New Trends in Growth

By Shah, Anwar Ali | Economic Review, October-November 2002 | Go to article overview

New Trends in Growth


Shah, Anwar Ali, Economic Review


The political stability is a crucial factor for economic prosperity of a country. The main growth factors, i.e., labour, human and real capital and technology are all mobile and can be easily imported whereas the political system can not be imported.

Since the 1960s, almost all Latin American countries have displayed poor economic performance. This was all due to poor political set up in these countries. Economic progress is possible in a democratic set-up only. However, a farce democracy is worse than dictatorship. The efficiency, innovation and growth of GNP per capita depend mainly on economic, political and legal institutions of a country. A so called planned social economy with state property is unable to motivate people to work efficiently or to be innovative. Since people cannot earn higher income, they are not motivated to work efficiently.

Free market economies only work if certain conditions are met. These include a legal framework, assured property rights and a stable monetary system which must allow for extensive government intervention, high taxation and unsustainable budget deficits are further pre-conditions. Where most of these conditions, if not all, are not net, economic efficiency and development will be thwarted as seen in Latin American economies. Political stability is an important determinant of real exchange rate. When there is political trouble, money is the first thing to fly across the border.

In 1992, a study was conducted by the World Bank to discuss the main obstacle to private business developing in Brazil and Chile. The research was based on interviews with 42 firms in each country. The entrepreneurs were confronted with a list of 20 possible problems about the business. There was one area of clear agreement in both countries. The entrepreneurs considered political and policy uncertainty a very serious problem for doing business.

The main obstacle in the eyes of the potential investors was the fear of unpredictable changes in important aspects of the institutional framework. In Nicaragua, outof 50 firms surveyed 72 per cent reported that they lived in constant fear at wide ranging policy changes. Undersuch uncertainty, firms preferred not to commit their resources to partially irreversible investment projects. There are four dimensions of political stability:

* Stable government

* Stable political system

* Law and order situation

* External stability.

Think of a few countries and it will be apparent that lack of stability is common. Angola for example suffers from a lack of all four stable conditions, Bolivia from first three, Japan although otherwise stable suffers from first and Columbia is stable but lacks third.

The resource rich (RR) strategy was to export their resources and use the rent to build a modern economy. This has proved remarkably difficult. A resource exporting strategy reduces the economic growth rate by about one per cent a year. Furthermore, statistics reveal that resource rich countries such as Zair, Zambia or Brazil have performed relatively poorly. In fact some of the richest countries such as Denmark, Switzerland and four Asian Tigers are resource poor. The population of Rr country knows that the state is very rich, large scale spending programmes have to be undertaken. This causes wages to rise faster than productivity.

Foreign investment inflows are an excellent gauge of a developing excellent gauge of a developing country's policy credibility. Malaysia, Thailand, Indonesia are major recipients of foreign direct investment and their economic and business policies are highly credible. China, which is attracting more foreign direct investment than any other country is a major exception as its legal and institutional environments lack credibility by international standards The answer is probably that most foreign investors are of overseas Chinese origin and seem to feel that family and traditional rules and enforcement mechanism provide sufficient comfort. …

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