Growth accelerations and collapses

1. Growth accelerations and collapses September5, 2013

2. Outline • Growth facts • Explaining accelerations • Explaining growth collapses • Lessons

3. The expanding growth frontier

4. Growth trends since 1950 Growth trends in developed and developing countries, 1950-2008

5. Convergence gap remains very large Ratio of developing to developed GDP per capita by region

6. Almost every country converges during some period (or diverges…) Source: Jones and Olken (2005)

7. Sustaining growth is difficult

8. Some sustained accelerations

9. What explains these turning points? • Geography? • Natural resources? • Culture? • Level of human capital? • Low inequality? • Institutions? These are all slow-moving (or unchanging) variables • a constant cannot explain a sudden change • at best, these must have interacted with something else that changed

10. What explains these turning points? Changes in governments and their “attitudes”? Economic growth as the new priority in TWN and KOR for political/strategic reasons KOR: Military coup in 1961 CHN: From Mao to Deng IND: shift to pro-business outlook by Indhira Gandhi, continued by Rajiv These are largely attitudinal rather than large-scale institutional changes But what kind of changes in actual policy came alongside these?

11. What explains these turning points? Changes in policy Economic liberalization? Certainly greater market orientation and larger incentives for private entrepreneurship and investments Greater outward orientation Big export push in KOR and TWN Reduction in the role of the state at the margin But hardly laissez-faire, and many elements of “heterodoxy” Export subsidies and a range of industrial policies in KOR and TWN Two-track reforms, lack of privatization, TVEs, SEZs in China “License raj” and trade restrictions dismantled only gradually in India; big liberalization of 1991 comes a decade after the take-off

12. Analytics of heterodox reform: dual-track pricing Initial equilibrium (pre-reform) farmers: surplus: A - B urban workers: pu, surplus: C + E + F + G + H government surplus: J + K + B

13. Analytics of heterodox reform: dual-track pricing Initial equilibrium (pre-reform) farmers: surplus: A - B urban workers: pu, surplus: C + E + F + G + H government surplus: J + K + B Post-reform equilibrium (two-track reform) farmers: surplus: A – B + M urban workers: (pu,, p*), q*surplus: C + E + F + G + H + N government surplus: J + K + B Equilibrium under complete liberalization farmers: p*, q* surplus: A + J + K + G + H + M urban workers: p*, q*surplus: C + E + F + N government surplus: 0 Government’s ability to extract output and to commit not to ratchet up deliveries are key.

14. Analytics of heterodox reform: dual-track pricing Initial equilibrium (pre-reform) farmers: surplus: A - B urban workers: pu, surplus: C + E + F + G + H government surplus: J + K + B Post-reform equilibrium (two-track reform) farmers: surplus: A – B + M urban workers: (pu,, p*), q*surplus: C + E + F + G + H + N government surplus: J + K + B Equilibrium under complete liberalization farmers: p*, q* surplus: A + J + K + G + H + M urban workers: p*, q*surplus: C + E + F + N government surplus: 0 Government’s ability to extract output and to commit not to ratchet up deliveries are key.

15. Analytics of heterodox reform: socializing investment risk • “You invest, I will bail you out if you fail.” • Bad policy if private returns and social returns from private investment are closely aligned • Leads to excessive private risk-taking (“moral hazard”) • But consider a world where: • Investments are lumpy (scale economies) • Their profitability depends on existence of other, complementary investments (e.g., investing in shipbuilding design and engineering skills requires a shipbuilding industry, and vice versa) • The relevant economic activities cannot be costlessly imported or exported • Then, coordination failures can depress private returns (at the margin) below social returns. • And an investment guarantee can crowd in socially productive investments • At no or little cost to the government budget

16. Analytics of heterodox reform: outward orientation with import protection • Import liberalization in theory releases labor to export-oriented activities, where its productivity is higher, generating economy-wide increase in y/l. • But in the real-world, new export-oriented activities may be slow to arise • either because of market imperfections inherent in structural transformation. • or because of appreciating currencies • In which case, import liberalization would instead release labor into unemployment or informal activities, with negative consequences for economy-wide y/l. • LA in the 1990s • Protecting employment in import-competing industries, while subsidizing new export oriented activities at the margin (through direct subsidies or SEZ/EPZs) makes sense as a second-best strategy

17. Analytics of heterodox reform: the downsides • Dual-track reform • Incentive for the government to ratchet quotas up, and hence dynamic credibility issues • Incentive for farmers to evade plan quotas altogether • Maintains rents and groups that benefit from them, rendering eventual comprehensive reform (perhaps) more difficult • Continued import protection • Retains inefficient industries and their owners • Socializing investment risk • Moral hazard and “crony capitalism” (cf. financial crisis of 1997) • Hence the balance of risks and rewards are highly context-specific.

18. Interpretation (1) • Igniting growth requires a relatively narrow range of reforms, targeted at relaxing the “binding constraint” • KOR and TWN: investment externalities: low private return to investment in tradables • CHN: socialism, communes, and price controls: lack of incentives to exert effort and to engage in market activities • IND: (perception of) anti-business attitudes on the part of the government, against a relatively decent institutional background in terms of rule of law and property rights • Rapid growth is possible even in the midst of severe institutional or policy failings • CHN: continued state ownership and weak rule of law • IND: high trade barriers until early 1990s, continued “rigidity” in labor laws, poor infrastructure • When do those become the “binding constraint?” (see below)

19. Interpretation (2) • Growth-promoting reforms often take unconventional or heterodox forms • KOR and TWN: export subsidies, credit subsidies (KOR), tax incentives (TWN), public enterprises, socialized investment risk • CHN: dual-track reforms, HRS, TVEs, SEZs • IND: mild liberalization of import quotas and industrial licensing during 1980s, compensated by an increase in import tariffs • Conventional account: these are blemishes or necessary compromises made to “politics” • Implication: growth would have been even more rapid in the absence of these heterodox policies • Alternative account: Heterodox policies help overcome specific second-best complications or political constraints • So they are part of the explanation for success • See next slides • But these reforms also create specific downsides • See below

20. Interpretation (3) • Sustaining growth is harder, and requires ongoing institutional reforms • At least 83 cases of significant growth accelerations since the mid-1950s, very few of which are sustained • Institutional prerequisites for sustaining growth are of two types in particular • Institutions of conflict management to maintain resilience to shocks and prevent growth collapses • democracy, “rule of law,” social insurance,.. • SSA (mid- to late-1970s) • Latin America (1980s) • Indonesia (1997) • Institutions that maintain productive dynamism and prevent growth from fizzling out • Need for a framework of public policies that foster structural change • Continued IP in East Asia, (gradual) liberalization in India that fostered IT services • Cf. Latin America after the early 1990s • So in the long-run, institutions do rule! • But don’t confuse what is required to instigate growth with what is required to sustain it

21. A theory of growth collapses Proxies for institutions of conflict management: civil liberties and political rights (democratic institutions) quality of governmental institutions rule of law bureaucratic efficiency and absence of corruption public spending on social safety nets Proxies for latent social conflict: inequality (income and land) ethnic and linguistic differentiation social trust”

22. Africa’s recent growth acceleration: how sustainable is it? how would we know? Source: Arbache and Page (2009)

23. Policy Implications • Binding constraints to growth differ across countries and over time • clear evidence that growth is unlocked in a large variety of ways • different strokes for different folks: CHN was constrained by poor supply incentives in agriculture; BRA is constrained by inadequate supply of credit, SLV by inadequate production incentives in tradables, ZAF by inadequate employment incentives in manufacturing, ZWE by poor governance … • Relaxing binding constraints requires well-targeted reforms that are cognizant of prevailing second-best and political complications • selectivity instead of a laundry list • pragmatism in lieu of “best practice” and rules of thumb • Over time, strengthening institutional underpinnings is critical • institutionalizing “diagnostics” (will return to it) • building resilience to external shocks • institutional reform is key, but to sustain rather than ignite economic growth