Submission To DFID Consultation

My article titled Submission to DFID Consultation on International Development was pubilshed on International Policy Network on April 7, 2006.

1. What determines economic success and promotes economic growth in poor countries?
¡ñ How do factors such as a government¡¯s macroeconomic policy, investment, trade, the environment, or regional markets and institutions affect the private sector¡¯s ability to raise the levels of growth?

¡ñWhat are the obstacles to growth and how can they be removed?
9. How can the UK Government make sure that international trade negotiations deliver the benefits needed for developing countries?

¡ñHow can trade barriers be broken down so that developing countries get better access to regional and international markets?

The three factors that primarily affect economic performance in poor countries are weak rule of law and enforcement of property rights, rising levels of regulations that reduce competition and increase the cost of entrepreneurship, and finally, the institutionalization of political patronage and inevitable ensuing corruption. All the three factors are related in the sense that one invariably leads to the others.

At the root of this triad, is the belief that coercive power of the government needs to be mobilised to direct economic relief to the poor. This provides the basis for political intervention in the economy in order to correct for perceived inadequacies. This creates an environment where businesses must respond by seeking political patronage or protection, which encourages the spread of corruption, depending on the degree to which political intervention encroaches economic affairs. Political interventionists seek to overcome the resultant economic inefficiencies through macro-economic intervention.

The resulting inflation becomes a hidden tax on the poor to perpetuate privileges of the elite. Inflation on a large scale discourages investment climate and promotes capital flight. Without the ability to invest, the private sector can no longer promote economic growth. As political intervention is now firmly entrenched, the typical reponse is to impose further restrictions on capital movement and also increase trade restrictions, both of which only further distort the economy.

Technically, it is possible to argue that insulating the economy from political intervention will go a long way in eliminating these obvious distortions and pave the road for economic growth. However, without popular mandate, political authorities have neither the incentive nor the ability to break cosy relationship with vested interests. Therefore it is important to have a competitive political democracy, where political authorities must seek the mandate of the people and the political space exists for more creative political entrepreneurs to reach out to the people and build new political constituencies in support of the necessary reforms.

Without this political space, the sustainability of economic reforms will always remain in doubt. Therefore, it is important to understand the political economy of reforms, and factors that may shape an environment conducive for economic growth.

On the subject of trade, the WTO Ministerial Summit in Hong Kong provides another opportunity to examine what factors stimulated economic growth in the Special Administrative Region (SAR) area. The comparison with India have useful illustrations. While Hong Kong has far fewer natural resources than India, it is a far wealthier economy and boasts far more diverse sources of wealth creation and economic development. Hong Kong unilaterally embraced free trade and opened its borders to the outside world, based on the understanding that trade between people is not a zero sum game, but a process that leaves both parties, engaging voluntarily, better off.

However, India toyed with the belief that it had to develop internally before it could integrate itself with the outside world. After decades of attempts at self-sufficiency, Indian policymakers made substantial reforms after 1991. The reforms admitted that high trade barriers depressed growth and proved that attempts through government-supported industrial development to alleviate the country¡¯s substantial population living in absolute poverty were counterproductive.

Trade barriers are gradually coming down through the multilateral WTO process and entrepreneurial Indians are beginning to seize the opportunities a stable economic environment can bring. The benefits of lower trade barriers accrue not just to the entrepreneurial class, but to all Indians engaging in wealth creating activities. These are reducing poverty and providing more opportunities in order to ensure the Indian economy becomes less reliant on basic agriculture and is able to move into higher value-added economic activity. This proves the benefits of trade liberalisation are greatest for the 600 million Indians who currentlyhave no other choice but to rely on basic agriculture both as employment and subsistence.

Freer trade is a necessary but not a sufficient condition for sustainable economic development. The success of Hong Kong, which embraced unilateral free trade and other economic freedoms, as compared to India, which did not, not only illustrates this but also provides a guide for how trade negotiations should proceed at the bilateral and multilateral level. The free trade policy of Hong Kong was backed by a respect for the rule of law, strong and well-defined property rights, macro-economic stability, and minimal political intervention in the economy.

As one of the most influential countries in trade discussions, the UK has the opportunity to transfer this empirical evidence to the poorest ¨C and most protected ¨C countries in the world.