Summary of The Elusive Quest for Growth
Next, Easterly examines how growth is driven by the process of creative destruction. The possibility that new technology will make old techniques unprofitable, obsolete, and useless can reduce the perceived incentives for innovations and lead to barriers, which inhibit acquisition and creation of new technology. These factors lead to forces within impoverished nations that can stanch economic growth.
Governments in poor countries should attack this problem by promoting foreign investment, subsidizing capital imports embodying new technology, and subsidizing research and development in technology creation and adoption.
Easterly places emphasis on the role of technology, not as a panacea for growth, but as a critical driver. But knowing or owning the technology -- no matter how advanced -- is not sufficient. What matters is how it is applied, who applies it and in what context.
Easterly underlines the fundamental importance of the Schumpeterian model of creative destruction. For societies to thrive, it is important not only to innovate, but also to destroy old technologies, obsolete practices, outmoded institutions and, of course, all the dead weight of the old.
The creation of new technology and the destruction of old technology is the essence of the growth process. Destruction, however, can be as difficult, if not more so, as creation. This is mainly because those who would wish to introduce new creative technologies will meet with forces of resistance and vested interests that wish to maintain the old technologies, and, generally speaking, the latter are older and more powerful than the former.
In technology, as well, we see another iteration of complementarity. Inventions that are complementary to existing technologies and skills, rather than substitutions for them, may be adopted and put to use more readily.
Under an Evil Star
Fortune, whether good or bad, can play a big part in an economys ability to grow. Disasters such as floods, earthquakes, and disease epidemics can destroy infrastructure and kill off skilled workers, moving an economy years backward. Poorer economies are affected much more deeply by natural disaster than wealthier ones.
In addition to the effect of natural disasters on an economys luck, sensitivity to expectations, choice of incentives, and the initial conditions of the economy all affect an economys fortunes and help in determining whether it will grow or stagnate.
Easterly hypothesizes that no matter what the other factors, luck is a major determinant in economic growth. It keeps economists honest by offering a control against which their studies can be measured, and despite lucks randomness, one can use the patterns of past growth and recession to predict the economic future through mean reversion. Mean reversion essentially says that after a particularly up or down time, everything will trend back toward the mean. So, if an economy is having a particularly high rate of growth, mean reversion will predict and eventual trend back toward a mean rate of growth.
Other factors that can be out of a countrys control, but still have a severe impact are external market pricesthe prices at which a country is required to buy or sell goods and productsas well as war, particularly civil war. Developing economies react dramatically to growth and contractions in large industrialized countries as well, particularly to the extent that such countries are clients or customers of developing economy.
While luck plays a major part in all economic growth or lack thereof, poorer economies are far more susceptible to being affected by random events than richer nations. Because poor countries are already living close to the bone with minimal reserves nascent technology and fewer skilled workers, any setback due to war, natural disaster or a mortgage crisis in a far off industrialized nation is likely to be felt more deeply and for longer in a developing economy than a first or second tier country.
Governments Can Kill Growth
Governments, obviously, like luck, can have a tremendous impact on growth. Because governments often dictate the incentives that drive growth, bad government can lead to a bad economy.
Inflation is a factor that is largely within government control. War or any other circumstance that may cause a government to print more money can lead to inflation, and once it takes root, it is difficult to stop. Inflation has a huge negative impact on growth and can lead to, among other things, large external budget deficits. Inflation also creates disincentives for growth. People avoid holding onto money, production slows and resources are diverted away from production.
The creation of a black market premium on foreign currency due unfavorable or uncompetitive official exchange rates is another way that a government can negatively impact an economys growth. When this happens the incentive is to skirt government rules and attempt to trade currency outside official channels such an incentive is not of the type that leads to economic growth. Moreover, it is detrimental to exporters in that they end up selling their exports at the official rate. Meanwhile, imports are effectively purchased at the black market rate, creating a trade deficit. The incentives for growth vanish.
Another government hindrance to growth is driving banks out of business by shifting interest rates, in effect creating a negative real interest rate for banks on their deposits, which dries up credit sources for businesses and individuals. When credit sources are unavailable, they dont go back into the economy and stifle growth.
Protectionism is another real threat to growth. Closing a countrys economy and turning it inward prevents an economy from being affected by outside forces, which means that prices, interest, wages, and exchange rates are not pegged to any real world benchmarks. Markets are limited to internal markets and the growth is halted.
Corruption and Growth
Next, Easterly discusses one major type of institutional failure, namely, corruption, which has been shown empirically to have negative consequences for growth.
Again incentives matter, and corruption changes the incentives in favor of unproductive rent-seeking activities and against the production of real goods and services. Easterly provides some numbers to give readers a sense of the enormity of the problem. Next, he discusses the corruption ratings of countries based on different definitions of corruption. He discusses the determinants of corruption, such as the extent of ethnic division of society, the importance of foreign aid, the rule of law, the quality of bureaucracy, red tape, and so on. Policies to control corruption are also discussed. In fact, the presence of distortions in the market can accentuate corruption, and economic reforms can therefore reduce corruption.
Governmental corruption is a tremendous deterrent to economic growth. Often, most of the GDP finds its way into government coffers, and it is not finding its way back into the economy. Unfair taxes are often imposed by such governments on imports and exports, stifling trade with outside countries. With the economy so stifled, the businesses are unable to afford to trade with foreign countries, inflationary pricing sets in, and the black market grows. This creates a demoralizing disincentive for business owners to engage in commerce, further stifling growth.
While there will always be difficulty in reforming a corrupt government, it is possible where government checks and balances are put in place to monitor other levels of government. Administrative agencies and courts of review can help police the lower levels of government. Measures such as reducing the amount of government red-tape and eliminating black market premiums, and government-controlled real interest rates serve to curb corruption. Lastly, non-corrupt governments should refuse to do business with or provide aid to countries whose governments are rife with graft.
This can create an incentive to eliminate corruption, particularly if the country has few resources that are valuable without refinement or manufacture. There is always the risk of corruption from the top down, but if there is enough support in the government itself and from the people, backed by enough actual power, it can be accomplished, as in Ghana.
Polarized Peoples
Easterly provides an extensive discussion of the effect of polarization on growth. He cites research indicating that greater income inequality leads to slower growth and greater political instability as measured by revolutions and coups. In addition, the most ethnically diverse nations have lower per capita growth, fewer public services and significantly greater risk of civil war and
genocide. Ethnic diversity is measured by the probability that two random members of a population speak different languages. Easterly notes that this measure of ethnic diversity is highest in sub-Saharan Africa, a region of the world, which has had a very poor growth performance over the last forty years.
Factionalized societies also put a damper on growth. Instead of seeing incentive in spurring development and economic growth, the governments in such countries are incentivized to take the available resources and income, and redistribute it across the society. The author refers to such governments as being redistributionist (as opposed to developmentalist), in which different societal factions fight over the division of existing resource, and the government works to accommodate as many interests as it can.
Class warfare is a major deterrent to growth. Oligarchies, societies in which the majority of wealth is owned by a small minority of the population, tend particularly disincentivize growth, because, similar to a corrupt government, much of the GDP ends up back in the pockets of the few wealthy individuals, dampening growth and creating disincentives among the population, as a whole.
Ethnic conflict is another factor in dampening growth in divided societies, particularly where a single ethnic minority in the population controls much of the wealth. The political and economic meltdown in the former Yugoslavia, in which all resources were focused on destroying ethnic groups not of the same class as the ruling party, killed regional growth and international trade for years. There is no incentive to enter into commerce, when it or you may be blown up the next day.
The United States has bordered on such inequality for years, particularly as white Americans make up a smaller and smaller percentage of the population as a whole. South Africa, was (and still is, to a degree) a more extreme example, with the white, colonial Europeans retaining the vast majority of the countrys wealth while subjugating the African majority, leaving much of the population in abject poverty, living in shanty towns. Not only did such internal ethnic conflict stifle growth, but the political ramifications thereof, in the forms of boycotts and divestment from foreign governments and business, dampened South Africas ability to develop further.
Conclusion-The View from Lahore
Pakistan is a country with much to offer, but due to dictatorship, corruption, and a population lacking education, nourishment and shelter, and hope of economic growth remains in the distance. In order for growth to occur, the impoverished must be given opportunities, polarized factions must coalesce and consider the economic future, and government must be held accountable for its actions by the people and other nations.
In turn, the government must invest in health, education and legal institutions. It must also strive to provide incentives to business and individuals in the way of technology and education.
Easterly bears witness to the lack of education, health and other basic services, as well as government corruption and interference and factionalization, while studying the developing world, but the success stories he encounters give him hope. Easterly concludes with the point he has been making throughout the bookthat the correct incentives, spearheaded by the government, are necessary for economic growth. At a minimum, economic growth requires government incentives encouraging technological adaptation and promoting primary level education donors who will only aid non-corrupt countries that have implemented effective policies to prevent the aid from being diverted into government or private coffers governments with a developmentalist mindset, rather than one engaging in redistributionist policies and a consensus from top to bottom that investing in the future should be at the forefront of any growth policies.
And in spite of his criticism of non-government organizations, the International Monetary Fund and the World Bank, Easterly acknowledges that such institutions are necessary and play a pivotal role in the future economic growth of developing nations.