Levers for Growth

• Author: Simon Johnson, Jonathan D. Ostry, and Arvind Subramanian
• Position: Professor at the Sloan School of Management at the Massachusetts Institute of Technology/Senior Advisor/Division Chief in the IMF's Research Department

Policy lessons from earlier bouts of growth in developing countries

Economists now generally agree that broad economic institutions (such as central banks and the judicial system)-which define the rules of the game in society for economic transactions-are critical building blocks for sustained long-run growth. Strong institutions imply effective property rights and mechanisms for enforcing contracts, thereby promoting investment and efficiency. But what happens when economic institutions have significant weaknesses, as in the vast majority of low-income countries? Changing these institutions is a slow and difficult process. Can other policy levers help kick-start growth when strong institutions are absent?

Here, we look at successful episodes of development that occurred in countries where broad institutions were weak-to draw lessons about which policy levers, if any, have been effective in fostering sustained growth despite adverse initial conditions. Of course, if there were no exceptions to what might be called a rigid institutional view of development, there would be little opportunity to draw relevant lessons, because there would be few episodes of sustained growth in countries with initially weak institutions. Fortunately, however, this is not the case. In particular, by examining growth experiences over the past four decades, we can find a number of countries that were able to sustain rapid growth even though their initial institutions were apparently weak.

For our study, we looked at 47 developing countries that have experienced rapid growth at some point since World War II. Of these countries, we focused on 43 that started a significant growth episode with initially weak institutions. The data suggest that countries with initially weak institutions that were able to ignite and sustain growth were also successful in upgrading the quality of their broad institutions during their growth episode. For this group, there is a kind of virtuous circle of policy levers (for example, fiscal, exchange rate, and trade policies, as well as policies relating to education and the costs of doing business) that ignite growth despite the weak institutions. Growth is then sustained and institutions are improved, possibly laying the foundation for an improvement in long-term growth prospects.

This article draws some lessons about which policy levers appear to have been particularly effective in promoting economic growth-that is, those levers present in the majority of successes but not in the countries that did not sustain growth-and draws some tentative implications for future policy design. We use a methodology that is halfway between regressions and case studies, and, hence, the findings here should be regarded as suggestive but not conclusive with regard to causation; some related work on the duration of growth spells is described in Berg and others (2006).

Sustained growth episodes

Our study built on work on growth accelerations by Ricardo Hausmann, Lant Pritchett, and Dani Rodrik (2004), who found that growth accelerations were unpredictable and that reform led to sustained growth in surprisingly few instances. In our study, we focused on two groups of countries, comparing them with each other and with our sample of all developing countries. Both experienced growth accelerations of at least 2 percentage points per capita, sustained growth of at least 3!/2 percent per capita for seven years, and achieved a higher postacceleration income level than the preacceleration peak. The focus here is on how countries managed to sustain growth...