Dani Rodrik's weblog

Zoellick wants to remake development economics

World Bank president Bob Zoellick gave an interesting speech today at Georgetown. I wasn't there, but have seen his prepared remarks, which I find both forthright and courageous. 

From my perspective, the speech hits all the right notes: the need for economists to demonstrate humility, eschew blueprints, search for differentiated solutions suited to context, learn from the actual policies of successful emerging economies, focus on evaluation but not at the expense of the big questions.

Zoellick, admittedly not an economist himself, goes further and takes on the economics profession. He has many valid points.  He wades in on some of the key debates in the profession and doesn’t mince his words.  Particularly telling are his surprisingly frank criticism of the current fad with randomized evaluations, which he decries as being too narrow and too unconcerned with scalability, and his open-mindedness towards policies that promote industry through various forms of incentives.  

The main theme of his speech is “democratizing development economics.” I like this as a slogan, but fear that it may end up another gimmick.  Zoellick offers no new ideas on the governance and internal organization of the Bank. And without changes in these, the bulk of the Bank’s research will continue to be done in Washington, DC by economists from advanced nations.

A manual for growth diagnostics

My colleague Ricardo Hausmann along with two co-authors (Bailey Klinger and Rodrigo Warner) have just put up an interesting essay on the practice of growth diagnostics (GD).  Ricardo calls this a "mindbook"--i.e. a manual on getting your mind around GD.  It is chock-full of illustrative examples, and also discusses some common misunderstandings.

Here is the kind of insight you will get from the piece:

Suppose you were asking: what is the binding constraint to animals thriving in the Sahara desert? This is not unlike the question of what limits economic growth in a country. However, in the Sahara, it is instructive to note that of those few animals that do thrive in that environment, a very large proportion are camels and a very small proportion are hippopotamus. The fact that the animals most intensive in the use of water, hippopotamus, are scarce while the animals least intensive in the use of water, camels, are thriving suggests that the supply of water may be a binding constraint to the spread of animals in the Sahara.

In general, the idea is that looking at the nature of the most successful parts of the economy can be informative of the constraints that affect others. We would expect to observe that those who are either structurally less intensive in the constrained factor, or at least more able to bypass it, will be doing comparatively well. Conversely, those sectors most intensive in the constraint will be doing relatively poorly.

A very simple principle, but it can be surprisingly powerful in practice.  For example, it suggests that asking successful firms what are the main problems they face--a very common strategy both in business consulting and in country analysis--is not only uninformative about the binding constraints of the economy, it may lead the analyst precisely in the wrong direction.  After all, successful firms are successful (relative to other firms) because they have been able to surmount the binding constraints.  So they are least likely to complain about the blockages that are holding the rest of the economy back.   

A Washington Consensus I can live with

My newest column for Project Syndicate discusses the Spence Commission report on growth, and places it in the context of a new intellectual climate which, I argue, departs significantly from the strictures of the old Washington Consensus.

The Spence report represents a watershed for development policy — as much for what it says as for what it leaves out. Gone are confident assertions about the virtues of liberalisation, deregulation, privatisation, and free markets. Also gone are the cookie cutter policy recommendations unaffected by contextual differences. Instead, the Spence report adopts an approach that recognises the limits of what we know, emphasises pragmatism and gradualism, and encourages governments to be experimental.

Yes, successful economies have many things in common: they all engage in the global economy, maintain macroeconomic stability, stimulate saving and investment, provide market-oriented incentives, and are reasonably well governed. It is useful to keep an eye on these commonalities, because they frame the conduct of appropriate economic policies. Saying that context matters does not mean that anything goes. But there is no universal rulebook; different countries achieve these ends differently.

The Spence report reflects a broader intellectual shift within the development profession, a shift that encompasses not just growth strategies but also health, education, and other social policies. The traditional policy framework, which the new thinking is gradually replacing, is presumptive rather than diagnostic .

It starts with strong preconceptions about the nature of the problem: too much (or too little) government regulation, too poor governance, too little public spending on health and education, and so on. Moreover, its recommendations take the form of the proverbial "laundry list" of reforms, and emphasise their complementary nature — the imperative to undertake them all simultaneously — rather than their sequencing and prioritisation. And it is biased toward universal recipes — "model" institutional arrangements, "best practices," rules of thumb, and so forth.

By contrast, the new policy mindset starts with relative agnosticism about what works. Its hypothesis is that there is a great deal of "slack" in poor countries, so simple changes can make a big difference. As a result, it is explicitly diagnostic and focuses on the most significant economic bottlenecks and constraints. Rather than comprehensive reform, it emphasises policy experimentation and relatively narrowly targeted initiatives in order to discover local solutions, and it calls for monitoring and evaluation in order to learn which experiments work.

The new approach is suspicious of universal remedies. Instead, it searches for policy innovations that provide a shortcut around local economic or political complications. This approach is greatly influenced by China's experimental gradualism since 1978 — the most spectacular episode of economic growth and poverty reduction the world has ever seen.

... 

It is to Spence's credit that the report manages to avoid both market fundamentalism and institutional fundamentalism. Rather than offering facile answers such as "just let markets work" or "just get governance right," it rightly emphasises that each country must devise its own mix of remedies. Foreign economists and aid agencies can supply some of the ingredients, but only the country itself can provide the recipe.

If there is a new Washington consensus, it is that the rulebook must be written at home, not in Washington. And that is real progress.

Re-uniting development economics

Development economics is split between macro- and micro-development economists.  The former focus on economic growth and tend to analyze economy-wide policies such as trade, fiscal, and currency policies.  Think Anne Krueger, Jeff Sachs, Bill Easterly, Paul Collier.  The latter focus on individual-level outcomes and analyze microfinance, education, health and other social policies. Think Angus Deaton, Mark Rosenzweig, Michael Kremer, or Esther Duflo. The first group relies on cross-country econometrics or analytical country studies.  The second relies increasingly on randomized field experiments.  Ostensibly, both groups share the same objective: achieving sustainable improvement in standards of living of the poor.  But the way they go about it seems so different as to make them look like members of entirely different disciplines. 

My latest paper argues that there is both good and bad news on this front:

The good news is that there is substantial convergence in the policy mindset exhibited by micro evaluation enthusiasts, on the one hand, and growth diagnosticians, on the other. The emerging “consensus” revolves not around a specific list of policies, but around how one does development policy. In fact, practitioners of this “new” development economics—whether of the “macro” type or “micro” type—tend to be suspicious of claims to ex ante knowledge about what works and what does not work. The answer is neither the Washington Consensus nor any specific set of initiatives in health or education. What is required instead is recognition of the contextual nature of policy solutions. Relative ignorance calls for an approach that is explicitly experimental, and which is carried out using the tools of diagnostics and evaluation. Old dichotomies between states and markets play little role in this worldview and pragmatism reigns. The proof of the pudding is in the eating: if something works, it is worth doing.

This convergence has remained largely hidden from view, because the analytical and empirical tools used by economists at the macro and micro end of things—growth economists versus social policy economists—tend to be quite different. But I will make the case that there is indeed such a convergence, that it is a significant departure from the approaches that dominated thinking about development policy until a decade or so ago, and that it represents a significant advance over the previous generation of research.

The bad news is that there has been an accentuation of the methodological divergence between macro-development economists and micro-development economists, which threatens to overshadow the convergence on policy. In particular, the randomized field trials revolution led by researchers in and around the MIT Poverty Action Lab (Banerjee 2007, Duflo 2006, Duflo, Glennerster, and Kremer 2006) has greatly enriched the micro end of the field, while creating bigger barriers between the two camps. This is not just because randomization is rarely possible with the policies—such as trade, monetary, and fiscal—that macro-development economists study. More importantly, it is because of the raising of the stakes with regard to what counts as “admissible” evidence in development. The “randomistas” (as Deaton [2007] has called them) tend to think that credible evidence can be generated only with randomized field trials (or when nature cooperates by providing the opportunity of a “natural” experiment)....

In fact, the micro experimentalists tend to overstate how much we learn from randomized trials and underestimate how much we learn from other types of evidence.

The question we need to pose of any piece of research is the Bayesian one: does the finding change our priors on the question we are interested in? Randomized evaluations do pretty well when they are targeted closely at the policy change under consideration, but less so when they require considerable extrapolation. In the latter case, evidence from randomized field experiments need not be more informative than other types of evidence which may have less airtight causal identification but are stronger on external validity (because of broader geographical or temporal coverage). In practice internal validity—just like external validity—is not an either-or matter; some studies do better than others on this score than others, and deserve more of our attention on that account. But this preference has to be tempered with a consideration also of external validity. The bottom line is that randomized evaluations do not deserve monopoly rights—or even necessarily pride of place—in moving our priors on most of the important questions in development economics.

But the paper is not meant to be a critique of randomized evaluations, which have greatly enriched our empirical toolkit.  It is instead a plea for not letting prevailing methodological differences overshadow the larger convergence. My purpose is to get macro-development economists and micro-development economists to see that they have much more in common than they realize.

Case in point: the greatest development success of our time, China.  As I review and document in my paper, the experimentalist mind set was deeply ingrained in China’s approach to reform. Some of the experiments that proved extremely successful were: the household responsibility system, dual-track pricing, township-and-village enterprises, and special economic zones.  Of course, the informal evaluations to which these experiments got subjected would not satisfy the standards of the MIT Poverty Action Lab. “Seeing whether something works” is hardly as rigorous as randomized evaluations. But it would be silly to claim that Chinese policy makers did not learn something from their experiments. 

The China example is important because it illustrates, in a vastly significant real-world instance, how the experimental approach to policy reform need not remain limited in scope and can extend into the domain of national policies. China, of course, is a special case in many ways. The point is not that all countries can adopt the specific type of experimentation ... that China has used to such great effect. But the mindset exhibited in China’s reform process is general and transferable—and it differs greatly from the mindset behind the presumptive strategies outlined above. It is perfectly illustrative of the potential convergence between the ideas of micro-development economists and macro-development economists. One would hope that the response of micro experimentalists to China’s experimentalism is not to say “but this is worthless, none of the experiments were evaluated rigorously through randomization,” but to say instead: “great, here is how our ideas can make the world a better place not just one school or health district at a time.”

So my bottom line is that the practice of development economics is at the cusp of a significant opportunity. We have the prospect not only of a re-unification of the field, long divided between macro- and micro-development economists, but also of a progression from presumptive approaches with ready-made universal recipes to diagnostic, contextual approaches based on experimentation and policy innovation. If carried to fruition, this transformation would represent an important advance in how development policy is carried out.

But we need more work. Macro-development economists will have to recognize more explicitly the distinct advantages of the experimental approach and a greater number among them will have to adopt the policy mindset of the randomized evaluation enthusiasts. As the Chinese example illustrates, extending the experimental mindset to the domain of economy-wide reforms is not just possible, it has already been practiced with resounding success in the most important development experience of our generation. Micro-development economists, for their part, will have to recognize that one can learn from diverse types of evidence, and that while randomized evaluations are a tremendously useful addition to the empirical toolkit, the utility of the evidence they yield is restricted by the narrow and limited scope of their application.

In the end, macro-development economists have to be humbler about what they already know, and micro-development economists humbler about what they can learn.

Does import substitution deserve its unsavory reputation?

It's hard to see why it does, in view of the numbers here. They reveal that import substituting industrialization (ISI) had a more-than-respectable productivity record. 

But there are two other objections that often surface in relation to ISI--and which were raised in the discussion that followed my earlier post. One is that ISI has an easy early stage, and then gets bogged down in its difficult later stage. The other is that the debt crises that Latin American and other countries succumbed to in the 1980s were the consequence of ISI. The first argument may be right, but is largely irrelevant. The second is almost surely wrong.

The "easy ISI" hypothesis has never been precisely formulated, as far as I know. I think I know that it can be done, but I strongly suspect that it would be a highly contingent argument rather than a general one. The typical formulations in terms of the ease of producing the first generation of light manufactures versus the difficulty of more sophisticated products is not very satisfactory, when one bears in mind the learning that takes place along the way. But the more telling point, in fact, is that countries like Brazil and Colombia were already pulling out of inward-looking regimes by the 1970s. So ISI was not just a static set of incentives. Countries did not necessarily get bogged down in some easy early stage.   

With regard to the debt crisis, the argument that gives ISI a causal role mixes up microeconomics with macroeconomics. ISI is about "distorting" relative prices and the sectoral allocation of production and investment. The debt crises were about mismanaging the relationship between aggregate expenditures and incomes. You can have as distorted a structure of relative prices as you want, but still run balanced budgets and zero current account deficits. Conversely, you can be extremely outward-oriented and have free-trade regimes, but still face currency and debt crises if your macro and exchange-rate policies encourage over-spending. (If this were a classroom, I would ask my students to fill the implied 2x2 matrix with real world country examples.)

Latin American countries ran into the debt crisis because they had expansionary fiscal policies and/or overvalued currencies, not because they had high trade barriers or directed credit. Incidentally, the country with the most overvalued currency of them all was Pinochet's free trading Chile. And Chile experienced the deepest collapse in the entire region in 1982-83 when capital inflows stopped. Its liberal economy and low trade barriers did not protect it.

But some myths die hard.

Industrial policy as picking stocks?

The most sophisticated critique that I have heard of industrial policy comes from Larry Summers, and it goes something like this. Think of industrial policy like picking stocks. Just because there are some investors who are really good at spotting opportunities and making money by beating the market, it doesn't mean that all of us should try to do the same. The vast majority of investors are better off holding a diversified portfolio and not playing the game.

Similarly, just because South Korea, Taiwan, and a few others have been successful with industrial policy, it doesn't mean other countries should emulate them. Most countries are better off staying away from trying to "pick winners."

I like this criticism because at least it grants that countries in East Asia have been successful with industrial policy. There are still people who think East Asia would have grown faster if they had not employed industrial policies.

But I have always felt that the analogy is misleading because it presumes there is the equivalent of a "diversified-portfolio" strategy for developing countries which delivers, if not East Asian growth, at least satisfactory growth. I don't know what such a strategy looks like, and I cannot find it in the evidence.

Consider the productivity growth numbers Bosworth and Collins have generated for different regions of the world by decades. 

 

	Total factor productivity growth by decade (%)
Region	1960-1970	1970-1980	1980-1990	1990-2000
East Asia (excluding China )	1.5	0.9	1.3	0.5
Latin America	1.6	1.1	-2.3	0.4
South Asia	0.7	-0.2	2.2	1.2
Africa	1.9	-0.3	-1.4	-0.5
Middle East	2.6	-0.6	0.1	0.0

 

These numbers are striking if you have been brought up thinking that import substitution and infant-industry protection were unmitigated disasters. It turns out that protectionist Latin America beat out East Asia in productivity growth during the 1960s and 1970s. Perhaps more tellingly, when Latin America adopted free trade and hands-off policies, its productivity growth performance never recovered to pre-1980 levels. (Some of you will wonder if the debt crisis and the debacle of the 1980s were not the result of import-substitution? In a word, the answer is no.) The performance of Africa and the Middle East during the 1960s is quite strong too.

So I am not sure the Summers analogy works. Developing country governments may not be the greatest stock pickers, but it looks like the alternative is more like handing your portfolio over to Nick Leeson.

Asian growth versus African growth

Here is a chart that has got me thinking. It shows the relationship between currency undervaluation and growth spurts in two sets of economies: those in Asia, and those in Africa. Basically, it depicts the "typical" (average) trend in under- or over-valuation in the ten years preceding and ten years following the onset of growth accelerations in the two regions. (See here for how growth accelerations are defined and their timing determined.)

Notice the difference?

In Asia, growth accelerations are preceded by a period of sustained increase in undervaluation, which is maintained during the period of high-growth. In Africa, by contrast, growth accelerations are preceded by growing overvaluation; the currency always remains in the overvalued zone (= negative undervaluation).

Here is the simplest explanation. In Asia, growth is typically engineered by increasing the profitability in manufacturing and other tradables. But in Africa the typical growth spurt is preceded by aid inflows and other transfers, which appreciate the exchange rate, and render future growth less sustainable. This is the so-called Dutch disease.

Africa has been having a good few years recently. To my mind, the key question with regard to sustainability of growth has to do precisely with the real exchange rate: is the real exchange under- or overvalued, and has it been appreciating or depreciating?

UPDATE: Luis Enrique is smart! (See comments below.)

Economic development strategy as a Toyota Production System

I have been spending some time in South Africa, along with my collaborators Chuck Sabel and Ricardo Hausmann, doing research on industrial policy. We are advising the government on its growth strategy, and this part of our work focuses on generating ideas for policies to stimulate structural transformation in the economy towards higher-productivity tradable activities. So I have been spending my time doing rounds in government offices and talking to firms and entrepreneurs.

On Thursday, our group spent the day with Toyota and one of its local suppliers. This is my second visit to Toyota here, and once again I am awed by the famous Toyota production system (TPS) with its on-going monitoring of output processes, feedback loops, and continuous improvement.

Chuck Sabel has been telling me for some time that our Growth Diagnostic framework is nothing other than the application of TPS principles to the design of economic growth strategies for countries as a whole. Listening to Toyota trainers, the point really hit home this time around. Toyota training manuals make clear how TPS differs from conventional "Western" modes of organizing a manufacturing operation. The former is based on experimentation, gradual but continuous change, identification of bottlenecks, self-correction, group approaches, small investments at the outset but continuous attention and effort. This is to be contrasted to the Western mode, based on top-to-bottom direction, big leaps, large investments, and over-reliance on technology. Not a bad way to describe the difference between the Growth Diagnostics framework, on the one hand, and approaches such as the Washington Consensus or the Millennium Development Project, on the other.

A Rorschach test for economists, with update

I was visited today by a cabinet minister from a medium-sized, middle income country (which shall remain nameless for the purposes of this post). He explained that, among other challenges, he faces the task of attracting foreign investors to his country. He related the story of how he has just induced a large IT multinational to make a big investment by providing it rent-free space for 10 years on a public site. In view of the subsidy, he had to bring the finance minister on board. But he said that had not been a problem. The finance minister was happy to approve the benefit.

When you hear this story, which one of these two responses comes closer to how you feel about it:

A. Great! Another government gleefully wasting the public's money.  When will those developing countries learn that you do not get ahead by distorting market forces. If the multinational needed a subsidy to be persuaded to come in, the social value it produces must be less than the social cost of the resources it will gobble up. Plus in this instance, the subsidy goes straight to foreigners.

B. How wonderful! For once a finance minister who understands that sometime you may need to grease the wheels of market forces to get you the kind of investments that you need. It may cost the budget money, but these kinds of things are the tonic on which growth depends. Economic development requires structural change, which market forces do not adequately reward. If this enables the country to set up a new IT hub, the policy will achieve its purpose.

Think about that one for a while.

And then see if the following piece of information changes your mind. The minister told me that he had looked at the pros and cons of giving the multinational the subsidy, and in the end he had figured that the likely increase in property values from the multinational's presence--and the extra taxes that would bring in--made the subsidy a good deal for the government. Now which one of these positions do you take:

A. Yeah right. I bet this argument was fed to the minister by the firm itself. Probably on the back of a napkin with some kind of graph...

B.  Well, entirely possible. Sometimes you do need a pioneer investor to get things started. Many industries in the developing world have been spawned from initial investments like this one--often made on a non-commercial basis.

And finally, suppose now you are told that the country in question is one that has averaged 4 percent growth on average (in per-capita terms) for the last 4 decades. Which would be your response?

A. Well clearly they would have grown even faster without policies of this kind.

B. I knew it!

So, what kind of economist are you? A Type-A one or a Type-B one?

UPDATE: OK, seeing the range of views reflected in the responses below has been quite useful, I think. And I do apologize for presenting such a simplistic, A-or-B kind of picture, when pretty much everything I write calls for nuanced, context-specific responses.  The reason I presented this choice is that I find many economists go instinctively for the A-position--something that is fully borne out in the responses below. In reality, and (I emphasize) sometimes, the B-position is the one that really pushes an economy go forward For my own views on these issues I am afraid I have to refer the interested reader to lengthier accounts. See this and this.

Easterly takes on ... everyone, updated

Bill Easterly has trouble not just with foreign aid; apparently the problem is with the whole idea of "development" itself. His most recent article in Foreign Policy magazine starts ominously:

A dark ideological specter is haunting the world. It is almost as deadly as the tired ideologies of the last century — communism, fascism, and socialism — that failed so miserably. It feeds some of the most dangerous trends of our time, including religious fundamentalism. It is the half-century-old ideology of Developmentalism. And it is thriving.

Like all ideologies, Development promises a comprehensive final answer to all of society’s problems, from poverty and illiteracy to violence and despotic rulers. It shares the common ideological characteristic of suggesting there is only one correct answer, and it tolerates little dissent.

Hmm. I have to say I'm confused. I am sympathetic to many of Easterly's ideas--his skepticism on foreign aid (although not quite to the same extent) and his view that development happens because of "searchers" rather than planners. But surely now he is painting with too broad a brush here. There are many of us who believe in development--I wouldn't mind being called a "developmentalist"--but who do not see this as ideological attachment to a "single right path."  The idea that what we do is dangerous, deadly, and feeds off religious fundamentalism is bizarre. 

I am truly puzzled by what Easterly is trying to achieve with this article. Consider the following passage:

Development also shares another Marxist trait: It aspires to be scientific. Finding the one correct solution to poverty is seen as a scientific problem to be solved by the experts. They are always sure they know the answer, vehemently reject disagreement, and then later change their answers. In psychiatry, this is known as Borderline Personality Disorder. For the Development Experts, it’s a way of life. The answer at first was aid-financed investment and industrialization in poor countries, then it was market-oriented government policy reform, then it was fixing institutional problems such as corruption, then it was globalization, then it was the Poverty Reduction Strategy to achieve the Millennium Development Goals.

One reason the answers keep changing is because, in reality, high-growth countries follow a bewildering variety of paths to development, and the countries with high growth rates are constantly changing from decade to decade. Who could be more different than successful developers such as China and Chile, Botswana and Singapore, Taiwan and Turkey, or Hong Kong and Vietnam? What about the many countries who tried to emulate these rising stars and failed? What about the former stars who have fallen on hard times, like the Ivory Coast, which was one of the fastest developers of the 1960s and 1970s, only to become mired in a civil war? What about Mexico, which saw rapid growth until 1980 and has had slow growth ever since, despite embracing the experts’ reforms?

I agree with everything in the second paragraph. But I disagree strongly that these facts cannot be analyzed "scientifically." Our task as economists is to make sense of the evidence and to discover the generalities in the diverse experience with development. The fact that there have been fads and fashions in development thinking does not condemn the study of development any more than the fads and fashions in macroeconomics condemn that particular field of economics. And there are tons of first-class economists who are looking at these issues without the ideological blinders and self-assurance that Easterly complains about.

UPDATE:  Bill Easterly responds:

Dani,

I’m surprised you disagreed so much with the piece, because your work was one of my inspirations! To clarify, development economics is a science, developmentalism is an ideology. The former can yield useful generalizations and findings that can influence policy, while the latter aspires to a comprehensive, dogmatic answer for a society to solve once and for all its problems of poverty, dictatorship, and war. The former features researchers who are careful and humble about what their findings imply for marginal changes for the better, the latter features “experts” who see themselves as the key to wholescale social transformation. “Big think development” by “development experts” (whether academics or IMF/World Bank structural adjusters) has failed and will continue to fail because it is too much like the latter extreme, and has actually done harm by providing the excuse for a backlash into some destructive economic policies like the xenophobic populism currently in favor in parts of Latin America, Africa, and the Middle East.

However, nowhere do I dismiss all of development economics! More humble economists will continue to provide a lot of useful guidance in development. As the article says:

"The opposite of ideology is freedom, the ability of societies to be unchained from foreign control. The only “answer” to poverty reduction is freedom from being told the answer. Free societies and individuals are not guaranteed to succeed. They will make bad choices. But at least they bear the cost of those mistakes, and learn from them. That stands in stark contrast to accountability-free Developmentalism. This process of learning from mistakes is what produced the repositories of common sense that make up mainstream economics.

The opposite of Development ideology is not anything goes, but the pragmatic use of time-tested economic ideas—the benefits of specialization, comparative advantage, gains from trade, market-clearing prices, trade-offs, budget constraints—by individuals, firms, governments, and societies as they find their own success."

UPDATE2:  I agree with many if not most of the details of Easterly's argument, but would not have packaged them in quite the way that he does, which I think gets too rhetorical and counterproductive at times. In his most recent book, Bill discusses many successful instances of aid--and yet the categorical message that one gets from him (at least until we get into the details) is "aid does not work."  The whole notion that we should not have "big ideas" in development is also paradoxical and counterproductive. Bill himself flouts it in any case. "It's all about incentives" (first book) or "development is produced by searchers not planners" (second book) are both "big ideas." Again, we agree in (most of) the details, but disagree about--well, yes, about what the "big idea" that we should communicate is.