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Dhaka Tribune

PATTERNS & TRENDS BY SYED AKHTAR MAHMOOD

How a book written 3 decades ago has lessons for Bangladesh in 2022

With all the talk of economic distress, and for some countries a real crisis or at least the specter of one, I was reminded of the book and the story we told there

Update : 02 Aug 2022, 04:38 PM

It was sometime in the autumn of 1987.

I had just started my final year as a D.Phil. student in economics at Oxford University.

One day my supervisor, Frances Stewart, called me to her office and introduced me to Gus (Gustav) Ranis, the well-known development economist who was then a Professor at Yale University in the US.

After some exchange of pleasantries and reminiscences (Gus Ranis had lived and worked in Pakistan in the 1960s and knew many Bangladeshi economists), the joint author of the famous Fei-Ranis model of dualistic development, came to the point.

Would I be interested in working with him on an interesting project he was doing on the political economy of development policy change?

Gus Ranis was looking for a research assistant to work with him on the project and I was looking for some extra money to augment my modest scholarship (my family of two was about to welcome a new member).

Frances Stewart knew both our needs and played the role of a matchmaker.

It may not have been a ‘match made in heaven’, but certainly one made in the city of the dreaming spires.

After I had spent a year working with him on the project, Gus Ranis offered me a position at the Economic Growth Center at Yale to complete the work.

Since my thesis was almost done, my supervisor allowed me to go on the condition that Ranis would give me some time off during my first three months at Yale so that I could finish and submit my thesis in the spring of 1989.

Ranis kept his end of the bargain and I kept mine.

The end-result of my two-year stay at New Haven was a book jointly authored with Gustav Ranis.

The Political Economy of Development Policy Change, published by Blackwell, came out in 1992.

But why am I talking about this specific episode in the early stages of my career?

I had not picked up this book for many years.

But now, with all the talk of economic distress, and for some countries a real crisis or at least the specter of one, I was reminded of the book and the story we told there.

I realized that there was much in that book, published three decades ago, and covering a period even older than that, which is very relevant for understanding the economic issues that are the staple of daily discussion in Bangladesh now – the falling reserves and rising imports, mega projects and small buyers of dollars, assertions that all is well and the news that we are seeking a $4.5 billion loan from the IMF.

Contents

In that book, we studied how development policy evolves over the course of a business cycle and how that pattern may differ across countries in the developing world.

In particular we looked at the differences between East Asia and Latin America.

The business cycle we focused on started in the early 1960s and ended in the early 1980s when many Latin American countries suffered a debt crisis while the East Asian tigers - Taiwan, South Korea, Singapore and Hong Kong - did not (the East Asian financial crisis came a decade and a half later.)

Business cycles, with their economic ups and downs, are a ubiquitous part of our existence.

It happens in all societies and has most likely happened in all times.

It may not always be apparent and for much of human history there is no good record of that.

But economic data for at least a hundred years, if not more, reminds us that “what goes up must come down”.

That is why I am sometimes impatient with the excessive short-termism we see in popular discourses in Bangladesh.

Short term movements in economic variables are important - by themselves and because they may be the harbinger of longer-term movements.

But sometimes it is useful to take a long view of things.

This is why the concept of business cycles is important.

In that book, as we discussed how economic policy changes over the course of a single business cycle, we made a distinction between the East Asian pattern and the Latin American pattern.

Before explaining these two patterns, let me mention a caveat or two.

First, we were talking of the East Asia of the 1960s, 1970s and early 1980s.

East Asia was not necessarily on the same path in later years (my previous column “The Three Koreas” gave a flavor of this.)

Moreover, the definition of East Asia in popular development discourses has also broadened in later years as knowledge accumulated on the remarkable growth experience of countries such as China, Vietnam, Malaysia and Indonesia, and there was greater recognition that there is no single East Asian model.

By the East Asian pattern, we meant a particular type of evolution from a predominantly import-substituting development approach to a primarily export-oriented one, with a concurrent evolution in the underlying policy stances.

We wrote about the import-substituting phase: “During this period, a cardinal element of the customary strategy is growth promotion through protection via quantitative restrictions and/or tariffs and government spending, i.e., the deployment of various macro-policies, both intended to assist entrepreneurs by “manufacturing” profits on their behalf.”

We wrote further: “The government’s political will penetrates the market system to determine not only the overall volume of aggregate demand but the precise direction in which resources are to be transferred and even individual investment decisions and allocations.”

In following such an approach until the 1950s, countries such as Taiwan and South Korea were not behaving too differently from other less-developed countries.

Changes in the 1960s

But things changed in the 1960s.

The East Asians moved decisively towards an export-oriented development stance.

The character of the policy also changed substantially.

While the government continued to play an important role, there was a liberalizing trend in policy making.

Under the import-substituting regime, important economic decisions were taken by the government.

Hence, these decisions were essentially political and often took the form of directives or direct controls.

Under the new regime, many important decisions were taken independently by market players although the government did shape their incentives through public policy.

As we wrote, this shift also meant that “private entrepreneurs must learn, sooner or later, to earn profits through their competitive productive performance in internal and world markets rather than via rent-seeking activities.”

The important point to note is that in East Asia, this liberalizing trend proceeded in a pace that was steady, even if slow at times.

By contrast, the Latin American move to an export-oriented approach was half-hearted and hesitant. Indeed, much of the developing world, to varying degrees, exhibited similar “Latin American” symptoms.

In the “Latin American” paradigm, we wrote: “All major policy instruments (the interest rate, the money supply, the budget, the foreign exchange rate, the rate of protection) are viewed as tools for growth-oriented activism by the government. Liberalization thus proceeds in an oscillating manner as the idea of “growth through controls” can be expected to atrophy only slowly.”

A business cycle

We may now introduce the notion of a business cycle to our story and discuss what happens when governments, operating within these two broad paradigms, respond over the course of such a cycle.

In a globalized world, business cycles are heavily influenced by happenings in the rest of the world.

Fluctuations in the external terms of a trade of a country, i.e., the prices of its exports relative to its imports which, in turn reflect changes in global demand and supply, are an important driver of business cycles.

For countries dependent on foreign capital inflows, whether as aid or commercial flows, fluctuations in such inflows can also generate a business cycle of some sort or, as is more often the case, amplify the fluctuations in external terms of trade.

As a country recovers from a previous business cycle and experiences a rise in fortunes, governments are typically emboldened to become more activist.

One reflection of this is in the rising government expenditure to GDP ratio.

Part of this is due to the government’s sense of a growth-promotion mission.

But it is also because the government feels that it now has the power to spend.

Two factors help generate this sentiment: an increase in foreign exchange reserves, which represents the government’s accumulated external purchasing power, and in tax revenues which represent internal spending power.

Even where tax revenues increase only modestly, as in the case of Bangladesh, governments are sometimes emboldened by positive developments on the external front to run larger fiscal deficits.

A windfall generated by favorable external factors, which leads to fast accumulation of foreign exchange reserves, thus translates into a windfall political power to spend.

When times are good, excessive government spending is justified by the need for growth.

Change is permanent

But good times do not last forever.

A business cycle is exactly that - a cycle.

Thus, at some point, the external environment turns sour, as it has done now for many countries around the world.

One reflection of this is in the stock of foreign exchange reserves.

First, its growth rate slows.

Then, it becomes negative.

This generates concern at first, followed by panic.

As we wrote 30 years ago: “The memory of the experience of previous cycles often leaves the developing country government with little doubt that mercantilist affluence (positive rate of growth of reserves) is necessarily good, while the opposite (negative rate of growth of reserves) is surely a sign of government weakness that causes national anxiety of crisis proportions.”

While downturns affect most countries, the policy responses vary.

In Taiwan, for example, and to a lesser degree in South Korea, the government did not reverse its liberalizing policy stance even when times were bad.

But it was different in Latin America. Take the case of Mexico.

When the good times of the 1960s came to an end, and the external environment became less conducive from the mid-1970s, we witnessed a stop-and-go policy approach.

The government increased controls in 1974 but two years later, in 1976, it floated the peso and depreciated the currency.

These liberalizing policies were reversed a year later through increased quantitative restrictions on imports, followed by a reduction during 1978-80, and another increase in such restrictions in 1981-82.

This was the time when things had become particularly challenging with the onset of a debt crisis.

This forced a major devaluation in 1982.

In summary, when times are good, countries operating within the ‘Latin American’ paradigm have a tendency toward excessive growth activism, followed by desperate attempts to maintain growth when times are relatively bad.

Such an approach proves unsustainable, and the countries slump into a prolonged recession.

By contrast, in the East Asian countries that we studied, even in good times, growth was allowed to follow a more or less natural path, i.e., one dictated by the resource endowments and technological capabilities of the countries.

For example, in Taiwan policymakers responded to both major oil shocks of the 1970s by allowing growth to drop temporarily.

Such prudence – the ability to resist the temptation to promote growth artificially - allowed Taiwan to revert to the high growth path once external conditions started becoming more favorable.

As Bangladesh faces headwinds after many years of a favorable growth performance, it will do well to pause and listen to history.

Although the story that Gus Ranis and I told in our 1992 book covered a business cycle almost five decades old, the contrasting East Asian and Latin American experiences in navigating that cycle has important lessons for Bangladesh even in 2022.

The author is an economist, previously with an international development agency

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