A Strategy for Economic Growth
Executive Summary
Economic growth strategy in context
The United States Agency for International Development (USAID) promotes economic growth in accordance with the 2006 National Security Strategy of the United States and the goal of transformational diplomacy. Economic growth, in tandem with the promotion of democracy, is an important key in achieving the Secretary of State’s goal of transforming the developing world, which includes most of the world’s countries and most of its people. Free markets and free societies are vital to achieving the development goals of the United States.
As stated by Secretary Rice, …the United States must assist the world’s most vulnerable populations through our transformational diplomacy—using our foreign assistance and working with our partners to build state capacity where little exists, help weak and poorly governed states to develop and reform, and empower those states that are embracing political and economic freedom. These are three main goals of our country assistance programs, with the ultimate purpose being “graduation” from foreign economic and governance assistance altogether. Vibrant private sectors in free, well-governed states are the surest form of sustainable development.
Economic growth is key to transforming the developing world, which includes most of the world’s countries and most of its people. Economic growth enables countries to reduce and eventually eliminate extreme poverty. It is the surest way for countries to generate the resources they need to address illiteracy, poor health, and other development challenges on their own, and thus to emerge from dependence on foreign aid.
Economic growth in developing countries creates important benefits for the United States as well. The developing world is emerging as the largest market for U.S. exports. Accelerating growth among developing countries that have done well, and encouraging it in those that have not grown as quickly, will further increase their contribution to global and U.S. wellbeing. Economic growth creates the prospect that more developing countries will become effective partners with the United States in working toward a more stable, healthy, and prosperous world.
Poor countries that fail to grow can pose serious problems. They are vulnerable to crisis, sometimes including state failure and violent conflict; can harbor terrorist activity; are vulnerable to the impact of natural disasters; and make large claims on U.S. and international resources. Countries that stagnate are less able and sometimes less willing to help address transnational issues, many of which originate within their borders, including illegal migration; trafficking in narcotics, weapons, and persons; health threats such as HIV/AIDS and avian flu; and environmental concerns such as loss of biodiversity. All considered, economic growth in developing countries is essential to securing their future and ours.
The Framework for U.S. Foreign Assistance (hereafter, the Framework) gives economic growth a central position in the U.S. foreign assistance program. This makes it important to have a clear understanding of the growth process in order to help countries grow more quickly. This strategy first reviews the principal insights into economic growth gained over the past 50 years. It then identifies priorities and approaches for promoting economic growth in the USAID assistance programs of the future.
Recent progress and future prospects are both encouraging
The developing world has achieved much more progress than is often recognized. Global growth since 1950 has been unparalleled in history. Average real incomes rose by at least half in all regions of the world, and the share of the world’s population living in extreme poverty fell from 55 percent to 18 percent in 2004. Life expectancy rose by 50 percent over the same period, while equally dramatic progress was made in other measures of the quality of life - from literacy and nutrition to access to water and electricity. Although Africa has historically had the slowest growth of any region, its performance has improved substantially over the past decade, lending hope for the future.
Looking forward, the global environment for growth in developing countries has improved markedly from a generation ago, and in many respects has never been better. Understanding of what makes for good and bad economic policies has expanded, with groundbreaking new work in microeconomic reform. Rapidly increasing global trade and investment offer unprecedented opportunities for countries that are willing and able to compete. The increasingly free flow of information connects developing countries more closely to the world’s fast-growing knowledge base.
But the challenge remains large. Despite widespread progress, there has been great variability in economic growth performance among countries and over time. The fact that 18 percent of the world’s population still lives in extreme poverty provides a sharp reminder of the urgent need to achieve faster growth and to spread its benefits more widely.
Economic growth begins with competitive firms
Economic growth is the sustained increase of a society’s output. The key is ongoing growth in productivity – turning the same resources into ever-greater amounts of goods and services over time. All productivity growth takes place at the level of the firm – a term that includes producers in all sectors and of all sizes, from the family farm and the vegetable seller with a handcart to the largest global corporation. Productivity growth, and the investment that stimulates and sustains it, result from the efforts of myriad individual producers. Seeking profit and spurred by competition, each works to increase sales, reduce costs, improve quality, and serve or create new markets. For growth to be sustained, producers must be motivated to search for and adopt a never-ending stream of such improvements. Any single improvement in technology or management boosts growth only temporarily.
By shaping producers’ incentives, economic governance “drives” growth
Producers’ decisions are strongly influenced by the incentives and disincentives created by government policies, regulations, and other aspects of economic governance, including the capacity of government to enforce these “rules of the game” in market-friendly ways. Key examples include the impact of macroeconomic policy on overall economic stability, along with the effects of microeconomic policies including taxes, regulations, and the enforcement of property rights and contracts. Macroeconomic and microeconomic policies represent the “drivers” of economic growth, because they are the primary determinants of the rate and sustainability of economic expansion.
Sound macroeconomic policy is essential. Fortunately, most developing countries have learned the principal macroeconomic lessons and made the principal reforms. Hyperinflation has almost disappeared and multiple exchange rates have become rare. Most governments recognize that deficits must be controlled. Macroeconomic reform will not, therefore, be the centerpiece of most USAID programs. However, in certain situations macroeconomic stabilization may emerge as USAID’s highest economic priority, especially in countries emerging from conflict.
Microeconomic governance has emerged as the new frontier. New data show that business regulation is much more extensive and onerous in poor countries than in rich ones. Some regulations are essential, but they should be designed so as to minimize costs, uncertainty, and the potential for abuse. In many poor countries, complex and costly regulations discourage firms from employing workers or investing in new technologies, and inhibit those firms from achieving high and growing productivity. Many such regulations place considerable discretion in the hands of government officials, giving rise to pervasive corruption and rent-seeking. There is tremendous opportunity over the next decade to address these constraints, and to improve the microeconomic environment more generally by strengthening systems of property rights, competition policies, and commercial law.
Other factors “enable” growth
If macroeconomic and microeconomic policies and institutions drive the growth process, other factors “enable” growth to move forward. The availability of finance, of infrastructure, and of an educated and healthy workforce, for example, can influence the rate and direction of growth. However, they cannot by themselves cause growth to occur where the drivers are not in place. Work in these areas is important, but its impact is much reduced in a country with a poor macro- or microeconomic policy environment.
Political context matters
The greatest obstacles to growth stem not from nature, but from politics. Because almost every economic change creates losers as well as winners, identifying the correct economic prescription is rarely enough to ensure that it is adopted. Understanding local interests is important in determining with whom to work and what to do. This often means that one size does not fit all when it comes to designing and prioritizing interventions. The basic principles – macro stability, market-based competition, etc. – can be applied in different ways to suit different situations. Governments committed to reform have sometimes found new and surprising ways to apply these principles successfully to accelerate growth.
Donor flexibility matters – and plays to USAID’s strength
Donor flexibility matters as well. Among the top reforming countries, some 85 percent of microeconomic reforms occur within 15 months of a change of government. While countries’ past performance must be taken into account when setting aid levels and designing interventions, the ability to refocus support rapidly when genuine opportunities arise is essential to take advantage of political breakthroughs affecting the local will to reform.
USAID has several advantages in this regard in relation to other donor agencies: a strong private-sector orientation, in-country staffs, the ability to field long-term technical assistance teams, grant funding, and the ability to respond quickly and flexibly to emerging needs. These allow USAID country staff to develop partnerships with reform-oriented counterparts in the public and private sectors and to be on the scene in situations where arriving in time counts for more than the dollar value of assistance. Additional flexibility arises from USAID’s technical capacity to address the full range of issues that ultimately affect a country’s growth – including issues of democratic governance, health, education, and other areas complementary to economic reform.
We will pursue rapid, sustained, and broad-based growth
USAID’s overarching goal in economic growth will be to help partner countries achieve rapid, sustained, and broad-based growth. Per capita growth of 2 percent per year should be regarded as minimally satisfactory. Experience shows that per capita growth rates of 3 percent , 4 percent , and higher are possible and are clearly preferred. Sustained growth is growth that is maintained over the long term. Prices, property rights, and other policies to encourage the responsible use of natural resources and an appropriate response to environmental concerns play an important role in supporting sustained growth. Broad-based growth is growth that includes all major income groups, ethnic groups and women, and that significantly reduces poverty.
In support of this goal, USAID will endeavor to:
Develop well-functioning markets in developing countries, working with the drivers and enablers underlying productivity growth to create the conditions for faster and more sustained economic expansion. This is the central challenge and the main area of opportunity. Efforts will mainly focus on supporting policy and regulatory reforms, while building local capacities to implement them and to continue the reform process. Principles of sound governance – openness, transparency, and accountability – will be important across the board. Capacity building can be more expensive than policy advice alone, but both are inexpensive compared with many efforts in other sectors. Moreover, both have the potential to achieve transformational results many times the cost of the investment. Activities should include a growing emphasis on microeconomic reform including support for greater competition and stronger property rights, improving the enabling environment for agricultural development, infrastructure, the financial sector, and trade capacity building. Macroeconomic reform and capacity building is likely to be pursued on a more selective basis.
Enhance access to productive opportunities for the poor, women, and other disadvantaged groups, to help ensure that they benefit from growth. Faster growth is the basic source of new opportunities for the poor as well as the non-poor. But complementary efforts are needed to help the poor and other disadvantaged groups gain access to those opportunities. Expanding access to improved basic education for poor children and girls, expanding access to financial services, promoting more flexible labor markets, and securing property rights for small farmers and urban slum dwellers are some examples of such efforts.
Strengthen the international framework of policies, institutions, and public goods that support growth prospects and opportunities for poor countries. Examples include research on agricultural, health, and other problems specific to developing countries, and promoting international standards – from accounting to customs operations – that provide sound models for developing countries to emulate.
We will seek systemic and catalytic impact in light of political opportunities and constraints
Economic growth is a complex process. Moreover, differences in country conditions and opportunities create a wide variety of potential donor interventions. Core principles for achieving the greatest results should guide the choice of interventions. In particular:
- Programs should seek large and systemic impacts. The success of a few firms, farms, or communities is not enough. The goal is growth that affects thousands of firms and millions of people. This typically requires improvements in policies affecting all businesses within a sector or across the entire economy. This means that USAID will generally not finance development directly, but will seek instead the systemic reforms that can mobilize much larger savings and investment by others.
- Where systemic reform is not achieved, catalytic impact is essential. Demonstration projects can be valuable, but they should either demonstrate approaches that cause a far larger number of people or firms to follow suit without subsidies, or should have the clear potential to catalyze policy or institutional changes with a much wider, systemic impact.
- Close attention to the politics of economic change is important for results. When change is slow, support to reform-oriented leaders – public and private – can help to generate political will. External factors – such as requirements for joining the World Trade Organization or the European Union, or a low ranking on a widely recognized index of country policies and performance – have motivated significant changes in the past and should be used creatively to leverage further change.
The Framework for U.S. Foreign Assistance provides a new beginning
The Foreign Assistance Framework adopted in 2006 places recipient countries into five categories based on their policy performance, level of development, experience with conflict, and other factors. The Framework also divides programmatic interventions among five broad objectives; efforts in these five program objectives are intended to be complementary and mutually reinforcing. This strategy suggests the kinds of economic growth interventions likely to be most appropriate in each country category, while emphasizing the need to recognize and respond to the differences among countries within each category. It explains why achieving the goals of the Framework, and significantly increasing growth and incomes in the developing world, require both a clear and visible priority to economic growth funding for USAID, as well as concerted attention to rebuilding USAID’s cadre of economic growth professionals.
This Strategy focuses most strongly on the challenges of achieving faster and more sustained growth in Developing and Transforming countries – those with a reasonable degree of political stability. Rebuilding countries have an equally compelling need to achieve sustained higher growth rates. The distinctive issues related to restoring economic growth in Rebuilding countries – particularly those emerging from conflict – are referenced in this Strategy, and are also addressed in detail in a separate document.
The Framework for U.S. Foreign Assistance provides the opportunity to recommit USAID to promoting economic growth in the developing world – the only route for developing countries to eliminate extreme poverty and generate the domestic resources needed to address their own development challenges. This Strategy establishes the basis for setting priorities within the Framework so that USAID’s economic growth programs will have the greatest impact. Through increased support for systemic and catalytic change in the economies of partner countries, and with adequate funding and technical staff, USAID can multiply the results of its work and help much larger numbers of people in partner countries secure a better future. In an interdependent world, a better future for the people of developing countries means a more secure future for us all.
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