Growth Strategies Dani Rodrik October 2005

There was once a Washington Consensus ….

Original Washington Consensus “Augmented” Washington Consensus the previous 10 items, plus: 1. Fiscal discipline 2. Reorientation of public expenditures 3. Tax reform 4. Financial liberalization 5. Unified and competitive exchange rates 6. Trade liberalization 7. Openness to DFI 8. Privatization 9. Deregulation 10.Secure Property Rights 11. Corporate governance 12. Anti-corruption 13. Flexible labor markets 14. WTO agreements 15. Financial codes and standards 16. “Prudent” capital-account opening 17. Non-intermediate exchange rate regimes 18. Independent central banks/inflation targeting 19. Social safety nets 20. Targeted poverty reduction

Countries that adopted it …

Structural reform index for Latin American Countries

0.8

0.7

0.6

0.5

0.4

0.3

0.2

1985 1986 1987 Argentina Dominican Rep.

Mexico 1988 1989 Bolivia Ecuador Nicaragua 1990 1991 Brazil El Salvador Peru 1992 1993 Chile Guatemala Uruguay 1994 1995 1996 Colombia Honduras Venezuela 1997 1998 Costa Rica Jamaica Regional average* 1999

… reaped very small benefits:

6% 5% LAC-7 Emerging Asia OECD 4% 3% 2% 1% 0% -1% 1961-1970 1971-1980 1981-1990 1991-2003 Notes: Regional GDP per capita. Asia includes Indonesia, Korea, Malaysia, Philippines and Thailand.

… while those that prospered played by different rules:

World Bank’s “star globalizers” *

Country Growth rate in the 1990s Trade policies in the 1990s

China 7.1

Vietnam India 5.6

3.3

Average tariff rate 31.2%, NTBs; not a WTO member Tariffs range between 30-50%, NTBs and state trading, not a WTO member Tariffs average 50.5% (the highest but one in the world) *According to World Bank, Globalization, Growth, and Poverty, 2001, p. 6.

Hence the WC is fast being replaced by a new emergent consensus:

• Economists have limited ability to recommend appropriate growth policies • It’s not policies, but institutions that matter • Appropriate policies (and institutions?) depend on local circumstances • Experimentation is inevitable

The changing conventional wisdom:

“there is no unique universal set of rules… we need to get away from formulae and the search for elusive “best practices” …. rely on deeper economic analysis to identify the binding constraints on growth…” From the introduction by Gobind Nankani to the World Bank’s

Economic Growth in the 1990s: Learning from a Decade of Reform

“whatever the policy area, there is no single formula applicable to all circumstances; policies’ effectiveness depends on the manner in which they are discussed, approved, and implemented…. A strictly technocratic approach toward policymaking shortchanges these steps ….” From the introduction to the forthcoming IPES Report of the IDB.

But some change less than others…

“reforms were uneven and remained incomplete…. More progress was made with measures that had low up-front costs, such as privatization, relative to reforms that promised greater long-term benefits, such as improving macroeconomic and labor market institutions, and strengthening legal and judicial systems” -- IMF (2005) “Meant Well, Tried Little, Failed Much” -- Anne Krueger (2004)

All agree on the need to:

• replace “quick fixes” with “deep fixes” • use different strokes for different folks

Towards a more operational agenda: Designing growth strategies

• Growth diagnostics: what are the most binding constraints on growth?

• Policy design: how do we best alleviate the relevant constraints?

• Institutionalization: how do we institutionalize the diagnostic/policy design process in view of the fact that the nature of binding constraints will change over time?

Step 1: Growth diagnostics

Problem: Low levels of private investment and entrepreneurship Low return to economic activity Low social returns Low appropriability High cost of finance bad international finance bad local finance government failures market failures poor geography low human capital bad infra structure micro risks: property rights, corruption, taxes information externalities: “self-discovery” macro risks: financial, monetary, fiscal instability coordination externalities low domestic saving poor inter mediation

Illustrations

• El Salvador: low investment demand due to low incentives for “self-discovery” – Need to find new high-return investment opportunities – Solution: industrial policy?

– What will not work: Improving “institutional environment” will not be very effective when constraint is low appropriability due to “cost discovery” and coordination externalities • Brazil: low investment due to high cost of capital – Need to increase domestic savings and enhance access to foreign savings – Solution: adjust fiscal policy?

– What will not work: improving “business climate” not very effective when problem does not lie with low investment demand

The growth diagnostics approach is based on the view that small changes, if appropriately targeted, can unleash growth

• Growth accelerations are frequent – More than 80 cases since the mid-1980s – Including in SSA • And they are rarely triggered by comprehensive economic reforms – Key is well-targeted effort to remove most severely binding constraints – China in 1978; India in 1980; Chile in 1984-85

Step 2: Policy design

• First-best logic: target policy on relevant distortion – but hardly works due to second-best interactions and political-economy/administrative constraints • Multiplicity of institutional solutions – the functions that good institutional arrangements perform (protect property rights, ensure macro stability, internalize externalities, etc.) do not map into unique institutional forms – local contingencies require local solutions • TVEs versus privatization as property reform • Experimentation and learning are necessary components of reform • Implication for government-business relations – government needs to be close enough to business to elicit information, far enough not to be captured … hardly the Washington Consensus!

Chinese shortcuts

• Two-track pricing insulates public finance from the provision of supply incentives • Household responsibility system and township and village enterprises obviate the need for ownership reforms • Special economic zones provide export incentives without removing protection for state firms • Federalism, “Chinese-style” generates incentives for policy competition and institutional innovation

Institutional domain

Property rights Corporate governance Business-government relations Industrial organization Financial system Labor markets International capital flows Public ownership

East Asian anomalies

Standard ideal

Private, enforced by the rule of law

“East Asian” pattern

Private, but govt authority occasionally overrides the law (esp. in Korea). Insider control Shareholder (“outsider”) control, protection of shareholder rights Arms’ length, rule based Close interactions Decentralized, competitive markets, with tough anti-trust enforcement Deregulated, securities based, with free entry. Prudential supervision through regulatory oversight. Decentralized, de-institutionalized, “flexible” labor markets “prudently” free Horizontal and vertical integration in production (chaebol); government mandated “cartels” Bank based, restricted entry, heavily controlled by government, directed lending, weak formal regulation.

Lifetime employment in core enterprises (Japan) Restricted (until the 1990s) None in productive sectors Plenty in upstream industries.

Step 3: Institutionalizing the diagnostic process

• Nature of binding constraints change over time • Growth will slow down if diagnostic process not ongoing – Dominican Republic, Indonesia, Cote d’Ivoire,..

– China’s future challenges • Sustaining growth requires ongoing institutional reform to – Maintain productive dynamism – Increase resilience of economy to external shocks

Why none of this is “heterodox”

• Approach outlined above is based on empirical evidence and standard economic theory – Policy recommendations in economics are always state contingent • policy A is desirable if … – This is how economists think in the seminar room • Approaches based on “rules of thumb” are not – Washington Consensus and later variants are based on implicit theorizing about market structure, political economy, institutional capacity

Some implications

• Successful growth strategies require policy experimentation – willingness to try unconventional solutions • Successful growth strategies result in higher trade and investment flows • Implications for WTO, WB, IMF: – de-emphasize “best practice” approach – policy space – selective approach instead of laundry list