income growth following macroeconomic stabilization in the conventional sense, such growth needs to be accompanied by ‘inclusive’ development, an epithet that is now widely embraced by international agencies. Inclusive development entails multiple dimensions: (a) sustained and significant decline in both income and non-income dimensions of poverty; (b) sustained and significant decline in the proportion of those at risk of poverty; (c) significant progress towards full and productive employment at decent wages and working conditions; and (d) low and stable levels of inequality or a sustained and significant decline in inequality.

Equatorial Guinea represents a glaring example of how insufficient a yardstick growth of per capita income can be from the perspective of structural transformation and inclusive development.4  A small country (population of less than 800,000) in Sub-Saharan Africa, Equatorial Guinea grew at spectacular rates after the discovery of oil at the end of the 1980s. Its per capita GDP grew fivefold between 1990 and 2000. It has the highest per capita income in the African continent

Equatorial Guinea also ran persistent and large fiscal surpluses for many years. Between 2003 and 2008, for example, the fiscal surplus ranged between 15.1% of GDP to 26.2% of GDP. Equatorial Guinea has very little debt: domestic debt and external debt were 1% of GDP and 4.7% of GDP respectively in 2011. Foreign exchange reserves amounted to more than eight months of import coverage (as at 2011) which is well in excess of the threshold considered to be prudent from the perspective of current account sustainability.

The numbers pertaining to fiscal surpluses and foreign exchange reserves do not mean much when viewed from the multiple dimensions of inclusive development. The Equatorial Guinea has a poverty rate of 77% (as at 2006 and based on two US dollars a day) and a life expectancy of 51.4 years (as at 2012) which is below the average for Sub-Saharan Africa. The improvements in terms of these core social indicators have been quite modest, especially when contrasted with the growth boom. Expected mean years of schooling (based on cross-country regressions) declined by 0.8 years between 1980 and 2012. In terms of the UNDP’s Human Development Index (HDI), Equatorial Guinea ranked 136 out of 187 countries in 2012.

The story of Botswana, an upper middle income country hailed for its macroeconomic stability and sustained per capita income growth, is not very different. Its poverty rate, based on the national poverty line as at 2009-2010, was 20.7% and 42% of its population live below $2 a day. It is the third most unequal country in the world with Gini coefficient of 0.61. Life expectancy in Botswana has fallen over the last decade to a shockingly low 47 years (as at 2011), well below the Sub-Saharan Africa average. The measured unemployment rate was 17.8% in 2009-2010 and youth unemployment stood at twice that rate. There is insufficient economic diversification, with mining accounting for 30.2% of GDP, diamond exports close to 70% of total and the manufacturing sector contributing 3.8% of GDP.5

The conspicuous case of Equatorial Guinea and Botswana suggest that the challenge is to find ways in which macroeconomic stability can be more closely connected to the agenda of structural transformation and inclusive development. This means going beyond a mere reiteration of the virtues of macroeconomic stability. One needs a ‘dual mandate’ for macroeconomic policy managers in developing countries. This dual mandate emphasizes the role of macroeconomic policy managers along two dimensions: (a) as a guardian of macroeconomic stability in a broader sense; (b) as an agent of inclusive development.

Being a guardian of macroeconomic stability does not merely mean passively accepting exogenous targets on debts, deficits and inflation derived from a ‘one-size-fits-all’ approach. It means upholding the principles of ‘reasonable’ price stability, fiscal and financial sustainability using a country-specific approach in line with Articles of Agreement (IV) of the IMF. It also means protecting people from the vagaries of business cycles and other exogenous shocks through sustainable counter-cyclical policies based on a mix of automatic stabilizers and discretionary interventions.

Furthermore, macroeconomic policy makers should make distinction between domestic and external debts, pay attention to productive utilization of public debt and consider causes of inflation before applying monetary tightening. They should also design credit policy to support productive activities; devise mechanism to manage capital flows for financial stability and ensure that the exchange rate fosters growth and economic diversification.6

Being an agent of inclusive development entails various obligations on developing country macroeconomic policy managers. At the very least, it entails an emphasis on a sustainable resource mobilization strategy to support the attainment of core development goals. A recent study by UN-ESCAP (2013) highlights what that means. The study – influenced by similar exercises conducted by other UN agencies (such as ILO, 2010) – specifies six elements of a policy package that cut across the provision of job guarantee schemes, social protection and environmental sustainability. The authors of the report show that developing countries in the Asia-Pacific region would need public expenditures ranging between 5 to 8% of GDP to meet the resource requirements of such a policy package at the national level. How to implement such public expenditure programmes in an efficient and fiscally sustainable fashion through tax and other revenue mobilization measures then becomes a core issue in development policy.

Macroeconomic policy managers should also identify binding constraints on sectors with the most potential for productive job creation. Many studies, such as the McKinsey Report (2012) and the enterprise-level surveys by the World Bank, find that lack of financial inclusion and inadequate infrastructure are the two most commonly identified constraints that inhibit the expansion of sectors with the potential to create ‘good jobs’. Drawing on such work, one can argue that promoting financial inclusion and addressing infrastructure deficits are best done by giving priority to raising adequate domestic revenue for public investment, incentive-compatible credit allocation schemes, and appropriate regulatory changes by monetary and financial authorities.

In sum, the case for macroeconomic policies to be closely connected to the agenda of structural transformation and inclusive development means a lot more than a mere focus on macroeconomic stability in a narrow sense of attaining pre-set nominal targets. Unfortunately, the conservative nature of conventional macroeconomics, reared in the institutional environment of advanced economies, have not adequately explored how macroeconomic policy managers can fulfil the dual mandate of acting as guardians of stability and as agents of inclusive development.


Islam, Iyanatul and Kucera, David (2014) (eds) Beyond Macroeconomic Satbility: Structural Transformation and Inclusive Development, ILO and Palgrave Macmillan

Chowdhury, Anis (2013), “Developmental Macroeconomics”, G-24 Policy Brief, No. 77.

Development Committee (2006), “Fiscal Policy for Growth and Development: An Interim Report”.

Easterly, William (2001), “The Lost Decades: Explaining Developing Countries’ Stagnation in Spite of Policy Reform 1980-1998” Journal of Economic Growth, 6, no. 2, (June), pp. 135-157.

ILO (2010) World Social Security Report 2010/2011: Providing Coverage in Times of Crisis and Beyond, Geneva

IMF (2013) Republic of Equatorial Guinea, 2012 Article IV Consultations, Country Report No. 13/83

McKinsey Global Institute (2012) Africa at Work: Job Creation and Inclusive Growth

Muqtada, Muhammad (2013) ‘Botswana: An Employment Policy, mimeo, 27 February, Government of Bostwana and ILO Pretoria

UNDP (2013) ‘Equatorial Guinea’, in UNDP Human Development Report 2013, New York

UN-ESCAP (2013) Economic and Social Survey of Asia and the Pacific 2013: Forward-looking Macroeconomic Policies for Inclusive and Sustainable Development, Bangkok

World Bank (2005), Economic Growth in the 1990s: Learning from a Decade of Reform, Washington, DC.

World Bank (2013) ‘Equatorial Guinea: Data’,

World Bank (2014) ‘Botswana: Data,

1 This paper draws on Islam and Kucera (2014), chapter 1.
2 Iyanatul Islam Chief, Employment and Labour Market Policies Branch, Employment Policy Department, ILO, Geneva; Anis Chowdhury, Director, Macroeconomic Policy and Development Division, UN-ESCAP. Views expressed herein are entirely of authors and do not represent in any form those of the ILO or UN-ESCAP or any other UN agencies.
4 IMF, World Economic Outlook (October, Chapter 3, p. 109).
5 This account of Equatorial Guinea draws on OECD’s African Economic Outlook (2002, 2012), IMF (2012), World Bank (2013), UNDP (2013).
6 The Botswana case is examined in Muqtada (2013). See also World Bank (2014) data on Botswana.
7 See, Chowdhury (2013).