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The World Bank needs innovative theory
More accurate risk-assessment
4/2004
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[ Economics ]
The World Bank needs innovative theory
The World Bank’s macroeconomic assumptions disregard many issues relevant to development. These include, for instance, population growth and income distribution. Endogenous growth models are better suited to analyse complex interactions than the conventional tools of neoclassic and post-Keynesian economics.
[ By Nina V. Michaelis ]
The World Bank is officially committed to sustainable development. Yet its own policy does not adhere to this principle. Structural adjustment programmes and poverty reduction strategies still conflict with social and ecological goals (Michaelis, 2003). One reason for the poor sustainability record is the World Bank’s outdated theoretical approach based on neoclassic and post-Keynesian ideas.
Both are incompatible with sustainability. Neoclassic understanding of sustainability rests on the belief that technological progress automatically leads to a more efficient use of resources and, accordingly, to less ecological degradation (“substitution optimism”). However, the model does not explain how technological progress is brought about. Nor is the neoclassical school of thought able to say anything about the distribution of welfare (Hampicke, 1999) and, therefore, does not pay the developing countries’ poverty problem adequate attention.
For several reasons, post-Keynesian models are similarly incompatible with the principle of sustainability. First of all, they produce analyses for the short term. Typically, merely two periods are considered, which is inadequate for designing a growth process in general and even more so for a sustainable path to development (Easterly, 1999). Moreover, these models also disregard distribution because they only take aggregated quantities into account.
World Bank economists, however, still work with country-specific variants of the post-Keynesian Revised Minimum Standard Model, although it is academically outdated and cannot deal with the complexity of development processes. The model’s merits are that it is easy to understand and apply. In addition, little information on the behaviour of the economic actors is required. The World Bank determines the volume of its loans on the basis of such calculations. In addition to the transfer of these sums, the bank believes that measures to promote growth are necessary. These are expected to be in line with the Washington Consensus approach of privatisation, deregulation and liberalisation (Easterly, 1999).
The structural and stabilisation measures that the World Bank economists implement are thus based on theoretical models which are incompatible with the principle of sustainability and which they, at most, supplement with cushioning elements (Michaelis, 2003). The obvious alternative would be to apply more recent approaches of endogenous growth theory. After all, economic growth is a precondition for sustainable development. Endogenous growth models are very diverse, so one cannot speak of an integrated and comprehensive theory. However, all endogenous models share the attempt to explain growth without recourse to exogenous factors. While the basic model of endogenous growth theory was developed for industrialised nations, it can be adapted to situations typical of developing countries. The diagram gives an idea of the complex interrelatedness of economic phenomena.
please click into the image to enlarge
Complex interactions
These manifold links clearly serve to illustrate the shortcomings of the World Bank. For example, the IMF and the World Bank call for the immediate opening of national economies to world trade. By contrast, endogenous growth models suggest assessing free trade’s benefits for developing countries more diligently (Redding, 1999). Trade liberalisation only presents an opportunity to increase long-term growth rates in developing countries when pursued in a differentiated way respecting specific needs of countries and sectors. Otherwise, there is a risk of economies specializing solely on low-technology goods, which, in turn, means forsaking long-term innovation.
Complementary measures are necessary if developing countries are to take advantage of liberalisation. Education, enhancement of communications and transport infrastructure and special mechanisms for the transfer of knowledge from advanced to developing countries (such as on-the-job-training, imitation of existing technologies and foreign direct investment) are important determinants for economic development. The level of education in a developing country is particularly significant. If a national economy has too little human capital, opening the markets mostly results in minor or even negative growth effects. Empirical studies support these statements.
Population growth is a serious obstacle to development. In many poor regions, it puts the already overburdened education and health systems under additional stress. Traditional economics theory, however, ignores the significance of fertility. Endogenous growth models can take family planning into account and link birth rates to social security systems as well as to environmental aspects (Michaelis, 2003). Doing so leads to developmental insights. For instance, short-term social cushioning measures, such as those implemented frequently by the World Bank and its partners to reduce the negative impacts of programme-tied loans, do not suffice for a positive development process. By contrast, long-term social security measures (such as introducing a pension scheme) contribute to reducing fertility.
Poverty stalls growth
Incomes in developing countries are mostly distributed very unevenly. The World Bank, so far, does not view this as an important obstacle to development. However, it is to be hoped that this will change following the appointment of François Bourguignon as the bank's Chief Economist last autumn. For years, Bourguignon has dealt with links between poverty, unequal distribution of income and economic growth. At any rate, the widespread thesis that, in the wake of economic development, inequality first increases and then decreases by itself (the “Kuznet Curve”), has empirically been shown to be wrong. Endogenous growth models underpin this finding in theoretical terms (Aghion et al., 1999). Unequal income distribution results in too little investment in training, the consequences of which impede growth.
Endogenous models are also useful from an ecological viewpoint. According to neoclassic environmental and resources theory, external effects of noxious emissions and over-exploitation of resources must be internalised in order to ensure long-term economic growth. Instruments in tune with the market, such as taxes or certificates, are better suited to do so than strict governmental regulation. Even these findings are not yet paid enough attention in the Country Assistance Strategies in which the World Bank lays down short- to medium-term development strategies.
Endogenous growth theory contributes to analysing the complex interactions of sustainable development. Even if most of the recommendations are well-established in the critique of developmental practice, formal theoretical analyses help to avoid the arbitrariness of policy statements. Future research must show how to develop a user-friendly, comprehensive econometrical model. Building on a profound analysis of development determinants, it will be possible to draft country-specific development strategies in line with sustainability principles. These should be reflected in the conditionalities of programme-tied loans. To ensure consistent implementation of sustainable development policy, the World Bank must update its theoretical models. Endogenous growth theory provides a starting point.
Further reading
– Aghion, P.; Caroli, E.; García-Peñalosa, C. (1999): Inequality and Economic Growth: The Perspective of New Growth Theories, in: Journal of Economic Literature 37, pp. 1615-1660
– Easterly, W. (1999): The Ghost of Financing Gap - Testing the Growth Model Used in the International Financial Institutions, in: Journal of Development Economics 60 (2), p. 424f.
– Hampicke, U. (1999): Das Problem der Verteilung in der Neoklassischen und in der Ökologischen Ökonomie [The Problem of Distribution in the Neoclassical and the Ecological Economy] , in: Beckenbach, F. (Ed.): Jahrbuch Ökologische Ökonomie - Zwei Sichtweisen auf das Umweltproblem: Neoklassische Umweltökonomie versus Ökologische Ökonomik [Ecological Economy Yearbook – Two Views of the Environmental Problem: Neoclassical Environmental Economy versus Ecological Economics], Marburg, p. 158
– Michaelis, N. V. (2003): Nachhaltige Entwicklung und programmgebundene Kreditvergabe der Weltbank – Eine theoretische und konzeptionelle Analyse, Dissertation Universität Kaiserslautern , Volkswirtschaftliche Schriften der Universität Kaiserslautern, Bd. 26 [Sustainable Development and Programme-tied Loan Allocations of the World Bank – A Theoretical and Conceptual Analysis, University of Kaiserslautern dissertation, Economic Papers of the University of Kaiserslautern Vol. 26], Regensburg.
– Redding, S. (1999): Dynamic Comparative Advantage and the Welfare Effects of Trade, in: Oxford Economic Papers 51, pp. 15-39
Dr. Nina V. Michaelis
is an economist with the German Government’s Advisory Council on Global Change (WBGU) in Berlin. Her dissertation of last year dealt with loan allocations of the World Bank.
nmichaelis@wbgu.de
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