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Tuesday, September 13, 2005

The Washington Consensus: "Ideology, not Analysis"

Brad DeLong discusses a fascinating debate between a Harvard economist and a Yale economist about the sources of India's remarkable growth. A common view is that India's growth acceleration is due to the neoliberal reforms that began in 1991: free trade, lowering tariffs, deregulating business, rolling back the "license raj," and so on.

A typical purveyor of this view is Thomas Friedman, according to Harvard's Dani Rodrik and the IMF's Arvind Subramanian. They quote a Friedman interview with a prominent Indian industrialist, who described "the cumbersome bureaucratic rules and pervasive state ownership that suffocated the Indian private sector," until the 1991 reforms, when "Our Berlin Wall fell."
It was like unleashing a caged tiger. Trade controls were abolished. We were always at 3 percent growth, the so-called Hindu rate of growth--—slow, cautious, and conservative. To make [better returns], you had to go to America. Well, three years later [after the 1991 reforms] we were at 7 percent rate of growth.
As Rodrik and Subramanian point out in a compelling paper, the problem with this story is that India's growth in the 1980s wasn't at all slow. In fact, it was just as rapid as it's been since 1991. India's growth miracle began around 1980, long before the neoliberal "Washington consensus" reforms.

The Yale economist, critiquing the Harvard study, doesn't deny that the growth takeoff began long before the 1991 reforms, but argues that India's growth in the 1980s wasn't sustainable because it was driven by an expansion of the public sector. I think the Harvard side rebutted the "growth due to unsustainable deficits" theory in the original paper*, and I won't try to summarize the whole debate.

But I was particularly struck by just how weak some of the "unsustainable growth" arguments really are, despite having apparently gained widespread acceptance, from Friedman's spot on the Times' op-ed page to the hallowed halls of Yale.

The Yale guy says that India's expansion was "fueled by" the expansion of government, including "real wage expansion in the public sector." If you read his footnote, you learn that public sector wages grew a factor of 3.45, while prices grew by a factor of 2.37 during the 1980s. Do some division and take a 10th root, and you find that real government wages grew by 3.8% per year. Is that fast or slow? Well, in the economy as a whole, labor productivity growth was also just about 3.8% per year in the 1980s! (Rodrik and Subramanian Table 1).

So India's bureaucrats were just keeping up with their private sector counterparts! Wage increases just sufficient to keep pace with economy-wide productivity gains are hardly evidence of expanding government. So this Yale argument seems truly lame.**

With academic understatement, Rodrik and Subramanian nicely sum up the problem with their critics:
We suspect that there is a tendency to dismiss the growth of the 1980s because it makes the subsequent reforms less impressive ("since the system was not reformed, any growth that came out should have been unsustainable--—i.e., bad growth"). But that would be just ideology, not analysis.


* Rodrik and Subramanian point out that the only way that "Keynesianism run amok" could cause the India's huge surge in productivity during the 1980s is by putting unused resources to work: raising capacity utilization in factors and lowering unemployment. But that didn't happen, they argue, at least not on a large enough scale to explain much of the productivity acceleration.

** This is just econ 101 stuff. The "law of one price" predicts that wages will tend to rise at the rate of economy-wide productivity. If private sector productivity and wages are rising, public sector wages have to rise too, even if government productivity isn't increasing. If public sector wages don't rise, bureaucrats will quit their government jobs and get higher-wage jobs in the private sector, as middle management in a factory, say. So basic economics predicts that public sector wages will tend to keep up with private sector wages, assuming the government doesn't want to see all its best workers leave.

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