Growth Strategies

Dani Rodrik
October 2005
 There was once a Washington Consensus ….

   
“Augmented” Washington Consensus
Original Washington Consensus
the previous 10 items, plus:

1. Fiscal discipline 11. Corporate governance

2. Reorientation of public expenditures 12. Anti-corruption
3. Tax reform 13. Flexible labor markets
4. Financial liberalization 14. WTO agreements
5. Unified and competitive exchange 15. Financial codes and standards
rates 16. “Prudent” capital-account opening
6. Trade liberalization 17. Non-intermediate exchange rate regimes
7. Openness to DFI 18. Independent central banks/inflation
8. Privatization targeting
9. Deregulation 19. Social safety nets
10.Secure Property Rights 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 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

Argentina Bolivia Brazil Chile Colombia Costa Rica

Dominican Rep. Ecuador El Salvador Guatemala Honduras Jamaica
Mexico Nicaragua Peru Uruguay Venezuela Regional average*
 … reaped very small benefits:

6%
LAC-7 Emerging Asia OECD
5%

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 Trade policies in the 1990s
in the 1990s

China 7.1 Average tariff rate 31.2%, NTBs; not a WTO

member
Vietnam 5.6 Tariffs range between 30-50%, NTBs and state
trading, not a WTO member

India 3.3 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 High cost of finance

Low social returns Low appropriability bad international bad local finance
finance

government market
failures failures

poor bad infra- information coordination

geography structure externalities: externalities
“self-discovery”
micro risks: macro risks: low poor
low property rights, financial,
human domestic inter-
corruption, monetary, fiscal saving mediation
capital taxes instability
 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
 East Asian anomalies
Institutional domain
Property rights
Corporate governance
Business-government relations
Industrial organization
 
Financial system
Labor markets
International capital flows
Public ownership
Standard ideal
Private, enforced by the rule of law
Shareholder (“outsider”) control,
protection of shareholder rights
Arms’ length, rule based
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
None in productive sectors
“East Asian” pattern
Private, but govt authority occasionally
overrides the law (esp. in Korea).
Insider control
Close interactions
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)
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