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The Ingredients of Growth
David W. Brady and Michael Spense

April, 2010

In recent decades, many economists have advised governments to stabilize, privatize, and liberalize markets. Economists do know how markets work, and they can often predict how mature market economies will respond to certain events and policies. But developing economies lack both mature markets and the institutions that support them—including institutions that define property rights, enforce contracts, convey prices, and bridge gaps between buyers and sellers. These are precisely the institutions that political leaders must establish and then modify as economic growth introduces new problems and opportunities.

The work of the Commission on Growth and Development tended to confirm that political leaders play pivotal roles in the success—and the failure—of economic development. As detailed in its publication The Growth Report, the commission closely examined 13 nations whose gross domestic product (GDP) grew at least 7 percent a year for at least 25 years after World War II. In other words, these economies at least doubled in size each decade.

Although these high-growth countries used different economic models and political structures and had different resources and histories, their governments followed broadly similar paths. Often ushered in by a crisis, new leadership chose a promising economic model and then stabilized the nation long enough to let the economic model take root. The leadership also began to create reliable and accountable institutions that kept politicians focused on citizens’ long-term well-being. As growth caused change and created new tensions, the leadership corrected the course of the nation by honing the economic model and tuning institutions to emerging needs while maintaining stability.

Rather than suggesting a single recipe for economic growth, our research reveals that there are different paths to development.1 In this article, we detail how this view plays out in three high-growth countries and eras: China from 1978 to 2005, Japan from 1950 to 1983, and Korea from 1960 to 2000. As the case of China shows, democracy is not a prerequisite for continuous and impressive growth, though some degree of economic freedom is. Meanwhile, Japan and Korea’s export-driven, dominant-party democracy follows a trajectory more typical of booming economies in Asia.

Our model further underscores the importance of government leaders in maintaining economic growth. Swiftly changing nations require leaders who adopt the policy or approach of careful experimentation. By avoiding sudden shifts in policy and balancing progress with caution, these leaders limit the damage of missteps. They “cross the river by feeling for the stones,” as the Chinese reformer Deng Xiaoping once recommended.

CRISES AND OPPORTUNITIES

In many of the 13 high-growth cases we studied—as well as in India and Vietnam, two countries that are well on their way to joining the ranks of high-growth nations—a crisis preceded economic expansion. One widespread crisis was dire poverty: The average per capita income of the 13 countries at the start of their growth was less than $1,000, and frequently closer to half that. Other crises were financial, or related to the balance of payments or external debt. Whether financial, social, political, or all three, these crises created conditions where leaders faced fewer constraints on their choices of economic models, their political machinations, and their institutional reforms.

In the wake of crises, many leaders fail to adopt a promising economic model, which is why most nations do not become high-growth economies. In contrast, the leaders who kick-started growth in our sample tended to converge on a similar set of practices. They shifted their economies to exporting products that met global demand while importing global knowledge and technology. They allowed competition. And they encouraged high levels of public- and private-sector investment and savings.

In the case of China, for instance, the crises leading up to dramatic growth included decades of low growth, policy-induced hunger and famine, and the turbulence associated with the Cultural Revolution. Deng, whom Mao Zedong had sent into exile during the Cultural Revolution, arrived in the midst of this deteriorating economic situation. Following Mao’s death in 1976, Deng returned to the upper echelons of China’s political hierarchy. As the country’s paramount leader—an unofficial position that nevertheless held great power—he inherited an economy in serious trouble. But there were important intangible assets created during the first 30 years after the Chinese Revolution of 1949: widespread basic education, the abolition of officially sanctioned caste and class distinctions, and some important rural infrastructure, including a strong tradition of family farming, which led the peasants to de-collectivize spontaneously from below, even before Deng came into power.

Building on these strengths, Deng and his fellow reformers introduced a successful three-step development plan that included market mechanisms in the agricultural sector, importation of knowledge and technology from the global economy, liberalization of trade and investment, various forms of quasi-private ownership, and reforms in education, science, and technology. His new, so-called Wenzhou model (of local economies formed mainly by private businesses) lived side by side with state-owned enterprises or, in the words of Deng, “one country, two systems.”

Japan likewise chose a high-growth export model, albeit under very different circumstances. Devastated by losses of population, resources, and pride following World War II, the nation faced starvation in its cities, rampant inflation, currency devaluation, and the halt of industrial production.

Following World War II, the U.S. occupation of Japan resulted in the choice of an open-economy growth strategy that leveraged both global demand and knowledge. Under the United States’ influence, Japan instituted a democratic form of government, albeit one dominated by a single party, the Liberal Democratic Party (LDP). Working closely with a competent bureaucracy and business leaders, the LDP consistently made decisions that promoted growth. These decisions included creating institutions characterized by rule of law, predictability, and incentives to keep politicians focused on citizens’ long-term well-being.

The Korean case roughly follows the Japanese model. In 1961, South Korea had not recovered from the effects of the Korean War and was a poor agricultural country still under martial law, because of the North Korean threat. That same year, President Park Chung Hee chose to follow a variant of the Japanese model by using the government to create an open economy growth strategy. The Koreans were less successful in creating a single dominant party that was consistently electable. They did, however, create competitive corporations, a competent bureaucracy, and an educational system capable of teaching how export economies and their necessary institutions worked.

In these three cases, leaders not only chose the right economic models in the midst of considerable turmoil, they also managed not to choose the wrong models. Leadership, then, appears to matter. Yet until recently, social scientists were not able to demonstrate this seemingly obvious fact. That is because history makes it difficult to disentangle whether a leader really caused change or he just happened to be at the helm of the ship of state when growth took off.

In a recent study, though, economists Benjamin F. Jones of Northwestern University’s Kellogg School of Management and Benjamin A. Olken of the Massachusetts Institute of Technology took advantage of history to examine what happens to economies when leaders suddenly die, resign, or are deposed.2 Across 57 cases of abrupt leadership change, all occurring after World War II, the researchers found that the transition of national leaders indeed affected economic growth. The effects were strongest (both positive and negative) in autocratic settings such as China and Iran, where one or a few leaders had centralized authority.

In democratic settings, however, the change of leaders did not have a statistically significant effect on growth. This may be because the lags between leadership changes and policy shifts are longer in democracies. For example, the reforms that India began in the late 1980s are only now beginning to fuel high growth. Future research will have to determine the validity of the widespread hunch that leaders direct growth in democracies, just as they do in autocracies.

STABILITY

To read more of this article please go to  http://www.ssireview.org/articles/entry/the_ingredients_of_growth/



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