Michael Spence, recipient of the 2001 Nobel Memorial Prize in Economic Sciences, explains why Ukraine, unlike Brazil or South Korea, has failed to make an economic breakthrough
“In 1960, the small island state of Singapore, adjacent to Malaysia, was a fishing village with an average GDP per capita of $427. It became independent of Malaysia in 1960 and today has an average GDP per capita of $38,000, one of the highest in the world. The fishing village became one of the largest ports in the world and a major financial center. Another island state, Cuba, had a revolution, made major changes in the lives of ordinary citizens by providing education and health care, but then chose to follow the Soviet version of central planning and languished in terms of growth and poverty reduction.”
The recipient of the 2001 Nobel Prize for the analysis of markets with asymmetric information, Michael Spence gives the example of two island countries in his book titled The Next Convergence that analyzes the circumstances under which some countries, including China, have managed to force economic development for decades.
Professor Spence is an optimist. He suggests that 75% of the world population will eventually enjoy the same quality of life currently evident in so-called developed countries.
To meet this criterion, a country’s GDP per capita rate must be over $20,000. China has already crossed the $7,600 line. Having slowed slightly as a result of the global financial crisis, it is still growing at around 9% annually.
No one can guarantee success. Each country must overcome its specific and often unpredictable difficulties. External interference is often inefficient, Michael Spence says.
Still, some inspiring examples include 13 states whose economies have been growing 7% annually over a 25-year period. Their experience is easy to outline and borrow, in theory at least. According to Prof. Spence, natural resources are often unnecessary, even burdensome to effective growth. What he means is that everything largely depends on the people of a given country, unless natural disasters and global crises affect the situation.
Why then are only a few countries repeating the success stories of Singapore and South Korea? Why have they failed to become producers and exporters or lift millions of their citizens out of poverty?
Atypical for an American economist, Prof. Spence puts an accent on factors other than purely economic ones, such as a country’s openness, free competition, market mechanisms and investment draw.
In addition to these, Prof. Spence discusses the crucial role of efficient public institutions, fair laws and some non-market factors, such as the national idea and self-identification as well as honesty and leadership talent.
Prof. Spence’s book offers interesting explanations for these. He kindly spoke with The Ukrainian Week, highlighting some important aspects on the path to economic growth, and expressing his opinions on the most critical financial and economic problems now facing the world.
U.W.: The creation of a common European currency is often called an exciting economic experiment. Many people now criticize it, saying that it was doomed from its very inception because it was motivated by politics rather than economics. As an economist, do you see European attempts to save the common currency as a good thing?
Absolutely! There were lots of people prior to the introduction of the euro who warned that it was risky without a higher degree of political or at least fiscal centralization. European political and policy leaders pretty much understood that, but they decided to introduce the euro first and continue with their political integration in parallel, albeit with a slight delay. What happened is that it got more delayed and the risks actually materialized, so a number of countries misused the freedom and low interest rates that went with the euro. It’s turned out to be a pretty difficult situation. But I think there is still a lot of commitment to the common currency. It’s a very good thing for Europe if we come out of the crisis and have a higher degree of integration that supports the monetary union, and it’s good for the whole world to have an integrated Europe that’s strong.
U.W.: Do you think that it’s possible to have one currency, one monetary policy and uniform interest rates that work as well for Germany as they do for Greece and Portugal, for instance?
I think it’s pretty difficult right now. Greece and Portugal probably have to find a way to reset their economies, which means exiting from the eurozone for a while. I don’t see how they can grow, especially Greece. Under the current conditions, I would say those are the two countries that most likely need to depart for a while.
U.W.: So, you think the euro should work, but with a different list of monetary union members?
I think the better outcome would be to have the core eurozone hold together, while it would probably be better for a couple of countries to leave. By that, I mean the countries that have become so out of balance in terms of their productivity-to-income ratio that they don’t really have any growth potential.
U.W.: Given the problems in Europe and the US, many fear that the global economy is headed for a 1930s-style recession. Is humanity condemned to repeat a cycle of economic boom and bust forever? Aren’t we supposed to accumulate knowledge and become smarter?
I guess nobody really knows the answer to that. But history suggests that we have not mastered the art of eliminating large boom and bust. Will we learn that in the future? That’s an interesting question but with a certain degree of humility one might say we don’t know the answer. I’m consciously optimistic about the fact that over time we can make the global economy reasonably stable, and I think we can learn to make it feel more beneficial to most people. But there are big challenges in getting there. We have stability issues, distributional issues, employment issues, and we have all that in the context of a difficult fiscal situation in advanced countries. So, this isn’t an easy problem. From an investor’s point of view, there are very big downside risks.
U.W.: We hear a lot about debt these days, even in successful businesses and rich countries. Is debt an integral part of the economic system?
Debt, if properly used, is a perfectly legitimate part of the economic structure and financial system. It allows you to make long-term investments and distribute the costs appropriately across longer periods of time. If you have stable cash flows at the company level, you can reduce the cost of capital or increase the rate of return on equity investment. The problems we’re seeing are not inherent with the notion of debt but rather with the excessive use of it.
U.W.: Political leaders are elected but they are not necessarily specialists in global economics. How can they be helped?
I think that over time, both political leaders and citizens are going be on a learning curve that entails a better understanding of the rapidly evolving environment in which we all live, economic and otherwise. So, we’re probably in the early stages of that. I’ve spent a fair amount of time in developing countries and I find that political and policy leaders in these countries are quite interested in learning about the experiences of other nations while they plot their own course, especially in places like China, India, Brazil and so on, and I’m sure it’s broader than that. I don’t think the more sensible and vigorous economic policy debate is having much effect on the political process in America. Lots of people wonder why this is so, but the political process seems to be in a somewhat different world at the moment. Maybe that will change after the presidential election, but it’s still too early to know.
U.W.: You say in your book that countries that were once poor, such as China and India, are now growing quickly and becoming more developed. Some say these countries are not getting closer to the West, but rather swapping places. For instance, China was the most developed country centuries ago while Europe was a wild place in the Middle Ages. Doesn’t it seem that the world is reverting to this earlier state: China was once the center of civilization and it is becoming so once again?
There’s an element of truth in that. Asia has always been quite populous and probably there were times prior to the industrial revolution when the Middle Kingdom was a little more developed by the standards of the day and had higher income compared to Europe. These differences weren’t very big by modern standards though. The book says we’re in a pattern of convergence, and we have much higher income levels than we had before the industrial revolution. In a sense we’re going back to the past, but in a very different configuration. And it’s true because if India and China succeed due to their populations they will clearly become economic giants in the global economy. And then you’ll have very big entities like North America, the European Union, Brazil and a number of other countries, but these won’t have the size or the scale of China or India if they succeed.
U.W.: There was once a simplistic perception that China, India and other “tigers” were growing mostly because the West was buying goods produced there on credit, basically accumulating debt. Now that the run is over, can China and other similar countries still go further without relying too heavily on exports?
No, they would be hit hard if the West stopped buying their products. If we had major economic difficulties in Europe and America, it would slow them down a little bit, although they’re pretty resilient. The technical term sometimes used for this is “partially decoupled.” They can definitely grow at a relatively high speed, so they’re not dependant on us in the way they used to be when they were starting out on this long journey. But if you look at developed countries more carefully you will notice that they tend to be more dependent on global demand, technology and knowledge at the early stages, and they become less dependent on this as they grow bigger and richer.
U.W.: You offer a number of clear steps to facilitate economic growth, such as introducing market motivation for producers, opening up countries for foreign competition and investment, and introducing simple and fair rules for business. Why are more countries not growing faster if they can follow this clear and simple path?
It gets a little more complicated in the details, but the basic idea is right. You need a functioning market system, private property, incentives to invest, and a reasonably stable environment governed by understandable rules that are applied even-handedly. Also, you need high levels of investment savings.
Just look carefully at the countries that haven’t succeeded in the past 20 years, although many of them are starting to show signs of success. If you look at the failures where growth never occurred, one reason is that politics got tangled up because nobody had really developed a growth agenda.
U.W.: You’ve mentioned self-identity. The audience in Ukraine is particularly interested in your opinion on this issue. What is national identity? Is it something intangible or, as some people say, unimportant?
Look at Africa. Most countries there were created in the post-war period as colonial empires collapsed. They were put together rather haphazardly from a geographic point of view. In many cases you had a group of people who really didn’t think of themselves as citizens of the country. Rather, they thought of themselves as members of a religious or ethnic group, or a tribe. They were put together and told “now you’re a country.” So, the most basic element of a political system should be the sense that people belong to the same unit; they have to elect honest and reasonably talented people to make decisions for them and represent their interests.
In non-mature states, these issues get sidetracked in the battle for who is going be in power. The underpinning of those battles is a set of identities, a group of identities that really don’t correspond to a country at all. That’s why it’s important. Leadership is important.
U.W.: National identification is an essential element of a successful economy?
Of course, it is important.
U.W.: Would you agree with a statement that some cultures are incompatible with economic growth?
I suppose you may think that cultures and traditions that are offended by materialism, the pursuit of wealth and goods, might well find their growth agenda inconsistent with their underlying values. I wouldn’t reject this but I wouldn’t accept it automatically either. Most religious traditions I know of are not completely inconsistent with the idea of reducing poverty and expanding opportunities for people, although their growth agenda is inconsistent for the most part.
U.W.: Some people may be surprised to know that you say in your book that natural resources are not necessarily beneficial to a country. Isn’t it good to have abundant natural resources?
It should be a good thing because it’s an asset and you can use the asset to educate people, to build infrastructure and expand opportunities over time. Based on experience, however, large amounts of natural resources have frequently distorted political incentives away from having a growth agenda, and towards a fight over who gets to benefit from this wealth. It’s not inevitable, yet it’s been the experience of many countries. Natural resources are an asset if government structures and institutions are built well enough to be able to deploy them to the benefit of the vast majority of the people.
LATEST WORKS BY MICHAEL SPENCE
Globalization and Growth. Implications for a Post-Crisis World, 2010. Edited by Michael Spence and Danny Leipziger
Leadership and Growth, 2010. Edited by Michael Spence and David Brady
Health and Growth, 2009. Edited by Michael Spence and Maureen Lewis
Urbanization and Growth, 2009. Edited by Michael Spence, Patricia Clarke Annez, and Robert M. Buckley