> ------- Forwarded Message Follows ------- > > Government as a Complement to Markets > So far I have been discussing the ways in which the Washington > Consensus on the issues of macroeconomic stabilization, financial > reform, liberalized trade, and privatization, was insufficient. It > contained important elements but in many ways does not go far enough > in promoting issues like financial sector reform and competition > policy. The next issues I am going to discuss are vital questions that > the Washington Consensus did not even address ( or underemphasized). > The first set of issues concern what the government should do and the > second how it can what it does more effectively. For much of this > century people have looked to government to do more - spend more and > intervene more. Government spending as a share of GDP has grown with > these demands. The Washington Consensus policies I have discussed were > based on a rejection of the state's activist role and the promotion of > a minimalist, non-interventionist state. The unspoken premise is that > governments are presumed to be worse than markets. Therefore the > smaller the state the better (i.e. less bad) the state. As should be > clear from my remarks, I do not believe in blanket statements like > "government is worse than markets". I have argued that government has > an important role in responding market failures, which are a general > feature of any economy with imperfect information and incomplete > markets. The implication of this view is that the task of making the > sate more effective is considerably more complex than just shrinking > its size. Typically the state is involved in too many things, in an > unfocused manner and as a result is less effective than it might be. > The success of an organization depends on focus. Trying to get > government better focused on the fundamentals - economic policies, > basic education, health, roads, law and order, environmental > protection - is a vital step. But focusing on the fundamentals is not > a recipe for minimalist government. The state has an important role to > play in appropriate regulation, industrial policy, social protection > and welfare. The choice should not be whether the state should or > should not be involved. Instead, it is often a matter of how it gets > involved. More importantly, we should not see the state and market as > substitutes. I would like to argue that the government should see > itself as a complement to markets, undertaking those actions that make > markets fulfill their functions better - as well as correcting market > failures. We have already discussed one important instance, in the > financial sector, where, without appropriate government regulations, > the sector simply does not function well (see also Stiglitz 1993). > Countries with successful economies also have governments that are > involved in a range of other activities. In some cases, an argument > can be made that the government has proven to be an effective catalyst > - its actions help solve the problem of undersupply of (social) > innovation. But once it has performed its catalyst role, it needs to > withdraw. Thus, in the United States, the government established a > national mortgage system, which has lowered borrowing costs and made > available mortgages to millions of Americans - leading to one of the > highest home ownership rates in the world. But having done this, it > may be time for this activity to be turned over to the private sector. > In the limited amount of time available today, I cannot review all, or > even the most important areas in which government can serve as an > important complement to markets. I shall discuss briefly only two, one > in which there is little disagreement about the paramount role of > government, but in the other of which attracts less attention. > > Human capital > The role of human capital in economic growth has long bee appreciated. > Studies have found that the returns to an additional year of education > in the United States, for instance, are between 5 and 15 percent. > Growth accounting also attributes a substantial portion of growth in > developing countries to human capital accumulation. The East Asian > economies, for instance, emphasized the role of government in > providing universal education, which was a necessary part of their > transformation from agrarian to rapidly industrializing economies. > Left to itself, the market will tend to under provide human capital. > It is very difficult to borrow against the prospects of future > earnings since human capital itself is not collaterizable. These > difficulties are especially severe for less wealthy families. The > government plays an important role in providing public education, > using other methods to make education more affordable and enhancing > access to funding. > > The transfer of technology > Studies of the returns to research and development in industrial > countries have consistently found individual returns in the range of > 20 to 30 percent and social returns of 50 percent or even higher - far > exceeding the returns to education (Nadiri 1993). Growth accounting > usually attributes the majority of per capita income growth to > improvements in total factor productivity - Solows's (1957) pioneering > analysis attributed 87.5 percent of the increase in output per man > hour between 1909 and 1949 to technical change. Based on a standard > Cobb-Douglas production function, Korea's per capita income in 1990 > would only have been $2,041 (in 1985 international dollars) if it had > relied solely on capital accumulation. In reality, its per capita > income was $6,665, three times higher. The difference comes from > increasing the amount of output per unit of input, which partly is the > result of improvements in technology. The case that, by itself, the > market under provides technology is even more compelling than the case > for education. Investments in technology are subject to the similar > financing problems as education because the investment cannot be used > as collateral. Investments in R&D are also considerably more risky and > open up much more serious adverse selection problems. More > importantly, technology has enormous externalities. Knowledge is like > a public good - you cannot exclude others from enjoying the benefits > (non-excludability) and my consumption does not diminish your ability > to consume it (non-rivalrous). As one of the America's great > Presidents, Thomas Jefferson, once said: ideas are like a candle, you > can use them to light other candles without diminishing the original > flame. As such, the benefits to society of increased investment in > technology far outweigh the benefits to individual entrepreneurs. > Without government action there will be too little investment in the > production and adoption of new technology. For most countries not at > the technological frontier, facilitating the transfer of technology > has much higher returns than original research and development. > Policies to facilitate the transfer of technology are thus one of the > keys to development. One aspect of these policies is investing in > human capital, especially in tertiary education. The argument for > funding universities is not just the provision of human capital to > particular individuals, but the major externalities that come from > enabling the economy to import ideas. Of course, many developing > countries have high unemployment rates for university graduates, and > have many more university graduates employed by unproductive civil > service jobs. These countries have probably overemphasized liberal > arts educations. In contrast, Korea has narrowed the productivity gap > with the lead countries through the training of scientists and > engineers. Another policy that can promote the transfer of technology > is foreign direct investment. Singapore, for example, was able to > assimilate rapidly the knowledge that came from its large inflows of > foreign direct investment. Finally, I would like to note briefly that > policies adopted by the technological leaders matter also. There can > be a tension between the incentives to produce knowledge and the > benefits from more effective dissemination. In recent years many - > including small firms in developed countries, the academic community > throughout the world, and many in developing countries - have become > concerned that the balance developed countries have struck, often > under pressure from special interest groups, underemphasizes > dissemination. The consequences, they argue, may slow both the overall > pace of innovation and adversely affect living standards in both > richer and poorer countries. > > Making Government More Effective > Let me return for a moment to our objective of this part of the talk: > how do we design policies that increase the productivity of the > economy? I have stressed that we should not confuse ends with means; > that the elements stressed by the Washington Consensus may have been > reasonable means for addressing the particular set of problems > confronting, say, the Latin American economies in the 1980s, but they > may not be the only, or even the central, elements of policies aimed > at addressing the problems in other circumstances. Part of the > strategy for a more productive economy that I have just stressed is > ascertaining the appropriate role for government: identifying, for > instance, the ways in which government can be a more effective > complement to markets. I now want to turn to another essential element > of public policy: how we can make government more effective in > accomplishing whatever tasks it undertakes. This year's World > Development Report shows that an effective state is vital for > development (World Bank 1997c). Using date from 94 countries over > three decades, we show in our Report that it is not just economic > policies and human capital, but the quality of a country's > institutions that determine economic outcomes. They, in effect, set > the overall environment under which the markets operate. A weak > institutional environment allows greater arbitrariness on the part of > state agencies and public officials. Given very different starting > points, very unique history, culture and societal factors, how does on > make the state more effective? Part of the answer is that the state > should match its role to its capability. What the government does, and > how it does it, should obviously reflect the capabilities of the > government - and those of the private sector. Low-income countries > often have weaker markets and weaker government institutions. It is > especially important therefore that they focus on how they can most > effectively complement markets. But capability is not destiny. States > can improve their capabilities by reinvigorating their institutions. > This does not mean merely building administrative or technical > capacity. But more importantly, it means instituting rules and norms > that provide state officials with incentives to act in the collective > interest while restraining arbitrary action and corruption. Five > interrelated mechanisms can help to enhance state capability: > > · First, rules and restraints are crucial for a professional and > capable bureaucracy. An independent judiciary, institutional checks > and balances through the separation of powers, and effective watchdogs > can all restrain arbitrary state action and corruption. · Second, the > civil service itself needs to be more effective, offering competitive > wages to attract talented people. · Third, state capability can also > be enhanced through voice and partnerships by bringing the government > close to the people and by seeking stakeholder feedback in policy > making and service delivery. · Fourth, there are ways in which > governments can improve their efficiency and efficacy by using > market-like mechanisms in the public sector. For instance, designing > and using performance standards, establishing incentive systems based > on performance standards, employing auctions for procurement and > selling public assets, such as spectrum licenses, and using > performance standards for regulations in areas like environment and > safety. · Finally, the state needs to adopt policies that reduce the > scope for rent seeking. Market mechanisms, like auctioning of natural > resources or spectrum allocations, is one way to reduce the private > sector's incentive to push for artificial creation of scarcity. In > addition, curtailing discretionary activities - like licensing and > trade restrictions - also reduces rent seeking. > > BROADENED GOALS OF DEVELOPMENT > > The Washington Consensus advocated a set of instruments (including > macroeconomic stability, liberalized trade, and privatization) to > achieve a relatively focused goal (economic growth). The > post-Washington Consensus begins by recognizing that a broader set of > instruments are necessary to achieve those goals. I have discussed > some of the most important instruments, including financial > regulation, competition policy, investments in human capital, and > policies to facilitate the transfer of technology. The second theme of > my remarks is that the post-Washington Consensus also recognizes that > our goals are much broader. We seek increases in living standards - > including improved health and education - not just increases in > measured GDP. We seek sustainable development, which includes > preserving our natural resources and maintaining a healthy > environment. We seek equitable development, which ensures that all > groups in society enjoy the fruits of development, not just the few at > the top. And, we seek democratic development, in which citizens > participate in a variety of ways in making the decisions which affect > their lives. Knowledge has not kept pace with the proliferation of our > goals. We are only beginning to understand the relationship between > democratization, inequality, environmental protection, and growth. > What we do know holds out the promise of developing complementary > strategies that can move us toward all of these objectives. But we > must recognize that given our highly multi-dimensional objective space > not all policies will contribute to all objectives. There will be > tradeoffs and hard choices. We need to improve our understanding of > these inevitable tradeoffs if we are going to be able to make more > informed choices in the future. I would like to illustrate this by > discussing four policy areas, two in which policies can achieve > complementary goals and two of which inevitably entail tradeoffs. > > Complement 1: Education > Promoting human capital is one example of a complementary policy, one > that can help promote economic development, equality, participation, > and democracy. Again the East Asian experience contains important > lessons. I have already discussed the role of education in promoting > human capital and growth. In East Asia, universal education also > created a more egalitarian society, facilitating the political > stability that is a precondition for successful long-term economic > development. Furthermore education - especially an education which > emphasizes critical, scientific thinking - can help train citizens to > participate more effectively and more intelligently in public > decisions. > > Complement 2: Environment > A second set of ways in which a single instrument can help achieve > multiple goals comes from environmental policy. I am going to focus > specifically on joint implementation of carbon reduction. In order to > minimize global climate change, the world needs to devise strategies > to reduce the production of greenhouse gasses, especially carbon > dioxide which is produced primarily by combustion. The reduction of > carbon emissions is truly a global problem. Unlike air pollution > (associated with SO2 or Nox), which primarily effect the polluting > country, all carbon emissions enter the atmosphere, producing global > consequences that are independent of their geographical origin. Joint > implementation gives developed countries (or companies within them) > credit for emissions reductions, that they would not otherwise have > undertaken, anywhere in the world. It may be a feasible first step > towards designing an efficient system of emission reductions because > it only requires commitments from developed countries, and therefore > does not entail resolving the huge distributional issues involved > either in systems of tradable permits or the undertaking of > obligations by developing countries. The premise of joint > implementation is that the marginal cost of carbon reductions may > differ markedly in different countries. In particular, developing > countries are typically less energy efficient than developed > countries. As a result, the marginal cost of carbon reduction in > developing countries may be substantially lower than in developed > countries. The World Bank has offered to set up a carbon investment > fund that would allow countries and companies that needed to pursue > emissions reductions to invest in carbon-reducing projects in > developing countries. For developed countries, this plan would offer > increased investment flows and pro-environment technology transfers. > These projects would also be likely to reduce the collateral > environmental damage caused by dirty air. And for developed countries, > joint implementation allows them to reduce carbon emissions at a lower > cost. This is a strategy which is designed to benefit the developing > countries as it improves the global environment. > > Tradeoff 1: Investments in Technology > Not all policies are like investing in primary education or jointly > implementing emissions reduction. Many policies entail trade-offs. It > is important to face these tradeoffs and make choices about > priorities. Concentrating solely on "win-win" policies can lead policy > makers to ignore important decisions about "win-lose" policies. One > important example of a potential tradeoff I am going to discuss is > investments in technology. Earlier I discussed the way investments in > tertiary technical education promote the transfer of technology and > thus economic growth. The direct beneficiaries of these investments, > however, are almost inevitably better off than average. The result is > likely to be rising inequality. More generally, the transfer of > technology may even increase inequality. Although some innovations > benefit the worst off, much technological progress raises the marginal > products of those who are already more productive. Even when it does > not, the opportunity cost of public investment in technology might be > foregone investment in anti-poverty programs. By increasing output, > however, these investments can benefit the entire society. The > potential trickle down, however Is not necessarily rapid or > comprehensive. > > Tradeoff 2: Environment and Participation > The second example of a tradeoff I would like to discuss is between > environmental goals and participation. We now recognize that > participation is essential. But while participation is essential, we > should not be confused: participation is not a substitute for > expertise. Studies have shown, for instance, that popular views on the > ranking of various environmental health risks are uncorrelated with > the scientific evidence (Environmental Protection Agency 1987 and > Slovic et al 1993). In pursuing environmental policies, do we seek to > make people feel better about their environment, or do we seek to > reduce real environmental hazards? There is a delicate balance here, > but at the very least, more dissemination of knowledge can result in > more effective participation in formulating more effective policies. > > CONCLUDING REMARKS > > I would now like to make some concluding remarks. The goal of the > Washington Consensus was to provide a formula for creating a vibrant > private sector and stimulating economic growth. In retrospect the > policy recommendations were highly risk averse - they were based on > the desire to avoid the worst disasters. Although the Washington > Consensus provided some of the foundations for well-functioning > markets, it was incomplete and sometimes even misleading. The World > Bank's East Asian miracle project was a significant turning point in > the discussion. It showed that the stunning success of the East Asian > economies depended on much more than just macroeconomic stability or > privatization. I have explicitly discussed the "Lessons of the East > Asian Miracle" elsewhere (Stiglitz 1996), but the general ideas have > pervaded all of my remarks today. Without a robust financial system - > which the government plays a huge role in creating and maintaining - > it will be difficult to mobilize savings or to allocate capital > efficiently. Unless the economy is competitive, the benefits of free > trade and privatization will be dissipated in rent seeking, not > directed toward wealth creation. And if public investments in human > capital and technology transfers is insufficient, the market will not > fill the gap. Many of these ideas, and more still that I have not had > time to discuss, are the basis of what I see as an emerging consensus, > a post-Washington Consensus. One principle of these emerging ideas is > that whatever the new consensus is, it cannot be based on Washington. > In order for policies to be sustainable, they must receive ownership > by developing countries. It is relatively easier to monitor and set > conditions for inflations rates and current account balances. Doing > the same for financial sector regulation or competition policy is > neither feasible or desirable. The second principle of the emerging > consensus is a greater degree of humility, the frank acknowledgment > that we do not have all of the answers. Continued research and > discussion not just between the World Bank and the International > Monetary Fund, but throughout the world is essential if we are to > better understand how to achieve our many goals. > > ENDS
