Transcript New - The Swiss Global Economics

Growth Strategies: The empirics of policy reform and growth
March 2014
• Over the past 50 years the world’s richest economies have seen gradual declines in
growth rates of GDP per person. The median rate has fallen from over 4% in the 1960s
to just 0.02% in the aftermath of the financial crisis, according to the IMF. After a slump
in the 1980s and 1990s, middle-income economies rebounded in the 2000s and have
maintained a healthy growth rate more recently. Low-income countries have seen the
most improvement over time: median growth was 3% in 2008-11. Even better, since the
1990s these countries’ “take-offs”— an expansion of income per person averaging at
least 3.5% for a period of at least five years—have been more numerous and longerlasting.
• The outlook for economic growth in the West is bleak, according to the IMF’s latest
World Economic Outlook, released on April 16th. Worldwide output is expected to grow
at just over 3% in 2013, but rich countries will lag behind, expanding at 1.2%. Growth
in emerging markets, by contrast, will exceed 5%, with Asia and sub-Saharan Africa
motoring along at 7% and 5.6% respectively. The IMF's report praises euro-area
policymakers for avoiding a break-up, but notes that parts of the currency union are still
uncompetitive and constrained by austerity. The failure of cash injections to trickle down
to households and businesses is dampening prospects, too. The American economy,
though buoyed by recovering housing and credit markets, must endure the effects of the
budget sequester.
Starting point: a change in emphasis
• Presumptive strategies
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ISI
Washington Consensus
U.N. Millennium Project, MDGs
Governance agenda
• Long laundry list of reforms
– In a wide range of areas: trade, fiscal, legal,
regulatory, health, education, etc.
• Focus on complementarity of reforms rather than
prioritization or sequencing
• A bias towards universal recipes, “bestpractices,” and rules of thumb
Starting point: a change in emphasis
• Diagnostic strategies
– We do not know ex ante what works and what doesn’t
– Need to look for binding constraints
• Which tend to be context-specific
– Experimentation central part of discovery
– Monitoring and evaluation equally central
• Focus on selective, more narrowly targeted
reforms
• Based on the idea that there exists lots of slack
– Well targeted reforms can produce a big bang
• Suspicious of “best-practice,” universal remedies
– Looking for policy innovations that unlock local
second-best/political complications
The Litmus test
• Do you believe there is an unconditional and
unambiguous mapping from specific policies to
economic outcomes?
– If yes, you are in the presumptive camp
– If no, you must rely on the diagnostic strategy
The Outline
• Why this mapping does not exist (in general)
– Arguments from theory
– Arguments from evidence
• How conventional wisdom skirts the difficulty
Why rules of thumb don’t work:
an illustration from trade policy
When is trade liberalization desirable (in theory)?
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The liberalization must be complete
– or else the reduction in import restrictions must take into account the potentially quite
complicated structure of substitutability and complementarity across restricted commodities.
There must be no microeconomic market imperfections other than the trade restrictions in
question
– or else the second-best interactions that are entailed must not be adverse
The government must be able to undertake a compensatory devaluation of the currency
– or else nominal wages must be downwardly flexible
The home economy must be “small” in world markets
– or else the liberalization must not put the economy on the wrong side of the “optimum tariff”
The economy must be in reasonably full employment
– or else the monetary and fiscal authorities must have effective tools of demand management
at their disposal.
The income redistributive effects of the liberalization should not be judged undesirable by society
at large
– or else there must be compensatory tax-transfer schemes with low enough excess burden.
There must be no adverse effects on the fiscal balance
– or else there must be alternative and expedient ways of making up for the lost fiscal
revenues.
The liberalization must be politically sustainable and hence credible
– or else the fear of reversal must not lead to too large a consumption boom in imported
durables
And none of this guarantees growth (as opposed to level) effects, which would require an even longer
list of prerequisites!
The empirics of policy reform and growth
• What do cross-national growth empirics show?
• Actually, not much
• Some serious methodological flaws
– As practiced:
• Fragility of results (non-robustness, non-linearities)
• Outcome versus policy variables on the RHS
– Inherent:
• governments use policy not randomly, but to achieve objectives--whether
good or bad
• cross-national correlations can take any sign, depending on the source of
variation in the data
• Therefore, the systematic statistical evidence gives us little
confidence that there is a determinate, uniform, and non-context
specific relationships between specific policy reforms and economic
growth
The tyranny of extreme outcomes
• Easterly (2005) runs growth regression with panel of 5year averages over 1960-2000
• “Policy” variables (inflation, budget deficits, black-market
premia, overvaluation, M2/GDP and trade/GDP) are
highly significant
• He re-estimates the regression by removing
observations with extreme policies (inflation and BMP >
35%, overvaluation > 68%, budget deficits/GDP > 12%,
M2/GDP > 100%, trade/GDP > 120%)
• “Policy” variables no longer enter significantly,
individually or collectively
• Bottom line: no reason to expect growth effects from
“moderate” changes in policies
Policies versus outcomes
“Our results indicate that all 20 Latin American and Caribbean countries
in our sample experienced a positive contribution from structural
policies to growth…. For most reforming countries, the estimated
growth contribution from improvements in … policies ranges from
2.5 to 3.0 percentage points.” (Loayza, Fajnzylber, and Calderon
2005, emphasis added)
What are these “structural policies”?
– secondary school enrolment ratio
– private credit/GDP ratio
– adjusted trade-GDP ratio
(not, say, spending on education)
(not, say, specific financial-market interventions)
(not import tariffs)
The trouble is that the regressions do not tell us which “structural
polices,” if any, actually led to improvements in these outcomes.
This is not a point about endogeneity, it is about the inappropriateness of
ascribing improvements in these areas directly to specific policy levers
included under the conventional “structural reform agenda.”
Modeling the cross-national variation in
policies and growth: an illustration (I)
Modeling the cross-national variation in
policies and growth: an illustration (II)
We get a negative relationship between s and g even though policy intervention
maximizes the growth rate and we would never want to restrain governments
from using policy intervention s.
Modeling the cross-national variation in
policies and growth: an illustration (III)
How has conventional wisdom accommodated the
“anomalies”?
Non-operational truisms
“I would suggest that the rate at which countries grow is
substantially determined by three things: their ability to integrate
with the global economy through trade and investment; their
capacity to maintain sustainable government finances and sound
money; and their ability to put in place an institutional environment
in which contracts can be enforced and property rights can be
established. I would challenge anyone to identify a country that
has done all three of these things and has not grown at a
substantial rate.”
But:
-- Larry Summers (2003)
• “ability” to do X and “capacity” to manage Y do not tell us what
the requisite policies area
• and if we try to give it operational content, it turns out that the
immediate implications are not quite consistent with the evidence
How has conventional wisdom accommodated the
“anomalies”?
Open-ended list of complementary reforms
“[Reforms in Latin America] 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)
“The moral of the Argentine story is that being an emerging market country is not easy:
not only do you have to have good institutions to support an efficient financial system,
but you need good institutions to support fiscal probity. It is not enough to be good:
you have to be very good.” (Mishkin 2006)
“[O]penness to trade is not by itself sufficient to promote growth—macroeconomic and
political stability and other policies are needed as well….” (Panagariya 2003)
A recommendation contingent on all the requisite “complementary
reforms”—many of which cannot be specified ex ante--is impractical (and
defeats the purpose of reform).
Where to next?
• A taxonomy of reform strategies
– taking second-best issues seriously
• How does the “binding constraints” approach
relate to other strategies?
Analytics of Reform
• Suppose an economy starts out with k distortions,
τ={τ1,τ2,…,τk} , with marginal social valuations of activities
diverging from marginal private valuations:
μjs(X) – μjp(X) – τj = 0 (X = vector of activities)
• Interpretations of τi:
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“tax” on investment
human capital externality
learning spillover
excessive logging of forests
μIs(X) – μIp(X) > 0
μHs(X) – μHp(X) > 0
μRs(X) – μRp(X) > 0
μFs(X) – μFp(X) < 0
• Problem is we have all these (and many other)
distortions and market failures simultaneously
• Important: a distortion in one market enters other
margins
Analytics of Reform
• What is the effect on growth (or welfare) of removing one
distortion leaving the other k-1 unchanged?
X j
X i
du
i
  j
d i
 i j i  i
Total effect = direct effect (positive)
+ sum of all other indirect
effects (positive or negative)
Where do indirect effects come from?
• Lowering one distortion can have good or bad effects,
depending on which way other distorted quantities move
– Example from agriculture: export promotion
– Example from trade: liberalizing intermediate inputs
– Example from macro: relaxing borrowing restrictions under moral
hazard
– Two sort of “budget” constraints
• Fiscal revenue constraint: reducing one tax requires a rise in another
• Political budget constraint: may need to compensate for loss of rents
• Key point: Undertaking partial reform while leaving other
distortions in place can have large, small or even negative
effects on growth and welfare
• We can envisage 5 alternative reform strategies in these
circumstances
Strategy 1: Wholesale reform
• Eliminate all distortions at once
• Sure to raise welfare
• Problem: impossible to do
– Full list not knowable
– Administrative, political, human-resource constraints
Strategy 2: Do as much as you can, as best
as you can
• Implicitly assumes:
– Any reform is good
– The more areas reformed, the better
– The deeper the reform in any area, the better
• Trouble is, none of these assumptions holds
under second-best environments
Strategy 3: Sophisticated
second-best reform
• Take into account all possible indirect effects
• Problem: technically infeasible, even if
administratively feasible
– Most of these second-best interactions are very
difficult to figure out and quantify ex ante
– Some distortions (for instance lack of credibility) are
not even observable
The pitfalls of “sophisticated” reform:
A Chinese counterfactual c.1978
problem
solution
Low agricultural productivity
Price liberalization
Private incentives
Privatization
Contract enforcement
Legal reform
Fiscal revenues
Tax reform
Urban wages
Corporatization
Monopoly
Trade liberalization
Enterprise restructuring
Financial sector reform
Unemployment
Labor market flexibility
And so on...
Strategy 4: Target the largest distortion(s)
• Under certain assumptions* (unlikely to hold in
practice), can be guaranteed to raise welfare
• But:
– It does require us to have a complete list of
distortions
– It does not guarantee that the biggest welfare
bang is achieved
* The (sufficient) condition is that the activity whose tax is being reduced be a net
substitute (in general equilibrium) to all the other goods.
Strategy 5: Focus on the most binding
constraints
• Pursue those reforms where direct beneficial
effect is largest
• This increases likelihood that the total effect
(including hard-to-measure indirect effects) will
be positive and large
• Advantage: less technically demanding, more
likely to result in big welfare bang
• Disadvantage: still need to check about key
likely indirect effects
How China did it instead
• Pragmatic, often heterodox solutions to overcome political
constraints and second-best complications
– Two-track pricing insulates public finance from the provision of supply
incentives
– Household responsibility system obviates the need for explicit
privatization
– Township and village enterprises overcome weaknesses in legal (thirdparty) enforcement of contracts
– Special economic zones provide export incentives without removing
protection for state firms (and hence safeguard employment)
– Federalism, “Chinese-style” generates incentives for policy competition
and institutional innovation
• Strategic and sequential approach targeting one binding constraint
at a time
– First agriculture, then industry, then foreign trade, now finance…
• Remaining institutional challenges
– Especially with regard to political democracy and the rule of law
Chinese experimentation
Source: Heilmann (2008)
Toward a growth diagnostics
• What we need is method for identifying the most
binding constraints
• This can be done in the following way
– Start from the proximate determinants of growth, X(i)
– Figure out which of those pose greatest impediment to higher
growth
– Identify the specific distortion(s) that lie behind these
impediments (tau’s)
– Come up with policies that target these distortions as closely
as possible, while bearing in mind potential interactions with
distortions in other, related areas
Growth Diagnostics
Reasons for low private investment
Low return to economic activity
Low social returns
High cost of finance
bad international
finance
Low appropriability
government
failures
poor
geography
low
human
capital
bad infrastructure
micro risks:
property rights,
corruption,
taxes
bad local finance
market
failures
information
externalities:
“self-discovery”
macro risks:
financial,
monetary, fiscal
instability
coordination
externalities
low
domestic
saving
poor
intermediation
An empirical diagnostic framework
• Explicit search for “diagnostic signals”:
– “If story A is correct, signals x, y, z must be present…”
• Direct evidence
– “shadow” prices: returns to education, real interest rates,
cost of transport,…
– benchmarking potentially helpful
• Indirect evidence
– if a constraint binds, effects must show up in differential
outcomes for activities that differ in their intensiveness in that
constraint
• informality, internalization of finance, self-enforcement of
contracts
– elimination of other plausible constraints
• A constant cannot explain a change
– high growth episodes of the past cause us to ask what has
changed
A policy reform agenda that is consistent
with a country’s recent growth history
• Episodes of high or low growth provide evidence
on necessary and sufficient conditions for growth
in a given setting
• Reforms under consideration must be consistent
with this evidence
• What to do:
– Develop internally consistent “stories” about the
causal mechanisms underlying recent growth history
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
Step 2: Policy design
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First-best logic often not helpful
– targeting policy on relevant distortion may not work due to secondbest interactions and political-economy or administrative constraints
Requires instead creative solutions that overcome these complications
– policies that can decouple complementary areas of reform often
work best, even if heterodox (e.g. China)
– Taking advantage of 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
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– local contingencies require local solutions
Policy solutions may lie in areas that did not appear to be the binding
constraint
– E.g. may recommend saving-augmenting strategy even if an economy is
not saving constrained, if that enables a depreciated currency that
increases tradables profitability
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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
Step 3: Institutionalizing the diagnostic process
• Nature of binding constraints change over time
• Growth will slow down if diagnostic process not ongoing
– Argentina, Indonesia, Cote d’Ivoire,..
– China’s future challenges
• Sustaining growth requires ongoing institutional reform to
– Maintain productive dynamism
• “industrial policy” institutions?
– Increase resilience of economy to external shocks
• “institutions of conflict management”
– democracy, rule of law, social pacts, social safety nets
Arguments against GD
• Poor nations suffer from many constraints
– Of course
– But this is no argument against the need to prioritize
• GD is a way of thinking about how to prioritize
• Diagnostic “signals” are model-specific
– Yes, the GD framework does place a premium on being explicit about
the underlying model of the economy one has in mind
– But that is probably an advantage, not a disadvantage
• Can never be sure you have identified binding constraint(s) correctly
– Yes
– But even then, it provides a useful way of framing the debate over
different recommendations
• “Since you recommend a, you must presume the binding constraint is x;
what evidence can you adduce for it?”
• It is hard
– Yes!
General lessons
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Binding constraints to growth differ across countries and over time
– clear evidence that growth is unlocked in a large variety of ways
– different strokes for different folks: CHN was constrained by poor supply
incentives in agriculture; BRA is constrained by inadequate supply of credit, SLV
by inadequate production incentives in tradables, ZAF by inadequate
employment incentives in manufacturing, ZWE by poor governance …
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Relaxing binding constraints requires well-targeted reforms that are
cognizant of prevailing second-best and political complications
– selectivity instead of a laundry list
– pragmatism in lieu of “best practice” and rules of thumb
•
Over time, strengthening institutional underpinnings is critical
– institutionalizing “diagnostics”
– building resilience to external shocks
– institutional reform is key, but to sustain rather than ignite economic growth