The Great Economists
Page 30
Exemplified by Vietnam and Myanmar, Asia is progressing with institutional reforms and its growth has led to expectations that extreme global poverty might be eradicated. But Africa remains the big question mark, where so many of the world’s poor still reside. Still, South Africa’s transformation, led by another path-altering political change, offers a glimpse as to what is possible.
Africa’s progress and challenges
When apartheid finally ended in South Africa in the early 1990s, the phrase ‘Africa rising’ was often heard. Over the past couple of decades, Africa was the second fastest growing region in the world after only Asia. This is a far cry from the years when the region’s dominant issues were discussions about debt forgiveness. But poverty rates remain stubbornly high.
This is despite the fact that on the back of the extraordinary commodity boom of the 2000s, African nations have grown well, many quite rapidly, averaging 5 per cent a year in the past decade. This was the longest expansion of incomes in the region in thirty years.
Whether these countries can sustain that economic growth, and do more for poverty reduction, depends on a number of factors, including whether they have managed to industrialize and mechanize agriculture using the proceeds from the commodity boom. That would make growth more inclusive in that the benefits from it are widely shared, which would matter a great deal to poverty reduction. Whether they have done enough to adjust to the end of that extraordinary period will soon be evident in their economies.
For the dominant economy in the region, the transformation post-apartheid has been notable and serves as a case study of effective institutional change. At one stage, South Africa accounted for one-third of the entire output of the nearly fifty countries in sub-Saharan Africa. Its average income during the 1980s was less than $3,000 per capita, which ranked it as a lower middle-income country. By the 2010s, a couple of decades after the end of apartheid, incomes had doubled and propelled South Africa to become an upper-middle-income country. And it became part of the BRICS, the ‘S’ to Brazil, Russia, India and China. South Africa is one of the five large emerging economies highlighted by financial markets. Its popularity with investors seeking higher returns signalled its arrival as one of the new players in the global economy.
This is not to suggest that South Africa doesn’t have challenges. To name just a few, income inequality and joblessness remain tough issues. The average income of black Africans in the country is one-tenth to one-fifth of that of whites. Work is another persistent problem. With the unemployment rate at over 25 per cent, the lack of jobs, particularly for the black population, is a recurrent concern. Some of these economic woes are legacies of apartheid, which was a system of racial segregation in place between 1948 and the early 1990s. It was ended after the release from prison in 1990 of Nelson Mandela, who was later elected president. Mandela had worked for decades to end the unfair system that designated the majority of the South African population second-class citizens. Even though official discrimination against blacks has ended, they remain less well off economically more than two decades later. It’s an example of Douglass North’s path dependence and why institutions are slow to change, even with the will to do so. And how it takes time for a disadvantaged group to advance even after the formal barriers have been removed since they start from a weaker economic position. It’s one of the challenges holding back the country’s growth potential decades after Nelson Mandela led the nation into a new era.
This jars with the perception that South Africa is an attractive destination for investors. This is why the country has been described as having a First World financial market within a Third World economic system. Further reform of its economic and political institutions is needed to close that gap, as South Africa has been a beacon for the sub-Saharan region but also epitomizes the development challenges the region still faces. For other African nations, South Africa demonstrates how far a country can advance when institutions are reformed to be more equitable. This is in line with the work of Douglass North: economic development that focuses a great deal on understanding the institutional impediments to growth. Every African nation has its own history and institutions to grapple with, but there is no question that their success will determine whether global poverty will be eradicated in the coming years.
Taking stock
So, what would Douglass North make of the development challenges in the years ahead? What would he say about why some nations remain poor while others have become rich? Is the sharp divide in the world’s economies set to continue? After all, current trends point not only to the end of the need to distinguish between developed and developing countries, but also to a concern that the emerging economy growth story could be over before those countries have overcome poverty.
North would certainly recognize that economic growth does not necessarily mean poverty reduction. He believed that poor institutions can persist and enrich some without any resultant economic growth benefiting the country as a whole: ‘Rulers devised property rights in their own interests.’21 So, North believed that institutions can be corrupt, particularly when it comes to who owns such assets as natural resources and land, which have been a source of conflict in Africa.
But North would argue that countries can learn from successful cases such as those in Asia where institutions have worked to bolster economic development and reduce poverty: ‘Clearly the existence of relatively productive institutions somewhere in the world and low-cost information about the resultant performance characteristics of those institutions is a powerful incentive to change for poorly performing economies.’22
Notably in East Asian nations such as South Korea and Singapore, good governance seems to have played a role in their growth. Their government policies were geared at promoting manufacturing and exporting. They also focused on expanding education to the entire society. These sorts of institutions are ones that North would describe as good for economic growth.
But good institutions are not easy to come by. Simply transplanting a well-crafted set of rules or even an entire legal system into a developing country doesn’t work. That’s evident from the countries of the former Soviet Union’s unsuccessful attempt to adopt Western legal systems during its transition from communism to capitalism. After the collapse of the USSR in the early 1990s, those newly independent countries in eastern and central Europe adopted the Western rule of law and regulations. But decades later, legal protections and rights are still not effectively enforced in many of those nations. Laws that are imposed artificially rather than develop organically do not necessarily fit. The challenge for economies is how to build good institutions suitable to their domestic contexts. As North observed:
Although formal rules may change overnight as the result of political or judicial decisions, informal constraints embodied in customs, traditions, and codes of conduct are much more impervious to deliberate policies. These cultural constraints not only connect the past with the present and future, but provide us with a key to explaining the path of historical change.23
Thus, North would say that bolstering the rule of law will take time as culture changes gradually, but developing rules-based institutions that provide for good governance will eventually determine how such countries will develop down the line. Of course, political stability and a lack of conflict are also essential or good institutions will struggle to take hold. North was well aware of the challenges of developing beneficial institutions within often messy political and economic backdrops in the world’s poorest countries. It’s why he advocated paying attention to informal institutions, which includes doing business with those you trust while the legal system improves. Social networks or social capital help to explain how countries with poor legal systems do business as the moral pressure, often from their own communities, constrains bad behaviour; for instance, if your neighbour absconds with your money, then his family will be ostracized in the village. How societies interact is crucial in understanding how institutions evolve. North stressed: �
��Informal constraints matter. We need to know much more about culturally derived norms of behavior and how they interact with formal rules to get better answers to such issues.’24
To get those answers about how norms of behaviour will influence the reform of formal institutions such as the rule of law will require economics to broaden its perspective to include the messier aspects of how societies operate. As North put it in one of his last contributions:
My pet peeve all through the last twenty years or thirty years has been the narrowness of economists, in fact of all social scientists, in not opening up whole new areas … I think the biggest thing I want to leave with you is how we’ve got to study more about how the mind and brain work and how the structure is evolving over time as we get more information, more knowledge, and when it’s going in directions that are creative.25
North’s research has certainly opened up the subject. As a result of his path-breaking work and legacy, economists have considered institutions much more carefully as an essential part of understanding economic development. For instance, building on North’s work, Daron Acemoglu and James Robinson, whose book was mentioned earlier as an exemplar of the current thinking in economics, examined in detail instances from around the world in which bad institutions led to dire outcomes. They concluded that the issue is when the institutions that underpin the economy are extractive and encourage exploitation rather than productive effort:
Nations fail today because their extractive economic institutions do not create the incentives needed for people to save, invest, and innovate. Extractive political institutions support these economic institutions by cementing the power of those who benefit from the extraction. Extractive economic and political institutions, though their details vary under different circumstances, are always at the root of this failure … The result is economic stagnation and – as the recent history of Angola, Cameroon, Chad, the Democratic Republic of Congo, Haiti, Liberia, Nepal, Sierra Leone, Sudan, and Zimbabwe illustrates – civil wars, mass displacements, famines, and epidemics, making many of these countries poorer today than they were in the 1960s.26
They agree with North that path dependence leads to a vicious circle of persistently poor development, and also that it is possible to break the cycle: ‘The solution to the economic and political failure of nations today is to transform their extractive institutions toward inclusive ones. The vicious circle means that this is not easy. But it is not impossible.’27
Acemoglu and Robinson point to successes, including Botswana, China and the American South, which are ‘vivid illustrations that history is not destiny’.28 But it will require a broad-based political and social coalition to push for reforms, as proposed by North, and a bit of luck ‘because history always unfolds in a contingent way’.29
There are more successes now than ever before. Research by the OECD estimates that by 2030, for the first time in history, more than half of the world’s population will be considered middle class. That’s 4.9 billion out of an estimated 8.6 billion people. In 2009 1.8 billion (out of around 7 billion) people earned between $10 and $100 per day, a measure of the income that defines the new global middle class. That’s enough to buy a refrigerator, adjusted for what a dollar buys in their countries.
In 2030, nearly two-thirds of the middle class worldwide – 3 billion people – will be in Asia on current trends. The United Nations describes it as a historic shift not seen for 150 years. The European and North American middle class will fall from more than half of that class’s world total to one-third.
Because of Douglass North’s insights, we are closer than ever before to understanding how to end poverty. Following his precepts, a number of countries have developed successfully in the past few decades, leading to an unprecedented expansion of the middle class around the world. Even if economics doesn’t have all of the solutions, looking more broadly at institutions holds the promise that one day we will learn why some nations are rich and others are poor, and, most importantly, why some nations fail and why some ultimately prosper.
North would agree: ‘We are just beginning the serious study of institutions. The promise is there. We may never have definitive answers to all our questions. But we can do better.’30
CHAPTER 12
Robert Solow: Do We Face a Slow-Growth Future?
Economic growth across major economies is slower today than before the 2008 global financial crisis, but not just as a result of the crash. Economies such as the United States, the euro area, Japan and the UK had been experiencing a marked slowdown in productivity growth since the mid 2000s.
Some economists are warning about permanently slower growth in advanced economies, in part because their ageing populations will be less productive. Could these economies be facing what the former US Treasury Secretary and Harvard economist Lawrence Summers describes as ‘secular stagnation’? If so, then those countries face a worrying economic future. Fewer workers require fewer office buildings and less equipment, which also depresses investment and therefore the economic outlook. That point seems to be approaching: US labour force growth slowed to just 0.2 per cent in 2015, down from 2.1 per cent from the 1960s to 1980s; for the UK, the annual average rate of labour force growth is somewhat better, but it is still down to around 0.6 per cent.
An overwhelming concern is that the situation in Japan in the early 1990s will be repeated in the West. When the real estate bubble burst, the ensuing economic collapse revealed an underlying stagnation that had been masked by the crisis. Japan’s problems have been compounded by a population that has been shrinking since 2010. A smaller workforce makes it harder to improve productivity and raise output growth. Slow productivity growth in particular is an issue for Britain, which is facing its weakest recovery in modern memory. This is a lesson to heed, since national output has recovered to pre-crisis levels, but productivity continues to lag behind the overall recovery.
So, the new normal growth rate may be lower than before. Or, worse, be stagnant. How worried should we be?
The author of the workhorse of economic growth models, Robert Solow, might provide some answers. The Solow model shows that economic growth occurs when workers and capital are added to the economy, but that it is sustained only when there is also technological progress. Better technology improves labour productivity, which increases capital accumulation by slowing down the diminishing returns to capital. Diminishing returns happen when a worker is given more than, say, two computers; that worker won’t produce as much with the third computer as compared with the first two unless there is better software that allows computing to be done without the person using it all the time. Technological progress allows the existing inputs of workers and capital to be used more efficiently. An increase in output due to technology is referred to as total factor productivity (TFP) in economic growth models. Physical capital as well as human capital – the skills and education of workers – are central to this model. It’s especially pressing for rich countries, where the working-age population is ageing or even shrinking and having better-skilled workers is even more important. How to raise productivity lies at the heart of whether or not we’re doomed to a stagnant future.
What would Robert Solow, whose pioneering work has helped us to understand what generates economic growth, make of the prospect of low productivity and a slow-growth future for major economies?
The life and times of Robert Solow
Robert Solow was born in 1924 in Brooklyn. The son of Jewish immigrants, his was the first generation of the family to go to college. He attributes his intellectual awakening to the New York City public school system, where a teacher got him interested in nineteenth-century French and Russian novelists. That wasn’t the only trigger that Solow describes: ‘Like many children of the Depression I was curious about what made society tick.’1
That curiosity led to him obtaining a scholarship to attend Harvard University in 1940. After serving in the US army from 1942 to 1945, he returned to Harvard and his fiancée, B
arbara Lewis, known as Bobby. They had met before he was deployed and wrote to each other daily while he was serving in North Africa and Italy. After the end of the war, Bobby graduated from Radcliffe College, the all-women sister college to Harvard. In 1945 they married and both embarked on their doctoral studies in economics at Harvard. Bobby completed her dissertation after a thirteen-year interruption to raise their three children and later taught at Brandeis and Boston universities, where she focused on Irish and Caribbean economic history. They were married for nearly seventy years until her death in 2014 at the age of ninety.
Bobby may have been the reason that Solow became an economist. He asked his wife whether the economic courses that she had taken were worthwhile. Solow was persuaded and pursued economics, which brought him under the tutelage of Wassily Leontief and others.2 Leontief was a Nobel laureate who won the top prize in economics in 1973 for his work on measuring inputs such as labour and capital and their relationship to national output, presented in ‘input–output tables’. As his research assistant, Solow produced the first set of measurements of how much capital investments added to output in the American economy.
As Solow’s interests turned to statistics and probabilistic models, he spent 1949–50 studying these subjects at Columbia University, which had more experienced teachers in that area. It helped him finish his doctoral dissertation, which modelled changes in wage distributions and unemployment. His thesis won the Wells Prize at Harvard, which offered not just publication as a book but also $500, which was a considerable sum in 1951. But upon rereading the thesis, Solow thought he could improve upon it, so it remains unpublished and the cheque is still uncashed.