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Monday, May 31, 2004

WHAT EXPLAINS ECONOMIC DEVELOPMENT? 1st of a 8-Part Mini-Series

So far, this lengthy series on the democratic prospects of the Arab countries --- viewed comparatively, especially with Turkey's laudable democratic development and better economic performance --- has concentrated mainly on political change and cultural matters, plus some references, now and then, to economic development. The last article in the series also widened the comparative focus. In a dozen different ways, it tried to show that the tumult, challenges, and violence that have accompanied radical political and economic changes in the Middle East and other developing regions --- prodded by the shockwaves of modernization and globalizing forces --- had also convulsed most of Europe from 1500 on as well . . . often with greater violence and high-coiled religious and ideological extremism.

Among other things, the earlier 11 articles in the series sought to clarify, theoretically, what constitutes democracy, distinguishing two main variants: the solid liberal sort, which is confined to about 30-35 countries, and the wider electoral kind that now encompasses dozens more. Some of these new electoral democracies may evolve over time into the liberal sort: that means instituting an effective rule of law, cutting down rampant corruption and nepotism, and spawning a vigorous civil society of voluntary associations . . . which includes cause groups galore and independent self-governing professions. An energetic and free media is also vital here. Several others of these electoral democracies might remain confined to electoral democracy, decades on end. Yet others might lapse again into authoritarianism, even of a brutal sort. It all depends.

What we have shown is that despite the big surge in the number of new electoral democracies --- dozens of them over the last two decades --- one area of the world remains stubbornly absent on the democratic roll-call: the 22 Arab countries. All are despotic; all are generally marked by a winner-take-all-politics, despite some greater freedom of expression and limited political participation in a half dozen of them; all lack an effective rule of law; and each and every one --- again with some variation in the degree of outright coercion or brutality they use --- rely ultimately on the secret police for their survival. Their failures and political obstacles to becoming electoral democracies --- a small handful more promising than others: the tiny Gulf states, Jordan, Morocco, and now Algeria --- have been carefully set out and analyzed.

So much for the Arab political record. Time now to nudge your attention away from politics and focus it the economic record, above all --- as a first-cut --- in the following ways:


PART ONE:
INTRODUCTORY COMMENTS: EXPLAINING ECONOMIC DEVELOPMENT




Our Task Here In This Article?

It's easy to set out, this current task: to shift our focus from political to economic concerns and concentrate on explaining the causes of economic development --- in general theoretical terms, mind you; and in ways that hold lessons for all poor countries seeking to grow their way out of poverty, not just the 22 Arab countries.

The latter, recall, add up to 300 million people: half of them under the age of 15. They will number 500 million or so in a couple of decades. Subtract oil --- abundant only in the tiny Gulf states, Iraq, and Saudi Arabia --- the 22 Arab countries manage together to export less than tiny Finland, with its 4 million people. Hard to believe, no? True all the same. Come to that, unemployment averages 20-25% among Arab men alone. Illiteracy remains the highest in the world --- higher even than in much poorer Tropical Africa.

It's a record of massive development failure. The following theoretical analysis of development --- what underlies successful long-term economic growth over generations or even centuries --- should help illuminate, even spotlight, the causes of these Arab failures . . . or come to that, developmental failures elsewhere too.

 

A Detailed Developmental Record Now To Generalize About About.

Fortunately, since WWII, we can now theorize more effectively than in the past about development --- above all, because several formerly poor countries, even in southern Europe and parts of Latin America, never mind Pacific Asia, have compiled a clear record of economic development that can then be compared with the earlier developmental achievements of Japan, Western Europe, and the English-speaking countries. Other countries have been less successful: their problems and setbacks are further sources of evidence for theoretical analysis. Some have bungled almost completely, especially in Tropical Africa.

Our main theoretical premise? Increasingly, since 1990, developmental economists have begun to recognize that sustained, long-term economic development requires, roughly, the same sort of institutional and cultural changes that lead, ultimately, toward solid, liberal democracies. Many economists balk at extending their theoretical models in that wide-ranging direction. Some even deny that it's needed. Even the World Bank, though, now grants that without major institutional reforms, developing countries won't develop.

And as we'll see, by definition the workings of institutions --- whether economic, financial, political, or otherwise --- always have a strong cultural component.

 



Agreed: These Are Fairly Abstract Points,

. . . all needing an explanation --- at a minimum, a good article's worth. This one for instance; or more precise, this one and the next three . . . the resulting quartet forming a dense, tightly knitted mini-series. So remember our task in these 4 articles once more:

  • To set out and clarify the general institutional and policy changes --- economic, political, and legal: even, come to that despite their slippery nature, cultural ones --- that need to be undertaken over time if the leaders and citizenry of poor countries hope to transform them into affluent, technologically advanced economies.


Wait though. Two sidebar comments suddenly intrude here, by way of clarification.

(i.) You'll note that the argument here refers to a few readings. Which ones? Those, as it happens, assigned to a buggy prof class at UC Santa Barbara in international relations theory, political science 121 --- in particular, the 3 week section of the class that deals with globalization and economic development. The students already have several hand-out exam questions dealing with these in the next mid-term, scheduled for June 1st. These questions, six in all, have to be prepared carefully. Each refers in detail to the assigned readings, and to a lesser extent to the buggy prof's lectures. Those readings will be set out here in a moment. Every one, by the way, can be accessed through the Internet, even if, come to think of it, three or four might require a subscription to the journals where they originally appeared.

(ii.) As you'll see when you reach Part V of the argument --- found in the second article in this mini-sries --- there's a theoretical model used to summarize the conditions of successful development . . . which means, to put it bluntly, the conditions that explain why the rich countries are rich and others aren't.

That model unfurls four major propositions, easy to follow. Three of the four are borrowed from a book by Charles I. Jones, Introduction to Economic Growth (Norton, 2nd ed., 2002), especially chapter 10. His model is sketched out in a suggestive way, nothing more --- a barebones model if you want. And though the borrowing from Jones' work needs to be underscored, the elaboration of the model and the extensive comments that follow are strictly the responsibility of the buggy prof's cogitations, for good or bad.

As for Jones' book, it's well worth buying and working your way through his clearly written analysis of various growth models, with one proviso in mind: the book's ordinarily used in upper division courses in economics --- possibly even in first year grad seminars --- and so to make sense of Jone's analysis, you need to have a good basis in statistics and multiple regression modeling --- the heart of econometrics. Some basic calculus would also help.

If you prefer, stick to the ps 121 reading listed right now, along with a couple of less demanding but unusually stimulating and intelligent books on development. Two stand out:

  • David Landes, The Wealth and Poverty of Nations: Why Are Some Rich and Others So Poor? (Norton, 1999) --- a masterful historical survey, written with the clarity and graphic vigor of a talented novelist, of how the world became divided into rich and poor nations since the Middle Ages. The book climaxes a long 50 year career of one of the most gifted economic historians of the last century. Its argument is mainly cultural and institutional, even if the analytical framework could at times be strengthened.


  • William Easterly, The Elusive Quest for Growth (MIT, 2001), probably the single best book ever written on development, and all the more admirable because its analysis is generally non-technical and easy for the general public to read. A talented academic economist, Easterly served decades with the World Bank and spent several years in the field in a number of developing countries. Impossible to over-praise this admirable book, which is discussed in the second section below, taken from the political science 121 syllabus.




The Readings Referred To Here:

All are taken from the syllabus for political science 121, spring 2004, for weeks 7-9:

IV. GLOBAL ECONOMICS AND INTERNATIONAL ORDER AND POWER POLITICS (WEEKS 7-9)

1. Globalization

Alan Taylor, Globalization, Trade, and Development: Some Lessons from History (NBER paper 9326, November 2002),
A,T, Kearney, "Measuring Globalization," Foreign Policy (March/April 2004). http://www.foreignpolicy.com/story/cms.php?story_id=2493
Joseph E. Stiglitz, "Globalism's Discontents," American Prospects (January 2001), plus Gordon comments
Dan Drezner, "Bottom Feeders," Foreign Policy (Nov-Dec 2002)
Exchange between Robert Wade and Martin Wolf, "Are global poverty and inequality getting worse?" Prospect (March 2002)
David Dollar and Aart Kraay, "Spreading the Wealth," Foreign Affairs (January/February 2002), pp 120-133.
Exchange between critics of Dollar and Kraay and Their Rejoinder," Foreign Affairs (Summer 2002).
Stanley Fischer, "Globalization and Its Challenges", paper prepared for the American Economic Association, January 3, 2003.




2. Economic Development:

"Interview with William Easterly: The Failure of Economic Development," Challenge (Jan/Feb 2002)
Benjamin Rowland, "Dissenting Economist," SAIS Review (Winter 2003)
Dani Rodrik, "Growth Strategies" (Paper, June 2003), pp. 1-26, Download here.


 

PART TWO: WHAT ACCOUNTS FOR SUCCESSFUL ECONOMIC GROWTH?

The Need To Distinguish Between Short-Term Growth Spurts and Long-Term
Sustained Development


What causes successful development then? Well, the starting point for any theoretical analysis are the distinctions made by Dani Rodrik in "Growth Strategies", especially the one just mentioned in the sub-heading here. More basically, his distinctions on this score show up in three key ways:

 

1) IGNITING ACCELERATED ECONOMIC GROWTH VS. SUSTAINING IT OVER THE LONG-TERM

Short-term accelerated growth that kick-starts an economy out of poverty and backwardness, as Rodrik rightly argues, needs to be separated from the pre-requisites of sustained long-term economic development.

The latter, if it goes on for several decades or more, will lead developing countries to converge toward the levels of per capita income and productivity --- the two going hand-in-hand --- of the rich leader countries. Think of Spain, Portugal, Greece, and Ireland in the EU; or South Korea, Taiwan, Hong Kong, or Singapore in Pacific Asia. Note: the convergence may never fully equal the leader's levels. For the matter, the EU average in per capita income --- Japan's too --- is only about 67% of the US's . . . the US lead, with ups and downs, roughly 125 years old by now, more than half the period since the industrial revolution started. Compared with 1950 or 1960, several other developing countries --- China in Asia, India now too, Mexico and Brazil and Chile and Argentina --- have also narrowed the gap with the rich countries, even if the gap is still very large. The same is true of some new East European members of the EU.

Rodrik doesn't define the short-term --- igniting growth from very low levels of per capita income so that a clear growth spurt occurs compared to the average GDP growth over the previous five years. Even so, his examples indicate it can go on for two or three decades without turning into dynamic sustained growth . . . exactly the case, say, of Mexico and Brazil, fast growing economies (roughly 6% a year), from 1950 to about 1980.

 

The Examples of Brazil and Mexico Examined Further for
the Light They Throw on The Short-Term


At that point, roughly the early 1980s, what happened in both countries --- rapid growers until them, full of developmental promise?

In effect, all the cumulative market inefficiencies and problems caused by Mexico's and Brazil's wider, unreformed institutional context --- plus policies of import-substitution and considerable regulation and closure to international competition --- led to a crash in their development, a dizzy nosedive. Mexican and Brazilian policymakers then struggled for a good decade before they succeeded in reorienting their policies ---and some of their institutions (banks especially) --- toward more "Washington Consensus" policies: less regulation that blocked competition from abroad and in the home market, privatization, more financial and trade liberalization, and far sounder monetary and fiscal policies that halted inflationary surges. Even then, as we now know, their institutions in key areas --- especially administrative, educational, and financial ones that hinder vigorous entrepeneurship in agriculture, manufacturing, and service industries --- still need drastic reform and upgrading. That's why, among other things, the boom of the early and mid-1990s ran out of gas by the end of the decade. (Another main reason: world economic growth itself faltered everywhere, even in the US economy).

The same institutional problems still haunt much of the legal system in both countries, particularly when it comes to suppressing rampant corruption and nepotism by influential people in political, administrative, and business life . . . not to forget tax evasion on a massive scale everywhere.

Little wonder that the underground economy in both Mexico and Brazil is estimated to be over 50% of official GDP. Nor is that all. As we'll see when we reach the topic of culture and its influences on development, both Brazilian and Mexican development --- like that of most Latin America --- suffer from widespread mistrust across family, ethnic, and class-based lines of distinction, hindering spontaneous cooperation and, for that matter, reinforcing corruption and tax evasion.

The legal system can be improved in all of Latin America, not just in Brazil and Latin America. . In some countries, admirably enough, it has, though much more needs to be done. Chile does the best in limiting corruption. Uruguay has done noticeably better too. And everywhere there are vigorous human rights groups at work to strengthen democratic tendencies in Latin America, along with a robust free media in almost every country too.

But note: there's only so much that good laws and enforcement mechanisms --- the courts, the police, prosecutors --- can do if people are convinced, in deep-seated mental ways, that everyone else is out to cheat the system. When beliefs of this sort prevail in a culture, small wonder that the vast majority of people happen to believe they would only be suckers to do what the law requires them to do when it comes to demanding bribes or evading taxes or finding a job for your family members one way or another.

 

2) IGNITING SPURTS OF ECONOMIC GROWTH IN POOR COUNTRIES

What can kick-start short-term growth spurts isn't easy to spell out in a brief set of theoretical propositions: most anything can do it, provided --- Rodrik doesn't say this, but it's the case --- the work force is sufficiently educated to work with modern technologies. Note, these technologies need not necessarily the most advanced, but modern ones anyway, especially in manufacturing, but possibly also in agriculture and finance (computers, debt management, credit analysis for allocating credit to those seeking loans, effective bond markets etc).

What does emerge from Rodrik's analysis is that the general prescriptions stressed by market economics --- protection of private property, sound monetary policies to keep a currency from inflating, limited government deficits, market competition, and openness to the global economy --- are essentially high-level principles that don't easily translate into one set of policy prescriptions for every country.

Instead, policymakers have been successful in Asia and elsewhere in experimenting and fitting these principles --- often highly diluted --- to local conditions: institutional and cultural as well as those that are politically feasible.

At times, he notes, there may even be scope as in East Asia for industrial targeting and fostering limited competition in certain industrial sectors. Import competition from foreign manufacturers can even be limited and helpful at times . . . the case of Japan and later East Asia. Similarly, though import-substitution manufacturing generally ended as a bust in most of Latin America, it did help lay a basis for India and CHina when they swung around to more export-oriented growth

In many ways, William Easterly --- formerly of the World Bank and the author of the best book on development ever written, The Elusive Quest for Growth (MIT, 2001): remember, the students in ps 121 are only reading an interview with him, plus a lengthy review of the book --- agrees with Rodrik here: there is no one formula that can be inferred from either general development theory or the development record that can be applied to successful take-offs in developmental growth.


Easterly does put more emphasis than Rodrik on policymakers seeking in each country to come as close to good Washington Consensus policies as they can, especially in taking into account the key premise of market-theory: the need to pay attention to incentives for encouraging saving, investment, entrepreneurship, and innovation on the part of private firms . . . even if the role for extensive governmental intervention and industrial targeting exists --- at any rate, in the early growth stages of an economy --- provided the countries in question are endowed with good honest governments and good technical knowledge. But careful here! Governments of this sort are a rarity in the vast majority of countries. In the Arab Middle East and almost all of Tropical Africa, they hardly even exist in rough-and-ready ways. Just the opposite.

Depending where, Latin American governments aren't much better.

 

3) WHAT SUSTAINS LONG-TERM ECONOMIC DEVELOPMENT? NECESSARY INSTITUTIONAL AND POLICY CHANGEs.

(i.) Institutions

Here Rodrik joins Easterly and Martin Wolf and Stanley Fisher --- see their articles listed earlier here --- in stressing a pivotal point about successful long-term development: all countries that hope to sustain development once it's ignited have to undertake major institutional changes. What sort of changes? Essentially, similar to those that characterize the EU, the English-speaking countries, Israel, Japan and the other East Asian dynamos. That means in effect, taking into account some visible differences between the successful rich countries:

Good government, an efficient rule-of-law that protects private property (including intellectual property) by an impartial judiciary, and a merit-bureaucracy, all operating with noticeable transparency and accountability.

By contrast, most bureaucracies in developing countries, even democracies, are packed with nepotism and corruption, and a rule-of-law is either undeveloped or a joke. Transparency and accountability, it should be added, are never perfect in even the best industrial democracies and vary across them in vigor.

Effective business and financial organizations that operate with good auditing practices and transparency --- corporations, banks, stock and bond markets, insurance companies, stock brokers, and venture capital --- and show flexibility in adapting to economic shocks like inflation or depression or caused by new technologies and shifts in global production.

Continued upgrading of educational institutions and --- no less important --- workers' training on the job. Improved facilities for R&D.too.


There may be room for adapting these institutional changes to local conditions, even if the room for such adaptation isn't as great as in the earlier period of economic growth spurts that lead poor countries out of poverty. Note though. In the end, Rodrik hints that democracy and solid and well-protected human rights are pre-conditions of advanced economic development and affluence. Easterly and Stiglitz and others agree that at least effective conflict-resolution processes are needed by responsive government. Easterly elsewhere notes that countries torn by ethnic and class conflicts will not develop.

 

(ii.) Specific Policies

As for policy changes, Rodrik, Fisher, and Easterly all agree ---- and to a lesser extent, so do Stiglitz and Wade as critics of the World Bank and IMF --- that when it comes to sustaining long-term economic growth that converges over several decades or more with the levels of per capita income and productivity of the rich leader countries, several generations or more, all countries' governments need to institute policies that

Would all approximate the Washington Consensus on 1) liberalizing trade and 2) opening up to global financial integration, plus ever 3) sounder monetary and 4) fiscal policies.

The desirability of effective tax policies, a sound social security network, and improved health services, public or private, were later stressed as additions to the Washington Consensus by the World Bank. So too were effective, market-oriented environmental policies.




 

(iii.)What Will Be The Ultimate Outcome of Effective Institutional and Policy Reforms:

The net effect of these policy and institutional changes is clear: over time, to sustain economic development and converge on the living standards of the rich countries is for any one country to become increasingly integrated into global capitalism: in trade, in finance, in technology transfers, and in multinational activity.

Are there no counter-examples of successful long-term economic development without such institutional adaptations and policies?

The blunt answer: no, none at all.

The Soviet Union grew rapidly for three or four decades, thanks to its coercive, mass-murdering Stalinist model, which totally cut off the Soviet economy from global capitalism. Then all the vast botches and cumulative inefficiencies --- a blatant lack of innovation, sheer irrationality, rippling corruption, and in the end a black-hole of decline --- came together by the 1970s; and when the Soviet Union finally collapsed and went into oblivion in 1991, its per capita income was a quarter of those that prevailed in the prosperous Western world. For that matter, the Soviet economy was incapable of producing a decent automobile or TV set, never mind making the shift to the bursting new world of computers and information-and-communication technologies.

 

(iv.) True Enough, Successful Capitalism Comes In Variants . . . But Ony Within Limits and With
Problems for the EU and Japanese Models


Half-way through the first decade of the 21st century, Japanese capitalism still differs from EU welfare-state capitalism, and both for that matter differ from the more free-market thrust of the English-speaking countries. Yet note. The differences aren't great. All the governments and legal systems in these diverse capitalisms protect private property; all have a good rule-of-law, even if it could improve; all are democratic; all are innovative or good at importing and diffusing new technologies; and all are heavily integrated into the global economy.

But note. They are beginning to resemble one another even more in certain key respects, with the Japanese and EU Continental countries moving to deregulate and become more flexible and competitive in line with free-market logic. They have no choice. Globalizing forces and new technologies --- including shifts in global economic dynamisma --- are putting them under relentless pressure to regain new economic vigor.

 

More specifically, since the 1980s, Japanese policymakers have had to abandon industrial targeting for the most part and move in a free-market direction. By that date, such governmental targeting --- with lavish subsidies and forms of protection --- had become little more than a defense of the vested quo, protecting more and more uncompetitive industries. Whatever boost it had brought to the impressive Japanese upgrading in technology in the 1950s, 1960s, and 1970s --- and most recent analyses doubt that industrial targeting had much impact here, compared with normal market-oriented strengths like good management, a qualified work force, and massive investments --- had ceased by the end of the latter decade. Simultaneously, Japanese policymakers have had to open up their highly protected financial system and make it increasingly easy for foreign banks and brokerage houses to locate in the country. The same is true of opening up to foreign multinationals.

The upshot? After a dozen years of lost economic growth since the early 1990s, Japan's overall economy --- struggling with the worst growth performance of any advanced industrial country since the Great Depression of the 1930s --- is beginning to look much more like that of the West Europeans and the English-speaking countries.

Similarly --- despite greater similarity with the Anglo-American free-market model to begin with --- the EU Welfare-State capitalist model with its greater governmental regulations, high taxes, and concerns for extensive social spending is being reformed in a more free-market direction too . . . and largely for the same reason the Japanese have had to liberalize and open up to globalizing capitalism: slow or stagnant growth, compounded in the EU by heavy burdens of social spending amid a slowdown or fall-off in tax revenue. Some of the EU Continental countries --- notably the small Scandinavian states and Holland --- have carried out a large number of successful reforms. France, Italy, Germany, and Spain continue, by contrast, to struggle with all the vested interests that encumber major reforms --- this, even though left-wing governments know as much as right-wing ones that the free-market reforms are inescapable if stagnation and decline are to be avoided.

On this, see the article in the L.A. Times, May 31st, 2004, on the mammouth resistances in Germany to the Schroeder government's limited reform program: Germany Grappling With A Deflated Sense of Pride: The Economy Is Limping, Benefits Are At Risk, the Mood Is Bleak.

 

Don't misunderstand.

Nobody expects the Japanese or EU models to evolve totally into Anglo-American capitalism. Japan's population will probably always insist on more social stability and protection than is the case in the US or UK, especially with the rapid aging of the work force --- more and more retirees, with ever fewer workers to support them. By the same token, the aging EU countries' populations will insist on retaining a larger system of welfare and other social spending --- something that almost all EU politicians, whether on the left or right, understand is essential to their social stability. Still, the gaps between their models and the Anglo-American model have narrowed over the last decade or so, and no doubt it will continue to do so, however slowly, in the next decade or two as well.





 

The Argument Will Be Continued in the Next Article in This Mini-Series