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Chapter 6 Compressed Compressed

Ch 6

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Vanshika
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6 Strategies for Economic Development What strategies can be adopted by governments and other organizations to foster economic development in LDCs? What are the merits and disadvantages of alternative strategies? What have been the policy expe- riences of LDCs that have had success in economic development compared to those which have failed or at east not done as well? What approaches to develop- ment have been adopted in India, what effects have they had, and what are appropriate paths to follow? Sometimes debates about issues of strategy have pro- ceeded as if there are two or perhaps three alternative paths to development, for instance, a neoliberal strategy, a state-led autarkic strategy and some kind of a middle path. Such debates have been unnecessarily divisive 176 - gw mo Oeeeaeer er bbe ) ebbobeeobeddid’ POU DELLLIS ry q S = = < and arguably failed to improve our understanding of the Strengths and weaknesses of different strategies, Often the middle path has been forgotten. Rather than chgaging in such broad debates, we may discuss strate- gies in terms of the questions about alternative paths to development mentioned in the introduction. The State versus the Markets Arguably the major debate regarding’ strategies of development has been about whether economic devel~ opinent is best promoted by harnessing the forces of the free market or through state involvement. mmmther emily days of development economics after World War’ @the experience with wartime controls and planning in more developed countries, the generally positive growth results of Soviet planned industrialization, the aspirations of the governments of newly independent LDCs, and the US's desire to promote development by providing foreign aid to LDC governments to confront 152 ‘Over twWordecades of the experience with this dirigiste de “velopment and its ee Poor results, thespenduz under Prime Minister Margaret Thatcher in the UK and President Ronald ea in the US. —— and its modern mainstream neoclassical economics formalization in terms of the fundamental theorem of welfare economies, discussed in Chapter 3/Necotding 178 a! . : Free markets also promote productive efficiency by » encouraging competition and. make: use of betters information possessed by private individuals, who have ¢ better knowledge about. what. concerns them than » does the state; State regulations were argued to dis- tort free market incentives, result in inefficiencies, and promote corruption and activities which attempt to secure government favours rather than production and investment. Moreover, ftee markets expand economic’ freedoms while state intervention reduces individual cedom and interferes with the rights of individuals, for example, to private property. ‘The case for state intervention is made with the argument that the strict conditions that are required fur the fundamental theorem of welfare, such as ‘pex- fect’ formation and the absence of externalities, public goods, and large firms which can set prices, | as discussed in Chapter 3, are unlikely to hold in real economies, especially in LDCs. Moreover, if the future Dove Lo bbdddddddddé is uncertain—rather than just risky in the sense that => " there are objectively calculable probabilities of future —9 events—the economy can experience macroeconomic 3 problems such as unemployment, inflation, and eco~ =) -+ nomic fluctuations, which can be corrected by suitable 2 » 2 154 iD | eeaaAgTIyIyyy ssssaasggg ead gevermment policy. The government can also have better information about macro. issues and, in fact, control the macro environment and overcome coordi- nation problems like the one we encountered concern- ing the shoe factory in Chapter 3. The governmenty can also reduce poverty and inequality, rather thaw focusing only on efficiency like the free market doesy at least in terms of the fundamental theorem of wel-y fare. economics, and expand the functionings and capabilities of people, which can imply expanding freedoms and upholding certain rights/(to education and adequate nutrition, for example), ven though government restrictions may reduce certain freedoms and violate some rights. The theoretical debates have been accompanied by controversies regarding interpretations of actual policy experiences around the world. The empirical case for free-markets has been made by pointing to the gen- eral success of capitalist economies of Western Europe and the US and the demise ofthe Soviet Union. The case for government intervention is made by drawing attention to significant instances of government sup- port for economic development in Western Europe and the US, and especially in Germany and Japan, and quauidojaaogy 2uwoworg sof sax8o1011g a an Uh tothe x he experiences of the Great Depression and the sis of the first decade of the twenty- which free markets are associated global financial cri first century, in with ‘economic decline and government intervention’ with recovery. Turning more specifically to LDCs in recent times, the experience of the East Asian newly- industrialized countries (NICs), such as South Korea and Taiwan, were initially interpreted as demonstrating the virtues of market-friendly strategies by the World Bank, among others, but later scholarship suggests the strong role of the state in these successful development efforts in the form of state-ownership of enterprises, government regulation and government allocation of credit to key industries (Amsden 1989; Wade 1990; Chang 2007). Bhe:poor performance of many LDCs, including India (Bhagwati 1993), has been hid at the door of state intervention.'The more recent growth, acceleration in China and India has also been attrib- uted to free market reforms, although it has also been argued that the experiences of these countries included state intervention, which made possible the creation of an industrial base and technological upgrading and laid the foundations for the more recent growth accelera~ Hons. The growth successes are attributable to the fact 156 tha a Leeepiates guardedly ra continue to” st state-interventionist economies” among LDCs, What these debates seem to overlook is the. fact that the market and the state are not substitutes but ate synergistic institutions which can strengthen the posi tive development effects of the other The mainstream neoclassical approach to markets does not usually rec- ognize the fact that the state and society need to pro- vide markets with appropriate underpinnings so that private property rights are protected to some degree and contracts are enforced, and ensure that the excesses of market competition do not disrupt social stabil- without which market economies will collapse (Polanyi 1944), Markets have many shortcomings, as discussed earlier, which open up the possibility that states can improve matters. But states can also create problems and not merely solve them, by promoting inefficiency and corruption and by furthering the goals of powerful groups in society at the expense of the Jess powerful, and ultimately at the expense of the country as a whole. The’ state can promote develop* juaudojaaag 2u0wory sof s18a10415 157 mH SSH OHOHHFH HS Hagnee ment? In particular, the state can make use of market forces, among others, to discipline social groups to achieve desirable outcomes and provide incentives to those whose activities can promote development country’A careful sendy and crue of these contexts, coupled with careful analytical thinking, is required. Autarky versus Openness ‘A second major development debate is over whether LDCs should follow an autarkic or inward-looking development path or one that is outward oriented and seeks to increase links of the country with the global economy, through greater openness to inter- national trade, foreign direct investment, and other forms of international capital flows. After World War II, there was a preference for a relatively inward-looking 158 183 approach, which accompanied the general strategy of state-led industrialization. Many LDCs embarked on import-substituting industrialization, attempting, to develop manufacturing industries under tariff barriers and import quotas. In addition to the goal of industri- alization, these LDCs were arguably reacting to their colonial pasts, suspicious of the colonial pattern of trade in which they imported manufactured goods and exported primary products, and of transnational cor- porations which represented to them the new face of colonialism. Moreover, policymakers in LDCs seemed to believe that their prospects of increasing exports of primary and simple manufactured goods were limited (what has been called export pessimism), and foreign exchange shortages and the import needs of indus- trialization were seen as requiring foreign exchange controls and licensing. From roughly the same time, as the switch from state-led «strategy to the market- friendly strategy occurred, the autarkic approach gave way to the more outward-oriented approach, Many explained the shift as occurring due to recognition of the inefficiencies and generally poor performance of the inward-looking approach, the exhaustion of the possibilities of import substitution, and the good 159 184 juomdojoaaqy nuouorg sof soins Pease PPPPOPTTTPGEL 6666 bObdddas LELLLEELEGGoob performance of LDCs which were more outward ori- ented, such as the East Asian NICs. Since the shift in strategy generally involved the liberalization of trade and international capital inflows, according to many analysts, the switch from inward to outward orientation was seen as a switch from state-led approach to a free market one. However, the relationship between the two debates is not a simple onc: as the East Asian experience shows, the outward-oriented strategy was pursued with active state intervention rather than through the free market and free trade approach. India’s approach reftected the general trend, although chere were differences in timing and extent of change. lndia-followed a highly protectionist trade policy in the early days after independence, in fact, pursuing what can be called a policy of self-reliance irrespective of cost. The move towards export promotion poli- cies, for instance, by providing import tax concessions and other incentives to exporters, was started as early as the 1960s. Trade liberalization was under way by the 1980s and gathered steam from the 1990s. However, during the 1970s, India became more restrictive towards transnational corporations and while inter- national capital flows were liberalized from the 1990s, 160 185 India’s ital ace i dia’s capical account is among the more regulated in the world. : The case for inward-looking development relies on the arguments discussed in Chapter 4 which point to the need for developing manufacturing industry to foster technological change and to diversify the economy away from primary production, for instance, due to the problems caused by deterioration of the terms of trade and volatility; the dangers of foreign direct investment caused by high profit repatriation, deleterious effects on domestic entrepreneurship and the inflow of inappropriate technology, and financial and foreign exchange instability caused by volatile international financial capital flows. The critics of such inward-looking development prefer an outward- oriented strategy because they argue that the promo- tion of exports increases the demand for domestic goods and brings in foreign exchange, exposes domestic producers (both import competing firms and export- ing firms) to international competitive pressures, the absence of trade restrictions allows LDCs to produce according to their comparative advantage, which lies in labour-intensive goods resulting in rapid employ- ment growth and reduction of poverty, less yestrictiv 161 186 suoudojanacy nusouorg sof sa1S000S PELVIS PPE 1999999 Pathways to Economic Development policies towards: capital inflows results in the greater availability of foreign saving which can finance both domestic and foreign direct investment, and advanced foreign technology is brought in, in the case of FDI. It is claimed, using case studies and econometric analysis, that LDCs which are more open to trade and interna- tional capital flows tend to experience higher growth and lower levels of poverty. However, the robustness of the econometric studies has been questioned, and it is pointed out that although in some cases restric- tions on trade and capital flows have had poor results, in others, as in the East Asian NICs, they have been more successful, and this success has been followed by some degree of trade and capital flow liberalization, which makes it seem that liberalization and economic success are causally related. An examination of the history of many of the more developed countries of today shows that these countries, including the UK, USA, Germany, and Japan, followed protectionist trade policies in the past to foster the development of their industries, and then become ardent free traders and champions of trade liberalization only after becoming more developed, attempting to kick away the ladder in the words of the German economist Friedrich List, 162 187 who supported Protectionism during the early stages of his country’s development—to prevent LDCs from following in their footsteps (Chang 2007). The appropriate course to follow is neither an_inward-looking strategy which indiscriminately imposes barriers oi foreign trade and capital move-~ ments or an outward-oriented one which reduces these a judicious combination of the two suc- cessfil LDCs have used protectionist policies to give barriers, but their nascent, relatively low-technology industries some breathing space to become internationally competitive, after which their governments have exposed them to foreign competition. While Promoting the exports of these goods they have also provided tariff and other forms of protection to relative high-technology indus- tries until some of them have been able to compete in international markets, and so on. These countries, including the East Asian NICs and, more recently, China, have sought to elimb the technology ladder, and have benefited by exporting relatively high-technology goods. This is not a matter of choosing between import reduction and export expansion, as simple static trade theory models with full employment, balanced trade, and two goods seem to suggest. Not all countries can, 163 188 uaudojanacy nuouorg sof sa1b2NS bes es we rt ww OP CCI ICS26 6 & 2 Ss < of course, proceed along this path with equatsuccess: in some cases the state is in no position, because it is too. beholden to powerful domestic groups, to force large domestic firms to compete successfully in foreign mar- kets, and others are too small and have small domestic markets to allow effective import substitution and the reaping of scale economics. Regarding foreign direct investment, countries that have been very hostile to transnational corporation and, indeed, dislodged them, as India did in the 1970s, paid a heavy technological price. However, other countries which experienced large amounts of FDI inflows have benefited by care- fully directing it to sectors which could benefit most from foreign technology, and imposing restrictions on entry into some sectors (such as service sectors like retail and finance) in which the possibility of technol- ogy gains is minor and adverse effects of monopoliza- tion, profit repatriation and lack of government control is high, and require and induce the foreign firms to transfer technology to domestic firms as suppliers or as partners. Regarding other capital inflows, while it makes sense to encourage foreign borrowing with long maturity periods, it may be sensible to take steps to restrict short-term capital inflows and outflows 164 1A with taxes and other restric successfully cope minimum damag during the including India, that have maintained a high a deg) sovernment control over their fi tained some tions. Countries that have d with volatile capital flows with © tO growth and equity—for inst: global financial crisis of 2008—are tl ance, hose, ree of nancial sectors, main- control over international capital flows, and pursued anti-cyclical monetary and fiscal policies, maintaining high levels of aggregate demand with expansionary macroeconomic policies during financial crises involving capital outflows (Reddy 2011). suawidojaaa snuouorg sof sa1Sa100g Growth versus Poverty, Inequality, and ‘Social’ Development Early development economists and policymakers focused on achieving high rates of growth of income and production in LDCs. This is not to suggest that they ignored the problems of poverty and inequal- ity, but they arguably believed that if the economy could be made to grow, poverty and even inequality would automatically and eventually decrease. Most countries, therefore, concentrated on increasing sav- ing, investment, capital accumulation, and the rate of Pathways to Ec technological change, rather than focusing directly on Poverty reduction. With the recognition of the fact that some LDCs, like Brazil, were experiencing rapid growth with rising inequality and litte poverty reduc- tion, and many others were experiencing neither sig- nificant increases in output nor reductions in poverty, from around the 1970s, there was a shift in focus from promoting growth to directly reducing poverty and inequality and addressing the problem of basic needs ke food, health care, and shelter for the poor. This was done by providing cash assistance and increasing income opportunities for the poor, and with government poli- cies that redistribute income to the poor. The success of some countries, such as Sri Lanka, Costa Rica, and Cuba, and states like Kerala in India, in terms of human development indicators such as health, education, and poverty reduction—without significant increases in income—has been recognized. Moreover, as we noted in Chapter 3, it has been argued that addressing the needs of the poor, such as basic health, education, and nutrition and reducing inequality promotes growth. However, emphasizing either growth alone or pov- erty, inequality, and other ‘social’ development indica- tors without emphasizing growth is problematic. An 166 ietease in the growth rate may not have effect on poverty and other ‘social’ indicators because ployment growth and appropriate spe- cific government policies may be required to affect the a positive Output growth need not Promote emy iflabour productivity rises rapidly, lives of the poor since market processes often exclude the poor. Attempts to reduce income poverty and improve health, education, and nutritional conditions, especially for the poor, may improve the conditions of the poor to a limited extent, but do little to make a large dent on the extent of poverty and reduce inequality, and is unlikely to promote sustained growth. Without sustained output and employment growth, improve- ments in education will have limited effects on the incomes of the [Link] may even result in emigration abroad (though resulting increases in remittances can compensate to some extent, as discussed in Chapter 4). Moreover, without long-term and sustained eco- nomic growth, government finances can come under strain, especially after adverse external and internal political and economic shocks, which can make it difficult to sustain poverty-reduction and other social programmes. In other- words, the recognition that eco- nomic development does not simply mean economic juowdoyaaagq srwouorgy 10f s21801001S PEBPMUBEEOOECES G60 66 ) a , ) a : J so 4 ibt ) hob bt growth, as discussed in Chapter 2, does not imply that the best strategy for reducing poverty and inequality is- by attacking them directly, without attempting to create conditions for sustained growth. Macroeconomic versus Microeconomic Approaches Macroeconomic approaches focus on indicators and policies at the macro oF aggregate level, or at ‘broad sec- toral levels, while microeconomic approaches focus on. interventions, both public and private, at the smal]— oicen village, or project—level. It is fair to say that early development economics focused mainly on the mac- yoeconomic approach, on attempting to raise overall investment and saving rates, on jnter-sectoral resource allocation, and on policy regarding, trade and foreign ent, More recently, the focus seems to direct investm have become much more micro-oriented and involve and promoting small} educational and health fundin} ding micro-loans to small enterprises, schemes, provi and the [Link] shift has come about partly due to the uccess or even failure of same macro inter- ing importance of non-government jimited si yentions, the grow! 168 193 Organization and aid donor institutions that focus on small projects, and the Srowth of private charities and volunteering work ‘which, understandably, 8reater personal involvement and results. In the rise in popularity of evaluation techniques interventions (like randomized experiments which randomly select small Projects to assess their effective- ness while ensuring that selected projects do not have some special advantages that make them more likely to fare well, for instance, by being located in more look: for addition, for small ‘devel- oped’ areas), has favoured small projects. Moreover, micro approaches that do not significantly alter the status quo are less likely to be resisted by powerful groups who may focus on preventing more macro changes—involving, say, broad-based land reforms or fiscal redistribution—to maintain their power. A micro focus has many advantages over a macro approach that neglects it. It can allow a more careful evaluation and understanding of how policy interven- tions work ‘on the ground’, so to speak. It is more capable of involving the poor themselves and obtain- ing a fuller understanding the needs and desires en poor and what precisely motivates them en and Duflo 2011), and is likely to involve the potentia' 169 2 7 & > om 8 7 2 y z 7 g ‘ee eneOeeoOOOeGSOOOaGgagaeegg oe bbbbobbedddaddsdé »bbED DS Development Pathways to Eco beneficiaries. of 4 ° iclaries of ‘development’ initiatives in success- ae ane os However, there are problems a issues and of expecting that the micro will simply translate into ‘aggregate outcomes. Improving school attendance by teachers may certainly help to improve education, but it is not clear that it will help to increase employment and reduce pov- erty unless the students with education find jobs, for which we require that employment prospects grow. Further, policies that seem to ‘work’ at the micro level need not have the same result at the macro level because of what economists call fallacies of composi- cion. For example, it may be relatively easy for a small increase in microcredit loans to increase incomes of a few self-employed entrepreneurs, but if there is a large inerease in such loans, excessive competition among. these. small entrepreneurs who sell similar products will very likely fail to increase incomes for them. Moreover, some things that do not ‘work’ at the micro level may well ‘work’ if done on a larger scale, for by generating sufficient aggregate demand or, instance, by mainstream economists, along the lines emphasized positive externalities. 170 Primary Production, Manufacturing, and Services As noted earlier, most early development economists stressed the importance of reducing the dependence of LDCs on primary production and developing the manufacturing sector for the reasons discussed in Chapter 3. Many LDCs adopted policies to promote the growth of their manufacturing sectors, sometimes even focusing on capital goods sectors. In part, as a result ofthese measures, manufacturing sectors in many LDCs expanded and the share of primary products in production and exports for many of them declined. The criticisms of this industrialization strategy grew louder over time, however, with the critics arguing that it led to inefficient industrialization, low employ- ment generation (especially in the case of capital goods sectors), and a bias against agriculture, which resulted in food shortages, stagnant primary goods exports, and failure of significant poverty reduction (given that most of the poor lived in rural areas). While some argued that this was mainly the result of the early devel- eta a . = opment economists disdain for the agricultural sect yuoudojoaocq 23uouorsy sof s21827PS i rn a bdddddddise 6 => es = = ae = Pathways to Economic Development as backward and traditional, others located the problem in the political economy of ‘urban bias’ resulting from the urban elite’s desire to concentrate resources in cities to help themselves directly and indirectly by appeas- ing urban voters (Lipton 1977). Moreover, it has been argued that despite their primary sector orientation, some countries, like Canada, Australia, and Argentina, and some US states have done well in the past and others, including some oil-rich countries, Botswana and Chile, have more recently taken. major strides by exporting primary and exhaustible products. As time went on development economists and policymakers began to focus more on the agricultural sector, with many countries experiencing productivity growth with the Green Revolution, and some countries pur- suing policies to increase employment in rural areas, especially among the poor and sometimes in the non- agricultural sector. In recent years some LDCs, including India have experienced a relative shrinkage of their manufacturing sectors with an expansion of their service sectors. The share of the service sector in GDP for India, for instance, was over 56 per cent in 2011, compared to 71 per cent in Japan, 78 per cent in the UK, and 79 per cent in the 172 197 USA (all in 2010). While some have welcomed this as reflecting the emergence of these couritries as, post- industrial economies following the path of successful more developed countries, others have viewed it as showing the service sector's role as a repository of those who cannot find employment in manufacturing and agricultural sectors and enter the informal service sector with low income and underemployment, and as evidence of deindustrialization which has adversely affected their technological dynamism. It should be noted that China’s services share in GDP was 43 per cent and South Korea’s was 58 per cent (despite the latter’s much higher per capita income level). Many of the protagonists of the debate on the strat- egy of industrialization take unwarrantedly extreme positions. Most of the reasons behind the early develop- ment economists’ support of industrialization remain valid, including those about technological change and the external terms of trade. While it is true that there are countries and regions have achieved high levels of income and standards of living despite being primary- sector oriented, they can be seen essentially as append- ages of larger national or international economies with which they were linked through migration, shared 173 juoudojaaacq muouong sof sapS0101'S Pere Pee ateaGoosesosgsgssvsesssess ‘conomic Development Pathways to istitutions and capital inflows, Moreover, though countries can experience economic impfovenients by exporting exhaustible primary resources, like copper (Chile), diamonds (Botswana), and oil (a number of petroleum-exporting countries), such improvements will be temporary unless che countries can success- fully diversify their production structure by developing manufacturing. Further, even before the exhaustion of their resources, they are prone to terms of trade instability and political problems including civil and international wars. However, the industrialization argument does not require the neglect of other sec- tors like the agricultural one. Many of its proponents, ‘in fact, did not recommend the neglect of agriculture: * recall that Lewis (1954), who referred to that sector as a subsistence one rather than the modern capitalist sector, did discuss the possible dangers posed by rising food prices due to agricultural stagnation for industrial profits, capital accumulation, and growth. Indeed, as discussed in Chapter 3, there are many ways in which the agricultural sector contributes to economic growth and development, which means that the neglect of agriculture can be an important obstacle for economic

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