Policy linkage, growth outcome

Policy influences on growth outcomes seem to be more pertinent, and not merely in the short term. Such measures can mean heightened distortions, making it impossible to objectively evaluate their effectiveness. All the same, objective evaluation of growth outcomes cannot really be over emphasised.

Conformity is the jailer of freedom and the enemy of growth, noted the young idealist who inspired a whole generation. That was then, in the sobering 1960s, and long before the policy pundits ideated on economic growth and convergence in the community of nations.

Fast-forward to the here and now, and the mavens at the Intenational Monetary Fund have chosen to be seemingly non-conforming, in estimating a higher-than-consensus year-onyear growth figure of 9.4%, for the Indian economy in calender 2010.
    
But given the fact that growth did decelerate in the third-quarter in the last fiscal year, the low-base effect would likely shore up the numbers in the like period this year. So, calender-year growth this time around can be expected to be a bit of a statistical mirage.
    
But one would need to be much too sanguine to take for granted buoyant growth here, given the weak global recovery, considerable debt overhang in the ageing, mature economies and rising commodity prices generally.

For an increasingly-globalising economy, the lacklustre external environment would tend to dampen investor sentiments and keep expectations range-bound. More pertinent seems to be policy influences on output growth, and not merely in the short term.

Thus, the accumulation of social and physical overhead capital is deemed as important for growth. Also, macroeconomic policy aiming at stable, low inflation and sound public finances, generally speaking, result in better growth performance.
    
Further, public expenditure on health, education and research are clearly vital to rev up growth and sustain living standards in the long term.

And a number of studies do suggest that policy and institutions affect the level of efficiency with which resources are allocated economy-wide, although there appears to be no agreement on the specific mechanisms and processes linking policy settings to actual growth outcomes.
    
The tool of choice for such analysis has been cross-country regressions, to assess the effectiveness of particular policies and their empirical relevance on growth. But the leading practitioners appear to remain sceptical of the formal correlations seen on the ground.
    
What’s indicated is that in growth regressions, the methodology by which economic growth or any other performance indicator, such as inflation, is reverted or ‘regressed’ on policy tells us ‘nothing on the effectiveness of policy’.

After all, the objective of policy initiatives is to arrive at outcomes, for instance, of correcting market failure via more efficient market design. Yet, policy measures can well result in a panoply of heightened distortions, making it well-nigh impossible to objectively evaluate effectiveness of policy, particularly in the short-to-medium term.

So, while the policy on special economic zones initiated circa 2005 has meant increase in exports, it has also led to much diversion of economic and export activity to cash in on questionable tax benefits on offer even for non-export activities, which is distortionary.
    
In broader terms, in drawing cause-andeffect relationships between policy and real growth, net of inflation, various methodological issues arise.

For example, it can be a tall order to neatly ‘disentangle cause and effect’ going forward. Anyway, the umpteen determinants of growth — such as financial reforms, or trade liberalisation or a well-managed exchange rate against the backdrop of large-scale capital inflows threatening to undermine the real economy — all tend to be correlated across the board and more likely to be only imperfectly measured.
    
It needs to be reiterated, however, that sustained institutional inflows, starting in the 1990s, have comprehensively modernised India’s capital markets.

It remains though that in a scenario in flux, it would be problematic to pinpoint policy effectiveness. There would be other rigidities, such a multiple conjectures and hypotheses but not enough data points.
    
Nevertheless, the effects of public policy on organisations, corporates and economic activities have been widely observed. Ultimately though, it cannot be gainsaid that policy is but one of the external conditions that market players and organisational bodies face.

Besides, policy effects can be more or less optimal to the extent that they are complemented and supplemented with cultural, societal and technological factors.
    
Anyway, policy advise come about not because regression analysis points at a particular result but more likely due to evidence from multiple sources, background knowledge, and considered opinions — albeit often with a political bias. All the same, objective evaluation of growth outcomes cannot be overemphasised.

Take, for instance, labour productivity. The figures available up to the mid-2000s show a decline in labour productivity economy-wide, with the sharpest fall in industry.

The services sector has the highest per-worker output and the changing pattern of services-sector bias in employment would scarcely lead to overall increase in labour productivity unless the measure improves both in agriculture and industry.