Macroeconomic theory - Essay Example

One consistent theme that emerges from current research is that the growth of real income and the overall macroeconomic stability - both internal and external - are mutually interdependent and both form an integral part of an adequate, consistently sustained process of economic development. The simple policy rules that follow are: This paper will attempt to address the second question, i.e. what distinguishes the countries that followed the optimal policy mix and hence succeeded from those which did not.

Perhaps it is useful at this juncture to refer to the experience of the successful countries of Asia. Clearly the vast majority of developing economies have failed to lift their economic growth and living standard compared with a small group of Asian economies which excelled. In little over two decades the dynamic Asian economies were able to catch up their former colonial masters while others stagnated. Two distinguishing economic features of these successful economies stand out: The neo-classical economists.

Two distinguishing economic features of these successful economies stand out: * openness or "neutral" trade regime; and * active government intervention. The neo-classical economists (e.g. Balassa, 1968; Bhagwati, 1978; Krueger, 1978; Little, 1979) emphasize the role of openness. On the other hand, there is a body of literature (e.g. Amsden, 1989; Lee, 1992; Sach, 1987; Wade, 1990) which emphasizes the role active government intervention played in achieving late industrialization. While both have some elements of truth, over-emphasis of one or the other misses important issues.

For example, the neo-classical economists are at unease with the co-existence of high import protection with export orientation, and active government non-price interventions with market-oriented policies in some of these economies. On the other hand, the "statists" explanation of why in these economies state interventions did not go fatally wrong as in other developing countries depends crucially on the state being "strong". More fundamentally, though, they cannot explain how a "strong" state emerges, and why some strong dictators (e.g. Marcos or Idi Amin) did not maintain macroeconomic stability and wrecked their economies.

One important shortcoming of both explanations is an inadequate focus on institutions. None of these approaches takes into account the formal and informal constraints and rigidities in which policy making occurs. This chapter reflects on institutional frameworks that are likely to induce optimal macroeconomic policy response by the government.Institutions and organizationsNobel Laureate economist, Douglas North (1990, p. 4) defines institutions as "any form of