Some of the best economic innovations come from places you wouldn't expect.
- By Jeffrey Frankel<p> Jeffrey Frankel, a former member of President Clinton's Council of Economic Advisors, is the Harpel Professor of Capital Formation and Growth at Harvard University. </p>
Looking for novel solutions to public policy problems? You could check the high-end think tanks in the U.S. or Britain, maybe research from the Fed, or perhaps Sweden’s Central Bank or the elite Sciences Po in Paris.
Then, again, you might want to follow a path truly less traveled. While the world has long been accustomed to looking to the mature industrialized countries for models in economic policy, they don’t have a monopoly on good ideas. Smaller, less affluent countries that would ordinarily slip under the radar can serve as laboratories for innovation. Indeed, states that are modest in size, newly independent, far from the influence of the big global players, or emerging from devastating wars (choose one or more) often find it easier to obtain sufficient political consensus to institute radical reforms.
Here are a few that come to mind:
Education Incentives. Universal public education pays dividends in myriad ways ranging from raising economic productivity to creating a more sophisticated electorate. But it exacts costs on families, especially in countries where child labor is a fact of life. And it often pits the will and interests of parents who do not value education against the interests of their children.
Hence, the logic of Mexico’s pioneering conditional cash transfer program in 1998 (originally called Progresa), in which welfare benefits to the poor are conditioned on their children’s school attendance. Note two bonuses here. First, getting the kids to school gives the state some control over the living standards of children who might otherwise be abused and/or malnourished. Second, it allows for controlled experiments to find out which anti-poverty policies work in developing countries and which don’t, fostering a very productive field in development economics. Brazil has since adopted a similar program — as have a long list of countries as diverse as Jamaica, Nicaragua and Zambia. The Progresa approach has even inspired reforms in New York City, which makes cash awards to families in return for regular school attendance and participation in parent-teacher conferences.
Buffering Export Cycles. Prices of commodities ranging from oil to gold to cocoa are highly volatile, putting countries that depend heavily on export earnings in a bind. When prices are high and government revenues are plentiful, political leaders face pressure to spend the money. This, in turn, feeds demand just when fiscal stimulus is least welcome, often generating inflation.
Then, when commodity prices fall, the process reverses. Politicians must find ways to retrench or accept the consequences of budget deficits. And retrenchment reduces demand just when the economy needs it.
Chile, which must cope with broad swings in the price of it copper exports, created rules in 2000 for smoothing the impact of the commodity cycle that largely depoliticize the process. The government may run deficits if the economy slips below the targeted growth rates or the price of copper falls below its long-term trend. Equally to the point, the government automatically accumulates surpluses during booms that cool down the economy and create a trust fund that can be used to stimulate the economy when it again heads south.
Managing Natural Resource Riches. A dozen countries ranging from Saudi Arabia to Venezuela to Algeria to Bolivia depend on natural resource exports (usually, oil and gas) to sustain living standards and pay for public services. But what happens when the resources run out?
The most extreme case is the tiny Pacific island of Nauru, which lived high off exports of bird guano deposits for a few decades, and then was left with nothing but an environmental wasteland. But doleful, if less dramatic, consequences are in store for other resource-dependent countries unless they invest in diversifying their economies or accumulate permanent funds from export proceeds. The model in this regard has been Norway’s Pension Fund (what don’t the Norwegians do right?) In fact, a better model is Botswana’s Pula Fund, built on the earnings from its rich diamond deposits. (The photo above shows a Botswanan diamond sorter at work.) This sovereign wealth fund, managed by independent professionals, is diversified into securities denominated in a variety of currencies — and, unlike Norway’s fund, is carefully walled off from the political priorities of elected officials.
The Flat Tax. Tax reformers have been kicking around the idea of replacing complex income tax systems that are riddled with inequities and distorted incentives with a single "flat" rate — a rate that that applied to all levels of income and allowed for few preferences. Such taxes can be made progressive (at least at the low-to-middle end of the income pecking order) by giving everybody a basic tax-free allowance. But getting from here to there — especially in rich, mature economies in which well-organized interests defend their own tax breaks — has proven next to impossible.
That wasn’t the case, though, in Estonia in 1994. The tiny Baltic state, newly liberated from Russia, effectively had a clean slate to work with. Its flat tax was widely emulated over the following decade, spreading to much of the former Soviet bloc including Latvia, Lithuania, Ukraine, Slovakia, Georgia, Romania — and even the Russian Federation. Rates, tax-free allowances, and breadth of coverage vary widely (some, for example, cover both personal and corporate income). But a World Bank analysis suggests the experiments have largely been a success, both in terms of increasing compliance and simplifying tax systems.
Traffic Congestion Pricing. Cars and trucks aren’t free; gasoline isn’t free. Why is the use of highly congested urban roads free? Why, indeed. Econ 101 suggests that the failure to charge for road use leads to overuse for the same reason that selling bread for almost nothing in the Soviet Union led many farmers to feed it to livestock. But creating a congestion pricing system that reflects the ever-changing costs of traffic density is a political challenge as well as an economic and technological one. In most localities, the potential losers from congestion pricing have generally been able to veto its imposition.
Yet Singapore — not, say, Paris, Tokyo or New York — was the first to introduce congestion pricing some three decades ago. The city-state’s willingness to be a pioneer made sense for two reasons. For one thing, Singapore‘s options for managing congestion were uniquely limited because it did not have the option to sprawl like, say, Los Angeles and Houston. Equally important, Singapore’s top-down political rule and compact size made it possible to impose a system that gored a lot of metaphoric oxen. Singapore’s initiative did lead to a host of parallel efforts ranging from straightforward congestion-pricing in London, to the auctioning of car-use permits in Shanghai, to high-occupancy-vehicle lanes on commuter road in a dozen U.S. cities.
No Standing Army. It’s hard to quarrel with the need for a permanent military establishment in many countries. But in many others, a standing army is a bad deal all round. It doesn’t make borders any more secure if neighbors respond by raising armed forces of their own. It creates the permanent threat of a military coup — or, at very least, limits the range of policy options of civilian government. And of course, it costs resources, diverting money, foreign exchange earnings and manpower from conventionally productive activities (like making stuff people want).
Such arguments haven’t carried much weight, though; once an army is created to meet a threat (real or imagined), it’s almost impossible to get rid of it. But two developing countries have managed to remain military-free for generations. Costa Rica abolished its army in 1948 after a bloody civil war — a decision made in part because the United States believed its interests lay in blocking a return to power of the losing side. And Mauritius chose not to create an army after it was granted independence by Britain in 1968.
I don’t mean to suggest that smart ideas can be effortlessly translated from one national context to another. Nor do I mean that the countries mentioned here have done everything (or even most things) right when it comes to public policy. Mexico’s economy, after all, is stagnating, and Estonia’s was among those worst hit by the global financial crisis. But the examples do illustrate the reality that countries small enough to aim for political consensus and flexible enough to avoid interest group paralysis have some major advantages when it comes to policy innovation.