Financial Daily from THE HINDU group of publications
Thursday, Jun 23, 2005
Developing ideas on development
Debt relief for poor countries is undoubtedly critical. And the moves of a number of countries in the developed world to raise the levels of aid are also critical for the development of Africa. However, the effectiveness of aid and the improvement in the absorptive capacity of the debt-ridden countries hinges upon governance which, in the African context, is known to be very poor.
But the African case is not an exception. As a matter of fact, economic governance should be effective in implementing policies in any country. This is easier said than done. For it would take considerable effort on the part of the political leadership and civil society to ensure that governance is sound in countries that are ridden with social and political conflicts. As conflicts are often found to be inherent in heterogenous societies, civil societies would have to work doubly hard to improve governance.
The initiative of the developed countries in cancelling African debt, however, is highly laudable but this does not mean that the economic distance between the African and other countries would shrink in the medium term. The gap could as well widen. For, almost all the countries other than those in Africa have recorded fairly high growth rates in the last two decades, in particular the developed nations in the 1990s. As a result, the economic convergence among nations would remain a distant dream. From all indications, there would be a tri-polar world of developed countries, poor nations and the rest of the world comprising emerging market economies including those in `transition'.
For many observers, some of the emerging economies would in the next 25 years or so overtake the present day developed countries in terms of prosperity partly because of skill formation and young and growing labour force. In this context, there was much speculation about the prospects of Brazil, Russia, India and China becoming super economic powers. But is it as simple as what the futurologists or, appropriately, the `development astrologers' say?
When the developed countries faced `stagflation' in the 1970s partly due to the oil crisis, many economists thought that they would be overtaken in economic performance by energy-abundant nations. But, by the early 1980s, inflation in developed countries was overcome, markets freed and made more harmonious, and new technologies set into effect, leading to a sharp improvement in overall productivity that helped the developed economies extract `innovation rents'.
It is this experience of the developed countries that is of extraordinary historical significance. For, the developed economies would not have come out of the morass had science and technologies not been superimposed on the already set market and institutional mechanisms and the rule of law. The burst of productivity raised the scale of operations, lowered the rates of inflation, improved the real wages and expanded the propensity of the firms to seek avenues for investment both domestically and internationally. Countries that opened up, as those in East Asia, benefited from foreign investments and technologies for a number of years.
The East Asian miracle, however, came to an end by 1997 mainly due to the inefficiency of the institutional mechanisms to be supportive of the economic openness. But the financial instability that resulted does not detract the value of the lesson from the economic experience of the developed world from about the 1970s onwards.
That lesson is simple get the set of policies and institutions right besides, of course, the ability to govern well. This would help the `animal spirits', as Keynes once described, to improve the growth performance. However, its sustainability would depend upon how sound the institutions are. In other words, policy thinking should give high priority to the creation of institutions that would help improve the performance of markets. On the other hand, the thrust that new technologies provide would be to not only raise the `potential' growth but also reduce the gap between the actual and potential growth. However, strides in science and technology would not be continuous, but as technology is critical, it is necessary to foster research and development through higher allocation of funds. In other words, countries would have to spend not merely to improve technological processes to lower costs and prices but also to innovate and reap rents thereof. Innovations would help raise real wages and expand demand to match the inherent ability to enhance supplies that new technologies afford.
The development process has thus become complex and cannot be triggered by getting one set of policies right. For example, the argument that price flexibility would help achieve the objective of getting prices right and enhance allocative efficiency is just not effective enough to place the development process on auto-pilot and enhance employment opportunities. It is, therefore, important that right prices are supplemented by getting the property rights, institutions, and competitiveness correct. Most policy-makers can work these out but cannot guarantee their implementation as good governance is often a black box.
Where does the Indian reform process stand? Most observers believe that correct policies are evolved along with the creation of a number of useful institutions including the new legal enactments. But it is in respect of governance, however, there is a general recognition of inadequacy, as so eloquently pointed out by the former Reserve Bank of India Governor, Dr Bimal Jalan, in his recent work.
Good governance and sound policy reforms would not be enough if the growth rate should go up and expand employment insofar as India is concerned. The experience of the developed countries since the 1970s shows up a need to get right the innovation system too. This is not adequately appreciated in India even in areas where the overall skill formation is recognised to be relatively high by international standards.
Private firms spend very little on R&D and are often content replicating what is available from outside, preferably from the West. Even in the area of information technology, there is little evidence of innovative breakthroughs, despite the large wage payments made to those employed in this sector.
Public expenditure on higher education are woefully short of the needs. Besides, there is callousness in the selection of professionals for conducting research or even for entry into higher education in public sector funded institutions.
What, then, are the implications? First, the seemingly high potential output level would stagnate, notwithstanding the sterile discussion on the rate of growth that the economy is capable of achieving. Second, in the absence of increase in productivity, the gap between the actual and the potential growth rates would continue to be high.
Third, the absence of technology shock would make it all the more difficult to expand employment opportunities and raise real wages. Finally, the divide between those employed in the New Economy and the other areas would widen giving rise to social conflicts over a period. The road ahead insofar as the emerging countries are concerned is, thus, difficult but has to be trodden by encouraging specialisation even as policy reforms are undertaken and governance is improved.
(The author, a former Executive Director of the Reserve Bank of India, can be accessed on firstname.lastname@example.org)
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