Rethinking Growth

• Author: Roberto Zagha, Gobind Nankani, and Indermit Gill

Economists are reconsidering what they really know about economic growth and how to go about formulating policies in the absence of reliable models

For development economists of the 1950s and 1960s, growth was a complex process of economic, social, and political transformation. New economic concepts were created to capture some of its dimensions-for example, Lewis's "dual economy" and "surplus unemployment"; Schultz's "human capital"; Gerschenkron and Rostow's "stages of development" theory, "takeoff," and "catching up"; and Seer, Prebish, and Hirschmann's "structuralism."

In the late 1980s and early 1990s, however, economists working on development came around to the simpler view that growth was a matter of getting national policies right. Whether it was landlocked Uganda, unstable Argentina, or transitioning Ukraine, the right policies meant lower fiscal deficits; lower import tariffs; fewer restrictions on international trade and capital flows; and a greater role for markets in allocating resources, regardless of history, political economy, or local institutions.

Much of this vision was reflected in the Washington Consensus. Articulated by John Williamson in 1990, the consensus synthesized the policies most economists in the World Bank, the IMF, the U.S. Treasury, and Washington's think tanks thought were necessary to rescue Latin American countries from cycles of high inflation and low growth. Williamson had emphasized that the consensus was to be applied judiciously, not mechanically, but it took on a life of its own, becoming the expression of what most economists inside and outside Washington thought most developing countries needed for growth.

As the 1990s unfolded, countries around the world implemented policies consistent with that consensus. In Eastern Europe and the former Soviet Union, market reforms followed the end of communism. In Latin America, countries stabilized their economies, defeated hyperinflation, further opened their markets to international trade and capital, and privatized public enterprises. In Asia, India abandoned central planning, embracing a wide range of reforms, and China continued its market-oriented reforms. In Africa, countries such as Ghana, Tanzania, and Uganda embarked on privatization, retrenched the public sector, and liberalized trade. And, in places as diverse as Bolivia, Brazil, India, and Russia, grossly overvalued exchange rates became more competitive; the devaluation of the CFA franc in 1994 was a particularly important change.

The scope, breadth, and depth of the reforms during the 1990s were unprecedented in recent economic history. The developing world emerged with more open and competitive economies, lower inflation, lower fiscal deficits, smaller governments, fewer restrictions on private sector activities, and more market-based financial sectors. The changes were not only economic. The number of democracies increased to 100 from 60 during the decade, and social indicators (particularly basic education and child health) improved steadily. In the early 1990s, most economists believed that these developments, combined with a favorable international environment-firm commodity prices, rapid growth of international trade, and abundant capital flows-would enable developing countries to overcome the "lost decade" of the 1980s and return to a path of sustained growth.

The results, however, were unexpected. They exceeded the most optimistic forecasts in some cases and fell well short of expectations in others. In East and South Asia, including China and India, which together account for 40 percent of the developing world's population, domestic liberalization and outward orientation were associated with spectacular growth, poverty reduction, and social progress. This was so even though reforms were implemented in a manner that departed from conventional wisdom-in terms of speed and design of reform, a large state presence, and, until well into the 1990s, high levels of import protection (with export orientation ensuring international competitiveness).

At the same time, booms and busts continued in Latin America, extending to other regions. For most former Soviet Union...