One Economics, Many Recipes: Globalization, Institutions and Economic Growth

Citation

Sánchez‐Fung, J.R. (2008), "One Economics, Many Recipes: Globalization, Institutions and Economic Growth", Indian Growth and Development Review, Vol. 1 No. 2, pp. 252-256. https://doi.org/10.1108/17538250810903819

Understanding economic development strategies and how they affect the growth prospects of an economy is essential. But finding a recipe for achieving sustainable economic growth and development that is applicable across countries and through time is a forlorn task. Many authors and institutions, including Nobel prize winning economist Michael Spence and the Commission on Growth and Development, endeavour to throw light on the issue.

One Economics, Many Recipes: Globalization, Institutions and Economic Growth is a collection of essays by Dani Rodrik and co‐authors contributing to this field. It takes on challenges that countries face in trying to achieve growth and development in a globalizing world economy. The book consists of three parts dealing with growth, institutions and globalization.

The first part focuses on the following question: why have some countries grown more rapidly than others, and what we can learn from these experiences? In seeking to answer that question Chapter 1 overviews country experiences, successful and otherwise, with economic growth and development strategies. What we confirm from this panoramic is that there is no single recipe for achieving sustainable growth.

In that regard, China and India followed unorthodox strategies and have performed outstandingly. In contrast, Latin American countries followed Washington consensus policies and their performance has been disappointing. Some economists argue that Latin America's failure highlights the need to pursue further wide‐spread policy reforms. Conversely, others, like Rodrik and his colleagues, propose following a more focused approach to designing and implementing policies in a country‐by‐country basis.

Chapter 2 aims at contributing to that subject. This is probably the book's most important chapter and it deals with the “growth diagnostics” approach. The approach departs from the standard theories of second‐best and partial reform, encompasses the major development strategies, and is implemented in a “tree” framework. The analysis focuses on the inefficiencies that may prevent an economy from operating at or close to the productivity frontier. These inefficiencies operate as a tax on, for instant, investment initiatives, but would also have an impact on other activities. The second‐best approach to eliminating these distortions implies considering the net effect of a reform, i.e. after accounting for the impact that eliminating a distortion in one sector impinges on another sector. But pin‐pointing second‐best interactions is difficult, and that is why the growth diagnostics approach suggests focusing on lifting the most binding constraints.

The first step in applying the growth diagnostics approach involves identifying the most binding constraint on economic growth, e.g. low human capital, high taxation or financial instability. The second stage involves thinking about the most suitable strategy for addressing the constraint. Rodrik et al. illustrate the approach's applicability to Brazil, El Salvador and the Dominican Republic, which the authors argue suffer from different binding constraints. For instance, in examining the Dominican Republic the authors single out tourism, maquilas and remittances as the key factors driving the Dominican Republic's performance. They also highlight the institutional weaknesses contributing to the new millennium banking crisis costing the country 20 per cent of its GDP in 2003. A key factor contributing to that crisis was the fast growing financial system following financial liberalisation during the 1990s alongside weak financial supervision.

So in the Dominican Republic the soundness of the financial system and of the macro‐economic policy institutions seem to be binding constraints to sustaining growth that merit further attention. That is in line with the findings arising from the exploratory econometric growth model in Pozo et al. (2008); inter alia, a negative association between domestic credit and the growth of real GDP per capita. Also, Figure 1 shows that in the Dominican Republic the two largest observations of the parallel market premium, an important indicator of the monetary policy stance and a common proxy for market distortions, coincide with the two largest drops in real GDP per capita in the three‐decade period spanning from 1970 to 2000.

Notwithstanding the previous illustration, deciding on the binding constraints on growth involves exercising a considerable dose of judgment. So the natural question that arises is: how can we actually implement the growth diagnostics framework, since each development problem could be arising from various causes? In this regard, Dixit (2007) argues that the tree approach is problematic[1]. He contributes to filling this gap by proposing a Bayesian modus operandi for diagnosing what causes economic failure in an individual country and for subsequently informing the choice of policy responses.

Table I synthesises Dixit's ideas on the matter. The first row contains the causes and the second row the probability that the given cause can actually occur. The remaining columns display a set of potential outcomes. Dixit suggests that econometric studies can help in determining the probabilities of occurrence of certain events. In making the growth diagnostic approach more operational, he argues that it would be ideal to be find that the conditional probabilities are P11 = P22 = 1 and P12 = P21 0. That would throw out a clear cause for explaining any given observed outcome.

Chapter 3 closes the first part of the book. The summing up suggests employing a three‐stage approach when thinking about growth strategies. The stages are diagnostic analysis, policy design and institutionalisation of the diagnostic and policy response process.

Part B moves on to examining the role of institutions in growth and development. Chapter 4 deals with industrial policy. The discussion focuses on the information externalities and coordination externalities marring industrial ventures. The first concept implies that there is a learning process involved in producing new goods, what Dani Rodrik and Ricardo Hausmann label “self‐discovery”. Coordination externalities imply that some projects require large‐scale, simultaneous, investments to be profitable. Both elements can be addressed via a well‐designed and targeted government industrial policy. The chapter goes on to provide detailed ideas on designing and implementing industrial policy.

Chapter 5 studies the institutions that promote the good functioning of markets and that are vital for a thriving economy. Particularly, it provides evidence showing that democracies generate more predictable economic growth rates, produce greater short‐term stability, are better equipped to deal with external shocks and yield better distributional outcomes.

Chapter 6 discusses the role of institutions. The exposition is particularly critical with regard to some of the key empirical findings in the literature. For instance, it argues that the conclusions in the widely cited work by Acemoglu et al. (2001) could be misleading. Particularly, finding colonial history proxies that are useful in achieving econometric identification should be interpreted with care. The colonial proxies are just instrumental variables aimed at overcoming an econometric problem. The message is that we should not draw conclusions regarding the link amongst colonialism and the wealth and poverty of today's world.

The book also addresses the link between geography and development arising from the empirical literature, which unveils mixed results. Also, the exposition cautions against pursuing shock‐therapy reforms. In that regard, it recounts examples of successful gradual reforming efforts undertaken in China during the 1970s and in South Korea during the 1960s. These examples contrast with the overwhelming list of reforms commonly prescribed by the international organisations. That theme also relates to the author's arguments elsewhere in favour of thinking about “second‐best” institutions for developing countries (Rodrik, 2008).

Part C focuses on globalization, simply defined as enhanced trade and financial integration. Chapter 7 studies the governance of globalization and draws attention to the global nature of markets with regard to the national nature of the institutions supporting them. The key questions are: should politics be as far‐reaching as economics? Can nations improve their well‐being by collaborating with other nations, or is decentralized behaviour always Pareto‐dominant?

Rodrik employs an intuitive analytical framework to aid thinking about these issues. The model shows that there are potential gains from adopting common standards (tc) (with an opt‐out clause and via a simple majority vote) in relation to behaving independently. Particularly, non‐cooperation (e.g. on financial regulation issues), implying the adoption of a distinct ideal standard (ai), yields an outcome in which a first‐best solution can only be achieved by introducing a Pigouvian tax or subsidy.

In contrast, under cooperation countries have to set their standard at least as high as the common standard (ti ≥ tc) or pay a cost amounting to k. For this to be binding k is chosen so that there is no country ending‐up worse‐off in comparison to the non‐cooperative equilibrium and for which the average policy is t =½. The analysis goes on to show that under cooperation there is always a common standard and a penalty that generate an outcome that is at least as good as that arising from no cooperation.

Figure 2 illustrates the outcome for given values of tc and k in the case of cooperation; the thick line depicts t as a function of a. In that figure, below the standard level as, in the range [0, as], a country will choose paying the penalty k and adopting its preferred t. Countries with standards falling in the range (as, tc] will choose the common standard, while those in the top range (tc, 1] will opt for the standard of their choice. The modelling is useful in showing that the scheme in question will increase the average standard to t =½+k. And that is at least as high as that arising from the non‐cooperative outcome t =½. The exercise also shows that for a small enough k the scheme always works as desired.

A framework like that elucidated above may be useful when thinking about the governance of globalization. That framework is close to what the World Trade Organisation does in practice, as the institution gives leeway (temporary opt‐out) regarding some aspects of individual countries’ trade policies. Additionally, in the sphere of international finance there is a plethora of international standards that countries are expected to comply with, but that may not be appropriate for all the economies. So countries should be able to agree at the outset what it will cost them to deviate from these policies if they deem it is in the best of their interest. That seems an important element if the world is to continue harvesting the benefits from globalization.

Chapter 8 looks at issues related to the international trading regime, focusing on the World Trade Organisation's role. The exposition reviews the arguments in favour and against a freer trade regime, and pays particular attention to how trade issues affect countries’ development prospects. A matter that comes to the front is the prevalent drive towards adopting market friendly polices, often pushed forward by international organisations like the International Monetary Fund and the World Bank. The exposition reveals that these policies have generated limited success at best, and that improving consumer's welfare seems an unachievable target. That is why the book suggests that the case for trade liberalisation must be examined with care and that trade openness is not a panacea for achieving higher rates of economic growth.

Chapter 9 concludes by putting forward some ideas on the link between economic growth and globalization. To be sure, the gains from globalization have so far been enjoyed by those with better initial endowments. But how do we make the balance more equal? In this regard the book's key advice is that countries should develop policies suitable for their own realities rather than following off‐the‐shelf recipes.

This book provides a critical assessment of important topics in the growth and development debate. There are some interesting contributions, like the growth diagnostics approach. Overall, the material should prove valuable for academics and practitioners. The author closes the book by stating that economists need to be more humble when it comes to selling their policy prescriptions and what they can actually achieve. That is one important message to have in mind.

Note

1. 1.

   Likewise, Rodríguez (2005) comments that the growth diagnostics approach is potentially useful but raises concerns about the pitfalls likely to arise when trying to implement it in practise.