Advanced
Search

The Rise of China

The Next Pandemic?

U.S. Foreign Policy
Survey

The Ethical
Economist
Joseph
E. Stiglitz
From Foreign Affairs,
November/December
2005

The Moral Consequences of
Economic Growth. BENJAMIN M.
FRIEDMAN. : Knopf, 2005, 592 pp. $35.00

Summary:  In a major new work, Benjamin Friedman
presents a compelling moral case for growth-oriented economic policies.
But even he sometimes needs reminding that the kind of growth matters as
much as the amount.

Joseph E. Stiglitz, University Professor of
Economics at Columbia University, has served as Chair of the President's
Council of Economic Advisers and Chief Economist of the World Bank. His
books include "The Roaring Nineties" and "Globalization and Its
Discontents."

Topics:
Economics,
Trade and Finance
Globalization
Political
Systems

Politics
and Passion: Toward a More Egalitarian
Liberalism
Michael Walzer. New Haven: Yale University
Press, 2004.

The
End of Globalization: Lessons from the Great
Depression
Harold James. Cambridge: Harvard University
Press, 2001.

On
the Edge of the New Century
Eric J. Hobsbawm. New York:
New Press, 2000.

The
Global Economy and the Nation-State
By Peter F.
Drucker
Foreign Affairs, September/ October
1997

Power
Shift
By Jessica T. Mathews
Foreign Affairs,
January/ February 1997

GROWTH MAY BE EVERYTHING, BUT IT'S NOT THE ONLY
THING

Economists have long been a natural constituency in
favor of growth. Since even the richest country has limited resources, the
central economic problem is choice: Shall we fund tax cuts for the rich or
investment in infrastructure and research and development, war in Iraq or
assistance for the poor in developing countries and our own? By providing
more total resources, growth should, in theory, make these choices less
painful.

The United States, however, has powerfully
demonstrated that while growth increases supply, it also raises
aspirations. Choices that rich countries have to make thus seem to be no
easier than those confronting poor countries, even though the tradeoffs
are more heart-wrenching in the case of the poor. Brazil, for example,
must choose whether to use its limited health budget to pay full-market
price for AIDS drugs; some AIDS victims may live as a result, but people
in need of other health care will die, because money that could have been
spent on their needs is simply not there. More growth-provided resources,
in this instance, mean the difference between life and death.

Still, growth has had its critics. There is a
well-developed populist antigrowth literature concerned with, among other
things, the impact of growth on the environment and on poverty. In this
major work, The Moral Consequences of Economic Growth, Benjamin Friedman
takes on such critics, positing that growth has not only obvious economic
benefits, but moral benefits as well. He argues that it has the potential
to improve the environment, reduce poverty, promote democracy, and make
for a more open and tolerant society. But this is not to say that
Friedman, a professor of economics at Harvard University, is simply a
naive cheerleader for the market economy. His message is nuanced (though
not, in some respects, as nuanced as I would have liked), and he realizes
that growth has not always brought the promised benefits. The market
economy does not automatically guarantee growth, social justice, or even
economic efficiency; achieving those ends requires that government play an
important role.

LET IT GROW

Historically, economists have questioned whether,
at least in the early stages of development, growth is accompanied by
societal goods such as greater equality and a better environment. Nobel
Prize-winning economist Simon Kuznets argued, based on experiences largely
before World War II, that there is an increase in inequality in the early
stages of development. Arthur Lewis, another Nobel economist, went
further: greater inequality, he argued, is necessary to generate the
savings that growth requires. A later generation of economists has posited
the existence of an environmental Kuznets curve: the early stages of
growth cause environmental degradation, not environmental
health.

Kuznets and his descendants held out the prospect
that eventually growth would bring more social justice (greater equality,
less poverty) and a better environment. But there is nothing inevitable
about this -- which means that even if it has been true in the past, it
may not be in the future. Inequality did seem to fall in the United States
after the Great Depression, but in the last 30 years it has increased
enormously. Many forms of pollution have gone down as richer countries
have turned their mind to air-quality issues, but greenhouse gas emissions
-- with all the dangers they present for global warming -- have continued
to increase with economic growth, especially in the United States.

Friedman emphasizes in particular the importance of
externalities -- instances in which an economic actor's actions have
consequences for others for which that actor does not pay (negative
externalities) or for which he is not compensated (positive
externalities). Almost everyone recognizes these "market failures" (when
markets on their own do not produce efficient outcomes) and their
implications, most notably damage to the environment. The United States'
production of greenhouse gases imposes staggering costs on others --
especially low-lying islands that will be inundated in the not-too-distant
future -- but American firms and consumers do not pay for these costs.
Correcting such a market failure does not require subsidies to oil
companies to increase oil production (there is no market failure in that
direction); it requires more conservation. But externalities imply a more
general argument as well: if growth has broad-based societal benefits that
go beyond those captured by each individual or firm, then there is a role
for government in promoting growth.

Although one of these broader societal benefits is
a more open and tolerant society, Friedman explains carefully that the
relationship between democracy and growth is two-way: growth affects
democracy; democracy affects growth. Both aspects of the relationship are
complex and often ambiguous. China -- not particularly democratic or open
politically -- has had the most rapid and sustained growth of any country
over the past quarter century. Conventional wisdom holds that democracies,
since they are more accountable to the "masses," pay more attention to the
poor. But China has done more to reduce poverty than most other countries.
In recent periods, the United States has seen median real household income
fall, and the rich have received huge tax cuts even as poverty has
grown.

Unlike so many growth proponents, Friedman realizes
that what matters is not simply growth; it is the policies that give rise
to it. His work thus provides an important critique of those studies (such
as at least one prominent World Bank study by Paul Collier and David
Dollar) that correlate growth and poverty reduction or growth and
integration into the global economy. For the most part, the policy
decision facing governments is not to grow or not to grow or to integrate
or not to integrate (though politicians often try to oversimplify in that
way). The questions are more specific: whether or not to reduce tariffs,
whether or not to liberalize capital markets, whether or not to invest
more in research and development, whether or not to spend more on
education. And the answers are less clear. Some of these policies may
promote growth in ways that will increase poverty; others may promote
growth in ways that will reduce it. Some growth strategies may be good for
the environment; others may not be.

In short, the debate should not be centered on
whether one is in favor of growth or against it. The question should be,
are there policies that can promote what might be called moral growth --
growth that is sustainable, that increases living standards not just today
but for future generations as well, and that leads to a more tolerant,
open society? Also, what can be done to ensure that the benefits of growth
are shared equitably, creating a society with more social justice and
solidarity rather than one with deep rifts and cleavages of the kind that
became so apparent in New Orleans in the aftermath of Hurricane
Katrina?

The problem is that most of the available empirical
evidence comes from cross-country analyses, which are not very
informative. Friedman's work provides an important reiteration of recent
calls by the World Bank for more micro-level and case-study-based research
on the potential tradeoffs between growth and poverty reduction and
environmental quality.

THE INCOME SWEEPSTAKES

Friedman ends his book, which covers a delightfully
wide range of topics, with an analysis of the kinds of policies that the
United States might pursue to achieve his vision of moral growth. This
discussion is simultaneously optimistic and pessimistic. The policies are
clearly within our grasp. Yet they are a far cry from the policies the
United States has been pursuing in recent years -- which have led to a
double whammy, simultaneously stifling growth (the most damaging
consequences of which may lie years in the future) and creating a society
marked by greater social injustice.

Among the developed countries, the United States
has been doing well in the growth sweepstakes -- or so you might assume if
you focused exclusively on GDP. GDP statistics, however, can be very
misleading. They do not really measure how well the country is doing or
how much better off its citizens are becoming.

No one would look at just a firm's revenues to
assess how well it was doing. Far more relevant is the balance sheet,
which shows assets and liabilities. That is also true for a country.
Argentina grew rapidly in the early 1990s, mainly as a result of a huge
consumption binge financed by international borrowing. But that growth was
not sustainable and was not sustained. Similarly, the United States has
been borrowing heavily from abroad, at the rate of $2 billion a day. It
would be one thing if this were being spent on high-productivity
investment. In fact, it has been used to finance increases in consumption
and massive tax cuts for upper-income Americans.

Consider the following thought experiment: If you
could choose which country to live in but would be assigned an income
randomly from within that country's income distribution, would you choose
the country with the highest GDP per capita? No. More relevant to that
decision is median income (the income level that 50 percent of the
population is below and 50 percent is above). As the income distribution
becomes increasingly skewed, with an increasing share of the wealth and
income in the hands of those at the top, the median falls further and
further below the mean. That is why, even as per capita GDP has been
increasing in the United States, U.S. median household income has actually
been falling.

There are other reasons why someone might not want
to look at just per capita GDP. He might worry about his security. What
happens if he gets ill? If he loses his job? What happens when he retires?
He might worry about crime. He might worry about the quality of his
children's schooling. How do his children fare in competition with those
who can afford the best schooling that money can buy or with those in
countries such as Singapore that offer a first-rate public education? He
might worry about the environment. Are there government regulations
prohibiting arsenic in the water?

When viewed through these lenses, the United States
does not look as good. There are some dimensions in which it is outpacing
others -- for instance, it boasts five to ten times the per capita prison
population of other advanced industrialized countries and more working
hours per week. It also has less job security, worse unemployment
insurance, and fewer people covered by health insurance.

To be sure, the American dream still attracts
millions from around the world. But some of that attraction may be based
on a lingering myth of upward mobility in the United States and an
underappreciation of the difficulties that confront the poor. And although
there is still no comparing the U.S. standard of living and that of poor
countries, these are not the laurels on which one wants to
rest.

HALF STEPS AND MISSTEPS

In the debate on the impact of globalization on
poverty, Friedman supports the view that even if globalization has been
associated with increases in inequality within countries, it has led to
reductions in poverty and inequality globally. There are three fundamental
flaws in this analysis. The first relates to the definition of poverty. As
the World Bank has emphasized at various points, poverty is not just a
matter of income; insecurity and voicelessness are also part of its
profile. Friedman's analysis completely ignores these other
dimensions.

The second criticism relates to the point that what
matters is not globalization per se, but specific policies associated with
it. Capital market liberalization, for example, entails closer integration
of capital markets, especially with respect to short-term capital flows.
Modern economic theory and empirical analysis have shown that with
imperfect capital markets, such integration may lead to greater economic
volatility -- a conclusion that even the International Monetary Fund now
supports -- and has a negligible effect on growth. Furthermore, there is
ample evidence that the poor bear the brunt of the burden from increased
volatility. In short, this particular aspect of economic integration
increases poverty without much affecting growth.

The third is that Friedman relies too heavily on
studies by Xavier Sala-i-Martin (The Disturbing "Rise" of Global Income
Inequality) and Surjit Bhalla (Imagine There's No Country: Poverty,
Inequality, and Growth in the Era of Globalization) that have been subject
to enormous criticism, without warning the reader of the debate
surrounding their numbers. (It should be said that having an article
published in a peer-reviewed academic journal and its conclusions parroted
in the media does not imply automatic certification of its validity.) The
problem is easy to state but hard to rectify: studies of inequality and
poverty are based on household surveys of expenditures and income, but the
numbers gleaned from those studies tend to be inconsistent with national
income accounts, an outcome that suggests massive underreporting in the
household surveys. One simple solution to this discrepancy -- the approach
largely used in the Sala-i-Martin and Bhalla studies -- is to blow up the
numbers from the household surveys. If the average income reported is
$3,000 and national income accounts show average incomes to be $4,000,
increase everyone's reported income by a third. This immediately reduces
the figure for the number of people living in poverty.

However, more sophisticated approaches observe that
higher-income individuals are more likely to worry about tax collectors
than are the poor. In this view, the shortfall in reporting is largely
accounted for by those with higher incomes, and the number for those
reportedly living in poverty according to the household surveys is roughly
accurate. Assessments of reporting "errors" support this view -- a view
that says the world still has a long way to go in meeting its goal of
reducing poverty by half by the year 2015. (For a discussion of both sides
of this issue, see the forthcoming Debates on the Measurement of Poverty,
a volume produced by the Initiative for Policy Dialogue, which I edited
along with Paul Segal and Sudhir Anand.)

Meanwhile, Friedman's contention that growth brings
with it the virtues of greater openness and tolerance invites these
questions: Is the United States, as it becomes richer, becoming more open
and tolerant? Do openness and tolerance entail putting equal weight on
modern science and pre-Enlightenment views?

Friedman is right, however, in arguing that
democracy is less sustainable in poor countries. Thus, if Bush were
serious about his commitment to spreading democracy, he would invest more
in these countries' development, living up to the agreement made by all
the advanced industrialized countries to commit 0.7 percent of their GDP
to foreign assistance. The money would make an enormous difference, both
for the quality of lives in the developing world and for the prospects of
democracy there. Of course, more than just money is required: nothing is
more convincing than successful examples of open and tolerant societies
that are able to bring the fruits of growth and democracy to all their
people. How can the United States claim to provide such an example if it
does not take care of its own?

THE MYTH OF THE INVISIBLE HAND

American economists tend to have a strong aversion
to advocating government intervention. Their basic presumption is often
that markets generally work by themselves and that there are just a few
limited instances in which government action is needed to correct market
failure; government economic policy, the thinking goes, should include
only minimal intervention to ensure economic efficiency.

The intellectual foundations for this presumption
are weak. In a market economy with imperfect and asymmetric information
and incomplete markets -- which is to say, every market economy -- the
reason that Adam Smith's invisible hand is invisible is that it does not
exist. Economies are not efficient on their own. This recognition
inevitably leads to the conclusion that there is a potentially significant
role for government.

Friedman, as a good American economist, begins his
discussion by paying homage to the usual strictures, identifying
externalities of the kind that warrant government intervention. He goes on
to point out the importance of investment, both in physical and human
capital, and to note that huge government deficits ("dissaving" on the
part of government) are hurting those investments. A perfect market
economist would dismiss this claim as nonsense: private savings will
eventually increase to offset negative government savings, and if citizens
want to consume more and save less now, that is their prerogative -- just
because Friedman wants to consume less today does not mean that he should
be allowed to impose his preferences on the rest of us. Moreover, such an
economist would say that it is not domestic savings that matter in our
globalized world, but the global balance of supply and demand for funds.

Perhaps Friedman does not spend time refuting these
perspectives because, notwithstanding the significant role they play in
academic debates, they are so patently absurd. Of course private saving
has not offset public dissaving on a one-to-one basis. Of course domestic
saving matters for domestic investment, even in a globalized world. But it
is important to grasp the reason why the predictions of the perfect-market
models fall so short: market failures go well beyond externalities.
Understanding these limitations of the market leads to an understanding of
the necessary role of government in promoting growth and making sure that
it is the right kind.

There is, for instance, a greater role for
government in promoting science and technology than Friedman seems to
suggest. A report by the Council of Economic Advisers (conducted when I
was its chair) found that the returns on public investment in science and
technology were far higher than for private investment in these areas and
than for conventional investment in plant and equipment. So, too, with
education, especially at a time of such concern with the quality of
American schools, and particularly for low-income families. Vouchers --
what amounts to partial privatization of our elementary and secondary
educational systems -- have been put forward as a free-market solution to
the shortfalls in educational quality. But the advocates of vouchers have
never made a convincing case that they can be designed to promote higher
educational attainments and greater racial integration across the entire
educational system, rather than just for those receiving the
vouchers.

Friedman's book is thus an important antidote to
the populist antigrowth movement and also to those who say that the free
market is all we need. It joins a growing chorus calling for a change in
the direction of U.S. economic policy -- toward achieving growth that is
stronger and more sustainable. Whether or not you agree with Friedman's
particular policy prescriptions, this much is clear: this kind of reasoned
analysis is precisely what is necessary to put the United States back on
the right track.

Already a
subscriber?
Login
now or register
for online access.

Subscriber Login

Email address:

Password:

Subscribers, Click
here to register for online access

• Have a
question?

—
ADVERTISEMENT —

Newsstand Finder

Enter U.S. ZIP code

• Browse U.S. &
Canadian locations

• Browse
international locations

Newsletter

• Subscribe

• Current
newsletter

• Newsletter
archives

New
from cfr.org

MIDDLE EAST: The
Arab League and Iraq
October
20, 2005

GAZA: What
Palestinians Want
October
19, 2005

SECURITY: China's
Military Threat
October
18, 2005

Copyright 2002--2005 by
the Council on Foreign Relations, Inc. All Rights Reserved. Privacy
Policy |  Contact
Us | FAQs |