The Quest for Prosperity: How Developing Economies Can Take Offby Justin Yifu Lin
Since the end of the/i>
How can developing countries grow their economies? Most answers to this question center on what the rich world should or shouldn't do for the poor world. In The Quest for Prosperity, Justin Yifu Linthe first non-Westerner to be chief economist of the World Bankfocuses on what developing nations can do to help themselves.
Since the end of the Second World War, prescriptions for economic growth have come and gone. Often motivated more by ideology than practicality, these blueprints have had mixed success on the ground. Drawing lessons from history, economic analysis, and practice, Lin examines how the countries that have succeeded in developing their own economies have actually done it. He shows that economic development is a process of continuous technological innovation, industrial upgrading, and structural change driven by how countries harness their land, labor, capital, and infrastructure. Countries need to identify and facilitate the development of those industries where they have a comparative advantagewhere they can produce products most effectivelyand use them as a basis for development. At the same time, states need to recognize the power of markets, limiting the role of government to allow firms to flourish and lead the process of technological innovation and industrial upgrading. By following this "new structural economics" framework, Lin shows how even the poorest nations can grow at eight percent or more continuously for several decades, significantly reduce poverty, and become middle- or even high-income countries in the span of one or two generations.
Interwoven with insights, observations, and stories from Lin's travels as chief economist of the World Bank and his reflections on China's rise, this book provides a road map and hope for those countries engaged in their own quest for prosperity.
"[A] brilliant survey of economic thought on the subject, from Adam Smith through Solow-Swan to Michael Spence's Growth Commission. Thousands of authoritative-sounding economic history essays will be written on the back of it by students smart enough to read it before their professors do. . . . [A]s an accessible summary of how the World Bank . . . thinks about development these days, The Quest for Prosperity is hard to beat. It will quickly find its way on to the course reading lists for development economics master's programmes."Howard Davies, Times Higher Education
"Justin Lin, the Chinese economist who was, until recently, chief economist of the World Bank, has written a book that is as remarkable as it is ambitious: its aim is to show the route to economic development. This is ambitious, because it has been the holy grail of economics since its inception. It is remarkable, because he largely succeeds. One does not have to accept everything Lin argues to recognise that he has made an invaluable contribution. . . . Moreover, the book is also excellently written. A book on a subject of the highest importance, which is intelligent, original, practical and thought-provoking, deserves indeed to be read."Martin Wolf, Financial Times
"In this book, Justin Yifu Lin, the World Bank's first non-western chief economist, offers a fascinating overview of development thinking since the Second World War."Lisa Moyle, Financial World
"Here, Lin, a former chief economist and senior vice president of the World Bank, explains here in detail the model he created there for developing economies to achieve success and sustainability. . . . The book is well organized and thus it is easy for readers to find information discussed throughout the book as a whole. Lin's use of history and popular culture metaphors make complex economic concepts more accessible to lay readers, especially in his analysis of global economics."Library Journal
"The most valuable new book I've read this year is Justin Yifu Lin's The Quest for Prosperity. . . . Lin's book is intellectually ambitious. He sets out to survey the modern history of economic development and distill a practical formula for growing out of poverty. It's a serious undertaking: Lin isn't trying to be another pop economics sensation. But The Quest for Prosperity is lightly written and accessible. It weaves in pertinent stories and observations, drawing especially from his travels with the World Bank. He leavens the economics skillfully."Clive Crook,Bloomberg News
"Lin . . . makes a case for what he calls a 'new structuralist' approach to economic development. Drawing on the experience of many countries, especially China, he argues for an active role for government in fostering development, not only through the traditional provision of infrastructure and the enforcement of rules but also in identifying and supporting industries that contribute to growth. . . . Lin presents a thought-provoking argument."Foreign Affairs
"The book is peppered with deep insights from economic thought, practical wisdom, and personal experience, and is easily accessible to policy makers, business leaders, and undergraduates studying development economics."Choice
"[T]his is indeed a stimulating volume, clearly indicating the author's extraordinary command of the development literature and his equally extraordinary level of motivation in making his case."Gustav Ranis, Journal of Economic Literature
"The Quest for Prosperity is an interesting and enjoyable read."Mukti P. Upadhyay, European Journal of Developmental Research
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The Quest for Prosperity
How Developing Economies Can Take Off
By Justin Yifu Lin
PRINCETON UNIVERSITY PRESSCopyright © 2012 Justin Yifu Lin
All rights reserved.
New Challenges and New Solutions
Since becoming the World Bank's chief economist, I have had ample opportunity to reflect on an old American saying: "Be careful what you wish for, you might just get it!" For better or worse, the beginning of my tenure coincided with the eruption of the most serious financial and economic crisis, both in magnitude and in scope, since the Great Depression. No country has been immune to the economic slowdown. Most economic and financial experts severely underestimated its timing, speed, and severity. As a result, despite strong macro policy responses, the current situation remains full of uncertainties.
This crisis, unlike many other crises preceding it, was not the fault of developing countries. It was an unexpected setback to and challenge for their macro management. Some of them had little exposure to the financial derivatives that triggered the crisis and had the fiscal space and the foreign reserves to apply strong policy stimulus programs. But many others had enormous short-term capital inflows through multinational bank branches, large current account deficits, overpriced housing markets, or limited fiscal space for countercyclical measures.
The amplitude, brutality, and unfairness of the crisis was perhaps most obvious in Sub-Saharan Africa. Despite being the global economy's least integrated region, it was perhaps the worst hit by the crisis. Each channel for the crisis to affect the continent has had a particularly nefarious impact. The decline in commodity prices, though a benefit to oil-importing countries, has led to a substantial decline in exports and government revenue for many commodity exporters. Even countries that saved their windfalls when prices were high suffered because their nonoil sectors are small and highly dependent on government spending.
Private capital flows, which had surged to record levels prior to the recession (and exceeded foreign aid to the continent) declined abruptly. African stock markets fell by an average of 40 percent, with some, such as that of Nigeria, falling by more than 60 percent. Workers' remittances, which had also been on the rise and had become a major source of growth for labor-exporting countries, also declined substantially. Only foreign aid continued to rise, but it remained well short of the commitments made by G-8 countries at the Gleneagles Summit in 2005, when the global economy was more robust. With mounting pressures in donor countries to stimulate their own economies and plan for fiscal consolidation, it could be expected that the volumes of aid they gave to Africa would be lower in the years ahead. Such developments were likely to slow their growth rates and derail progress toward the Millennium Development Goals.
Luckily, through a joint effort, the world has avoided the worst. Policymakers quickly understood the almost unprecedented scale and dangers of the crisis. Other post–World War II economic crises occurred either in some individual developing country or region (East Asia, Latin America, Mexico, or the Russian Federation) or in only one or two high-income countries (Japan, Sweden). Their impact was a small fraction of global GDP. This time, the crisis struck almost all advanced and developing economies at the same time, making it impossible for one country to escape high unemployment and large excess capacity through individual actions on monetary, exchange rate, or trade policies.
Thanks to the strong policy coordination of the G-20 countries, the world escaped another Great Depression. Policymakers responded swiftly and creatively to the crisis, using various instruments, including credible pledges to free trade, large-scale fiscal stimulus packages, very accommodative monetary policy, and decisive and often innovative support for the financial sector (liquidity provision, recapitalization, asset purchases, and guarantees on various types of assets and liabilities). The objectives were to cushion the direct effects of the credit crunch and financial turbulence on the developed economies and to reduce the virulence of the adverse feedback loop in which economic weakness and financial stress were mutually reinforcing.
The Bane of Excess Capacity
These swift actions by international financial institutions and governments prevented a global economic meltdown and buffered the impact of the crisis. But although the short-term effects of the policy response have helped the world economy avoid a depression, they have not addressed the underlying issues of heightened systemic risks, falling asset values, and tightening credit—which have taken a heavy toll on business and consumer confidence and aggravated a sharp slowing in global economic activity. Central bank provision of liquidity to banks and primary dealers has not always been very effective because, with large excess capacity in housing, construction, and, to a large extent, the manufacturing sector as well, the business environment in developed countries is dominated by concerns about capital, asset quality, and credit risk. These concerns limit the willingness of many intermediaries to extend credit, even when liquidity is available. As a result, the global recovery has been fragile. Moreover, growth is not expected to be fast enough to make big inroads into high unemployment and spare capacity. Besides, the downside risks have increased, not least those related to potential currency conflicts and the attendant risks of protectionism.
Indeed, the world has had a two-track recovery, and most high-income countries, which still constitute 70 percent of the global economy, continue to struggle with high unemployment, large excess capacity, towering public debts, slow growth, and volatile financial markets. In my view, the global crisis was triggered by the financial sector, but the main challenge for a sustained global recovery lies in the real sector. Excess capacity could have persistent negative effects on corporate profits, private-sector investment, and household consumption. And it could eventually render traditional monetary policies ineffective, especially in rich countries.
When capacity is underused, low interest rates may not stimulate private investment and consumption due to a lack of profitable investment opportunities and a lack of job security that hurts household consumption. Excess capacity also creates a vicious circle in financial markets: asset prices (real estate), private investment, and household consumption are likely to remain sluggish, so the excess capacity will persist. This dynamic puts additional downward pressure on asset prices and corporate profits and increases the volumes of nonperforming loans. In addition, wages in many industries are still flat or declining, further curtailing personal consumption. Deteriorating household balance sheets tend to add to the uncertainty. The wait-and-see attitude of investors and consumers may sustain the downward spiral in output decline in some large countries: the reduction in consumption due to the concerns about job security and low confidence about the future causes even more excess capacity.
The crisis-hit advanced countries need structural reforms in their labor markets, welfare systems, and financial institutions to regain competitiveness and dynamic growth. Structural reforms are recessionary in general and politically infeasible when excess capacity is large and unemployment is high in a country. The way out is not traditional monetary and fiscal policies but a large-scale, coordinated, global productivity-enhancing, bottleneck-releasing infrastructure program to create enough demand to absorb the excess capacity and space for structural reforms in advanced countries. I called this "Beyond Keynesianism" in a speech I gave at the Peterson Institute of International Economics in February 2009. Without it, the weak growth in advanced countries—known as the "new normal"—may persist. In the face of excess capacity, "cheap money" may not stimulate private demand. Instead, cheap credit will encourage speculative profit-seeking ventures and fuel the surge in some asset prices, notably in emerging markets, through carry trade and other short-term capital flows. Given the low profitability in the real economies of many countries, such surges may not be sustainable. Fiscal policy is indeed more promising if the challenges of rising debt are addressed. If governments and private-sector leaders can identify and make investments in key areas that present binding constraints to growth, the spending today will not only have a short-run effect of boosting demand and jobs—it may also pave the way toward a brighter future of sustained strong economic growth. That would help overcome the debt sustainability problem that may occur when a fiscal stimulus does not increase future productivity.
When the global crisis erupted, the World Bank, under the leadership of President Bob Zoellick, quickly formed a three-pillar package of crisis responses to help client countries: strengthening the social safety net to avoid a long-term adverse impact on the vulnerable, supporting small and medium enterprises for job generation, and investing in bottleneck-releasing infrastructure projects as countercyclical interventions. No matter how the global economy evolves, it is imperative for developing countries to continue their dynamic growth. Growth and jobs are essential for them to maintain social stability and reduce poverty today and to achieve their development aspirations in the future. If they can do so, they will also contribute to a sustained global recovery. How? The global crisis provides a good opportunity for the development community to rethink many tenets of economics and policy.
The Apparent Mystery of Economic Success
In the wake of global crisis, "rethinking" has been one of the most frequently used terms in the media and among professional economists. The Institute for New Economic Thinking, founded with an endowment from George Soros, held its inaugural conference, "The Economic Crisis and the Crisis in Economics," at Cambridge University in April 2010. Delighted to be one of the 200-plus participants from around the world, I observed that renowned economists, government officials, and journalists challenged much accepted wisdom in economics. I was also encouraged to see Olivier Blanchard, my counterpart at the International Monetary Fund, doing something many skeptics thought was impossible—showing humility on behalf of economists and acknowledging mistakes in judgment. He wrote: "It was tempting for macroeconomists and policymakers alike to take much of the credit for the steady decrease in cyclical fluctuations from the early 1980s on and to conclude that we knew how to conduct macroeconomic policy. We did not resist temptation. The crisis clearly forces us to question our earlier assessment."
Summarizing the long-standing conventional wisdom, he also observed: "We thought of monetary policy as having one target, inflation, and one instrument, the policy rate. So long as inflation was stable, the output gap was likely to be small and stable and monetary policy did its job. We thought of fiscal policy as playing a secondary role, with political constraints sharply limiting its de facto usefulness. And we thought of financial regulation as mostly outside the macroeconomic policy framework." Other prominent researchers such as Akerlof (2009), Krugman (2009), and Stiglitz (2009) have also questioned some fundamental tenets of mainstream macroeconomics, notably the assumption that competitive markets are enough to produce strong business incentives, efficient outcomes, and wealth.
In the domain of development economics, which became a field of research only after World War II, the failure of several waves of theories to provide successful policy prescriptions has been even more obvious. To be sure, development economics has provided us with some remarkable insights. But as a subdiscipline of economics, it has so far been unable to provide a convincing intellectual agenda for generating and distributing wealth in poor countries, evidenced by the persistence of poverty in many parts of the world.
Several decades from now, when economic historians look back on the story of the past 100 years, it is very likely that they will be more intrigued by the mystery of diverging performances by various countries, especially in the second half of the twentieth century. They will be amazed by the rapid-growth path followed by a small number of countries such as Brazil, China, India, Indonesia, the Republic of Korea, Malaysia, Mauritius, Singapore, Thailand, and Vietnam, where the industrialization process quickly transformed their subsistence agrarian economies and lifted several hundred million people out of poverty in a single generation.
Even more perplexing may be the unusual intellectual route that many of these successful countries followed: few, if any, actually adopted the dominant policy prescriptions of the time. Leaving aside the United States, which ranks third, the four most populous countries (Brazil, China, India, and Indonesia), have made great strides, averaging annual growth rates well over 6 percent a year. That vastly improved the standards of living for more than 40 percent of the world's people. The same is taking place in other South American countries (Chile, Colombia, and Peru) and in some African countries (Ethiopia, Ghana, and Mauritius). These countries hardly adopted standard recommendations from prevailing development theories.
But future economic historians will be puzzled by the apparent inability of many other countries, with more than one-sixth of humanity (the "bottom billion," as Paul Collier famously put it), to escape the trap of poverty. They will also notice that, except for the few successful economies, there was little economic convergence between rich and poor countries before the global crisis erupted in 2008—this despite the many efforts of developing countries and the assistance of many multilateral development agencies. Also puzzling may be the realization that some countries grew from low to middle incomes but have stayed there for decades, if not centuries. Argentina, the Philippines, Russia, South Africa, and the Syrian Arab Republic are well-known examples of countries caught in the "middle-income trap," with growth slowing after they reach a certain income level.
How can we make sense of economic success—or failure? Economists have conjectured about that seminal question for centuries—most recently with the help of the Growth Commission Report. But beyond a consensus on broad principles and a rejection of one-size-fits-all approaches, economists still have trouble identifying actionable policy levers directly relevant to specific countries.
The global financial and economic crisis confirmed the observation that countries with sustained high rates of growth have also performed well despite the global meltdown. With its heavy human, financial, and economic costs, the crisis provides a unique opportunity to reflect on knowledge from several decades of growth research and development thinking, draw policy lessons from successful countries, and explore new approaches going forward. In a more global world where fighting poverty is not only a moral responsibility but also a strategy for confronting some of the major problems that ignore boundaries and contribute to global insecurity (diseases, malnutrition, insecurity, violence), thinking about new ways of generating and sustaining growth is a crucial task for economists.
Taking Einstein's Joke Seriously: A New Structural Economics
Albert Einstein once joked: "Theory is when you know everything but nothing works. Practice is when everything works but nobody knows why. We have put together theory and practice: nothing is working ... and nobody knows why!"
As strategies for achieving sustainable growth in developing countries are being reexamined in light of the global crisis, it is critical to refocus development research efforts on the nature of economic development, which, from what I see, is a process of continuous structural change including not only industrial and technological upgrading and economic diversification but also changes in employment structure (with labor moving into high-productivity sectors) and changes in "hard" (tangible) and "soft" (intangible) infrastructure. The economic literature has devoted much attention to technological innovation but not enough to these equally important issues.
Excerpted from The Quest for Prosperity by Justin Yifu Lin. Copyright © 2012 Justin Yifu Lin. Excerpted by permission of PRINCETON UNIVERSITY PRESS.
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Meet the Author
Justin Yifu Lin is founding director and professor of the China Centre for Economic Research at Peking University. From 2008 to 2012, he served as chief economist and senior vice president of the World Bank. His many books include "Demystifying the Chinese Economy" and "Economic Development and Transition". He is a corresponding fellow of the British Academy, and a fellow of the World Academy of Sciences for the Developing World.
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