Back to Economic Growth Basics Jayati Ghosh

Suddenly, discussions about economic growth and how to generate it are back in fashion among economists. Ironically, this renewed interest comes about 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.

There was a period of around two decades, from the mid 1980s onwards, when how to kick-start economic growth was not recognised as a relevant question. The focus was not on growth per se but on stabilisation and “efficiency”. It was taken for granted by mainstream neo-classical economists and the policy makers influenced by them that economic growth would come about on its own, once markets were deregulated and rules for domestic and international trade and investment were liberalised. In this story, growth was something 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 both more efficient and more dynamic.

Much of the empirical debate around globalisation also somehow ended up in this simplistic paradigmatic framework, even though the processes of globalisation were not essentially about “free” and competitive markets so much 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 wholeheartedly embraced these principles, and the most dynamic economies turned out to be those with much more flexible and heterodox approaches to economic policy. So economic growth moved from being the obvious result of “good policies”, to becoming the subject of the newest growth industry inside the economics profession.

Economists have begun, even if very belatedly and without much enthusiasm, to interrogate their prior suppositions. We now have a spate of academic books and reports of international organisations, rediscovering basic truths of development economics that were not so much forgotten as 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 could have told them all along if only they had cared to listen. Consider some of the insights that they have come up with:

  • It is overly naïve to expect that simply reducing tariffs or liberalising finance will automatically increase growth
  • Stabilisation and macroeconomic management need to be growth-oriented.
  • Governments need 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 for all these years.

As a result, there was nothing to mitigate the dogmatic and relentless pressure that was applied to developing country policy makers, 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 existing livelihoods without generating enough new employment, did not allow enough public investment in physical and social infrastructure to sustain future 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 easily reversed, so that the suffering will continue for some time even if the economic 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” that was chaired by Nobel Prize-winning economist Michael Spence, and included inter alia Montek Singh Ahluwahlia from India. With its estimated budget of more than $4 million, for more than two years this Commission held meetings and workshops, consulted with about 200 economists, commissioned around 80 research papers, all to “unravel the mystery of economic growth”.

The resulting Report has been criticised for saying little more than what undergraduate students in economics could come up with. But it is significant in that market fundamentalism, which would probably have characterised such a Report even recently, is replaced by a genuine acceptance of ignorance and acceptance of past mistakes in declarations about growth. The Report admits that “orthodoxies apply only so far.”

The Report identifies 13 countries that are described as “high growth” because they have grown at an average rate of 7 per cent a year or more 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 another 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;
  • the need to bring environmental protection into development from the beginning;
  • equality of opportunity, particularly for women.

Similarly, the Report 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 uncritically accepted to be 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 policy makers to apply, since no generic formula exists. 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 anyway, 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 the opposite of success because they have been combined with other market-oriented policies that have completely undermined any possibility of growth.

So it is also interesting to read 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 Report’s silence is deafening on the Washington Consensus conditions for growth such as “prudent” macroeconomic policies and fiscal discipline, which it barely mentions. It even says that it is bad to reduce fiscal deficits by cutting public infrastructure spending!

So what does one make of all this “new” knowledge? The central point – and one that our policy makers would do well to remember – is that the orthodox set of stabilisation and liberalisation policies to which we were told that “there is no alternative” are 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 some indication of how much the economics mainstream itself is shifting.