Growth accelerations and collapses

SEPTEMBER5, 2013

Outline1. Growth facts

2. Explaining accelerations

3. Explaining growth collapses

4. Lessons

The expanding growth frontierHistorical experience with growth

0

1

2

3

4

5

6

7

8

9

1000-1500 1500-1820 1820-1870 1870-1913 1913-1950 1950-73 1973-90 1990-2005

Western Europe United States Other Westernoffshoots

Mexico Norway Japan South Korea China

GDP per capita growth rate of fastest growingcountry/region (annual average, %)

World GDP per capita growth rate (annualaverage, %)

Growth trends since 19500

.02

.04

.06

1950 1960 1970 1980 1990 2000 2010year

smoothed developed countries growthsmoothed developing countries growth Developing

Developed

Growth trends in developed and developing countries, 1950-2008

Convergence gap remains very large.1

.2.3

.4.5

1950 1960 1970 1980 1990 2000 2010year

All developing countries AsiaLatin America Africa

Ratio of developing to developed GDP per capita by region

Almost every country converges during some period (or diverges…)

Source: Jones and Olken (2005)

Sustaining growth is difficult

Some sustained accelerations Growth take-offs

5

5.5

6

6.5

7

7.5

8

8.5

9

9.5

10

19

50

19

52

19

54

19

56

19

58

19

60

19

62

19

64

19

66

19

68

19

70

19

72

19

74

19

76

19

78

19

80

19

82

19

84

19

86

19

88

19

90

19

92

19

94

19

96

19

98

20

00

20

02

20

04

log

GD

P p

er

ca

pit

aChina

India

South Korea

Taiwan

Year of growth

accelerationGrowth before

Growth after Difference

KOR 1962 0.6 6.9 6.3TWN 1961 3.3 7.1 3.8CHN 1978 1.7 6.7 5.1IND 1982 1.5 3.9 2.4

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

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?

WHAT EXPLAINS THESE TURNING POINTS?

Changes in policyEconomic liberalization?

Certainly greater market orientation and larger incentives for private entrepreneurship and investments

Greater outward orientationBig 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 TWNTwo-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

Analytics of heterodox reform: dual-track pricingAnalytics of heterodox reform: dual-track pricing

q *q

D

MC

p

pu p*

A

B

N

K

H G

E F

C

J

M

Initial equilibrium (pre-reform)

farmers: surplus: A - B

urban workers: pu, surplus: C + E + F + G + H

government surplus: J + K + B

Analytics of heterodox reform: dual-track pricingAnalytics of heterodox reform: dual-track pricing

q *q

D

MC

p

pu p*

A

B

N

K

H G

E F

C

J

M

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.

Analytics of heterodox reform: dual-track pricingAnalytics of heterodox reform: dual-track pricing

q *q

D

MC

p

pu p*

A

B

N

K

H G

E F

C

J

M

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.

Analytics of heterodox reform: socializing Analytics of heterodox reform: socializing investment riskinvestment 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:

1. Investments are lumpy (scale economies)

2. 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)

3. 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

Analytics of heterodox reform: outward orientation Analytics of heterodox reform: outward orientation withwith import protection 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

Analytics of heterodox reform: the downsidesAnalytics 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.

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)

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

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

A theory of growth collapses

managementconflict of nsinstitutio

conflict social latent shocks external growth Δ

Proxies for latent social conflict:inequality (income and land)ethnic and linguistic differentiationsocial trust”

Proxies for institutions of conflict management:civil liberties and political rights (democratic institutions)quality of governmental institutionsrule of lawbureaucratic efficiency and absence of corruptionpublic spending on social safety nets

Africa’s recent growth acceleration: how sustainable is it? how would we know?

Source: Arbache and Page (2009)

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