(Update) A Perverse Reform Outcome

Bill Easterly a development economist who uses empirical reasoning to refute much of the prevailing wisdom in economic circles debunks the argument of Rodrik (based on an IADB report) regarding the perverse contribution of structural adjustments in Latin America to productivity growth in the decades that followed reform.

He does so in passing as he makes a "clumsy" sports analogy between the World Cup and economic competition among nations. His claim is that in such a tournament type setting, skill trumps luck. The analogy is clumsy in the sense that the length of time covered in the analysis plays a part in determining whether developing the "right" skills in soccer (analogous to developing the "right" policies and institutions) pays off in the end.

Easterly claims that the IADB report's time periods were too short. He means that randomness or "luck" may have played a part in making it appear that the Washington Consensus failed to deliver productivity improvements in the Latin American region. In stating this, Easterly implies that a different time horizon in the report would have revealed the long-term impacts of import substitution policies on the (under)performance of economies in the region.

A Perverse Reform Outcome

Dani Rodrik of Columbia University featured the following chart in his blog. It was taken from a report by the Inter-American Development Bank entitled The Age of Productivity. It covers Latin America's experience with industry policy from the 1950s to the 2000s.

Rodrik's comments regarding this chart are worth quoting in full:

Ignore the intermediate period of debt crisis (1975-90) and focus on the differences between the periods of import-substitution (IS, 1950-1975) and Washington Consensus (WC, 1990-2005).  What do we see?

1. Labor productivity under IS grew at a rate that is double the rate under WC.
2. The rate of labor productivity growth within sectors (the component identified as “within” in the chart) was comparable under the two policy regimes.
3. The worse overall performance under WC is accounted entirely by the fact that there was much less desirable structural change -- labor moving from low to high-productivity activities -- under WC than under IS.

For all its faults, IS promoted rapid structural change.  Labor moved from agriculture to industry, and within industry from lower-productivity activities to higher-productivity ones.  So much for the inherent inefficiency of IS policies!
Under WC, firms and industries were able to accomplish a comparable rate of productivity growth, but they did so by shedding (rather than hiring) labor.  The displaced labor went not to higher-productivity activities, but to less productive lines of work such as informality and various services.  In other words, the WC ended up promoting the wrong kind of structural change.
This account reinforces the centrality of structural change in driving rapid economic growth. It should also cause us to be wary of productivity studies that focus on what is happening within manufacturing alone.  After all, productivity within manufacturing can be stellar, but if manufacturing or other high productivity sectors as a whole are rapidly shedding labor, economy-wide productivity performance will be disappointing.