Edited Version of a Workshop Dinner Speech

by Nick Stern
Chief Economist, World Bank
at the
Workshop on Macroeconomic Policies and
Poverty Reduction
Thursday, April 12, 2001, 7:30 p.m.
Washington, D.C

Let me begin by offering a long excuse for the interpretation of macroeconomics that I'm going to take. When I talk about macroeconomics and poverty, what I'm actually going to talk about is medium-term growth and poverty, confident in the view that medium-term growth is indeed a large part of macroeconomics.

In the sixties in Cambridge macroeconomics was Keynes; it was all about effective demand.

The other thing young lads in the sixties doing Ph.D.s in economics did was growth theory. That's what I did. I worked with Jim Mirrlees and Bob Solow, so I was lucky. But then, just as I was finishing, growth theory seemed to stop. So I turned to teaching development economics, into which I snuck in quite a lot of the growth theory I had learnt—Harrod-Domar, Mahalanobis, Lewis, Solow. I soon realized that I was the only person teaching growth theory, whether it was Oxford or Warwick, or LSE or wherever. So if you wanted to do growth theory, you came to my development economics course.

Then, about midway through the 1980s, I discovered that some of my friends teaching macroeconomics were also teaching growth theory. So I discovered that because I had stayed the same and macroeconomics had changed, I had become a macroeconomist. Growth theory, as it were, came back into macro, and I think it's rightly there and will stay there.

I'll say a sentence about the demand side, which the record probably requires of me. I sincerely believe that high inflation is bad for poverty reduction. The evidence is overwhelming, and there is no need to elaborate on it here. That's the end of, as it were, the demand side of my discussion of macroeconomics and poverty.

Now, what I am going to talk about is the strategy for economic development and how IFIs can affect it. To be specific: What does pro-poor growth mean and how we can bring it about?

I'm going to say it in terms of two very simple sentences that actually are now part of the World Bank strategy. We have a Strategic Framework Paper that we have just shared with our Board, and in it, there are two key sentences.

The first sentence is that the investment climate is crucial for investment, growth, and jobs. And the second sentence is that empowering and investing in poor people is crucial to their participation in the growth process. I think those two sentences explain what we mean by pro-poor growth.

They are very different from sentences that sound similar. For example, the statement that "You've got to increase the savings rate and keep down the incremental capital-output ratio" would be one, as it were, vulgarization of the first sentence. And another—different—version of the second sentence would be that "You've got to invest in people's human capital so that their productivity goes up." I actually think that the two sentences I just gave are widespread vulgarizations, and that they miss a large part of what is important in the first expression of those two sentences that I gave.

A great deal of the story of growth is about creating an investment climate. What does an investment climate mean? Well, the first thing it encompasses is macro stability and economic openness. If you look at the way that, for example, inflation and openness to trade have changed in the world over the last 15 years, you can argue that the increase in growth we are seeing in developing countries is coming in large part from those basic policy changes. Income per capita in developed and developing countries grew at roughly the same rate in the 1990s. I think we'll find income per capita in developing countries growing faster than that in developed countries over this coming decade. A fundamental part of that story is the improvement in broad macroeconomic stability and in openness that we have seen over the last 10 or 15 years. We who work in international institutions can claim at least some credit for that change.

The second broad area is that of governance and the competition process. There is an enormous amount that certainly the World Bank can and should do in terms of improving the investment climate. It should not be all the forms of governance that we could possibly think of and might like as decent citizens. The focus that we should insist on is: "Which aspects of governance and promotion of competition and quality of the labor force and so on are really important to the investment climate?"

There is a great deal that we can do empirically to answer that question. We can do it in terms of detailed surveys, which we are doing at the firm level. We can do it in terms of the experience of investors, be they international investors or domestic investors. So there is a great deal of evidence that we can gather, and are gathering, on the details of what we mean about what is important on the governance side.

Third, there is, of course, the whole area of the infrastructure, which is crucial to the investment climate.

The answers to what specific features of the environment matter for the investment climate will vary enormously from one country to another. Careful measurement and quantitative assessment through surveys of firms, such as the survey that we have carried out with the Confederation of Indian Industries, is essential to identifying specifics. In the Indian case, one key dimension of the investment climate is the reliability of power supplies. At the state level, the power doesn't go off in Maharashtra nearly as often as it goes off in Uttar Pradesh (U.P.). Ninety-eight percent of the firms we surveyed in U.P. had their own generators, versus 45 percent in Maharashtra. It's not surprising that Maharashtra is growing faster than U.P., and poverty is going down faster in Maharashtra than it is in U.P. So there are very profound differences. Another factor behind these differences is the intrusiveness of government regulation: the local authorities visit firms, including SMEs, at least twice as often in U.P. than they do in Maharashtra.

The evidence is clear and quantitative, and you can talk about it, and you can do things about it. The whole area of governance in relation to investment climate is something that we can really be serious about, and the implications for growth and poverty reduction are serious.

The story I have just told about the climate for investment, and particularly the role of small and medium enterprises, and so on, is very different from the Mahalanobis model with fixed coefficients, where you push up the savings rate and try to control incremental capital output ratios, and so on. It is a different spirit: the former is not in conflict with the latter, but it is much broader.

The second sentence is also important: empowering and investing in poor people is crucial to their participation in growth. We all know that things work better if people are empowered to participate. We know that schools work much better if there is participation from the local community and from parents. It's not simply the odd observation of a case here and there. If you look at the District Primary Education Program in India, which now covers more than 55 million people, there has been an enormous change in the way in which education takes place. Local communities are now much more involved in the story. This translates into simple improvements like the building of toilets and so on, which enable Indian girls to go to and remain in school at much higher rates than they could before. In the field of rural infrastructure, now we have many more water users' associations involved in the irrigation projects we support. In the health field, there is now much more community involvement in the running of hospitals. In short, there is a whole range of areas where empowerment is important. We are getting much better in many parts of the world, India included, in land titling, which is an enormous improvement in the empowerment of poor people.

If you look at those two sentences together—about the importance of building an investment climate and empowering and investing in poor people—you have a definition of what we mean by pro-poor growth, a definition that actually pulls together much of what we are trying to do.

Now, a cynic could always justify anything he or she proposed in terms of the two priorities that I have just described. A little bit of creativity, and you can bring anything into that net. So there is an obligation, it seems to me, to insist fiercely on the content of what I have just described and actually make it quantitative and analytical. What we will have, then, is a theory of pro-poor growth.

To have a strategy for an international institution, you have to add to that some understanding of the effectiveness of our institutions in bringing about the kinds of outcomes that I have just described. There again we have learned a lot over the last 10 or 15 years about how we can bring about improvements along these two very broad dimensions—the investment climate and empowerment. And essentially, it is a very, very simple proposition: the international institutions have to act as agents of change along these two dimensions. If we simply transfer resources, we are doing something close to zero. I mean, if you transfer resources into an environment where nothing changes, the borrowing capacity of the country hasn't gone up, and what you put in goes out somewhere else. It may be a little bit of help, because your interest rates or the terms of the loan are particularly favorable, but if you build a road from Bangalore to Mysore, and it doesn't change anything else that happens in that country, then that project—even though it is well-defined—is actually doing very little.

So we have to be able to explain that our institutions are agents of change. What I want to describe next is some of the shifts in our instruments that follow from this logic. First, we have to do more economic and sector work (that is, country-focused analytical work) and do it better, because that, if done well, is about promoting change. A former Finance Minister told me that in the 1970s and 1980s, the World Bank documents gave him a serious and thoughtful analysis of what was going on in his economy, and that this analysis provided him with an alternative to whatever the public authorities, or his own civil servants when he was in office, were providing to him. Our emphasis, as we have put very clearly in the Strategic Framework Paper and the Strategic Directions Paper that we are taking to our Board around our budget right now, is that we have to improve the quality of the analytical and economic and sector work. This work really matters, and our investment in it has slipped in recent years. Reversing that trend is one part of acting as agent of change.

The second is a shift over to more programmatic lending. What is programmatic lending? I think it has three dimensions. The first is that such lending has to cover a significant part of the economy. It is not just some isolated thing, like the road between Bangalore and Mysore. (I give that because they are my two favorite cities in India, so I can't be accused of being biased against these two places.) So there has to be something that is economy-wide or covers a significant fraction of the economy, and the District Primary Education Program in India would be one example like that. Second, the project or program has to lead to significant change. If we satisfy those two criteria—covering a significant part of the economy and bringing significant change—then that is what we understand by programmatic lending, and that is another aspect, in addition to the economic and sector work, of being an agent of change. A third point is that in most cases, it would be multi-year.

The last thing is the demonstration project. There can be some projects that really change the way in which things happen through the demonstration effects that they have. A project with really powerful demonstration effects can indeed carry the kind of economy-wide change that I think we ought to be requiring of ourselves if we are to claim to be agents of change.

Let me end my talk with some words about how the World Bank and the IMF might work together in this spirit, specifically in the design of crisis-prevention and -response programs. Structural and social reforms are usually an element of such programs, and these programs typically have to be worked out with the government in great haste. The question is, how do we come up with views about the appropriate reforms and necessary conditionality in the structural and social areas?

It seems to me that it is reasonable to expect the World Bank country team to have well-considered views on this subject, and to be able to distill them down to the essentials on short notice. One, this list of reforms should include those new structural and social measures which we believe to be in the interests of both long-run development and crisis response. This can't include everything that's in the Country Assistance Strategy, because this is a time for choice: your back is against the wall, so you've got to make up your mind. So there ought to be a selection, within the framework of the CAS of course, of those structural and social measures that are crucial to resolving the crisis. Two, there should be a list of social protection, health, and education programs that we ought to fight to keep amongst the existing programs. This seems to me to be an area of collaboration where the IMF has a right to expect a response from the World Bank within the tight time frame of a crisis-response effort.

There may be a note of optimism in what I have been saying that comes from being in the World Bank for only nine months. But I actually think that most of what I've described is real and do-able, and a lot of it is actually already in our strategy.

Thanks very much.