Pointers, yes, but the formula for success is elusive

DESPITE the contrary impression they like to convey, there's a lot economists don't know. And in various parts of their discipline fads and fashions change without much real progress made. Take development economics, the study of how countries develop economically, lifting their production and consumption of goods and services until they move from being poor to being rich.

In his book, The Quest for Prosperity, Justin Yifu Lin - who spent four years as the World Bank's chief economist before becoming the director of the China centre for economic research at Peking University - reviews the progress of development economics and sums up the latest thinking.

Economists have specialised in the study of economic development since the end of World War II. How can a country accelerate its growth and wealth creation to move from a low-income agrarian economy to an industrialising middle-income economy and then a post-industrialising high-income economy? And what are the roles of the public and private sectors in this?

In 2006 the World Bank set up a commission to report on growth and development, noting the "increasing evidence that the economic and social forces underlying rapid and sustained growth are much less well understood than generally thought; economic advice to developing countries has been given with more confidence than justified by the state of knowledge".

Since the war, only about 13 countries have made the transition to being high-income economies, with many progressing from the bottom only to get caught in the "middle-income trap".

In the early period after the war the dominant view of development economists was distrustful of markets and as a result highly interventionist. "It held that the market encompassed insurmountable defects and that the state was a powerful supplementary means to accelerate the pace of economic development," Lin says. "Many development economists then advocated that the state overcome market failures by playing a leading role in the industrialisation push, directly allocating the resources for investment and setting up public enterprises in the large modern industries to control the 'commanding heights'."

These "structuralists" believed international trade could not be relied on as an engine of growth because any attempt to increase exports of commodities would simply worsen the developing country's terms of trade. They argued the way for a developing country to avoid being exploited by developed countries was to develop domestic manufacturing industries behind high tariff barriers, a process known as "import substitution". These attitudes continued to dominate until it became apparent they weren't working.

In the 1980s, the pendulum swung to the opposite extreme. The "Washington consensus" - so called because it was enthusiastically adopted and imposed by the Washington-based international agencies, the International Monetary Fund and the World Bank - emphasised macroeconomic discipline (limited accumulation of government debt), a market economy and openness to international trade and foreign investment.

But this "neo-liberal" approach fared little better. Lin says the main reason it failed to deliver was it relied on an idealised set of market institutions - including well-functioning commercial laws and social norms of behaviour - which hardly existed in developing countries and weren't fully present even in advanced economies.

When you look at those few countries that have moved up the ladder, you find they "have rarely followed the policy prescriptions of the dominant development paradigm of the time. Most successful developing countries . . . have expanded their manufacturing bases and moved into more sophisticated industrial products by defying conventional wisdom. In their development process, they pursued an export-promotion strategy instead of an import-substitution strategy . . .

"And they each had a proactive government helping the private sector enter new industries instead of relying on market competition alone as advocated by the Washington consensus."

Lin argues there's no uniform formula for developing countries. The strategy has to be adapted to their circumstances. Even so, the World Bank's growth report does identify five "striking points of resemblance among all highly successful countries". First, they made the most of globalisation, importing ideas, technology and know-how and exploiting global demand.

Second, they maintained a stable macro-economic environment, despite periods of high inflation and public debt. Third, they had high rates of saving and investment, reflecting their willingness to forgo current consumption in pursuit of higher incomes in the future. Fourth, they adhered to a market system to allocate resources. Their governments did not resist market forces in reallocating capital and labour from industry to industry. Fifth, they had committed, credible and capable governments.

In some countries, such as Hong Kong, the administration chose a laissez-faire approach (though it also had quite a number of sectoral policies), whereas in others the state was more hands-on, (tax breaks, subsidised credit, directed lending) in the world of business to help private companies enter industries they might not have otherwise considered. The report also identified "bad ideas" to be avoided by policymakers in their search for growth.

The list includes subsidising energy, using employment in the civil service to reduce joblessness, reducing budget deficits by cutting spending on infrastructure, providing open-ended protection to domestic companies, imposing price controls to stem inflation, banning exports for long periods, resisting urbanisation, measuring educational progress by the increase in school buildings, ignoring environmental issues as an "unaffordable luxury" and allowing the exchange rate to appreciate excessively.

It's clear Lin's book offers a valuable and balanced account of the progress and present state of development economics.

But it is marred by an amazing, credibility-destroying omission: in more than 300 pages about how the developed countries can raise their material living standards to those of the rich world, nowhere does he mention the challenge of climate change or the implications of such growth for the natural environment. Like so many economists, he simply assumes the ecosystem away.

Twitter: @1RossGittins