Skill or luck: what matters more in the economic destiny of nations?
This is a question worth asking in a week when the new United Progressive Alliance government begins its work. There are divided opinions in the immediate Indian context. On the one hand are those who have high expectations that the Manmohan Singh government will use its expertise to ensure that the economy performs as well as it did between 2004 and 2008. On the other hand, there are others who believe that the awesome growth record during that period was an accidental benefit from the global economic boom fed by cheap money.
There are interesting parallels in the financial markets. Many had believed a certain class of investors and fund managers were blessed with extraordinary skills that helped them earn millions in recent years. The reality turned out to be more pedestrian: High returns were merely a result of an asset bubble, and those who beat their peers did so not through skill but by taking more risks.
And what about economic development? Does the same stark truth hold? Do some countries succeed more because of luck rather than the skill of their respective governments?
A commission staffed by some of the world’s finest academic and policy economists said in its report released in May 2008 that sustained high performance is a rarity. Since 1945, only 13 countries have managed to grow their economies at 7% or more for more than 25 years and longer: Botswana, Brazil, China, Hong Kong, Indonesia, Japan, South Korea, Malaysia, Malta, Oman, Singapore, Taiwan and Thailand. That’s it.
The usual thing to do is to look at success stories and see what lessons one can learn from them. But there are two problems here. One, the lessons keep changing. Indian policymakers were fascinated by the apparent success of the Soviet economy in the 1930s, and tried to follow at least those elements in it that did not violate democratic principles. Then there was the dalliance with import substitution and state-directed industrial investment in the 1950s and 1960s, following what then looked like economic miracles in Latin American countries such as Brazil and Argentina.
Well, the Soviet economy eventually imploded, while Latin America stumbled from crisis to crisis after the early 1980s. But by then, new models worth emulating emerged, first in East Asia and then in China.
The second problem is more technical. In a recent blog post, development economist Bill Easterly said that Dani Rodrik, another fine development economist, was confused about conditional probabilities. Rodrik believes poor countries need explicit industrial policies directed by governments to achieve fast growth, and often points to the success of countries such as South Korea as proof.
“Unfortunately, Dani is also reversing conditional probabilities. Dani’s evidence is based on what he believes is the high probability that if you have had steady growth for six decades, then you had industrial policy. This is interesting, but this is not the right probability in deciding whether to choose industrial policy, which is ‘if you have industrial policy, then what is your chance of steady growth for six decades?’
“This second, correct probability would seem to be pretty low, since many other countries—especially African and Latin American—extensively tried industrial policies over the past six decades with low and erratic growth as a result,” Easterly wrote.
But both Easterly and Rodrik seem to believe that government policy has a role to play in keeping economies on the fast track. Their disagreement is on what the nature of that policy is.
There are enough disagreements among economists and policy experts on what allows a country to escape the trap of poverty through sustained economic growth. It would not be an exaggeration to say that we know little about what does the trick, except a few basic principles: open trade, strong institutions, property rights, market exchange, low inflation, public investment in education, health and so on.
In a 2005 speech at the World Bank, an institution that is usually pretty sure it knows what countries should really be doing with their economies, Princeton economist Avinash Dixit lobbed a rhetorical hand grenade at policy certitudes: “Faced with all these contradictions and shifts, I can identify only one consistent policy prescription. It is the quality Napoleon valued most in his generals, namely luck. Researchers want to identify causes, and practitioners want to know what they can choose or change; therefore, both sides may have neglected the important role that luck has played in many countries’ development successes or failures.”
This does not mean that sensible policies and economic reforms are not essential. It merely means that both policymakers and commentators have to be more modest and less certain about specific policy prescriptions.
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