9.2 POLICIES FOR THE FUTURE
9.2.1 First Principles: Setting up Conditions for Growth
Protection of private property is essential for the development of any entre- preneurial activity. In situations where private property rights are weak or non-existent, it is almost impossible to attract investments from private investors. Predatory behaviour either by the state or other non- state actors on private investment creates uncertainty for the investors. The risk of predation makes the cost of investment prohibitively high. This leads to very low levels of investment and poor growth outcomes. Therefore, it is absolutely essential that private property rights are guaranteed by law and also properly enforced by the government in case of disputes. In many instances, the law guaranteeing property rights may exist, but predation by private individuals or non- state actors, or expropriation by the state
or bureaucrats may be rife. In such instances, long- term growth outcomes may be poor because of investment risks. As a result, the true economic potential of that country may not be realized.
Rule of law
Like property rights, the rule of law is also a key ingredient for growth.
The rule of law ensures that private individuals are protected by law and makes it diffi cult for a state to actively engage in expropriation or preda- tory behaviour. In other words, it makes it diffi cult for powerful individu- als within the state to unlawfully use the state apparatus against private individuals. If such a situation arises, then there are provisions to hold that individual to account in a court of law. Therefore, it provides an important layer of protection for investors. In the absence of rule of law, investment risks multiply and investors only invest in low- risk low- return projects (for example, in the subsistence sector). Furthermore, violent confl ict may arise making investments unworthy. Therefore, the upshot is a poor growth outcome in the absence of the rule of law.
Contract enforcement
A strong contracting environment is essential not only for investments but also for the development of fi nancial markets. Business and enterprise fl ourish in an environment where it is easier for two completely unrelated private individuals to draft contracts and take action in situations where these contracts are reneged. The law of the land should facilitate this process. The easier and faster the process, the better it is for new invest- ments and innovations. In situations where this is not the case, growth dividends are relatively smaller. However, one could argue that formal contracting institutions are redundant in an environment of high social capital and trust. In reality, trust and social capital could operate within relatively small groups. Therefore, the cost of seeking a contract or getting access to credit becomes diffi cult for individuals who are not part of this network. In such an environment, potentially high pay-off projects may fail to get funded if they come from an individual who is not part of the network. Hence, by construction such institutions limit growth as they fail to ensure free entry.
Regulatory institutions
Strong regulatory institutions are important for growth. Private economic agents in the market are driven by greed and animal spirit. Therefore, if left unregulated, economic agents may engage in predatory and anti- competitive behaviour, which may lead to market failure and net welfare loss to society. Recent events in fi nancial markets across the world, which
led to the global fi nancial crisis, underscore the importance of regulation.
Regulators in the previous decade were increasingly of the view that self- regulation is Pareto superior to regulation by the state or independent bodies. In retrospect, one could now clearly identify that error. Therefore, it is important to put in place independent regulatory bodies oversee- ing the behaviour of market actors to limit anti- competitive behaviour, monopoly practices and collusion. It is important for the regulators to be independent of the government so that they are relatively free from political pressures and also independent of market actors so that they are relatively free from industry pressures. A strong regulatory environment may foster investments and economic growth. However, there is a risk of over-regulation. Excessive regulation, on the other hand, may lead to red tape, increased cost of investment and low growth. Therefore, in an ideal world, regulatory institutions should optimize the level of regulation.
Macroeconomic stabilization
Macroeconomic stabilization is crucial for growth over the long term.
Investment, by defi nition, is a risky activity. In most cases, there is a gap between investment in a project and the point in time when it starts delivering returns. This is commonly known as the gestation gap. In an environment of macroeconomic volatility, it becomes diffi cult for inves- tors to foresee costs and future returns. Price volatility could impact on both input costs as well as future returns. Interest rate volatility could also impact on costs through the credit channel. Therefore, it is crucial for macroeconomic institutions such as the central bank and the treasury to deliver a stable macroeconomic environment for growth. Central banks are best able to do that when they are independent. In most successful economies, central banks are mandated to tackle infl ation by using inter- est rates as an instrument. However, government borrowing also has an impact on interest rate. If a government is borrowing from the market for government spending, it is likely to make credit dearer and increase the interest rate. This would have an impact on the balance sheet of private businesses seeking credit from the market. The cost of credit for private businesses would go up, crowding out investments. Therefore, the treas- ury’s actions would also have an impact on investments and the economy.
To sum it up, the use of a central bank’s monetary policy to keep infl ation low and the treasury’s eff orts to keep debt low are important for a stable macroeconomic environment and growth.
Representative politics
The process of economic growth can be harsh at times. Growth in a capitalist economy, by its nature, picks winners and losers. Rapid growth
driven by technological progress or expansion of a particular sector in an economy might make other sectors unprofi table. This would lead to redundancies, unemployment and factory closures. Therefore, redistribu- tion would be an important policy tool to help the unemployed receive training and re-engage with the workforce. Examples of such support mechanisms are social safety nets, unemployment benefi ts and social insurance. These policies are capable of minimizing social unrest and help to maintain a climate conducive to further investments. Representative political institutions are best to deliver on redistribution. Some have argued that democratic institutions are the most effi cient form of repre- sentative political institution. However, there are examples of other types of institutions that are also capable of delivering redistributive outcomes as well as a democracy. Of course, China comes to mind. Even though inequality in China has risen over the last three decades, signifi cant steps have been taken by the Chinese authorities to reduce the gap through retraining and re-employing the unemployed workforce, allowing migra- tion and providing unemployment benefi t. Nevertheless, it is perhaps fair to conclude that the more representative the political institutions are, the better it is for redistribution.
Human capital investments
Having an educated population is also crucial for growth. Without an educated population it would be diffi cult to properly run institutions.
Running institutions would require properly trained bureaucrats. With a low level of schooling in a country, there would be a limited supply of properly trained bureaucrats to run the institutions important for growth.
It would also be diffi cult for businesses to recruit an adequately skilled workforce. This may lead to low levels of investment and also investments in low- return projects. On the other hand, in a country with high levels of schooling, the workforce would be skilled enough to handle multiple tasks and hence would be much more employable. Therefore, they would be extremely attractive to investors in more than one sector. Hence, it is crucial for countries to improve the level of schooling in order to run national institutions, attract investments and deliver economic growth.
Access to markets
Infrastructure bottlenecks in developing countries often scuttle economic growth. Lack of roads, railway links, seaports and ocean- navigable water- ways limit access to markets and thereby restrict growth. Landlocked economies in Africa and Central Asia suff er from the lack of access to international trade routes. Lack of telecommunication networks also limit business growth and reduce productivity as sellers struggle to contact
potential buyers of their products. This could cost economies dearly in terms of future economic growth. In contrast, an economy well connected to the global markets both physically as well as through telecommunica- tion networks can engage in internal trade and international trade much more easily. The positive externalities from a functioning road and railway network could be large. They facilitate institutional delivery at the local level, in addition to helping business and trade. It makes it much easier for the central government to keep in contact with local level institutions and deliver public goods such as health services and materials for schools eff ectively. Therefore, infrastructure investments to overcome geographic bottlenecks are essential for growth.
International trade
International trade increases the size of the market. It can also induce tech- nology transfer and transfer of institutions. All of these factors are poten- tially growth enhancing. Therefore, trade in general is believed to be good for growth even though hard evidence from macro data is diffi cult to fi nd.
However, there is a caveat for developing economies. Trade and thereby specialization in one or two products may make a developing economy vulnerable to volatility in international prices. If the specialization is in primary products and natural resources, the risk of Dutch Disease also multiplies. In such a situation, a developing economy may not benefi t from trade over the long term. It may also have an adverse impact on its institutions as natural resource exports are likely to increase inequality and increase social friction. Diversifi cation, expanding export product mix and curbing over- reliance on natural resource exports are perhaps the best way forward in such situations. Therefore, trade openness is perhaps best for developing countries when the aim is to diversify their exports.