Monday, October 10, 2011

A Strategy for Development - Nicholas Stern

After joining the World Bank as Chief Economist and Senior Vice-President, Nicholas Stern published A Strategy for Development, which deploys the vision of the World Bank during the last decade.

Development and development assistance have been perceived in different ways since World War II. Originally, it was thought that creating infrastructure would be enough to unchain the economic forces of developing countries: a bridge over there, and a dam in the next river, would be enough to bring prosperity and higher standards of living across the World. The problem with that was that developing countries contracted tremendous amounts of debt (with the World Bank, obviously) and eventually went bankrupt (the World Bank obviously refinanced their loans). In the 1980s, the focus of development moved from the microfoundations of a sound infrastructure to the macroeconomics: discipline in fiscal and monetary policy, in addition to an open capital account, would tame inflation, attract foreign investment, and would allow mrkets to clear, creating employment. The problem with that was that austerity was not popular within the population, and that developing countries did not have the technical skills or the political weight to survey capital account movements.

At the end of the XXth century, it became evident that a combination of a state that could address market failures with somewhat efficient markets would alleviate poverty across the World.  Creating the legal and economic infrastructure that would avoid the excesses of the sixties and crowd in the private sector became the priority of the development community. Terms like "governance" or "smart state" became common places and attractive funding projects in Washington. Two natural experiments were hailed as examples of what the right mix of state and markets could achieve in terms of poverty reduction: India and China, both of which did more to alleviate poverty and inequality than the rest of the World during the eighties and nineties, most of the time disregarding the policy advice of the World Bank.

A Strategy for Development is an argument in favor of having a strong and smart state that could create the conditions for business development. There were two problems with this argument: the first is conceptual: having a smart state sounds great and of course it would help enormously to alleviate poverty. The problem is that having a state that avoids capture, cronyism, and delivers infrastructure, and provides rule of law at the same time, is a characteristic of a developed country. A country does not become developed by creating a smart state; in fact, a country has a smart state because it is developed. The classical egg and chicken problem, or to put it in economic terms, the causality determination problem.

The second problem is probably more important in practical terms. Stern has a blind faith on small and medium enterprises (SMEs) as engine of growh. The problem with the argument is that it rests on the premise that small is beautiful. That is wrong. SMEs have a structure of costs that make them inefficient and not prone to innovation. SMEs are important as long as they are allowed to grow and, eventually, become huge conglomerates that trade in the stock markets.

The World Bank is now in the middle of an intellectual crossroads: we have liberalized trade and the capital account, and the problem of poverty is still prevalent (we could liberalize migration, but rich countries do not like that idea). In addition, it is becoming evident that governance sounds fantastic as a concept (I mean, once you define it), but getting good governance is the final part of the development process, not the first one.

Now that everyone likes to be alternative, some Bank economists actually play with some ideas that used to be anathema until recently: maybe property rights actually hinder industrial development in developing countries; probably natural resources conservation is great for tourists from developed countries, but people in the field would actually benefit from harvesting corn or commercial crops. Governance might be great, but rich countries had terrible governance until after World War II: the political process of the United States was co-opted by corporations most of the first half of the XXth century; London was an awful place to live in the XIXth century, just like Ciudad Juárez or Islamabad today. Getting governance right might actually take some centuries and needs to be a bottom-up process...

By the time Nicholas Stern left the World Bank, the institution created a set of indicators dedicated to evaluate governance and ease of doing business. The governance indicators used to be the flagship of the World Bank, but are now forgotten and underfunded for political reasons (basically, African countries do not like to be in the last places). The doing business indicators are loved by governments of developing countries, which use these metrics as an excuse to promote vested interest of the corporate sector.

Nicholas Stern eventually authored a famous report on climate change.

Sic transit....

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