IN SEARCH OF GROWTH’S MAGIC POTION

This shows how important economic growth remains for the very poor countries. For those who believe in either the Solow model or the Romer model, extreme poverty of the kind we still see in the world is a tragic waste, because there is an easy way out.

As Romer wrote in 2008: “The knowledge needed to provide citizens of the poorest countries with a vastly improved standard of living already exists in the advanced countries.”

He goes on to offer his growth masala:

If a poor nation invests in education and does not destroy the incentives for its citizens to acquire ideas from the rest of the world, it can rapidly take advantage of the publicly available part of the worldwide stock of knowledge. If, in addition, it offers incentives for privately held ideas to be put to use within its borders—for example, by protecting foreign patents, copyrights, and licenses; by permitting direct investment by foreign firms; by protecting property rights; and by avoiding heavy regulation and high marginal tax rates—its citizens can soon work in state-of-the-art productive activities.⁷⁷

This sounds like the usual right-wing mantra: low taxes, less regulation, less government involvement in general, except perhaps in education and in protecting private property. And by 2008, when Romer wrote this passage, this was familiar ground and we already knew enough to be skeptical.

During the 1980s and the 1990s, one of growth economists’ favorite empirical exercises became cross-country growth regressions. The game is to use the data to predict growth based on everything from education and investment to corruption and inequality, culture and religion, the distance to the sea or to the equator.

There were two problems. First, as Bill Easterly, a vocal skeptic of the ability of “experts” to give any recipe for economic growth, has convincingly shown, growth rates for the same country change drastically from decade to decade without much apparent change in anything else.⁷⁸ In the 1960s and the 1970s, Brazil was a front-runner in the world growth tables; but starting in 1980, it essentially stopped growing for two decades, before resuming in the 2000s, and stopping again after 2010. Lucas’s poster child for a country that failed to grow, India, started to grow faster more or less exactly when Lucas wrote the famous piece we quoted above, where he was puzzling over why growth in India was so low. For the last thirty years, India has been one of the growth stars of the world. Growth in the countries Lucas wanted India to emulate, Indonesia and Egypt, on the other hand, tanked. Bangladesh, famously described by Henry Kissinger as a “basket case” in the 1970s, has grown at a rate of 5 percent per year or more for most years in the 1990s and 2000s, and at above 7 percent in 2016 and 2017, which puts it among the twenty fastest growers in the world.

Second, perhaps more fundamentally, these efforts to discover what predicts growth make very little sense. Almost everything at the country level is partly a product of something else. Take education, for example, one factor emphasized in the early cross-country growth literature. Clearly education is in part a product of the effectiveness of the government in running schools and funding education. A government good at delivering education is probably good at other things as well; maybe the roads are better in the same countries where teachers show up to work. If we find growth is faster where education is higher, it could be due to these other policies it tends to be bundled with.

More generally, both countries and country policies differ in so many different ways that in effect we are trying to explain growth with more factors than the number of countries, including many we may not have thought of or cannot measure.⁷⁹ Consequently, the value of these exercises depends very much on how much faith we have in our exact choice of what we put in them. Given that we have very little to justify any of these choices, we think the only reasonable position is to forget the entire project.

That does not mean we have not learned anything. Some of the most surprising results came from efforts to cleanly separate cause and effect. A classic pair of papers by Daron Acemoglu, Simon Johnson, and Jim Robinson (affectionately known as “AJR”) contains the most striking of these.⁸⁰ They showed that countries where, in the initial years of European colonization, mortality among the early settlers was high still tend to do badly today. AJR argue that is because Europeans preferred not to settle there; instead they set up exploitative colonies where the institutions were designed to allow a small number of Europeans to lord it over vast numbers of natives who labored to grow sugarcane or cotton or to mine diamonds that the Europeans would then sell. By contrast, the places that were relatively empty to start with (think of New Zealand and Australia, for example) and where settler mortality from malaria and other such diseases was low, were the places where Europeans settled in large numbers. As a result, these places got the institutions the Europeans were then developing and that would eventually provide the basis of modern capitalism. AJR show that settler mortality several hundred years ago is an excellent predictor of, say, how business friendly contemporary institutions are in a particular country.

While this does not prove being business friendly causes growth (it could be the culture the Europeans brought, or the political traditions, for example, or something else entirely), it does imply that some very long-run factors have a lot to do with economic success. This broad insight has been confirmed by a number of other studies, and indeed it is in some ways what historians have always insisted on.

But what does all this tell us about what countries can actually do here and now? We learn that if you want high growth in the modern era, it is useful to have been largely empty and have had less malaria in the period between 1600 and 1900, and to have had large numbers of Europeans settle in your country (though that may have been cold comfort if you happened to be a native resident of the country at the time). Does it mean countries should try to attract European settlers in today’s very different world? Almost certainly not. The brutal indifference to local custom and lives that allowed settlers to promulgate their institutions in the pre-modern period is not likely to be available today (thank God for that).

What this also does not tell us is whether it would help to set up a particular set of institutions today, because the evidence emphasizes institutional differences that have their roots in events that took place several hundreds of years ago. Does it mean institutions need to be developed over several hundred years for them to be effective? (After all, the US Constitution of today is a very different document than when it was written, enriched by two hundred years of jurisprudence, public debate, and popular involvement.) If so, must the citizens of Kenya or Venezuela just wait?

Moreover, it turns out that among countries at roughly the same level of business friendliness, none of the conventional measures of good macroeconomic policy (such as openness to trade, low inflation, etc.—the kinds of things Romer wanted countries to adhere to) seem to predict GDP per capita.⁸¹ Conversely, while it is true that countries with “bad” policies grow slower, they are also more likely to have “worse” institutions by the measures used in this literature (less business friendly, for example), and therefore it is not clear if they are doing poorly because of policies, or because of some other side effects of their poor institutions.

What does that leave us with? It seems relatively clear there are things to avoid: hyperinflation; extremely overvalued fixed exchange rates; communism in its Soviet, Maoist, or North Korean varieties; or even the kind of total government chokehold on private enterprise India had in the 1970s with state-ownership of everything from ships to shoes. This does not help us with the kinds of questions most countries have today, given that no one, except perhaps the Venezuelan madmen, seem to be very keen on any of these extreme options. What Vietnam or Myanmar want to know, for example, is whether they should aim to emulate China’s economic model, given its stunning success, not whether to follow North Korea.

The problem is that while China is very much a market economy, as are Vietnam and Myanmar, China’s approach to capitalism is quite far from the classic Anglo-Saxon model and even its European variant. Seventy-five of the ninety-five Chinese firms on the 2014 Fortune Global 500 list were state owned, though organized like private corporations.⁸²

Most banks in China are owned by the state. The government at both the local and the national level has played a central role in deciding how land and credit should be allocated. It also decides who gets to move where and with them the supply of labor to various industries. The exchange rate was kept undervalued for some twenty-five years, at the cost of lending billions of dollars to the United States at almost zero interest rates. In agriculture, the local governments decide who gets the right to use the land, since all land belongs to the state. If this is capitalism, it is surely with very Chinese colors.

Indeed, for all the excitement generated by the Chinese miracle these days, very few economists in 1980 or even 1990 predicted it. Often, at the end of one of our talks someone rises and asks why whatever country we are talking about doesn’t just emulate China.

A similar puzzle arises in the cases of Japan and South Korea, where the governments initially pursued an active industrial policy (and to some extent still do), deciding what products to push for eventual export and more generally where investments should be made. And Singapore, where everyone had to put a large part of their earnings in a central provident fund, so the state could use their savings to build a housing infrastructure.

In all of these cases, the debate among economists has been whether growth happened because of particular unconventional policy choices, or in spite of them. And in each case, predictably, the discussion has been inconclusive. Did East Asian countries just luck out, or is there actually a lesson to be learned from their successes? Those countries were also devastated by war before they started growing fast, so a part of the fast growth might have been just the natural bounce-back. Those who herald the experience of the East Asian countries to prove the virtue of one approach or the other are dreaming; there is no way to prove any such thing.

The bottom line is that, much as in rich countries, we have no accepted recipe for how to make growth happen in poor countries. Even the experts seem to have accepted this. In 2006, the World Bank asked the Nobel laureate Michael Spence to lead the Commission on Growth and Development (informally known as the Growth Commission). Spence initially refused, but convinced by the enthusiasm of his would-be fellow panelists, a highly distinguished group that included Robert Solow, he finally agreed. But their report ultimately recognized that there are no general principles, and no two growth episodes seem alike. Bill Easterly, not very charitably perhaps, but quite accurately, described their conclusion: “After two years of work by the commission of 21 world leaders and experts, an 11-member working group, 300 academic experts, 12 workshops, 13 consultations, and a budget of $4m, the experts’ answer to the question of how to attain high growth was roughly: we do not know, but trust experts to figure it out.”⁸³