Towards A Competitive Malaysia #10

Chapter 3: Diamond of Development (Cont’d)

Barro’s Determinants of Economic Growth

Meanwhile another Harvard scholar, economist Robert Barro, initiated a massive cross-national survey to discern the commonalities that might explain why some countries experience superior economic performance and their citizens enjoy high standards of living, while others remain economic laggards and their citizens trapped in poverty. The assumption is that these successful countries must be doing something right, worthy for others to emulate. The other premise is that the misery endured by the Rwandans and Romanians, and the affluence enjoyed by the Swiss and Singaporeans are not the result of some divine design rather the consequence of the policies of their leaders, institutions, and governments. Meaning, progress and economic development just do not happen; they can be planned and executed.

Barro collected voluminous data from over 100 countries spanning over three decades.3 Using sophisticated statistical techniques he isolated the many variables and examined their individual impact on economic growth. A formidable task! Imagine having first to standardize the data to ensure their comparability, and then to analyze them. He was able to do so and presented a number of interesting observations, some expected, others surprising.

As expected, countries with highly educated citizens, strong rule of law, favorable trading activities, low inflation, and where the government has low levels of expenditures (except for defense and education) tend to have high economic growth. Growth also goes hand in hand with high life expectancy, higher male secondary schooling, and low fertility. These are also indictors of the quality of their human capital.

Surprisingly, freedom (and democracy specifically) is not critical for economic development. This is best illustrated by contrasting South Korea (little freedom and democracy but high economic growth) to the Philippines (freewheeling democracy to the extent that it interferes with the formulation and execution of sound economic policies). The Filipinos may have more political freedom in the sense that they can take part in elections and remove leaders they do not like, but unlike the South Koreans, the Filipinos lack that most basic of freedom—to be free from privation. No sane South Korean would wish to trade places with the Filipinos.

Freedom and economic growth are linked on an inverted U curve. At low levels of freedom, an expansion of these rights stimulates growth. Once that is achieved, further expansion of these rights reduces growth. The democratic system of governance responds to popular political demands; this generally means focusing on redistribution policies (generous social welfare programs and entitlements) at the expense of growth.

In America, powerful interest groups lobby the legislatures at all levels for favorable treatment. The greatest obstacle to sound economic planning in America and other mature Western democracies is the unrestrained growth in entitlements like social welfare and pension plans. It is impossible to have rational discussions on these issues because they have huge and deeply entrenched constituencies.

The Philippines apes America in this sorry respect; the Filipinos’ freewheeling democracy produces nothing but gridlock, with the president and legislators engaged in endless squabbles while their citizens starve.

A benevolent and wise dictator-like leader could formulate sound and effective policies, and then execute them efficiently without having to face needless opposition. We see this in South Korea and Singapore. On the other hand, if he turns out to be a corrupt and malicious dictator like Saddam Hussein, the damage inflicted would be irreparable and long lasting. At least with a functioning democracy, the authoritarian tendencies of these leaders could at least be checked and restrained. Mahathir was a great leader, but had he had his way without the restraint of Parliament and the opposition parties, how many more scandals like Perwaja Steel, London Tin, and Bank Bumiputra would there be?

Barro’s remarkable research demonstrates that the poorer the country is to begin with, the more pronounced would be the effects on growth of these various factors, a phenomenon referred to as “conditional convergence.” This should be an impetus for poor countries to pursue these proven pro-growth policies.

One reason for this conditional convergence is the law of diminishing returns. Spending on education is conducive to economic growth, but there is a limit to this. After the basic primary and secondary schooling, the added costs for providing more education do not produce commensurate increases in returns. This applies not only to education but also other endeavors.

The experiences of multinational corporations that had moved their plants to the Third World bore this out. Their workers are not as well educated as in the West; most have only primary level education. Despite that, these companies discovered that with the proper on-the-job training, the lowly educated Mexicans and Chinese could perform their work just as well as their highly educated counterparts in the West, much to the chagrin of Western union leaders.

We cannot carry this assumption too far, for while it may be true for simple manufacturing and assembly work, it may not be so for other jobs. Experiences in Japan and South Korea, where the workers have much higher education and are well versed in science and mathematics, show that their productivity is much higher than those in the Third World. They are also more receptive to and better prepared for innovations, and more easily re-trained to meet changing market conditions.

A well-educated citizenry is important for other reasons. They would be more informed and less likely to be swayed by chauvinistic leaders. Besides, before a nation could leap onto the next trajectory of development—the innovative-driven stage—it must have a highly educated workforce.

This conditional convergence phenomenon, carried to its conclusion, would result in poorer countries ultimately achieving the status of and be on par with developed countries. Unfortunately, the reality is far different. Conditional convergence notwithstanding, the gulf separating poor countries from the rich continues to widen. For an explanation of why developed countries continue to grow faster and defy the laws of diminishing returns, I turn to the novel ideas on economic growth postulated by among others, Paul Romer.

Next: Romer’s “Ideas Matter”