Back to basics

The Growth Commission report admits that the orthodox set of stabilisation and liberalisation policies can be counterproductive in terms of generating growth.

SUDDENLY, discussions about economic growth and how to generate it are back in fashion among economists. Ironically, this renewed interest comes just as the recent global economic boom is petering out, when the immediate prospects for the international economy are not of sustained growth but of stagflation.

How to kick-start economic growth was not recognised as a relevant question in the period of around two decades from the mid-1980s . The focus then was not on growth per se but on stabilisation and efficiency. Mainstream neoclassical economists and the policymakers influenced by them took it for granted that economic growth would come about once markets were deregulated and rules for domestic and the international trade and investment were liberalised. In this story, growth was best left to market determination, freed from the dead hand of the state and unfettered by government failures, which would make the resulting economic expansion more efficient and more dynamic.

Much of the debate around globalisation also ended up in this simplistic paradigmatic framework, even though the processes of globalisation were not so much about free and competitive markets as about new trajectories for corporate capital and changed bargaining relations between capital on the one hand and workers and peasants on the other.

But the reality of the past two decades has been chastening, as the promised growth did not materialise in many countries that embraced these principles wholeheartedly, and the most dynamic economies turned out to be those with much more flexible and heterodox approaches to economic policy. Economists have begun, even if belatedly and without much enthusiasm, to interrogate their prior suppositions. We now have a spate of academic books and reports of international organisations rediscovering the basic truths of development economics, which were in fact actively suppressed and covered up.

Thus in 2005, the World Bank, previously the leader of the pack espousing free-market principles as the inevitable formula for all economic contexts and requirements, came up with a volume entitled Economic Growth in the 1990s: Learning from a Decade of Reform. In this, a bunch of World Bank economists examined growth patterns and thereby suddenly discovered what many others knew all along and could have told them if only they had the will to listen.

Consider some of the insights they have come up with:

It is overly naive to expect that simply reducing tariffs or liberalising finance will automatically increase growth.

Stabilisation and macroeconomic management have to be growth- oriented.

Governments have to be made accountable, not bypassed.

Governments should abandon formulaic policymaking.

Of course, it is nice to know that at least some people in the World Bank have now realised all this, and we should no doubt welcome their entry into the real world. But it is startling, if not downright appalling, to think of how much suffering and undue economic pain has been inflicted upon people across the developing world because these rather obvious points were simply not accepted all these years.

As a result, there was nothing to mitigate the dogmatic and relentless pressure that was applied to developing-country policymakers not only by the World Bank but by international finance and the prevailing mainstream consensus. The resulting policies created patterns of production and specialisation that destroyed livelihoods without generating enough new employment, did not allow enough public investment in physical and social infrastructure to sustain growth, and reduced the access of the poor to basic goods and services, including food, sanitation, health and education. These conditions and processes are not reversed easily, so the suffering will continue for some time even if the policies are changed now. After all this, to come up with a volume that effectively says Sorry, we got it wrong is more than mildly outrageous.

The latest such offering from the international establishment is the Report of the high-profile Commission on Growth and Development. This Commission, with a secretariat based in the World Bank, consisted of 21 world leaders and experts and was chaired by Nobel Prize-winning economist Michael Spence. It included, inter alia, Montek Singh Ahluwahlia, Deputy Chairman of the Planning Commission, from India. With an estimated budget of more than $4 million, for more than two years it held meetings and workshops, consulted about 200 economists and commissioned around 80 research papers, all to unravel the mystery of economic growth.

The commissions report has been criticised for saying little more than what undergraduate students in economics could come up with. But its significance lies in the fact that market fundamentalism, which would probably have characterised such a report even recently, has been replaced by a genuine acceptance of ignorance of past mistakes in declarations about growth. The report admits that orthodoxies apply only so far. It identifies 13 countries as high growth because they have grown at an average rate of 7 per cent or more a year for 25 years or longer: Botswana, Brazil, China, Hong Kong, Indonesia, Japan, South Korea, Malaysia, Malta, Oman, Singapore, Taiwan and Thailand. On the basis of these success stories they build a story of the likely elements that generate such a sustained growth process.

So, in the Growth Commission report the elements for success are as follows:

investment of at least 25 per cent of gross domestic product, predominantly financed by domestic savings, including investment of some 5-7 per cent of GDP in infrastructure;

spending by private and public sectors of 7-8 per cent of GDP on education, training and health;

inward technology transfer, facilitated by exploitation of opportunities for trade and inward foreign direct investment;

acceptance of competition, structural change and urbanisation;

competitive labour markets, at least at the margin;

bringing environmental protection into development from the beginning;

equality of opportunity, particularly for women.

The report also provides a list of policies to be avoided if sustained high growth is to be achieved:

subsidising energy;

using the civil service as employer of last resort;

reducing fiscal deficits by cutting spending on infrastructure;

providing open-ended protection to specific sectors;

using price controls as a way to curb inflation;

banning exports, to keep domestic prices low;

under-investing in urban infrastructure;

underpaying public servants, such as teachers;

allowing the exchange rate to appreciate too far, too quickly.

Even with all the caveats, there is much that is simplistic and over-generalising in these recommendations. To start with, of course, the basic presumption that growth will necessarily lead to improved economic conditions of the majority of the population is questionable, as is tentatively noted in an early chapter. The example of the African success story, Botswana, testifies amply to this, since its spectacular growth has been accompanied by poverty rates that persist at more than half of the population, falling life expectancy and sharply worsening income distribution.

Even if growth per se is accepted uncritically as the goal, each of these positive and negative conditions can be questioned and counter examples can be provided. The report does accept that it cannot provide a formula for policymakers to apply. But aside from some obvious points (such as the need for high investment rates, especially in infrastructure) most of the other points can be contested.

For example, while bringing in environmental protection into the development process from the start is undoubtedly a good thing and should be encouraged, none of the successful examples quoted by the commission has actually practised it. With respect to the policies to be avoided, one or other of these has been practised at different times by several of the success stories, often precisely during their high growth phase. Conversely, many low or even negative growth countries (such as Zambia, Ghana, Nicaragua, Bolivia) have followed many or most of these prescriptions, but with no success because they have been combined with other market-oriented policies that have undermined completely any possibility of growth.

So, it is also interesting to find out what the commission does not say, since that reflects finally a minimum recognition of reality. Crucially, there is no mention of financial liberalisation as a necessary condition for growth. Nor is there a blanket recommendation for trade and investment liberalisation: exploiting opportunities for trade and foreign direct investment can be done as much and probably more effectively under highly regulated circumstances, as in China. The reports silence is deafening on the Washington Consensus conditions for growth, such as prudent macroeconomic policies and fiscal discipline, which it barely mentions. So what does one make of all this new knowledge? The central point and one that our policymakers would do well to remember is that the orthodox set of stabilisation and liberalisation policies to which we were told there is no alternative is not only not sufficient but can even be counterproductive in terms of generating growth.

This conclusion may not be particularly novel to many observers, but remember that this was a commission of largely mainstream thinkers. It may have avoided the question of what pattern of growth is really desirable for most people, but that it was prepared to go even this far in questioning standard beliefs is an indication of how much the economics mainstream itself is shifting.