The Baker Hypothesis
In 1985, James A. Baker III's “Program for Sustained Growth” proposed a set of economic policy reforms including, inflation stabilization, trade liberalization, greater openness to foreign investment, and privatization, that he believed would lead to faster growth in countries then known as the Third World, but now categorized as emerging and developing economies (EMDEs). A country-specific, time-series assessment of the reform process reveals three clear facts. First, in the 10-year-period after stabilizing high inflation, the average growth rate of real GDP in EMDEs is 2.2 percentage points higher than in the prior ten-year period. Second, the corresponding growth increase for trade liberalization episodes is 2.66 percentage points. Third, in the decade after opening their capital markets to foreign equity investment, the spread between EMDEs average cost of equity capital and that of the US declines by 240 basis points. The impact of privatization is less straightforward to assess, but taken together, the three central facts of reform provide empirical support for the Baker Hypothesis and suggest a simple neoclassical interpretation of the unprecedented increase in growth that has taken place in EMDEs since 1995.
We are grateful to Nandini Gupta and Paul Romer for helpful comments, and to Sandile Hlatshwayo and Bill Megginson for help with the privatization data. Henry and Reyes thank the Sloan Foundation for financial support of the Ph.D. Excellence Initiative, of which Reyes is Fellow and Henry is Principal Investigator. Henry is a member of the Board of Directors of Citigroup and Nike; neither corporation has funded this research. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.