My Say: Correlations in the history of earth and economic policy

This article first appeared in Forum, The Edge Malaysia Weekly, on February 11, 2019 - February 17, 2019.
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The World Bank in Malaysia recently organised a conference at Bank Negara Malaysia called, “Globalisation: Contents and Discontents”. I attended a few of the sessions and found them very interesting. But the highlight for me was a keynote address by William Easterly, an economics professor at New York University. This was personal — Easterly had written a book called The Elusive Quest for Growth, which was the catalyst for my passion in the field of Development Economics.

In his talk, Easterly made a persuasive case that the oft-maligned Washington Consensus — a set of economic policy prescriptions that constitute the standard reform package promoted for developing countries by Washington, DC-based institutions such as the World Bank and the International Monetary Fund — did bring a particular benefit to developing economies.

He argued that whatever the faults of the Washington Consensus (and there were many), at the very least, it prevented some extreme policy outcomes, such as inflation rates above 40%, black market premia over 40% and currency overvaluations of over 100%, among others.

Indeed, Easterly shows that “extremely bad and moderately bad policy outcomes were surprisingly common in the 1980s and early 1990s, [but] such outcomes have mostly disappeared since then”. He then finds that the improvements in these policy outcomes were positively correlated with improvements in economic growth across countries. He remarks that, “[Washington Consensus] critics (including this author) failed to emphasise the dangers of extreme policies in the previous reform literature…”

As such, while it remains to be seen if Washington Consensus-style “liberalise everything” reforms are suited for sustainable economic development, at the very least, those reforms potentially led to a reduction in extreme policy outcomes, which are then associated to an improvement in economic growth.

This takeaway point of “extreme scenarios are usually bad; we can have improved outcomes just by preventing or minimising extremes” is intuitive, but I think often taken for granted. This point struck me particularly when I was reading, Origin Story by Macquarie University History professor David Christian. He tells of the “Big History of Everything from the Big Bang to the first stars, to our solar system, life on Earth, dinosaurs, homo sapiens, agriculture … and mass globalisation”.

Parallel to Easterly’s point on extremes, the history of our universe and of our Earth is also a history of having avoided extreme scenarios. For life to have developed on Earth, we needed the so-called Goldilocks conditions — not too hot, not too cold, but just right. The Goldilocks conditions for life on Earth include our solar system being in the middle of the Milky Way’s habitable zone, Earth itself being in the middle of the sun’s habitable zone, the presence of liquids and liquid water and excellent chemical diversity on Earth. If any of those had been a little too extreme, I would not have been around to write this article, nor would you be around to read it.

Indeed, Christian’s book also made me think of some pretty neat connections between the natural history of Earth and life, and sound economic policy. Tied in to the Goldilocks conditions is a long period of general stability. As Christian says, “Life-friendly conditions are not enough. You also need those conditions to persist for a long time so that life can keep evolving and experimenting.” Fortunately for the development of life on earth, we did not experience a supernova in a neighbouring star system and we did not collide with another planet. Earth has been life-friendly and generally stable for more than three billion years.

The same is also true of an economy. For an economy to find its groove, it needs time and it needs stability, particularly political stability. Too many external shocks, or too many internal tantrums, will inevitably lead to stop-start growth, dragging it — in the worst-case scenario — to a lower equilibrium. In the economic literature, this notion of stability is why democracy is seen as preferable to economic growth than authoritarianism.

Economists Heitor Almeida and Daniel Ferreira show that more centralised societies have more volatile economic performances and that “both the best and worst performers in terms of growth rates are more likely to be autocracies”. Of course, there are authoritarian countries that have shown spectacular growth — South Korea in the 1970s, China today and so on — but authoritarianism is also strongly linked to very poor growth. Democracy is a better bet for stability.

Yet, while general stability is crucial both for life to form and for economies to grow, some instability is needed for innovation and experimentation. In a 10-million-year interval starting about 530 million years ago — also known as the Cambrian explosion — perhaps the most rapid stretch of biological innovation in the history of the earth happened. Part of the explanation for this explosion is unstable climates — violent climatic and geological events would drive the speed of evolution, forcing a whole bunch of species into extinction, but also leading to the evolution of many new types of species.

As Christian puts it: “…the history of big life was an unpredictable and dangerous roller-coaster ride. Asteroid impacts, sudden shifts in Earth’s innards, changes in the planet’s atmosphere and massive volcanic eruptions sent evolution careering down new and unexpected pathways.” Biologists Niles Eldredge and Stephen Gould put it best, “…evolution meant long periods of boredom punctuated by moments of terror and life-threatening violence.”

For an economy, too much stability is also sub-optimal. Periodic moments of volatility and instability, such as business cycle downturns, are necessary to weed out firms or economies that have become far too complacent, while strengthening firms and economies that have worked on being competitive. It provides opportunities for new entrants into the economy, and relegates those who fail to make the cut to the sidelines.

And then there is innovation. The constant introduction of new technology or innovative practices is like a shot in the arm to the economy, but some will win and some will lose. This is Joseph Schumpeter’s Creative Destruction — the forced obsolescence of certain technologies in favour of new and improved ones that continuously drive the economy forward by increasing the productive capacity of the economy.

The development of life on Earth required Goldilocks conditions and general stability punctuated with moments of instability and volatility. I find that is also true of economies. Scenarios which are too extreme are associated with suppressed economic growth, as evidenced by William Easterly.

Unstable and volatile regimes do not lend themselves to extended periods of economic development. Why would any investor, domestic or foreign, want to put skin in a game where rules are ever-changing? Yet, too much stability can breed complacency. We need periods of volatility, be it via business cycles or creative destruction that help to weed out the unfit, and allow the fit to survive — this is evolution after all.

These are but some of the similarities that economic policy share with natural history. There is bound to be more. There is also surely much wisdom that we can extract from studying the history of life — it has been around for over three billion years after all.

What factors allow for an explosion in new species, what type of shocks can cause mass extinctions and what type of species are more susceptible to natural disasters can be written as what factors allow for rapid innovation, what type of economic shocks can cause great depressions and what type of economies or firms are more susceptible to external shocks. The more we try to learn from other fields, the richer the field of economic policy will be.

Nicholas Khaw is an economist with the Khazanah Research and Investment Strategy Division

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