What’s the most effective way to sabotage economic growth?
According to a new analysis of five-plus decades of economic data and history, it’s often as easy as increasing tariffs and playing favorites among industries and companies. Corruption helps too.
Consider Brazil. In the 1960s and early 1970s, Latin America’s largest economy grew rapidly. But the country’s emphasis on trade policy that protected domestic industries, such as steel production and automobile manufacturing, caught up with it. Corruption, inflation and the oil shocks of the 1970s all conspired to reverse the country’s growth -- it still hasn’t made up lost ground.
Korea also pursued more effective industrial policy. It jumped into the elite ranks of high-income nations by investing in globally competitive sectors such as high tech. In the 1960s, its economy was a third the size of Brazil’s, even after adjusting for population. Today, South Korea’s economic output per person is double that of the South American giant.
The reversal wasn’t pre-ordained -- Brazil started with a stronger economy and more resources than South Korea. It also wasn’t rebuilding from two devastating wars. Yet it fell behind. Across the globe, the situation repeated itself. Countries as diverse as Malaysia and Mauritius -- a small Indian Ocean island more than 500 miles east of Madagascar -- soared even as better-positioned rivals such as the Philippines and Ghana struggled.
A analysis of ten representative high-growth countries and ten disappointing laggards, published in the Review of the Federal Reserve Bank of St. Louis, helps explain why. Institutions -- rather than orthodox economic considerations such as gains in technology or efficiency, or gains in equipment and education -- explain why some countries squandered their early advantages.
By their very nature, institutions defy measurement. Economists Ping Wang of Washington University in St. Louis and the Federal Reserve Bank of St. Louis, Tsz-Nga Wong of the Federal Reserve Bank of Richmond and Chong K. Yip of the Chinese University of Hong Kong had to infer their influence based on 51 years of data and a methodology commonly used in development accounting.
But that merely indicated that institutions determined economic winners and losers. It didn’t say which institutions played the deciding role. For that, Wang, Wong and Yip dug through each country’s economic history, looking for a host of possible factors. The trends they found are summarized below.
MIT economist Daron Acemoglu, co-author of Why Nations Fail, The Origins of Power, Prosperity and Poverty, said that while he thinks Wang came to the right conclusion, future research ought to rule out competing explanations, as well as attempt to isolate the effect of specific institutional features.
In a 2016 working paper released by the National Bureau of Economic Research, Acemoglu and his co-authors write that one feature shared by many high-growth countries -- a democratic government -- “increases future GDP by encouraging investment, increasing schooling, inducing economic reforms, improving public good provision, and reducing social unrest.”
Their analysis of 175 countries from 1960 to 2010 indicated that adopting a democratic form of government was worth a 20-to-25 percent boost in output per person over the following quarter century.
Former International Monetary Fund Chief Economist Olivier Blanchard, now a senior fellow at the Peterson Institute for International Economics, cautioned that because “bad governments are bad in many ways,” it’s nearly impossible to tease out specific factors. Protectionism often goes hand-in-hand with other policy mistakes, for example.
Wang, Wong and Yip didn’t just study countries such Kenya and the Comoros that have long been trapped in poverty. They also looked at countries such as Argentina, Chile and the Philippines, which were among the darlings of the developing world in the early 1960s, but quickly fell off the pace.
More than technology, resources, or environmental factors, two trends united the two groups. Almost every slow-growth country raised barriers to international trade and capital markets and favored certain industries and firms -- even when there was no strategic reason to do so.
“We have a lot of the same problems in the U.S. right now,” Wang said. “The government tries to create a lot of trade barriers. The government looks to help select industries -- steel and aluminum, for example.”
Governments should pursue an industrial policy that fosters economic growth and innovation, Wang said, not one that is primarily for “election purposes.”
Helping industries in exchange for political contributions often happens in plain sight, so it doesn’t fit traditional notions of government corruption. But, according to Wang, it creates similar economic problems.
“We are going backward,” Wang said. “This may create another big recession. We had the 1929 Great Depression. We had the 2008 Great Recession. I don’t want to see another ‘Great’ bad thing. We may run out of terminology.”
Blanchard isn’t as sure that a recession is imminent. “Leaving aside big psychological effects, the adverse effects are likely to take place slowly over time,” he said. “It took many decades to destroy Argentina.”
The success stories
The successful countries in the sample, particularly the Asian Tigers (Korea, Taiwan, Hong Kong and Singapore), didn’t recoil from international competition. Instead, they built the institutions needed to win in a globalized economy.
They exported heavily, attracted outside investment and encouraged internationally competitive businesses. They built up education infrastructure and promoted high-skilled labor. They tamped down black markets. And, of course, they kept tariffs relatively low.
When they intervened in the economy, it was to build on natural advantages rather than curry votes or pay off cronies. Korea focused on high-tech trade with its neighbors, China and Japan. Landlocked Botswana went all in on diamonds. Mauritius invested in tourism. To be sure, the island may not have had many options: its best-known natural resource, the dodo bird, has been extinct for more than 350 years.
Growth in even the most successful countries was rarely smooth or uninterrupted, but that’s often how they pulled away from the pack. When global growth sputtered, they relied on the fundamental strength of their institutions.