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Response to Dani Rodrik on Washington Consensus

Dani gives a response to some “counter-arguments” against his post favoring Import-substituting Industrialization (ISI) over Washington Consensus (WC) that had mysteriously “resuscitated” themselves after they “had long been laid to rest.” I appreciate Dani’s courtesy in not identifying the culprits in this misguided resuscitation of long-dead counterarguments, but it does make it a little difficult to carry on a precise debate. It’s possible that my post about skill vs. luck, and the comments that followed, may have been one of the culprits (fitting the theme of that post, this can only be a probability rather than a certainty).

Anyway, assuming that my post and ensuing comments was partly to blame (and thanks to Chris Blattman for a more favorable review), Dani does not have time in his short post to get to the crucial arguments. His original post was too vague about the timing and identification of just who had ISI and who had WC and when, and so what growth experiences to attribute to each, and whether to control for the overall fall in average growth of ALL countries in the world from the ISI to the WC period. And in Dani’s new post, we also have the third category of policy regime “unorthodox but well-targeted reforms” (UBWTR?) for Asian countries. And to test a hypothesis that growth under one regime is higher than under another, you have to calculate standard errors reflecting noise in the growth rate (affectionately called “luck,” which standard errors I and others have shown are large), you cannot dismiss standard errors with a quip about “the check is in the mail.” Most attempts to sort all that out have not been very successful or conclusive, which is why economists started saying things like:

the experience of the last two decades has frustrated the expectations …{that} we had a good fix on the policies that promote growth.

I will acknowledge from whom I think I absorbed this valuable cautionary statement. I am pretty sure it was from a 2005 article by a certain D. Rodrik (ungated version here, official version here).

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7 Comments

  1. Anon wrote:

    Standard errors do not give posterior probabilities and residuals are not luck.

    Posted June 23, 2010 at 2:51 pm | Permalink
  2. Tord Steiro wrote:

    Considering the effectiveness of policies in Latin America, I think it is more useful to look behind the scene of ISI vs WC, and look into the politics of the state.

    As first mentioned by Hernando de Soto in the case for Peru (the other path), there is a chance that LAtin American governments selected policies that would maximize their ability to create rents rather than gtowth.

    This corresponds fairly well with the recent theory outlined in Violence and Social Orders by North et. al.

    A debt crisis is probably a logic scenario following from natural state politics in an international setting where credit lines are plentiful and cheap. However, a change in the access to international credit will constrain natural state governments, lead to less rent creation, or, constant rent creation and a falling economy.

    This may, or may not, be logical or understandably spelled out, it’s just a thought that struck my head.

    Posted June 23, 2010 at 3:34 pm | Permalink
  3. Ted wrote:

    In addition to the argument you make I have a few separate points.

    At first Rodrick was comparing productivity under the “Washington Consensus” regime versus “ISI” regime and now he is saying in point 1 that the arguments about debt crises don’t apply because they were “macroeconomic imbalances.” Last I checked, the Washington Consensus endorsed flexible exchange rates and responsible fiscal policy. Fixed exchange rates and / or irresponsible fiscal policy were the primary causes of the debt crises – is that disputed? If he was talking about specific aspects of the Washington Consensus he needed to be more specific.

    Point #2 seems misguided as well. Policies are complementary. Let’s say you have a country that is going to become “fiscally responsible”, as the Washington Consensus (WC) suggests. Well, if they do that by jacking up marginal tax rates to very high levels and maybe even throwing in some tariffs, well, then the benefits of being fiscally responsible really aren’t going to show up in the data. I’m not saying that’s what happened, it’s just an example – but we can’t know that by looking at Rodrik’s analysis. That’s why I said I’d like to see what policies were implemented where and when. Blanketing every regime that did some of the reforms that the WC recommended as WC-policy countries ignores how various policies interact with one another. I don’t discount that some of the reforms in Latin America were quite positive (taming inflation chief among them), but I don’t think it’s unfair or “unjust” as he claims to question whether they really did pursue the type of policies recommended by the WC. I can even prove I’m not being unfair. One of the things the WC recommended was the removal of restrictions that impeded competition and entry. So, I decided to go back to Djankov et al’s paper “The Regulation of Entry” (the original 2000 paper, in case they updated their data when it was published, as it should capture the 1990s well). Here is a sample of the number of procedures needed to open a business in some Latin American countries: Panama (7), Uruguay (9), Argentina (12), Ecuador (12), Peru (14), Brazil (15), Mexico (15), Venezuela (15), Columbia (17), Bolivia (20). Now, let’s look at the cost of becoming operational as a share of GNP/capita: Panama (0.3105!!), Uruguay (0.0551), Argentina (0.2323), Ecuador (0.1553), Peru (0.2142), Brazil (0.6735!!), Mexico (0.5742), Venezuela (0.1107), Columbia (0.1244), Bolivia (2.6252!!!!!). This ignores the other procedures that are listed for labor, environmental, screening etc that are also burdensome in those countries listed (particularly “screening”). I, for example, see very little evidence that “barriers to entry” were reduced in any serious way that the WC proposed they do. I would be shocked if Rodrick seriously thought that by significantly reducing these barriers, as prescribed by the WC, that growth wouldn’t have been greater.

    On point #3. I think we have plenty of historical evidence that these type of policies have been successful. As I said above, policy interactions are likely very important. You can’t just do one policy and leave another extremely burdensome policy in place and expect everything to be great.

    Also, I don’t understand why Rodrick is picking time periods to compare when the underlying environment was quite different. You can’t pick and choose time periods like he did (should I compare U.S. growth in the 2000s and then compare our growth in the 1920s and then conclude what policies we should pursue?) without appreciation for the underlying economic climate. Economies were structurally changing even without ISI during that period and were quite different when these type of structural movements begun to slow in the late 1980s. You can’t compare these two different times and places. A more productive exercise is to compare countries of similar characteristics around the same time period and compare policies.

    I think Rodrick is a very talented economist, so it confuses me why he is resorting to such crude analysis as this.

    Also, my point of interacting policies would seem to be relevant for identifying “growth policies,” in regressions anyway. Let’s say you are trying to test whether reducing barriers to entry to starting a business prompts growth. But what about the corporate tax rate? If the corporate tax rate is too burdensome you won’t find a lot of benefit from reduction in entry barriers. Or does privatization of state enterprises help? Well, what if the country lacks the ability to efficiently and impartially enforce contracts, then the benefits will be limited. Of course, this also gets back to my critique of Rodrick that it’s silly to think one or two policy changes should promote growth when you most certainly need a combination of policies that complement one another. His analysis doesn’t allow us to determine whether there were counteracting policies that were canceling one another out.

    Maybe my critique is misguided and I’m wrong, but Rodrick’s data set doesn’t allow us to conclude either way.

    Posted June 23, 2010 at 4:34 pm | Permalink
  4. William Easterly wrote:

    Dear Anon,

    You’re right, my language was imprecise. What I should have said that the greater the importance of “luck” (or more generally, transitory shocks, which includes human actions like a one time spurt in growth due to an entrepreneurial break-through), the higher will be the standard errors of average growth rates for a period. This makes it more difficult to distinguish the effect of “growth-promoting” policies when comparing period averages.

    Posted June 23, 2010 at 5:47 pm | Permalink
  5. William Easterly wrote:

    Anon, actually I just reread it and saw I was too hard on myself. The word “luck” referred to the noise in growth rates, not the standard errors. Bill

    Posted June 23, 2010 at 5:54 pm | Permalink
  6. Tom D wrote:

    Dear Ted,

    I had a slightly different reading of Rodrik’s 2nd point. I think rather than absolutely saying WC policies were implemented across the board 100%, he is arguing that latin american leaders used a lot of political capital implementing WC policies – and there was a real and concerted effort – the ‘failure’ to successfully implement WC is the result of political variables that WC ideology does not account for (note that they are not implemented anywhere ‘fully’).
    So, the arguement goes, WC could never have been implemented because of political realities, hence the analogy with ‘communism didnt work because it was never tried’.

    Posted June 24, 2010 at 8:11 am | Permalink
  7. I may be a culprit too!!

    Dani,

    I reckon what you have done here is concoct the fiction of an improbable duel between mismatched straw men with severe wind distortion.

    #1 — Your original post did indeed omit the crucial fact that the culmination of ISI was economic crisis, the crisis that gave rise to neoliberal policy, namely Washington Consensus. In fact the single overriding reason for WC was the need to correct the crisis caused by activist ISI.
     
    WC was a technical-corrective response to ISI decay, like doctor and patient. It was not some free-floating ideological innovation.

    In fact there is no confusion at all. ISI produced BOTH price distortions and macro imbalances in Latin America and East Asia because countries in those regions ran up massive public debts and private debts to finance losses on ISI and to compensate for lack of competitiveness (e.g. due to price distortion) in ISI sectors.

    #2 — Yes WC tried hard, but also largely succeeded in its limited aim of post-crisis stabilization. Contrary to your implication, its longer run failure was rather a misunderstanding of, or shortfall in, the institutional component of structural adjustment. This failure of WC follow-through on institutional reform was the source of its non-sustainability and the subsequent *political* crises of neoliberalism.

    #3 — Actually the Asian growth successes were/are inherently unsustainable for the same institutional imperatives that caused British and USA proto-activism in the nineteenth century to be tempered and replaced (discontinuously) by liberalism in the twentieth century. Asian liberalism is the twenty-first century task.

    My argument is that there is a one-size-fits-all development model called ‘capitalism’. The recipes for pasta are essentially all the same, all that differs is the sauce on top.

    Counter-arguments against your neoactivist counterrevolution against the neoliberal counterrevolution are set out clearly in my book published last year — called Capitalism, Institutions, and Economic Development — which includes a chapter on the relevant Latin American story and comments on your book.

    Actually between 2003 and 2006 I tried to get your publisher Princeton interested in my book about the universal recipe of capitalism, to no avail.

    My book published eventually by Routledge can be read gratis in near-final form at my website http://sites.google.com/site/impersonalcapitalism/

    … and the pages relevant to the “counter-argument” and the Latin America story would be 214-39.
     

    Posted June 24, 2010 at 3:31 pm | Permalink

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    The Aid Watch blog is a project of New York University's Development Research Institute (DRI). This blog is principally written by William Easterly, author of "The Elusive Quest for Growth: Economists' Adventures and Misadventures in the Tropics" and "The White Man's Burden: Why the West's Efforts to Aid the Rest Have Done So Much Ill and So Little Good," and Professor of Economics at NYU. It is co-written by Laura Freschi and by occasional guest bloggers. Our work is based on the idea that more aid will reach the poor the more people are watching aid.

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