Understanding growth

Why are some countries rich and others poor? Why do some economies grow faster than others? How are some economies able to create jobs while others fail?

These are the questions that William Lewis tries to answer in this book. It's a subject that has been debated for decades by economists, but Lewis' approach sets him apart from the standard textbooks on growth theory, or from the myriad analyses of development that focus on economic history.

Lewis was a partner at global consulting firm McKinsey & Company for 20 years and the founding director of the McKinsey Global Institute, and he uses the firm's bottom-up approach to study the roots of economic growth.

As he puts it, "An evaluation of economic performance requires an analysis at the level of individual industries, such as automotive, steel, banking, and retailing...You must look at the sector level for causal factors for economic performance."

Not surprisingly, his conclusion is that the one key factor responsible for the differences in economic growth between nations lies in productivity.

Also unsurprisingly, the United States of America is taken as the paragon of productivity and as the benchmark against which all other economies are compared.

Lewis analyses in detail the economies of Japan, Europe, the US and Korea among the rich and middle-income countries, and Brazil, Russia and India among the poor ones.

His conclusions: One, much of the differences in economic performance is due to differences in competition in product markets. Keen, and fair, competition is one of the keys to growth. Two, it's not necessary for the workforce to be highly educated to be productive.

Three, merely pouring in capital into a poor country won't make it rich. Rather, "if poor countries improved productivity and balanced their budgets, they would have plenty of capital for growth from domestic savers and foreign investors".

Four, rather than distort product markets through subsidies, import tariffs and high minimum wages, it is better to raise productivity, create a bigger economic pie and then, if felt necessary, distribute that pie through changes in individual tax rates.

Five, big government is inherently inefficient and a burden on the economy. Six, economic and political elites are not likely to maximise economic growth "" rather, they are far more likely to reward themselves. Seven, countries shouldn't protect their own industries and ask rich countries for money.

Lewis says, "Direct investments by the more productive companies from the rich countries would raise the poor countries' productivity and growth rates far more effectively than sending them money." Eight, we need strong consumer interest groups that can stand up to producer special interest groups who impede productivity growth.

Coming to the individual economies, Lewis shows how Japan is a dual economy, with its productivity in autos being the highest in the world, but there are also very inefficient sectors such as retailing where mom-and-pop stores are protected.

Similarly, high minimum wages and generous unemployment benefits in Europe impede its ability to create new jobs.

Of course, for us, it's Lewis' view of what's wrong with the Indian economy that's most interesting. He believes that it's the modern sector that holds the key to development.

He says that over-regulation distorts and diminishes competition, and as examples he points to the reservations for small-scale industries, the ban of foreign direct investment in retailing, inefficient government ownership in many industries, the lack of a market in land (he says that 90 per cent of land titles in India are subject to dispute).

India, he says, has "by far the tightest restrictions on new competitors entering markets". He is dismissive of IT, pointing out that it accounts for a minuscule fraction of the economy.

There is little doubt that productivity is very important for economic growth, and that the American business model has shown itself to be tough, resilient and innovative. Lewis is right, therefore, to call attention to America's strengths.

But there is also another side to the story. Surely mention should also have been made of China's emergence as the workshop of the world, based mainly on its capacity to attract huge amounts of FDI and on massive spending on infrastructure?

And surely America's huge current account deficit says something about the competitiveness of its goods and services?

Also, the BPO phenomenon, which has caused so much heartburn in the US, is entirely ignored. Nor does everyone agree that the US' is necessarily the most productive economy "" economist Robert Gordon has said that "Europe envied the US high-tech boom of the late 1990s, but the US productivity revival was shortlived.

Over the five years 1996-2000 the US briefly caught up to the European rate of productivity growth, but over any longer period, 1990-2000 or 1973-2000, the US growth rate lagged behind."

The World Economic Forum places the US behind the welfare state of Finland in its survey of global competitiveness. Moreover, can a rich country that doesn't deliver basic healthcare to millions of its citizens really be a model for anybody? Nor is productivity necessarily the be-all and end-all of economic policy.

All late developing economies, from Germany to Japan to Korea and China, have developed by having high import tariffs and far from conventional mainstream economic policies.

Doubts also arise about Lewis' grasp of the facts when he makes statements like, "no mortgage financing is available in...India because of lack of confidence of local and foreign investors in the maintenance of macroeconomic stability". Which planet does Lewis inhabit?

In short, a perfectly valid thesis highlighting the role of competition in driving economic growth has been marred by Lewis' rather one-sided analysis and preachy manner.

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THE POWER OF PRODUCTIVITY
Wealth, Poverty and the Threat to Global Stability

William W Lewis
The University of Chicago Press
Price:$28, Pages: 339