Growth in the 1990s: Common lessons across sectors

1. Growth in the 1990s: Common lessons across sectors Presentation to ICRIER September 28, 2004

2. Are there common lessons from the experiences of policy reform? • Macroeconomic • External policies • Privatization • Financial sector

3. Three common lessons • Policy reform generally had the magnitude of impact expected—”growth” expectations were too high • Getting rid of discretion is too high a price to pay—but properly exercised discretion is difficult to achieve • Expectations are central

4. 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

5. “Growth” is nearly always a transitional phenomena, differences in “steady state” growth are small

6. 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

7. What is to be done about discretion? • Diagnosis of the 1990s • Attempts to limit discretion in policy making • Lessons from the experience

8. 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

9. The diagnostic pre-1990s: illustration with Central Banks

10. 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

11. Figure 7.2: The elements of policy action 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). Model (description of how policy actions lead to outcomes M) Feasible Policy Actions (The set of actions A that the policy making organization can take) 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 Citizen organizing capability Administrative Judicial Political (Executive, Legislative) Impact of policy action on actions of relevant agents Free Press Background Institutions of policy making Outcomes

12. Lessons from the “limit discretion” movement • With weak “background” institutions rules and discretion are identical • Eliminating discretion is like squeezing a balloon—it just changes shape • Both tied and untied hands have their dangers

13. 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

14. Key role of expectations: Examples • Modest reforms can have enormous growth impacts—if they are the harbinger of future reforms • Enormous policy action changes can have no impact—if 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)

15. Implication 1: Common principles, heterogeneity of implementation • “Institutions” cannot matter • “Institutions” are all important • Both are true

16. 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?

17. 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 don’t have it, you shouldn’t do it

18. 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?