Chapter Five

1. Chapter Five Reforms and Growth

2. Chapter 5 Outline Discusses the relationship between unemployment and economic growth Moves on to review some obstacles to economic reforms and growth Concludes by discussing the prospects of continued growth-friendly reforms around the world

3. Reforms and Growth • EINAR BENEDIKTSSON Those who want and intend To wake and comprehendWill muster a thousand means. There is practically no limit to what you canaccomplish in politics as long as you don’tcare who gets the credit. HARRY S. TRUMAN

4. Reforms and growth Smith, Mill, and Marshall seem to have got it right. Lasting economic growth is available to those who: save and invest enough of their national income use their resources asefficiently as possible through free trade low inflation good education private enterprise export diversification away from excessive dependence on natural resources

5. Reforms and growth • The collapse of communism • coincided with the beginning of the endogenous-growth revolution • Theory and experience paved the way • market-friendly economic and institutional reforms generally good for growth Important issues are left open for political judgement Not a question of right and left. Rather, a question of what economic theory and empirical evidence can teach us about the sources of economic growth

6. Reforms and growth • The economic collapse of Uganda • Correlation between economic performance and politics • Economic stagnation or even collapse is sometimes the consequence of economic policies, attitudes, and institutions

7. Uganda: Real per capita GDP, 1970-1995, Uganda shillings (1990 prices) Fig 5.1 130000 120000 110000 Amin Museveni becomes president 100000 takes power 90000 80000 Amin overthrown 70000 60000 1970 1975 1980 1985 1990 1995

8. Unemployment and growth • Trade liberalization increases output at full employment and a given stock of capital • Stabilization increases the amount of output produced by a given stock of total, i.e. real and financial, capital at full employment • Privatization increases the quantity and quality of the output that can be squeezed out of given inputs at full employment • Educationis good for growth • Unemployment as another kind of inefficiency • Is unemployment thus an impediment to economic growth? Recap Efficiency = amount of output produced per unit of capital

9. Unemployment and growth • The stimulus to economic growth from a reduction or eradication of unemployment is different from increased growth through increased efficiency • Existence of unemployment violates assumption of full employment • Two possibilities: • I. output decreases because of increased unemployment • output per unit of capital also falls if the capital stock remains unchanged • II. output decreases less than employment • Increased unemployment is generally inimical to economic growth, but ...

10. Unemployment and growth • ... full employment is notnecessarily good forgrowth ‘creative destruction’

11. Unemployment and growth • The case of the former Soviet-Union • The case of Ireland • radical transformation of the Irish economy • Rigidity of European labour markets • centralized wage bargains • detailed regulations

12. Unemployment and growth • Flexibility of labour markets in the USA • American labour markets are more conducive to job creation than European labour markets • ... but at the cost of a less even distribution of income in America than in Europe

13. Unemployment and growth • Europe vs. East Asia • Labour markets in East Asia are more flexible and less centralized than in Europe • Since 1980 unemployment in East Asia has generally been lower than in Europe • In flexible labour markets wage claims accord more closely with productivity developments • Advantages of efficiency through non-intervention by the State are no smaller, and no less tangible, in labour markets than in other markets

14. Unemployment and growth • Flexible labour markets seem to have contributed significantly to East Asia’s rapid economic growth over the past 30 years • Efficiency and flexibility are not, however, the sole desirable attributes of labour market arrangements • There is also a basic human need for a fair system of social security including unemployment insurance designed to fend off the worst social and economic ramifications of economic shocks

15. Unemployment and growth Unemployment and economic growth: no simple, all-encompassing relationship between the two • Ireland, Russia, and Chile • Temporary joblessness can sometimes be a natural consequence of necessary structural change • Africa and Latin America • Widespread unemployment is a mixture of both phenomena The European Union Unemployment results in large measure from deep-seated inefficiency through lack of flexibility in labour markets, and causes economic waste and social misery The connection between jobs and growth needs to be assessed case by case

16. Some obstacles toreforms and growth • Why do growth-friendly reforms often fail to be implemented? • Why do many countries fail to grow as fast as they could? • Future gain from reforms vs. present pain … better political leadership and better governance Democracy is good for growth and conversely

17. Some obstacles toreforms and growth • Fear of unemployment in the wake of economic reforms • Instinctive fear of change • The experience of the countries of Central and Eastern Europe in the 1990s • Economic and institutional reforms - liberalization, stabilization, privatization - accompanied by a substantial decrease in recorded output, followed by recovery • Intergenerational conflict of interest

18. Central and Eastern Europe andthe Former Soviet Union:The Path of Output 1989-1997 Fig 5.2 110 100 90 1989 = 100 80 Central and Eastern Europe and the Baltic States 70 Commonwealth of Independent 60 States 50 1989 1990 1991 1992 1993 1994 1995 1996 1997

19. Some obstacles toreforms and growth • Conflict between those who stand to gain from reforms and those who lose • The example of free trade • Common Agricultural Policy (CAP) • extremely resistant to reform • The costs and benefits of economic reforms are almost always unevenly distributed • Losses are confined to relatively few, while gains accrue to many • special interests vs. public interest

20. Some obstacles toreforms and growth • It pays special interest groups to organize themselves well • Farmers’ organizations are typically strong, while consumers’ organizations are weak • The importance of conflict resolution One of the prime purposes of growth-friendly economic and institutional reforms is generally to uproot, or at least reduce, economic privileges In the long run, a rising tide lifts all boats

21. Some obstacles toreforms and growth • The theory of public choice • Politicians viewed like consumers, businessmen, and other economic agents • Likely to stack the cards even further against reforms and rapid growth by increasing the probability of all manner of collusion of vested interests at public expense

22. In conclusion • Much progress in economic policy around the world in the 1990s • Growth-friendly reforms widely embraced • among ordinary people and politicians across the political spectrum • But progress tends to be slow - Why? • Imperfect information • Protectionism • Common Agricultural Policy of the European Union

23. In conclusion ‘Reformers have the idea that change can be achieved by brute sanity’ George Bernard Shaw To grow or not to grow is in large measure a matter of choice

24. Questions for review • 1. ‘Liberalization and decentralization of European labour markets would reduce unemployment in Europe at the cost of increased wage dispersion without any effect on economic growth over time.’ Do you agree? Explain why or why not. • 2. ‘High unemployment is always and everywhere a sign of economic inefficiency, which inhibits economic growth in the long run.’ True or false? Why? • 3. Take a country of your choice and outline the main economic and institutional reforms that you think would improve the country’s growth performance in the long run. In your view, what are the main obstacles to the implementation of the growth-promoting reforms that you advocate?

25. Classroom discussion