Emerging Giants' Macroeconomic Strategies

1. Public Policies and Macroeconomic Strategies of the New Emerging Giants Joseph E. Stiglitz Caracas October 10, 2007

2. The Changing Role of Developing Countries • China and India, with 2.4 billion people, growing at historically unprecedented rates • Countries that were marginalized, excluded from the global economy are closing the gap between themselves and advanced industrial countries • China at close to 10% for 30 years • India recently at more than 8% • Engine of global economic growth • Global growth at 5% for past couple years has been almost historically unprecedented • Increased demand for commodities has helped developing countries

3. Historical Perspective • 1820: China had 1/3 of global GDP, India more than 15% • 1814-1828: Industrial Revolution and tariff barrier knocked out Indian export • Indian textile export to Britain fell by two-thirds • British export of textile to India rose five times

4. 35% 30% 25% 20% China 15% India 10% 5% 0% 1998 1000 1600 1820 1913 1973 China and India: Share in World GDP Angus Maddison, World Economy, 2001

5. Real annual GDP Growth in BRICs: 2000-2006 Source: Euromonitor International from International Monetary Fund (IMF), International Financial Statistics. Note: 2006 data are preliminary.

6. Current Perspective • Globalization has played major role in their success • Access to markets • Access to technology • Lower communication and transportation costs • 50 percent compounded annual decline in telecommunication cost in the 1990s • Fiber optic glut during the Internet Bubble slashed telecom cost • Scanners convert data to image file - 160 pages per minute. • They took advantage of globalization, managed globalization far better than other countries

7. Common Element of Success • Heavy investments in education and technology • Comparative advantage not just based on unskilled labor • Closing knowledge gap • In case of India, long term investments (IIT and IIS) have finally paid off (large number of engineers) • In China, active technology policies have assisted development of new sectors • Both are concerned about strengthening • Especially University education • China: “New Innovation System”

8. Strong Macro-economic policies • Keeping exchange rate “reasonable” • Hard to grow with over-valued exchange rate • Especially hard problem for resource rich countries • Part of “resource curse” (“paradox of plenty”) • Built up reserves to protect themselves against vagaries of international markets • China took more active role in managing exchange rate • China built up larger reserves • Managed to keep inflation limited • But neither was obsessed with inflation • Both restricted short term capital flows • Insulated them from vagaries of market • Gave them more room for macro-management

9. Concern about Poverty • China has moved more than 300 million out of poverty • China has better health and education statistics • But India is closing gap in health statistics • Both countries have moved reduction of poverty and inequality to center of agenda • Necessary for political and social stability • Growing urban and rural divide, regional disparities, in China, growing overall inequality • Innovative programs to help rural sector • Both countries must create large number of jobs for new entrants to labor force • India is having difficulties in doing so

10. Some DifferencesIndia’s Success • Colonial legacy of English legal system facilitates global integration • Began with internal reforms, moving to business-friendly policies • Followed by external liberalization

11. China faced special problem • Moving from Communism to Market Economy • Pragmatic policies • Marked contrast with other countries (other than Vietnam) making the transition • Examples: still have not fully liberalized capital markets

12. Contrasts • Infrastructure—China’s is far better • Though in telecom India has had impressive success • China’s high savings rate means it does not require foreign capital • Only needs to acquire technology, access to markets • Not needing to borrow made them less affected by vagaries of international financial markets • China talking about moving away from export dependence • Trying to reduce domestic savings rate

13. And Similarities • 11th “five year plans” are focusing on environment, education, and especially higher education, and inclusive growth (reducing inequality) • Unless environmental problems are addressed, growth will not be sustainable • Unless growth is more inclusive, growth may not be politically and socially sustainable • Both are facing major problems in land acquisition for development

14. DEVELOPMENT IN THE LAST 50 YEARS: SUCCESSES AND FAILURES • East Asia- stupendous growth • Africa- a decline • Latin America- disappointments • First, the lost decade of the 1980s • Then, seven years of growth • Then, seven years of malaise 1997-2004 • Last couple of years--strong growth • Based largely on commodity price boom • Generated by China’s growth

15. Until recent commodity price boom • Growth since 1990 at half of what it was in earlier periods • 6.80% 1950-1980: Asian Tiger level • 5.72% 1930-1980: Respectable level • 2.3% 1994-2004: Poor performance under Washington Consensus

16. ECONOMIC GROWTH: EAST ASIA, LATIN AMERICA AND BRAZIL

17. ANOTHER COMPARISON: GDP GROWTH IN TWO PERIODS (1960-1980 and 1994-2004)

18. GROWTH RATES: BRAZIL, CHINA AND INDIA

19. 2005 and 2006 GDP Growth • Brazil: 2.9% in 2005, 3.7% in 2006 • Russia: 6.4% in 2005, 6.7% in 2006 • China: 10.2% in 2005, 10.7% in 2006 • India: 9.2% in 2005, 9.2% in 2006 Source: The World Bank

20. LATIN AMERICA ALSO EXPERIENCED TREMENDOUS VOLATILITY OF GROWTH

21. AND UNEMPLOYMENT HAS BEEN RISING

22. DECLINING PER CAPITA INCOME IN LATIN AMERICA

23. LATIN AMERIA: INEQUITABLE SHARING UNDER THE WASHINGTON CONSENSUS • Washington Consensus policies produced only limited growth • But even when growth did occur, it was not equitably shared • Washington Consensus was at best indifferent, and at worst hostile, to policies that would have promoted equality • Failures are not surprising: • - Trickle down economics do not work • - Equality issue not even considered

24. POVERTY RATES IN LATIN AMERICA: 1980-2001

25. THE CONTRAST BETWEEN EAST ASIA AND LATIN AMERICA AND THE FRAYING OF THE WASHINGTON CONSENSUS • Unlike Latin America, East Asia did not follow Washington Consensus policies in some important respects. They • Were slow to liberalize capital markets • Were slow to liberalize trade • Adopted strong government industrial policies, including creating some successful government enterprises • Policy differences account for much of the performance differences between East Asia and Latin America: • - More growth and faster growth • - Benefits of growth more widely shared • - And more stability (the only exception being the 1997 crisis, from which all but Indonesia recovered quickly, and which was partially caused by not following their traditional policies)

26. WASHINGTON CONSENSUS: A BRIEF SUMMARY • Development strategies based on market fundamentalism • Emphasizing privatization, liberalization and macroeconomic (usually meaning price) stability • Downscaling and minimizing the role of government • Problems lie with both what was on the agenda and what was not

27. SOURCES OF FAILURES • View of the economy - Including the relationship between economic success and political and social stability/structures • Objectives: • Not just increases in GDP • But, achieve sustainable, equitable democratic development

28. SOURCES OF FAILURES • Confusions between ends and means • The pursuit of rapid privatization in the former Soviet Union • Contributed to the enormous increase in inequality • Compromised the legitimacy of private rights, undermined market economy • And did not lead to faster economic growth • Capital market liberalization-- “supposed” to lead to more stability, growth • Did not lead to faster economic growth • But did lead to more instability • Even the IMF has begun to recognize the problems • Might have had predicted effects in models with perfect information and infinitely lived individuals • But would not in models with credit rationing and finitely lived individuals • Evidence supports latter view

29. WASHINGTON CONSENSUS AND EQUALITY • Justifications for ignoring equity • It was argued that one could separate equity and efficiency considerations, and economics should just focus on efficiency • Trickle-down economics meant that the poor gain if growth is pursued and attained • There were really no “trade-offs”- the single best policy would benefit everyone • Could essentially leave economic policymaking to technocrats to find that “best policy”

30. PROBLEMS WITH THESE JUSTIFICATIONS • These arguments are neither theoretically or empirically correct • Modern theories emphasize that equality and efficiency cannot be separated • Agency theory • The arguments for land reform • Sharecropping attenuates incentives just as taxes do • Washington Consensus policies did serve the interests of technocrats • And established special interests • Too much faith in markets • Even under the best of circumstances, there is no reason to believe markets are consistent with social justice • But even if one did not care about equity, distribution of income, there is an important role for government because of market failures

31. IMPORTANCE OF EQUITY • Equity is an “end” in itself • GDP a bad measure of success • GDP can increase even as the country gets poorer • Latin American debt • Resource depletion, environmental degradation • Better to focus on NNP • Even better to take account of liabilities • There can be rich countries with poor people • Better to focus on median income • Median household income in the US is declining, even as GDP increases • Equity promotes growth and even efficiency • Better use of human resources • Social and political sustainability

32. MARKET FAILURES • One of the most important findings of modern economic theory is that with imperfect information and imperfect risk markets (that is ‘always’ the case) markets are not efficient (e.g. Greenwald-Stiglitz) • Adam Smith was ‘wrong’ • The reason the invisible hand often seems invisible is that it is not there • Exemplified by problems of conflicts of interest, herding behavior, bubbles that were evident in the 90’s • With massive misallocation of resources during the boom • And massive losses from under-performance of the economy after bursting of bubble • Estimated in excess of $1 Trillion

33. MARKET FAILURES IN DEVELOPING COUNTRIES • Problems are particularly significant in developing countries • Markets also by themselves do not produce efficient outcomes when technology is changing or when there is learning about markets • Such dynamic processes are at the heart of development • There are important externalities in such dynamic processes • Giving rise to an important role for government • Successful East Asian countries recognized this role • The Washington Consensus policies did

34. SOURCES OF FAILURE OF THE WASHINGTON CONSENSUS • Because the Washington Consensus did not understand the limitations of markets, it focused on too limited a set of instruments • It ignored: • Land reform • Industrial policies • Strengthening the financial sector • Improving education • Competition policy • Governance issues in both the public and private sector

35. PROBLEMS WITH MACRO POLICY • Problems reflected in macro policy (an area in which it was concerned) • Too narrow a view of objective—controlling inflation • Good policy also looks at growth and employment • Controlling inflation does not automatically lead to faster growth • And indeed it may hamper long run growth • Lower GDP now is associated with lower GDP long into the future • Stabilization and growth policies are interconnected • Relying on interest rates in crises limits use of debt • Weakens financial markets and impairs efficiency of allocation of capital

36. PROBLEMS WITH MACRO POLICY • Key role of finance in growth is ignored • Making credit available at affordable terms • What matters is both availability and lending rate (not just T-Bill rate) • Greenwald and Stiglitz, New Paradigm in monetary economics • Importance of reducing T-Bill rates and spreads • Regulatory policy, competition policy and standard macro-economic policy instruments all have to be employed

37. There are many roads to success • But any critical mistake can lead to failure • Some successful East Asian countries invited in foreign direct investment • Both others did not • Some successful East Asian countries focused on large enterprises • Others on small • Most shared common elements described earlier

38. Brazil • Invented new concept: Export led non-growth • Remarkable success in export success • In which government policies played an important role • Innovative industrial policies • Ethanol, Embraer have been global successes • Innovative poverty policies emulated around world (zero hunger, contingent welfare payments) • Innovative democracy policies (participatory budgeting) emulated around world • But growth has been anemic

39. Brazil’s failure • Monetary policy—high interest rates • Leading to high exchange rate • Would have been difficult for any country to grow with these macro-economic conditions

40. Russia’s Failure • Decline during first decade of market economy • Market economy was supposed to improve efficiency • Lead to higher GDP • Only led to higher poverty, huge and persistent inequality • Has been growing • Based on high oil prices • Worry about retreat from market economy and democracy • Mafia capitalism • Is it sustainable?

41. Russia similar to other economies in transition, other than China, Vietnam

42. Average growth rates were dismal—gap between countries and rest of world increased

43. In many countries, poverty rate increased enormously

44. INCREASES IN INEQUALITY

45. OIL DEPENDENCE IN RUSSIA

46. While the Global Landscape Has Changed, the World is Still Not Flat… • Growing disparity between richest countries and poorest countries • Growing disparities within most countries

47. While the Global Landscape Has Changed, the World is Still Not Flat… • Globalization has played an important role in these disparities • Predictable effect on inequality within advanced industrial economies • Effects on developing countries harder to explain • Africa has neither resources nor education to take advantage of new opportunities • Unfair trade treaties have compounded problems in developing countries • Problems compounded by asymmetric liberalization

48. New Global Order • Provides unprecedented opportunities for growth for those who can take advantage of it • Provides unprecedented challenges in economic management, with grave risks for those who do not manage it well • Public policies are key • Balanced role of market and government • Need for development of broad political and social consensus behind this balanced role

49. Summary: THE ROLE OF PUBLIC POLICY IN THE ECONOMY • There is an important role of government in developing countries, not only to • address market failures • Such as controlling conflicts of interest • And ensuring the safety and soundness of the financial system • promote growth and development • Through education and technology • Creating an enabling environment for the private sector • But also to: • promote equity, provide safety nets

50. Important roles in education, technology, reducing poverty, regulation, finance • Exploring wide range of instruments, including new and innovative instruments • Macro-economic stability with growth • Focus on real stability, not just price stability • Focus on access to credit • Focus on exchange rate