There is a lot of literature on what drives growth. Read the Growth Commission Report for insights and vast literature survey. One can also read the various papers available on the Growth Commission website. All the numerous factors can be clubbed in two broad factors – macroeconomic policies and institutions. The research lately has stressed on role of latter (pioneered by Douglass North and advocated by Daron Acemoglu), and has even added that institutions determine policies as well. (A counter was provided by Henry Blair in this paper)
With all this, the authors add that it is not just policies alone but volatility in policies that matter.
In this paper we argue that these criticisms have overlooked the possibility that policy volatility is an independent and strong determinant of economic growth. Looking at the relevance of volatility is not new; there is a long tradition, especially among emerging markets, of studying the effects of volatility on growth.
In particular, we have looked at how the volatility of fiscal policy fits into this debate. By looking at the growth effects of volatility induced by fiscal policy we are able to address the endogeneity concerns of the volatility and growth literature. By showing that this policy variable is a determinant of growth rates in a cross‐country regression and that the result is robust to many specifications and the introduction of other controls and variables, including measures of institutional quality, we are showing that macroeconomic policy matters for growth.
What about policy implications?
Our results have strong policy implications. Recent academic research has pushed policy makers to focus on institutional reform. This has turned out to be less productive than anticipated because of the inherent difficulties in reforming institutions. While the advice was sound, progress was limited.
The results reviewed in this paper do not deny the importance of institutions; in fact we show that they are strong determinants of economic policy. But we show that even without institutional reform, there is room for increasing growth rates through good economic policies.
Most of the results reviewed in this paper are about fiscal policy and in particular about the discretion that governments have and exercise regarding changes in fiscal policy that are not related to the business cycle. There is a strong message that the more discretion governments have, the more they will exercise it and it will cause unnecessary volatility and lower growth.
Interesting findings. It is further additional research on role of fiscal policy. There has been a dearth of research on fiscal policy and we see so much of it now. The findings also have implications for today’s times. The role of government in an economy is increasing across the globe and if it continues after the crisis, it will be interesting to note the impact on future growth prospects.
It will also be interesting to expand this study from fiscal policy to other policies as well.
In their blogpostthe authors point evidence that institutions are not really helpful for low income economies. However, once you get to $12,000 per capita incomes, quality of institutions is critical.