Growth Strategies Dani Rodrik October 2005

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 Original Washington Consensus There was once a Washington Consensus ….

Countries that adopted it …

… reaped very small benefits: Emerging Asia -1% 0% 1% 2% 3% 4% 5% 6% LAC-7OECD Notes: Regional GDP per capita. Asia includes Indonesia, Korea, Malaysia, Philippines and Thailand.

CountryGrowth rate in the 1990s Trade policies in the 1990s China7.1Average tariff rate 31.2%, NTBs; not a WTO member Vietnam5.6Tariffs range between 30-50%, NTBs and state trading, not a WTO member India3.3Tariffs average 50.5% (the highest but one in the world) World Banks star globalizers * *According to World Bank, Globalization, Growth, and Poverty, 2001, p. 6. … while those that prospered played by different rules:

Hence the WC is fast being replaced by a new emergent consensus: Economists have limited ability to recommend appropriate growth policies Its not policies, but institutions that matter Appropriate policies (and institutions?) depend on local circumstances Experimentation is inevitable

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 Banks Economic Growth in the 1990s: Learning from a Decade of Reform The changing conventional wisdom:

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 High cost of financeLow return to economic activity Low social returnsLow appropriability government failures market failures poor geography low human capital bad infra- structure micro risks: property rights, corruption, taxes macro risks: financial, monetary, fiscal instability information externalities: self-discovery coordination externalities bad international finance bad local finance 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

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

East Asian anomalies Institutional domain Standard idealEast Asian pattern Property rightsPrivate, enforced by the rule of lawPrivate, but govt authority occasionally overrides the law (esp. in Korea). Corporate governanceShareholder (outsider) control, protection of shareholder rights Insider control Business-government relationsArms length, rule basedClose interactions Industrial organization Decentralized, competitive markets, with tough anti-trust enforcement Horizontal and vertical integration in production (chaebol); government- mandated cartels Financial systemDeregulated, securities based, with free entry. Prudential supervision through regulatory oversight. Bank based, restricted entry, heavily controlled by government, directed lending, weak formal regulation. Labor marketsDecentralized, de-institutionalized, flexible labor markets Lifetime employment in core enterprises (Japan) International capital flowsprudently freeRestricted (until the 1990s) Public ownershipNone in productive sectorsPlenty 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 dIvoire,.. –Chinas 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