SHANKAR ACHARYA

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This brief paper is a personal attempt to grapple with these large questions. Section I outlines some of the “stylised facts” of the growth experience so far. Section II reviews (in a very summary way) the evolution of ideas regarding what leads to growth. Section III presents a view from south Asia (the region of the world I know best). Section IV outlines the present state of knowledge (as I have gleaned it) of the links between economic growth, equity, employment and poverty. Section V outlines some thoughts on how the international environment is likely to evolve in the medium term and how it can be made more supportive of the economic progress of developing nations. The final section summarises some tentative conclusions.

Some Facts about Growth

What are some of the “brute” facts of the growth experience? Here are some:

enormous variability in growth rates across countries, upwards of 5 per cent a year between fast and slow growers in any given decade [World Bank 2005].

– Very few developing countries have sustained decent per capita growth for two decades or more. Specifically, out of 117 developing countries with population over half a million, only 12 countries achieved per capita growth of more than 3 per cent per year in 1980-2002, with at least 2 per cent growth in each decade of the 1980s and 1990s. These 12 countries were: China (8.2), Vietnam (4.6), South Korea (6.1), Chile (3.3), Mauritius (4.4), Malaysia (3.4), India (3.6), Thailand (4.6), Bhutan (4.3), Sri Lanka (3.1), Botswana (4.7) and Indonesia (3.5). (The number falls to nine if we specify a minimum population of 3 million.) Nine of these 12 countries are in Asia and, fortunately, they include the three most populous: China, India and Indonesia (Table 1 for details).

II What Causes Growth? A Capsule Summary

(A) From Roy Harrod to the Washington Consensus: Right from the times of Adam Smith and Karl Marx, capital (and its accumulation) has occupied a central place in the explanations of growth and economic development. Back in the 1940s, Roy Harrod gave us the simple but powerful little equations linking capital and output in an economy.1 Even today, economists look at incremental capital output ratios (ICORs) of countries and

Country 1980-1990s 1980s Population 2002 in 2000 (Millions)

1 China 8.2 8.6 7.7 1262 2 Vietnam 4.6 5.7 1.9 78 3 South Korea 6.1 5.0 7.4 47 4 Chile 3.3 4.3 2.1 15 5 Mauritius 4.4 4.1 4.9 1 6 Malaysia 3.4 3.7 3.1 23 7 India 3.6 3.6 3.6 1016 8 Thailand 4.6 3.4 6.0 61 9 Bhutan 4.3 3.4 5.4 1 10 Sri Lanka 3.1 3.1 3.1 18 11 Botswana 4.7 2.7 7.2 2 12 Indonesia 3.5 2.6 4.4 206

Source:World Bank (2005).

sectors. From these underpinnings stemmed the enormous focus on raising savings (resource mobilisation) and investment in the newly independent developing countries in the 1950s and 1960s. Much of early development planning (and allocation of foreign aid) was driven by this central idea.

In the 1950s, Robert Solow (1956) of MIT generalised the relationship between capital, labour, technology and output in the neat little “neoclassical production function”, which still lies at the heart of contemporary growth accounting exercises. Other theorists (as well as planners and policy-makers) also emphasised the importance of education (human capital) and technological development in spurring sustained growth.2 Most of these ideas (as well as notions of scale economies and “Big Push”) favoured a central role for the freshly empowered governments of developing countries in boosting savings and investment, building infrastructure and expanding education and health facilities. Most governments eagerly accepted these responsibilities and some went further than others in adopting detailed investment planning, according important roles for public enterprises (new or nationalised) and pushing import-substituting industrialisation). The Bretton Woods institutions and the international development community also broadly supported this investment-raising, government-led, import-substituting industrialisation approach to accelerating economic development, not just in developing countries but also in war-ravaged Europe and Japan.

Importantly, growth did accelerate in most developing nations. For example, in India, the so-called “Hindu growth rate” of 3.5 per cent for GDP in the “slow growth decades” of 1950-80 was more than four times greater than the 0.8 per cent per year

11th 12th 13th 14th 15th 16th 17th 18th 19th 20th

Century

estimated for the final half century of British rule [Sivasubramonian 2000]. Latin America enjoyed some of its fastest growth during the 1950s, 1960s and 1970s. But, over time, the problems and disappointments mounted. South Asian growth was below expectations and constantly plagued by foreign exchange scarcities. Latin American development ground to halt with the early 1980s debt crisis and the “lost decade”. Africa (which mostly became independent in the 1960s) never really took off. Only some east Asian countries enjoyed “miracle growth” by following much more outward-looking (though usually state-supported) foreign trade policies, backed by strong programmes for human capital development and agrarian reform. Just as disillusionment was rising with the increasing incidence of “government failures” in the majority of developing nations, the “New Growth Theory” evolved in academia, imparting much more emphasis to “getting the policies right” and the Reagan-Thatcher leadership of the G-7 espoused much greater market orientation.

To cut a long story short, the 1980s saw the evolution of the “Washington Consensus” (henceforth, WC), which was thus labelled in 1990 [Williamson 1990]. It comprised 10 broad policy prescriptions for sound development and management of an economy (Table 2). Originally articulated in the context of Latin America, its applicability was universal. Its content was sometimes summarised by the rubric “stabilisation, deregulation, liberalisation and privatisation”. With time, as the juggernaut of policy reform gathered momentum (at least in IFIs and OECD aid ministries), additional policy desiderata accumulated, dubbed as the “augmented Washington Consensus” by Rodrik (forthcoming) (Table 3).

(B) Cracks in the consensus: In the years since 1990, two major developments have seriously weakened (if not shattered) this consensus. First, the development experience of the 1990s has left observers wondering about the potency of good policies in yielding robust economic growth. By some accounts, Latin American (and even some African) countries undertook fairly serious policy reforms along the lines of the WC but they earned relatively modest growth dividends for the countries concerned [World Bank 2005].3 In the “transition economies” of Russia and east Europe the passage to market economy institutions and pursuit of WC policies was associated with much greater and more prolonged declines in output and incomes than had been originally expected. In contrast, the big Asian economies of China and India grew rapidly in the 1990s by following significantly more heterodox (compared to WC) policies. This interpretation of the 1990s experience questions the efficacy of WC policies.

The second, and perhaps deeper, attack on the WC comes from new (or resurrected) interpretations (and theories) of long-term growth experience, which downplay the role of policies in promoting growth and accord much greater importance to other dimensions, such as institutions and geography. In the “institutions” view, the massive differences in current average incomes across countries (arising from differences in long-term economic growth performance) is mainly due to historical (and lasting) differences in the quality of institutions prevailing across countries. For example, Acemoglu et al (2001) have argued that the “settler colonies” of north America and Australasia nurtured institutions which promoted property rights, investment and development, while in the “extractive colonies” of Africa, Latin America and Asia the colonial institutions focused on “transferring the resources of the colony to the coloniser” and did little to encourage indigenous economic development.4

An alternative approach stresses the primacy of geography in explaining

Table 2: The Washington Consensus

1 Fiscal discipline 2 Reordering public expenditure in favour of education, health and economic infrastructure 3 Tax reform (towards broader bases with

moderate rates) 4 Financial liberalisation 5 Competitive exchange rate 6 Trade liberalisation 7 Liberalisation of foreign direct investment 8 Privatisation (of public enterprises) 9 Deregulation (of barriers to entry and exit)

10 Property rights

Source: Williamson (1990).

Table 3: The ‘Augmented’ WashingtonConsensus

1 Corporate governance 2 Anti-corruption 3 Flexible labour market 4 WTO agreements 5 Financial codes and standards 6 “Prudent” capital-account opening 7 Non-intermediate exchange rate regimes 8 Independent central banks/inflation targeting 9 Social safety nets

10 Targeted poverty reduction

Source: Rodrik (forthcoming).

Economic and Political Weekly November 4, 2006

Figure 2: The ‘Deep Determinants’ of Income

(3 ) (4 ) (1 ) (2 ) (5 ) (6 ) (7 ) (8 ) (9 ) Income Level Cross-border Integration Geography Institutions

Endogenous

Exogenous

Source:Rodrik, Subramonian and Trebbi (2004).

cross-country differences in long-term economic development.5 In this view, countries in tropical regions suffer very serious handicaps of much worse disease vectors, poor crop yields, climates favouring low labour productivity and so forth. As Jeffrey Sachs points out, of the 30 countries classified as “high income” by the World Bank, only the two city states of Hong Kong and Singapore are in the tropics. And to be a landlocked country in the tropics (such as Chad, Niger, Bolivia, Burundi or Laos) is to suffer a double jeopardy. Of course, the tropics may also exert their negative influence on economic development through the institutions they “encourage” (for example, Engerman and Solokoff argue that tropics are suited to large plantation crops, which “invite” politico-legal institutions that protect a few landowners to the detriment of broad-based development).

The directions of causality between these “deep determinants of income” and longterm development need not be simple and linear (see, for example, Figure 2). The main point is that these alternative views of long-term growth potential and performance tend to diminish the role of policies in promoting economic growth.

(C) A revisionist approach to policy reforms: If we believe in the significance of these “deep determinants” of income, does it mean that there is no role for policies in promoting economic growth? Surely, this is not the case, for several reasons. First, the“deep determinant” theories tend to look at the problem in a very long-run context (when we are all dead, as Keynes famously said) and not in the short- or medium-run perspective of usual policy-making. Second, the empirical “testing” of these theories (usually through cross-country regressions) leaves plenty of “unexplained” variation, which could be due to policies and other factors. It is one thing to say that the endowment of geography and the legacy of institutions matter in determining economic performance; it is quite another to say only they matter.

To take the example of geography, it is surely interesting that near-tropical southeast China is today one of the most dynamic regions of the world, not to mention the tropical dynamos of Malaysia, Thailand and Vietnam. Within India the southern (tropical) states have done better in the last 25 years than most of the sub-tropical states. Third, the distinction between institutions and policies is not as clear cut as some would believe.6 Fourth, and perhaps most importantly, no serious policy-maker is likely to abdicate his/her prerogatives on the basis of a handful of cross-country statistical regressions!

Not surprisingly, even committed “institutionalists”, like Rodrik (forthcoming), see a major role for policies in accelerating the economic growth of developing countries. However, they tend to be sceptical of the WC policies. In their revisionist view, the WC prescriptions do not take adequate account of institutional and other differences across countries and are too universalist (“one size fits all”) and “scattershot” in their approach. In their recommended approach it is vitally important to be thoroughly country-specific in identifying “the binding constraints” to growth, and diagnosing likely policy remedies, which take appropriate account of the institutional context of each country [Hausmann et al 2005b and Rodrik forthcoming]. Rather interestingly (and importantly), this “new view” accepts that “there are of course some general, abstract principles – such as property rights, rule of law, market-oriented incentives, sound money, and sustainable public finances – which are desirable everywhere”.

III A South Asian Perspective

As both a practitioner and analyst of India’s economic policies over the last 25 years, what do I make of all this? First, and foremost, there is no doubt in my mind that policies matter for spurring growth and they matter a great deal [Acharya 2006]. India’s per capita growth tripled from 1.5 per cent in 1950-80 to 4.5 per cent in 19912006 in large part due to the policy reforms carried out in the 1980s (slowly) and the 1990s (more comprehensively). Second, if I compare the list of key reforms with the WC list in Table 2, I would have to say that most elements of the WC list of policies were important to India’s success in accelerating growth and countering macro instability. Some were more important than others. Of the 10 policies listed in the WC, I would say deregulation (of industry and trade), trade liberalisation, a competitive exchange rate policy, financial liberalisation and tax reform were probably the most important. Contrary to some accounts [Devarajan 2005], India’s partial and temporary success in reducing the aggregate fiscal deficit in the first-half of the 1990s was important in signalling commitment to fiscal discipline and accommodating the mid-1990s investment boom. Opening up to foreign investment was also important, though in India’s case the principal response came from foreign institutional investors in the country’s reformed equity markets. In this context, I must emphasise the very important institutional innovations and legal reforms (not on the WC list) of India’s capital markets carried out in the 1990s; they were central to the growth and success of a large number of strong Indian companies, including the IT icons like Infosys and Wipro.

Looking ahead, the priorities for reform (for sustaining strong growth of output and employment) look significantly different. They would include:

(i) Reversing recent slippage in fiscal discipline;

(ii) Reorienting public expenditures away from large, non-merit subsidies and towards education, health and infrastructure;

(iii) Regulatory, organisational, ownership and pricing reforms in the key infrastructure sectors of electric power, hydrocarbons, transport and water/sanitation;

(vii) Deeper financial sector reforms, including privatisation of some of the public sector banks, which today dominate the banking sector.

Of these seven sets of reforms, (i), (ii) and (vii) belong to the original WC list,

(iv) is the only item from Rodrik’s “augmented WC” list and the other three are important India-specific priorities.

The importance of WC policies in explaining the good performance of other south Asian economies in the last two decades is also attested by the recent monograph by Ahmed (2006). As he sums up (p 79),

Thus the south Asian countries have maintained good macroeconomic environments; opened up their economies to greater domestic and international competition; and reduced the role of corrupt and inefficient enterprises...These policies have improved investors’ incentives and supported increases in private investment, exports and incomes. At the same time attention has been paid to improving human development through public spending.

In recent years I have had the occasion to study the economies of Sri Lanka and Bangladesh and can readily agree with Ahmed’s assessment. Anyone doubting the potency of policy reforms in improving economic performance has only to acquaint himself with the economic transformation wrought by Sri Lanka’s foreign trade and investment reforms of the late 1970s [Athukorala and Rajapatirana 2000 and World Bank 2004]. Similarly, Bangladesh’s strong economic performance since 1990 has deep roots in economic policy reforms and poses something of a puzzle for “Institutionalists”, given the country’s very low ranking on governance indices (like those by Transparency International) for many years.

The linkages between economic growth, poverty reduction, employment and equity are both complex and critically important. The academic and policy literature on these issues is huge, quite beyond the scope of this note to survey.7 Perhaps the best way to approach the subject is by attempting to distil a set of propositions-cum-issues from this literature:

(iii) Broadly speaking, east Asian countries have been among the most successful in achieving sustained pro-poor growth through a combination of outwardlooking, labour-intensive industrialisation, initially egalitarian income distributions, fiscal prudence, broad-based and effective human development policies and flexible labour markets.

Looking ahead, there are six key aspects of the international economic environment, which are likely to influence significantly the growth prospects of developing countries: trade, OECD growth, private capital flows, oil prices, migration and external assistance. A few words on each follow.

The rapid expansion of global trade has been one of the most remarkable features of the post-second world war period. It has been driven by a combination of factors, including: continued (and reasonably) steady growth of most industrial countries; successive rounds of multilateral trade liberalisation; large, technologically-driven declines in transport and communication costs; good growth (on average) of developing countries and unilateral trade liberalisation by many developing countries. This sustained, strong expansion in world trade has underpinned some of the major development successes of the last 60 years, including southern Europe, many east Asian nations and (more recently) south Asian countries. With the recent stalling of the Doha round of the WTO and the continued proliferation of regional/ bilateral trading arrangements, the medium term outlook for global trade is perhaps more uncertain today than and at any time in recent memory. True, most of world trade today is free of significant restrictions (barring the well known exception of agriculture). But the absence of forward movement in multilateral negotiations enhances the vulnerability of the world trading system to protectionist pressures, especially if there is a global downturn. The solution lies in resuming and concluding successfully the Doha round (easier said than done, I appreciate).

The growth of OECD economies continues to be dominated by the largest member country, the United States. The cyclical recovery of the last four years has been exceptionally strong. But there are some clear signs of slowing in the US. Fortunately, the economic performance of both EU and Japan appear to be improving and China continues on her uniquely dynamic trajectory. The three substantial downside risks in the medium-term are: rising oil prices, a “hard landing” on the problem of unprecedented global imbalances and a sharper-than-expected deceleration of the US economy. None of these can be ruled out. While all are amenable to moderation through policy actions, there seems to be little appetite for the necessary measures.

Private capital flows to developing countries have recovered from the nadirs of the 1997-98 “Asian Financial Crisis” and constitute important sources of supplemental capital and technology in a growing

Economic and Political Weekly November 4, 2006

number of developing economies. While flows of direct foreign investment are likely to remain robust in the medium-term, portfolio flows are vulnerable to rising interest rates in the US and other industrial countries and a possible reassessment of risks arising from high and rising oil prices.

Very high (and possibly higher) oil prices constitute a real threat to growth prospects of oil-importing developing countries in both the short and medium run. Against the background of strong and rising demand for oil and slow expansion of extraction and refining capacities, the recent ratcheting up of west Asian hostilities does not augur at all well for the future trajectory of prices. Thus far, the adverse impact on developing country growth has been less than expected, but that could easily change for the worse.

External migration and remittances play an important role in the development of a substantial number of developing countries, including those of south Asia. As many analysts have pointed out, higher levels of migration of low-skilled emigrants from poor to rich countries could be a direct and powerful mechanism for reducing global poverty.8 However, the social and political impediments to this are well known. The most promising options may lie with managed programmes that combine temporary migration with incentives for return. And these too have their problems.

Foreign aid (or development cooperation as it is now called) is subject to cyclical bouts of criticism [Birdsall et al 2005 is a recent example]. True, it can never be a panacea for development. There are also plenty of cases of misallocated and misused external assistance. Equally, there are many cases where foreign aid has contributed significantly to specific projects and programmes and sometimes even to overall development momentum in individual countries at particular times. Generally, external assistance is of greatest potential value to smaller, low income countries with negligible access to private capital markets. Even in such countries, the primary thrust for sustained development has to come from domestic sources. As always, the global outlook for foreign assistance is mixed.

Some Conclusions

So what are some of the conclusions that this discussion of the agenda for growth for developing countries points towards? I would suggest the following:

it has been in a number of fast-growing east Asian economies. Their success has been based on a combination of outwardlooking, labour-intensive industrialisation, initially egalitarian income distributions, fiscal prudence, broad-based and effective human development policies and flexible labour markets.

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Email: acharya.shankar@gmail.com

References