Economic planning: Govt needs to take a back seat

When it comes to devising economic strategy, the politicians need to stay out.

“A crisis is a terrible thing to waste.” Paul Romer

Pakistan’s Planning Commission has started a dialogue with citizens — it is about the so-called New Development Framework, which focuses on economic growth.  I have put “growth” in bold characters because it is a term that we hear all the time without really understanding its meaning.

Since conversations founder on misunderstandings about terms, let us be clear first of all what economic growth is not. It is not about the value of Pakistan’s GDP increasing by five per cent, as it did last year. Surprised? Well that is not your fault because most people think of growth as how an economy increases in size. But what is important is the quality of life. A proxy of the standard of living is how an economy increases in size relative to its population. A nation realises real growth when the value of its output grows faster than its population. The formal term is per capita growth. A nation becomes more prosperous over time when it experiences high per capita growth.

Per capita growth is difficult to achieve when we look at the long time horizon (for example, over the past 200 years). Statistics on growth began to be recorded and compiled for the first time at the end of the eighteenth century in Western Europe. Before that economies as a whole had grown but the welfare of common folk had not changed. Every increase in national wealth led people to breed to the point where the increase was exhausted. Thomas Malthus, an English thinker of the nineteenth century believed that while a country’s wealth might grow, individuals would be trapped in poverty because its population would grow at a faster rate than the value of the economy. He would have been puzzled how a few years after his writings, European economies managed to increase not just their overall wealth but that of each individual. This is the situation which we also face in Pakistan.

Yet we do not need to feel our way around in the dark as did thinkers in Malthus’ time because the ingredients of growth are starting to become clear. One of the ingredients is innovation. But talk about the need to spread innovation is mostly economic twaddle. It is the stale rhetoric found in Western countries policy discussions during the 70s and 80s. The sad approach to innovation led to endless and spectacular policy failures in the heyday of industrial policy, the 1970s and 1980s, when the spirit of John Galbraith possessed even the sanest of economists. What economists have now realized is that it is not up to government to decide what innovation is. The work on Thomas Kuhn on the nature of scientific revolutions also taught us that there is no prescription for intellectual progress nor is there any bright line leading from discovery to implementation.

These are questions that are best addressed by Armen Alchian’s view of innovation and entrepreneurship as evolutionary processes. Those who survived were not necessarily the brightest, but simply those who by some quirk passed through the filters of market demand to produce something no great thinker had been able to divine. We in the government must not divine or judge what innovation is or entails.  We must remain mute because in essence we are dumb on such issues.  Our wisdom is in knowing how limited we are. In the recognition of our limitation we can discover a path to success and that is to stand back from markets and simply create the circumstances for their growth. What innovation is ultimately is a question that markets answer. The upshot of all of this is that we do not need to encourage innovation by targeting R&D. To say we must encourage innovation through active support of R&D is just a formal apology for instituting a structure of giving money to rent-seekers. Let us learn from the West and avoid their disasters in this field.

Innovation and economic growth are organic and spontaneous processes which occur when people take resources and arrange them into more valuable products and services, according to Paul Romer, a well known growth economist. He has a useful metaphor: production in the kitchen. To create delicious foods, we mix inexpensive ingredients according to a recipe. Economic growth comes from innovating fantastic recipes, not just from more cooking. We underestimate the potential for finding new recipes and ideas — we at the Planning Commission believe the possibilities are infinite.

So how exactly do we set up this economic kitchen (which we call markets) in which we can cook recipes no one imagined? In the recent past, development experts thought the answer lay in government command. Those in high ministries would choose industries producing goods with “high value-added” and would champion them at the expense of other industries and dole production rights, with special protection, to the rich and powerful. Well, things did not quite turn out as hoped and expected. By protecting certain industries government became subservient, pouring never-ending subsidies and funds into catastrophic ventures. The lesson was clear. The government is not good at choosing winners. What it is good at is in setting enabling conditions and environment out of which winners can emerge.

The writer holds a PhD from the University of Chicago and is the Chief Economist of the Planning Commission.

Published in The Express Tribune, April 4^th,  2011.