Growth and Equity in Fragile States
On 18 March 2010 CRU published the report Growth and Equity in Fragile States, by Rolf Maier.
Fragile states are characterized by deep structural economic and political constraints. This study takes a long-term perspective on economic development in fragile countries to discuss structural causes of fragility. The guiding research question is how inclusive growth can be achieved in fragile states.
Dimensions of state fragility broadly cover aspects of security, economic and social development, as well as political representation and governance. The term 'fragility', however, hides a broad spectrum of heterogeneous country experiences ranging from countries in a situation of early recovery to countries with chronic levels of underdevelopment or protracted conflict.
The key insight of the economic growth theory is that high rates of accumulation of physical and human capital as well as technical progress may have a positive influence on growth. The critical question then is to explain why fragile states accumulate less capital than others and have lower rates of technological progress.
Modern theories of underdevelopment argue that severe distortions and inefficiencies in fragile state markets hinder the adoption of new technologies and a successful industrialisation process. Thus purely economic constraints may inhibit inclusive growth and could lead to self-reinforcing poverty traps.
Proponents of the geography hypothesis stress the direct effects of geographic conditions on the inputs of production functions or the production process itself. Possible constraints are climatic conditions, location, and natural resources.
The pace and structural features of economic growth result in distribution changes which mainly depend on country specificity. A middle range of inequality is supposed to be growth maximizing and to vary across countries depending on structural determinants like natural resource endowments, the history of past policy decisions or asset distribution. While several transmission channels are argued for a negative effect of vertical income inequality on subsequent economic growth, the empirical evidence is ambiguous. On the other side, horizontal inequality seems to be a risk factor for conflict and consequently low economic growth.
New institutional economics and political economy approaches explain poverty traps based on formal and informal institutional constraints. The basic economic rationale is here the importance of institutions to lower transaction costs to achieve economies of scale and specialization. The path of economic growth is determined by the quality of institutions. Low level equilibrium can persist over a long period of time. In addition, groups with political power may not be able to credibly commit on reforms.
An emerging consensus in the debate is that instigating growth may require only a 'small' set of reforms with limited institutional changes. An 'encompassing' authoritarian regime with 'good' economic policy may be pro-poor at the beginning of development in fragile states. To maintain productivity and to sustain development, however, economies have to initiate deeper levels of reforms and to acquire high-quality institutions. The central question for long-term inclusive growth in fragile countries would then be whether and how a society can transform its institutions at a deeper level to sustain long-term growth.
A final critical question is whether one also assumes that positive policy interventions would have an impact on inclusive growth in fragile countries. A policy hypothesis would argue that an adequate economic policy in the form of a stable macroeconomic framework can enhance welfare even when set against the background of detrimental geographical and institutional characteristics. This paper argues that the policy, institutions, and geography hypotheses are interconnected as well as complementary and feasible policy recommendations very much depend on country analysis of the specific factors of underdevelopment.