Introduction and Impetus of Economic Policy

1. INTRODUCTION AND IMPETUS OF ECONOMIC POLICY

1.1 WHY POLICY IS IMPORTANT

Why is policy important? Perhaps the starkest example of what the gains and losses from policy can be comes from the varying experience of sub-Saharan Africa and East Asia in the last quarter of a century. Consider the following details. Between 1970 and 1992, average GDP per capita in Sub-Saharan Africa (SSA) grew by $73 in purchasing power parity terms. In contrast, per capita GDP in South Asia grew by over $420 and in East Asia growth was in excess of $900 in the same period.

Table 1 provides some simple economic indicators. The picture that emerges is clear. In Africa economic performance has been poor, resulting, since 1978, in actual declines in per capita income. Savings rates have declined in Africa and in recent years have been barely over half the levels attained in East Asia. Investment has duly suffered. Other indicators offer as stark a contrast. For instance, life expectancy at birth by 1995 in Sub-Saharan Africa was no higher than 52 years and adult illiteracy was around 43 percent; sharp contrasts with the 68 years and 17 percent attained in East Asia. These contrasts are as dramatic if Latin America is the comparator and, at least in terms of life expectancy, if South Asia or the Middle East are the comparators.

Table 1: Some Economic Indicators

Source Summers and Heston 1995; World Development Report 1996

Table 1:  also signals some important macroeconomic contrasts over regions. Budget deficits have been consistently higher in African countries than in Asia and inflation has duly been substantially higher. Between 1978-87 African countries ran inflation rates roughly double those of Asian countries and this gap has persisted into the 1990s. Cross country evidence compiled by a range of researchers indicates the important role that a stable macroeconomic environment can play in growth. While macroeconomic stability is likely to be a necessary -- but not sufficient-- condition for growth -- as the CFA zone countries' experience suggests, there is robust evidence that growth is negatively associated with inflation and positively linked to good fiscal performance and undistorted foreign exchange markets (Fischer, 1993). Inflation tends to reduce growth by reducing investment and lowering the rate of productivity growth. A recent study (link to Bruno and Easterly site) of inflation and growth with information from 127 countries over the period 1960-1992 shows a clear and close association between rising inflation and diminishing growth rates. Over this period, average growth rates seem to fall only slightly as inflation rates move up to 20-25 percent per annum. But growth rates decline more steeply as inflation rates approach 25-30 percent and become increasingly negative at higher rates of inflation. Similarly, a clear message coming out of the East Asian experience is that these countries maintained single or low double-digit inflation, have generally avoided balance of payments crises and have moved rapidly to correct such disequilibria when they have emerged.