The growth report and new structural economics

Justin Yifu Lin and Célestin Monga of World Bank write an excellent paper on the topic.

Here is some background before I discuss the paper.

 Growth Commission had come out with a report looking at one of the most important questions in economics – what drives growth. Unfortunately, the crisis struck and the report wasn’t discussed as much as it should have been. There was just initial hype but not much useful discussion.

New Structural Economics (NSE) is an idea being promoted by WB chief economist Justin Lin. He argues for a bigger role for government but not as a doer but a facilitator.

In this paper, authors first review the developments in growth economics and then suggest there is a synergy between the two – Growth report and NSE.

Despite its heavy human, financial, and economic cost, the recent global recession provides a unique opportunity to reflect on the knowledge from several decades of growth research, draw policy lessons from the experience of successful countries, and explore new approaches going forward. In an increasingly globalized world where fighting poverty is not only a moral responsibility but also a strategy for confronting some of the major problems (diseases, malnutrition, insecurity and violence) that ignore boundaries and contribute to global insecurity, thinking about new ways of generating and sustaining growth is a crucial task for economists.

This paper reassesses the evolution of knowledge on growth and suggests a new structural approach to the analysis. It offers a brief, critical review of lessons learned from growth research and examines the remaining challenges — especially from the policy standpoint. It highlights how the 2008 Growth Commission Report identifies the stylized facts associated with sustained and inclusive growth. And it explains how the new structural economics provides a consistent framework for understanding the key findings of the Report.

The paper has a very good short literature review of growth literature. Before Great Depression there was research on growth and its factors. But GD shifted the focus

But growth analysis slowed down after the Great Depression, as the intellectual focus shifted from long-run to short-run issues. In fact, with the notable exception of the pioneering work of Robert Solow, for much of the 20th century and certainly through the 1960s and 1970s, macroeconomists tended to study business cycles issues that characterized the post-war period. As they tried to better understand stabilization policies—monetary and fiscal measures to avoid disruptive and costly inflation—few resources were devoted to the analysis of the long-run determinants of growth.

Things changed in the 1980s when many prominent researchers focused their attention on differences in economic performance among countries. Surveys of economic growth and levels of performance in different parts of the world economy show that growth has indeed been uneven across countries and regions: between 1900 and 2001, per capita GDP in Western Europe increased by a factor of 6.65 (6.7 in Western Offshoots), compared to 5.2 in Latin America, 4.2 in Eastern Europe, and only 2.5 in Africa.

Hmm. The authors then track Growth economics from Harrod Domar model to the Random Evaluation methods.

Growth Com report said there are five basic factors that lead to growth:

  • Openness to global economy
  • Macro stability
  • High savings and investment rates
  • Market allocation
  • Leadership and Governance

In NSE there are 3 ideas:

  • it includes an understanding of a country’s comparative advantage defined as the evolving potential of its endowment structure
  • reliance on the market as the optimal resource allocation mechanism at any given stage of development;
  • the recognition of a facilitating role of the state in the process of industrial upgrading.

The authors explain that the principles of Growth report and NSE are similar and help understand the what drives growth.

They conclude:

The quest for economic growth has preoccupied economists and policymakers since at least the 18th  century. Much progress has been achieved over the past 50 years, most notably on theoretical and empirical grounds. On the theoretical front, the analysis of endogenous technical innovation and increasing returns to scale has provided economists with a rich general framework for capturing the broad picture and the mechanics of economic growth. On the empirical side, the availability of standardized data sets such as the Penn World Tables has stimulated interest in cross-country work that highlights systematic differences between high growth and low-growth countries with regard to initial conditions, policy and institutional variables.

Yet, despite progress, policymakers around the world—especially in developing countries, still face difficulty in identifying actionable specific policy levers that can help ignite and sustain the type of dynamic growth rates that are necessary to reduce poverty. In recent years, growth researchers have responded to their concerns by trying to address various new challenges: the lack of convergence among countries; the identification of robust determinants of economic performance; the design of the supporting institutions for innovation and technological change, which are widely acknowledged to be the foundations for structural change and prosperity; and the identification of binding constraints to growth, the evaluation of successful development programs through randomized control trials, with the goal of scaling them up whenever possible.

By adopting a radically different approach to growth analysis, the Growth Report has made an important contribution to knowledge. It has identified five stylized facts (openness, macroeconomic stability, high rates of saving and investment, market mechanism, committed, credible and capable government) that can guide policymaking in developing countries. But in doing so, the Report has not disentangled causes and consequences.

The new structural economics framework proposed in Lin (2010) helps explain the endogeneity and exogeneity issues surrounding these five stylized facts. A central proposition that runs through this paper is that, developing countries that implement economic policies in contradiction with their comparative advantage tend to perform poorly and suffer macroeconomic instability. They do not exploit the benefits of globalization to the fullest. Typical features of such strategies are large budget deficits due to government support of nonviable firms, inflationary policies caused by excessive consumption, financial repression, and over-valued exchange rates in the context of low productivity.

By contrast, countries that adopt comparative advantage-following strategies are typically in the position to achieve dynamic growth. They rely on the market as the key mechanism for allocating resources at any given  stage of development, and they have credible and capable governments. As a consequence of following their comparative advantage, they have an open economy, achieve macroeconomic stability, and record high rates of saving and investment.

Useful stuff. However, Growth is a holy grail of economics. The hunt to continue….

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