Pathways to Development: What We Know and Don't Know
By: Raj Nallari and Shahid Yusuf
Development is about welfare enhancing transformation through economic, social, political, and technological progress. Transformation is predicated on per capita income growth but development is also about progress in reduction of poverty and inequality, individual capabilities, access to social services, and quality of life. Both growth and development are also predicated on distributive politics of how a society is able to deal with vested interests and social conflicts.
During past sixty years, growth spurts have occurred in most countries but generally outcomes have fallen short of expectations. Developed economies have averaged growth rates of 2.4 percent during 1990 and 2008 while developing economies have collectively increased their GDP by an average of 4.7 percent over the same period. For low and middle income countries, physical capital is the principal determinant of growth, while for upper middle income and higher income economies total factor productivity was the most important driver. TFP is a catchall for other factors, which are human capital variously measured, and its quality; technological capability and innovation; managerial skills; organizational effectiveness; institutions affecting incentives, competition, allocative efficiency and governance; and the characteristics of urbanization.
The $1 a day poverty in developing countries declined from 40 percent of the population in 1981 to 18 percent in 2004. The reduction in absolute poverty has been greatest in China and India, countries registering some of the fastest growth rates. But some of the growth benefits have been undercut by rising inequality. Although global inequality changed little between 1980 and the early 2000s, inequality rose in 30 of the 49 countries for countries with data covering the 1990-2004 period.
At early stages of development, industrial sector spearheaded the growth and later the services took over in most countries. Industry remains the more productive and innovative of the two major sectors, with the share of agriculture in GDP everywhere shrinking into relative insignificance. The recent experience of India, Ireland and some of the smaller East European countries points to the growth potential inherent in tradable impersonal services and of software. For small economies, services led growth backstopped by investment in IT and skills is a real possibility and for large economies it can prove to be a valuable supplement to the impetus from other sectors.
Some countries, many in Africa and in the Middle East, have derived much of their growth from the development and export of natural resource based products whether minerals or agricultural commodities. In most instances, mineral (including energy) extraction has been paced by foreign investment and it has created enclave sectors generating few spillovers and loosely linked to the rest of the economy. Although natural resources can boost economic performance and supplement other sources of growth as for instance in Malaysia and Indonesia, large mineral resources have tended to inhibit industrialization, growth and development more generally for a number of reasons that have been labeled the "resource curse".
Although the bulk of demand derives from consumption followed by investment, most economies small and large have supplemented these with demand arising from trade. The smaller open and rapidly growing economies, have relied on net exports for as much as 40 percent of their growth with 20 percent being closer to the norm. Imports have played an almost equally important role because they are vehicles for technology transfer and contribute to technological catch-up. Thus, tradable goods and services mainly manufactures and resource based products, have underpinned the rapid growth of economies that were able to create a production base of sufficient size through domestic investment financed in large part from national savings.
Foreign direct investment in production facilities, infrastructure, and R&D has supplemented domestic investment and supplemented also the technology transfer through trade and the indigenous efforts at building innovation capacity. The contribution of FDI has rarely exceeded 3-5 percent of GDP, although in a number of the most successful economies, foreign investment catalyzed industrialization, helped to promote exports and upgrading of the product mix.
For the past three decades, growth has been powerfully aided by the integration of the global economy. In particular, trade liberalization and measures that have eased the flow of capital, the circulation of skills and the sharing of information, have stimulated economic performance directly and through a variety of externalities.
Last but not least, the recent economic growth is partially due to the incentives, innovations and productivity gains arising from a number of general purpose technologies (GPT). Two GPTs that have been at the forefront are the semi-conductor/IT technology and the Internet, each of which has spawned a host of productivity enhancing innovations.
Successful developers have emphasized to varying degrees five objectives in their pursuit of growth, all of which relate back to the drivers of TFP identified above. These are (i) creating a 'learning economy' so as to acquire skills, absorb ideas and technologies and lay the foundations for domestic innovation, and includes the schooling system and vocational training, tertiary education, research conducted in universities, public institutes and by domestic and foreign businesses, and the harnessing of digital intelligence with the help of a state-of-the-art IT network; (ii) stimulating entrepreneurship and organizational efficiency which is necessary for innovation and technology adoption. Entrepreneurship must be complemented by deep managerial skills in order to sustain business performance; (iii) Building institutions promoting competition and openness particularly to trade, foreign investment, and technologies; (iv) crafting the institutional infrastructure in a modern-complex economy to formulate, coordinate, implement and monitor a longer term strategy that satisfies the social partners of labor, business community, civil society and the government, while enlarging the administrative capacity of the state to effectively deliver essential services; and (v) internalizing these within an urban system that is conducive to spillovers and maximizes agglomeration economies. The focus of development is increasingly on the urban sector which is the more productive and innovative by a wide margin compared with the primary sector.
Each of these five determinants discussed above has an economic dimension and an overlapping political dimension. Does growth lead to political openness (civil and political liberties and democracy) or do open societies tend to grow faster? The broad categories of "democracy" and "'authoritarian" are not enough to analyze growth and development performance; the only thing one can say is that politically repressive governments tend to have much higher variance of per capita growth. Capturing the state is a typical objective, with affluent individuals or groups, private firms, or oligarchs attempting to shape the laws, public policies, rules and regulations of the state to their own advantage. This 'shaping' may be done not only by the private firms or richer elites but in some countries by ethnic groups or the military or even the bureaucracy.
The pathways to development are few and narrow and all too often political factors can constrain access and movement along these pathways. Successful development is predicated not just on a facilitating external environment and good policies but also domestic political dynamics that at a minimum are neutral towards development and ideally are highly supportive. Even weak states can develop if the politics are conducive and the business sector is powerfully motivated. By the same token, strong states have the power to hobble development if they are distracted by other objectives.