Export-led growth: Past and Future

How did Germany, Finland, Japan, Korea, China, Malaysia, Thailand, Taiwan and Singapore manage to enjoy export-led growth and not others? Is there still room for export-led growth? Shahid Yusuf has a very interesting blog post about this issue. He argues that export-led growth model might not be dead yet but it would be difficult to repeat the same successful feat enjoyed by the ‘high achievers’.

The successful countries specialized in high-valued, sophisticated products, leading to constant innovation and thus high productivity and sustained competitiveness.

Some facts about export-led growth:

• Fast growing economies relied on a mix of manufacturing activities with electronics, transport, textiles, and engineering industries. The share of manufacturing sector is over 25% of GDP.
• Electronics industries provided a necessary stepping stone to industrial maturity and technological deepening. The share of electronics in manufactured exports averaged 40%.
• Innovation in electronics, automotive and engineering industries sustained competitiveness and enhanced productivity.
• Exports of manufactures remain one of the most important sources of growth.
• Investment to develop manufacturing industries and necessary supporting infrastructure averaged over 30% of GDP. The source for most of the investment was domestic.

Even if there is a stock of resources (investment and capital requirements) ready to be deployed in the economy, countries may not necessarily achieve high marks as the successful countries that relied on export-led growth. Why? How did the successful export-led growth countries become successful? Yusuf points to some necessary conditions required for this to happen:

• Political and macroeconomic stability
• Openness (the US market after the Cold War proved to be an elastic source of demand for imports); The EU also opened up its market. The countries that facilitated domestic production managed to export more when conditions were ripe.
• Advancement in technology allowed outsourcing and offshore production.
• Open trading environment facilitated the mobility of people and diffusion of ideas.

Export-led growth might not be dead yet but for new entrants it won’t be as easy as it was for the successful countries in the past. Why?

• There is excess production capacity in most industries. It would be hard for new entrants to break into the already competitive market.
• The most important and largest exporter, the US, might not be able to live with debt-financed consumption binge. This means there will be weak demand for imports.
• Rising energy and resource costs.
• ICT/electronics revolution is almost over. So, innovation in manufactures might not be at the same rate as it was in the past. Green technology might be the next big driver for innovation and related manufactures but it is not certain.

If export-led growth model is dubious, then what would drive growth? Yusuf throws a Keynesian wand arguing that the state much play a larger role by investing in productive assets, infrastructure and services. A new balance will need to be struck between the guiding hand of the state and the hidden hand of the market.

I think there is still room for export-led growth for small landlocked country like Nepal because of its market and geographic proximity to growing economic giants, India and China. Nepal trades more than 60% of its goods and services with India.

Given the clear lack of benefits from the WTO regime, is there still room for export-led growth in Nepal? The answer is yes, provided that we focus on full integration into the regional markets and in signing FTAs with countries that possess potential markets for Nepali exporters. This also includes instituting right measures on trade facilitation and specialization on products that are relevant and within purchasing power of customers in targeted markets.

Charting out strategies to fully integrate with other SAARC nations would also help to stimulate investment and exports. Nepal exports more to SAARC members than it does to other nations. Nepal’s export to SAARC, as a share of its total exports, increased from 53.9 percent in FY 2003/04 to 72.5 percent in FY2007/08. Meanwhile, imports, as a share of total imports, from SAARC increased from 53.9 percent in FY 2003/04 to 67 percent in FY 2007/08. In this regard, expediting integration under SAFTA (and BIMSTEC) would produce more gains than from any other trading blocs. These two blocs (plus China) could be the most important markets for Nepali exports in the coming days. The future of export-led growth would depend on how much Nepal can capitalize from integrating with these markets with huge potential.

Dani Rodrik thinks export-led growth is not a passé yet:

Many countries are trying to emulate this growth model, but rarely as successfully because the domestic preconditions often remain unfulfilled. Turn to world markets without pro-active policies to ensure competence in some modern manufacturing or service industry, and you are likely to remain an impoverished exporter of natural resources and labor-intensive products such as garments.

Nevertheless, developing countries have been falling over each other to establish export zones and subsidize assembly operations of multinational enterprises. The lesson is clear: export-led growth is the way to go.

None of this implies a disaster for developing countries. Long-term success still depends on what happens at home rather than abroad. What is moderately bad news at the moment will become terrible news only if economic distress in the advanced countries — especially America — is allowed to morph into xenophobia and all-out protectionism; if large emerging markets such as China, India, and Brazil fail to realize that they have become too important to free ride on global economic governance; and if, as a consequence, others overreact by turning their back on the world economy and pursue autarkic policies. Absent these missteps, expect a tougher ride on the global economy, but not a calamity.

Eduardo Zepeda argues that the financial crisis has revealed the limitations of export-led growth but it still is an option. But, this strategy has to be combined with strategies that promote domestic market. Also, diversification is needed (especially avoiding over reliance on agricultural sector). Restoring selective industrial policy might be helpful.

As the financial crisis forces developed countries to rein in their spending on exports, export-dependent developing economies will be drained of much of their driver of growth and will be forced to shift to measures to expand domestic demand to maintain growth rates. Still, the export-led growth strategies of developing countries – and particularly that of China, which is most often cited -- have not caused today’s global imbalance. Trade openness and export diversification will remain key drivers for growth and development, but substitutes for currency undervaluation and large current-account surpluses will have to be found.

Aid and entrepreneurship in Rwanda

It is very simple: nobody owes Rwandans anything. Why should anyone in Rwanda sit back and feel comfortable that taxpayers in other countries are contributing money for our own well-being or development? Why should we not be doing what we are able to do and raise ourselves up to higher standards and achieve more and better and get out of this poverty that we find ourselves in. Change has to start in mind. And that is what we have been working on over time. Once the mind gets correct, the rest becomes simple.

This is the reason that we are focusing on creating an entrepreneurial mindset in every Rwandan. This mindset begins with a sense that one's life, choices and actions matter to the whole country. It begins with a clear understanding that business as usual is not acceptable. Every day, every Rwandan from all walks of life has a unique opportunity to change our country for the better.

That is from Rwandan President Paul Kagame. The Rwandan economy has been growing at an amazing rate. Rwanda is ranked as one of the top reformers in the latest Doing Business report.

Paul Krugman profiled in The New Yorker!

A long but very interesting profile of probably the most celebrated economist of recent history.

Here is why Keynesian economics makes sense:

[...] he discovered later, a development that Keynes had helped to bring about. In the nineteen-twenties and thirties, economics had been more like history: institutional economics was dominant, and, in opposition to neoclassical economics, emphasized the complicated interactions between political, social, and economic institutions and the complicated motives that drove human economic behavior. Then came the Depression, and the one question that people wanted economists to answer was “What should we do?” “The institutionalists said, ‘Well, it’s very deep, it’s complex, I mean, you just talk about what happened in 1890,’ ” Krugman says. “Keynesian economics, which was coming out of the model-based tradition, even if it was pretty loose-jointed by modern standards, basically said, ‘Push this button.’ ” Push this button—print more money, spend more money—and the button-pushing worked. Push-button economics was not only satisfying to someone of Krugman’s intellectual temperament; it was also, he realized later, politically important. Thinking about economic situations as infinitely complex, with any number of causes going back into the distant past, tended to induce a kind of fatalism: if the origins of a crisis were deeply entangled in a country’s culture, then maybe the crisis was inevitable, perhaps insoluble—even deserved.

“What does it mean to do economics?” Krugman asked on the stage in Montreal. “Economics is really about two stories. One is the story of the old economist and younger economist walking down the street, and the younger economist says, ‘Look, there’s a hundred-dollar bill,’ and the older one says, ‘Nonsense, if it was there somebody would have picked it up already.’ So sometimes you do find hundred-dollar bills lying on the street, but not often—generally people respond to opportunities. The other is the Yogi Berra line ‘Nobody goes to Coney Island anymore; it’s too crowded.’ That’s the idea that things tend to settle into some kind of equilibrium where what people expect is in line with what they actually encounter.”

About trade:

Krugman wrote his thesis on exchange rates, but another class, on international trade, inspired him. “There was this kind of platonic beauty to the whole thing,” he says. “I remember going through the two-by-two-by-two model—two goods, two countries, two factors of production. The way all these pieces fitted together into a Swiss-watch-like mechanism was beautiful. I loved it.” The traditional theory of international trade, first formulated by the British economist David Ricardo, two hundred years ago, explained trade by comparative advantage: a country exported the goods that it could produce most cheaply, owing to whatever advantages it possessed—cheap labor, climate, technological expertise, and so on. It followed from this theory that countries that were the most dissimilar should do the most trade—countries in the Third World dispatching labor-intensive goods to the First World, the First World selling technology- or capital-intensive goods in return. In the years following the Second World War, however, economists had noticed that much international trade didn’t follow this pattern at all. There was a large amount of trade between countries whose economies were extremely similar, and these countries traded goods that were virtually identical: Germany sold BMWs to Sweden and Sweden sold Volvos to Germany. People had speculated about why this should be so, but nobody had come up with a model that explained it in a rigorous manner.

Krugman realized that trade took place not only because countries were different but also because there were advantages to specialization. If one country was the first to begin manufacturing airplanes, say, it might accumulate an advantage in economies of scale so large that it would be difficult for another country to break into the industry later on, even though there might not be anything about the first country that made it particularly well suited to airplane-making. But why would countries trade goods that were almost the same? Because consumers like to have a choice, and, as Avinash Dixit and Joseph Stiglitz had pointed out a few years earlier, the same logic of increasing returns to scale that Krugman had identified as an essential dynamic in trade could apply to a single brand as well as to a whole industry. Krugman presented his theory to the world in the form of a paper at the National Bureau of Economic Research in July, 1979. “The hour and a half in which I presented that paper was the best ninety minutes of my life,” he wrote later. “There’s a corny scene in the movie ‘Coal Miner’s Daughter,’ in which the young Loretta Lynn performs for the first time in a noisy bar, and little by little everyone gets quiet and starts to listen to her singing. Well, that’s what it felt like: I had, all at once, made it.”

Ahhh...and industrial policy:

One implication of Krugman’s theory was that, contrary to economic orthodoxy, industrial policy might have its benefits. If the location of a new industry was essentially arbitrary, then a government, by subsidizing and protecting its emergence, could enable it to gain such a lasting advantage that other countries would find it difficult to catch up. But Krugman tried to discourage industrial strategists who cited him. For, while in principle industrial policy could be helpful, in practice, he believed, it was so difficult to determine which industry should receive government help, at the expense of all the others—so difficult to predict an industry’s future, and so difficult to determine merit when powerful interests would be trying to influence that determination—that in the end industrial policy would be likely to benefit mostly the owners of a few businesses and hurt everybody else.

The Role of Government & Global Economic Challenges

In his new book, Freefall: America, Free Markets, and the Sinking of the World Economy, Stiglitz outlines six economic challenges the world has to address:

1. mismatch between global demand and supply because productive capacity is underutilized and necessary economic and social needs are unmet;
2. climate change because environment prices are distorted leading to unsustainable use of resources;
3. global imbalances because of excess consumption in the developed countries and excess savings in the developing countries;
4. manufacturing conundrum because increase there is increase in productivity but decrease in employment;
5. inequality because it is affecting overall aggregate demand as there is more money with rich and less with poor people, whose marginal propensity to consume is higher;
6. and growing financial instability leading to unmanageable risks.

Addressing these challenges is crucial for global economic stability. And, these challenges calls for a new economic model.

Stiglitz argues that this new model should include a bigger role for government as markets do fail sometimes. It is the government's responsibility to ensure that errant markets do not lead to catastrophic situations. In fact, the government should play a vital role in escorting the market in the right direction so that there is no unhealthy competition and excessive risk-taking that could endanger the whole economy. There are certain things markets cannot do by themselves. The government should play a critical role in maintaining full employment and a stable economy; promoting innovation; providing social protection and insurance; and preventing exploitation by "correcting" market distortion of income.

One of the key roles of the government is to write rules and provide referees. “The rules are the laws that govern the market economy. The referees include the regulators and the judges who help enforce and interpret the laws. The old rules, whether they worked well in the past, are not the right rules for the twenty-first century.”

This post comes from sticky notes I used while reading Stiglitz’s book. Here is previous post (Botswana versus USA) based on the same book.

Food Crisis in Nepal: Don’t Forget the Starving Poor

In my latest column, I discuss about the food crisis in rural Nepal. I focus on what should be done to reduce deficit food production and incidences of hunger in the rural areas.  Nepal should not only look for quick short-term fixes like food aid and subsidies. It needs to come up with a plan to prevent this recurring crisis in the long run. I propose a rural public works program akin to the NREGA model launched in India in 2006. (Thanks to Adnan Kummer for his help in editing this article!)

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Don't Forget the Starving Poor

Amidst fruitless multiple rounds of elusive political deliberations in Kathmandu, a large swathe of population in the rural areas is either facing starvation or is in danger of encountering one soon. The rural economy is reeling under deficit food production even though more than 70 percent of the population depends on agricultural sector for livelihood. Deficit food production and increase in the incidence of hunger in rural areas are not uncommon. Meanwhile, concerted efforts by the government to tackle the root causes of deficit food production and to alleviate the incidences of starvation are uncommon. The policymakers are yet to realize that ignoring such a brewing crisis could wreak havoc not only economically but also socially.

Food crisis is acute in the mid- and far-western regions. In fact, last July, the UN World Food Program (WFP) reported that starvation in these regions is as severe as in Congo and Ethiopia. In rural Nepal, over 600,000 people are facing starvation every day and around two million will potentially experience the same fate in the coming days. The WFP is running out of resources to feed the hungry people. Landless agricultural wage earners are particularly hit hard. Production of major agricultural crops such as paddy, wheat, and pulses has nosedived. The country might face food deficit of over 400,000 metric tons this fiscal year, according to the Ministry of Agriculture & Cooperatives. The most isolated regions are facing high intensity of starvation and food deficit. This problem has to be deal with swiftly and with a decisive food security policy to address not only the immediate causes but also to prevent occurrence of such cases in the long run.

It is encouraging to see the donors and development agencies taking promising steps to address the short-term challenges. However, the same cannot be said about the government’s plan of action. It allowed export of lentil and pulses at a time when the domestic demand is far greater than domestic supply, leading to severe food shortage in the rural areas. It is also importing 50,000 metric tons of wheat from India. The government should have purchased food from the domestic private sector at the prevailing international price and supplied it to the regions facing food shortage. Note that prices of both pulses and lentil are already skyrocketing in the domestic market. In fact, due to supply constraints, prices of most food items are already going up.

Severe food crisis is not a new phenomenon: there were food crises in 1979-80 and 1982-83. There was a particularly serious one in 2007.The economy has never been self-sufficient in food production. Agricultural output has not kept pace with increasing demand and population growth rate. Worse, productivity growth has stalled at a very low level for a long time. These issues were never fully explored by previous governments for various reasons. First, the WFP and other UN agencies have been regularly providing direct food assistance to the starving people in rural areas. Second, the media hardly ever prominently featured issues associated with deficit food production, food crisis, and starvation in rural areas as it does with political, entertainment and economic issues. Third, the government kept allocating budget for fertilizer and seed subsidies regardless of efficiency, outcome, and sustainability of such programs. Fourth, lack of local elections and prevalence of civil war for almost a decade deprived farmers of their right to effectively raising their voices. Fifth, poor infrastructure and burgeoning corrupt bureaucracy impeded effective distribution of food.

Poor farmers were repeatedly left at the mercy of state subsidies and food aid funded by donors. This addressed immediate consumption needs but not long term issues related to sustainable production and productivity. The agricultural policies designed to reap political dividends distorted individual and market incentives. Perhaps, we should learn lessons from the successful struggle of India and Pakistan to be self-sufficient in food production amidst famine and starvation five decades ago. Thanks to the Green Revolution spearheaded by Norman Borlaug, who received the Nobel Peace Prize in 1970, and good food security policies, India and Pakistan became self-sufficient in food production in 1974 and 1978 respectively. There is no reason why Nepal cannot follow suit.   

Lack of equitable land reforms, distribution and ownership of land, and unfavorable weather patterns are not the only causes of deficit food production and increase in incidences of starvation in far-western and mid-western regions.  A lack of government's attempt to seek alternative means to address these challenges is one of the main reasons. Studies have shown that 40-50 percent of public works budget in Nepal has been used for personal gains, resulting in massive misappropriation of resources. Additionally, replication of fairly successful programs, such as Churia Food-for-Work program launched in 1992 in Eastern Terai to address severe drought and declining production, has been disastrous due to over politicizing and excessive leakages. The Indian experience in dealing with drought and famine could provide valuable lessons not only to successfully target the most affected population but also to control leakages. There is a lot to learn from successful programs such as Maharashtra's Employment Guarantee Scheme (EGS) lunched in 1978 and Mahatma Gandhi National Rural Employment Guarantee Act (NREGA) lunched in 2006.

Replicating public works programs that are close to the NREGA model is essential to address four issues-- deficit food production, starvation, rural infrastructure and rural unemployment-- at the same time. Construction of local infrastructure could aid in enhancing productivity and reducing distressed migration. Apart from the job guarantee aspect, a program akin to NREGA model was funded by the World Bank and lunched in 2008. Unfortunately, it is slated to end this year. Nepal urgently needs public works programs of a much larger scale. 

There is a big multiplier, i.e. investment of one rupee would produce an outcome worth more than one rupee, associated with these kinds of programs. If these programs are complemented with distribution of high yielding seeds that are resistant to inclement weather and provision of easy credit to farmers as was done in India and Pakistan in 1970s, food production would be higher and the multiplier stronger. Ensuring “fair” prices for agricultural goods produced by rural farmers would provide an extra incentive to seek better methods of farming by the farmers themselves. We also need to address infrastructural constraints in production and distribution of food.

It is high time the government launched a program to address the root causes of starvation and food deficit. Craving for food aid from the WFP and the donors every time horrors of starvation strike the population is not a sustainable solution to a recurring crisis. It is time to find a permanent long-term solution to food deficit and starvation in rural Nepal. Let us not forget the starving people.

 [Published in Republica, February 18, 2010, pp.7]

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Brain drain could be good!

Here are four reasons:

1. Gains to migrants themselves. Why is this often ignored in brain drain discussions? Perhaps it reflects a neglect of the rights and well-being of individuals and an overemphasis on the nation-state as the object of development. The migrant is better off with higher living standards, not to mention satisfying her revealed preference to live in a country other than where she was born.

2. Gains to migrants’ families. Remittances is the most obvious and commonly-cited benefit of the brain drain. Even using official figures, which likely far undercount the value of remittances by excluding informal channels, remittances sent back by Africans abroad outweigh the cost of educating them at home. Why pass up a high return opportunity (Africans earning high incomes abroad and remitting) and insist on a low return activity (educated Africans underemployed at home)? Not to mention that families also get satisfaction from seeing their offspring realize their dreams.

3. Brain circulation.  Brains don’t just leave Africa, never to return.  Africans who have been educated or worked abroad do come back to their home countries to visit, to establish dual residence, to start businesses and universities, and, sometimes, to stay. These people bring back new ideas and skills—crucial ingredients to economic growth. Similar processes brought enormous benefits already to Asia and Latin America, so why would donors want to shut down this motor of opportunity only for Africa?

4. Stimulation of skill accumulation (“brain gain”). The possibility of migration and the example of role models who find success abroad (the Kofi Annan factor) provide incentives for young students to work hard and gain skills that will help them overcome the hurdles to migration. The authors argue that the new human capital created through these incentives offsets the loss of skilled people who do eventually leave.

Previously, Clemens and Mckenzie also argued that brain drain might benefit for both the receiving  as well as sending countries. Meanwhile, a ADB paper shows that unskilled migrants remit more than skilled migrants.

Rodrik's paradox!

Assume political power such that we have to make a transfer of $X to each worker in a certain industry. This could be done by:

1. Giving each worker now in the industry $X
2. Giving $X to all current and future workers
3. Giving an employment subsidy that raises wages by $X
4. Giving a production subsidy that raises wages by $X
5. Imposing a tariff that raises wages by $X

In terms of welfare ranking, 1>2>3>4>5

But, why do most countries choose 5 even if in terms of welfare 1 is better?

Possible reasons:

• Pro-revenue bias
• Commitment mechanism: deliberately use inefficient income redistribution to impose self-restraint
• Uncertainty, ignorance
• obfuscation (?)
• terms of trade

Source: Krugman