Why Growth Matters

Jagdish Bhagwati, Arvind Panagariya
ISBN: 9781610392716
Preface Pages xiii-xviii

Growth Follows Reforms

Reforms led to growth in India in exactly the same way as in Brazil after President Hernando Cardoso, who as an academic sociologist had opposed globalization as leading to dependency (this is the famous dependencia thesis), took Brazil toward globalization. The same happened in China, starting in the late 1970s and early 1980s.

Some economists, such as Dani Rodrik, have argued that economies have grown despite embracing anti-trade policies and disregarding markets, so it is wrong to attribute success on growth to these liberal and pro-trade reforms. But this claim is hollow because there is no compelling case where such policies led to significant growth over a sustained period. This was particularly true of the Soviet Union, where growth rates were high for nearly two decades but then declined steadily as the autarky and the absence of market-based incentives steadily undermined the economy.

The old saying insists that economists never agree, but the late Joan Robinson, a radical economist from Cambridge who admired pre-reform China, and Gus Ranis, the mainstream Yale University economist, were overheard astonishingly agreeing on how remarkable Korean development was. It turned out that she had North Korea in mind, whereas he was thinking of South Korea. Of course, down the road, she turned out to be wrong. The North Korean autarkic and heavily antimarket developmental strategy could deliver missiles and nuclear weapons, but not sustained overall development. South Korea, which instituted “liberal reforms,” grew steadily.

The growth in China in the late 1970s and early 1980s was also led by the elimination of collective farming and the introduction of incentives to peasants. Subsequently, in response to sustained opening of trade and foreign investment, there followed the enormous expansion of exports from Guangdong province in the southeast, with large inflows of DFI and technology absorption resulting in an expansion of Chinese income and growth rate. A movement away from antimarket fundamentalism through the introduction of promarket policies and the removal of the disincentives against trade and DFI lay at the heart of the economics of Chinese gains in productivity and enhanced growth.

The East Asian miracle was also based on outward orientation in trade. The phenomenal growth in exports followed the deliberate integration into the world economy. Whereas India followed a policy of near-autarky in the pre-reform 1960s and 1970s, the East Asian economies looked ever more globally. As a consequence the Indian industry was constrained by the internal domestic demand. This meant that the inducement to invest in industry was constrained by the domestic expansion of agricultural incomes. But since agriculture rarely grows at a sustained rate in excess of 4 percent in historical experience, the East  Asian decision to exploit foreign markets meant that the inducement to invest was not so constrained. Investment expansion on a dramatic scale followed and the expansion of exports that was its flip side meant also that East Asian economies could import capital goods that embodied advanced technology.

This in itself would not have been enough, however, to generate extraordinarily high returns and associated growth. To get the most out of the new technology, the workforce had to be literate enough to work with the advanced machinery. If not, the embodied technical progressivity would have borne no fruits. Thus, for example, the older of us has a DVD player with the latest features, but he is able to play only Start and Stop on the remote control; the productivity of his DVD player is the same as if no technical progress had been embodied in his state-ofthe-art machine.

East Asia fortunately enjoyed, partly as an unintended benefit of Japanese occupation and the example of Japanese tradition of educating the masses—see the splendid autobiography of Junichiro Tanizaki (1988), arguably Japan’s greatest writer, which describes his school experiences— a primary and secondary education commitment that assured East Asian countries of astonishingly high levels of literacy. Besides, countries such as Singapore and Hong Kong freely imported skilled manpower at higher levels, making up for absent indigenous skills by importing foreigners with skills, and simultaneously sending masses of natives abroad to top universities to acquire the skills in the meantime and bringing them back at high remuneration. Benign attitudes toward trade and DFI combined with high and productive investment rates, importation of equipment with embodied know-how, and its successful exploitation by a highly literate population in a policy framework that additionally permitted incentives and rewards, created a virtuous circle that produced the East Asian miracle. But central to the phenomenon was the outward orientation in trade.

The experience of China, India, and East Asia—whose population amounts to not quite half of the global total population—demonstrates how growth is stimulated and sustained within the policy framework that exploits the opportunities provided by integration into the world economy, and also relies on a sophisticated use of market incentives in guiding production and investment.11 Conversely, they also demonstrate that a shift away from such a policy framework undermines growth.

Three important caveats must be kept in mind. First, the liberal policy framework that has produced prosperity is not libertarian, nor is it one of “market fundamentalism.” For instance, it allows environmental objectives, such as reducing domestic pollution, while proposing the use of price-based instruments, such as emission taxes instead of direct quantitative controls. If producers of a good can simply dump waste into a lake or a river in the country, that will lead to overproduction of the good since the private cost to the producers will be lower than the social cost, which should not ignore the damage to the environment. We therefore need a polluter-pay tax, which puts a cost on the discharge of pollutants. The correct way to diagnose this issue is to say that we have a “missing market” regarding pollution, and in effect the tax creates that market. You do not have to be an ideologue of markets to embrace it as part of the appropriate policy agenda.

Second, openness in trade is only an enabling mechanism. If other domestic policies create obstacles to taking advantage of the trading opportunity, the gains from trade will be minuscule. If domestic restrictions on production and trade prevent investment in new capacities to undertake exports, any opening to trade would have been frustrated: gains from trade could not be obtained in any significant way if resources could not be pulled toward the export industries, old and new. To use an apt analogy, if a door is opened but you do not have traction in your legs, you will not get through that door.

Finally, much is made of the so-called Washington Consensus as having driven the shift from the counterproductive policy framework. But this is nothing more than Washington Conceit. The shift in development strategy owed, not to any institutions in Washington, whether Bretton Woods or the US Treasury, but to the theoretical ideas and analysis of actual experience with autarkic policies and mindless interventionism that were the result of domestic experience. That they were then taken over and folded into coherent prescriptions for sound development strategy by Washington institutions, chiefly the World Bank, does not give ownership of these ideas to these institutions.

During the last quarter of the twentieth century, three extraordinarily important countries, India, the Soviet Union, and China, changed their counterproductive policies that had been based on antimarket fundamentalism and autarkic inward-looking policies on globalization. The changes were self-motivated, as we discuss below, not imposed by Washington. Public opinion and/or the politicians had realized that the “old” model, which some, including Stiglitz and Soros, would like to resurrect in their virtual embrace of what might be called “Jurassic Park Economics,” was not working and a drastic change was necessary.12 “Washington Consensus” was also a popular phrase in the antireform circles because it would galvanize the antireform anti–US imperialism forces that were in retreat by suggesting that the United States, directly or indirectly, was behind the liberal reforms.

It has become fashionable among opponents of the liberal reforms to say that the Washington Consensus has now been replaced by the Beijing Consensus, an ambiguous phrase with little content, but aimed at suggesting that the liberal developmental strategy is now replaced by China’s success with a very different state-dominated and state-driven developmental model.

While China’s export-led development appears to suggest that one element of the liberal development model—openness to trade—is part of China’s developmental model, many features of China’s economy and political regime raise concerns instead of offering a role model. In particular, the huge reliance on the state-owned enterprises (SOEs) has not merely enabled the Chinese regime to have the Communist Party capture these enterprises—which many in the West, and increasingly in China itself, think of as SOBs instead of SOEs—to the advantage of the party functionaries. It has also meant that extensive corruption prevails in China as bureaucrats and party officials seek to put their children and spouses into every enterprise, siphoning a share of the profits themselves. This model is hardly sustainable as the common people begin to resent such corruption and their economic aspirations rise as the Chinese pie grows at an extraordinary pace. The authoritarian regime also denies political agitation for democracy that inevitably is breaking out, as elsewhere. While therefore China has grown dramatically, it is unlikely that the growth performance is sustainable. So the mix of political and economic features that characterizes China is hardly a role model for other nations to adopt for their development.

Growth and Poverty

If growth did follow liberal policies and reforms in the Indian economy, as we argue in this book, still some critics argue that the growth is not “inclusive,” that it has failed to reduce poverty and has not spread to the marginalized groups in society. It is often argued that a policy of redistribution is preferable. This sounds plausible except that the Indian experience, and we might also add the East Asian experience, shows otherwise.

In 1980, economist Gary Fields, who specializes in poverty, described India as a “miserably poor country.” Yet the reforms that followed, especially beginning in 1991, transformed it from a basket case into a powerful engine of growth, with poverty declining at rates never before observed in the country. Because India experimented within the same democratic framework first with command-and-control and autarkic policies and then with a move away from those controls and toward a greater role for markets and globalization, its experience offers important lessons to other developing countries regarding their development strategies and for the many government aid budgets and NGOs that seek to end poverty in the developing world.

Common sense suggests that we should expect a rapidly growing economy to create more jobs and opportunities for the poor to escape poverty, whereas slow-growing economies would hardly do so. Poor and stagnant economies can no more offer hope to the poor than private-sector enterprises making losses can offer additional jobs. Pro-growth advocates are often confronted with the failure of “trickle-down” economics, which sounds like the Earl of Nottingham and his courtiers and vassals are eating venison and roast legs of lamb at the sumptuously endowed dining table and crumbs are falling to the serfs and dogs below. We don’t care for the concept or analogy. Instead we use the now-popular phrase “pull-up” growth strategy, which much better describes what we have observed: a radical, activist set of policies to accelerate growth and to pull up more of the poor into gainful employment. In fact, with the shift to systemic reforms after the 1991 crisis, Indian growth did take off dramatically and poverty declined as well. And as we demonstrate, the benefits extended to the marginalized groups, with poll data also confirming that these groups actually consider themselves to be better off.

Copyright © Jagdish Bhagwati and Arvind Panagariya.