Markets: still a pretty good idea
Civitas, 19 April 2011
The financial crisis and ensuing recession has produced a wealth of different economic predictions and advice. Some critics of free market capitalism have used the crisis to suggest that free markets are fatally flawed and need restraint. Other proponents of state involvement in the economy have, worryingly, talked up the benefits of the ‘Chinese model’ of state-led capitalism. In contrast some governments, including our own, have pledged to remove barriers to growth, implicitly or explicitly earmarking some aspects of state. Wading into this debate is Brink Lindsey, Senior Scholar in research and policy at the Ewin Marion Kauffman Foundation in his new paper: ‘Frontier Economics: Why Entrepreneurial Capitalism Is Needed Now More Than Ever’. His hypothesis is unsurprising given the Kauffman Foundation’s commitment to entrepreneurship, yet it finds a degree of support in another paper, recently released by Barry Eichengreen, Donghyun Park and Kwanho Shin: ‘When Fast Growing Economies Slow Down: International Evidence and Implications for China’.
Eichengreen et al’s paper as discussed in this week’s Economist examines how countries that experience rapid growth, witness a slow-down once this ‘catch-up’ growth has been exhausted. Examining rapidly developing countries, the authors looked at those that had witnessed GDP growth per head of more than 3.5% on a purchasing-power-parity basis and then suffered a sharp slow-down where growth decreased by 2% or more. On average countries experienced this slow-down once GDP per head reached $16,740 and then average growth slowed from 7.1% to 5.6%.
Eichengreen et al do not go into great detail on how this slow-down can be counteracted, yet this is perhaps where Brink Lindsey’s paper can shed some light. Lindsey argues that there is a distinction between ‘imitative’ and ‘innovative’ growth. The former occurs before a country reaches the ‘technological frontier’, the latter is required to push the frontier further. Lindsey argues that underdeveloped countries can more easily play catch-up than developed countries can push development further. This is perhaps not too surprising, indeed less developed countries can learn lessons from developed countries, lessons not available to countries seeking to innovate rather than imitate. So far, so uncontroversial one may think.
Yet Lindsey’s hypothesis goes further than this, he posits that there is a ‘ratchet effect’ between economic development and economic freedom: as the former increases the need for the latter increases at a growing rate. Mathematically you could say that required economic freedom is economic development squared. Historically Lindsey draws attention to the fact that governmental involvement in the US and western European economies was far greater in the post-war period than it has been since 1980. This was economically productive because government’s can ape others, copying successful development strategies. However the early 1970s marks the beginning of these economies hitting the ‘technological frontier’ and the liberalisation of their economies since the 1980’s marks their response to this: further growth (albeit slower) being only possible with a greater degree of economic freedom.
Why economic freedom? Referring to the ideas of Hayek Lindsey argues that only the market possesses a sophisticated enough ‘discovery procedure’ in the face of an increasingly complex, information-saturated world, where obvious solutions and ideas have already been discovered and applied. The state’s decision making ability is redundant, Lindsey argues possibly dangerous, in an economic world where innovation may come from any number of diverse sources, and trial-and-error, creative destruction are the keys to success.
What are the ramifications of Lindsey’s and Eichengreen’s work for developed and developing countries? ‘When Fast Growing Economies Slow Down’ warns emerging economies that growth rates will, in all probability, eventually slow. Beyond this the authors, perhaps wisely, do not make any definite predictions about when this slow-down will occur. ‘Why Entrepreneurial Capitalism Is Needed…’ on the other hand is far more aggressive, the message is clear for all countries, but particularly those approaching or at the ‘technological frontier’:
‘at the higher levels of development there is simply no substitute for the robust competition and perpetually unsettling dynamism of entrepreneurial capitalism.’