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Growth in the 1990s: Common lessons across

sectors

Presentation to ICRIERSeptember 28, 2004

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Are there common lessons from the experiences of policy reform?

MacroeconomicExternal policiesPrivatizationFinancial sector

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Three common lessons

Policy reform generally had the magnitude of impact expected—”growth” expectations were too highGetting rid of discretion is too high a price to pay—but properly exercised discretion is difficult to achieveExpectations are central

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Three implications for policy making

Common principles, heterogeneity of implementationFocus on initiating and sustaining episodes of rapid growthPro-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” impactsThe 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 BanksTied 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” bodiesEnter into binding international agreements

Feasible PolicyActions (The set of actions A that the policy making organization can take)

Citizen organizing capability

Background Institutions

Relevant “States of the World”(empirically contingent “facts” that are relevant to the desirability of various policy actions--S)

Notional Policy-Objectives with discretion-Conditional rules (A mapping from “states of the the world” to “policy actions”)-Unconditional rules (always do policy action a).

Organization

(The organizations or agencies legally authorized to take actions)

Policy Actions

(The outcome of all of this is the actual sequence of decisions and policy actions taken)

Background Institutions of policy making

AdministrativeJudicial

Political(Executive, Legislative)

Impact of policy action on actions of relevant agents

Outcomes

Model(description of how policy actions lead to outcomesM)

Free Press

Figure 7.2: The elements of policy action

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Lessons from the “limit discretion” movement

With weak “background” institutions rules and discretion are identicalEliminating discretion is like squeezing a balloon—it just changes shapeBoth 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 impacts—if they are the harbinger of future reformsEnormous policy action changes can have no impact—if they are perceived as temporary“Digging deeper” can have perverse impactsWith 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 governmentIt all depends on the capacity to exercise discretion productively

Improving that capacity is centralIf you don’t have it, you shouldn’t 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?