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Thursday, June 05, 2008

Brad DeLong: Gambler’s Ruin

Should developing countries keep betting on neo-liberal growth policies?:

Gambler’s Ruin, by J. Bradford DeLong, Project Syndicate: From Adam Smith (1776) until 1950 or so, capital was considered by economists to be absolutely essential for economic growth. You also needed a few good basic institutions. “Security of property and tolerable administration of justice,” as Smith put it. ...

For Smith and his successors over the first 175 years, any episode of sustained economic growth overwhelmingly required investment capital. We economists were by and large capital boosters, and our magic formula for economic development was saving, investment, thrift, and wealth accumulation. ...

Then Robert Solow and Moses Abramovitz challenged this near-consensus. They calculated that 75% to 80% of economic growth did not come from increasing the capital-output ratio... Instead, the keys to growth and development appeared to ...[be]: skills, education, technology broadly understood, and improvements in organizational management.

Yet capital continued to be seen as necessary, if not sufficient. In the framework developed by ... Dani Rodrik, a shortage of capital can be a binding “growth constraint”: the place where “the biggest bang for the [policy] reform buck can be obtained.” ...

The problem is that for poor economies, raising the capital needed to relax binding growth constraints is difficult. That’s why the world took the neo-liberal bet in the 1990’s: international capital mobility would come to the rescue by relaxing capital constraints where they were binding, and by reducing the scope for corruption and rent-seeking, which was often a more significant binding growth constraint.

The hope was that, like the pre-1913 era of British overseas investment, ... net capital outflows from the industrial core would finance much late twentieth and twenty-first century industrialization.

But we all know the outcome: ... the large net flow of capital from rich to poor countries simply never materialized. In fact, the principal outcome was an enormous flow of capital from the periphery to the rich core. ...

The reason is not that the periphery offers an attractive labor force from which capital profits, but rather that the core – especially the United States – offers a form of protection for capital against unanticipated political disturbances.

But even though net international capital flows are going the wrong way, there are still substantial gross capital flows outward from the world economy’s core to its periphery. And we can hope that these capital flows will carry with them the institutions and managerial expertise that have made the core so wealthy.

Nevertheless, a dispassionate observer might point out that for someone with limited resources and opportunities for policy reform to keep betting double-or-nothing on neo-liberalism is a strategy that has a well-deserved name: “Gambler’s Ruin.”

    Posted by on Thursday, June 5, 2008 at 02:34 PM in Development, Economics, International Finance | Permalink  TrackBack (0)  Comments (14)

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