UPDATE (May 15th, 2012) Caroline Freund, World Bank Chief Economist for the Middle East and North Africa has joined the debate. See her remarks.
The Chief Economists of all the regions where the World Bank implements programs got together recently to exchange thoughts about the current state of development economics.
You can read a summary of our views related to Africa, South Asia, and Europe and Central Asia here.
And we hope you can participate in this debate by sharing your own views via the comments section below.
- Africa and Development Economics
- South Asia and Development Economics
Europe and Central Asia and Development Economics
Middle East and North Africa and Development Economics
By Shanta Devarajan
In a speech to the United Nations in 1957, Ghanaian President Kwame Nkrumah said that, because institutions and capacity in his country were so weak, the government had to control the economy. His soon-to-be Ivoirian counterpart Felix Houphouet-Boigny disagreed. Precisely because institutions and capacity in Cote d’Ivoire were so weak, he would rely on the market to drive the economy. They took a bet. While the outcome of the “West African wager” is uncertain—Nkrumah was toppled in a coup d’état, Cote d’Ivoire enjoyed 20 years of rapid growth but then declined with a decade-long civil war—it represents the two competing visions of development economics that have guided African economic policy over the last half-century.
There is no question that the first phase (“Development 1.0”) was geared towards overcoming market failures. There is also little doubt that this phase resulted in massive failures, such as the Morogoro shoe factory in Tanzania that never exported a single pair of shoes. The reason was that these well-intentioned government interventions led to government failures, mostly having to do with political capture of the rents associated with the interventions.
However, the second phase, described as the “neoliberal Washington consensus”, did not result in elimination of these government interventions and a return to the market. That was the prescription of many of the development agencies. But many governments did not implement these reforms because there was no domestic political consensus. The vested interests were able to block the reforms, especially since they were imposed from outside. Some governments would agree to do the reform (to get the money) and then reverse them, as Zambia did with maize price reform in the early 1990s. Others would simply promise and never deliver. The World Bank issued three structural adjustment loans in a row to Kenya for the same agricultural price reform. And Africa emerged from this phase with the highest rate of protection in the world.
The big shift came in the late 1990s and early 2000s when, in the context of debt relief, low-income countries were asked to design their own programs, the Poverty Reduction Strategy Papers. These strategies contained most of the same policies as those of the structural adjustment era. But the difference was that they emerged from a domestic consensus. As a result, the reforms were implemented and sustained. And economic growth in Africa accelerated from about 3 percent a year to almost 6 percent a year.
To be sure, this growth has not led to structural transformation. African countries are still dependent on primary commodity exports. The labor-intensive manufacturing boom has yet to occur. But the reason for this is not that reforms have gone too far, but they have not gone far enough. Take the two most common factors behind Africa’s lack of structural transformation—infrastructure and skills. Africa’s infrastructure deficit has at least as much to do with policies and regulations as with lack of “hardware”. Road transport prices are so high because of monopoly profits accruing to trucking companies that are protected by regulations that prohibit entry into the trucking industry. And the skills deficit is at the primary level where, in Tanzania, for example, 20 percent of the 7th grade students could not read Kiswahili at the 2nd grade level, and 30 percent could not do a two-digit multiplication problem. Why? It may have something to do with the fact that teachers in public primary schools are absent 23 percent of the time. When present, they spend about 2 hours a day teaching.
In short, what is preventing Africa from achieving structural transformation is a series of different government failures from the ones that were addressed in the first phase of reform. But these too are difficult to overcome because they are deeply political. Powerful rent-earning interests can resist them. That is why the Ethiopian Light Manufacturing Study is so valuable. By focusing on a few sectors (garments and footwear), it shows that, by removing some of the distortions in the economy such as import tariffs or domestic monopolies, employment can increase from 9,000 workers to almost a million. Such findings focus the mind of policymakers, and may enable them to address the political constraints to reform, so that the labor-intensive growth can take off.
By Kalpana Kochhar
Until about 2 decades ago, the South Asia region (SAR) development philosophy was based on heavy handed government presence in all aspects of the economy, production, finance, trade, and on weak information-sharing, and accountability. This was close to Justin Lin’s characterization of Development 1.0, and was a clearly failed strategy and resulted in low growth, famously dubbed the “Hindu” rate of growth in India.
Then from the early 1990s, SAR countries introduced a significantly more business friendly and market oriented set of reforms founded on bringing down tariff walls, liberalizing financial markets, and removing the choking license requirements on industry. Progressive reforms were also implemented to reduce financial repression by reducing the scope of heavy handed government policies to allocate finance. In addition, more key financial prices, such as the exchange rate and interest rates, became market determined, which gave agents the incentive to create the markets and the instruments to price and hedge risk.
Thus, the development model moved close to Development 2.0 but it is worth stressing that SAR countries never went to the caricature of the “Washington consensus” namely unfettered markets and light handed regulation. Another point to stress is that the reforms that were implemented especially in India were “home grown”, with policy makers at the time having a blue print of what was needed to stabilize the economy and rejuvenate growth—in other words, the Washington Consensus or some version of it was NOT imposed on these countries. It was very much part of their own plans. The much greater competition internally and externally set off a process of creative destruction that set them off a much higher growth path. Financial liberalization, and favorable demographics resulted in high savings and the greater competition and larger markets raised investment, productivity and growth.
By and large, the lesson from the SAR experience is that expanding production, increasing product variety, inserting producers into global production chains results basically from self-discovery. Examples include government-lite sectors--India's IT industry and manufactured exports, Bangladesh (contrast with Pakistan and Sri Lanka) garments and textiles (these are not niche products, they are economywide drivers of growth).
Where is SAR now? As a broad characterization, the growth and development challenge in SAR needs to be framed against the following conditions: (a) despite a much reduced role, still strong government presence in the agricultural and manufacturing sectors that distort incentives for production and trade, (b) despite reforms, insufficient economy-wide external trade orientation, (c) policy induced restrictions on the mobility of products and factors, (d) lack of appropriate or sufficient physical infrastructure, (e) fragility and post-conflict problems that are depriving large parts of their populations of the gains from economic development; (f) few natural resource endowments; (g) weak governance environments.
In all of these, while there is a role for the government, it is subsidiary to the trinity of market led innovation, marketing to the world, and steady, but firm, competitive pressures overseen by functioning institutions.
Put differently, the role for the government is not the strategic selection of industries. In general, the Government's role in creating rents should be severely circumscribed.
Instead, the simple (but not necessarily easy) rules for public spending decisions should be:
- Invest in the general rather the specific, and as human capital is the most general, invest in education, health, opportunity and security.
- Invest in other public goods of a multi-purpose, multi-beneficiary and contestible nature (e.g., roads). If other specific sectoral investments are considered necessary, policies need to build in explicit sunset clauses and early opportunities to offload the financing risk on as many partners as possible. But I should add that even this is risky— as Milton Friedman said “nothing is so permanent as a temporary government program.”
- Provide transparent and accountable regulatory framework which is applied consistently and is protected from rent seeking behavior.
By Indermit S. Gill
Preparing for this roundtable make me think back a lot. To my education in India in the 1980s, to my years as an economist in Brazil during the 1990s, to my work on East Asia and China in the 2000s, and to work that we are doing on Russia as part of my current job. I realized that I have a connection with the four BRICs—obviously not as close as the connection that Bert Hofman has with China, or the one that Kalpana Kochhar has with India, or Augusto de la Torre’s with Brazil. But I have connections with each of the four. I also have connections with America and Europe, both places that I admire, for different reasons: I live in the United States, and I work in Europe. So what I will say is based in good measure on the long-term experience of the BRICs, of Europe, and of the United States.
Let me start with three observations that summarize what I learned:
• First, for many years governments were not employing the right mix of policies—that is, they were both overactive and not active enough in areas important for development. To quote Amartya Sen (1996), the decades of economic planning illustrate both “horrendous over-activity in controlling industries, restraining gains from trade, and blighting competitiveness, and soporific under-activity in expanding school education, public health care, social security, gender equality, and land reform,” sometimes in the same country. This was the story of India and of China in the 1950s, 1960s and 1970s, and it was a sad story.
• Second, aided by the experience of countries around the world and by debates in the World Bank, the IMF and other Washington-based institutions, there was a noticeable shift in development policy in the 1980s and 1990s: governments reduced their control of industry and embraced trade, and increased their attention to education and health and social security. There was a surge in development—especially in Asia and Europe. This is a very happy story.
• Third, there was a rush to claim credit for this success. This is human nature. Everyone likes to claim credit for success. Brazil, Russia, India, and China all feel they did things their way, and that succeeded by not taking the advice of the Bretton Woods institutions. In the 2000s, even Nobel Prize winners got into the act: the prize of being right about development policy seems to be even more prestigious than the highest award in economic theory. So there seems to be a lot of disagreement, because some of these folks were actually wrong back then. It is an amusing story.
Actually, if you read carefully, people agree on a lot of things today:
• Everybody agrees about the importance of fiscal and monetary discipline, the reliance on markets, and the benefits of trade. To quote one former chief economist at the Bank, nobody has made “a serious intellectual case against disciplined macroeconomic policies, the use of markets, and trade liberalization.”
• Everybody agrees on the need for establishing property rights, a switch of government spending towards basic education and health and infrastructure, broad and moderate taxes, and sensible deregulation of product and factor markets to ease barriers to entry and exit by enterprises.
• Almost everybody agrees on the need for a competitive exchange rate, liberalization of foreign direct investment, and well-executed privatization of public enterprises.
Financial deregulation and capital account liberalization remain areas of debate, and they should. But even here a consensus seems to be emerging.
So as I prepared for this discussion, I thought: Was there anyone who had put all these things together into a list? Of course, I was also thinking: wouldn’t it be cool if nobody had done it, so I could write something up and post a blog on Shanta’s website? So I did what every serious chief economist does—I went to the Joint World Bank-Fund library to look up development economics between 1980 and now.
I’m kidding of course. I went to Google. And I discovered that it had all been written up in a very nice way by—of all happy coincidences—a former regional chief economist. To give you a hint, it was written more than twenty years ago by someone who later became the chief economist of South Asia. For some reason—with apologies to my colleagues from other regions—South Asia seems to always have had the smartest chief economists. They’ve also had Gobind Nankani, and Shanta, and now Kalpana Kochhar.
But let me get back to why it is important to have these thoughts clear in one’s head. It is because of one reason: being clear-headed helps to be both principled and practical in dispensing policy advice. You know as World Bank economists that it is not enough to be just one—you have to be both principled and practical. So why is it important to be clear about development thinking? Three reasons:
• It is important because you need to distinguish what are the first-order changes that have occurred in development policy, and what is second order stuff. The big shift is that governments are less active in industry, and more active in education. Less active in farming, and more active in land reform. And so on. Governments are doing more of what is social, and less of what should be private. And that is the way it should be.
• It is also important because the line between what is social and what is private is often blurry, it is necessary to know one from the other. After starting out in the right direction, governments can go too far. This is what I think has happened in Europe. Many European governments made the right moves in the 1960s and 1970s and 1980s by getting out of the productive sectors and into the social. With such policies as reliance on markets, and trade and financial integration, Europe created a convergence machine that took in poor countries and made them into high income economies. If you want evidence, take a look at what Poland has done during the last two decades. But then some countries went too far in social security—and made everyone less productive. If you want evidence, take a look at our recent flagship report on European Growth, which the Polish Presidency of the European Council sponsored, and to which Caroline Freund, World Bank Chief Economist for the Middle East and North Africa, contributed.
• The third reason is that you can start to overemphasize the second-order stuff—such as which of the private sector activities governments should favor. This is not dangerous, until you inadvertently start to deemphasize the policies of first-order importance. Of course I am talking about the new industrial policy, which my boss and good friend Justin has been championing with energy and earnestness.
In doing this, I have seen that Justin—perhaps because such things happen in the course of vigorous debate—has come close to asserting things that another former chief economist of the World Bank has been saying and writing about what policies have worked and which have failed. I am talking of course about Joe Stiglitz and what he has had to write about the Washington Consensus during the last two decades, after being a part of it as head of the President Clinton’s Council of Economic Advisers. I noticed in a recent article that Justin also wrote somewhat dismissively of the Washington Consensus, and yesterday I heard him recommend something called the “Seoul Development Consensus.”
Now maybe after June 30 we will all be talking about the Korean Consensus, and Bert will be its author. But I must say that I still believe in the Washington Consensus, and not just because it was proposed by perhaps the most distinguished of all regional chief economists, John Williamson. I believe that it is a list of ten necessary (not sufficient) things, and the experience since 1989 in all parts of the world has only validated it. Take a look at a humble and thoughtful article by John Williamson called “Short History of the Washington Consensus” that he wrote in 2004. I think it will persuade you that I am right.
Let me end with a few words on the issue of the new industrial policy. I think I know why Justin believes so strongly in this. It is because he has seen up-close the workings of a very capable government, and has helped the Chinese people pull off an amazing feat. Such success can make you forget even big parts of a Chicago education. But don’t forget that there is an even more amazing story. I am talking of the economic success of a people that were not even a country 250 years ago, and which is today the economic center of the world. There is a reason why we are debating these things here in America, a block away from the White House.
Of course, we should learn from the experience of all countries, not just one. But if I had to learn from just one country, I would pick the United States. This is what the most influential policy practitioner of the last century had to say about America. I quote:
“The American people, in the short span of two hundred years, brought into being gigantic forces of production and abundant material wealth, and made an outstanding contribution to human civilization. In the course of expanding production in the United States, a wealth of experience has been gained from which others can learn.”
These are not the words of a former chief economist. They are the words of Deng Xiaoping— who I consider one of the most important people who ever lived and who was perhaps the person who best combined principle and practicality. I can’t think of a better role model for practitioners of policy. And I can’t think of a better list with which to start than the one compiled by John Williamson.
Sen, Amartya. 1996. “Development thinking at the beginning of the 21st Century.” Paper presented at a conference on Development Thinking Practice’ of the Inter-American Development bank, Washington DC, 3-5 September, 1996.
Krueger, Anne. 2011. “Comments on “New Structural Economics” by Justin Yifu Lin,” World Bank Research Observer, vol. 26, no. 2.
Lin, Justin Yifu. 2011. “New Structural Economics,” World Bank Research Observer, vol. 26, no. 2.
Lin, Justin Yifu. 2011. “Development Thinking 3.0: The Road Ahead,” World Bank Research Observer, vol. 26, no. 2.
Stiglitz, Joseph. 2011. “Rethinking Development Economics,” World Bank Research Observer, vol. 26, no. 2.
Williamson, John. 2004. “A Short History of the Washington Consensus,” Paper commissioned by Fundacion CIDOB for a conference “From the Washington Consensus towards a new Global Governance,” Barcelona, September 24-25, 2004.
The path to transformation: Creative destruction or destructive creation?
By Caroline Freund
Structural transformation is about moving resources to into most productive sectors and raising the living standards of the population. Conventional wisdom is that increased openness to trade and investment is a mechanism to facilitate this move, as it pushes resources to the sectors that are globally competitive. But as many countries have liberalized over the last two decades, openness has not always brought widespread gains. In some cases, when there are other distortions in place--such as weak governance or excessive business regulations-- structural transformation can be perverse, with labor traveling overwhelming to the informal sector. The intuition is that as a country opens to trade, resources are stuck so new sectors have trouble expanding, while some existing sectors shrink in response to greater competition.
In the case of the MENA region, where only 10 percent of labor is working in the private formal sector and firms are on average nearly twice the age of their counterparts in Easter Europe and East Asia, this seems to be at least part of what has happened. Growth has not been associated with an expansion of manufacturing and decent jobs, as has occurred in other parts of the world.
The question is how to encourage a productive reallocation of resources to new dynamic firms, when distortions are present that prevent them from emerging. I argue that what is needed is to address these distortions head on. That is, improve governance and build a level playing field for business. Property rights and rule of law give investors confidence, simple regulations that are uniformly enforced allow new firms to enter and thrive.
An alternative is for the government to intervene directly with some form of industrial policy to steer resources to the sectors it deems more productive. But if structural transformation has failed to advance because we can't trust the government to allow good businesses to thrive, why should we trust that same government to select and develop new productive sectors?
Indeed, the principle concern with such a policy is that if the distortions are in weak governance and a poor business climate then the government is highly likely to be subject to the same special interest groups that encourage arbitrariness in regulation when it proceeds with this intervention. This can create a process of destructive creation, where resources are steered toward uncompetitive incumbent firms that are unlikely to develop the productive industry for which the policy was intended. Put differently, the same distortions that prevented structural transformation from happening naturally are very likely to prevent it from happening via targeted policies. Moreover, those targeted policies could very well create a new beast that is difficult to discipline and costly to feed.
Instead what is needed for structural transformation is creative destruction, where bad businesses exit and new and strong firms grow and create jobs. This requires good governance and a strong business climate. Specifically, respect for property rights, simple and uniformly applied regulations, clear bankruptcy procedures, and accountability. While industrial policy can work in theory, it seems especially unlikely to be successful in economies where distortions push resources to cronies, where business regulations protect incumbents and where governance makes new investors wary.