Growth in the 1990s: Common lessons across sectors

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Growth in the 1990s Common lessons across sectors

• Cairo, Egypt
• November 8,2004

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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
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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?