China, India, and the Developing World

A remarkable reversal in fortunessince 1990s

-.04

-.02

0.0

2.0

4.0

6

1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010year

Developed DevelopingDeveloped smoothed Developing smoothed

Growth trends in developed and developing countries, 1950-2011

Growth was widespread, for once-.

050

.05

.1

1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010year

Africa Latin AmericaAsia (excl. Japan) Africa smoothedLatin America smoothed Asia smoothed

Developing country growth trend by region, 1950-2011

Growth has been good for poverty reduction

Source: http://siteresources.worldbank.org/INTPOVCALNET/Resources/Global_Poverty_Update_2012_02-29-12.pdf

Two narratives on what drives economic growth

• Orthodox view: economic growth is conditional on “good fundamentals” – defined in practice in terms of policies such as openness, deregulation,

privatization, protection of property rights, contract enforcement, low inflation and budget deficits, …

• Structuralist view: economic growth is conditional on rapid structural change– which requires policies that stimulate employment in manufacturing

industries (and modern services), including industrial policies and undervalued currencies

While there is overlap between the two sets of policies, there are also tensions and differing priorities

Disappointments of orthodox policy reform

0

0.005

0.01

0.015

0.02

0.025

0.03

0.035

0.04

1950-1980 1980-2000 2000-2008

Brazil

Mexico

Growth rates of Brazil and Mexico by period

Why structure of employment matters: Large productivity gaps

Why structure of employment matters : some sectors are special

-.05

0.0

5.1

gro

wth

(p

art o

rth

ogon

al to

oth

er

regr

ess

ors)

0 .1 .2 .3 .4 .5industrial employment share

Each observation is a country over a 5-year period. Initial income and country and time fixed-effects are included.

How structural factors explain growth slowdown in Latin AmericaProductivity decomposition in Latin America across different periods

(annual growth rates)

-0.01 -0.005 0 0.005 0.01 0.015 0.02 0.025 0.03 0.035 0.04 0.045

1990 - 2005

1975 - 1990

1950 - 1975

Sectoral productivitygrowth

Structural change

Data from Pages, Carmen ed., The Age of Productivity, Inter-American Development Bank, Washington, D.C., 2010.

Productivity growth within sectors

Productivity growth due to structural change

… and the difference between slow and rapidly growing regions

-0.02 -0.01 0 0.01 0.02 0.03 0.04 0.05

HI

ASIA

AFRICA

LAC

within

structural

Decomposition of productivity growth by country group, 1990-2005

Productivity growth within sectors

Productivity growth due to structural change

The policy context: what does it take to move resources in the right direction?

• Government failures: poor “institutions”– Which takes long time to fix

• Market failures: learning spillovers and coordination failures– Which require pro-active interventions even when pro-market

reforms are in place

• What has worked in practice– Macro stability and broad market orientation, plus– Shortcuts to compensate for above failures, such as:

• Trade protection• Directed credit• Other forms of IP• Undervalued currencies

Questions

• Why economic convergence, where it has taken place, has been more rapid than before– Productive diversification and the role of manufactures in particular

• Why convergence has been so rare– The process of structural transformation is rife with market and

government failures that are hard to overcome

• What is special about countries that have managed rapid and sustained convergence– Ability to deploy effective shortcuts that compensate for market and

government failure

• What does all this imply about the future of convergence– Not as bright as it’s often made out to be, both because of above and

because requisite policies demand global environment permissive of heterodoxy

The Chinese case

• Pragmatic, often heterodox solutions to overcome political constraints and second-best complications that block structural change – 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 (third-party)

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 – “Exchange-rate protection” subsidizes manufactures following WTO entry

• Strategic and sequential approach targeting one binding constraint at a time– First agriculture, then industry, then foreign trade, then finance…

• Remaining institutional challenges– Switch to domestic consumption from foreign demand– Building up political democracy and the rule of law

Problems

• Even the shortcuts are hard to implement and come with their own problems– Standard arguments against IP: information and politics– Institutional lock-in

• They require dealing with successive bottlenecks over time

• They require permissive global environment– Benign neglect on the part of U.S. and Europe versus

narrowing of the policy space

Conclusions

• The presence of a large convergence gap ensures significant potential for rapid economic growth in developing world, regardless of what happens in the rich countries

• Fulfilling this potential requires ongoing process of diversification and structural change

• This process is not automatic, especially in countries with an initial comparative advantage in primary products

• It necessitates pragmatic, experimental policies that support new industries– These are often unconventional policies– Require a supportive external environment– Doubtful that such an external environment will exist during the next

phase of the global economy