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In Search of Prosperity
Analytic Narratives on Economic Growth
By Edited and with an introduction by Dani Rodrik Princeton University Press
Edited and with an introduction by Dani Rodrik
All right reserved. ISBN: 0691092680
Chapter One
INTRODUCTION
WHAT DO WE LEARN FROM COUNTRY NARRATIVES?-DANI RODRIK
THE SPECTACULAR gap in incomes that separates the world's rich and poor nations is the central economic fact of our time. Average income in Sierra Leone, which is the poorest country in the world for which we have data, is almost one hundred times lower than that in Luxembourg, the world's richest country. Nearly two-thirds of the world's population lives in countries where average income is only one-tenth the U.S. level (fig. 1.1).1 Since the starting points for all these countries were not so far apart prior to the Industrial Revolution, these disparities must be attributed almost entirely to differences in long-term growth rates of per capita income. The world is split sharply between countries that have managed to sustain economic growth over long periods of time and those that have not. How do we make sense of this?
The economics of growth has come a long way since it regained center stage for economists in the mid-1980s.2 The early focus on theoretical models that generate self-sustaining growth and endogenous technological advance has been increasingly replaced with attempts to shed light on the diversity of experience with economic growth.3 On the empirical front, the search for correlates of growth has gone beyond economic variables (such as physical and human capital, and price distortions) to examine "deeper" determinants of economic performance (such as geography and institutions).4 Our understanding of the economic growth process has increased considerably as a result.
However, there remain serious gaps in the existing research. Consider some of the questions that come to mind after a cursory look at the cross-national record of the last few decades. How has China managed to grow so rapidly despite the absence of full-fledged private property rights? What happened in India after the early 1980s to lift its growth rate by approximately three percentage points? How have Mauritius and Botswana managed to avoid the problems that other countries in the rest of sub-Saharan Africa have succumbed to? Why did countries like Brazil, Mexico, or Venezuela do so well until the early 1980s and so poorly thereafter? How did Indonesia manage to grow over a 30-year period despite weak institutions and highly distorted microeconomic policies-and why did it collapse so spectacularly in the aftermath of the Asian financial crisis of 1997? Why do the Philippines and Bolivia continue to stagnate despite a sharp improvement in their "fundamentals" since the 1980s? What explains the very sharp divergence in the performance of the former socialist economies since the early 1990s? It would be fair to say that neither the cross-national growth literature nor existing country studies have made adequate progress in answering these and many other fundamental questions.
Of course, there is no shortage of country studies in the literature. But we have few examples that are explicitly informed and framed by the developments in recent growth theory or growth econometrics. Alwyn Young's (1992) work on Singapore and Hong Kong, Robert Lucas's (1993) quantitative exercise on South Korea, and Paul Romer's (1993) short discussion of Mauritius and Taiwan are rare exceptions.5
This volume begins to fill some of the holes. It offers a series of analytical country narratives that try to provide answers to selected growth puzzles-those that I have enumerated above as well as many others. These narratives explore the respective roles of microeconomic and macroeconomic policies, institutions, political economy, and initial conditions in driving patterns of technological convergence and accumulation in selected countries. Since the authors tend to be growth theorists and macroeconomists rather than country specialists, these are not country studies in the usual sense of the word. The strength of the chapters lies in drawing the connections between specific country experiences, on one side, and growth theory and cross-national empirics, on the other. The authors evaluate and extend our understanding of economic growth using the country narratives as a backdrop.
As the organizer of this collaboration and the editor of the volume, I must take full responsibility for the speculative nature of the efforts that resulted. I encouraged the authors to be bold and imaginative even if that meant going out on a limb. I even insisted that they take on countries about which they knew little, so that their vision and judgment would not be clouded by preconceptions. (I can now confess my amazement at how many of the contributors complied!) The compensating benefit, I hope, is that the authors have felt less restrained by conventional wisdom and more inclined to break new ground. They have formulated new insights for modelers to formalize, and new hypotheses for the econometricians to test. And if, as a by-product, they have ended up teaching us (and themselves) something about the individual countries, all the better!
SOME ORGANIZING PRINCIPLES
To organize our thinking about the economics of growth, it helps to distinguish between the "proximate" and "deep" determinants of growth. Figure 1.2 shows the standard way in which economists think about the determination of income. The total output of an economy is a function of its resource endowments (labor, physical capital, human capital) and the productivity with which these endowments are deployed to produce a flow of goods and services (GDP). We can express this relationship in the form of an economy-wide production function, with a representing total factor productivity. Note that a captures not only the technical efficiency level of the economy, but also the allocative efficiency with which resource endowments are distributed across economic activities. The growth of per capita output can in turn be expressed in terms of three proximate determinants: (a) physical capital deepening; (b) human capital accumulation; and (c) productivity growth.
Conceptually, this is a straightforward decomposition, and it has given rise to a large literature on sources-of-growth accounting. But one has to be careful in interpreting such decompositions because accumulation and productivity growth are themselves endogenous. This prevents us from giving the sources-of-growth equation any structural interpretation. For example, observing that 80 percent of the growth is "accounted" for by accumulation and the rest by productivity does not tell us that growth would have been necessarily 80 percent as high in the absence of technological change; perhaps in the absence of productivity change, the incentive to accumulate would have been much lower and the resulting capital deepening signifcantly less. Indeed, to the extent that growth is driven by other fundamental determinants, not directly captured in the growth-accounting framework, the causality my well run backwards, from growth to accumulation and productivity instead of the other way around.
For these reasons it is best to think of accumulation and productivity change as proximate determinants of growth at best. The deeper determinants are shown in fgure 1.3. While there is no shortage of candidates, I fnd a threefold taxonomy useful:
Geography
Integration (trade)
Institutions
Geography relates to the advantages and disadvantages posed by a country's physical location (latitude, proximity to navigable waters, climate, and so on). Integration relates to market size, and the benefts (as well as costs) of participation in international trade in goods, services, capital, and possibly labor. Institutions refer to the quality of formal and informal sociopolitical arrangements-ranging from the legal system to broader political institutions-that play an important role in promoting or hindering economic performance.
Figures 1.4, 1.5, and 1.6 display some illustrative scatter plots, showing the relationship between each of these three factors and incomes. I use distance from the equator as the measure for "geography," the share of trade in GDP as the measure of integration, and a commonly employed subjective index for the quality of institutions. A frst pass through the data indicates that all three are signifcantly correlated with per capita income. Such correlations are the stock-in-trade of the growth empiricist. The problem, however, is that neither trade nor the quality of institutions is truly endogenous, which creates severe difficulties when it comes to interpretation. I shall return to this issue below.
Geography
Geography plays a direct and obvious role in determining income because natural-resource endowments are shaped in large part by it. The quality of natural resources depends on geography. Commodities such as oil, diamonds, and copper are marketable resources that can be an important source of income. Soil quality and rainfall determine the productivity of land. Geography and climate determine the public-health environment (the inhabitants' proclivity to debilitating diseases such as malaria), and shape the quantity and quality of human capital.
Geography also influences growth via the other two factors. Geography is an important determinant of the extent to which a country can become integrated with world markets, regardless of the country's own trade policies. A distant, landlocked country faces greater costs of integration. Similarly, geography shapes institutions in a number of ways. The historical experience with colonialism has been a key factor in the institutional development (or lack thereof) of today's developing countries, and colonialism itself was driven in part by geopolitical considerations-consider the scramble for Africa during the 1880s. The natural-resource endowment bequeathed by a country's geography also shapes the quality of institutions. Natural-resource booms, for example, are often associated with the creation of rent-seeking and rent-distributing institutions-the so-called resource curse.
Geography is arguably the only exogenous factor in our threefold taxonomy. Trade and institutions are obviously endogenous and coevolve with economic performance. Nonetheless, it is useful to think of these as deep causal factors to the extent that they are not fully determined by incomes per se. Trade is obviously shaped in large part by a country's conscious choice of policies; and institutional development is at least partly a choice variable as well (or in any case can be determined by developments exogenous to the economy).
Trade
The signifcance of integration in the world economy as a driver of economic growth has been a persistent theme in the literatures on economic history and development economics. An influential article by Jeffrey Sachs and Andrew Warner (1995) went so far as to argue that countries that are open to trade (by the authors' defnition) experience unconditional convergence to the income levels of the rich countries. Leading international policymakers from the World Bank, International Monetary Fund, World Trade Organization, and Organisation for Economic Cooperation and Development frequently make the case that integration into the world economy is the surest way to prosperity. The traditional theory of trade does not support such extravagant claims, as trade yields relatively small income gains that do not translate into persistently higher growth. However, it is possible to tweak endogenous growth models to generate large dynamic benefts from trade openness, provided technological externalities and learning effects go in the right direction. Capital flows can enhance the benefts further, as long as they go from rich countries to poor countries and come with externalities on the management and technology fronts.
Institutions
Institutions have received increasing attention in the growth literature as it has become clear that property rights, appropriate regulatory structures, the quality and independence of the judiciary, and bureaucratic capacity cannot be taken for granted in many settings and that they are of utmost importance to initiating and sustaining economic growth. The profession's priors have moved from an implicit assumption that these institutions arise endogenously and effortlessly as a by-product of economic growth to the view that they are essential preconditions and determinants of growth (North and Thomas 1973).
Once one moves beyond general statements of the kind that property rights are good for growth and corruption is bad, there is much that remains unclear. Which institutions demand priority? What are the specifc institutional forms that are required? Do these differ across countries according to level of development, historical trajectory, and initial conditions?
Interrelationships
As the arrows in fgure 1.3 indicate, the basic framework is rich with feedback effects, both from growth back to the "causal" factors, and among the "causal" factors. There are reasons to think, for example, that as countries get richer, they will trade more and acquire higher-quality institutions. Much of the cross-national empirical work on institutions has been plagued by the endogeneity of institutional quality: are rich countries rich because they have high-quality institutions, or the other way around? Only very recently has work by Acemoglu, Johnson, and Robinson (2001) provided convincing evidence that institutional quality is truly causal.6 Similarly, there are hints in the empirical literature of a two-way interaction between trade and institutions: better institutions foster trade (Anderson and Marcouiller 1999), and more openness to trade begets higher-quality institutions (Wei 2000). These feedbacks make simple-minded empirical exercises of the type shown in fgures 1.4-6 highly suspect. They require extreme care in laying out the hypotheses and in ascribing causality.7 While case studies do not necessarily possess a methodological advantage here, they at least have the advantage of allowing a "thick" description of the interactions among geography, trade, and institutions.
Determinants of development such as institutions and geography change slowly, or hardly at all. Yet countries like China and India have gone through remarkable transformations during the last two decades in their economic performance, while many others have experienced sharp deteriorations. This suggests that moderate changes in country-specifc circumstances (policies and institutional arrangements), often interacting with the external environment, can produce discontinuous changes in economic performances, which in turn set off virtuous or vicious cycles. In-depth country studies can highlight these important interactions in ways that cross-country empirics cannot.
THE QUESTIONS
Which are the arrows in fgure 1.3
Continues...
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