economics
Source: http://economics.utah.edu

By Deepanshu Mohan (@prats1810), O.P. Jindal Global University

In a recent article published via Mint, the author, Arun Maira, argued for a “new economics” that does away with the economic models of yesteryears designed to cater different expectations in economies facing different stages of development. Economists like Barry Eichengreen, Dani Rodrik, Ha Joon Chang and others have often argued along these lines over the last few years while deliberating on new approaches to growth and development economics.

The old neo-liberal approach to growth has often confused the attainment of economic prosperity with greater economic openness through increased trade and investment per se, contributing to higher growth and per capita income, making everyone “better off.” The focus on making everyone “better off” in an economy thus rests more on increasing productivity levels across all lines of production in a developing economy through greater capital accumulation (by domestic of foreign induced investment). This uniform model prescription has most often been proposed by all international financial institutions (IMF, World Bank, etc.) to all late developing economies since the times of the Washington Consensus (of the late 1980s).

However, lessons from economic history of late developing economies showcase that these models present half-baked truths at best. Economic openness through increased integration processes (trade, investment, fewer capital controls, etc.) does contribute to higher economic growth over time, raising the per capita income for emerging nations. But, for consistent, inclusive and sustainable growth linked developmental processes to be maintained, the necessity and role of the state is often understated.

Developing economic states need to realize their role as active stakeholders in not only creating but managing market-created incentives, while organically tapping into the potential of local endogenous factors. Endogenous growth is “long run economic growth at a rate determined by forces that are internal to the economic system (like technology, institutions and integration processes, i.e., the role of public policy in trade, investment etc.), particularly those forces governing the opportunities and incentives to create technological knowledge.”

The “old” economics of growth

To shape our thinking about the economics of growth, it helps to distinguish between the “proximate” and “deep” determinants of growth. Figure 1 below highlights the traditional ways in which economists across the globe study growth—through elements that determine a higher income, which is considered as a sign of increasing economic prosperity. The total produced output in the form of goods and services (as computed by GDP) for an economy is shown here as a function of the resource endowments (labor, physical capital, human capital) and the productivity with which these endowments are deployed.

According to Dani Rodrik (2002), the growth of per capita output can be expressed in terms of three proximate determinants: 1) physical capital deepening 2) human capital accumulation and 3) productivity growth. In the equation given below, a as a constant represents the “technical and allocative efficiency level” for an economy that allows for studying the role of technology in measuring outcomes for capital accumulation. This efficiency level also reflects the optimum use of the resource endowments across varied economic activities.

Figure 1

Per capita growth = physical capital deepening + human capital accumulation + productivity growth

Rodrik’s analysis on defining proximate determinants of growth with deeper determinants can best be explained using a threefold taxonomy that significantly adds to the final value of economic growth in an endogenous or exogenous way. As per the threefold taxonomy defined here (Figure 2), Geography relates to the advantages and disadvantages posed by a country’s physical location (latitude, proximity to navigable waters, climate, and so on). Integration relates to the market size, and the benefits (as well as costs) of participation in international trade in goods, services, capital, and possibly labor and Institutions refer to the quality of formal and informal sociopolitical arrangements ranging from the legal system to broader political institutions that play an important role in promoting or hindering economic performance.”

Figure 2

What is missing in this taxonomy is the state itself in shaping the path to higher growth through effective policies that in turn best allow the resource/factor endowments (land, labor, capital etc.) to be most effectively used in generating income and producing the maximum production output. Policies, at the same time, would also allow the state to equitably distribute the gains from production, trade and foreign investment (received inwards) to the society.

What a state represents

In the classic, Anatomy of the State, Murray Rothbard defines a state through the eyes of some as “an institution of social service; the apotheosis of society; an amiable, though often inefficient, organization for achieving social ends” and “a necessary means for achieving the goals of mankind, a means to be ranged against the ‘private sector’ and often winning in this competition of resources.”

Contrary to Rothbard’s views, the role of the state today goes much beyond this. This is particularly true in the case of a late developing/industrializing economy seeking to achieve maximum returns, where it remains critical to promote the participation of the private sector in sharing resources while encouraging economic competition. To define the state only as an “organization of the political means and as the systematization of the predatory process over a given territory” would circumscribe its role by excluding the benefits of good, efficient economic policies. In expanding the economics of growth, it is thus pertinent to involve the “visible hand,” i.e., state, as an active stakeholder.

Also, a distinction needs to be made between what constitutes/defines a “state” and a “government”. Where a government can be removed through revolutions, coups, and so forth, the state with its rights and obligations remains.

Study of growth warrants reviewing interrelationships

The economic systems across the developing world face three disruptions today (as explained here) with respect to preexisting economic models: a) an increasing role of technology b) rising aspirations for a fairer, equitable world and c) the ease of communications among people with the proliferation of internet media and telecommunications. In the economics of growth, governing dynamics of current times warrants a different outlook towards the role of emerging states, incorporating the above disruptions and economic policies that go beyond an “increase in productivity leads to prosperity” argument.

The arrows indicated in Figure 2, reflect the basic framework with feedback effects, both from the growth back to the “causal” factors and among the “causal” factors. The central question in economics mustn’t revolve always around which of these arrows matter the most for economies and why. Rather, in today’s context, it is pertinent to expand upon how these arrows can work best through the effective intervention of the state. For example, institutions in countries like China (since 1980s) and India (since late 1980s) have been shaped by the state’s ability to understand the changing needs of local politico-economic requirements, which allowed for these rising economies to work on building their own set of institutions. Similarly, for economies that are rich in terms of their natural resource endowments (say oil in the Middle East and diamonds in case of African economies like Botswana), the state needs to acknowledge the primacy of GIST (geography, local institutions and potential technological innovations) in planning for long term inclusive growth measures. Economies like Australia and Mauritius have given us narratives on how, in spite of the absence of a rich geography, both these economies have grown and developed through effective state intervention and good quality institutions.

 

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