Economic Growth and Development: Perspectives for Policymakers: A Summary of the 2006 Philadelphia Fed Policy Forum

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Most economists agree that economic growth is the driver of a country's standard of living. But what drives economic growth? What programs and policies are effective at promoting economic development and the reduction of poverty and how is effectiveness best determined? Have there been unforeseen consequences of policies that we need to bear in mind when designing new programs? These were some of the questions addressed in the 2006 Policy Forum.

Charles Plosser, president of the Federal Reserve Bank of Philadelphia, provided opening remarks. He pointed out that while the developed world has spent trillions of dollars promoting development around the world, the track record has not been entirely positive. In his view, it is important that we recognize and learn from past mistakes, and this means taking a step back to look at the long-run economic impacts of different types of programs. It also means tackling challenging and sometimes controversial issues like corruption, foreign aid, and trade. These were among the topics addressed the rest of the day.

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ECONOMIC GROWTH AND DEVELOPMENT: AN OVERVIEW OF ISSUES AND EVIDENCE (1)

Roberto Zagha, of the World Bank, began the first session with an overview of a World Bank study on development lessons from the 1990s and their implications. (2) In the late 1980s and early 1990s, the World Bank had a sense that to spur economic growth, all governments need do is implement the so-called Washington consensus of financial and trade liberalization, macroeconomic stability, and privatization. However, as the 1990s unfolded, the effectiveness of these policies began to be questioned as countries thought to have improved their policies still suffered from low growth rates. Indeed, although policies improved in the 1980s and 1990s, growth performance was lower than in the 1960s and 1970s. There appeared to be no set formula for success. China and India, which remained relatively closed economies with large public sectors, grew much faster than countries like Brazil, Argentina, and Chile, which had liberalized much faster. The length and depth of the recession in Russia and other countries of the former Soviet Union surprised many, given the improvement in the economic policy regime. Several countries, including those in East Asia, Brazil, and Argentina, experienced financial crises. It appeared that improvements in policy did not necessarily lead to improvements in economic performance, leading the World Bank to conclude that growth

processes are much more complex than it had earlier thought. In addition, since the models underlying certain economic systems are unknown, the response functions to certain policy actions were not necessarily what one expected. The World Bank concluded that there typically needs to be a lot of learning by doing and experimentation until effective policies are implemented.

The World Bank's systematic study of the 1990s combined information from empirical analyses and from practitioners in the field. The study suggests that institutions and history matter and that no two successful outcomes are necessarily alike. Among the study's many lessons is that how macroeconomic stability is achieved is as important as stability itself. As Zagha pointed out, when fiscal deficits are reduced by curtailing investment in infrastructure, there is a clear tradeoff between stability achieved in the short run and longterm economic growth. Another lesson is that trade reforms are not a panacea. They typically require complementary reforms, e.g., exchange rate policies and trade logistics, to he effective, and the gains from trade reforms are not necessarily shared with the poor--income inequality remains an issue. This lesson was also emphasized later in the day by speakers Dani Rodrik and Ann Harrison. A third lesson is that policies should not merely focus on achieving the efficient use of resources (a static concept) but also on expanding productive capacity (a dynamic concept). Based on the study's revelation of the complexity of the issues surrounding effective growth policies, the World Bank in partnership with other international agencies and private foundations has established an independent commission on growth and development, chaired by Nobel laureate Michael Spence. Zagha explained that the commission brings together top academic researchers and practitioners, so that the best empirical and analytical thinking on economic growth and development can be coupled with experience in the field to inform policymaking.

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Xavier Sala-i-Martin, of Columbia University, continued the discussion, focusing on the consequence of economic growth for the distribution of income, in particular, the level of poverty, i.e., the percentage of people below a certain income threshold, and the degree of income inequality, i.e., dispersion in income levels. Sala-i-Martin pointed out that the national income data for countries indicate that growth of per capita income worldwide has been increasing for the last two centuries and accelerating since 1970, while it has also diverged across countries. The economies for poor countries have tended to grow slower than those of rich countries, so-called [beta]-divergence. In addition, measures of cross-country income dispersion, e.g., the variance of log income, have been rising, so-called [sigma]-divergence. But these results are based on country-level income data and not on the income levels of individuals--they essentially treat every country as a single observation and thus give a low weight to individuals in high-population countries like China, compared to those in low-population countries like Lesotho. The country-level distribution has little to say about the welfare of individuals. Weighting country-level per capita income by population goes part of the way toward uncovering the worldwide income distribution of individuals but not all the way, since it still assumes that everyone within a country earns …