The Science of Everything Podcast - Episode 108: Political Institutions and Sustained Economic Growth

Episode Date: July 1, 2020

In this sixth and final part in our series on economic growth and development, I discuss in more detail some of the key institutions necessary for economic growth to begin, focusing on property rights, enforcement of contracts, and control of corruption. I review the importance of these institutions in the context of historical case studies of countries ranging from the Soviet Union to Mexico, and outline how the most critical institutions vary with the level of development, giving rise to a middle income trap. I also discuss the Washington Consensus and critically analyse the arguments of critics that such institutional reform is not essential for growth. I conclude with a summary of all we have learned and discussed throughout the growth series. The recommended pre-listening is Episode 107: Economic Growth and Development Part V. If you enjoyed the podcast please consider supporting the show by making a paypal donation or becoming a patreon supporter. https://www.patreon.com/jamesfodor https://www.paypal.me/ScienceofEverything

all listening to The Science of Everything podcast episode 108, Economic Growth and Development Part 6, Institutions for Sustained Growth. I'm your host, James Fodor. In this episode, we're going to conclude our six-part long series on economic growth and development, and so needless to say, the previous episode, 107, Explanations of Growth Differences is prerequisite for this, and really much of what I say won't make a lot of sense if you haven't listened to the previous episodes in the series. And what we're going to do in this episode is to sum up and conclude everything that we've discussed in the previous five episodes in the series by focusing on which institutions are most important for sustained economic growth and sort of try to bring everything together looking at some case studies of countries and how that they've gone, which institutions are important and I'll provide some overall sort of summary conclusions, perspective and so forth to sum us up.

So remember that our fundamental question in this series is why have some countries been successful? in achieving economic development and growth over sustained periods of time, whereas others have not have grown little or not at all. In the previous episodes, we've looked at a history of the world economy. We've looked at the structural change that needs to occur for economic growth and development to take place. We've looked at how growth theories describe that process of structural change. And in the previous episode, we looked at different single-factor theories or explanations of growth differences, including culture, dependency, democracy, geography, education, and institutions. and I explained why I think institutions play the leading role in explaining growth differences between countries.

In this episode, we're going to delve into institutions in more detail and talk about which institutions are important for growth, the empirical evidence and theoretical insights relevant to those institutions, and apply that to specific case studies. So, that's the agenda for today. There's a lot to get through, so let's jump right in and start talking about property rights. So I talked about property rights briefly in the previous episode, but we're going to go into a bit more detail now. Property rights are, in essence, a set of rules and norms that assign rights to the use of particular goods and assets and exclude the use of others of those goods and assets. So there's a number of different components of property rights. It's not just sort of who owns it. There's specific rights that are assigned. And these include the right to use the good, the right to earn income from that good, the right to transfer the goods to others or alter the good in some way, and the right to exclude others from using the good. Now, historically, people have had some of these rights, but not others.

For example, many feudal lords had the right to earn income from their land, but not the right to transfer that land to other people. That is, they were to like to sell it. And likewise, different forms of property rights have provided some but not all of these rights. But they're all important because they all serve different economic purposes. First, the right to use a good and the right to earn an income from the good have the economic function of assuring that individuals are able to realize the benefits of investing and putting effort into improving and effectively using. that good. So, for example, if you have the exclusive rights to benefit from improving your agricultural land, then you're going to have much more of an incentive to do that, obviously. And this applies to basically any type of productive asset. The right to exclude others from use of your

good is important because it ensures, it reduces the costs that individuals have to incur in order to defend their property against others. I mean, this includes physically preventing other people from just occupying your land or taking your property, but also includes reducing legal costs and other sorts of expenditures, which in themselves are unproductive because they don't help to increase output. They just sort of redistributed amongst people. So being able to exclude people from using your goods is very important for reducing those costs.

The ability to transfer goods to others, which is basically the right to sell your assets, is important because it allows gains from trade, ensuring that assets can be redistributed to those who can use the most productively and profitably, because generally people who are able to user resource more productively and profitably are able to and willing to pay a higher price for that. And so if the owner is, the current owner is not able to use it as productively, then it's likely that there'll be a trade that's possible in which they sell it to those who are able to use it more productively, who are willing to pay for it precisely because of their expected future higher earnings. A final importance of economic property rights is having rights over a good

enables you to use that property in support of other transactions, most particularly as loan collateral, which enables you to use future earnings in order to finance investment in your current activities, which is important for being able to raise the capital for investment. So there's a variety of critical functions of property rights, basically relating to facilitating investment and trade. And without these, it's very difficult for an economy to function effectively or efficiently because resources get locked into inefficient uses. People lack the incentives or the ability to improve those resources in ways that help increase efficiency and utilising new technologies.

And this describes much of the history of the pre-modern economic history of the world in which property rights were not well-defined or not enforced in an appropriate way or were restricted in various ways, which meant that it was very difficult for many people to exercise these ability of sale and innovation and investment in their property. Now, looking at how property rights differ across countries is quite difficult because it's difficult to measure the strength of property rights. The most commonly used metric is just to measure the risk of appropriation of a foreign

investor in a particular country. The problem with that is that foreign investment only occurs in certain industries and takes particular forms, and it's not really representative of the economy as a whole. Also, it's important to distinguish actual de facto rights from official legal de jiro rights, which may exist on paper but not really apply in the real world. And it's really de facto rights that are important. And in particular, when it comes to investment decisions, it's actually not even the current de facto rights that are most important, but it's future expectations. So if people expect things to change, then that's going to affect what they're going to do in the present. People have attempted to study the importance of property rights in different countries,

and as I said, it's difficult. One form that this research has taken is to look at the effects of land registration or titling in developing countries, especially sub-Saharan Africa. These are government programs, or they're usually government programs in which they attempt to officially register, make a record of, and delineate property rights, usually in terms of land of different farmers or villages and so forth. And the results of these are quite mixed. times it seems to have lead to improvements in investment and productivity. In other cases, it seems to have little effect or indeed it can have a negative effect. Other types of cross-country studies and a small number of experimental studies have pretty similar effects. They sort of

usually find beneficial outcomes, but there's a lot of variation. And it really seems to matter how the property rights are defined and how they relate to the traditional communal-based property rights. And this isn't really surprising because it's like many things the devil is in the details just because you call something land titling or registration doesn't necessarily mean that it actually enforces property rights well. Property rights need to be well-defined, private, secure, and general, and the last meaning that they apply to everyone, not just a specific group or class of people, such as a specific ethnic group or a specific economic class. The issue is that traditional communal-based property rights, where it's usually the idea is that a village, people in the

village know whose land is whose, and it's just sort of the way it's been for a long time, and it's probably not written down anywhere or certainly not in any formal way, but kind of people know that, and that's the way it often traditionally works, and a lot of land is also held in common so that multiple people can, say, grace their cattle in a particular place. That's also a common communal method of property rights. And so these systems can actually be quite effective, but it varies a lot. So it depends on the customary arrangements that exist in a particular place and time. And the issue is attempting to impose from outside modern private property rights can be counterproductive because it can destroy or weaken existing communal property rights,

and that might be fine as long as you're able to replace it with something that's better, but the problem is that they're not always able to do that. In particular, if the central government cannot actually enforce those property rights, then you're not actually going to get secure property rights. There may be a lot of corruption involved in the process, in which case there's actually a risk of expropriation, in which case property security may decrease during the process. The process may be bungled or records not properly kept or be very confused,

not having specific or very regularly applied criteria as to how you translate communal arrangements into a modern institutional setting. And that can lead to a whole lot of uncertainty, such that the new property rights are actually not well defined, even though they were supposed to be well defined. And so through mechanisms like this, titling schemes can actually lead to a reduction in the security of property rights. So it really depends on the nature of the communal systems that they're replacing and how well the new system is implemented. Another problem with these land titling programs is that they may undermine mechanisms of cooperation between resource users. So, for example, if there's a resource that's held in common, like a river or a forest or grazing

lands by a community, there may have been mechanisms to ensure cooperation amongst users who know each other and work together, whereas if that is then split up into individual units, then that might break down and actually mean that the resources utilize less efficiently. So property rights are complicated. there's very substantial evidence that they are very important for growth, but attempting to improve traditional property rights schemes can backfire if it's not implemented very carefully. Let's now move from property rights talking about contract enforcement.

So contract enforcement is different to property rights because it's not about ensuring that people have specific rights with respect to their property, but it's about enforcing contracts between two parties, often business contracts. And the importance of enforcing contracts is to ensure the predictability of a wide range of economic transactions. Enforcement of contracts is not necessary in what are called cash and carry markets, which means that you go, you pay in cash and you take the good physically and leave at the same time and place. You don't really need a contract for that to work, but most markets, especially in the modern world, are such that its cash and carry is either very expensive or just

not possible at all. So this includes markets for credit, insurance, labor, any type of long-term supply contracts or provision of specially made goods, especially for industry, and many types of service arrangements. And without these sorts of business arrangements, it's really impossible to build a modern, a diversified, productive economy. So enforcement of contracts becomes critical in order to move beyond simple cash and carry markets. Therefore, this raises a question as to what institutions exist to ensure that contracts are enforced and how this is done in different economic context. So in developed countries, contracts are enforced by the legal system. So ultimately, you can, you know, sue someone for bridge of contracts. And there's various specific mechanisms for that.

and generally more or less well-functioned court systems that are often. There are a lot of delays and expenses involved. But in a lot of developing countries, that really doesn't exist at all. And many contracts are not written down or they're not legally enforceable in various ways. And the legal system is completely corrupt or just is inaccessible to many people engaging in business transactions. This has a number of effects on the economies of developing countries, especially in sub-Saharan Africa. And it's been observed in numerous ways that firms in sub-Saharan Africa are very tolerated. relative to Western firms, certainly, of things like delays of payment or delays of provision,

basically because there are so many factors beyond the control of contracted parties that can prevent fulfillment of the contract, including corruption and including natural disasters, including political disruptions, including roads that don't function. And the problem with this is that it leads to self-fulfellate prophecies, because when other people don't pay you on time, then you can't pay other people on time and they can't pay their bills on time and so forth. So it's a bit of a collective action problem in that if no one fulfills their contracts on time, then no one will expect that their contracts are fulfilled on time,

nor will anyone be able to fulfill their contracts on time. And so this just makes everything more inefficient. It means you have to hold larger inventories. It means that things take longer. It means that you can't predict the resources that you'll need, and everything gets more expensive and therefore hurts productivity. In particular, these sorts of costs penalize small and medium-sized firms more than larger firms because often these costs are sort of, if not entirely fixed.

at least they scale more slowly than the size of the firm, and larger firms have more entrenched networks to be able to work around this, and they know the local officials and so forth. And so it's even harder for small and medium-sized firms to overcome these problems, which makes it harder for innovation to occur, because often innovation and technology transfer occurs through these small and medium-sized firms. So inability to enforce contracts hurts efficiency everywhere, but especially it hurts innovation. The prime mechanism of working around the difficulty of officially enforcing contracts, contracts is something called relational contracting, which occurs everywhere, but is especially

prevalent in developing countries. Now, relational contracting refers to closed business networks of insiders, often families, although often extended families, although it doesn't have to be, and also very commonly from a common ethnic group, and this is observed in a huge range of countries that there's a particular ethnic group, or often ethnic minorities who engage in a disproportionate share of business contracts. So in the Middle Ages in Europe, these were typically Jews, in many countries. Southeast Asian context, it's Chinese entrepreneurs, and in various African countries, it can

be particular African ethnic groups that are engaged in these transactions. And one of the reasons for this is just because it's easier to sort of keep track of people's reputations if you're from a smaller, more insular group. And so you know who you can deal with and who is not to be trusted. And this dramatically reduces the costs of keeping and sharing this information and reduces search costs in terms of finding out reliable business partners. So this sort of relational contracting is prevalent, and historically it's been the norm in all countries, really, and it has a lot of advantages. The main downside, though, is that it means that there are significant barriers to entry

by any outsiders, and often, of course, this means that there's a significant impedance to innovation, because innovation often comes from outsiders or people wanting to do things differently that will disrupt the status quo, and if you can't get the contacts you need to find suppliers or people who buy your products or provide labor and so forth, then it's very difficult for you to implement your innovations and new ideas. This is often compounded in many developing countries by the fact that these networks often get the help of the government and co-op the banking sector and other key factors so as to reduce competition and reduce innovation because obviously that hurts incumbent profits. So the issue is that relational contracting is a response

to low ability to enforce contracts and has many advantages, but the main disadvantage being that it significantly reduces innovation and responsiveness to economic change. And this makes it very difficult for developing countries to implement more efficient methods of production, use new technologies and so forth, which is, of course, one of the main reasons that they remain developed. So having looked at the importance of property rights and the importance of contract enforcement, let's now move and talk about control of corruption. Corruption is a huge problem in developing countries. It's a problem in all countries, but it's a problem in all countries. much worse in developing countries, and it's a significant source of impeding economic development.

So corruption refers to the illegitimate use of public power or position for private gain. So it includes activities such as bribery, money laundering, theft of government property, nepotism, smuggling, extortion, cronyism, and just a general failure to fulfill public duties and responsibilities. So it's a wide range of phenomena we're talking about here. But they share in common the idea that you have some sort of public position or role, or as elected official or an appointee or another responsibility that's being abused for private gain. Because every country experiences corruption, and especially every developing country, experiences corruption, it's not the case that you have to have no corruption or even very low corruption

in order to experience economic growth. That's not been the case anywhere. What appears to be the case is that as the country grows, it is able to improve its institutions, and monitor corruption better, and there's more public oversight and things like that, and corruption gradually comes down, because corruption is in pretty much all rich countries a lot lower than in pretty much all. However, in order to get economic growth, you do have to maintain corruption at low enough levels, specifically levels that are low enough, that they don't threaten the ability of the state to provide the critical things that it needs to in order for

growth to occur. And these critical things, as I've discussed before and we've discussed in this episode as well, are the basic legal system that enforces property rights and contract enforcement. So it has to be able to provide that to a sufficiently high standard. It has to be able to enforce basic regulations. And it has to be able to provide a key critical public infrastructure like roads and railways and so that allow markets and transactions to occur. If the state's not able to perform those functions to a minimal standard because of such high levels of corruption, then corruption is going to significantly impede development

in that country. And this is the case in many sub-Saharan African countries in particular, although again, not limited to that. let's talk about different types of corruption. They're so-called grand corruption, which is corruption occurring at the highest level of government. And usually this involves significant subversion of political, economic and legal systems. So a classic example of this is Abuatu and, well, then Zaire, now the Democratic Republic of the Congo, who over, I think, about 30 years stole billions of dollars from the state and diverted it to his own

private use and private Swiss bank accounts and so forth. There are many other examples of this in Haiti and in other sub-Taharan African countries in particular. of people at the very highest levels of government, just stealing huge sums of money and giving positions of power to relatives and other cronies, deliberately not enforcing various laws and regulations because it helps to keep them in. This is often what people think about when they think of corruption as corruption at the very highest level. However, there's also what's called petty corruption. And in my opinion, especially today, when there are fewer as obvious examples of grand corruption as they have been in the past, petty corruption is often more of a problem.

Pentee corruption occurs at a smaller scale, as the name indicates, and it takes place more at the implementation level at the level of public services and public officials. So this is corruption of policemen, state licensing boards, military officers, registration offices, regulatory agencies and especially tax collectors. And usually this involves people, again, appointing relatives or friends to positions, people not fulfilling their duties appropriately, people stealing public property, money laundering or taking bribes. Bribes is a very common thing. And what it means is that it just disrupts the ability of these services to be provided properly and distorts the incentives as well, because people spend less time doing the job that they're supposed to do in more time trying

to get more bribes. There's a huge range of negative effects that such bribery has. I've just indicated some of them. Additional effects are decline in the rule of law. So corruption erodes the institutional capacity of a government because, you know, there's laws and there's regulations and there's appropriate procedures, but everyone knows that they're just kind of fake, that they're not actually apply to practice. Public offices are bored and sold, resources are siphoned off, and just generally, the legitimacy of the government is significantly disrupted, and also it makes it very difficult to enforce health and safety, environmental, judicial, and other forms of regulation

and legislation. This is a major problem in all developing countries, especially the very poorest of countries, because it means that anything that they might like to do to try to improve the standard of living or economic performance, such as reform in the judicial system, provide better education, provide better health, build better infrastructure. All of these things are very hard to do because of corruption throughout the system of government. That resources will be siphoned off. People won't do their jobs properly. Regulations and quality assurances will be ignored. The high teachers and don't turn up, which is a very common problem in sub-Saharan African schools,

there's all of these problems occurring across the board. And that's very, it's very important to remember this when thinking about policies to improve outcomes, not just growth outcomes, but other outcomes in developing countries, because it's not just a matter that the government, can just decide to do something. Its ability to get anything done is significantly impeded by this form of corruption. Another negative effect of corruption is its regressive effects on distribution. So what that means is that some people benefit a lot from corruption, but many people benefit only a little bit, and most people, of course, not at all, and are actively hurt by it. So bribery is unfair. It poses attacks which most usually hurts those who encounter public officials most commonly.

So traders, for example, are often very hard hit by corruption and bribes because they're likely to encounter police. They're likely to encounter roadblocks, which are very common in sub-Saharan Africa. Either government officials or militia groups or other people will just block roads and demand that you pay them to let you pass. That's quite common in some countries. And obviously, merchants are more likely to encounter that than other people, as well as having to deal with other government permits and business licenses and things like that. This hurts smaller businesses, more than larger businesses, again, because, Larger businesses usually have the contacts and connections more than smaller businesses, so it hurts innovation as well.

There's also strong negative incentive effects imposed as a result of high levels of corruption, because I've mentioned this before, the ability of politicians and public officials to extract bribes means that there's a high incentive to try to find ways to erect further barriers to trade, thereby generating more bribing opportunities. So it's not just an issue that while the government implements regulations and then corruption means that they're not instituted very efficiently, but it means that because you can get bribes, there's an incentive to find ways of enacting legislation that results in the most bribes possible, which means that a lot of regulations

have nothing to do with benefiting the public and are solely introduced to increase bribery. It's one of the reasons why in many developing countries, not all, some have made really good reform efforts, but still in a lot of developing countries, you need a very large number of licenses and permits and special permissions from different offices in different cities and different departments in order to be able to set up a business or trade across the country or import a particular product. It's not because there's any real reason that this is necessary. It's just because each agency wants a piece of a pie and they want to be able to extract a bribe. Of course, there's always some high-minded or public benefit reason that can be given for the existence

of the permit, but that doesn't mean it's the real reason it exists. Now, empirical evidence for the importance of corruption is, I think, quite definitive in how negative on the negative impacts it has for economic development. A number of studies have found that the more regulations there are, the higher the frequency that members of the public have to interact with the government and therefore the high the probability that they will have to engage in corrupt practices, such as paying bribes. Empirical studies have looked at the rates at which corruption reduces growth. One study found that a 1% increase in corruption reduces the growth rate by about 0.7%.

This study also found that one of the main mechanisms for this is that, corruption increases political instability. And of course, one of the reasons for that is because as corruption increases, there's greater ability of people to extract private gain from the public sphere and therefore greater conflict over that source of income. Other studies have also found that corruption reduces quality of provision of government services. For example, corruption in Brazil was found to result in significantly worse outcomes in terms of the training of their teachers. So there's quite a wide range of empirical evidence that corruption is negative. The empirical evidence regarding how to combat corruption is, I think, less clear.

There's many different ways that different empirical studies have tried to examine this, from cross-country growth regressions through to experimental studies, through to naturalistic or field experiments, or just surveys and qualitative evidence. And none of them are very definitive, but the two main types of reforms that seem to show the best evidence are providing greater rewards, or that is higher salaries for those in the public service, providing higher penalties for people caught engaging in corrupt practices and to increase monitoring over public officials and politicians and increasing transparency.

So none of these things are really that surprising, but they do seem to have generally significant effects. So one specific reform is that freedom of the press appears to be beneficial in reducing corruption, which isn't surprising because it's a mechanism for exposing corruption, especially at higher levels, and therefore increases accountability. Institutional reform can be helpful if it's a way, if it's a mechanism for increasing the transparency of decisions of public agencies and public officials,

especially things like public announcement of contract tendering, so you can't just give government contracts to your friends, which is a common practice in many countries, and to ensure that there's clear objective methods for establishing investigations and enforcement. So again, it's not just sort of whatever a particular agent feels like doing, which again provides opportunities for corruption. A number of studies have found that political transparency in particular is very important, such as disclosure rules for information about parliamentary members' investments or other conflicts of interests. And it's particularly been found that it's important that this is a public disclosure, not just disclosing it to Parliament or another government agency, but so that the public has

access to this information, so that they have abilities to respond to that in ways that are outside the existing status quo, because otherwise it's too easy to co-opt other government institutions on your side. Punishment also, as I've mentioned, seems to be effective. So if you increase the cost of engaging in corruption by increasing the probability of being caught or increasing the penalties if caught, then that has a significant effect at reducing corruption. And this seems to have been found even in environments that are highly corrupt. Paying higher salaries to government officials also has been found to reduce corruption, although it's not a solution that it doesn't completely fix the problem, but it does have an impact. And the reason for this,

if it might be somewhat less obvious than transparency and higher penalties, is basically because public officials have two sources of income, an official salary, which is often very low, and then income from bribes, and in many cases at a lower level, officials rely on bribes to supplement their very low official salaries and thereby provide for themselves and their families. So it's not the case that everyone's just trying to get rich at the expense of other people. It's often just a way of getting by, at least the lower level. And of course, because everyone else is doing it, it's expected, and so you end up in a bad equilibrium, which is something we've discussed in previous episodes.

And that's also one of the reasons why it's so hard to escape from that, because if everyone else is doing it, it's so hard to identify any one person who's doing it. And there's relatively little shame, for example, because again, it's such a common practice. So in terms of why higher salaries are helpful, the basic idea is that if you assume that the degree of corruptness, so the more often you ask for bribes or the large of the bribes you ask for, if you think that the degree of corruptness increases your chances of being caught, then what happens is that as the official salary increases, the cost of being caught, which is obviously the loss of that salary, also goes up. And therefore, increasing the salary increases the cost of being caught, whereas increasing the salary doesn't increase the benefit from exacting bribes,

which presumably isn't really dependent on your salary. So increasing the cost of being caught can be done by increasing the penalty or increasing monetary, but it can also be done by increasing salaries. And so these in combination are often most effective. And really, it's going to be impossible to eliminate corruption from public service if they just not paid anywhere near enough to support themselves and their families. So that's a critical component of this. But again, by itself, it's not going to be sufficient, obviously,

because corrupt officials like being paid more just like anyone else. But the point is that you combine it with better monitoring and higher levels of transparency and then in combination that they can be quite effective in reducing corruption. That concludes the section on corruption. So now what I want to do is kind of combine some of these aspects that we've been talking about, in particular ideas about property rights, contract enforcement and control of corruption, and look at some case studies, mostly from the post-war period, although there's a few that extend a bit earlier than that, and see how some countries have gone in terms of their economic growth and economic development trajectories.

One of the reasons for doing this is because in these sorts of discussions, people often give examples of countries that they think either support their theory or refute other theories, and it's useful to have some idea about some of the countries that are often given as examples and sort of how they have fared and also a kind of a, it gives an idea of the growth trajectories of some important countries around the world, particularly when they've engaged in different policies, which can be helpful in looking at which policies have succeeded or which have failed. And what I want to emphasize in these case studies is the importance of property rights and contract enforcement and control of corruption, but also the limits to those in not being able to

explain everything because, of course, we know that there are other factors as well. Importantly, as we've discussed in previous episodes, we know that from the Solar Swan model, we expect countries to slow down as they get richer. And that's a very important factor that's relevant to analyzing these growth trajectories in addition to institutions and in addition to geography and education, which also make a difference. So let's begin then by looking at some of these case studies that I think illustrate some of these trends. So let's talk about the Soviet Union.

Now, the Soviet Union experienced a very impressive rates of economic growth in the 1920s and 1930s. And some people point to this as evidence that the centrally planned economy, especially that was instituted under Stalin from 1928 up to, well, I mean, up to the end of the Soviet Union, really, but particularly for our analysis up to when they were invaded by Germany in 1941, because obviously that had significant effects on the economy. The argument is that there was extensive growth over this period, and that was seen certainly at the time, and it's still sometimes argued today, that that's evidence in favor of the fact that you can achieve high levels of growth without protecting property rights or enforcing private contracts,

because that wasn't really a thing in the Soviet Union, especially under Stalin, but instead through central planning and centralized decision making, which we've talked about in previous episodes as to how that worked. Likewise, the post-war performance of the Soviet Union up until at least the late 1970s has also been raised as an example of relatively good economic performance and was seen by many developing countries of the time as a model for them, and so many countries adopted at least some of the economic planning and restrictions on private enterprise and innovation that the Soviet Union had. And again, still to this day, although not too many people advocate for essential planning in the style of the Soviet Union,

it's still given as an example of how you can have at least a reasonable success without a free market economy, without free trade and so forth. Now, when you actually look at the data, I think, especially looking at the sort of best data that's available, you get rather a different picture. And the trouble is that it's very difficult to know which are the best or most reliable GDP figures for the Soviet Union. And if you look around at different databases, you can find quite different. In fact, wildly different numbers. I've found estimates varying by almost a factor of two. Anyway, so how you interpret the data depends on which dataset you're using. I've used a dataset based on Madison's data series that he constructed.

I think I've mentioned him before, Angus Madison. There's a number of issues here because the Soviet Union has had a very extensive and trouble history throughout the 20th century. So it's vital to consider these developments when trying to interpret growth trends. So in particular, the Soviet Union experienced, well, first the First World War, and then a major economic collapse

following the revolution in 1917. Its GDP went from per capita, went from over 2000 to about 1,000, so it fell by more than half. This was obviously devastating for people at the time. The relevance for us, though, is that we know that from just Soloswan model, that when you have a major collapse in GDP, you expect to following the end of the disaster that led to that

collapse, in this case, following the end of the Russian Civil War, you expect to see a rapid recovery because many of the much of the technology institutions and education and other factors that allowed you to reach the previous level of development are still present, and you just need to kind accumulate capital, rebuild and so forth after the disaster. And so this is called recovery growth. That is, after a disaster, you can fairly rapidly recover to the level that you'll were before the disaster. So this is observed in many countries following both recessions, the Great Depression, World Wars and other catastrophes. Germany and Japan following the Second

World War are probably the best examples of this. They recover quite quickly. At any rate, if you look at the trajectory of growth that Russia was on prior to the revolution and extrapolate that out right through to around 1940, you see that the growth experienced under Stalin's five-year plans, which began around 1928. They basically intersects with where you would expect Russia to be around 1940, even if they just continued sort of business as usual under the old Zaris growth rate, which was somewhat less than 2% a year. There's studies that have looked at this and plausibly growth may have accelerated somewhat without the revolution for various reasons. But the point is that it's not clear that Stalin's five-view plan did anything to make Russia

wealthier or to increase growth relative to what we would have expected them to otherwise be. It's true that growth rates were fairly high, but the point is they were still recovering, even from the late 20s, they hadn't fully recovered to where you would expect them to be with business as usual growth in the absence of the Russian Revolution. And this is a very common theme that we'll see in a few other countries as well. You have to look at not just the race of growth over periods of time, but what's happened before those times. So I think that it's not at all clear that the central planning under Stalin did anything

to accelerate Russian growth. It certainly accelerated the development of heavy industry, which was very important for defending the country in the Second World War. But that's a different question from whether accelerated economic growth. per se. Now, if we look at the post-war period, again, we have to factor in that a large portion of the Soviet economy and agriculture industry was destroyed or heavily damaged in the war, and so there's some amount of catch-up growth, which occurred certainly into the 1950s. Overall, between about 1950 and 1980, or just the late 70s, the Soviet economy grew at about 3.3% per year

using the data that I'm using. Some data sets will say a bit higher than that, maybe 4% a year, although I think that those lead to implausibly high numbers, but that's a discussion for another time. and then for about the next 15 years until the early 90s, the economy stagnated with very little growth, and then there was a massive reduction in economic productivity and output during the 1990s following the collapse of the Soviet Union. The point, though, is that 3.3% between 50 and 1980, considering that some of that's likely to be catch-up growth, is solid growth. It's not bad, but it's hardly very impressive, given the quite low level, about $4,000 per person, that the Soviet Union started at around 1950. And that growth rate, as we'll see, of around 3%, or a little above 3%,

is similar to what many other countries, developing countries, for example, Mexico and Turkey, is similar to what they observed over that time period. And so, as we'll see in some of these other examples, it's certainly possible for countries to experience development in the absence of extensive property rights or contract enforcement, but it doesn't seem that they're able to achieve their growth potential, because certainly at its level of development, the Soviet Union should have been able to grow much faster

than 3% a year. Also, as we'll talk about in a little bit later, the growth that the Soviet Union experienced stalled in the mid-1970s and did not resume until really long after the Soviet collapse. And I think that there's an example of what's called the middle-income trap, which is when a country that does well for a while and gets to middle-income, has institutions that then are unable to get to allow it to get to the next step and continue to reach high-income status. One final point about Russia, I know I've talked about it for a while, but it's a very interesting case because of all of the changes that they've seen in their history, Russia experienced a very rapid growth in the 2000s to around 2010 or just after that. Again, much of this is recovery growth from the huge collapse that occurred following the collapse of the Soviet Union.

And so although their economic institutions weren't especially great in the 2000s, although better than they were under communism, again, you have to look at the growth in the light of the fact that a lot of that was recovering to the sort of previous trend. And the growth of Russia in the 2010s has been very slow, which I think is indicative of the fact that their property rights, contract enforcement, other institutions are quite poor generally. Again, not as bad as they were, but a lot of reformers are necessary, I think, to allow the country to return to higher growth. So the bottom line from all that is that I think a careful look at Russian history indicates

that central planning and especially Siams-5-year plans were not helpful to growth. They didn't eliminate it completely, but growth would very likely, if we look at other case studies and the theory that we've discussed, have been more rapid if they had better institutions. Now, let's talk about another commonly appeal to example, which is Mexico. Across a roughly 50-year period from around 1930 to 1980, Mexico sustained a fairly consistent growth rate of about 3.2% a year. Remember, that's about the same as the Soviet Union in the post-war decades. This, again, it's not a super-fast rate.

Again, we compare this to roughly 2%, which is the rate at which the most developed countries grow. So anything less than 2% is falling behind, and anything more than 2% is catching up. And we do expect poor countries if they're doing. well to catch up to the developed world. So 3.2% is not bad, it is catching up, but it could be doing much better than that. Again, we know from other cases, if it had better institutions. And during most of this period, especially post-war, Mexico followed what I've called import

substitution policies, which we've discussed in the past. This basically means restricting foreign trade and requiring a lot of licenses and other government permissions to engage in economic activity. Not as extensive in the Soviet Union, obviously, but it was sort of following that model to some extent. So some people have pointed to this period of fairly successful growth in Mexico as evidence that import substitution is a better policy than trade liberalization and that you don't really need. A lot of focus on private property rights and contract enforcement and other things like that because Mexico did quite well in this period. And since reforms, which occurred sort of in

the early to late 1980s and continued in the 2000s to liberalize the economy and free up trade and so forth, the economy has performed much worse from 1992 to roughly the present. The average growth rate has been about 1.2%. So significantly less, almost a third of the growth rate experienced in the previous period. So that's what some people have argued. Again, I think a careful look at the growth trend, a lie of such a simple interpretation. For one thing, you need to consider that Mexico experienced a massive revolution, civil war, between roughly 1910 and 1920. And then throughout the 1920s, there was a series of major agricultural land reforms and continued political instability. And then, of course, in the late 20s and early 30s,

it was hit pretty bad by the Great Depression. So economic growth during these two decades was basically none. Then Mexico did fairly well during the late 30s and 40s during and after World War II, of course, not affected by combating World War II, benefiting from high demand for its products from the US. So it performed fairly well over this period. But it was still engaging in recovery growth because of the lost growth potential over the 1910s and 20s.

By my estimates, it recovered to the levels it would have otherwise been at. It recovered to trend by around the early to mid-1950s. It still maintained that 3% growth rate for another couple of decades after that. However, we do know that by the 1970s, a lot of that growth was artificial, and it was sustained by massive amounts of external borrowing and injection of that money into the economy in often very unproductive ways. I think I've discussed this a little bit in episode two about the history of the world economy, But again, it's thought to relate to the middle income trap that Mexico managed to get to middle income status, but its institutions weren't able to support continued growth.

It was able to maintain artificial growth a bit during the mid to late 70s through a lot of investment of borrowed money. But that collapsed in the early 1980s with a series of financial crises and led to a decade of slow growth or indeed negative growth in the 1980s that only began to recover from properly in the 1990s and 2000s. but it still hasn't returned to the growth levels of the 50s, 60s and 70s. But my reading of the history is that probably those growth rates were a product of the generally better economic environment for really every country in the 50s and 60s, plus some recovery growth, especially during the 40s and 50s following the revolution and the land reforms, and then the growth was continued a little bit longer, longer than it would normally have lasted because of the large amounts of borrowing in the 1970s.

So it's not clear to me that we can really attribute the reasonably good growth performance to the specific policies. Of course, that's not to say that Mexico hasn't underperformed where we might have expected it to, given the large institutional reforms that have occurred in the 80s and 90s. Growth has returned, but it's still slow and indeed is still falling behind the US. And there's a lot of complicated reasons for that, which we might talk about in a future episode. So again, the economic history of Mexico provides an interesting case study, but which we can see that having strong protection of property rights contract enforcement and low corruption, isn't essential for growth, but you do need to meet basic minimal standards, which it seems that Mexico did meet during that 30 to 80 period to achieve modest rates of economic growth, but certainly not what they could have achieved if they had better institutions.

Now, let's talk about Turkey. Turkey is an interesting case in that unlike the Soviet Union or Mexico or other countries, since the end of World War II, its growth has been remarkably consistent at about 3% a year, pretty much bang on. Obviously, there's some ups and downs, but if you just sort of draw that line on the exponential graph, it's pretty straight. And the rate of growth that they experienced, as I said, about 3%. So basically the same as Mexico. This is interesting because Turkey originally followed import substitution policy, so similar to Mexico. But around 1980, they significantly reformed and liberalized a lot, focused more on open trade, property rights, private investment, and so forth.

That seems to have helped them recover from a slowdown in growth that occurred in the late 1970s, which I think is part of the global trend that happened in many countries around that time, that borrowed money, and then it was the oil shock and the slowdown in world economic activity. But unlike Mexico, which has been unable to recover from that, Turkey has continued to grow, at least until the last couple of years. So it seems that the reform efforts have been more successful in Turkey than in Mexico, although, again, the reason for that are rather unclear. Mexico and Turkey both show examples of how you can experience modest rates of economic growth,

in spite of not having best practice institutions. again, though, from the low level that Turkey started at, which was about 3.5,000 after the end of World War II, it seems, again, from comparison to other countries, that Turkey could have grown much more rapidly, perhaps twice as fast as it did, had it adopted institutions that better rewarded investment and innovation. Now, let's look at the case of Chile, which is a very interesting and controversial case. Chile experienced modest rates of economic growth, maybe 1.5% right through from the end of World War II up to around the mid-19. 70s. In 1973, there was a coup which put in power a right-wing military regime, which instituted a wide range of economic reforms, freeing up markets and removing restrictions on

imports and investment and so forth. So focusing very much on the private property rights and foreign trade side of things. That did very well for a few years until there was a massive exchange crisis in the early 1980s, which caused GDP to drop quite a bit. But then after that, Most of the reforms were kept and the economy recovered and has been doing quite well since then. The average growth in particular between the late 1980s through to the early 2000 and 10, so I think that's a 25-year period, was 3.7% per year, which is very impressive growth, especially because they started at a sort of a middle-income level around the 1980s. This is an interesting case because Chile actually accelerated their rate of economic development

even after having reached roughly middle-income levels, again around the 1980s. And this is quite unusual because we generally expect countries to slow down their growth, at least once they reach middle-income levels, which is sort of around 8,000. So Turkey and Mexico slowed down somewhat, especially Mexico, whereas Chile has accelerated, and it seems to be very clearly connected to the economic forms that they implemented in the 1970s. And to this day, Chile is still, to my understanding, the richest country, South America. Thailand is an interesting case study. Obviously, this is a Southeast Asian country.

Now, compared to many other countries, Thailand has always pursued a fairly liberal economic policy. So this is more about contract enforcement and private property rights free trade. Its growth from 1960 to 2000 was 5% per year, that being from a lower level than Mexico started. But still, that's a very impressive rate. It's in slow to about 3.5%. But it's now a middle income country, so that's expected that it would slow down. I think that this is one little example that does show how you can experience significantly greater than 3% growth rates if you pursue more liberal economic policies. Again, one case study

doesn't prove that, but I do think it's interesting to compare that to the Turkey-Mexico cases. Another case in point is Indonesia. In Indonesia, in 1966, there was a massive political upheaval in which the Communist Party was purged and the new government came to power. Since that time, Indonesia has pursued fairly liberal economic policies similar to Thailand. Starting from a fairly low level, the growth rate has been about 3.5%. So around the same level as Mexico, Mexico over its 1930 to 1980 period, which also it started at a similar level. And this is actually quite remarkable for a country that's so large and diverse, sort of ethnically, culturally diverse as Indonesia is one of the largest countries in the world. Again, its growth rate is not as

impressive as Thailand's has been or Chile after its reforms, and perhaps it illustrates that you can achieve similar growth outcomes even with quite different economic policies, comparing, for example, Mexico and Indonesia over this period. Now, the final example that I wanted to talk about here is India. Now, India is different to these other cases, because unlike all of the other cases which experienced, which are now at least middle or if not high income countries and experienced quite a bit of economic growth over the course of the late 20th century, India experienced very little economic growth until the 1980s. As late as 1980, its GDP per capita was still, was still only about, I think, 7 or 800, which would make it a very poor country. From independence,

which was 1947 for India, until 1980, India only grew up 1.4% per year. So that is not even keeping up with the US. So it's falling further behind during that period. And during that period, it pursued mostly fairly restrictive policies. Indeed, it became famous for having such a large number of permits that you're required to engage in any sort of trade or economic activity or innovation that it was called the permit raj. And this seems to have not been helpful at all for economic activity because as we see in the growth statistics and as a number of studies have shown from the period, it was very hard for any type of private economic activity that wasn't state sanctions to occur, and growth therefore was very slow.

Now, there were some modest reforms that loosened up the system in the early 1980s, and also some increase in investment spending from the government during that period, which seemed to have bumped up growth to about doubles, so 3.2% over the course of the 1980s. Then there were a string of major reforms, much more substantial reforms in the early 1990s. And since then, the country has experienced a much more rapid growth rate of a, of a bit of a 5% since 1990. And if anything, its growth has been accelerating over that period rather than slowing. Again, this isn't surprising because the country is still poor.

It's still not in middle-income country. We don't necessarily expect the slowdown to occur yet, at least not to slow down very much. And indeed, 5% is probably not even as fast as it could potentially be growing at these income levels, given other country's experiences that we have. But nevertheless, is much, much faster than it's grown at any previous period. So this case, the India case, along with, I think, the Chile case, both show very clearly the significant effects that economic reforms can have that loosen up restrictions and allow for more private trade innovation and better contract enforcement and so forth can have on economic performance

that you can have fairly rapid accelerations in economic development. The India case like many others is controversial because there are some people who say that while the main reforms are in the 1990s and the growth started to accelerate before then. So therefore the acceleration and growth isn't really due to the reforms. It's due to something else. I personally don't find those arguments very convincing. For starters, the growth acceleration was substantial in the 1990s and since then relative to even the 1980s. So even if the growth acceleration in the 1980s was not due to the reforms, there was still significant growth acceleration afterwards, which seems to be very closely linked to the reforms. And secondly, there was some liberalization that occurred

in the 1980s, and again, appears to my eye at least to be closely linked to those reforms, even if the liberalization wasn't nearly as large as that as happened later on. Plus, we also have good reasons from economic theory and from other countries' experiences to think that these types of reforms would have significant effects on growth. So it would be quite surprising to me if they didn't at least have some effects. Of course, it's very difficult to predict how large the effects will be because it depends on the particular institutional context of a given country. So we've seen, for example, that reform in Chile had very large effects on growth, whereas reform in Mexico, which occurred around the same time, maybe slightly later,

to not have nearly as large effects of growth, although it stopped growth from being negative and returned it to the positive. Mexico is not catching up to the US, whereas Chile is still catching up, or at least roughly keeping pace with the US. So it's not entirely clear as to why we do observe these differences, but hopefully at least considering these case studies was sort of informative in seeing the diversity of experience. And I think case studies like this do show that institutions do matter, but it also shows that they're certainly not the only thing, that countries can experience modest rates of growth even with

fairly poor institutions. Okay, so we've talked a lot about the importance of institutional reform, but how exactly do you get better institutions and why do some countries have better institutions than others? Well, this is a question that takes us far beyond the scope of this podcast, but there are a few things that I wanted to mention about this. One important thing to realize is that reforming inefficient institutions often requires collective action. So you can't just change things as one person or one organization. You have to have many people cooperating to change the way things work. And that's often very difficult to achieve, especially when institutions don't work well. And this so gives the right to the free rider problem that sort of everyone else is hoping that someone else will

do the work. And bargaining is very difficult between the groups, especially because even if you expect everyone to benefit, there'll be disputes on who's going to get more of the benefit than other people. And so often reforms can break down at that sort of bargaining level. For example, if there's a policy to liberalize trade, even if everyone expects to benefit, people may break down trying to bargain as to which region of the country or whether workers or industries or the government or who gets more of that benefit, and that might actually prevent the benefit from being realized for a long time. So that's one thing that makes institutional reform hard. Another factor is that ruling elites often seek to maintain inefficient institutions,

because they know that when the country is impoverished, that it is easier for them to maintain their power. Liberalization and reform may enrich other groups, such as merchants or new industries or different regional groups, which could undermine their political power. So it's not necessarily in their interest for these groups to do well. even if it raises the level of the country as a whole. Also, with respect to political power, it's often relative power that counts, not absolute power. So even if the rulers would benefit from a wealthier country, they may benefit less relatively than other people who may therefore be able to oust them from power. So it's a similar point to the previous one, but just

emphasizing that it's often relative, not absolute political power that matters. So the point is that even if the people in power might like to have a larger pie for them to steal from, it's better to have a smaller pie that you can steal from the no pie at all. And therefore, that's a reason why many leaders deliberately don't implement reforms that may destabilize their position. Also, even if the national elites at the highest level try to push forward these reforms, it's often resisted by elites at local levels due to basically the same reasons that the local elites don't want to disrupt their position which allows them to extract bribes or receive gifts or just have a lot of power and influence over what happens, or be involved in business ventures that would be

competed with by, you know, foreign firms or new entrants. And of course, national elites don't necessarily have the resources to be able to push reforms through in the face of opposition by these local elites, which may have significant friends in the military or in the civil service or in existing private institutions. And therefore, it can be very difficult to actually get these changes to be implemented, even if the national government wants it to happen. These sorts of factors have been observed in a wide range of cases in instances where we see that land becomes concentrated under the ownership of a relatively small number of absentee landholders. This is a very common form of land tenure in South America that I've talked about in previous episodes. And the thing is

that it's in most cases demonstrably the case that the land is used less efficiently than it is when it's worked by much smaller farms, particularly people who own their own land. So the question is how that situation is able to be maintained if it's less efficient. You'd think that the small holders will be able to buy out or lease out or something the land from its current owners who'd be willing to take the money because they'd be able to pay them more than the land holders currently earn because the landholders are currently using the land so inefficiently, someone else will be willing to pay them more than they're currently earning from it. And therefore, you'd expect them to sell up and reduce their holdings and therefore distribute the land more efficiently. Why doesn't that

happen or why hasn't that happened historically nearly as much as you would expect? Well, as I've sort of been saying, many of the reasons are similar as to why institutions and other contexts don't reform. In particular, the political power that is obtained by having very large land holdings, as well as the social status as well, is often disproportionate to the economic gains and increases much more than the economic gains. So it might not really matter that you're not using the land economically the most efficiently, as long as you get sort of enough out of it. The real benefit is the social and political power that that gives you. And that's not something that can necessarily be offset by people paying you for the land. Also, large landowners may be concerned about

allowing small farmers to compete against them, both for producing agricultural products, but also potentially for purchasing labour of people that they might want to work on their farms or to engage in other projects. That may bid up the price of wage labour and therefore actually make the landowners worse off in the long run. Also, there's other issues like markets are often not very liquid and there's difficulties on enforcing property rights and so forth. Peasants may be concerned that the land will be expropriated from them again. So there's other issues there as well. But that's just an example in terms of land tenure of how inefficient institutions can

be perpetuated for a long time, basically because there are social and political factors such that those in a current position of power don't want to disrupt the system, even if it would make them richer, because though it might make them richer, it may make other people even more relatively richer than them and therefore destabilize their position. of power, which is often the sort of foremost thing that they're concerned about. Despite the difficulties in institutional reform that we've just been discussing, international organizations such as the World Trade Organization, and especially the World Bank, have for decades, especially since the sort of early 1980s, been spearheading efforts to bring about institutional and policy reform

in many developing countries, with a particular focus on Latin America since those countries have generally been a bit more receptive and are more developed and so more able to implement policy changes and say many sub-Saharan African countries have been, though those have also been making significant efforts to reform. So when we talk about institutional and policy reform, often there's a focus on a set of policies or ideas, which is called the Washington Consensus. Now, this was originally prepared as a list in the early 1990s

to describe not a normative approach that is what people should be taking necessarily, but it was originally described as just a sort of a description of what countries in Latin America were already doing. and had been doing for some time. And the term Washington Consensus has been used a lot since then, and I think it's come to be misunderstood, and it's often used in a negative context to describe sort of a top-down attempt

by foreign governments and international organizations to force developing countries to implement policies, which are not necessarily beneficial for them, but are beneficial rich country. One of the most prominent critics of the Washington Consensus is a respected economist called Danny Roderick, and I just wanted to briefly discuss some of his criticisms here because they're directly relevant to the idea that institutions are

extremely important for determining which countries succeed and which countries fail. Now, Danny Roderick does not deny the importance of institutions, but he is critical, particularly of Washington Consensus and sort of mainstream approaches by the World Bank and many economists focusing on development. So to understand his criticisms, first let's look at the 10 items that are on the sort of the canonical Washington Consensus list, although there's slight variations, but the basic idea is that these all they describe a set of policy reforms and institutional reforms that attempt to reorient an economy from an internally focused, closed, highly regulated and restricted economy to a more open, free market, protection of property rights, and privately run economic system, although with, of course, some state oversight.

So the elements of the consensus include fiscal discipline, which basically means not spending too much money on things that the state can't afford and not borrowing too much, redirection of public expenditure towards health education and infrastructure. So we've looked at the evidence for the importance of all of these types of spending, especially education. Tax reform, including broadening of the tax base and cutting marginal tax rates. So these are aspects related to trying to promote incentives and connected to the notion of property rights that people should be able to, the private owners should be able to reap a large proportion of their returns from their investments

by not having extremely high rates and very sort of variable rates from different types of investment or activities that can give rise to corruption. So number four is unifying and competitive exchange rates. So basically this means reducing or eliminating government controls over exchange rates to facilitate foreign trade. Secure property rights. So we've talked about that at length. Deregulation, which involves removing government restrictions over many types, although not all

types of economic activity. The important aspect of that is to try to promote trade and investment and innovation, which are often restricted by many types of regulation. We talked about how this was the case in India, for example, for a long time and in China prior to the reforms in the 1970s and of course in the Soviet Union. Seven is trade liberalisation. We haven't talked a great deal about the importance of foreign trade. I may do an episode on that a bit later on.

But again, the idea is that countries are able to trade more easily without trade barriers with the rest of the world, thereby earning money from exports, which they can use to machinery and import technology and expertise to modernize their economies and also helps to foster competition amongst domestic firms because of the competition and expertise from foreign firms. Number eight is privatization, which involves selling off of certain government-owned enterprises. So this doesn't necessarily mean privatizing everything, but it generally refers to privatizing businesses that don't have a strong economic rationale for being run by the government.

So this would include many of the manufacturing and service industries. The idea being that they can run more efficiently when they're able to compete against other firms and have price signals that can be used to focus in. investment and also consumer spending to what people are most interested in and what's most efficient and to promote innovation. Number nine is eliminating barriers to direct foreign investment. So that's foreign investment into a country, which serves similar purposes to trade liberalization. And the last one is financial liberalization, which is similar to eliminating barriers to direct

foreign investment, although applies more in the domestic realm. Again, the importance being there to facilitate mechanisms of aggregating savings and allocating those savings to the most efficient uses so that the country can accomplish. manipulate capital and build up his industrial base, which is an important aspect. So that's a brief overview of the ideas of the Washington Consensus. Danny Roderick has critiqued the Washington Consensus on the basis that, in his argument, if you look at some of the most successful countries, particularly South Korea and Taiwan, in the period of the 1960s through, well, really the 2000s, they did not pursue all of these

policies. And indeed, in some cases, for example, there are significant restrictions on foreign investment, restrictions on foreign trade and operation of many government-owned enterprises, as well as various other types of regulation, they seem to have flat out contradicted the recommendations of the Washington Consensus. And Dana Roderick uses this to argue that there's, as he describes, many recipes to economic success and that the Washington consensus is too narrow in focusing on the things that it does, and that the countries that have most followed the Washington Consensus, which

are Latin American countries or most countries in Latin America. since the 1980s, have not, for the most part, seen a great deal of success, especially, for example, the example of Mexico, which we've already talked about. So how do we reconcile these arguments and these examples with the evidence that we've previously looked at in my claims that it's institution that are the primary factor that differentiates successful from unsuccessful countries? Well, fundamentally, I think that there are two key mistakes that Roderick makes in his analysis. The first is that he fails in these sorts of comparisons that he does, for example, in comparing Latin America to South Korea and Taiwan and other countries,

to incorporate the differences in starting point of their development at the period he's looking at. Because remember, as we've talked about consistently, the Solo Swan model, which has a great deal of evidence to support it, predicts that as a country gets richer, the maximum rate that it is able to grow at decreases, that is growth is predicted to slow down. Now, the issue with comparing South Korea and Taiwan in the 19th, 1960s, when they started to experience rapid growth to Latin America in the 1980s,

is that Latin America in the 1980s, at least many of the countries, including Mexico, for example, were middle-income countries by that point. And therefore, the maximum growth that they could be expected to achieve is significantly lower than was the case for countries like South Korea and Taiwan, which were very poor countries in the early 1960s, and therefore had much more capacity for rapid growth. So that's an adjustment that needs to be made whenever one is doing these comparisons in order to have a fair comparison that looks at the effects of policies and not just at the difference in growth. So that's one factor that I think Roderick is missing in this comparison. The second

consideration that I think he misses is that even in his own analysis and he presents a table showing this, the 10 elements of the Washington Consensus and then an analysis of South Korea and Taiwan, he shows even in his own analysis that from the period of the 1960s through to the early 1980s, South Korea and Taiwan fulfilled about five to six of the elements of the Washington Census, including security of property rights, for the most part, redirecting public investment towards health and education, fiscal discipline, tax reform, and unified and competitive exchange rates. So many of the key elements relating to property rights and contract enforcement were in place in South Korea and Taiwan as well as appropriate public investment, a general

extent of law and order, and corruption controlled at least enough to facilitate. growth. Now, it's true that the other aspects of the Washington census, including trade, liberalization, deregulation, and privatization did not occur until the 1980s, which he notes on his table. But of course, the claim is that the institutions that are necessary for growth change as countries get richer, and talk about that slightly more in the next section when we get into the middle income trap. But the point is that for the first 25 years or so of their growth, South Korea and Taiwan could get away with not having the best practice institutions because they were so far behind the West. They had enough good policies and institutions to facilitate growth at that level. But then as they achieved

middle income status by around the 1980s, it was necessary for them to reform. And as Roderick himself illustrates in his table, they did in fact reform with significant privatization and trade liberalization and financial liberalization in the 1980s. The point, though, is that I think that when you actually look at even Roderick's own analysis, it shows that South Korea and Taiwan did follow many of the recommendations of the Washington Consensus, and those that they didn't, they began to implement later on as they reached middle income status, and those things became more important. So I actually think that when you consider the cases that Roderick presents, it provides support for the claim that the institutions recommended by the Washington Consensus

and similar policy sets are in fact important for economic growth. One thing that Danny Roderick does emphasize is the importance of second-best reform approaches, by which he means policies that aren't necessarily the best practice of institutions but are better than alternatives. And the main example that he gives is that of the reforms that have occurred in China since the late 1970s, which I've discussed in previous episodes, many of which don't necessarily bring about the best practice economic solutions. For example, the town and village enterprises, which were sort of quasi-private and government operations where property rights weren't entirely clear, at least officially, although

So in practice, it seems that they were clear and protected enough and substantially more than they had been previously under the Maoist economic system to facilitate rapid economic growth. So that's an example of what you could call a second best reform. And I think that that is a very important insight, that the point is not necessarily that you have to have a set of institutions and policies that look like, that look exactly like what Western countries do. But rather, you need to ensure that property rights are sufficiently protected, that there is not excessive restrictions of trade. excessive regulation to prevent trade in innovation and entrepreneurship and savings and so forth and that there's not gross corruption and such that it prevents the state from providing key services that are necessary and so on and so forth. And so it's about the state achieving key objectives in establishing an economic system and those incentives that are necessary for growth

and not necessarily the precise form that those institutions take. Nevertheless, I do think that if you actually look at the elements of the Washington consensus, they are fairly broad in the way that they're framed that don't actually say specifically what form that institution should take, at least for most of the items. So I think that although Roderick brings up a number of good arguments, overall, I think his emphasis is a bit too strong on the downsides or on the failings of the Washington Consensus, and he overstates his case with respect to how heterodox South Korea and Taiwan were in their policies. Now, just before I mentioned the middle income trap, and I've mentioned this before, this is an important idea which relates to the relevance of institutions for economic performance.

Remember that the Solo Swan model predicts that as countries grow, they will slow down because they're reaching or they're increasingly getting closer to the technological frontier. As such, it's not entirely surprising that empirically a number of researchers has observed evidence for the fact that a number of countries have grown to the point of reaching middle income status but have seemingly become trapped at middle income level without having continued to converge to the developed world. And specifically the regions where we see most middle-income countries are the Middle East and North Africa and Latin America, both of which have experienced quite slow growth and generally have not converged with the West, or at best have only just kept pace with it since

the 1980s, roughly when they achieved middle income status. Although the Solar Swan Model predicts that these countries would slow down, it does not predict that they would stagnate and not continue to catch up with the West. It just says that they would grow slower, but they would still expect them to catch up gradually. So there's a question as to why this has happened. Why do we see a middle-income trap or stagnation of a number of countries when they reach middle-income level? Well, in my opinion, the best explanation for this, although the phenomenon is still not fully understood, is that the set of policies, norms, and institutions that are necessary to sustain growth change as a country grows. Inefficiencies that are not such a big issue when a country's

very poor, become much bigger of an issue as the country develops. So, for example, looking back at some of the cases we discuss with South Korea and Taiwan, but I think this applies to many countries. Foreign trade, privatization, and barriers to direct foreign investment are probably not that important when a country is extremely poor, and they engage in very little foreign trade, and there are few foreign investors who want to invest there, and many firms are small and inefficient anyway, and it doesn't necessarily matter if a number of them are run by the state. It doesn't make a huge difference. But as the state becomes richer, as there are more opportunities for foreign investment and

also for foreign trade, as the market becomes much more complicated, many more goods and services are produced and they increase in variety and complexity, and there's much more scope for innovation and competition, then privatization, trade liberalization, and financial liberalization become more important to facilitate continued growth. I think that we see this in the case of the Soviet Union most obviously, where they were able to, with the centrally planned system, they were able to go from a poor to a middle-income country because many of the technological and institutional factors that were necessary for that are,

at least possible to achieve in a planned system because it's, although not exactly simple, it's possible to centrally plan a simple economy where there's a focus on large quantities of especially industrial goods and fairly bland, generic, standardized set of consumer products, ensuring that people have basic apartments and food and television and things like that. But when you reach much more sophisticated levels of development, where you're moving towards a service economy with a much more diversified range of products and goods and a more knowledge-based economy and competition based on a differentiation of products and quality and so forth. It's just much harder to centrally plan that.

And this, I think, is partly why we saw the stagnation in the 70s from the late 1970s. And I believe that this is also contributing to the stagnation of Mexico since the 1990s, although they don't have a centrally planned economy, but there are many problems with their economic institutions, especially the labor market and the financial system, which I think or have been impeding their growth. And I think that this is the case in many. countries that have reached middle income status, that their institutions were good enough to get them from low to middle income, but are not sufficient for them to converge with the West.

Countries that have succeeded in conversion to the West, I think, have been able to undergo multiple institutional reforms, such as I mentioned with South Korea and Taiwan, for example, or the countries in Eastern Europe, which achieved middle income status, or at least a number of them, under the Soviet centrally planned period, but then since then have liberalized and instituted many of the policies similar to other European countries and have experienced more rapid growth than now either have reached or are just reaching high-income level status. Chile, I think, is another example of a country that's successfully able to further its liberalization and institutional reform process to achieve high-income level status.

But many countries, particularly countries like Brazil and Mexico and countries in the Middle East, such as Iran, have not been able to achieve high-income status. Before ending this episode, I want to wrap everything up. and bring together the things we've talked about by discussing what I think are the key preconditions for achieving economic growth. I think we can identify roughly five different factors that are essential for a poor country to begin the process of growth. This is not necessarily what's necessary to achieve high income, but what's necessary to at least begin the process of growth. So the first is freedom from conflict. Wars use up resources. They undermine trust. They make investments difficult,

and therefore sustained growth is essentially impossible in poor regions that experience prolonged conflict, especially civil war, which is particularly disruptive. For example, Iraq and Afghanistan have seen nearly continuous conflict since the 1980s, and this has dramatically hampered their growth prospects, which prior to that were actually quite good. Today, the same is true for Libya, Syria, countries like many parts of Sudan, the Democratic Republic of the Congo, Central African Republic and other places like that. It's not surprising that these places don't experience growth because things are so unstable and there's a little ability to invest.

The second item is basic degree of rule of law. Now, this doesn't have to be, by any means, the best form of rule of law, or the least corrupt or anything like that. We're not talking about Scandinavian levels of institutional efficiency, but it needs to be at a basic level, minimum level of control that the central government is able to exercise over its territory, including the ability to levy taxation, prevent rebel groups from exercising significant control over areas

or arbitrarily arresting or killing people. They have to be able to enforce law, to a minimum degree and apply them in at least a somewhat consistent manner. Otherwise, it's basically impossible that you'll be able to protect property rights or reduce corruption, enforce contracts, or institute any other forms of economic policies or a legal system necessary for growth to occur. There are a number of countries whose central governments are simply too weak to achieve this, even if there's not necessarily active conflict in them.

And these include states such as the Democratic Republic of Congo, Somalia, and Papua New Guinea, where the central state is for a variety of reasons too weak to achieve basic rule of law. And these states, I argue, have also very little prospect of growth until that's able to be achieved to a minimal degree. So this explains the first two, freedom from conflict and basic rule of law, I think, explain why many countries in sub-Saharan Africa have failed to achieve growth over the post-war period. Some countries which this previously applied have begun to reform and have achieved peace, and so have better prospects than they used to. but nearly all countries in sub-Saharan Africa experienced coups and civil wars and weak states for much of the post-war period. And I think that alone can explain much of their poor growth record. This also applies to a number of countries in the Middle East and Southeast Asia.

Now, the third item on the list is basic education. So it appears that a certain level of mass education, so particularly primary education, is necessary before workers are able to be absorbed in large numbers in an urban industrial economy. So it's unclear exactly what this level is, but it appears that it's, is, there is a certain threshold. And prior to that, being reached, it's just impossible to achieve the mass absorption of workers from rural areas into urban industrial areas, which is essential for the takeoff phase of the growth trajectory. And this basic provision of education was absent in sub-Saharan Africa until at least the 1980s in some places it still doesn't exist. But there's been a very substantial increase in educational provision in sub-Saharan Africa since the 1960s. And I think

that probably beginning in the 1980s or 1990s, minimal levels of education and associated urbanization were reached where you could begin to potentially reach a level consistent with economic takeoff. And I think the situation is similar in India. In the decades immediately following independence, there was very little provision of elementary education. Again, that's changed a lot in the last few decades. But I think that this lack of basic education is a factor that significantly impeded, particularly South Asia and Sub-Saharan Africa, in the 1950s through the 1970s. The fourth item on the list is basic infrastructure. So this includes roads, railways, postal service power, sewerage, another critical infrastructure for trade and investment.

Without this, then it's basically impossible for firms to access the inputs that they need or to sell their products at a market. They can't achieve the necessary economies of scale to reach efficiencies. New technologies can't be used because they can't be imported. You can't get spare parts of them, the expertise can't be brought into where it's needed and so forth. And also, you can't get competitive markets because transportation is so difficult that it's very hard to, or any one firm, to sell over a wide enough area to have competition. Infrastructure is still exceptionally poor in many some Samperean African countries, which is still a major factor impeding them. And, again, many developing countries have engaged in significant infrastructure building in the post-war period. Not all of it productive, but some of it productive.

I do think this has been a factor that has assisted Latin America. or at least some Latin American countries, where the infrastructure is generally a lot better than in sub-Saharan Africa, where in many places there are just no railroads or even basic roads to connect key cities or villages. And so there's little scope for any sort of significant modernization until that occurs. And the fifth element on the list are what I call basic market institutions. So this is sort of the minimal level of institutional support necessary to protect property rights, enforce contracts, permit private trade, allow for investment and so forth. These institutions do not have to be highly developed, and they can be significantly restricted by the state, as we've seen, in many cases.

But there needs to be a minimal level. The idea is that there needs to be certain minimal level of ability for people to benefit from innovation and investment. And some countries are able to attain that, for example, South Korea and Taiwan, even with the existence of many imperfections and restrictions, and other countries have not been able to achieve this, and therefore have been unable to begin the growth process. So I think one key example was China and India where prior to the 1980s there were too many restrictions on private trade and investment, along with lower levels of education and other factors that made growth very difficult. By the time that these countries began to reform in the 1980s, they were able to move to a set of institutions, which, although highly imperfect, were nevertheless good enough for them to begin the growth process. Once the growth process begins, it feeds on itself, and institutional reform can then continue and then facilitate further growth. So these five key factors of freedom from conflict, basic rule of law, basic education,

infrastructure, and basic market institutions appear to have been present at sufficient levels in places such as Eastern Europe in the early 20th century and after World War II, in the so-called Asian Tigers, so that's South Korea, Taiwan, Singapore and Hong Kong, in the 50s and 60s, which is when they experienced their great growth periods, and also in Latin America during much of the early 20th century, as well as the post-war period, at least of the last year. until the 1980s, whereas these conditions were largely absent or significant aspects of them were absent in much of sub-Saharan Africa until at least the 1990s, and we're also lacking in

China and India until around the 1980s. And I think that this is one of the reasons that we have seen better growth performance in many sub-Saharan African countries beginning in the 1990s, because many of the countries, not all of them, but many of them have significantly improved rule of law, significantly expanded basic education, have brought relative peace compared to previous times have improved infrastructure to some extent, although there's still a lot of improvement needed there, and have reformed their institutions enough to allow basic market institutions. And so I think we are starting to see in countries such as Ethiopia, for example, the beginnings of economic growth. But these things took far longer than people, I think, in the 1950s had thought when there

was optimism that the countries would be able to grow much more rapidly. These things seem to take decades rather than years to achieve. So in summary, we can sort of combine these elements together to get an understanding of what levels of growth are possible and what factors determine what growth occurs. So at very low levels of development, so a few percent of the US GDP per capita, because that's the world leader, so that's the standard we compare to. If a country is, say, less than 5% of the world level of GDP per capita, then there are many factors that act to impede its growth. And we've talked about some of these in the previous episodes about growth theories. We talked about multiple equilibria, poverty traps, coordination failures.

We've also talked about in other episodes of problems of conflict, corruption, poor protection of property rights, low education levels, poor infrastructure, and all of these factors combined together to make it extremely difficult for any sustained growth to occur. Now, this is what all pre-industrial societies experienced, and it corresponds to the roster stage of the traditional economy. When countries begin to have some basic successes, they reduce conflict enough, reduce corruption enough, protect property rights enough, start to get a basic domestic industry existing which helps to overcome coordination failures. Then they move from the traditional phase to the preconditions for growth phase.

And an example of this might be a country like Ethiopia, for example, which has experienced quite rapid growth in the last 10 years and is now a fair bit richer than countries such as Nigeria. And this roughly corresponds to the UK in the early to mid period of the 18th century when they were beginning to escape from some of these transactions. and problems, although they were still very poor and still experiencing fairly slow growth compared to what happened later. Then, when countries are able to reach some key threshold, which appears from my look at the

data, at least, to be something around 5 to 10% of the US GDP per capita, though that's only very rough, they're able to break free from these traps and coordination failures and corruption and other things enough to be able to achieve much more rapid rates of growth. And this corresponds to the rostose stage of the takeoff phase when the country's able to rapidly begin industrializing. And this happened in the UK around the late 18th to early 19th century. And currently this appears to be happening in India since the 1990s and may be happening in Ethiopia right now, although it's a little too early to say for sure. In this phase of growth, growth can be extremely rapid, so up to from the data that I've seen, 8% per year for a

sustained period of time, that's for 20 to 25 years. But the country still plagued by high corruption, poor protection of property rights, low education and poor infrastructure. So these things are a problem, it's just that they're not as much of a problem as they were when poverty traps and coordination failures were dominant and preventing any sustained growth. So there's a sort of a threshold that appears to be reached, which once you overcome that, you're able to grow much, much more rapidly. And this is interesting because it means that even countries that are only have slightly better conditions, a little bit better infrastructure, somewhat less corruption, somewhat better protection of property rights might just reach that threshold,

whether they're able to break free enough for sustained growth to begin or for the takeoff to occur. And so you might actually find that small differences in institutions or preconditions can make a big difference to growth prospects. This is something that I think needs quite a lot of further research. Now, the next phase of GDP growth seems to be something from about 10 to 60 percent of US GDP levels. And this corresponds to the Rosto stage of the drive to maturity, when growth, it's after the takeoff phase as the country is growing and industrializing and modernizing. When growth gradually slows down, consistent with the Sol S-1 model. So corruption continues to be a problem in such countries, but new problems begin to take the fore, as generally education levels in infrastructure

improve and become less of a constraint on development, but ineffective and inefficient capital on labour markets, as well as trade barriers, become more of a concern, as well as in some countries excessive levels of debt. And this has been observed in countries such as Latin America in the 1980s that I've discussed before. And in order to continue, achieving good growth outcomes by the end of this phase of the drive to maturity countries need to continue their institutional reforms to overcome

some of these new barriers. Otherwise, they won't be able to continue converging to advance country levels of GDP and they'll get stuck at a middle income trap. This period of the drive to maturity, eventually reaching sort of middle income levels of development, corresponds to the UK during much of the 19th and early 20th century,

probably up to the interwar period. And current examples of countries that seem to be in this period include China, Russia, and Mexico, although Mexico is kind of right at the end of this period. The final period that I've identified is when countries reach about 60-ish percent or more of the US GDP level. And at this point, they've kind of almost converged, maybe not quite converged to the US, but they're getting there. And maximum growth levels drop down right down from 3 to 7%, which is roughly what we saw, the drive to maturity phase, down to maybe 2% to 3% per year, just a little above the US as they gradually converge. And the current day,

examples of this are the UK and various countries in Europe and particularly Eastern Europe that are just sort of converging up. Japan as well, which is a little behind the US, but not too far behind. And this corresponds to Rostos stage of mass consumption. And the key problems in this phase of growth include inequality, externalities and rigid labor markets, all of which seem to put significant stress on political and social and economic systems in developed countries and are still issues that are ongoing, but note that they're generally somewhat different from the key barriers that are present to middle-income countries,

which are different in turn from those that are present to low-income countries. And the type of growth theory that we talked about here was endogenous growth theory, which remember is about how technological progress could be understood to emerge from people's decisions, investment. And the UK entered this period roughly, I think, in the 1950s, just after World War II and the recovery period. So that concludes our series on

economic growth and development. As I have mentioned, I do have some further material about specific policy debates, such as structural adjustment, trade liberalization, privatization, and debt crisis in exchange rates. I might discuss those in future episodes, but I decided to split those off because they're related, but somewhat more self-contained as their own topics. And hopefully you have enjoyed this series and learned a few things about what we know and what we don't know about the process of economic growth and development. If you have enjoyed the show, please help us grow by leaving a like on our Facebook page. You can go to Facebook and type in the Science of Everything podcast and like us there. You can also review the show on iTunes or the podcast

aggregator of your choice. If you would like to send questions, suggestions, feedback, or any other comments, please email me. My address is Fodds12 at gmail.com. And finally, if you'd like to support the show, you can click through on the links provided on the podcast description or go to our website at Fodsdwarf.poddin.com and there are links there to support options via PayPal or Patreon. I really appreciate everyone who has been able to support the show financially. That helps me to devote more time to produce more content. So thanks for listening and I'll talk to you next time.