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«Growth Strategies and Dynamics: Insights from Country Experiences Mohamed A. El-Erian Michael Spence WORKING PAPER NO. 6 Growth Strategies and ...»

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Growth Strategies and

Dynamics: Insights from

Country Experiences

Mohamed A. El-Erian

Michael Spence


Growth Strategies and Dynamics

Insights from Country Experiences

Mohamed A. El-Erian

Michael Spence

© 2008 NTC Economic & Financial Publishing. All rights reserved. First published in World

Economics (www.world-economics-journal.com), vol. 9, no. 1.

Published by The International Bank for Reconstruction and Development / The World Bank on behalf of the Commission on Growth and Development 1818 H Street NW Washington, DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org www.growthcommission.org E-mail: info@worldbank.org contactinfo@growthcommission.org

The Commission on Growth and Development is sponsored by the following organizations:

Australian Agency for International Development (AusAID) Dutch Ministry of Foreign Affairs Swedish International Development Cooperation Agency (SIDA) U.K. Department of International Development (DFID) The William and Flora Hewlett Foundation The World Bank Group The findings, interpretations, and conclusions expressed herein do not necessarily reflect the views of the sponsoring organizations or the governments they represent.

The sponsoring organizations do not guarantee the accuracy of the data included in this work.

The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of the sponsoring organizations concerning the legal status of any territory or the endorsement or acceptance of such boundaries.

All queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, The World Bank, 1818 H Street NW, Washington, DC 20433, USA;

fax: 202-522-2422; e-mail: pubrights@worldbank.org.

Cover design: Naylor Design About the Series The Commission on Growth and Development led by Nobel Laureate Mike Spence was established in April 2006 as a response to two insights. First, poverty cannot be reduced in isolation from economic growth—an observation that has been overlooked in the thinking and strategies of many practitioners. Second, there is growing awareness that knowledge about economic growth is much less definitive than commonly thought. Consequently, the Commission’s mandate is to “take stock of the state of theoretical and empirical knowledge on economic growth with a view to drawing implications for policy for the current and next generation of policy makers.” To help explore the state of knowledge, the Commission invited leading academics and policy makers from developing and industrialized countries to explore and discuss economic issues it thought relevant for growth and development, including controversial ideas. Thematic papers assessed knowledge in areas such as monetary and fiscal policies, climate change, and equity and growth and highlighted ongoing debates. Additionally, 25 country case studies were commissioned to explore the dynamics of growth and change in the context of specific countries.

Working papers in this series were presented and reviewed at Commission workshops, which were held in 2007–08 in Washington, D.C., New York City, and New Haven, Connecticut. Each paper benefited from comments by workshop participants, including academics, policy makers, development practitioners, representatives of bilateral and multilateral institutions, and Commission members.

The working papers, and all thematic papers and case studies written as contributions to the work of the Commission, were made possible by support from the Australian Agency for International Development (AusAID), the Dutch Ministry of Foreign Affairs, the Swedish International Development Cooperation Agency (SIDA), the U.K. Department of International Development (DFID), the William and Flora Hewlett Foundation, and the World Bank Group.

The working paper series was produced under the general guidance of Mike Spence and Danny Leipziger, Chair and Vice Chair of the Commission, and the Commission's Secretariat, which is based in the Poverty Reduction and Economic Management Network of the World Bank. Papers in this series represent the independent view of the authors.

Growth Strategies and Dynamics: Insights from Country Experiences iii Acknowledgments We would like to acknowledge the extensive comments from Edwin Lim and Roberto Zagha, and to thank the numerous participants in the workshops of the Commission on Growth and Development (CGD).

iv Mohamed A. El-Erian and Michael Spence Abstract The paper examines the challenges that developing countries face in accelerating and sustaining growth. The cases of China and India are examined to illustrate a more general phenomenon which might be called model uncertainty. As a developing economy grows, its market and regulatory institutions change and their capabilities increase. As a result, growth strategies and policies and the role of government shift. Further, as the models of economies in these transitional states are incomplete and because models used to predict policy impacts in advanced economies may not provided accurate predictions in the developing economy case, growth strategies and policies need to be responsive and to evolve as the economy matures. This has lead governments in countries that have sustained high growth to be somewhat pragmatic, to treat the policy directions that emerge from the advanced economy model with circumspection, to be somewhat experimental in seeking to accelerate export diversification, to be sensitive to risks, and as a result to proceed gradually in areas such as the timing and sequencing of opening up on the current and capital accounts. The last is an area in which existing theory provides relatively little specific guidance, but in which there are relatively high risks that decline over time as the market matures.

Growth Strategies and Dynamics: Insights from Country Experiences v Contents About the Series



1. Introduction

2. Why Growth Challenges Can Be Easily Misunderstood

3. Salient Characteristics of China’s and India’s Growth Processes

4. Growth Strategies and Specific Policy Challenges

5. Learning Process in Development

6. Why Other Countries Should Notice: Learning without Overgeneralization.26

7. Effectiveness of Cross-Border Conveyors of Best Practices or Why the International Institutions Should Also Notice

8. Encouraging and Accommodating Higher Growth in the Global Economy...31

–  –  –

1. Introduction Designing and implementing strategies for growth in a developing economy is an important and difficult challenge. Most developing countries have legitimate high aspirations with respect to growth and poverty reduction. Indeed, it constitutes an important economic, political, and social challenge.2 Yet in the period following World War II, only 12 countries have achieved sustained high growth, that is, average annual rates of growth of 7 percent or above over a period of two and a half decades or more. A decade of 7 percent growth produces a doubling of income and in all the known cases, leads to a dramatic reduction in poverty. The majority of the developing world has until recently not grown significantly on a sustained basis or in the case of many countries in Latin America, have stalled in the middle-income category with large fractions of their citizens remaining poor.

The aim of this paper is to contribute to the understanding of what works best in terms of encouraging sustainable and inclusive growth, and why. In the process, we also highlight what does not work well. To do so, we draw on country experiences, focusing in particular on China and, to a lesser extent, India.

We argue that successful growth strategies require clarity about the objective, realism about the underlying model, and sociopolitical buy-in. The strategies involve a dynamic mindset that addresses the inevitable uncertainties and risks through an iterative process. And they need policy reaction functions that can readily respond to the “challenges of success,” particularly as they pertain to internal and external financial matters.

1 Mohamed A. El-Erian is Co-CEO and Co-CIO of PIMCO, the global investment management company. He was formerly President and CEO of the Harvard Management Company and a member of the faculty of the Harvard Business School. Michael Spence is Senior Fellow at the Hoover Institution and Philip H. Knight Professor Emeritus of Management in the Graduate School of Business at Stanford University. In 2001, he was awarded the Nobel Memorial Prize in Economic Sciences. Michael Spence is the Commission on Growth and Development Chair.

2 The political challenge includes the task of building a consensus behind a strategy or set of policies that lead to growth and poverty reduction, where the benefits come in the future, there are sacrifices in the short run, and investment displaces consumption. The nature of this challenge varies from country to country because of different forms of political organization, governance, and traditions. Although the political and consensus building challenges are not the main subject of this paper, they are important dimensions of development and they interact with the ability to produce coherence in the strategies and packages of policies designed to produce inclusive growth (inclusive in this case refers to growth benefits being broadly shared by the citizens over time).

Growth Strategies and Dynamics: Insights from Country Experiences 1 We know that sustained high growth is possible. The 12 sustained highgrowth cases referred to above all occurred in the postwar period. Of these, six saw their countries grow from very low income levels all the way to advanced country income levels today. There are of course significant differences across countries and over time within a country in policies, the role of government, and the state of market and regulatory institutions, for reasons we will discuss later.

Having said that, there are also some interesting common features of the growth dynamics of these economies. These are not policies per se but ingredients in

recipes that generate growth, and include the following::

1. Reliance on the market system for resource allocation (price signals, incentives, decentralization, and enough clarity of definition of property ownership to facilitate transactions and investment).3

2. A commitment to and intense focus on sustained growth and a government that acts in a manner that is representative of the interests of the citizens of the country. Persistence and determination are key ingredients as the process takes decades and involves inevitable bumps along the way. It is a multi-decade endeavor, somewhat akin to a long voyage (unique to each country in some respects), inevitably undertaken with incomplete and sometimes inaccurate charts and requiring midcourse adjustments, especially as the structure of the economy and the appropriate supporting policies shift significantly over time.

3. Effective governance and leadership in building consensus behind policies designed to produce intertemporal improvements in the lives of citizens by choosing the right models and strategies for growth.

4. Competent management of the macroeconomic environment in such a way as to promote domestic and foreign investment, including control of inflation and avoidance of policies that lead to damaging periods of very high inflation followed by growth-slowing policies needed to bring inflation down.

5. High levels of saving and investment, especially public and private sector investment (in physical and social infrastructure, education, and health).

6. Resource mobility, particularly labor mobility, combined with rapid creation of new productive employment and rapid movement of people Reliance on market mechanisms does entail the requirement that market institutions are fully developed. In fact it is normally quite the opposite: in many cases, the maturation and deepening of market institutions and related government regulatory processes is an important part of the development process. It is a common part of the process that the government’s role evolves as the private sector market institutions develop and mature. This is clearly evident in China, which began the reform process from a centrally planned economy starting point.

2 Mohamed A. El-Erian and Michael Spence from rural to urban centers. The result is rapid diversification and structural transformation of the economy.

7. Leveraging the global economy to accelerate growth. This is the most important point of commonality and has two components: inbound transfer of knowledge and technology, and drawing on global demand to complement domestic components. The former rapidly increases the potential output of the economy, the latter permits much more rapid growth with exports as the driving force.4 At one level then, the challenge of sustained growth is to set in motion reforms, investments, and adaptive processes that in conjunction with the domestic and foreign private sectors lead to these kinds of dynamics. But the challenge is considerable. Were it not so, the list of sustained high-growth cases would be longer.

Against this background, the objective of this paper is to address some of the complexities in formulating strategies and policies for accelerating and sustaining high growth. It also considers related issues associated with governance of the global economy and the relation between developing and industrialized countries.

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