Chapter Five
Reforms and Growth
Outline
Chapter 5
Discusses the relationship between
unemployment and economic growth
Moves on to review some obstacles to
economic reforms and growth
Concludes by discussing the prospects of
continued growth-friendly reforms
around the world
Reforms and Growth
Those who want and intend
To wake and comprehend
Will muster a thousand means.
EINAR BENEDIKTSSON
There is practically no limit to what you can
accomplish in politics as long as you don’t
care who gets the credit.
HARRY S. TRUMAN
Reforms and growth
Smith, Mill, and Marshall seem to have got it right.
Lasting economic growth is available to those who:
save and
invest enough of their national income
use their resources as efficiently as possible through
free trade
low inflation
private enterprise
good education
export diversification away from excessive
dependence on natural resources
Reforms and growth
The collapse of communism
coincided with the beginning of the endogenous-growth
revolution
Theory and experience paved the way
market-friendly economic and institutional reforms
generally good for growth
Not a question of right and left. Rather,
a question of what economic theory and
empirical evidence can teach us about
the sources of economic growth
Important
issues are
left open
for political
judgement
Reforms and growth
The economic collapse of Uganda
Correlation between economic performance and
politics
Economic stagnation or even collapse is sometimes
the consequence of economic policies, attitudes, and
institutions
Uganda:
Fig 5.1
Real per capita GDP, 1970-1995,
Uganda shillings (1990 prices)
130000
120000
110000
Amin
Museveni becomes
president
100000 takes power
90000
80000
70000
Amin overthrown
60000
1970
1975
1980
1985
1990
1995
Unemployment and growth
Unemployment as another kind of inefficiency
Is unemployment thus an impediment to economic growth?
Trade liberalization increases output at full employment and a
given stock of capital
Stabilization increases the amount of output produced by a given
stock of total, i.e. real and financial, capital at full employment
Privatization increases the quantity and quality of the output that
can be squeezed out of given inputs at full employment
Education is good for growth
Efficiency = amount of output
produced per unit of capital
Unemployment and growth
The stimulus to economic growth from a reduction or
eradication of unemployment is different from increased
growth through increased efficiency
Existence of unemployment violates assumption of full employment
Two possibilities:
I. output decreases because of increased unemployment
output per unit of capital also falls if the capital stock remains
unchanged
II. output decreases less than employment
Increased unemployment is generally inimical to
economic growth, but ...
Unemployment and growth
... full employment is not
necessarily good for
growth
‘creative destruction’
Unemployment and growth
The case of the former Soviet-Union
The case of Ireland
radical transformation of the Irish economy
Rigidity of European labour markets
centralized wage bargains
detailed regulations
Unemployment and growth
Flexibility of labour markets in the USA
American labour markets are more conducive to
job creation than European labour markets
... but at the cost of a less even distribution of
income in America than in Europe
Unemployment and growth
Europe vs. East Asia
Labour markets in East Asia are more flexible and
less centralized than in Europe
Since 1980 unemployment in East Asia has
generally been lower than in Europe
In flexible labour markets wage claims accord
more closely with productivity developments
Advantages of efficiency through
non-intervention by the State are no
smaller, and no less tangible, in
labour markets than in other markets
Unemployment and growth
Flexible labour markets seem to have contributed
significantly to East Asia’s rapid economic growth
over the past 30 years
Efficiency and flexibility are not, however, the sole
desirable attributes of labour market
arrangements
There is also a basic human need for a fair
system of social security including unemployment
insurance designed to fend off the worst social
and economic ramifications of economic shocks
Unemployment and growth
Unemployment and
economic growth: no
simple, all-encompassing
relationship between the two
The European Union
The
connection
between
jobs and
growth
needs to be
assessed
case by
case
Unemployment results in large
measure from deep-seated inefficiency
through lack of flexibility in labour
markets, and causes economic waste
and social misery
Ireland, Russia, and Chile
Temporary joblessness can sometimes be a natural
consequence of necessary structural change
Africa and Latin America
Widespread unemployment is a mixture of both phenomena
Some obstacles to
reforms and growth
Why do growth-friendly reforms
often fail to be implemented?
Why do many countries fail to grow
as fast as they could?
Future gain from reforms vs.
present pain
Democracy is good for
growth and conversely
… better political leadership
and better governance
Some obstacles to
reforms and growth
Fear of unemployment in the wake of
economic reforms
Instinctive fear of change
The experience of the countries of Central
and Eastern Europe in the 1990s
Economic and institutional reforms - liberalization,
stabilization, privatization - accompanied by a
substantial decrease in recorded output,
followed by recovery
Intergenerational conflict of interest
Central and Eastern Europe and
the Former Soviet Union:
The Path of Output 1989-1997
Fig 5.2
110
1989 = 100
100
90
80
70
Central and Eastern Europe and
the Baltic States
60
Commonwealth of Independent
States
50
1989
1990
1991
1992
1993
1994
1995
1996
1997
Some obstacles to
reforms and growth
Conflict between those who stand to gain
from reforms and those who lose
The example of free trade
Common Agricultural Policy (CAP)
extremely resistant to reform
The costs and benefits of economic reforms
are almost always unevenly distributed
Losses are confined to relatively few, while gains
accrue to many
special interests vs. public interest
Some obstacles to
reforms and growth
It pays special interest groups to
organize themselves well
Farmers’ organizations are typically
strong, while consumers’ organizations
are weak
The importance of conflict
resolution
One of the prime purposes of
growth-friendly economic and
institutional reforms is generally
to uproot, or at least reduce,
economic privileges
In the long run,
a rising tide
lifts all boats
Some obstacles to
reforms and growth
The theory of public choice
Politicians viewed like consumers,
businessmen, and other economic
agents
Likely to stack the cards even further
against reforms and rapid growth by
increasing the probability of all manner
of collusion of vested interests at public
expense
In conclusion
Much progress in economic policy around
the world in the 1990s
Growth-friendly reforms widely
embraced
among ordinary people and politicians across
the political spectrum
But progress tends to be slow - Why?
Imperfect information
Protectionism
Common Agricultural Policy of the European Union
In conclusion
‘Reformers have the idea that change can
be achieved by brute sanity’
George Bernard Shaw
To grow or not to grow
is in large measure a
matter of choice
Questions for review
1. ‘Liberalization and decentralization of European labour
markets would reduce unemployment in Europe at the cost of
increased wage dispersion without any effect on economic
growth over time.’ Do you agree? Explain why or why not.
2. ‘High unemployment is always and everywhere a sign of
economic inefficiency, which inhibits economic growth in the
long run.’ True or false? Why?
3. Take a country of your choice and outline the main economic
and institutional reforms that you think would improve the
country’s growth performance in the long run. In your view,
what are the main obstacles to the implementation of the
growth-promoting reforms that you advocate?
Classroom discussion