Growth in the 1990s: Common lessons across sectors

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Growth in the 1990s Common lessons across sectors

• Presentation to ICRIER
• September 28, 2004

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Are there common lessons from the experiences of
policy reform?

• Macroeconomic
• External policies
• Privatization
• Financial sector

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Three common lessons

• Policy reform generally had the magnitude of
  impact expectedgrowth expectations were too
  high
• Getting rid of discretion is too high a price to
  paybut properly exercised discretion is
  difficult to achieve
• Expectations are central

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Three implications for policy making

• Common principles, heterogeneity of
  implementation
• Focus on initiating and sustaining episodes of
  rapid growth
• Pro-active actions of government have to be
  scaled to capacity

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Growth is nearly always a transitional
phenomena, differences in steady state growth
are small
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Micro-economists were generally right about
direction and magnitude of the impact of policy
reform Trade

• Most estimates of the impact of tariff reform are
  a few percent of GDP, with small associated
  growth impacts
• The output gain increases with the square of the
  distortion
• Discretionary restrictions (without effective
  secondary markets) can have huge losses

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What is to be done about discretion?

• Diagnosis of the 1990s
• Attempts to limit discretion in policy making
• Lessons from the experience

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Diagnosis pre-1990s Discretion is the problem

• Inadequate information led to erroneous
  decisions,
• Insufficient (and overstretched) technical
  capacity to take correct decisions,
• Multiple objectives led to ineffective actions,
• Policy actions were politicized in a way that led
  to sacrifice of effectiveness for political
  expediency (e.g. populism),
• Inadequate incentives for public sector officials
  to be dynamic or to innovate.
• Outright corruption

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The diagnostic pre-1990s illustration with
Central Banks
Rationale for public sector intervention Symptoms of excessive discretion Attempts to limit discretion
Regulate money supply, FEX printing money to finance deficits Independent Central Banks Tied exchange rates (currency boards)
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Three ways to limit discretion of government

• Move activities into the market (privatize,
  deregulate)
• Pursue rules based regulation by independent
  or autonomous bodies
• Enter into binding international agreements

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Lessons from the limit discretion movement

• With weak background institutions rules and
  discretion are identical
• Eliminating discretion is like squeezing a
  balloonit just changes shape
• Both tied and untied hands have their dangers

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Key role of expectations

• A policy is a sequence of future policy actions
  which depends on states of the world
• Investors/entrepreneurs respond to expected
  profitability
• Hence, anything can happen, depending on how
  current policy actions affect anticipated future
  actions

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Key role of expectations Examples

• Modest reforms can have enormous growth
  impactsif they are the harbinger of future
  reforms
• Enormous policy action changes can have no
  impactif they are perceived as temporary
• Digging deeper can have perverse impacts
• With credibility the direction of effects can be
  reversed (e.g. Chile and deficits)

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Implication 1 Common principles, heterogeneity
of implementation

• Institutions cannot matter
• Institutions are all important
• Both are true

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Implication 2 Initiating and sustaining
episodes of rapid growth

• Growth is about confident belief that output will
  be much higher in the future
• What current actions will convince investors
  (small, large) that output will be double in ten
  years?

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Implication 3 Actions have to be scaled to
capacity

• There are no arguments in principle in favor of
  limiting discretion of government
• It all depends on the capacity to exercise
  discretion productively
• Improving that capacity is central
• If you dont have it, you shouldnt do it

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The wrong debates

• Is activist industrial policy good or bad?
• Is free trade better than use of trade as an
  instrument?
• Should country regulate banking or have public
  sector banks?
• Should utilities be private or public?