State and Market in Development: Synergy or Rivalry? 9781685856342

Table of contents :
Contents
Tables
Abbreviations
1 State and Market in Development: An Introduction
Part 1 Alternative Views of the Problem
2 Varieties of Policy in the Third World
3 Against Minimalism
4 Some Thoughts on Plan and Market
Part 2. State Action and the World Economy in Comparative Perspective
5 A Theory of Government Intervention in Late Industrialization
6 The Role of Governments and Markets: Comparative Development Experience
7 International Aspects of the Role of Government in Economic Development
8 The Effect of Government Intervention on Growth and Equity: Lessons from Southern Asia
Part 3 The Political Economy of Systemic and Policy Choice
9 State, Cooperative, and Market: Reflections on Chinese Developmental Trajectories
10 The Logic and Unfulfilled Promise of Privatization in Developing Countries
11 The State in the Initiation and Consolidation of Market-Oriented Reform
Part 4 Conclusion
12 Synergy or Rivalry?
About the Authors
Index
About the Book

Citation preview

State and Market in Development

Emerging Global Issues Thomas G. Weiss, Series Editor

Published in association with the Thomas J. Watson Jr. Institute for International Studies, Brown University "=~

State and Market in Development Synergy or Rivalry? edited by

Louis Putterman Dietrich Rueschemeyer

Lynne Rienner Publishers

• Boulder & London

Published in the United States of America in 1992 by Lynne Rienner Publishers, Inc. 1800 30th Street, Boulder, Colorado 80301 and in the United Kingdom by Lynne Rienner Publishers, Inc. 3 Henrietta Street, Covent Garden, London WC2E 8LU © 1992 by Lynne Rienner Publishers, Inc. All rights reserved

Library of Congress Cataloging-in-Publication Data State and market in development: synergy or rivalry? / edited by Louis Putterman and Dietrich Rueschemeyer. p. cm.—(Emerging global issues) Includes bibliographical references and index. ISBN 1-55587-311-1 (alk. paper) 1. Economic development. 2. Economic policy. 3. Industry and state. 4. Free enterprise. 5. Markets. I. Putterman, Louis G. II. Rueschemeyer, Dietrich. III. Series. HD87.S74 1992 338.9—dc20 92-17038 CIP British Cataloguing in Publication Data A Cataloguing in Publication record for this book is available from the British Library.

Printed and bound in the United States of America The paper used in this publication meets the requirements of the American National Standard for Permanence of Paper for Printed Library Materials Z39.48-1984.

Contents List of Tables List of Abbreviations

1

State and Market in Development: An Introduction Louis Putterman and Dietrich Rueschemeyer

Part 1 Alternative Views of the Problem 2

Varieties of Policy in the Third World Goran Ohlin

3

Against Minimalism Paul P. Streeten

4

Some Thoughts on Plan and Market Alec Nove

Part 2 State Action and the W o r l d E c o n o m y in Comparative Perspective 5

A Theory of Government Intervention in Late Industrialization Alice H. Amsden

6

The Role of Governments and Markets: Comparative Development Experience Gustav Ranis

7

International Aspects of the Role of Government in Economic Development Henry J. Bruton

8

The Effect of Government Intervention on Growth and Equity: Lessons from Southern Asia Gustav F. Papanek

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CONTENTS

Part 3 T h e Political E c o n o m y of Systemic and Policy Choice 9

10

11

State, Cooperative, and Market: Reflections on Chinese Developmental Trajectories Mark Seiden

171

The Logic and Unfulfilled Promise of Privatization in Developing Countries Thomas J. Biersteker

195

The State in the Initiation and Consolidation of Market-Oriented Reform Stephan Haggard and Robert Kaufman

221

Part 4 Conclusion 12

Synergy or Rivalry? Dietrich and Louis Putterman

About the Authors Index About the Book

Rueschemeyer 243

263 267 277

Tables

5.1 5.2 5.3

8.1 8.2 8.3 8.4A 8.4B 8.5 8.6 8.7 8.8 9.1 9.2 9.3

Inward Direct Foreign Investment (IDFI) in Gross Investment, 1967-1986 Income Distribution Estimation of Variation in Growth Rate of Value Added per Employee Hour in Thirteen Late-Industrializing Countries, 1970-1986 Growth Rates Under Dirigiste and Market-Oriented Strategies Foreign and Domestic Savings Rate of Investment and Incremental Capital-Output Ratios Export Earnings, 1949/50 to 1969/70 Export Earnings, 1969/70 to 1986/87 Capital Intensity in the Indian Manufacturing Industry Trends in Income Distribution in Four Countries A Summary of Changes in Incoine Distribution in Four Countries Changes in National Income and in Real Wages, 1950s to 1980s Food Grain Production and Consumption in China, 1952-1989 China's Agricultural Performance, 1957-1989 Growth of Modern Agricultural Inputs in China, 1957-1987

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64 74

78 134 136 137 139 139 142 145 147 149 178 184 187

Abbreviations

BOI BRAC ECLAC ESCAP FLACSO GATT GDP ICOR ILO IMF ISI JCRR LDC NGO NICs OECD PRI SOE TNC UN UNCTAD UNFAO UNIDO USAID WIDER WIS

Board of Investment Bangladesh Rural Assistance Committee United Nations Economic Commission for Latin America and the Caribbean United Nations Economic and Social Commission for Asia and the Pacific Faculdad Latina Americana Ciencias Sociales General Agreement on Trade and Tariffs Gross Domestic Product Incremental Capital Output Ratio International Labour Organisation International Monetary Fund Import Substitution Industrialization Joint Commission for Rural Reconstruction Less Developed Countries Nongovernmental Organization Newly Industrializing Countries Organization for Economic Cooperation and Development Partido Revolucionario Institucional (Institutional Revolutionary Party) State-Owned Enterprise Transnational Corporation United Nations United Nations Conference on Trade and Development United Nations Food and Agriculture Organization United Nations Industrial Development Organization US Agency for International Development World Institute for Development Economics Research Work and Income Sharing Sector

IX

. 11 State and Market in Development: An Introduction LOUIS PUTTERMAN & DIETRICH RUESCHEMEYER

The issue seems decided before it is fully spelled out: state interventions in the economy harm economic growth and development. State action that goes as far as planning and political control of the economy leads to economic disaster. Prosperity comes with reliance on the market. It is the free interaction among economic actors all pursuing their own improvement, not political decision and collective action, that brings sustained advances in economic efficiency. Two historic developments offer themselves as compelling evidence: the dramatic economic success of the NICs of East Asia, especially Taiwan and South Korea, and the collapse of the state socialist political economies of Eastern Europe. For the past generation, both Korea and Taiwan followed an economic policy geared to exploiting the opportunities of the world market and exposing their industries to the discipline of that market. B y contrast, the command economies of Eastern Europe made only minimal use of the market mechanism within their borders, and in the pursuit of regional autarky, they protected their industries against international competition. Their economies not only fell further and further away from their one-time ambition of surpassing the capitalist West in productivity but increasingly failed in meeting even elementary demands of their own societies. Now the Second World merges into the Third. Such developments seem to call for strong and stark conclusions. And there is indeed a clear-cut shift in the opinions of commentators and policymakers. In fact, public discourse shows an overwhelming tendency toward simplistic trust in "the market" and skeptical rejection of the state's role in the economy. However, the authors of this volume, among them distinguished economists as well as social scientists, resist without exception this temptation to form simplistic conclusions. They are far from united in their fundamental positions. And their contributions vary a great deal in substantive theme—from a demonstration of the ill effects o f government intervention on growth and equity in Southern Asia (Gustav Papanek) to a

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warning against reducing the tasks of states to a minimum (Paul Streeten), from a theory of government intervention based in large part on the East Asian experience (Alice Amsden) to reflections on the aftermath of state socialism in Eastern Europe (Alec Nove) and an examination of the political prerequisites for market-oriented reforms (Stephan Haggard and Robert K a u f m a n ) . Yet all show a sophisticated appreciation of the complexities involved in any serious analysis of the roles of the state and the market in economic growth and development. A first clue about the wisdom of avoiding premature and simplistic conclusions of the " m a r k e t - y e s , s t a t e - n o " variety is found in those developments so often cited as convincing proof—the emergence of the East Asian N I C s and the collapse of state socialism in Eastern E u r o p e . Most accounts agree on the strong role the state played in the policies credited with the success of Korea and Taiwan as well as in the creation of their preconditions. And it is becoming increasingly clear that the disintegration of public authority looms as a major obstacle to successful market reform in Russia and the associated republics of the former Soviet Union. 1 T h e roles of states and markets in fostering economic efficiency are intricately intertwined. If this is true about economic growth in mature industrial societies, it is even truer when it comes to creating and maintaining the institutional conditions required for sustained economic growth. This is the broader problem of development as distinguished from economic growth within a given framework of institutions. The chapters of this book grew out of several workshops sponsored by the Center for the Comparative Study of Development and the Thomas J. Watson Jr. Institute for International Studies at Brown University. These conferences were enjoyable occasions for intense discussion, and at their best they achieved that difficult goal—a fruitful dialogue across disciplinary boundaries. 2 The book is divided into four parts. The three chapters in the first part present alternative views of the problem of the roles of the state and the market in development. The four chapters in the second part discuss state action and the world economy in comparative perspective. The third part, consisting of three chapters on the political economy of systemic and policy alternatives, includes discussions of the sharply contrasting roles of state and market in development, of market-oriented restructuring policies and of state socialist development efforts. In the final part, the editors put these essays in context and draw some substantive conclusions.

Alternative Views of the Problem In the opening chapter, "Varieties of Policy in the Third World," former Assistant UN Secretary-General Goran Ohlin suggests that there is increasing

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a g r e e m e n t about the things that markets do well and the things that governments must do. He argues that the technological requirements of modern society are leading to convergence toward a common model of the roles of government throughout the world. Paul S t r e e t e n ' s essay, "Against M i n i m a l i s m , " is an impassioned but nuanced and sustained broadside against the philosophy of state minimalism. He reminds the reader of numerous ways in which governments are crucial to the development of markets and economic well-being and lashes out at political economists who allege that bureaucrats can d o nothing but seek rents and that all state activities are inherently inefficient. In " S o m e Thoughts on Plan and Market," Alec Nove addresses the aftermath of Soviet-style socialism in Eastern Europe and the former Soviet Union. Like Streeten, Nove argues that the appropriate alternative to central planning is not a minimalist state—which he labels "Thatcherism"—but a mixed economy welfare state exemplified by many countries of Western Europe. He points out that world capitalism has been no panacea f o r developing countries, whose ranks the East is now joining.

State Action and the World Economy in Comparative Perspective In "A T h e o r y of G o v e r n m e n t Intervention in Late Industrialization," Alice Amsden extrapolates from her well-known recent work on South Korea to develop a general model of late industrialization or economic development. She argues that state subsidization of dynamic industries and breakthroughs in shopfloor organization are the requisite ingredients of industrial success. Rather than directing prices to equilibrate at competitive market levels, she advocates "getting prices wrong" through subsidies as a matter of practical necessity. Yet the developmental state uses the market as a test of the success of the firms it is supporting and prodding toward efficiency. Amsden also argues that income equality is a cause, not a result, of development, and she suggests that developmental states are more likely to arise where the objective prospects of development are greater. Predatory states, she continues, will be the rule where those prospects are dismal. Gustav Ranis argues, in "The Role of Governments and Markets: Comparative Development Experience," that the duration of interventionist import substitution industrialization policies has varied among three groups of countries, mostly as a result of different demands placed on the state within differing polities. In homogeneous East Asian societies, the state was only expected to facilitate social modernization. In socially heterogeneous Latin America, competing groups attempted to use the state to serve their particular interests, and the state became a vehicle to redistribute income and

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protect entrenched economic positions. An intermediate type is associated with Southeast Asia. Henry Bruton takes the position—unusual for a respected mainstream development economist—that economic openness is correlated with social, cultural, and political openness and that the latter are not unqualified "goods." In "International Aspects of the Role of G o v e r n m e n t in E c o n o m i c Development," he proposes that a developing society needs to find its own identity and that too much openness may interfere with this search. He advocates an unusual policy instrument, the undervalued exchange rate, as the least distorting way to protect the domestic economy while encouraging the efficiency-stimulating development of export industries. Gustav Papanek, in "The Effect of Government Intervention on Growth and Equity: Lessons from Southern Asia," presents the striking results of his comparative studies of five South Asian economies: India, Pakistan, Bangladesh, Sri Lanka, and Indonesia. His results suggest that periods of greater state intervention were associated with both slower economic growth and lower wages for the working poor. He explicates these results carefully, pointing out that the interventions in question protected the interests of monopoly enterprises and their elite labor forces at the expense of farmers and unorganized and informal-sector workers and that state intervention in the provision of rural infrastructure had favorable effects. The experience of these five countries also supports the Amsden and Bruton notion that government intervention to subsidize exports effectively and indirectly is an important ingredient in the attainment of economic success.

The Political Economy of Systemic and Policy Alternatives Mark Selden's "State, Cooperative, and Market: Reflections on Chinese Developmental Trajectories" considers the most important developing country to follow a state socialist path—China. Selden focuses primarily on the experience of the large majority of Chinese who are rural. He compares several competing visions of rural development in China, ranging from the democratic cooperation of the revolutionary base areas to the Maoist variant of Stalinism to Deng Xiaoping's mixed economy socialism, arguing that while the last system has clearly outperformed its Maoist precursor, elements of the democratic cooperation model remain attractive and potentially can be integrated with it. In "The Logic and Unfulfilled Promise of Privatization in Developing Countries," Thomas Biersteker attempts to separate the actual experience of privatization from the rhetoric advocating privatization. He finds that the experience has been mixed: privatization cannot guarantee a short-term increase in efficiency, and it carries long-term social costs. Some guidelines on when and how to privatize are offered. In "The State in the Initiation and Consolidation of Market-Oriented

INTRODUCTION

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5

Reform," Stephan Haggard and Robert Kaufman treat the political conditions for carrying out economic liberalization programs. They take up the difficult question of whether authoritarianism is necessary to shield the economically liberalizing state from the demands of opposing groups and conclude that while numerous Latin American experiences of the 1980s belie this assumption, at least in the short run, the long-term compatibility of democracy and economic liberalization in the Third World remains in question. There are both complementarities and oppositions of views in this collection. For example, Streeten and Nove oppose state minimalism, while Amsden sees the need for "getting prices wrong," contrary to neoclassical doctrine. Although Ranis treats such interventions as a stage to be outgrown, and Papanek finds interventions as a whole to have had negative effects, Bruton, Amsden, Ranis, and Papanek are united in recognizing the legitimacy of infant-industry protection and the desirability of export promotion. Bruton, however, advocates only selective openness and proposes an unusual policy tool—the undervalued exchange rate. Amsden's emphasis on shopfloor innovation and subsidies is both novel and provocative, as is her explanation of why subsidies work well in one case (e.g., Korea) and not in another (e.g., India). Selden challenges all of these views by voicing doubts that liberal policies have yet helped the poor of the developing world, finding some favorable outcomes in China, and suggesting that some of the negative aspects of that country's experience need not be considered intrinsic to a more flexible and democratic socialist path.

Notes 1. As Roman Frydman and Andrzej Rapaczynski recently put it: "We have . . . the makings of a genuine paradox which constitutes the most fundamental systemic obstacle to the economic transformation in Eastern Europe: The most important aspect of the transition to a spontaneously functioning market economy cannot be initiated by market forces themselves. Indeed, the only force powerful enough to set the market forces in motion is the very state which is supposed to remove itself from the economy." See Roman Frydman and Andrzej Rapaczynski, "Privatization and Corporate Governance in Eastern Europe: Can a Market Economy be Designed?" C. V. Starr Center for Applied Economics, N e w York University, Research Report No. 9 1 - 5 2 , September 1991. 2. The workshops were held on April 18-19, 1990, November 2, 1990, and April 9 - 1 0 , 1991. Many colleagues participated in addition to those who are represented as authors in this volume. We thank them for their contributions to the discussions, which aided us in composing this volume: April 1990: Enos Bukuku, Y i n g - m a o Kau, Robert Marsh, Daniel Schydlowsky, Nodari Simonia, Andrew Zimbalist, and Jonas Zoninsein. November 1990: David Becker, Fred Carstensen, Lina Fruzzetti, Morris Morris, Thomas Skidmore, Eric Thorbecke, Daniel Schydlowsky. April 1991: David Becker, James Boyce, Fred Carstensen, John Harris, Branco Milanovich, Vedat Milor, Morris Morris, Cathy Schneider, Michael Spagat.

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We also wish to take this occasion to express our gratitude for the very important help we received in conducting these workshops from Thomas Weiss, associate director of the Watson Institute, and from Julia Emlen, who copyedited the manuscript. Finally, we note the contribution of the late Howard R. Swearer, former president of Brown University and first director of the Watson Institute, under whose guidance this project was launched.

• Part 1 • Alternative Views of the Problem

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2m

Varieties of Policy in the Third World GORAN OHLIN

State and Market is a suggestive title. These days it will bring to mind the extraordinary reassessment of the fundamental principles underlying the organization of society that is going on in Eastern Europe and the Soviet Union, and it may seem like another way of referring to the old debate about planning versus capitalism. The impression that communism has suddenly vanished may be premature, for it seems reasonably certain that opposition to the social ills of society will again find nourishment in the socialist tradition. But the peculiar circumstances that linked Marxist theory with the collapse of the Russian empire and the rise of a world power pretending to change the world and failing in the end even to achieve its objectives at home are unlikely to be repeated. However, the role of the state has been under debate much longer than communism and ccntral planning. It has been a live issue in the Western world for centuries, and this was long reflected in the mainstream in economic history. The edicts of the state were the most obvious sources about earlier economic conditions. Heckscher, in his classic study of mercantilism, reproached Cunningham and others for their tendency to think that laws and regulations described the economic reality when, in fact, they often aimed at reforming a very different state of affairs. But for Heckscher, too, as for Adam Smith and Alfred Marshall, to mention only the two economists who had inspired him most, the relationship between the state and the market was at the heart of the matter, although the tenor of his work was distinctly liberal. Much like extreme marketeers in the East and West today, he saw little but folly and error in those ambitions of the state that characterized Western European nations from the Middle Ages until the deregulation of the late eighteenth and early nineteenth centuries. Others have been more impressed by the role of the state, and even Heckscher did not deny its importance as a provider of law and order, infrastructure and institutions, whether officially initiated or simply allowed

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to flourish. In answering such classic questions as why the French, who, under Colbert, had built the most advanced economy in Europe, were then surpassed by the English, the tendency has been to praise the greater economic freedom that allowed entrepreneurship to flourish in Britain. But when, toward the late nineteenth century, British industry was overtaken by a unified Germany, the tendency is rather to ascribe this success to the strong public engagement in training, in science and research, and in industrial promotion. Japan, both in the earlier post-Tokugawa period and in recent times, has provided another example of the role of the state and an alternative conception of the industrial society that intrigues all observers. These historical debates have been stimulating but inconclusive. Still, it seems at least possible to claim, especially after the self-confessed failure of central planning in the Soviet Union, that there is today a broad consensus about the mix of public and private activities that dynamic industrial societies will need and will develop. This consensus, however, does not extend to the question of the significance that political freedoms and democratic institutions have for economic growth. It is often confidently asserted these days that they go together, and many are inclined to see the collapse of communism and central planning as the confirmation that Frederich Hayek was right all along in his relentless and impassioned claim on behalf of political freedom as a condition for economic growth. Nonetheless, there are those who strongly argue that premature democracy would rule out the great transformation that is necessary to launch a traditional society onto a path of sustained growth. The historical evidence allows for many conflicting interpretations, partly because political freedom is not necessarily the same as multiparty democracy, let alone general suffrage. In an extreme view of democracy, European countries did not attain it until this century, when women got the vote, and Switzerland has not reached it yet. But this kind of discussion easily deflects one's attention from the question of what the mainsprings of growth and development really are. I do not think anybody disputes that technology is fundamental. We also know that technology in a broad sense has to include distribution and management. In this sense, it is obvious that the economic growth of the Western world has been a matter of technology and, more specifically, of ingenious ways of replacing human drudgery with more and more sophisticated ways of using other forms of energy. Lately, it has taken the form of new technologies for communication and information that have revolutionized the world economy by making financial flows even easier than before. Leaving this brief recapitulation of Western economic history and attempting a more horizontal panorama of the situations in other parts of the world, what do we find? One big question is why the developing countries do not simply try to do things the same way that richer countries do them. In all its naíveté, this question is not a bad way to start this discussion about the

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state and the market. The recipe is easy, but the difficulties seem to be very great. Why is this so? As long as the East-West conflict reigned, it was natural to assume a great divide between the countries that allied themselves with the Soviet Union and the others. And it is true that some of the countries taking their lead from the Soviet Union tried to adopt a system of government similar to that of Eastern countries, including central planning and state ownership of factors of production, generally with dismal results. But many other countries have not done much better, and it would obviously be a great mistake to see the developing countries in terms of a stark contrast between planning and liberalism, statism and market orientation. T h e interaction between historical forces and contemporary influences has produced a far more complex pattern. And it would also be a mistake to overlook the fact that the nature of "the state" is itself not self-evident— political instability is endemic in many developing countries, and one hears more and more talk about "the crisis of the state," especially in regard to Africa and Latin America. Military dictatorship, or for that matter, civilian dictatorship, is widespread. Is the state simply the state no matter who is in control of it? Of course not. So one should not expect any clear or simple answers to the question of the state and the market. What, in general terms, should one be looking for? For my part, I shall assume that the fundamental contribution of the state in the modernization and industrialization of a country is not the participation of the government in production or even the task of getting prices right or wrong by sophisticated manipulation of the instruments of economic policy. I am assuming that development requires pervasive changes in traditional ways of life, a radical break with the past, which is likely to be agonizing. The state has, in principle, the monopoly of coercive power, and it can play an important role in social and economic change. But that power can be used either to retard or to step up the transformation. Gunnar Myrdal, in his Asian Drama, complains of the diplomacy that made it so difficult in international organizations to speak the truth about the deficiencies of what he terms "the soft state" in Asia. What is perhaps even more remarkable is the extent to which most development economists until recently saw the political dimension of development as an international conflict between rich and poor countries and closed their eyes to the domestic political problems in developing countries. The World Bank and IMF, which influence the thinking about these matters very greatly, tried to reduce the problems to a technocratic dimension. For m y part, I shall only attempt a crude overview, and I shall begin with Latin America, which has been independent for more than a century and has an average per capita income at the level of Europe a few decades ago and many times higher than that in Asia or Africa. The aspect of the role of the state in Latin America that has been most sharply brought to the fore in recent years is the massive resistance that the

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state puts up against development at the same time that it promotes grand projects of all kinds. Hernando de Soto's incendiary book {El otro sendero) about the impossibility of conducting small business in Peru in a legal fashion in the face of innumerable and impossible requirements for licenses and permits put the spotlight on a phenomenon well known throughout the developing world—the crushing power of petty bureaucrats and the corruption that it engenders. Another code word for Latin America is oligarchy: the distribution of wealth and incomes is in most countries extraordinarily inequitable, and because the rich control the government and the masses have the votes, there is bound to be tension. Except for a few countries, such as Chile, inequality is staggering and inevitably dominates political life. Nonetheless, there has been an impressive return from military to civilian rule. In the countries in Africa that gained their independence some thirty years ago, new governments took on the roles, houses, and pretensions of the colonial rulers. The ethnic complexity of these countries imposes a great number of constraints on political life. Many governments aim primarily at the retention of central power and display an extreme ruthlessness and disregard for the welfare of the population. Economic conditions have been deteriorating for a long time in many countries. In the worst cases, capital flight and subsequent exile of skilled elements of the population are widespread, and people see no future for themselves or their children. There is a general feeling that a "second liberation," a profound political change, may be necessary in many countries if development is to succeed. The Middle East is the region where political concepts are more controversial than anywhere else, chiefly because the contending forces of Islamic fundamentalism and Arab nationalism only partly overlap and because there is little recognition of the legitimacy of the presently existing states. The dependence of the rest of the world on its oil resources creates a highly precarious situation, and the inequalities among and inside the countries of the region are explosive. Asia is too large for facile judgments, but in spite of the open wound of Cambodia, one can see a process of political maturity and stability in most countries. The great success of the small Asian NICs, and the example of Japan, which the Asian countries have largely followed, have shown that development can work and have indicated some of the guidelines: responsible macroeconomic policies and attention to human development—education, health, and welfare. Some of the biggest countries—India and China, for example—seem to have found their way to a precariously sustained growth path. This overview may have seemed disconcerting, but I think there are three rather positive developments more or less across the board. The first one relates specifically to the relationship between the state and the private sector. In most countries, governments have in the past picked up loss-making

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enterprises of the most diverse kinds, and in some cases they have even started them: hotels, breweries, tobacco companies, furniture factories. The present wave of privatization is not primarily ideological but more inspired by the need to get rid of loss-makers that government budgets can no longer afford to keep on board (this does not extend to natural resource companies, which are considered to be central to the national interest). The second point I wish to make is that in the areas of health and welfare there has been sustained progress throughout the world. This is very much recognized as a state responsibility, but there is also a tradition in the medical profession and a clear humanitarian objective that may have helped to reduce mortality and morbidity across the world even in the face of the economic setbacks of developing countries in the 1980s. The third thing to note is the impact of the new communications technologies on the globalization of the world community. The flow of ideas, funds, and people has been enormously facilitated. This affects the role of the state profoundly, essentially by weakening its power of coercion and imposing on it the need to create a national environment that attracts investment and offers hope for the future of its people.

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Against Minimalism PAUL P. STREETEN

If we call the doctrine that the "correct" prices and markets have an important role to play in allocating resources efficiently and equitably, in promoting free choices, and in decentralizing power pricism, and the doctrine that efficiency, equity, and liberty call for minimum state intervention state minimalism (or laissez-faire), 1 the currently prevailing view is that the two go together: get the government off our backs and let there be markets! The thesis of this chapter is the opposite: that for the proper working of markets, strong, and in many cases expanded, state intervention (of the right kind, in the right areas) is necessary. It is possible to favor a strong state with a limited agenda. It would confine itself to ensuring that individuals and the social groups in which they associate can pursue their own purposes with a minimum of frustration. This is not the thesis of this chapter, which argues for a strong state with an expanded agenda, though a different one, differently implemented, from that which the state has commonly adopted in many developing countries. The expression getting prices right has undergone a curious transformation. In the 1960s, it was intended to point to the calculation of correct shadow or accounting prices in the face of "distorted" market or actual prices. Because market prices reflected all sorts of "distortions," 2 including those caused by the existing and, from an ethical point of view, arbitrary income and asset distribution, it was the task of government to intervene and allocate resources according to the "correct" shadow prices. The purpose of government intervention was to correct the distortions caused by the free play of market forces. More recently, the recommendation has been reversed: developing countries should get rid of state interventions in order to permit market prices to reflect the correct opportunity costs and benefits. Distortions are now regarded as caused mainly (or only) by governments. A subsidiary thesis presented here is that many distinctions, important for an understanding of the role of markets and the state, have been blurred in the neoclassical resurgence. In this chapter, various theories of the state and

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their bearing on the relation between government and markets will be discussed, and a realistic one will be proposed. The need for a fuller discussion of managing the transition from the wrong to the right type of state intervention and for a normative political economy to complement the positive theory will be put forward. Finally, donor conditionality insisting on liberalization, deregulation, decentralization, and privatization will be discussed.

State Minimalism and Pricism The free, competitive market is a public good. My participation does not detract from yours, indeed it encourages yours. Like other public goods, it calls for public action to maintain it. When I worked with the Myrdal team on Asian Drama,3 we emphasized the need to use pricing policy rather than direct controls long before the current fashion for getting prices right had swept the profession. We thought it important for the government to organize markets so that they work efficiently, but we did not confuse price policy, measures to encourage competition, and the creation of previously absent markets with the unrestrained play of market forces. In the words of Michael Lipton, setting prices right is quite different from letting prices come right from state inaction. Contemporary discussions frequently confuse the question of how large the state should be in relation to total economic activity with the quite different questions of what policy instruments the state should employ and how they should be used. There are several ways in which government intervention can contribute to a better functioning of markets. Not only should government provide a legal framework and maintain law and order, including the enforcement of contracts, property rights, and so on, it must also encourage competition by antimonopoly and antirestrictive practices and legislation or by setting up competitive enterprises in the public sector. There is nothing in the nature of free markets that either establishes or maintains competition. Yet the virtue of markets depends on the existence of competition. In addition to guaranteeing competition, the government can intervene in the processes of price formation and production. It can encourage the introduction of markets for insurance—for example, by providing or by guaranteeing the insurance of bank deposits. It can tax activities it wishes to discourage—for example, pollution, traffic congestion, certain types of shortterm stock exchange speculation, or the consumption of cigarettes, drugs, or gasoline—and subsidize those it wishes to encourage—for example, the use of public transportation or programs in education and health. Government has a special role in promoting the development of human resources. Through agricultural extension services, it can improve the skills of farmers. By providing unemployment assistance, it can help workers to accept more readily new laborsaving technologies. By providing information

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and conducting research, it can help to reduce monopolistic practices. By investing in physical infrastructure (such as communications and roads to bring products to markets), it can provide the conditions for price incentives (such as devaluation) to work. By assisting in the design and strengthening of institutions (for information, credit, or marketing), it can contribute to the effectiveness of price policy. And so on. Most of these activities will be accepted by even quite extreme marketeers. The questions are whether a shift from present, admittedly often very inefficient, state activities to these can be achieved by a minimalist state and what the functions of the state should be, once markets are working. Perhaps the largest area of controversy is the state's involvement in social services and in changing the income distribution brought about by free markets. The neoliberals' view is that in any government's war on poverty, it is poverty that always wins. In the present context of the need f o r government action to strengthen both the allocative and the creative functions of markets, such involvement would have to be justified not on grounds of social justice or of human needs but on grounds of human capital formation and of reducing barriers to income-earning opportunities. 4 The proposition that pricism and state minimalism are incompatible is open to two interpretations. According to the strong interpretation, liberal markets require authoritarian regimes that prevent trade unions from pushing up wages, jeopardizing exports and foreign investment, and causing inflation and prevent special interest groups from grasping rents. "A courageous, ruthless and perhaps undemocratic government is required to ride roughshod over these newly created special interest groups," writes Deepak Lai. 5 This interpretation points to the East Asian economies (and perhaps Augusto Pinochet's Chile), cited as the great success stories. But it is questionable whether these regimes are truly liberal in the economic sphere. Their dirigisme is indeed market oriented. But if there is evidence of an invisible hand, it is surely guided by a strong, visible arm. According to the milder and more realistic interpretation, democracies and free markets can go together, although the ruthless efficiency of markets will then be tempered by the compassion of social provisions, as exemplified by the Scandinavian countries. 6 The current debate about the effects of the welfare state on incentives to work and save and on inflation is, of course, provoked by this experience. But for the present purpose, the focus is not on the s t a t e ' s welfare provisions but on its interventions in the areas of antimonopoly legislation, R&D, information, marketing, physical and social infrastructure, and human resource development, all of which are conditions for the efficient functioning of markets. The state minimalists are prone to argue asymmetrically. They have pointed out, correctly, that market failure is not automatically an argument for state intervention, for this may produce even worse results. But they forget that government or bureaucratic or state failure is not necessarily an

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argument for private markets, at least not until much more empirical evidence is produced that the outcomes of government action are necessarily worse than those of markets. Shapiro and Taylor have pointed to a peculiar asymmetry in these models, "whereby individuals coalesce to force a political redistribution, but do not do the same in the marketplace. The political arena is depicted full of lobbyists and cartel builders, while the economy is presented as being more or less subject to competition." 7 A related asymmetry is that rent seeking has been indicted almost exclusively as resulting from public action. 8 It is, however, equally common in the private sector. Private allocation of contracts to subcontractors gives rise to rents in exactly the same way as import quotas. Adam Smith recognized businessmen's "conspiracy against the public" and "contrivance to raise prices" and landlords' and others' love "to reap where they never sowed." We would expect these observations by the father of market economics to encourage us to develop strategies of state intervention to counteract these private rent-seeking activities. Instead, we are served today with two ideas: first, that rent seeking occurs only in the political process and, second, that the only way to reduce rent seeking is to limit government. Both are wrong, or at least unproven without considerably more empirical evidence. 9 Private and public action often have to go together. Prices have their impact on demand and supply only if complementary action is taken by the government. A factory may depend on a road, which is normally constructed by the government. Increases in agricultural output in response to higher prices may depend on irrigation or research into new varieties. The ability to make use of high-profit opportunities may depend on the availability of information about inputs and markets provided by the government. When the IMF recommended that Tanzania devalue its shilling, no attention was paid to the fact that the transport system had broken down, and however attractive the prices for farmers, their produce could not have been transported to the ports. In South Africa, the "black" taxi trade is often upheld as a splendid example of the spirit of free enterprise. And so it is, if we accept the absence of the need for an efficient and safe public transportation system for the blacks. But with roads full of potholes and without public safety regulations, the accident rate is one of the highest in the world. In Europe there is now talk of deregulating trucking. Now trucks are prohibited from picking up return loads and often have to return empty. After 1992, this regulation may be dropped. Two opposite tendencies will be at work. On the one hand, truck traffic may be reduced, because a given amount of traffic can be carried out by fewer journeys. On the other hand, the lower costs will make increasing road transport worthwhile. If the net outcome were to lead to more road traffic, safety and the health of the drivers would suffer, roads would be more congested, and underused railways would have further reduced loads.

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One example of the complementarity or symbiosis between public and private sectors is the "crowding-in" effect (in contrast to the normally assumed crowding-out effect, resulting from higher interest rates), according to which public investment, often in infrastructure, stimulates private investment. 10 The fact of crowding-in is now well established. The task of government is to raise the productivity of the investment in both public and private sectors. There are many other nonprice, nonmarket measures, such as research, information, or appropriate institutions, that the government must take in order to make the incentives of prices bite. It might be argued that while the combination of price and nonprice measures is best, to get prices right by itself is at least a step in the right direction. This is, however, not so. I have shown that the right prices by themselves, without the complementary public-sector action, can be ineffective or counterproductive. 11 Anyone who has tried to go on a diet has discovered that any low-calorie food tastes good only when combined with a high-calorie food. Strawberries are fine, but strawberries and cream are much better. Soda quenches the thirst, but whisky and soda cheers you up. A salad is all right for rabbits, but for human consumption it should be drenched in a nice oily dressing. The same is true for the need to combine private- and public-sector action. I leave it to the reader to decide which is the high- and which the low-calorie sector. Japan and South Korea are often cited as examples of successful privatepublic cooperation. It is sometimes said that the relation is supportive, not antagonistic. But looking more deeply into the nature of successful state interventions, we note that the state in Japan and South Korea, as Jagdish Bhagwati puts it, issues prescriptions rather than proscriptions. 12 They intervene by encouraging and promoting selected activities, not by prohibiting and restricting. Of course, to be able to get credit for only one type of investment implies being prevented from doing another. The distinction is not as clear-cut as it may seem. Japan uses government intervention to promote industrial productivity through export incentives, barriers to protect the domestic market, low-cost credit to selected investments, and policies that favor business and education. In addition, there are numerous more covert policies to favor companies that move into government-approved types of production, such as commercial intelligence services, nationalistic patent policies, and so on. The government practices an art—industrial policy—despised and condemned by most US economists who are minimalists. The South Korean public-sector Pohang Iron and Steel Company is one of the most efficient enterprises in the world, while the Steel Authority of India is a testimony to bureaucratic inefficiency. The Korean firm has financial autonomy, seeks to make profits, has clear objectives, has operating independence, and is open to potential competition from domestic rivals and imports. It is not burdened with multiple social objectives, and the incentive

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structure encourages it to export. The Indian Authority accepts losses and has confusing and multiple objectives. Its finances overlap with the budget, it is subject to close political scrutiny and interference, its prices are politicized, and it is protected from competition through tariffs, import licensing, and legal restrictions on domestic entry. The East Asian success stories, moreover, illustrate that the same type of intervention, such as subsidized interest rates, that in Latin America has impeded growth, has been used by these governments to accelerate growth. Corruption and its control also contribute to explaining differential performance. 13 It is now generally acknowledged that "getting prices right" has not been the principal recipe for the success of East Asian countries, although their government interventions have been "market friendly." Differences in the institutional arrangements of the relations between managers of public enterprises and the public authority are also important. Managers are given sufficient autonomy to get on with their jobs while remaining accountable to the public. With all the current talk about incorporating political variables in economic analysis and endogenizing political change, remarkably little work has been done on how specific political institutions function. In Europe, too, new forms of cooperation between local authorities, central government, and firms have been evolving. In the Third Italy and in Baden-Württemberg in Germany, methods of production called by some flexible specialization and by others diversified quality production have successfully combined markets, firms, local government, and central government regulation. Economists are trained in the study of the operation of economic forces within political, social, and moral constraints. 14 This approach has to be supplemented (and in some cases replaced) by the study of the operation and manipulation of political, social, and psychological forces within economic limits. More fundamentally, the distinction between economic and noneconomic variables may not be tenable if the aim is to understand society.

The Civil Society States and markets do not exhaust the players in this game. Frequently, although they need each other, they also weaken and undermine each other. States damage markets by regulations, licensing, and bureaucratic red tape. Markets tend to corrupt governments. Therefore, there is a need for the civil society that can contribute to more constructive relationships between the two. Private voluntary organizations have come to play an increasing role, next to governments and profit-seeking companies. They comprise the most

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diverse organizations: religious, political, professional, educational, and cooperative organizations; pressure groups, interest groups, and lobbies; institutions that are project oriented, give technical assistance, provide disaster relief, or are concerned with disaster prevention; and so on. Although they often claim to work without or even against governments, their contributions can sometimes best be mobilized by working jointly with governments. T h e most successful NGOs in the Third World, such as the SelfE m p l o y e d W o m e n ' s Organisation based in Ahmedabad, India, or the G r a m e e n Bank or B R A C of Bangladesh, depend for their operations on access to and support and replication by governments. Of course, in some situations their function is to criticize and exhort governments; or to fill gaps in government activities; or to do things at lower costs, with better results, and with more popular participation than governments. In other situations, when they promote their selfish interests irrespective of the wider interests of the community or when they reflect the dominant power of particular groups, government may be justified in trimming their influence. The relationship between NGOs and governments can be understood as one of cooperative conflict (or creative tension) in which the challenge of the voluntary agencies and their innovative activities can improve both government services and the working of markets and help to resolve tensions between them. In some situations, the state plays a passive role, only responding to the pressures of interest groups. The outcomes will then be determined by the power of these groups, which in turn depends on their size, age, motivation, and enforcement mechanisms. In other cases, the state is more active, imposing regulations and restrictions that can give rise to competitive rent seeking by private interest groups. In yet other situations, both the private groups and the state work together for common objectives. Functions are divided between the state and civil society. The institutions of civil society—churches, trade unions, interest groups, action groups, the media, and many others—are often quite undemocratic, and there is a need for the empowerment of weak and neglected groups such as women, the unemployed, and ethnic minorities within them. There can be undesirable concentration not only of political power but also of social power. Although in the early stages of development there is a need to strengthen both states and markets, in fact they often tend to weaken and undermine each other. It is the institutions of the civil society that can intervene and inhibit such weakening and undermining. 1 5 Interactions between the state, markets, and civil society are complex. A state that is both too weak and too strong can discourage the growth of civil society. And private organizations that are too strong can undermine the power of the state, as in Sri Lanka or in Lebanon, and lead to the dissolution of society.

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The Loss of Some Distinctions Some important distinctions drawn in the 1950s and earlier have been swamped by the neoclassical resurgence. There is the distinction between price policy, in which prices (including indirect taxes and subsidies) are used as instruments of policy, and laissez-faire, the free play of market forces without intervention to maintain competition; to supply an infrastructure, information, and research; to provide the formation of human capital; and to look after the victims of the competitive struggle. There is the distinction between markets and the private sector. Privatization of a public enterprise without the managerial and technical personnel, without competition, and without the provision of infrastructure and information can only raise false expectations, while markets can exist where public enterprises compete with each other or with private ones, as Renault in France has done so successfully or in the case of the previously mentioned Pohang Iron and Steel Company in South Korea. Motivations in the private and in the public sector are distinct. Of course, self-seeking occurs in the public sector as it does in the private. What is so absurd is to maintain that this is the only motivation to be found there. Each of us behaves differently in different settings: as buyers and sellers in markets, as citizens voting in elections; as supporters or critics of government policies, as moral agents when our conscience is aroused. Sometimes we exercise the option of exit, at others voice. To level these distinctions to a uniform selfishness is not helpful to understanding or policymaking. Even behavior in the market has been grossly oversimplified. All that it is necessary to assume for economic man is rationality in the sense of constancy and consistency of behavior. Selfishness can manifest itself in impulsiveness, inconsistency, inconstancy, and irrationality. On the other hand, the perfect model of the rational person is the disinterested trustee, who administers funds completely unselfishly on behalf of others. Finally, there is the distinction between centralized and decentralized government decisionmaking. Some of the criticisms made against a central bureaucracy do not apply to decentralized authorities (though others do apply), which can enhance participation, especially of small entrepreneurs and farmers, be more responsive to needs, gather more information, be more transparent and accountable, and improve the quality of government activities. They can also raise more resources, because the benefits are more visible. On the other hand, decentralized control can reinforce local power elites, which are less responsive to the needs of the poor than central groups. Decentralization can also aggravate interregional disparities. The task is to design a structure of decisionmaking that combines the informational and motivational merits of decentralization and participation with central control.

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The Unimportance of the Private-Public Distinction Going one step further, it can be doubted whether the very distinction between private and public ownership or management is relevant. Much discussion is conducted in binary terms: central planning versus free markets. Sometimes a spectrum between these two poles is considered, but the ideological values attached vary with the position on this spectrum—for example, Soviet-type planning is bad; therefore, the nearer we are to free markets the better. But it is possible to add dimensions to the linear spectrum that render the value choices more complex. A regime combining certain features of central intervention with others of a free market may avoid the failures of the two poles and be preferable to either extreme. Hybrid institutions that encourage initiative and enterprise and are subject to covering their costs, but are at the same time accountable to the public, can harness the best of both sectors. An example is the British C o m m o n w e a l t h Development Corporation, run autonomously on commercial lines in the sense that it has to cover its costs and its board consists of bankers and industrialists. It draws its funds mainly from the Exchequer, and its objective is to maximize development, not profits. It not only lends funds but also manages firms and projects. At the same time, it trains local counterparts and hands over control, management, and ownership as soon as the local people are ready. As a result, it is cited by Conservatives as a model of efficient private enterprise and by Socialists as a model of public enterprise. The absence of more such organizations testifies to the poverty of our institutional imagination. There is also a large third sector, neither private nor public, that consists of nongovernmental nonprofit organizations that draws on the voluntary energies of its members. Churches, colleges, universities, Oxfam, Bread for the World, orchestras, hospitals, museums, the Red Cross, Friends of the Earth, Amnesty International, charities, cooperatives, the Grameen Bank, neighborhood organizations, local action committees, and many others draw on people's voluntary efforts and contribute often highly efficiently not only to the gross national product but to a flourishing civil society, essential for a democracy. Some libertarians (such as Mrs. Thatcher) are eager to destroy this civil society, while reformers in societies in which it has been destroyed (such as Mr. Gorbachev) are trying to build it up. But here again, as in the case of the complementarity of private and public activities, the strength of the civil society and of NGOs in particular often lies not in opposing the public sector but in cooperating with it, whether for finance or for replication of successful ventures or for support in opposing exploitative local power elites. In other circumstances, for example, when faced with a predatory state, their function is to combat it. When I taught at the Oxford Business Summer School many years ago, I came across a truly self-made tycoon. He was a refugee from Europe who had started penniless and had amassed a fortune, some of which he donated to the

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Oxford Centre for Management Studies. In the common room after his talk, he told us that the important distinction in business is that between what he called "the institutions" and "private enterprise." By the institutions he meant the large firms, whether privately owned and managed or in the public sector. Private enterprise stood for the small firm, owned and run by the head of a family and a few employees. The principles of running a large private sector company and a public enterprise are indeed very similar. The spirit of truly free enterprise is best exemplified in the small enterprises of the informal sector. To bracket these with the large corporations under the heading private enterprise can be very misleading.

Theories of the State We now have a menu of theories of the state to choose from. According to the one I was taught when an undergraduate, an idealistic, competent, and well-informed government, like Platonic guardians or Fabian bureaucrats, reigns above the interest conflicts and promotes the common good. It is implicit in the writings of A. C. Pigou, Abba Lerner, Jan Tinbergen, and James Meade. According to this old romantic theory, the government can do no wrong. The opposite theory, represented by the new classical Chicago economists, neoclassical political economy, and the public choice school (better named the self-interest school), holds that the government can do no right. Citizens, politicians, bureaucrats, and states use the authority of government to distort economic transactions for their benefit. Citizens use political influence and pressures to get access to benefits allocated by government, politicians use government resources to increase their hold on power, public officials trade access to government benefits for personal reward, and states use their power to get access to the property of citizens. 16 The result is an inefficient and inequitable allocation of resources, general impoverishment, and reduced freedom. A narrow interpretation of selfish political man (and woman) pursuing ruthlessly his (her) interests can lead to mutual impoverishment. According to one version, the predatory officials and bureaucrats or politicians promote actively their selfish quest for money or power; according to another, they respond passively to powerful pressure groups in order to stay in power. "The model of government motivations" has been simplified "into a single-track form, supplying the public sector with a brain transplant straight out of the marketplace." 17 Any intervention by this "predatory state" with the "magic of the market place" is bound to make matters worse. Government action is not the solution (as it is in the first theory), it is the problem—"invisible feet [of rent seeking] stomping on invisible hands." 1 8 As has been said, while according to the Platonic theory, government intervenes to correct distortions, according to the public choice theory, all distortions are due to

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government interventions. But for both of these apparently opposite views, the state is an optimizing agency: in the Platonic view, promoting the welfare of the people as a whole; in the public choice view, advancing the welfare of special interest groups—those on whose support the politicians rely, such as the bureaucrats, the army, the politicians themselves. The Platonic view is normative (or naive); the public choice view crudely cynical. Even if it were true that politicians, bureaucrats, and interest groups always pursue only their self-interest, this is open to different interpretations. Some of these may be in conflict with one another and with the interests of others; others may be in harmony. There may, for instance, be a conflict between smaller present and larger future gains; or between "hot," impulsive, and "cool" deliberated interests; or between concentrated smaller and more widely dispersed larger gains; or between certain smaller and uncertain larger gains; or, perhaps as important as interest conflicts between groups, the conflict between perceived smaller and actual but unperceived larger gains. A third theory, propounded by Anthony Downs, holds that politicians maximize their own welfare by selling policies for votes. 19 Because not many (though a growing number of) developing countries are democracies, this theory would not have wide application among them, even if it applied to democracies. Then there are social contract theories from Hobbes, Locke, and Rousseau to John Rawls and Mancur Olson that suggest that citizens surrender some of their rights or liberties in return for protection against aggression, provision of collective goods, benefits from externalities, and other services from the state. 20 A limited sacrifice of individual autonomy— by increasing the prospects of avoiding related ills such as prisoners' dilemmas, the isolation paradox, the free rider (and, worse, the sucker) outcome, and the tragedy of the commons—gives each citizen greater freedom and more benefits. The undersupply of public goods and the oversupply of public bads can be avoided by some enforced action by the central government. Marxist theory says that the government is the executive committee of the ruling class and always serves the economic interest of that class. But this is open to different interpretations. Some Marxists regard the state as acting in the interest of international, metropolitan capital, extracting surpluses from the periphery for the benefit of the center. This is the view of neo-Marxist dependency theorists and was Marx's view of the relation of Ireland to England. 21 Others regard the state as acting in the interest of an indigenous capitalist class, sometimes against the interest of the capitalists at the center. According to both these views, the state acts in the interest of a ruling class. A more sophisticated version of this theory holds that it is the function of the state to reconcile differences of interest within the ruling class to maintain its power and the capitalist mode of production. According to this version, it is possible for the government to impose measures in the

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interest of the exploited workers and small peasants in spite of the loss of profit that this involves if these measures save the system from revolt or revolution. It can also be that higher wages or a land redistribution, while reducing the profits of particular groups, raises total savings and/or lowers capital-output ratios to increase the volume of the total surplus, although not the ratio of surplus to GNP. Others again regard the state as the agent of a "state class" or a bureaucracy. Paleo-Marxists like Bill Warren hold that peripheral capitalism is a progressive, revolutionary force, making for productivity growth and economic progress. 2 2 They make Dudley Seers's remark about the convergence of "Marxism and other neoclassical doctrines" comprehensible. 23 And it is ironic that both neoclassical political economy and Marxism, two largely noncommunicating groups, conclude that thinking and research about government policy for poverty reduction or income redistribution are futile. According to both, the predatory state inevitably acts in its own interest and that of powerful pressure groups; there is no place for disinterested, benign, altruistic government policies; only the forces of the free market are capable of advancing the society. It is worth remembering in the debate over market versus state that real states fall under neither extreme; dogmatism here leads to error even more than usual. A more commonsensical view, borne out by overwhelming evidence, holds that many governments are neither monolithic nor impervious to pressures for rational and altruistic policies. Moreover, if there is scope for a positive-sum game (as there is bound to be in the reversal of rent-seeking movements away from the Pareto frontier) and if the government can hold on long enough to tax the sum, the possibility of rational policies is opened up even on the public choice school's narrow assumption about predaceousness. The structure of government decisionmaking consists of many departments, ministries, and agencies, and many layers from central government through provinces (or states in a federation) to village or town councils. 24 Power in some countries is divided between the legislature, the judiciary, and the executive. Each of these pulls in a different direction. The obstacle to "correct" policymaking is neither solely stupidity nor solely cupidity, neither just ignorance nor simply political constraints or monolithic selfishness. On occasion, governments, like charitable foundations, universities, or voluntary associations, do act disinterestedly and in the public interest, particularly, but not only, if there are pressure groups behind them. It is these pressure groups with some power or influence that constitute the "trustees for the poor" and the "guardians of rationality." 25 Count Oxenstierna may not have had the whole explanation, but knavery has no monopoly either. 26 At the same time, there are areas in which a better analysis and a clearer sense of direction would help, just as there are areas where it is fairly clear

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what should be done, but vested interests, whether those of the policymakers or of pressure groups on whose support they depend, prevent it from happening. Governments sometimes create rents and encourage rent seeking; at other times they destroy rents and reduce wasteful competition in their pursuit. The private sector also creates and seeks rents. Some government officials act sometimes in their selfish interest; the same ones and others are, or want to be seen as, at other times moral agents, acting in the common interest. Some pressure groups, individual or collective, domestic or foreign, are motivated by reason, humanitarianism, and morality. According to this commonsensical theory, for which there is overwhelming evidence, the state does not optimize anything. It compromises, attempts to resolve conflicts, manages bargaining between groups, and occasionally leads. Gunnar Myrdal's notion of the "soft state," in which declared policies are not implemented or not enforced, fits into this picture. But so does that of the hard state, which pursues successfully both growth and equity.

An Alternative Window Some of the neoclassical theories regard the private sector as the source of wealth creation and the public sector as the domain of authority, exercised either benevolently or as a wasteful drain on resources. The distinguishing features of the state, according to this view, are that its membership is universal and that it has powers of compulsion not given to other o r g a n i z a t i o n s . 2 7 According to some adherents of this view, many governments in developing countries have usurped the sphere of production, which should be left to the private sector. The remedy lies in the state withdrawing from this area and confining itself to the protection of its citizens against external and domestic threats. But it is equally possible to look at the same situation in a different way, with a different division of responsibilities. We may regard each sector, or better each sphere of responsibility, as creating different forms of wealth and exercising different forms of authority and compulsion. According to this view, the private sector creates forms of wealth that can be sold for profit, the public sector those that, although also useful, cannot, because powerful externalities and inappropriabilities exist. Public goods are characterized by nonrivalrous consumption, so that one person's use does not detract from another's, and occasionally, though not always, by nonexcludability from the benefits whose costs are incurred by some. The classic example, given by John Stuart Mill, is a lighthouse (its construction, however, can be subcontracted to private firms, and it benefits not all sailors but only ships in the region). Armed protection, monetary and employment stability, an efficient market, the administration of justice, and mass education are other examples of public goods, or rather public services. Certain types of

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infrastructure, such as underused roads, bridges, and subways, or harbors, dams, and irrigation, are nonrivalrous but nonexcludable, because the provider can charge tolls or fees and exclude nonpayers. But this means excluding some people whose benefits would exceed the costs of supplying them. When price discrimination is impossible, the alternative is for the government to provide these goods and services free and finance them by taxation. Not all public goods should be produced, provided, or financed by the central government. Some can be supplied by local government or by cooperatives, clubs, or other interested private parties, such as a group of farmers who jointly provide common control over common grazing rights. On the other hand, there are reasons for public-sector production in addition to the public nature of goods, including natural monopolies, if their regulation is less efficient, and merit goods, to which a high value is attached by the community, but which are beyond the means of those who need them. 28 Or goods and services, such as the arts or museums or theaters, that are regarded as important but would not exist if they had to rely on private finance. (There are also merit bads, or demerit goods, such as dangerous drugs, tobacco, alcohol, and weapons, whose production or sale the government may wish to restrict.) Production of different things can therefore occur in both the public and the private sectors. The same is true for authority. The private sector exercises authority through work discipline (and hiring and firing, giving and withholding payments), the public sector through the army and the police. And the authority of the state depends on widespread voluntary acceptance by the citizens. A worker can, of course, leave the firm and go to another, but citizens in many countries can also leave and move to another country. States are also constrained by both supemational bodies, such as the European Community, and subnational bodies, such as provinces and municipalities. The question whether the private and the public sector use their authority to the benefit of the public or wastefully or exploitatively remains to be answered. Such shifts between the two perceptions give rise, however, to very different evaluations. They reflect different ideologies, different ways of organizing, filing, and evaluating the same observations. The role of profit, of moral and aesthetic considerations, and of the use of force will appear quite different according to which of these two perspectives one accepts. Rhetoric and Practice The academic and political rhetoric about the virtues of the market and the vices of the state is far removed from the actual behavior of libertarian governments that profess to follow this rhetoric. Although both the Reagan and the Thatcher administrations decried the role of the state, public expenditure relative to GNP increased under both leaders. In 1990 the public sector in the United States spent 43 percent of the national income. It was 40 percent in 1980 and 38 percent in 1970. This represents an increase of more

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than 13 percent over twenty years and was the result of growing expenditure on defense, on state and social security, on R&D, and, above all, on growing interest payments on the rising public debt in an economy without a sense of direction. These expenditures, and particularly those on research, reflect three powerful collective sentiments to which libertarians just as much as interventionists succumb: collective fear (defense and, more recently, environmental protection), collective greed (the desire to be competitive in international trade that leads to subsidies, such as those to Sematech, the Pentagon-aided corporation consortium for improving the manufacture of semiconductors), and collective pride (the desire for international prestige reflected in the award of Nobel Prizes). There are two important yet neglected areas in this debate. One is concerned with the problems of the transition from excessively interventionist to more market-oriented policies; the other is normative political economy. Problems of the Transition Much of the writing on economic transitions is concerned with state intervention—how much, what kind, and by what means?—but largely neglects the important question of how to manage the transition from excessive to reduced state intervention; from interventions in the wrong areas to those in previously neglected important ones; and from one form (say reliance on quantitative controls) to another (reliance on prices as instruments of policy). This is a problem with which many countries, not only in Eastern Europe, are faced today and for whose solution guidelines are needed. If, for example, reducing public sector employment is implemented by not replacing people who leave, the best will tend to leave and only the deadwood remain. If salaries in the public sector are kept too low, demoralization and added temptation to corruption and the search for additional outside jobs are created. What Robert Klitgaard calls incentive myopia can be more damaging than an overstaffed public sector. 2 9 If staff are just sacked without the provision of alternative jobs, unemployment and poverty are created or the burden of maintenance is thrown on others. The examples of Sri Lanka and China have shown that liberalization that raises output and average incomes has been combined with rising infant mortality rates and falling life expectancy. It may be that demobilization—the change from a war to a peacetime economy—has lessons to teach. In many respects the experience of the British economy in both mobilization for the war and demobilization after it has been wrongly transferred to developing countries. But some aspects of it may be relevant. More transitional intervention may be needed in order to reduce or change the form of past intervention. Neoclassical Political Economy I have already mentioned the two basic ideas of neoclassical political economy: that rent seeking is an exclusively political phenomenon (and does

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not occur in the private sector) and that the only way to reduce rent seeking is to limit government action. There are several criticisms that can be made of this position. First, as already pointed out by Adam Smith, rent seeking is just as common in the private sector, and government action may then be necessary to reduce or eliminate it. Antimonopoly and anticartel legislation, import liberalization, and the creation of competing public enterprises are examples. Second, as Jagdish Bhagwati has shown, in a situation where there are already many rent-seeking activities, the creation of additional rent-seeking opportunities by government intervention can be productive. 3 0 The alternative use of these resources might be even more damaging. It is an application of the theory of the second best. The creation of new rents can reduce or altogether destroy existing rents and existing competitive rentseeking activities, both in the public and in the private sectors. Third, as Michael Lipton has argued, it is odd that the objection is not to the creation of rents (and thereby to reducing the share available for wages and profits, and with it the creation of incentives to generate surpluses) but to the creation of rents in forms that give rise to competitive rent seeking. Efforts and resources are diverted from productive to nonproductive activities, for example, to acquiring an import license. Had the import license been handed to the brother of the bureaucrat, or had it been sold corruptly to a merchant and had no competition for it occurred, there would have been no social cost according to this theory. The theory does not seem to envisage any social gains (compared with the nepotistic or corrupt rewards) from the fact that the rents are competed for rather than monopolized. In fact, the social costs of rent seeking seem to arise only from competition for them, whereas corruption and nepotism appear to involve none! Fourth, the theory assumes that if rent seeking were to end, all resources diverted to rent seeking from productive activities could be returned to those activities. 31 It is quite obscure what these resources, released from lobbying and logrolling, are, how they can be transferred to productive activities, what the costs of transfer might be, and how their productivity might be affected by the transfer. Mrinal Datta-Chaudhuri has argued: "Perhaps more important than the resource cost of rent seeking are the effects of the policy environment on the perception of economic agents. In such an environment, producers tend to become obsessed with the short-run gains associated with cornering the licenses at the cost of the long-run benefits connected with technological and managerial improvements." 32 But are the same people capable of pursuing these alternative activities? Fifth, Michael Lipton also points out that the theory ignores the likelihood of rent-avoiding transactions (black or parallel markets, smuggling; abbreviated by Lipton to RATS) as a response to rentseeking opportunities. Such substitution is normally assumed in

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neoclassical economics but appears to be excluded here. According to neoclassical political economy, invisible feet stomp on the beautiful work of the invisible hand. But smuggling is one way in which the invisible hand can defeat, or at least reduce, the destructive efforts of rent-creating and rent-competition-creating invisible feet. Of course, illegal markets are wasteful compared with open and free trade. But they may be regarded as less wasteful than distorted, regulated, and restricted markets without these outlets. The case for state minimalism is, of course, not based solely on rent seeking. It is widely believed that in most developing countries the public sector and public expenditure are "overextended," hampering economic growth. The evidence does not confirm this. A recent econometric study, based on more than one hundred time-series and cross-country regressions, shows that government size and public expenditure are positively associated with economic growth, especially for developing countries. 3 3 Obviously, there is enormous scope for more efficient reallocation and restructuring of public expenditure, in particular to make it complementary to private expenditure and to fill gaps. But there is no evidence that the state is overextended.

Normative Political Economy Many of the recent criticisms of governments and states by the state minimalists, the neoclassical political economists, the theorists of rent seeking and of directly unproductive profit-seeking activities, and the theorists of public choice have been concerned with explaining why and how inefficiency, inequity, and deprivation of freedom arose; and with the positive political economy, largely of government failures. They have been useful in explaining bad policies and the absence of reforms and have thrown light on such regimes as those of Amin, the Duvaliers, Marcos, Somoza, Tmjillo, and Mobutu. But in explaining the evils of predatory governments and by advocating free markets they have once again reasoned the state away and reestablished the division between economics and politics. The task of integrating the two would consist in showing how the government and pressures on it can be used for the objectives of development. This would also help to explain the successes of development from Japan to South Korea, Botswana to Costa Rica. Much less interest has been shown in this normative aspect of the subject. It is true, James Buchanan, one of the founders of the public choice school, has indeed written on the processes by which efficiency is achieved and on voluntary contracts, institutions, decision rules, and constitution making as guides to reform. 3 4 But there has been little interest in how to build up political pressures against the pressures for the destructive policies so well analyzed by him and his disciples.

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Sometimes authors from different schools attribute poor policies to "lack of political will." But it is futile (or tautological) to say that the political will is lacking. It is an expression that should be banned from political discourse. One does not have to be a behaviorist to think that behavior is the manifestation of will. If the will to action is lacking, there is no point in asking for the will to have the will to action. This only leads to an infinite regress or to the charge of hypocrisy. It is a case of ignotum per ignotius. Political will itself should be subjected to analysis and, for purposes of action, to pressures and to mobilization. It is more fruitful to think of how to create a political base for efficiency, equity, and liberty; how to create pressure groups; how to mobilize the poor; how to shape reformist alliances; how to recruit coalitions for progress; how to strike bargains, achieve c o m p r o m i s e s , f o r g e c o m p a c t s , r e s o l v e c o n f l i c t s , o r p e r m i t their tolerance; how to use persuasion; when to offer compensation to losers when total gains exceed total losses, and so on. Amartya Sen has used the expression "cooperative conflict" for the relations within a family. 3 5 Similar relations exist both within the state and between it and outside pressure groups. It might be thought that if such a normative theory had to be built on pure self-interest, no research would be needed, for people are very good at discovering and pursuing their interests. But we know from parables such as those of the prisoners' dilemma, the isolation paradox, the tragedy of the commons, social traps, and the free rider, that the pursuit of self-interest can be mutually destructive and that there are ways of cooperation, apparent sacrifice, and coercion that advance it. Moreover, there is no need to stick to the assumption of self-interested bureaucrats and politicians. Mobilizing the guardians for the poor and the trustees of rationality to put pressure on governments can produce good results even if governments were correctly analyzed by the public choice school. Governments can themselves initiate reforms. In analyzing the sources of pressures on governments for reform directed at improving the lot of poor people, for example, six areas, about each of which I have attempted to say something in another paper, 3 6 are worth exploring: 1. Common or shared interests between rich and poor 2. Mutual interests and bargains between rich and poor, including the payment of compensation 3. Interest conflicts within the ruling groups that can result in benefits for the poor 4. Empowerment of the poor and participatory forms of organization 5. Organization of distinct "trustees for the poor" and "guardians of rationality" 6. International pressures and support

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Donor Conditionality, Pricism, and State Minimalism Structural adjustment loans have been given by the World Bank on the condition that recipients liberalize, decentralize, privatize, and deregulate. Pricism and market orientation have been combined with state minimalism, both in domestic and foreign policies. The change from exclusive project lending to program lending with its macropolicy conditionality is the result of projects having gone sour because of the wrong macroeconomic policies. Policy conditionality was further supported by the belief that it would support like-minded domestic political coalitions in recipient countries. Apart from the (superficial) double paradox that foreign donors are in a better position to know what is in the country's best interest and that the country does not have to pay a fee for accepting this good advice but gets rewarded with extra funds, there are five problems with this type of conditionality. 37 First, adjustment aid to mostly Latin American and Southeast Asian debtor countries is aid not to the countries but to the banks in the United States and other advanced countries, if the creditors are private banks and the alternative is default. This, of course, may have contributed to the conversion of the multilateral banks and a Republican US administration to program lending. Second, policies like projects are substitutable and avoidable. The donor imposes a condition that is met, but other policies circumvent the intended result of the condition. This is the macroeconomic equivalent of fungibility, which was regarded as an objection to project aid. For example, the donor imposes as a condition devaluation, but subsequent inflation renders it nugatory. This happened in several African countries. Third, donors' embrace of political groups advocating "correct" policies can be the kiss of death. An example was the pressure on India for devaluation in 1966. 38 It may be wiser to refrain from seeking such allies and to encourage correct policies by quietly signaling approval through the unconditional support of good governments. Fourth, in view of our ignorance of the impact of these conditions, both in the transition period and ultimately, the premature crystallization of flawed orthodoxies should be avoided. The neoclassical doctrines are not scientific truths, and the ability of governments to implement them, even if they were such truths and even if the governments were willing, is often in doubt. Fifth, our confidence in the ability of the developing countries to implement the required macroeconomic policy reforms has declined. In light of this, at least as m u c h attention should be paid to project design and implementation, to institution and capacity building, and to human rights in the aid dialogue as has been given to macropolicies.

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Conclusion T h e theoretical case for free, unregulated markets depends on many conditions that rarely exist in reality. Adam Smith is often cited as the authority for advocating laissez-faire. Amartya Sen wrote: "Shakespeare did not say it, but it is true that s o m e men are b o m small, some achieve smallness, and s o m e h a v e s m a l l n e s s thrust u p o n t h e m . A d a m Smith, the father of m o d e m e c o n o m i c s , has had to c o p e with a good deal of such thrusting." 3 9 A d a m Smith defended particular liberties, not liberty in general, and he objected to particular g o v e r n m e n t interventions (especially in foreign trade), not to g o v e r n m e n t intervention in general. One p e r s o n ' s " f r e e d o m f r o m " and " f r e e d o m to" implies restrictions on other people's freedom. A d a m S m i t h thought that the state should undertake three m a i n tasks: d e f e n d i n g its citizens f r o m the "violence and invasion of other independent societies"; p r o t e c t i n g e v e r y m e m b e r of society f r o m the " i n j u s t i c e o r oppression of every other m e m b e r of it"; and "providing certain public works and certain public institutions, which it can never be for the interest of any individual, or small n u m b e r of individuals, to erect and maintain." A d a m S m i t h also d i s c u s s e d e x t e n s i v e l y the i m p o r t a n c e of social i n t e r d e p e n d e n c e and the c o m m u n a l a d v a n t a g e s of f o l l o w i n g " r u l e s of conduct," even when they go against what he called "self-love." 4 0 This chapter is entirely in the spirit of Adam Smith. Collective defense and the administration of justice are generally agreed upon public goods. The provision of certain public works and certain public institutions permits a wide range of public interventions. Infrastructure, public education, and help for the p o o r were certainly in Adam S m i t h ' s mind. A r g u m e n t s f r o m free riders and externalities are used today to justify them. M o d e m theory and events have added other justifications for state intervention. The theory of the second best has s h o w n that if one price is not competitive, intervention with all other competitively determined prices is justified. T h e world of small producers has given place to one of large corporations and trade unions. M o d e m industry has polluted the environment. At the same time, A d a m Smith saw that market failure is not necessarily an argument for government intervention. T h e r e are, it is h a r d l y n e c e s s a r y to say n o w a d a y s , also g o v e r n m e n t failures. But equally, though less widely noticed, g o v e r n m e n t failure is not n e c e s s a r i l y a n a r g u m e n t for the market. Only p r a g m a t i c experiments can show w h e n and where intervention is the lesser evil or the nth best in this least bad of all feasible worlds. P e r h a p s the m o s t serious problems arise not from market failure but f r o m market success. If it were just a matter of correcting failures, the task would be relatively easy. But if the signals propagated by the market are based on a very u n e q u a l distribution of assets and income, it is market success in responding to these signals that causes the trouble. Amartya Sen has analyzed f a m i n e s and shown that often total food supply was adequate, but that the purchasing p o w e r (or, more generally, the entitlements) of the

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poor had declined. In those conditions the market is all too successful while the people starve. Similarly, it is not government failure but government success (in pursuing the objectives of its officials) that produces the destructive results rightly deplored by the state minimalists. What is needed then is fundamental structural change, a redistribution of assets and power.

Notes I am grateful to Professor Louis Putterman for helpful c o m m e n t s on this chapter. 1. The terms are from Michael Lipton. 2. The widely used notion of price "distortions" is not as clear as it may s e e m . Distortion is the d e v i a t i o n of the actual f r o m s o m e natural, p r o p e r , legitimate norm. But there is no reason to believe that prices determined in free markets under laissez-faire reflect such a norm. Any one of an infinite number of income distributions would produce a different set of relative prices. Free-market p r i c e s a l s o r e f l e c t m o n o p o l y p o w e r and d o not r e f l e c t e x t e r n a l i t i e s in c o n s u m p t i o n (such as my wearing a tie only because you wear o n e ) or in production (such as pollution). In conditions of widespread u n e m p l o y m e n t and underemployment, w a g e rates do not reflect the opportunity cost of labor. In an e c o n o m y already " d i s t o r t e d , " an additional distortion may m o v e it toward an i m p r o v e m e n t . F o r r e a s o n s s u c h as t h e s e , the n o t i o n that g o v e r n m e n t interventions " d i s t o r t " an o t h e r w i s e correct set of signals and incentives is highly misleading. In the presence of such "private distortions," the addition of "public distortions" can be a beneficial corrective. 3. G u n n a r M y r d a l , Asian Drama: An Inquiry into the Poverty of Nations (Harmondsworth, England: Pelican Books, 1968). 4. Adam Smith is often quoted in support of state minimalist doctrines. His views on education and other public goods are more complex than his latter-day disciples claim. 5. D e e p a k Lai, The Poverty of Development Economics (Cambridge, Mass.: Harvard University Press, 1985): 33. See also Robert Wade, Governing the Market (Princeton, N.J.: Princeton University Press, 1990). L a n c e T a y l o r distinguishes between the four possible combinations of weak/strong states and c o m p e t i t i v e / c a r t e l i z e d or r i g g e d m a r k e t s . T h e w e a k state c o m b i n e d with competitive markets is J a m e s B u c h a n a n ' s heaven. T h e strong state c o m b i n e d with atomistic markets is D e e p a k L a i ' s heaven. The weak state c o m b i n e d with monopolistic markets is M a n c u r O l s o n ' s hell. And the strong state c o m b i n e d with monopolistic markets is Douglass N o r t h ' s hell. 6. C o n t r a s t e d with L a n c e T a y l o r ' s h e a v e n s a n d hells, this m i g h t be considered earth, or the real world. 7. Helen Shapiro and L a n c e Taylor, "The State and Industrial Strategy," World Development 18, no. 6 (1990): 867. There are s o m e exceptions, such as Deepak Lai, quoted previously, and Mancur Olson. Another asymmetry has been identified by Shapiro and Taylor. While it is pointed out that bureaucrats have no special talent for running an e c o n o m y , they are called upon to do so in the authoritarian state that dismantles the controls. 8. S e e A n n e O. K r u e g e r , " T h e Political E c o n o m y of the R e n t - S e e k i n g Society," American Economic Review 64 (June 1974): 2 9 1 - 3 0 3 . 9. For additional criticisms of the theory of rent seeking, see the later section on neoclassical political economy.

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10. V a r i o u s authors h a v e estimated these crowding-in coefficients to lie between o n e and two. See Mario Blejer and Mohsin Khan, "Government Policy and Private Investment in Developing Countries," IMF Staff Papers 31 (1984): 3 7 9 - 4 0 3 ; S u k h a m o y Chakravarti, Development Planning: The Indian Experience (Oxford: Clarendon Press, 1987); Guillermo Ortiz and Carlos Noriega, Investment and Growth in Latin America (Washington, D.C.: International Monetary Fund, 1988); R o b e r t B a r r o , " A C r o s s - C o u n t r y S t u d y of G r o w t h , S a v i n g a n d G o v e r n m e n t , " N B E R W o r k i n g Paper N o . 2885 (Cambridge, Mass.: National Bureau of Economic Research, 1989). 11. Paul J. Streeten, What Price Food? (Basingstoke: Macmillan, 1987; Ithaca, N.Y.: Cornell University Press, 1987). 12. Jagdish Bhagwati, Protectionism (Cambridge, Mass.: MIT Press, 1988): 98. 13. See M y r d a l , Asian Drama, vol. 2, part 4, chap. 20; and Robert Klitgaard, Controlling Corruption (Berkeley: University of California Press, 1988). 14. A recent book, w h o s e contributors are mainly political scientists and historians, is John D u n n ' s The Economic Limits to Modern Politics (Cambridge: C a m b r i d g e University Press, 1990). But this is not quite the needed companion volume to the political limits to modern economics. 15. M i c h a e l L i p t o n , " T h e S t a t e - M a r k e t D i l e m m a , Civil Society, and Structural A d j u s t m e n t , " Round Table 317 (1991): 2 1 - 3 1 . 16. Merilee S. G r i n d l e and John W . Thomas, Public Choices and Policy Change: The Political Economy of Reform in Developing Countries (Baltimore: Johns Hopkins University Press, 1991). 17. John P. Lewis, " G o v e r n m e n t and National E c o n o m i c Development," in Francis X. Sutton (ed.), A World to Make: Development in Perspective (New Brunswick, N.J.: Transaction Publishers, 1990): 77. It should be noted that even in the marketplace, individuals do not always behave selfishly. 18. David C o l a n d e r (ed.), Neoclassical Political Economy (Cambridge, Mass.: Ballinger, 1985). 19 Anthony Downs, An Economic Theory of Democracy (New York: Harper and Row, 1957). 20. S o m e countries, such as Italy, give the impression that their citizens have entered into an «/¡»'-social contract with their governments: we shall not pay taxes, and in return we do not expect any public services. 21. As is so often the case, the prefix neo is a euphemism for old hat. 22. See Bill W a r r e n , " T h e P o s t w a r E c o n o m i c E x p e r i e n c e of the Third World," in Toward a New Strategy for Development, A Rothko Chapel Colloquium (Oxford: P e r g a m o n Press, 1979): 144-168. Marx himself, of course, originated this view in his writings on India. 23. See Dudley Seers, "Introduction: The Congruence of Marxism and Other Neoclassical Doctrines," in Toward a New Strategy for Development, A Rothko Chapel Colloquium, 1 - 1 7 . 24. See M i c h a e l L i p t o n , " A g r i c u l t u r e , Rural People, the State and the Surplus in S o m e Asian Countries: T h o u g h t s on S o m e Implications of Three Recent Approaches in Social Science," World Development 17, no. 10 (1989): 1553-1571. 25. See Gerald M . Meier, Emerging from Poverty: The Economics that Really Matters ( O x f o r d : O x f o r d University Press, 1984). "The guardian of rationality" is Kenneth A r r o w ' s phrase for the economist; "trustees for the poor" is Gerald Meier's. Without these two groups there is no Archimedean point from which any political e c o n o m y that endogenizes politicians can lift itself out of

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full d e t e r m i n i s m and m a k e room for the possibility of r e f o r m . If w e accept determinism, we have no choice. 26. Thomas Balogh dedicated his book The Dollar Crisis to Lord Lindsay of Birker, the Master of Balliol College, Oxford, "who never quite could convince m e that Oxenstierna had the whole explanation." Count Oxenstierna had written to his son in 1648, " A n nescis, mi fili, quantilla prudentia regitur orbis?" (Dost thou not know, my son, with how little wisdom the world is governed?) Balogh, disagreeing with Lindsay, believed that it was knavery more than foolishness that was responsible for the world's troubles. 27. See Joseph E . Stiglitz et al., The Economic Role of the Stale ( O x f o r d : Basil Blackwell, 1989): 21. The classical definition is that given by Max Weber, as a territorially d e f i n e d organization "that successfully upholds a claim to the m o n o p o l y of the legitimate use of physical force in the e n f o r c e m e n t of its orders." Max Weber, The Theory of Social and Economic Organization, trans. A. M. Henderson and Talcott Parsons (New York: Free Press, 1947): 154. 28. See Robert L. Heilbroner, " T h e Murky Economists," New York Review of Books, 24 April 1986, 4 6 ^ 1 8 . 29. Robert Klitgaard, " I n c e n t i v e M y o p i a , " World Development 17, no. 4 (1989): 4 4 7 - 4 5 9 . 30. See Jagdish Bhagwati, "Directly Unproductive Profit-Seeking Activities," Journal of Political Economy 9 0 (October 1982): 9 8 8 - 1 0 0 2 . 31. See M i c h a e l L i p t o n , " A g r i c u l t u r e , Rural People, the State and the Surplus," 1561-1565. 32. Mrinal D a t t a - C h a u d h u r i , " M a r k e t Failure and G o v e r n m e n t F a i l u r e , " Journal of Economic Perspectives 4, no. 3 (1990): 30. 33. Rati Ram, "Government Size and Economic Growth: A New F r a m e w o r k and S o m e E v i d e n c e f r o m C r o s s - S e c t i o n and T i m e - S e r i e s D a t a , " American Economic Review 76, no. 1 (1986): 191-203. See also Christopher Colclough, " A r e A f r i c a n G o v e r n m e n t s as U n p r o d u c t i v e as the Accelerated D e v e l o p m e n t R e p o r t I m p l i e s ? " IDS Bulletin 14, no. 1 (1983): 2 4 - 2 9 ; and C h r i s t o p h e r C o l c l o u g h , " S t r u c t u r a l i s m V e r s u s N e o - L i b e r a l i s m : An I n t r o d u c t i o n , " in C h r i s t o p h e r C o l c l o u g h and J a m e s M a n o r (eds.), States or Markets? NeoLiberalism and the Development Policy Debate (Oxford: Clarendon Press, 1991): 1-25. 34. James M. Buchanan, Economics Between Predictive Science and Moral Philosophy, comp. Robert D. Tollison and Victor D. Vanberg (College Station, Tex.: T e x a s A & M University Press, 1987); and Liberty, Market and StatePolitical Economy in the 1980's (New York: New York University Press, 1986). See also Agnar Sandmo, " B u c h a n a n on Political Economy: A Review Article," Journal of Economic Literature 28, no. 1 (March 1990): 50-65. 35. Amartya Sen, " G e n d e r and Cooperative Conflicts," Working Paper No. 18 ( W I D E R Helsinki, 1987), to be published in Irene Tinker (ed.), Persistent Inequalities (New York: Oxford University Press). 36. Paul J. Streeten, " T h e Political Economy of R e f o r m " (Paper prepared for the Conference on "Structural Adjustment: Retrospect and Prospect," sponsored by the Department of Economics, The American University and The Development Studies Program of U S A I D , Institute for International Research, Washington, D.C., M a r c h 2 1 - 2 2 , 1991); to be published in a v o l u m e edited by Daniel Schydlowsky and James Weaver. 37. For several reasons why this conflict may arise, see Paul Streeten, "Structural Adjustment: A Survey of Issues and Options," World Development 15, no. 2 (1987): 1469-1482, and "A Survey of the Issues and O p t i o n s , " in Simon Commander (ed.), Structural Adjustment and Agriculture in Theory and Practice in

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Africa and Latin America ( L o n d o n : Overseas Development Institute, 1989; Portsmouth, N.H.: Heinemann, 1989); and "Program Versus Project Aid: A Role Reversal," Melhodus, Bulletin of the International Network for Economic Method ( D e c e m b e r 1989): 1 4 - 1 5 . 38. India did, of course, devalue, but the domestic groups that supported d e v a l u a t i o n lost c r e d i b i l i t y . T h e r e are, of course, e x a m p l e s illustrating the opposite, such as Belaunde and the Alliance for Progress in the 1960s. Belaunde escaped political opposition to land reform, which he advocated, by blaming the A m e r i c a n s , w h o m a d e essential aid conditional on it. The Peruvian congress acceded eventually. 39. A m a r t y a Sen, " A d a m S m i t h ' s Prudence," in Sanjaya Lall and Frances Stewart (eds.), Theory and Reality in Development; Essays in Honour of Paul Streeten (Basingstoke: Macmillan, 1986): 28. 40. Amartya Sen, " E c o n o m i c Methodology: Heterogeneity and R e l e v a n c e , " Melhodus 3, no. 1 (1991): 74.

.4.

Some Thoughts on Plan and Market ALEC NOVE

In rejecting Lenin it is not necessary to embrace Milton Friedman.—Boston Globe

The Marxist-Leninist vision of socialism (or communism) is bankrupt. In my own work, 1 I sought to show that Karl Marx's ideas on a socialist future were essentially of a romantic-utopian nature. It is true that he nowhere systematically set out his ideas on that subject; his great work was called Das Kapital. Nonetheless, he and his followers did sketch out certain features of what they believed to be a socialist future: abundance, no markets, no m o n e y , no wages, no "commodity production" (i.e., production f o r exchange). The division of labor would be overcome; the state would wither away. The administration of men would be replaced by the "administration of things." True, this would only happen after a transition period, but even during this period, as can be seen in M a r x ' s Critique of the Gotha Programme, many of the features of full socialism would be present, although at first the slogan "from each according to his ability, to each according to his needs" would have to be replaced by "from each according to his ability, to each according to his work." Such vital questions as opportunity-cost (i.e., the cost of alternatives foregone), the need for guarantees against abuse of power, labor incentives, and, above all, alternatives to the market as a coordinator of economic activity were almost totally ignored. As Friedrich Engels remarked in his Anti-Duhring, "Everything will be simple without the so-called value." This is not the place to undertake a detailed critique of these conceptions. I will only stress one quite fundamental error: the belief that the task of replacing the market by the deliberate decisions of the "associated producers" would be "simple and transparent." Already in 1908 the Italian economist Enrico Barone warned that it would be very complicated. All Soviet experience confirms this. There are hundreds of thousands of enterprises (in

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industry, mining, construction, agriculture, distribution, transportation, etc.) and, fully disaggregated, well over 10 million kinds of goods and services. Each enterprise must receive plan instruction that must be integrally linked with the plans of their suppliers and their customers. The task of drafting and coordinating such plans is of its nature a central one, for who below the center can consider all the interconnections and alternatives. So it was no accident that regional planning was little used. But the center's task was much too big. This fact had a number of consequences, which can each be seen as being a diseconomy of scale. One was the need for a large, complex, hierarchically structured bureaucracy, with social and political as well as economic consequences. Another was the need to create and then to coordinate numerous subhierarchies: to plan the output of different products, to allocate materials, to decide on investments, on wages, and so on. Information from below had to be collected, checked, aggregated, disaggregated. As academician Nikolai Fedorenko, onetime director of the Mathematical Economics Institute of the Soviet Academy of Sciences, once put it, a fully coherent and allinclusive plan for the next year would, with the help of computers, be ready in 30,000 years' time. The actual central plan was therefore inevitably incomplete, inconsistent, contradictory. The detailed needs of the user had little influence on what was produced (with the exception of the superpriority military sector). Quality was sacrificed to quantitative plan fulfillment. Waste was rewarded, economy penalized, as when plans were set in tons. The plan was supposed to incorporate the detailed needs of society but could not in fact do so. Such a system serves well in a war economy, because it concentrates resource allocation in the hands of the state for urgent and clearly defined priority purposes. But its deficiencies became apparent, particularly during the long reign of Leonid Brezhnev and his geriatric leadership. The USSR began to fall further behind in technology, in living standards, even in growth rates. Stagnation set in. It was increasingly realized that market forces had to be used, that is, that the centralized system had to be supplemented or supplanted by horizontal links between enterprises, that production should be for the customer (directly or through trading intermediaries), not for planfulfillment statistics. In other communist-ruled countries, the "market reform" discussions and experiments started earlier. In 1968, the Hungarian government adopted farreaching measures in the direction that could be called market socialism, that is, seeking to subordinate the activities of state enterprises to market criteria, while allowing some small-scale private and cooperative activities. In the USSR, under Mikhail S. Gorbachev, a number of measures were taken in the same direction. It is not my task in this chapter to describe these measures. Suffice it to say that errors and inconsistencies of policy led to an acute crisis; in the USSR the command system disintegrated, and the market system has not (yet) come into being to replace it. In Hungary,

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Czechoslovakia, and Poland, a radical change in politics occurred, while there, too, earlier attempts to reform the economy were seen as failures. From this, many (in some countries most) economists drew the conclusion that capitalism had proved its superiority; that the entire socialist idea was flawed; that Barone, Mises, Hayek, and other critics had been right all along; and that consequently the basic problem is how most rapidly to achieve the transition from "socialism" to capitalism. As Komai put it in his book, "There is no third way." 2 Market socialism is then a chimera. Or is it? And even if it is, does it imply embracing the ideas of Milton Friedman? Does one have to go from l'état, c'est tout to l'état, c' est rien, from the totalitarian planning state to liberal anarchism, in which the state is confined to law and order and keeping track of the money supply? There is among many East European economists, reacting to the overcentralization of the past, an almost naive belief in the free market, in laissez-faire, as a cure for all diseases. It is surely a cure for many diseases. I would strongly stress that the bulk of goods and services should be sold, marketed, by competing firms seeking profit and that private entrepreneurship should have every encouragement. However, this leaves considerable functions to public authority, either as direct providers or as sources of finance. Examples of the latter include road or school building, undertaken by private firms but with public money, or even street cleaning, which can be done by municipal employees or, as in Paris, by a private firm hired by the municipality. The point of these examples is that the decision to build a road or a school, or to clean a city is not taken because these activities are profitable, but one can hire private enterprises to undertake them (and to make it profitable for them to do so as subcontractors). So let us list activities that fall or should fall within the responsibility of public authorities, directly or indirectly. One category is "natural monopolies," sectors—for example, water, electricity, and gas—where competition can be impracticable or undesirable: there will not be competing pipes or wires under the same street. One could add urban public transportation, which is a publicly operated (and subsidized) monopoly in almost every conurbation in the United States, Canada, and Europe. In these and similar instances, it is always possible to "improve" commercial results by raising prices and/or worsening quality. Consequently, even where they are privately owned, such activities are usually subject to state regulation of some kind. An instruction to "act commercially" can result in the worsening of quality. It is fear of loss of goodwill, that is, the possibility of customers choosing another supplier, that acts as a powerful force for maintenance of quality, a point usually omitted from textbooks on microeconomics. A related area may be labeled infrastructure. Why are almost all ports and airports, even in the United States, in the public sector? Surely because they are there to serve the local business community, to assist in its search for

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profits, rather than aiming to maximize their own profitability. The two objectives are not identical. An example from a different sphere: the British government, even after Margaret Thatcher, still committed to privatizing everything, proposed in May 1991 to sell off the Export Credit Guarantee Department. Again, anyone not blinded by ideology can see that the raison d'être of this department is to help exporters and not to aim to maximize its own profit. Then there are areas significantly affected by externalities, both external economies and external diseconomies. Even the most orthodox textbook mentions their existence. All, even Friedman, agree that there are circumstances in which action (or inaction) imposes losses on (or yields benefits to) parties or agents external to the transactions—although Friedman himself professes to believe the corrective action by the state would do more harm than good. Of course, almost everything has an external effect of some kind, but it is plainly impossible to consider every transaction in the context of everything else. However, it would be foolish indeed to ignore externalities when they impose a major external cost or provide a major benefit. Ecological considerations clearly matter. If cutting rain forests in Brazil can affect the climate thousands of miles away, or if a nuclear disaster at Chernobyl can damage sheep rearing in North Wales, or if power-station emissions in Yorkshire can destroy forests in Scandinavia, such matters cannot be omitted from economic profit and loss calculations. On the positive side, rapid transit is almost everywhere operated at a loss, but the subsidy is justified by two considerations: it reduces congestion and it enhances property values, and in both instances it confers significant benefits on those who do not purchase tickets. Only Thatcherite economists in Britain refuse to accept arguments that are taken for granted in all other Western countries. One hopes that their voices will not be listened to in Budapest or Prague. Then there are public goods, for example, street lighting, public parks, fire fighters. Presumably not even Frederich Hayek would assert that privatizing (selling off) public parks increases human liberty. Health and education may "belong" here, too. While private provision is certainly possible, even extremist individualists must be aware of the advantages for all society (and for profit-orientated business) of a literate, trained, and healthy population. The huge cost of health provision in the United States and the failure to provide it to the millions of uninsured poor contrasts with both Western Europe and Canada. Scientific research and training are areas where even orthodox neoclassical economists must surely see the existence of the "free rider" problem: expenditure on such matters by any one firm ceases to be worthwhile if the knowledge (know-how) or the trainees become available also to other firms. It is an example of Thatcherite myopia to cut state expenditure for these puiposes.

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If visitors introduce themselves as coming from the Adam Smith Institute, it may be useful to quote to them the following words from Adam S m i t h ' s Wealth of Nations: Public authorities have a role "erecting and maintaining certain public works and public institutions which it can never be in the interests of any individual or small number of individuals to erect and maintain, because the profit would never repay the expense, though it may frequently do much more than repay it to a great society." These considerations apply to infrastructure, transportation, training, and so on. Of course, if, as Mrs. Thatcher claimed, "there is no such thing as society," these considerations can be ignored. But surely not by those who profess to follow the ideas of Adam Smith, who was indeed a great man. Public provision of housing is a controversial area. There are those who believe in total privatization and deregulation. It is true that rents were usually fixed at very low levels in Eastern Europe, while in the West various forms of rent control discouraged private provision. However, given the level of land prices in large conurbations, it seems altogether naive to imagine that a tolerable situation would exist under laissez-faire, with no public housing program at all. House prices and free-market rents are beyond the pockets of the poorer half of the population in New York, London, Paris, Budapest, and just about everywhere. A mix of private and public (municipal) provision is in fact widespread in the West. The alternative would lead to thousands of homeless sleeping rough, as has indeed happened in London as the result of a policy of severely limiting municipal housing programs since 1979. Mention must be made here of "public choice" theory, which correctly reminds us of the importance of several factors. First, the "public interest" is seldom operationally definable; and, second, public servants (politicians, bureaucrats) are likely to be influenced by interest groups and rent seekers and are themselves human, pursuing their own interests. So far, so good. But this approach can be, and often is, used to argue against public provision and for privatization. It rests on the assumption of methodological individualism. It assumes that—to take some examples—the chief librarian of Charles University in Prague or the head of the education department in Boston or the man in charge of the (excellent) public parks in Glasgow is primarily concerned not with the library or education or parks but with maximizing his own personal utility. Of course, there is danger here of tautology: we could be held to be maximizing our personal utility by revealed preference—by doing whatever we prefer to do. Yes, there are corrupt public servants. Yes, there are careerist bureaucrats. (Such exist also in the private sector!) But it is surely erroneous to disregard commitment to one's work, loyalty, pride in carrying out o n e ' s responsibilities, and this at all levels of society in all and every activity, from cleaning lavatories to commanding an army. Economic theory disregards the complexities of human motivation and their effect on quality of performance by just assuming "maximization" (of personal utility or profit).

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Let us pass on to macroeconomic issues. First and foremost, can we assume that John Maynard Keynes never existed, that crises and recessions (including the one we are now suffering from in the West) are self-correcting, that unemployment is due to (removable) market imperfections? It may be recalled that in 1931-1932, orthodox economists recommended cuts in public expenditure while unemployment grew rapidly, and one consequence was the coming to power of Hitler. Although no such danger awaits us now, in some formerly communist countries, one also finds a belief that "labor markets clear" if left alone, provided wages fall low enough, while budgets should be strictly balanced (i.e., state spending, especially on public investment, should be reduced). Talk of countercyclical state expenditure is ill regarded. Yet in such countries as Poland and Czechoslovakia the rise in unemployment is due largely to a fall in demand, itself a consequence of the reduction in real wages. It must seem odd in such a situation to imagine that a further reduction in wages will result in increases in employment! In any case, labor markets do not (indeed should not) clear because under conditions of real (not perfect) competition there must be some unused resources—otherwise what is there to compete with? In practice, in any flourishing market economy, supply exceeds demand, which is indeed a precondition for user choice. Only in textbook equilibrium can all resources, including human ones, be fully used. But more than that: unlike, say, horses or bananas, a fall in demand for human labor cannot be followed by a reduction in supply; one can slaughter horses and cut down banana plantations but not people. It is believed by many that Ronald Reagan and Margaret Thatcher were economically successful. Yet Reagan managed in eight years to turn the United States from the world's biggest creditor into the world's biggest debtor, and many US banks, finance houses, and corporations are heavily in debt, too. In Britain, the inflationary boom of 1988-1990 was due to (deregulated) consumer credit, not to budget deficit, and it was associated with severe restrictions on public-sector investment. I can only agree with William Keegan: We had "a reckless deflation which led to a contraction of the manufacturing base, then a reckless inflation, during which the entire economy lived 'on tick.' The economy is now so bad that the disappearance of the balance of payments deficit is not even on the horizon, despite the vast contribution of North Sea oil in the 1980's." 3 And manufacturing and investment have been contracting rapidly since! Faced with inflationary pressures and a huge trade deficit, the British government's ideology allowed only one form of counteraction—raising interest rates. This, however, had some negative side effects: it redistributed income from borrowers to lenders, it added to industrial costs, it discouraged investment, and it helped maintain an overvalued pound while attracting short-term "hot money" to London (which financed the trade deficit). Adam Smith would discriminate between productive borrowers and those called "prodigals and projectors," those who borrow for consumption or

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speculation. Such discrimination, however, would be rejected by those who use his name today and by the British government. It is difficult to see economic rationality in the behavior of foreign exchange rates or, indeed, of Wall Street. Japan's huge trade surplus and the US deficit do not lead to a self-correcting trend—the yen does not go up and the dollar down; the reverse happens. And the recession and bankruptcies in the United States coincide with the highest Wall Street stock prices in history. Maybe Keynes's "Casino" is not far off the truth. And Wall Street and L o n d o n ' s City are repeatedly blamed for short-termism: institutional investors have no long-term commitment to firms whose shares they can and do sell at any time. Those in Eastern Europe who (correctly) desire to have a capital market might note that things are arranged differently in Japan and Germany, where banks and finance houses have long-term commitments to the industries in which they invest. Investment, indeed, is an area on which the typical textbooks are either silent or misleading. There is a "theoretical" reason for this. Within the general-equilibrium paradigm, it is difficult to handle investment: in the real world one undertakes investment (and the risk involved) because one identifies an existing or an anticipated disequilibrium—whence the profit. On assumption of so-called perfection (of markets, of information), no one would invest, because by definition the profitable opportunity is known to everyone, but the model does not allow for prior knowledge of o n e ' s competitors' intentions. As pointed out 30 years ago by G. B. Richardson, 4 a profitable opportunity known to everyone is in fact available to none. Investment occurs because of so-called imperfections: in information (you know what others do not); or due to market domination (existing or anticipated), collusion, or conscious coordination (for example, by the MITI [Ministry of International Trade and Industry] in Japan or the president's office in South Korea). The so-called imperfections are not imperfections but necessities for investment to occur. Hungary, Czechoslovakia, and Poland inherited from the communists a distorted (and polluting) industrial structure, with many "lacks," notably in infrastructure, communications, and health. The closedown of a part of industry is seen as necessary, and unemployment must therefore rise. Yet the antiplanning ideology prevents any serious consideration of an investment strategy. They learn not from Japan and South Korea but from laissez-faire textbooks, and this in a situation where private capital is in very short supply. There appears to me to be a clear role for the public sector as a source of capital (including low-interest credits for the private sector and to finance essential improvements in infrastructure and ecology). Both domestic private and foreign capital could be influenced, guided, and encouraged within some sort of desired investment pattern that takes into a c c o u n t i n t e r d e p e n d e n c e s , complementarities, and the Richardson a r g u m e n t summarized above, as well as regional unemployment.

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One aspect of the strategy highlights another gap in the laissez-faire ideology: regional imbalances are, as a rule, not self-correcting; on the contrary, they are cumulative. "Nothing succeeds like success." "To him that hath shall be given." Countries as different as Mexico (Mexico City will soon have 20 million inhabitants), Italy (the Mezzogiomo), and England (the depressed northeast) provide some of the many examples. If the area happens also to be inhabited by a different nationality or a tribe (for example, Slovakia, Kosovo, Quebec, Turkmenistan), then public policy must surely be particularly concerned. There is a role here for a plan, for a deliberate regional policy. The role of the public sector must surely be significant also in town planning, There are, it is true, some shocking examples of bad town planning, but industrial zoning and preservation of architectural ensembles are the rule in most civilized countries. Here "individualist" doctrine is totally inappropriate. It is not the case that an ensemble (be it a guards regiment, the Chicago Symphony Orchestra, a firm, the Champs-Elysées in Paris, or the Old Town Square in Prague) is no more than the sum of its constituent parts. T h e freedom of individuals—soldiers, musicians, employees of the firm, property owners in Paris or Prague—is and should be circumscribed because of the effect of their freedom to act upon others with whom they are closely associated. I am not allowed to alter the facade of my house in Glasgow because it would affect the look of a Victorian terrace of which my house is an integral part, and it is a public authority—the city of Glasgow—that rightly limits my freedom to do what I like with my property. Public ownership and entrepreneurship are said not to mix, even when a publicly owned corporation is set free in a market environment. Indeed, it is the case that under communist rule state enterprises had little reason to innovate, and the m a n a g e m e n t had few incentives and even f e w e r opportunities to show initiative. It is also true that reforms of the Hungarian type had only modest success in overcoming these defects, owing partly to what Kornai has called a "soft budget constraint," 5 partly to lack of competition, including (because of balance-of-payments constraint) foreign competition. In my own model of "feasible socialism," the private entrepreneur plays a significant part. I visualize a mixed economy, with owner-managers, or partners, and also cooperatives of various kinds. Because private capital is scarce in Eastern Europe, the new regimes there have every reason to encourage all forms of entrepreneurship. They should bear in mind, however, that if (as Komai had argued) an important defect of state ownership is that ownership is "anonymous," then one should recall that in French a joint stock company is société anonyme, an aspect that worried Adam Smith because m a n a g e m e n t is separated from ownership and there is no clear proprietor. W h e n , as is often the case, the owners of the shares are institutions, such as pension funds, insurance companies, and mutual funds, they are totally anonymous: thus, I do not know what stocks and shares the

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management of "my" investment trust buys and sells in the course of a year or a week. Here one has both a cause of the much criticized short-termism and a lack of control by owners. Management can then become remarkably generous to itself. An example was cited recently by Business Week: The boss of United Airlines paid himself $18 million in salary, bonuses, and stock options in 1990 when the firm's profits fell by 71 percent, "which is 1300 times larger than the pay of a stewardess, whose annual $14,382 has not been increased for five years. America's leading institutional shareholders are concerned about executive pay." 6 This is not an arrangement that one should encourage. Nor should one overlook the tendency, especially in the United States and Britain, for fortunes to be made by wheeling and dealing— in financial services, in real estate—much of it in activities that ought to count as transactions costs rather than the production of goods and services. Markets cannot exist without being accompanied by speculation, but when speculation dominates, when large market fluctuations occur through computer-programmed buying and selling, one is far away from the kind of capital market that the former communist countries do urgently need. The title of a book by the US economist Seymour Melman is Profits Without Production.1 The lawyer and accountant dominate the corporation, and in the United States at least, executives move from one corporation to another on average in less than five years, another cause of short-termism. It is different in Japan. Because in any event there is insufficient private capital in the East to fund the speedy privatization of large enterprises, the practical policy conclusion might be to encourage entrepreneurship in every possible way, having in mind the relatively small- or medium-sized entrepreneur-owner enterprise, while finding ways of stimulating managerial initiative, independence, and competition in the sector where public and cooperative ownership will survive for many years yet. It is also useful to study without ideological presuppositions the record of public-sector activities in different countries and also the real (and not propagandist) record of privatization where it has occurred. Some public enterprises have been remarkably efficient, others have not. The reasons are worth careful examination. And, of course, if, as under Mrs. Thatcher's government, the public sector is deliberately starved of investment (to keep down the "public sector borrowing requirements") and the privatized firm has free access to the capital market, then this, and not some inherent defect of public ownership, could explain any improvement that occurred. Much could (and should) be written on foreign trade and payments and on the way to respond to balance-of-payments crises that beset a number of the former communist countries. Convertibility is clearly a desirable and priority aim. However, there are lessons to be learned from the postwar experience of Western Europe. These countries did not leap at once into convertibility; it was achieved in stages, and full freedom of capital movements was in some

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instances delayed until just a few years ago. This avoided the excessive gap between purchasing power parity and the exchange rate that now characterizes the Polish, Czech, and Russian economies. This affects inward investment too: there is danger in foreigners' being able to buy too cheaply. It may also be worth noting that some capitalist countries, for instance Switzerland and Austria, do have rather strict controls over the purchase of capital assets and land by foreigners. A few generalizations by way of conclusion: 1. The evident failure of Marxist-Leninist socialism leads—and must lead—to the conclusion that a market economy in which there is ample scope for private enterprise is the only feasible alternative. The word socialism is discredited in the East by its association with the communists and also by failure of moderate reforms, of which the Hungarian experience is a particularly notable example. 2. The transition to the market is a complex and painful process, and some halfway stages do not work. There must be a predominance of free prices, strict limits on money creation, financial discipline, and limits on money-wage increases. (However, as some economists in both East and West have been pointing out, it is an odd form of laissez-faire that believes in full freedom for all prices except the wages of labor.) 3. Naturally, a market requires appropriate market infrastructure, stock and commodity exchanges, and a labor market. Private enterprise should be legalized, encouraged, not taxed too highly. All this needs a solid legal framework and political confidence. The absence of these requirements in Russia is one of the principal obstacles to the introduction of a market economy. If the minister of justice, N. Fedorov, can speak of "a total paralysis of Russian state structures" 8 and Vice President Alexander Rutskoi states that "numerous laws are adopted that nobody carries out, as there is no mechanism of state administration or control over implementing decisions," 9 the required legal order, necessary also for the observance of commercial contracts, cannot be said to exist. Foreign investment should be welcomed, although one could distinguish investment that creates new capacity from that which simply acquires existing assets. (And if, as in Hungary, the assets so acquired include most of the country's newspapers, this should be an object of legitimate concern, as would be the dominance within the country of one publishing tycoon.) For a market to function, there must be competition and also regulation of those monopolies that exist, whether these be in the public or the private sector. Given the lack of private capital and the evident difficulty of introducing capitalism without capital and capitalists, the formerly communist countries will in fact have a mixed economy with different forms of ownerships and a large publicly or cooperatively owned sector for many years. So one does need a realistic approach to the role of the state, the region, the municipality

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in operating or regulating "natural monopolies"; in infrastructure, including transportation and communications; in ecology; in employment and wages policies; and in planning (yes, planning) industrial development and investment strategy, with lessons to be learned from the experience of such countries as South Korea, and indeed of postwar Western Europe, as examples of how to emerge from ruin and disaster. This was not laissez-faire. Nor, of course, was it socialism. Not least among these lessons is the need for social peace—which brings me to the "welfare" role of the state: education, health, housing, pensions, and so on. It astonished me to leam that some highly influential political economists are opposed to the concept of Soziale Marktwirtschaft and wish to do away with the Soziale. Even in a country that gave rise to the concept of "socialism with a human face," they advocate "capitalism with an inhuman face." Supporters of this view exist in Russia, too: thus Lyudmila Pyasheva and Boris Pinsker denounce the German social democrats as well as the Swedes for spending too much on welfare. They seem unaware that the very substantial social benefits that exist in (for instance) Germany and France were introduced not by left-wing governments but, respectively, under Ludwig Erhard and Konrad Adenauer, Charles de Gaulle and Georges Pompidou. The Germans in particular introduced the notion of worker participation, Mitbestimung. The alternative approach resembles class war and is surely a recipe for conflict. Rodger Boyes has written: "The East European workers are angry. Betrayed by the Bolshevik revolution and the communist governors, who both cosseted and repressed them, they now feel abandoned by leaders of the 1989 democratic revolution."10

Notes 1. A l e c N o v e , The Economics of Feasible Socialism (London: G. Allen and U n w i n , 1983). 2. Janos Kornai, Economics of Shortage (Amsterdam and N e w York: North Holland Publishing, 1980). 3. William Keegan, Observer, 25 November 1990. 4. G. B. Richardson, Information and Investment (Oxford: Oxford University Press, 1960). 5. Kornai, Economics of Shortage. 6. London Times, 23 April 1991. 7. S e y m o u r M e l m a n , Profits Without Production ( N e w York: Knopf, 1983). 8. Sobesednik, no. 49, 1981. 9. Ekonomika i zhizn, no. 50, 1991. 10. R o d g e r Boyers, London Times, 1 May 1991.

• Part 2 • State Action and the World Economy in Comparative Perspective

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A Theory of Government Intervention in Late Industrialization ALICE H. AMSDEN

The Inability to Industrialize When Markets Are Working, Not "Failing": An Overview T h e plot c o n t i n u e s to thicken over the role of the state in late industrialization, where lateness refers to countries whose leading enterprises do not enjoy (at least not at first) the competitive asset of pioneering technology. Pioneering technology was the crux of the competitiveness of leading enterprises in the first and second Industrial Revolutions and a principal reason why they could prosper with less government intervention than has been necessary in the twentieth century. Late industrializers must grow exclusively by borrowing technology. Denied a competitive advantage from new products and processes, they initially have only their low wages to rely on in wresting market share from countries with higher productivity. 1 Low wages, however, are a necessary but insufficient condition for industrial development. As late industrialization has unfolded, it has become clear from observing its "leading sector"—cotton textiles—that low wages are no match for the higher productivity of more industrialized countries. If one looks at South Korea and Taiwan in the 1960s, two of the lowest-wage lateindustrializing countries, with unusually good educational systems and modern infrastructure thanks to foreign aid, and if one studies their cotton spinning and weaving industry, then what is apparent is that even after South Korea and Taiwan borrowed foreign technology and repeatedly devalued their real exchange rate to appease US aid advisors, their leading enterprises in cotton textiles still could not compete on the basis of low wages against the more productive cotton textile industry of Japan. Under these circumstances, and a fortiori in industries requiring greater skills and capital investments, governments have to intervene and deliberately distort prices to stimulate investment and trade. Otherwise industrialization won't germinate. Needless to say, the m o d e m view of government intervention in late industrialization originated in the ideas of Alexander Gerschenkron. 2 But 53

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Gerschenkron regarded the increase of government intervention in sequentially later industrializations as a consequence of the shortcomings of institutional actors in the marketplace, particularly the capital market, rather than as a consequence of the market mechanism itself failing to generate industrial growth. Government intervention, however, cannot simply take the passive form of providing remedies for institutional shortcomings or even "market failures." Rather, late industrialization must necessarily be triggered through a proactive process of getting the prices "wrong." In the first section of this chapter, the general argument about the necessity for government intervention in late industrialization is presented schematically. So, too, is the reason for the variation across countries in the quality of government intervention, something about which Gerschenkron was largely silent. In subsequent sections, key issues of the argument are explored further. The Inadequacy of Low Wages as a Competitive Asset Governments must subsidize industries for them to develop in a far more pervasive fashion than was warranted for successful infant innovators in Germany and the United States in the second Industrial Revolution. In the case of such innovators, protection was necessary, if at all, only during the time lag between the stage of invention and the stage of commercialization, whereupon competitiveness on the basis of pioneering technology could be expected to ensue. 3 Many economists take their cue from this historical experience and assume that if protection is ever appropriate, it is only so during the interim period of technology transfer. After a firm introduces a globally efficient "technology" (as depicted by a particular production isoquant), its total factor productivity is assumed to be the same as that of firms in other countries, and it follows that the lowest-wage countries can dominate international markets for the most labor-intensive goods. Nevertheless, the history of most major industries in late-industrializing countries suggests that it takes a long time before leading enterprises can export or compete against imports on the basis of market-determined production costs (which may be taken as the definition of competitive). South Korea's cotton spinning and weaving industry, for example, originated in the 1920s, if not earlier. 4 In the 1930s, leading textile firms were subsidized by the Japanese colonial administration. 5 Subsidies were increased substantially under US foreign aid programs in the mid-1950s. 6 Yet textile companies still could not compete against Japan on the basis of market prices in the mid-1960s. 7 South Korea's automobile industry was heavily subsidized for at least thirty years. During that period, no foreign cars were to be seen on Korean roads and no Korean cars were to be seen on foreign roads. One reason for the lengthy delay in catching up (even in industries in which technology can be bought on competitive terms internationally and in which labor costs are a sizable share of total costs) is the cat-and-mouse quality of competition, a dynamic that standard price theory largely ignores.

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Foreign competitors may be expected to introduce a stream of new innovations in productivity and quality to retaliate for their loss of market share, and it takes time for late industrializes to build a team of engineers and a work force with the capabilities to keep abreast of these advances. 8 Even the initial process of technology transfer is fraught with problems because technology is never completely codified, and to operate it optimally in different environments requires adaptation. 9 Moreover, the quality of human and physical infrastructure and the efficiency of suppliers vary internationally. Even the most enterprising late-industrializing companies have no control over these inputs, but their productivity levels are likely to be significantly influenced by them. 10 Finally, not only have productivity gaps between developed and underdeveloped countries widened in the twentieth century, overpowering the competitive advantage of cheap labor, but labor markets have remained segmented in the industrialized countries, 11 allowing countries with high average wages to maintain competitiveness in low-end, labor-intensive industries on the basis of pockets of low-paid workers—usually female, immigrant, or a racial minority. A study conducted in the 1930s to ascertain why the Japanese textile industry was destroying Lancashire concluded that Japan's lower wage rates were not responsible. 12 Wages were discounted as the critical variable because it was found that young female labor in Lancashire earned wages that were not much higher than those being paid in Japan's textile sector. If Japan were competing against Lancashire only on the basis of low wages, Britain might have triumphed. Instead, Japan's superiority was attributed to its more modem and integrated production facilities (theoretically, capital-rich Britain's competitive advantage), its cartelized bulk purchase of raw cotton, its better distribution channels, and its superior management (all of which overwhelmed the textile industries of South Korea and Taiwan in the 1960s).

The Gerschenkron Hypothesis Overturned Whereas in the market model, competitiveness in low-income countries is a matter of borrowing technology, closing the productivity gap, and then allowing low wages to gain market share in labor-intensive sectors (or, in the Ricardian framework, allowing real exchange rates to depreciate to overcome productivity differences, as noted shortly), in the model of Alexander Gerschenkron, latecomers may do more than merely catch up with leaders— they may spectacularly overtake them. According to Gerschenkron, industrialization is a process of "revolutionary," "eruptive" spurts, with the most backward countries promoting "those branches of industrial activities in which recent technological progress has been particularly rapid." 13 Gerschenkron was writing with the example of Russia in mind and failed to recognize that the basic rules of international competition changed in the

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course of the twentieth century. Global enterprises arose in the twentieth century with "organizational capabilities" based on a core technology. 14 The institutionalization of research and development in such enterprises allowed them to erect entry barriers around their proprietary technology family. Because of this historical condition, Gerschenkron's idea of leaping to the world technological frontier could no longer work. 15 Earlier, in the nineteenth century, when British firms could not establish equally impenetrable international entry barriers, leading US and German enterprises could and did follow a Gerschenkron-like competitive strategy: they leapfrogged ahead of England in the most dynamic sectors. 1 6 In the twentieth century, the only major country to attempt this strategy was Russia, and it failed to become a stable, industrialized country. The Gerschenkron conception of industrialization predicts that the more backward the country (measured in terms of productivity level), the faster the productivity growth rate. This has been found to be true empirically for the advanced capitalist countries. 1 7 It has not been found to be true when the country sample is extended to include cases like Argentina and Chile. 1 8 Obviously, Gerschenkron's catch-up postulate only works above a certain threshold. Below it, the laws of industrialization change. These laws, or the tendencies associated with having to industrialize without original technology, do not reward backwardness and do not permit technology transfer alone to close huge productivity gaps. Under these conditions, lower wages are generally inadequate to overcome the penalty of lateness. The Inadequacy of Market Forces to Serve as Disciplinarian During what may be lengthy periods of subsidization to arrive at productivity levels that are cost competitive, market forces cannot be relied upon to discipline business to act efficiently—that is, to invest heavily in adapting foreign technology and then to invest further in incremental improvements in quality and productivity in order to compete against foreign imports or capture export markets. Even if more than one subsidized firm operates in the same industry and even if there is no price collusion among them (which is unlikely under oligopolistic conditions—say, those prevailing in the South Korean automobile example), such competitors (possibly including foreignowned firms) do not necessarily have an incentive to compete to the extent of becoming as efficient as the firm at the world technological frontier. 1 9 If the South Korean automobile industry ultimately succeeded in becoming globally efficient, as evidenced by its export success, there was nothing intrinsic in its thirty years of infant industry protection to ensure this outcome. In the first Industrial Revolution, in the eighteenth century in Britain, the disciplinarian of business activity was a competitive market structure. By the time of the second Industrial Revolution, in the nineteenth century, and the rise of big business and oligopoly in Germany and the United States, an economist like Joseph Schumpeter recognized that competitive market

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structures were no longer providing the disciplinary service necessary for an economy to operate efficiently. Schumpeter postulated a new agent of discipline in the form of technological change, those gales of creative destruction that razed inefficient oligopolists and replaced them with new innovators. By definition, however, late industrialization is a process devoid of major innovation; it is predicated on borrowing technology and then i m p r o v i n g it incrementally. Consequently, the nineteenth century disciplinarian of technological change can no longer be relied upon to function. Leading enterprises in twentieth century industrialization must be subsidized, but in order for subsidies to be effective, a new agent must act as disciplinarian. One may state the two critical problems of late industrialization as follows: First, if countries have no competitive advantage in pioneering technology and if they must compete on the basis of market-determined production costs, then even in a wide range of labor-intensive industries they will not be able to compete against the higher productivity levels of more industrialized countries. This proposition is lent empirical support by the industrialization problems of Japan versus Lancashire in the early 1900s; or the difficulties that South Korea and Taiwan faced in competing against Japan beginning in the 1960s; or the troubles China encountered vis-à-vis Japan in the 1930s, and so forth. Second, in industries requiring a lengthy period of subsidization before the market mechanism can assume its role as disciplinarian (i.e., the point in time when firms can compete at home or abroad without subsidies on the basis of market-determined production costs), even if late-industrializing firms compete rather than collude with one another, there is no inherent incentive for competition among them to be so intense as to generate international levels of productivity. Subsidy recipients, therefore, must be disciplined or the prognosis for sustained industrial development is dim: a continuation of subsidies to inefficient firms (inefficient by comparison with the world frontier) or deindustrialization and unemployment as subsidies are retired. The Mismodeling of Technology The deduction of price theory, that low wages are a sufficient basis on which to compete in labor-intensive sectors, must rely on the assumption that either exchange rates are flexible, as noted shortly, or that technology (production functions) and productivity are the same in an industry in all countries. The error of the latter assumption lies in its oversimplified modeling of technology. Technology is modeled as though it consisted solely of capital equipment and product and process designs. So defined, technology does increasingly tend to be the same in all countries, given that capital good suppliers and engineering consulting firms operate globally. Nevertheless, technology is multidimensional. It includes not just machinery, equipment, and designs—call them alpha technology—but also supporting institutions, such as management systems, labor relations,

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shopfloor practices, subcontractual arrangements, and public policies—call them beta technology. Beta technology is by no means similar in the same industry in all countries and is probably responsible for a large part of the differences in productivity observed in the same industry around the world. Writing about such differences in the nineteenth century. Pollard notes, "Right up to 1850 and 1860, continental centers frequently failed to achieve British productivity and economy even when using apparently similar equipment" [italics added]. 20 Since then, productivity gaps among countries have grown cavernous despite larger flows of technology across borders and despite a greater codification of production processes and product designs (alpha technology), attesting to the importance of beta technology and the misspecification of technology generally in the market model. The Deus ex Machina of Devaluation In Ricardian theory, technology broadly defined—alpha and beta—is assumed to differ across countries. There is still, however, the presumption that poor countries can compete against the higher productivity levels of more advanced countries on the basis of low wages. However great the productivity gap, foreign exchange rate devaluation is the deus ex machina that drives real wages down to a level low enough for competitiveness to be attained. This was implicit in Ricardo's discussion of comparative advantage and has become an article of faith in World Bank and International Monetary Fund policy prescriptions to low-income countries since World War II. Nevertheless, there is always a physiological or political limit beyond which real wages cannot be reduced. Latin America in the 1980s demonstrated that it was impossible to lower real wages without triggering a wage response that led to serious price instability and general macroeconomic disorder in the form of volatile nominal and real interest rates, unpredictable foreign exchange rates, variable and large fiscal deficits, and stop-go growth. 21 This, in turn, undermined investment and competitiveness further. Moreover, even if real wages are not at a subsistence minimum, there is limited scope for reducing them through devaluation if exports are highly dependent on imported inputs (including fuel and food); such dependence appears to have risen in the relatively free trade environment since World War II. The idea that low wages are an inadequate basis for industrialization may be found in the early development literature that is rooted in the classical rather than neoclassical tradition. Hla Myint, for example, attributes underdevelopment to the onset of what he calls a "low-wage economy." 22 Low wages were seen by Myint not as the treasure they are taken to be in neoclassical theory but rather as an obstacle to economic development because they constrained the size of the domestic market and operated hand in hand with low productivity. There was no question of exporting manufactures not because of "export pessimism" but because wages were too low.

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The Muddle of Market "Failure" T h e inadequacy of low wages to serve as a competitive asset to trigger industrialization—in a world where followers can no longer leapfrog over leaders by innovating and face huge productivity gaps—is, in the words of the Mikado of Gilbert and Sullivan, a pretty "how-de-do." This reality robs market theory of an industrialization mechanism free from the need for government intervention. To circumvent this embarrassment theoretically, one must resort to the tautology of market failure. If, in reality, low wages are an inadequate basis for industrialization in labor-intensive industries, then there must be some "failure" of the market mechanism operating. The tautology is such that the market mechanism can never be working properly and fail to generate industrial development; the theory can never be wrong. So, say, in the Ricardian model, if a country with relatively low productivity cannot achieve lower real wages through real exchange rate devaluations because real wages are at a physiological subsistence minimum, then there is some rigidity or distortion in the labor market preventing a competitive market-clearing wage rate from arising. Or, in the neoclassical model, if competitively determined wages cannot offset higher productivity abroad, then production functions are not really identical (if they were, productivity would be equal in the two countries). In reality, late i n d u s t r i a l i z e s have faced far easier conditions of technology transfer and far more competitive downward pressures on their wages (as discussed shortly) than in previous industrial revolutions. Yet they have still found it extremely difficult to industrialize—precisely because markets have been working, not failing. Rent Seeking The market failure rhetoric does not provide an explanation for the inability of the market mechanism to trigger late industrialization, but it does offer a respectable rationale for governments to intervene in order to do so. 23 In other words, if the market mechanism fails to instigate industrial development, there are ways to justify the introduction of active state industrial policies and not violate the canons of competitive price theory. The private sector may not initiate industrialization because it is shortsighted or operates with imperfect information. Or it may simply be undercapitalized and hence unable to take short-term losses due to the underdevelopment and inefficiency of capital markets. Or future profits may not compensate for current losses (in the absence of incremental productivity and quality improvements), or investing in manufacturing may be less profitable than, say, speculating in land o r i m p o r t i n g f o r e i g n products, in which cases subsidies to manufacturing are justified if such activity has spillovers, externalities, or complementarities. However one rationalizes the imperative for state intervention under the conditions of late industrialization outlined above, the important question is whether the benefits of government intervention exceed the costs. In the

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earliest development literature (related to twentieth century industrialization), there was no question of the state acting developmentally because under colonial rule the state was part of the problem, not part of the solution. Later, dependency theorists such as Paul Baran largely construed the Third World state as a pawn of the neocolonialists and as unlikely as the colonial state to act developmentally. 2 4 For market-oriented economists, the postindependence state became an irredeemable rent seeker, with the costs of government intervention assumed to far outweigh the benefits. The standard model of the rent-seeking state, however, makes extreme theoretical assumptions about how states operate and is insensitive to the empirical evidence on how different states in various countries have, in fact, performed. 25 The major assumption of the standard rent-seeking model is that the state is corrupt to the point of aborting economic development (and that the private sector in deregulated markets is above suspicion of any antisocial behavior). For example, in Krueger, 26 the rent-seeking scenario results in no developmental benefits whatsoever accruing from a system of import licenses. Nevertheless, whatever the nature of the state—dictatorial (say, in postwar Taiwan), democratic (say, in India), authoritarian (say, in Malawi), or militaristic (say, in Brazil in the 1970s)—to model it as so greedy that rent seeking entirely frustrates economic development implies complete impotence or irrationality on the state's part, conceptualized either as a set of individual actors or as a collective institution. Even in a democracy, where the term in office of individual political agents is finite so that these agents are prone to maximize short-run rent-seeking activities, under certain conditions there are almost sure to be institutional safeguards against such antisocial behavior. Instead of viewing rent seeking as unbounded, it seems more reasonable to argue that in countries where it is generally perceived that industrialization is ultimately possible (as discussed later in conjunction with income distribution), a development process is likely to emerge wherein rent seeking is still present but not to the point where it entirely miscarries industrialization. Rational agents within the state, acting either individually or collectively, may even enthusiastically embrace the possibility of curbing rent seeking, just as the state intervenes to, say, make deregulated markets work better. 27 This is because in the long run, in countries where the outlook for ultimately succeeding in industrializing is positive, rent seekers can probably enrich themselves more by sustaining a systematic process of capital accumulation (through saving and investment) than by ransacking the economy in the short run through gross misappropriation of revenues. As for the empirical evidence on rent seeking, it is mixed, as is to be expected. On the one hand, there is an abundance of facts to support the view that state intervention is disastrous for economic development, particularly in the poorest countries. 2 8 On the other hand, the fastest-growing late-

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industrializing countries—South Korea, Taiwan, Singapore, Thailand, Malaysia, and, to a lesser extent, Japan (lesser because postwar Japan was relatively economically advanced)—have all had extensive government intervention and highly active industrial policies. The State as

Disciplinarian

The critical difference in the two sets of countries relates to the principles governing subsidy allocation. In all late-industrializing countries, states have intervened to get prices "wrong" because initially firms could not compete even in labor-intensive industries on the basis of low wages. Subsidies have been a necessary condition for industrial development in the absence of pioneering technology. The principles governing subsidy allocation, however, have been different in fast- and slow-growing late industrializers. In slower-growing countries, no performance standards have been imposed on subsidy recipients. Subsidies have been allocated according to the principle of giveaway. In the case of financial incentives, for instance, often subsidized loans have not been repaid altogether, or they have been used for purposes for which they were not intended, or they have been bottled up in investments that never approach international standards of productivity and quality. The giveaway principle raises the total production costs of the economy and makes it necessary to have even higher subsidies to offset inefficiency (or face massive deindustrialization). In the fast-growing cases, subsidies have been allocated according to the principle of reciprocity, in exchange for concrete performance standards (with respect to output, exports, product quality, investments in training, and, more recently, research and development). To the extent that such performance standards raise the level of productivity, they increase cost competitiveness and allow subsidies to be lower than otherwise. In terms of causality, and comparing high subsidies in, say, Latin America with those in East Asia, the relationship between East Asia's lower subsidies and efficiency seems to run from the presence of performance standards, to higher efficiency, to lower-than-otherwise subsidies rather than from low subsidies to high efficiency. Moreover, performance standards not only discipline business but also discipline the state. When subsidized firms have to meet certain performance standards, the performance of the bureaucrats and politicians involved in choosing which firms to subsidize can be judged by the same objective criteria. In all late-industrializing countries, the state has disciplined labor, driving wages down as far as politically possible. What accounts for differences in rates of growth of industrial output and productivity among late-industrializing countries is not the degree to which the state has disciplined labor but the degree to which it has been willing and able to discipline capital. The discipline of capital constitutes a major factor in the success or failure of state intervention in late industrialization. In the remainder of this chapter, the object is not to present a model for

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aspiring industrializes to follow but rather to develop a descriptive theory to show the conditions under which the model of late industrialization is likely to succeed or fail. Late industrialization is dependent on getting the prices "wrong," but it turns out that the "wrong" prices are right only under certain conditions (and even under these conditions, some "wrong" prices are simply incorrect).

Foreign Investment, New Technology, and Ultra-Labor-Intensive Investment Opportunities B e f o r e proceeding to the " w r o n g " prices that are needed to initiate industrialization, it is necessary to discuss the issue of foreign investment and the e m e r g e n c e of investment opportunities in late-industrializing countries in industries that are more labor intensive than cotton spinning and weaving. Not just the standard market model but virtually every other theory of twentieth-century industrial development views the unfolding of late industrialization as a consequence of international wage differentials. The impulse for such industrialization is typically attributed to rising wages and a m o v e m e n t up the ladder of comparative advantage in the developed economies, whose own firms then relocate labor-intensive manufacturing operations in underdeveloped areas. These theories do not consider that late industrialization has occurred largely as a direct consequence of actions taken by underdeveloped countries themselves or that these actions taken together compose a systemically new process of industrializing by comparison with the first and second Industrial Revolutions. Instead, late industrialization is conceived as a qualitatively undifferentiated expansion of "capitalism on a global scale" (for better or worse, depending on the political persuasion of the writer). Falling under this analytical rubric are theories of the "new international division of labor," 2 9 and "global Fordism." 3 0 In the latter case, massproduction industries and not just labor-intensive ones are relocated by the multinationals to the peripheral economies. The same conception of Third World industrialization underlies the "flying geese" theory first articulated by Akamatsu in 1938, 31 and recast as the product life cycle by Vernon. 3 2 In the latter case, sequential waves of industrial development in poor countries are linked not with crisis and rising wages in the advanced capitalist countries but rather with innovation. In fact, technological change in the advanced capitalist countries since the 1960s has created many new, highly labor-intensive investment opportunities for those low-wage countries industrializing even later than South Korea and Taiwan. When Korea and Taiwan began to industrialize, the electronics sector was in its infancy. Now, of course, the location by multinational firms of electronics assembly operations is a big business in

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low-wage countries. Moreover, textiles in the 1960s largely meant spinning and weaving. Only Hong Kong, with its political stability and excellent infrastructure, could boast significant clothing manufacture (which is one reason it needed less government intervention initially than Korea, Taiwan, and Singapore). 33 Since then, the apparel industry, which is more labor-using than spinning, has become a major Third World employer. In conjunction with freer floating exchange rates and greater cost consciousness, the multinationals have also begun locating more labor-intensive stages of their production processes overseas, as the above-mentioned theories predict. Despite these investment opportunities, however, multinational investment does not in fact account for the most recent wave of late industrialization (in, say, Chile, Indonesia, Malaysia, and Thailand, not to mention China), and they have not allowed industrialization to ferment without government intervention and subsidization. For one, technological change since the 1960s has probably destroyed as many labor-intensive jobs as it has created new ones. Moreover, investments by multinational firms are limited to only a handful of developing countries. Even in these countries, such investments are only a tiny fraction of total capital formation (as indicated by Table 5.1). The timing of these investments is also such that they tend to lag rather than lead such countries' rapid growth. If linkages do occur from these investments, the credit for them is due more to planning agencies than to market forces. Relocation of labor-intensive manufacturing from the developed to developing countries supposedly acts as a catalyst for industrialization in two respects: one could be called an income effect and the other a substitution effect. In the former, labor-intensive production supposedly generates enough income in the form of profits and wages to pull the economy along by a multiplier effect that creates further investment and consumption. In the latter, induced production-related backward and forward linkages substitute for imports and are responsible for further expansion. 34 With respect to the income effect, we would expect it to be strongest in those low-income countries that attracted the greatest amount of exportoriented, labor-intensive direct foreign investment—Singapore, South Korea, Malaysia, Thailand, etc. Yet as Table 5.1 suggests, what is striking about even these countries is how unimportant direct foreign investment (DFI) was in their total gross capital formation (the share of DFI is relatively high in Malaysia and Indonesia due to their extraordinary abundance of oil and other natural resources). The figures in Table 5.1 may be biased downward, because they probably exclude foreign investments in real estate. But speculative foreign investments that drive up rents do more to retard industrial development than to further it. As for the timing of foreign investments in manufacturing, a study of the Asian experience concludes: "The bulk of the economic transformation of developing countries has always been financed by domestic saving, especially once domestic incomes start a sustained rapid

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Table 5.1 Inward Direct Foreign Investment (IDFI) in Gross Investment, 1 9 6 7 - 1 9 8 6 Amount

Share

(mil. $)

(%)

1967-1975 1976-1980

51.0 61.0

1.7 0.4

1981-1986 Taiwan 1967-1975

168.0

0.7

47.0

1976-1980 1981-1986

106.0 212.0

2.0 1.2

Indonesia 1967—1975 1976-1980 1981-1986 Malaysia

99.0 253.0 230.0

4.4 2.4

173.0 559.0

13.7 11.6

991.0

10.5

66.0

2.9

98.0 276.0

1.5 3.1

1,750.0 8,947.0 20,077.0

0.8 2.0 3.0

Republic of Korea

1967-1975 1976-1980 1981-1986 Thailand 1967-1975 1976-1980 1981-1986 United States 1967-1975 1976-1980 1981-1986

1.7

0.9

Source: ESCAP, Restructuring the Developing Economies of Asia and the Pacific in the 1990's (New York, 1990).

growth. Aside from investment in raw material extraction, foreign savers and investors come to developing countries to take advantage of the factors that are already generating growth, and their activities can accelerate it significantly" (italics added). 35 Neodependency, flying geese, and product life cycle theories of economic restructuring regard Third World development as a response to investment relocation decisions of the multinationals, but given the insignificance of such investments in the total capital formation of even the most gracious host countries and given the tendency for such investments to lag rather than lead rapid increases in GNP, this way of viewing industrial development is wagging the dog by the tail. In Indonesia, Malaysia, and Thailand, annual growth rates were averaging

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roughly 5 to 6 percent for 30 or so years before direct foreign investments in the manufacturing sector became significant (in the late 1980s). Moreover, the rapid growth experienced by these countries beginning in the 1960s was related to exports of oil and agro-industrial products rather than to exports of manufactures based on low wages and getting the prices right.36 Finally, the upsurge in manufactured exports starting after the mid-1980s (still largely in agro-industries in Chile) reflected the fruits of highly subsidized importsubstitution policies begun at least 20 years earlier. 37 With respect to the substitution effect (of production-related linkages from labor-intensive manufacturing), most of the evidence suggests that it does not happen automatically, by dint of free-market forces. If laborintensive export activity starts a "roll," its momentum is maintained by deliberate government policies. This is partly because many investments linked to labor-intensive activity, say, the manufacture of synthetic fibers for spinning, weaving, and apparel manufacture, are not profitable initially at market-determined production costs and partly because the coordination that is required to realize potential linkages is greater than the market mechanism can, or at least does, provide. Take, for instance, the case of the Bangladeshi garment industry, which by 1990 was exporting about $1 billion worth of goods. Of that value, however, over $800 million represented imported inputs, despite the presence of local spinning companies and handloom weavers. There were not more linkages f r o m apparel m a n u f a c t u r e because the garment makers in question considered local handloom weaving below acceptable quality standards. Exporters also preferred to import yam (in cases where they did employ local weavers), partly because they received better financial terms from foreign spinners. Without some central coordinating mechanism that the m a r k e t did not appear to be providing, linkages from garment making were minimal, and shortages of foreign exchange were not greatly alleviated. Given the experiences of Japan in both the pre- and postwar periods; Korea, Singapore, and Taiwan in the 1960s and 1970s; and Indonesia, Malaysia, and Thailand in the 1980s, it will be assumed in what follows that there are not a sufficient number of labor-intensive industries to allow low wages alone to act as an engine of growth. For industrialization to occur, a necessary condition is state intervention.

Getting the Prices "Wrong" As a first step, it is necessary to establish that the wage rates that are claimed to be no match for the higher productivity of more industrialized countries are competitively determined. If distortions of one type or another keep money wages high, then their removal could increase competitiveness without resorting to subsidies.

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Low Money Wages The first point to note is how low the ratio of wages to productivity probably is in late industrialization by comparison with earlier industrializations because the supply of labor is more "unlimited," in the sense of the term employed by W. A. Lewis. 38 There are four reasons for a more abundant labor supply in late industrialization. One relates to population growth rates, which have been far greater in developing countries today than in eighteenth- or nineteenth-century Europe. Moreover, there is no relief for excess labor in the form of international migration, which for all practical purposes withered with World War I. In addition, wages are kept depressed by extraordinary difficulties in trade union organization. In part, organizing is made more difficult by the absence of the figure responsible for trade unionization in earlier industrializations—the dispossessed skilled artisan, who either never existed in many late-industrializing countries (such as Taiwan) or who was decimated by competitive imports long before industrialization began (as in India). In part, organizing is made more difficult and wages are generally kept in check by political repression. Hostility toward trade unions on the part of government and business is hardly unique to late industrialization, but it does take a particularly virulent form. The political systems of late industrialization have tended to be more authoritarian than those of earlier industrializations and labor has typically not enjoyed trade union protection or representation by a parliamentary labor party (if not consistently, then for long time periods in many countries). Even in democratic India, the caste system and other coercive mechanisms generally keep labor abject. The trade union movement in Mexico is government controlled. The different G N P growth rates that late industrializes have enjoyed, with, say, South Korea and Malaysia toward the high end of the distribution and India and Mexico toward the low end, could conceivably be explained by differences in political repression were it not for the fact that repression in late industrialization has been so general. In what follows, differences in labor repression are ruled out as a direct explanation for variations in growth rates, although their importance for a deeper understanding of the late industrialization process is incontrovertible. Despite downward pressures on wages, it might still be argued that money wages are high at international prices (and therefore competitiveness is low) because of "distortions" in the labor and foreign exchange markets. Labor market distortions may have arisen from foreign influences. In Latin American countries that experienced inward migration—say, Argentina or Brazil—administrative salaries were typically set at European levels. Consequently, wage differentials between administrative and production workers are far greater than in countries that never experienced inward foreign migration, for example. East Asia. The wage differential between managers and production workers in basic industry in South Korea is 4, 5, or at most 10 compared to an estimated ratio of 162 in Brazil. 39 In Africa, the wages of

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civil servants were also inflated as a consequence of being pegged to British and French colonial salaries. Moreover, under colonial rule the government in many African countries was the largest single employer and paid rather high wages for political reasons, thereby driving up the general wage level. 4 0 Nevertheless, most wage distortions in late-industrializing labor markets, if they ever existed, have probably been removed by the ravages of the 1980s foreign debt crisis. Real wages in Africa, for example, are estimated to have fallen by about 40 percent as a consequence of deflation. 4 1 Although the rebirth of competitiveness by 1990 in parts of Latin America is typically attributed to freer markets, it should not be forgotten that Latin American capitalists received a huge subsidy in the form of steep real-wage declines. Taking 1980 as the base year (=100), the real urban minimum wage over roughly a 10-year period fell to only 69.9 in Argentina, 50.7 in Venezuela, 45.5 in Mexico, and 23.4 in Peru. 4 2 Generally we may say that at any given moment, the wage in late-industrializing countries may deviate from its "labor surplus" trend. To some extent this deviation may reflect an efficiency consideration: labor is paid more to induce it to exercise its intelligence on the shop floor, which is necessary for efficient technology absorption. Net of this effect, there is a tendency for wages to be beaten down to the "Lewisian" trend. In what follows, it is assumed that wages approximate this long-run level. Driving Down Labor Costs Through Devaluation It is possible that with enough currency depreciation, wages will become low enough at international prices to create competitiveness in a wide range of labor-intensive industries. In practice, no country allows its currency's value to be determined completely by the forces of supply and demand in a free float. If currencies are not fixed, then they are pegged. Therefore, the realistic questions are as follows: How far can pegged exchange rates be depreciated deliberately to qualify as undistorted, or a right price? And at that more or less market-determined price, will competitiveness be attained? The US aid administration in South Korea and Taiwan pressured Seoul and Taipei to devalue repeatedly in the 1950s and 1960s. Eventually, enough real depreciation was achieved to satisfy US demands. 4 3 Even then, neither country could compete against Japan in major industries at market prices. The same inability of a real depreciation of the exchange rate to create competitiveness is likely to characterize late industrialization generally because of the limits to which real exchange rates can be devalued. Even if real wages are not already at a physiological or political minimum subsistence level, a serious limitation to real devaluation is rising prices of imported wage and producer goods. The Korean textile industry, for example, required subsidization partly because devaluation drove up the costs of its most important inputs, machinery and raw cotton. 44 Japan was better able to adopt a "beggar-thy-neighbor" exchange rate policy in the 1930s because even then dependence of its cotton textile industry on manufactured

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imports was low. 4 5 Japan was already self-sufficient in textile machinery, for example, whereas in the 1960s (and 1980s) the Koreans were not. One of the factors that allowed the Korean textile industry to be weaned from subsidies was the innovation in advanced countries of synthetic fibers. T h e K o r e a n g o v e r n m e n t then quickly moved to support the import substitution of local synthetic f i b e r m a n u f a c t u r i n g , which reduced the burden of raw c o t t o n imports on K o r e a ' s balance of payments and also raised the quality of spun yam. Selective policies such as K o r e a ' s are generally necessary to industrialize b e c a u s e the e f f e c t s of e x c h a n g e rate devaluations are blunted by their countereffects on imported inputs. Moreover, currency depreciations d o not differentiate a m o n g industries, and they cannot influence, say, bilateral trade i m b a l a n c e s . A n important part of industrial strategy and e x c h a n g e rate m a n a g e m e n t in successful late-industrializing countries is selective policies within both the traded-goods and the nontraded-goods sectors to ensure that the effects of a devaluation are positive. 4 6 Such policies represent a departure from laissez-faire and an attempt to manipulate the price mechanism in order to m a k e devaluations work. In w h a t f o l l o w s , it is a s s u m e d that after a real devaluation of the exchange rate to the level where real wages are at m i n i m u m subsistence— physiological or political—money wages at international prices are still not l o w e n o u g h to p e r m i t c o m p e t i t i v e n e s s in l a b o r - i n t e n s i v e g o o d s . Consequently, the government must use selective policies and other m e a n s to distort prices in order to industrialize. Determining the Right Prices and Avoiding Incorrect Ones It is necessary to consider briefly what the right prices m e a n insofar as government determination of the " w r o n g " prices requires a benchmark. It is also necessary to consider when the " w r o n g " prices are simply incorrect. T h e first issue has already been touched on briefly with respect to the price of foreign exchange, but here a more general discussion is presented. T h e right prices are defined below as being market determined, by the forces of supply and demand. It could, however, be argued that m a r k e t determined prices themselves are not necessarily right insofar as they ignore "market failures" (as mentioned earlier). In other words, it could be argued that rather than market prices, a set of "social" prices that take market failures such as externalities and l e a r n i n g - b y - d o i n g into account should be the benchmark for government policy. If this analytical approach were followed, late-industrializing governments would not have to "distort" market prices to compete; they would simply have to create another set of prices to guide industrialization and call them "social" prices rather than prices that deviated from free-market equilibria, or what I call "wrong" prices. I think, however, that nothing is gained by defining the right prices to include externalities and learning-by-doing. This merely adds another layer of unnecessary complexity and c o n f u s e s the issue. The main problem of late

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industrializers is that they cannot compete at market-determined prices because their productivity is so low. It only helps to bring in concepts like externalities and leaming-by-doing to justify government intervention, not to explain the problem of underdevelopment. Nevertheless, even when the right prices are accepted as being determined by supply and demand, ambiguity does not disappear. A market-determined price of capital may be influenced by how open or closed a capital market is. In standard price theory, it is assumed that the opening of a capital market will reduce capital shortage and lower interest rates. In fact, capital market openness may create competition between domestic and foreign currency assets, which pushes up the real rates on the latter given the greater degree of uncertainty and risk in domestic assets and a tendency of the currency to depreciate in real terms. 47 In any event, if one opts for open capital markets to determine the right interest rate, by the same logic one should also opt for open labor markets to determine the right wage rate, which few economists are willing to do (as pointed out by the late Carlos Diaz-Alejandro). In what follows, it will be assumed that the right or market-determined rate of interest on investment capital is determined by scarcity in the closed domestic capital market, although a closed domestic capital market does not preclude borrowing from abroad. Getting the interest rate "wrong" then means subsidizing credit below this rate. In the case of Taiwan, for example, a market-determined interest rate could be said to have been approximated more or less by the curb market interest rate. The curb rate was not determined in perfect competition because there were large, wholesale lenders, but it was still quite competitively established. Below the curb market rate was the rate set by the governmentowned commercial banks. These banks were habitually getting the interest rate "wrong" as evidenced by the fact that the commercial bank rate was consistently below the curb rate. Although some portion of the higher curb rate may have been due to greater risk, often the same large companies got commercial bank credit and curb market credit (to meet their residual credit needs), so risk could not have been a major factor in the higher curb market price they had to pay. Moreover, the nominal interest rate they received from commercial banks was higher than their effective interest rate because they on-lent to smaller firms at higher prices. 48 After South Korea's financial "liberalization" of the 1980s, the right price of capital may be said to have been approximated by the interest rate in the secondary short-term government bond market. That "liberalization" is a misnomer is indicated by the fact that whereas in May 1989, for example, the interest rate in this market was 18.9 percent, the loan interest rate of commercial banks was only 12.5 percent. 49 Obviously, commercial bank credit was still being subsidized even after "liberalization." South Korea had a three-tier financial structure for the first 25 years of its development. In the 1970s it was characterized by a real curb market interest rate (of about 20

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percent), a real commercial bank rate (of roughly 0), and a rate on foreign loans. Due to inflation and the relative constancy of the exchange rate, the real interest rate on foreign loans was negative throughout most of this period. 50 All three prices that existed side by side in Korea's capital market could not have been right, and the negative real interest rate on foreign loans was fundamentally "wrong" in a capital-scarce country. Even Thailand, with its reputation for economic liberalism, had positive real interest rates for only 24 out of 52 quarters between 1970 and 1982. A World Bank study called this performance "quite respectable" in comparison with most developing countries. 51 The right exchange rate should conform as closely as possible to a rate determined by market forces, and if East Asian experience is any guide, the "wrong" exchange rate should take this rate as its base. Setting a "wrong" rate that deviates substantially from what market forces dictate would be setting an incorrect "wrong" price, inasmuch as one of the clearest lessons to emerge from late industrialization is that monkeying around with the exchange rate is dangerous to an economy's health. Nevertheless, as Taylor points out, even an exchange rate that mirrors market forces only seems to work well in conjunction with other incentives. 52 Therefore, in what follows it is assumed that a "wrong" exchange rate is pegged as closely as possible to what the forces of supply and demand dictate but is then larded with whatever incentives and institutional supports are necessary to compete—say, protection for the home market, export subsidies, an export targeting system, and so forth. The only practical point remaining to note is that if the advanced countries also subsidize business—which they all do in varying degrees— then the benchmark used to calculate subsidies in late industrialization would have to be scaled up to account for this.

The Conditions Under Which the Wrong Prices Are Right A necessary condition for the wrong prices to succeed in generating industrial development is the imposition of performance standards in exchange for subsidies. Such standards tend to reduce the risk of rent seeking—public and private. They also tend to raise the growth rates of productivity and quality, and incremental increases in productivity and quality ultimately become the chief competitive asset of late industrializers in "mature" industries (those in which international technology transfer is available on fairly competitive terms). To the extent that productivity is higher than otherwise, trade restrictions can be lower than otherwise, which further reduces cost pressures on users of protected products. Performance standards also typically operate in conjunction with an industrial policy that is aimed at increasing industrial complexity and removing impediments that arise in the process. Two countries that successfully adopted performance-driven subsidy

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allocation principles were Taiwan and Thailand. Although Taiwan had a reputation for less government intervention than South Korea, estimates of "total effective incentives" in 1969 suggested greater government financial support for business in the former than in the latter case. 5 3 Certainly the governments of both Korea and Taiwan were instrumental in targeting special support for industries considered critical for industrial growth. A case in point in Taiwan was the integrated circuit industry. According to Se-Hwa Wu, professor of business administration at Chengchi University, The most important reason for the integrated circuit's development was the government's active involvement. Although the IC industry existed in Taiwan prior to 1967, it grew and flourished only after the government got involved, establishing a demonstration factory, organizing manpower, transferring technology, providing manufacturing services, establishing a c o m m o n d e s i g n service center, and creating a high-precision IC manufacturing facility. These actions prompted other firms to join the industry, which then grew rapidly. 54

Where Taiwan and other fast-growing late-industrializing countries distinguish themselves is not in their absence of industrial policy but in their discipline of business. As Haggard noted, 55 subsidies to Taiwan exporters in the 1960s were tied to export targets and administered by industry associations that were overseen by government agencies. These associations acted as cartels. They collected dues from members out of which bonuses to exporters were paid. Firms were allocated export targets and penalized if they fell short of their targets. Loan officers of Taiwan's state-owned banks were also held personally responsible (in terms of pay and promotion) for the credit they allocated. Consequently, they were both conservative in their lending policies—lending only to relatively large firms—and careful in their monitoring of how effectively borrowers used their credit. 56 By the 1990s, the T a i w a n government was making preferential treatment of business dependent on firms' meeting conditions related to R & D spending, personnel training, and even environmental protection standards. 57 In the case of Thailand, virtually all major investment projects passed through a statutory BOI, which gained leverage over business through its powers to grant tax exemption to favored firms under a Byzantine tax system. T h a i l a n d ' s high protective tariffs were originally designed for revenue purposes, but according to the assistant secretary general of the BOI, Mr. Chackchai Panichapat, they abetted import substitution and enabled the BOI to impose performance criteria on its clients in exchange for granting them exemptions from both corporate income taxes and customs duties on imported machinery and intermediate inputs. The BOI maintained industrywide policies that it used as a basis to determine industry-wide performance norms. After the first energy crisis, for example, the BOI changed its policy toward textile manufacturers and made further subsidies to them contingent

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on their exporting 50 percent of their output. By the 1990s, the BOI was imposing performance standards related not just to output, exports, and local content but also to product quality. For example, one standard Promotion Certificate of the BOI in 1991 specified that "the quality of the product must be in accordance with international standards," as determined by the Thai Industrial Standards Institute, which was actively involved in monitoring the quality standards of BOI clients. Not just T a i w a n and Thailand but other fast late-industrializing economies, such as Japan, South Korea, Singapore, and Malaysia, have all, in varying degrees, subsidized business contingent on the achievement of performance standards. The question then arises, What, if any, is the defining characteristic of countries whose states are both willing and able to discipline capital (and, in turn, impose standards of performance on themselves)? Income Distribution and the Quality of State Intervention While the above-mentioned question is a difficult one, I still think it is possible to predict empirically something about the quality of state intervention in late industrialization from the theory of late industrialization itself. The quality of state intervention may be said to depend on a set of objective conditions which, in turn, determines the likelihood of a process of industrialization taking root and succeeding. The higher the probability that investments in industrial development will generate positive returns (in terms of profitability, or at least employment at break-even costs), the greater the likelihood that governments will become developmental. The lower the probability of industrial success as a result of this set of objective conditions, the greater the likelihood that governments will become or remain nondevelopmental, in a vicious circle. In countries where the odds of industrializing successfully are very low—say, in Haiti—rent seeking is almost certain to get out of hand. In cases where a successful process of industrialization is by no means certain but not entirely implausible (the situation in which m a n y developing countries find themselves), the probability is greater of a developmental state emerging pari passu as industrialization succeeds. Taiwan and South Korea exemplify the second case. Their governments turned only gradually f r o m egregious rent seeking in the 1950s to d e v e l o p m e n t a l i s m . As the subsidy allocation process b e c a m e more systematic and output increased, their governments became more committed to economic development, which led to further growth, greater government commitment, and so on. In these two countries, the state both transformed the economy and, in turn, was transformed by it. 58 It should be emphasized that the situation in countries with poor industrialization prospects and, hence, relatively predatory states is not cast in stone. First of all, the situation only describes an average case, and there are bound to be exceptions. Moreover, the situation can change in response to, say, internal variations in leadership or external policies. For instance, the

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World Bank now imposes strict conditions on sovereign borrowers in exchange f o r a structural adjustment loan. If the b a n k ' s conditionality changed from demanding less government to helping governments impose their o w n p e r f o r m a n c e conditions on domestic borrowers, states in the w o r l d ' s poorest regions would probably become more developmental overnight. There is a host of possible objective conditions that may influence whether or not industrialization succeeds or fails: the size of the internal market, geography, education level, ethnic composition, external relations, and so forth. I think, however, that one characteristic stands out above all others in influencing the process of (capitalist) industrialization because its influence is intrinsically related to industrializing late—the distribution of income. A more equal income distribution raises the probability of industrial success f o r a host of reasons related to class struggle and, hence, worker motivation, the expected returns to investments in education, cost-push inflation, the effectiveness of currency devaluations, and other micro- and macroeconomic variables. To the extent that more equal income distribution increases the growth of output and productivity, it makes the state more committed to industrialization and willing to impose performance standards on business. In addition, a more equal income distribution makes the state more able to impose performance standards on business, as discussed shortly. It hardly needs to be emphasized that the issues involved in "state f o r m a t i o n " and the rise of " w e a k " or "strong" states are c o m p l e x . 5 9 Nevertheless, the distribution of income lies at the heart of any political economy, and consequently, it is almost certainly a critical factor determining the relationship between business and the state. A relatively equal income distribution is a necessary condition for late industrialization because it e m p o w e r s the state to discipline business and facilitates the state bureaucracy's monitoring of the disciplinary process. One m a y speculate that the more equal the distribution of income economywide, the higher the quality of government intervention and, hence, the faster the rate of growth of manufacturing output and productivity. In societies where income is distributed relatively unequally, the process of subsidizing business to achieve industrial transformation is more likely to be either highly erratic or fatally flawed. T h e association of equal income distribution with the state's ability to extract performance standards from capital may well transcend the issue of whether the late-industrializing state is a dictatorship or a democracy. If income is distributed unequally under dictatorial rule, the imposition of performance standards may still be relatively difficult—a case in point is the Philippines, where the income of the top quintile of the population exceeded the income of the bottom quintile by a ratio of 16.1 (see Table 5.2). 60 Similarly, if the distribution of income is quite equal, the imposition of performance standards may be relatively easy even under parliamentary

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T a b l e 5 . 2 I n c o m e D i s t r i b u t i o n (the r a t i o b y w h i c h t h e i n c o m e of t h e t o p f i f t h of t h e p o p u l a t i o n e x c e e d s that o f t h e b o t t o m f i f t h ) Year

Ratio

Industrialized Countries Australia

1978-1979

6.0

Canada

1981

9.0

Denmark

1981

9.3

France

1975

12.5

Germany

1978

6.6

Japan

1979

4.0

Netherlands

1981

5.5

N e w Zealand

1981-1982

8.8

Norway

1982

8.0

Sweden

1981

7.3

Switzerland®

1978

6.9

UK

1982

7.1

USA

1929

15.5

1951

9.0

1980

10.7

1989

13.0

te-Industrializing Countries Brazil

1982

27.7

Hong Kong

1981

12.1

India

1975-1976

10.1

Indonesia1"

1983

11.9

Mexico

1977

15.4

Philippines

1971

16.1

Singapore

1977-1978

7.5

South Korea0

1981

4.9

Taiwan Thailand

—

1975-1976

4.3 11.2

Sources: All countries except the United States (1929, 1951, and 1989), Indonesia, and Taiwan: National survey data reported in UN, "Special Study," National Accounts Statistics (New York, 1985). United States 1929 and 1951: Jeffery G. Williamson and Peter H. Lindert, American Inequality: A Macroeconomic History (New York: Academic Press, 1984). United States 1989: Congressional Budget Office, as reported in "Even Among the Well O f f , " New York Times, March 5 , 1 9 9 2 : 1 . Indonesia: A. Gelb and Associates, Oil Windfalls: Blessing or Curse? (New York: Oxford University Press, 1988). Taiwan: Statistic reported i n K u o - T i n g L i , The Evolution of Policy Behind Taiwan's Development Success (New Haven, Conn.: Yale University Press, 1988). Notes: Data for all countries are national, except as noted. a. Covers only three cantons. b. Rural only. c. Urban only.

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democracy—say, in postwar Japan, where the income of the top quintile of the population exceeded that of the bottom quintile by a ratio of only 4.1. 6 1 In democracies such as India and the United States, where the power of the state to discipline business is generally regarded as weak, it is arguable that this weakness is not the product of diverse interest groups expressing their needs. Rather, it is the product of wealthy interest groups overwhelming the authority of the state because of their control over economic resources (the income ratio of the top to bottom quintiles in the Indian and US populations was as high as 10.1 and 10.7 (13.0 in 1989), respectively, as indicated in Table 5.2). 6 2 India also e x e m p l i f i e s the case of unequal income distribution dominating society's development goal, away from rapid industrial growth toward greater income equality. In societies with relatively equal income distributions, the growth objective can be maximized with less distraction. "Post-Gerschenkron" Backwardness O n e m a y speculate further that the importance of an equal income distribution for industrial development is unique to late industrialization; that is, previous industrializations that flourished on the basis of technological revolutions may have been relatively less dependent on income equality in income distribution for their success. The rising importance over time of equality f o r industrial success relates to two characteristics intrinsic to industrializing late: first, the need for governments to subsidize business in the absence of pioneering technology and, hence, the importance of governments' possessing the power to discipline subsidy recipients; second, the i m p o r t a n c e of generating incremental productivity and quality improvements as a competitive weapon and, hence, the need to motivate managers and workers toward this exacting end. These two defining properties of late industrialization appear to be favored by income equality. Typically, a skewed income distribution reflects concentration of ownership of assets. Such an ownership pattern may be expected to undermine the disciplinary power of the state. A small class of ultrarich landowners, financiers, and industrialists has the p o w e r to manipulate the state, undermine its authority, and maintain an economy based on its own private rent-seeking activities (such as land speculation, price collusion, capital export, and so forth). Moreover, relatively equal income distribution economywide (which in countries at an early stage of industrial development is closely linked to the distribution of land and resources in agriculture) may be expected to be correlated with relatively narrow earnings differentials between managers and workers in industry. As noted earlier, the work force in most late-industrializing countries has been s u b j e c t e d generally to more political repression than in p r e v i o u s industrializations. The demoralizing effects of this may be expected to be mitigated somewhat by a better income distribution. The narrower the wage gap between managers and workers in the industrial sector, the greater the

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motivation of the work force and the higher the growth rates of productivity and quality. 63 An equal income distribution may be a necessary condition for industrializing late but is almost certainly not a sufficient one. T h e distribution of income is an economic variable, but there are political variables and other economic ones that influence the behavior of the lateindustrializing state. Moreover, depending on a country's size and natural resources, rapid industrial development may occur for limited time periods even in the presence of high income inequality. Brazil, a case in point, grew very rapidly in the 1960s and 1970s and had a ratio of top to bottom income quintiles of 27.7 (Table 5.2). But as the case of Brazil suggests, the ability of such countries to sustain growth and to respond effectively to external economic shocks may be expected to be less than in countries whose income distribution is less skewed and, hence, whose class conflict is less intense. As noted earlier, Alexander Gerschenkron's prediction that productivity growth rates are faster the more backward the country has been found to be invalid for countries falling below a certain economic threshold. 6 4 Without adequate h u m a n and physical infrastructure below that threshold, the "advantages of backwardness" seem to sour. In addition to basic "social capabilities," 6 5 the above discussion suggests that the distribution of income will also play a critical role in the process of catching up. The problem is that testing this hypothesis with respect to the manufacturing sector (which is the subject of this paper) is vexed by greater data problems than testing catch-up hypotheses for the aggregate economy in which per capita income can be used as a proxy variable for productivity growth. It is difficult to obtain any data on income distribution for most developing countries, and it is also problematic to obtain consistent data on m a n u f a c t u r i n g productivity growth for a large n u m b e r of developing countries with a time horizon that includes the 1980s (when the m a j o r manufacturing investment projects of many late-industrializing countries in heavy industry began to pay dividends). These data problems exist even when productivity growth is measured as value added per employee (corrected as best as possible for differences in hours of work) rather than total factor productivity. 6 6 Data on value added per employee in the manufacturing sector are collected by UNIDO, but data are unavailable for most of the least industrialized countries—for example, many of the African states or even some of the most advanced late industrializes, such as Argentina and Mexico. Moreover, while data exist for some countries for part of the time period in question, their accuracy is marred by hyperinflation—as in Chile and Brazil. An invariable consequence of these data problems is a sample selection bias. The results reported below pertain to a sample of 24 countries for the period 1970-1986. The sample includes some of the most industrialized countries (the United States, Canada, Australia, Austria, Germany, Italy, and

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the United Kingdom); a handful of cases that could be said to represent the end of the second Industrial Revolution (Finland, Ireland, Portugal, and Spain); and as many late-industrializing countries as data permitted (Bangladesh, Colombia, Ecuador, Hong Kong, India, Malaysia, Panama, the Philippines, Singapore, South Korea, Turkey, Venezuela, as well as Japan, which was treated in regression analysis as both a developed and a lateindustrializing country). Even with this biased sample, there was still no evidence to support the Gerschenkronian view that the more backward the country (measured in terms of per capita income or rate of gross domestic saving in the base year, 1970), the faster the growth rate of labor productivity in the manufacturing sector in subsequent years. If many of the least-developed countries had been included in the sample, the evidence might conceivably have confirmed still more strongly the direct opposite of Gerschenkron's proposition. T h e findings of the effect of income distribution on the growth rate of m a n u f a c t u r i n g labor productivity are supportive of the arguments made earlier, although the findings should be treated as preliminary for the reasons just mentioned. 6 7 When all 24 countries were included in a simple regression equation, the effect of income distribution (measured as the ratio of the income of the top quintile of households to the bottom quintile) on the growth rate of labor productivity was not all that statistically significant— the t-statistic on the ratio of income inequality was - 2 . 0 5 , but the adjusted R-squared of the equation was only 0.12. However, the results of the same regression equation restricted to only late-industrializing countries in the sample were much stronger. As Table 5.3 indicates, the t-statistic on the ratio of income inequality rose to - 2 . 9 0 , and the adjusted R-squared of the equation increased to as much as 0.38. The difference in these two sets of results suggests that the impact of income distribution on labor-productivity growth is stronger below a certain economic threshold. (The same regression equation for only developed countries in the sample yielded a t-statistic on the income inequality variable o f - 0 . 7 9 and an adjusted R-squared of 0.04.) It is noteworthy that in other regression equations for the restricted group of late-industrializing countries in the sample, the variable of income distribution had greater explanatory power by far than other plausible influences on the growth rate of manufacturing labor productivity, such as the growth rate of gross fixed capital formation (in the manufacturing sector), the growth rate of manufactured exports, the growth rate of machinery imports (a proxy variable for technology transfer), and various measures of education. Nevertheless, the performance of these variables may have been influenced by the sample selection bias—for instance, if a greater number of least-developed countries had been included, the influence of manufactured exports m i g h t have been greater. Moreover, many of the so-called independent variables tested in multiple regressions appeared to be related to one another, biasing the regression results.

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Table 5.3 Estimation of Variation in Growth Rate of Value Added per Employee Hour (labor productivity) in Thirteen Late-Industrializing Countries, 1970-1986 GVA =

Where

GVA =

5.057 (6.54)

-0.152YD (-2.90)

Growth rate of value added per employee hour in constant 1984 domestic prices

YD =

The ratio of the income of the top quintile of households to the bottom quintile

Source: UNIDO, Yearbook of Industrial Statistics (various years). Note: R2 = 0.433 Adjusted R 2 = 0.381 S.E.E. = 1.30 The values of the t-statistics are shown in parentheses.

All that can be said thus far is that the distribution of income may well be a powerful explanator of differences in manufacturing productivity growth rates among late-industrializing countries. If it is, then G e r s c h e n k r o n ' s proposition about catching up should be modified to state that among such countries, the more equal the distribution of income (rather than the greater the degree of backwardness), the faster the growth rate of manufacturing productivity. T h e r e are a host of reasons why an equitable i n c o m e distribution may be expected to impact favorably on productivity growth, not least of all those related to the quality of government intervention.

Weaning Subsidies T h e f o r e g o i n g descriptive theory about state intervention in late industrialization is incomplete for several reasons. First, no mention has been made of how the late-industrializing state responds to macroeconomic shocks and how its responses condition its long-term industrial policy. Second, no mention has been made of the process whereby late industrializers become competitive and subsidies cease. The first issue is altogether beyond the scope of this chapter. The second, the process of subsidy phaseout, would take almost as long to analyze systematically as the process of subsidy allocation. A few remarks on the subject of phaseout, however, are warranted. It has become a banality that as an economy grows more complex, the ability of government to plan and manage the subsidization process through industrial policy is reduced. Yet in an important sense the reverse is true. Because the number of new industries that require subsidization falls in rela-

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tion to the number of existing industries as an economy's industrialization succeeds, an industrial policy becomes easier, not harder, to manage. A quick look at Taiwan, South Korea, Singapore, and even Hong Kong suggests that government intervention remains active—even hyperactive—in the p h a s e of late industrialization that may be termed " n e o - i m p o r t substitution" or in the phase during which business is subsidized by the state to enter high tech and to upscale into markets of higher quality within existing industries. In the case of Taiwan, for example, 12 industries were designated by 1990 as "star industries" (rather than "strategic industries," the n o m e n c l a t u r e of the 1970s and 1980s). Star industries are to receive government support for R & D and training, which will be administered by industrial associations (just as export subsidies were administered by industrial associations 20 years earlier). Moreover, T a i w a n ' s Industrial Development Bureau has established a fund to facilitate the purchase of US companies by private Taiwanese firms. T w o of the sectors targeted are precision engineering and machine tools. 6 8 The machine tool sector is interesting because it developed in Taiwan with almost no government assistance (except for exports). 69 Apparently, however, government assistance is on the rise as the machine tool industry becomes more, not less, developed. Thus, as late industrializers march closer to the world technological frontier, the relevant question is not when all subsidies should be withdrawn but when particular ones should commence and others cease. T h e second point relates to income distribution. While systematic studies on income distribution have become rarities 70 and past works on the subject were usually not concerned with how the process of industrialization was influenced by how income was, in fact, distributed, virtually every study extant finds that income distribution worsened in the early phases of e c o n o m i c growth. 7 1 These findings of rising inequality are likely to be strengthened by the emergence of diversified business groups, which appear to be another ubiquitous property of late industrialization. 7 2 One may anticipate, therefore, that as the institution of the diversified business group becomes further entrenched, the disciplinary state will evolve in new directions. 73 The third point to note about ending subsidies is historically specific. By the 1980s the US government appeared intent on putting the subsidydependent paradigm of late industrialization out of business. Mobilized by its trade deficit, the United States, in conjunction with the Bretton W o o d institutions, launched a land, sea, and air attack against industrial policy. Because the United States was unable to adopt an industrial policy and because it was unable to compete very well against one, it appeared bent on eradicating industrial policy regimes in world markets. This hostility, however, proved a mixed blessing for late-industrializing countries to the extent that it strengthened the state's hand to discipline

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business and withdraw subsidies when they were no longer warranted. The most pragmatic answer to date to the question of when business should be weaned from a subsidy is when major trading partners won't tolerate it a minute longer. The life of any particular subsidy will increasingly become a function of the current account balance.

Notes I am grateful for the helpful insights I received from Yilmaz Akyuz, Richard Bensel, E d w a r d B u f f i e , Duncan Foley, Takashi Hikino, S. M. Naseem, E d w a r d Nell, C h r i n j i b Sen, R e h m a n Sobhan, the editors of this volume, and the swell people associated with the conferences Lance Taylor hosts on stabilization for W I D E R (Helsinki). Part of the research for this paper w a s u n d e r t a k e n in conjunction with projects sponsored by U N C T A D and ESCAP. 1. Neither G e r m a n y nor certainly the United States overtook England by means of low wages. S o m e countries have additional competitive assets in the form of natural r e s o u r c e s , which increase m a n u f a c t u r e d output if they are p r o c e s s e d . W h i l e s o m e t i m e s of great c o m p e t i t i v e a d v a n t a g e , these a s s e t s generally will be ignored in what follows because they are not present in all countries, and even in countries where they are in abundant supply, they are usually an insufficient basis on which to industrialize. 2. A l e x a n d e r G e r s c h e n k r o n , Economic Backwardness in Historical Perspective (Cambridge, Mass.: Harvard University Press, 1962). 3. Protection may be taken to mean subsidization in the most general s e n s e , i n c l u d i n g c o n c e s s i o n a r y credit and i n c e n t i v e s o t h e r than s i m p l y protection against imports. 4. J. Carter Eckert, " O f f s p r i n g of Empire: The K o c h ' a n g Kims and the Colonial O r i g i n s of K o r e a n Capitalism, 1 8 7 6 - 1 9 4 5 " (Seattle: U n i v e r s i t y of W a s h i n g t o n dissertation, 1991). 5. Dennis L. M c N a m a r a , The Colonial Origins of Korean Enterprise, 1910-1945 (Cambridge: Cambridge University Press, 1990). 6. Stephan Haggard, Pathways from the Periphery: The Politics of Growth in the Newly Industrializing Countries (Ithaca, N.Y.: Cornell University Press, 1990). 7. A l i c e H. A m s d e n , Asia's Next Giant: South Korea and Late Industrialization (New York: Oxford University Press, 1989). 8. A case in point is the steel industry, where every time productivity in the Pohang Iron and Steel Company of South Korea approached Japanese levels, the Nippon Steel C o m p a n y or Kawasaki Steel Company of Japan introduced an innovation that enabled it to retain its productivity lead. 9. R i c h a r d R . N e l s o n , " I n n o v a t i o n a n d E c o n o m i c Development: Theoretical Retrospect and Prospect," in J. M. Katz (ed.), Technology Generation in Latin American Manufacturing Industries (London: Macmillan, 1987): 7 8 - 9 3 . 10. A l t h o u g h d i f f e r e n c e s in i n f r a s t r u c t u r e across countries are w i t h o u t question an important determinant of differences in productivity, no attempt will be made to discuss their importance systematically. 11. S e g m e n t e d labor markets do not necessarily imply imperfect m a r k e t s and certainly not irrational markets. See, for example, Glen G. Cain, " T h e Challenge of Segmented Labor Market Theories to Orthodox Theories: A Survey," Journal of Economic Literature 14, no. 4 (1976): 1215-1257. 12. G. E. H u b b a r d , Eastern Industrialization and Its Effects on the West

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(London: Oxford University Press [for the Royal Institute of International Affairs], 1938). 13. Gerschenkron, Economic Backwardness, 9 - 1 0 . 14. Alfred D. Chandler, Jr., Scale and Scope: The Dynamics of Industrial Capitalism (Cambridge, Mass.: Harvard University Press, 1990). 15. Alice H. Amsden and Takashi Hikino, "Innovating or Borrowing Technology: Exploration of Two Paths Towards Industrial Development," in Ross Thomson (ed.), Learning and Technological Change (London: Macmillan, forthcoming). 16. See, for example, David Landes, The Unbound Prometheus: Technological Change and Industrial Development in Western Europe from 1750 to the Present (Cambridge: Cambridge University Press, 1969). 17. See, for example, Moses Abramovitz, "Catching Up, Forging Ahead, and Falling Behind," Journal of Economic History 46 (June 1986): 3 8 5 ^ 0 6 ; William J. Baumol, "Productivity Growth, Convergence, and Welfare," American Economic Review 76 (December 1986): 1072-1085; and Angus Maddison, "Growth and Slowdown in Advanced Capitalist Economies: Techniques of Quantitative Assessment," Journal of Economic Literature 25 (June 1987): 6 4 9 698. 18. Bradford DeLong, "Have Productivity Levels Converged?" American Economic Review 78 (December 1988): 1138-1154. 19. Typically, it is assumed that if a foreign firm produces in a developing country, this is in and of itself sufficient to ensure that productivity (of the investment project in question) will equal productivity at the world technological frontier. This is clearly not the case empirically (if only because of differences in infrastructure) and is an unwarranted assumption theoretically unless it is also assumed that productivity is the same in all multinational firms in the same industry—which is precisely the type of assumption that deserves to be criticized. (See, however, Magnus Blomstrom and Edward N. Wolff, "Multinational Corporations and Productivity Convergence in Mexico," Economic Research Reports, C. V. Starr Center for Applied Economics, New York University, 1989, for a discussion of the positive impact of the multinationals on Mexican productivity.) 20. Sidney Pollard, Peaceful Conquest: The Industrialization of Europe, 1760-1970 (Oxford: Oxford University Press, 1981): 182. 21. See, for example, UNCTAD, Trade and Development Report, 1989, part I, chap. 4; and Lance Taylor, Income Distribution, Inflation, and Growth (Cambridge, Mass.: MIT Press, 1991). 22. Hla Myint, The Economies of the Developing Countries (New York: Praeger, 1964). 23. See, for example, the classic analysis of externalities by Tibor Scitovsky, "Two Concepts of External Economies," Journal of Political Economy 62 (April 1954): 143-151. 24. Paul Baran, The Political Economy of Growth (New York: Monthly Review Press, 1962). 25. Some criticism of the "new political economy" is found in Gerald M. Meier, Politics and Policy Making in Developing Countries: Perspectives on the New Political Economy (San Francisco: ICS Press, 1991). 26. Anne O. Krueger, "The Political Economy of the Rent-Seeking Society," American Economic Review 64 (June 1974): 291-303. 27. The South Korean government, for example, attempted to make deregulated financial markets work in a way it considered to be more desirable. All banks—public and private—were required to allocate a certain percentage of their

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loans to small- and medium-sized businesses, something they appeared unwilling to do when left alone to choose their clients in the 1980s. Alice H. Amsden and Yoon-Dae Euh, "Republic of Korea's Financial Reform: What Are the Lessons?" UNCTAD Working Paper No. 30 (Geneva, 1990). 28. See, for example, Robert H. Bates, "Governments and Agricultural Markets in Africa," in Robert H. Bates (ed.), Toward a Political Economy of Development: A Rational Choice Perspective (New York: Columbia University Press, 1988): 331-358, for the agrarian debacles in Africa. 29. See, for example, Folker Froebel, Jeurgen Heinrichs, and Otto Kreye, The New International Division of Labour: Structural Unemployment in Industrialized Countries and Industrialization in Developing Countries (Cambridge: Cambridge University Press, 1980). 30. Alain Lipietz, Mirages and Miracles: The Crisis of Global Fordism (London: Verso, 1985). 31. See Miyohei Shinohara, Growth and Cycles in the Japanese Economy (Tokyo: Institute of Economic Research, Hitotsubashi University, 1972). 32. Raymond Vernon, "International Investment and International Trade in the Product Cycle," Quarterly Journal of Economics 80 (May 1966): 190-207. 33. In 1960, 1965, and 1970, clothing accounted for roughly 35 percent of Hong Kong's domestic exports (which exclude reexports). This percentage was four or five times higher than the share of clothing in the manufactured exports of either Taiwan or South Korea in the same period. See Tzong-biau Lin, Victor Mok, and Yin-ping Ho, Manufactured Exports and Employment in Hong Kong (Hong Kong: Chinese University Press, 1980), for data on Hong Kong's exports. 34. As described by Albert O. Hirschman, The Strategy of Economic Development (New Haven, Conn.: Yale University Press, 1958). 35. Barry Herman, "International Finance of Developing Asia and the Pacific in the 1990s" (Department of International Economic and Social Affairs, United Nations, New York, 1991, Mimeographed). 36. For the case of Thailand, see Karel Jansen, "Thailand: The Next NIC?" (Institute of International Affairs, The Hague, 1990, Mimeographed). 37. Alice H. Amsden, "The Public Sector in Industrialization: Examples from North- and South-East Asia" (Paper prepared for UNCTAD Secretariat, Geneva, 1991); and S. Gomez and J. Echenrique, La Agricultura Chilena (Santiago, Chile: FLACSO, March 1988). 38. W. Arthur Lewis, "Economic Development with Unlimited Supplies of Labour," Manchester School (May 1954): 139-191. 39. Paolo R. Souza, "Wage Disparities in Urban Labour Markets," CEPAL Review (January-June 1978): 199-224. 40. Alice H. Amsden, International Firms and the Labour Market in Kenya (London: Frank Cass, 1976). 41. Gerald K. Helleiner, "Structural Adjustment and Long Term Development in Sub-Saharan Africa," LD'A-QEH Development Studies Working Papers No. 18 (Oxford University, March 1990). 42. ECLA, Preliminary Overview of the Economy of Latin America and the Caribbean (Santiago, Chile: United Nations, September 1991). 43. For the Korean case, see David C. Cole and Princeton N. Lyman, Korean Development: The Interplay of Politics and Economics (Cambridge, Mass.: Harvard University Press, 1971). 44. In 1961, a devaluation increased cotton prices by 29.5 percent in one month. Amsden, Asia's Next Giant, 65. 45. Mitsubishi Economic Research Bureau, Japanese Trade and Industry: Present and Future (London: Macmillan, 1936).

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46. On selectivity, see Howard Pack and Larry E. Westphal, "Industrial Strategy and T e c h n o l o g i c a l Change: Theory vs. Reality," Journal of Development Economics (June 1986): 87-128. 47. Yilmaz Akyuz, "Financial Liberalization in Developing Countries: A Neo-Keynesian Approach," U N C T A D Discussion Paper No. 36 (Geneva, 1991). 48. Tyler S. Biggs, "Financing the Emergence of Small and Medium Enterprise in Taiwan: Financial Mobilization and the Flow of Domestic Credit to the Private Sector," Employment and Enterprise Policy Analysis Discussion Papers No. 15 (Washington, D.C.: Employment and Enterprise Development Division, O f f i c e of Rural and Institutional Development, Bureau of Science and Technology, U S Agency for International Development, 1988). 49. Amsden and Euh, "Republic of Korea's Financial Reform." 50. Yung Chul Park, "Korea's Experience with Debt Management," in Gordon W. Smith and John T. Cuddington (eds.), International Debt and the Developing Countries (Baltimore: Johns Hopkins University Press, 1985): 2 8 9 327. 51. James A. Hansen and Craig R. Neal, "A Review of Interest Rate Policies in Selected Developing Countries," World Bank Financial Unit, Industrial Department, 141, September 1984: Annex 6,3. 52. Lance Taylor, Varieties of Stabilization Experience: Towards Sensible Macroeconomics in the Third World (Oxford: Clarendon, 1988). 53. Ching-yuan Lin, Latin America v.*. East Asia (Armonk, N.Y.: M. E. Sharpe, 1989), based on estimates in Bela Balassa and Associates Staff, The Structure of Protection in Developing Countries (Baltimore: Johns Hopkins University Press for the World Bank, 1971). 54. S e - H w a Wu, "The Integrated Circuit Industry," in N. T. Wang (ed.), Taiwan Enterprises in Global Perspective (Armonk, N.Y.: M. E. Sharpe, 1992). 55. Haggard, Pathways from the Periphery. 56. Biggs, "Financing the Emergence of Small and Medium Enterprise in Taiwan." 57. Carl J. Dahlman and Ousa Sananikone, "Technology Strategy in Taiwan: Exploiting Foreign Linkages and Investing in Local Capability" (Washington, D.C.: World Bank, 1990, Mimeographed). 58. For Taiwan, see A l i c e H. Amsden, "The State and E c o n o m i c Development in Taiwan," in Peter Evans, Dietrich Rueschemeyer, and Theda Skocpol (eds.), Bringing the State Back In: States and Social Structures; Research and Implications of Current Theories (Cambridge: Cambridge University Press, 1985): 7 8 - 1 0 6 . 59. Charles Tilley, Stales, Capital, and Coercion (Oxford: Basil Blackwell, 1990); and Gianfranco Poggi, The State (Stanford, Calif.: Stanford University Press, 1991). 60. The United Nations publication cited in Table 5.2 reviews available national surveys on income distribution. Most surveys cover households. 61. United Nations, "Special Study," National Accounts Statistics (New York, 1985). 62. It is noteworthy that within India, growth has tended to be fastest in the Punjab, a region with one of the most equal income distributions. 63. One may also argue on theoretical grounds that greater income /'«equality is conducive to higher productivity growth. If wages and salaries are distributed too equally, managers may not be motivated to work hard. If savings are a positive function of income and are undertaken mainly out of profits, then more unequal income distribution may stimulate savings, investment, and productivity. Nevertheless, even in those capitalist countries where the wage gap

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between m a n a g e r s and workers is relatively small—Japan and South Korea, for e x a m p l e — m a n a g e r s still earn at least four times more than workers on average and may earn nonpecuniary benefits as well, such as a shorter work week, a free car, and an entertainment allowance. Provided income inequality (even within a reasonable range) is d u e to relatively high profits rather than rents, it m a y be expected to generate higher savings ceteris paribus. Other things, however, may not be equal, such as investment opportunities, and these may o v e r w h e l m the favorable effect on savings and investment of income inequality. Edward J. Nell, Prosperity and Public Spending ( L o n d o n : U n w i n and H y m a n , 1988), a n d Transformation, Growth, and Effective Demand (London: Macmillan, 1991). 6 4 . See, for e x a m p l e , Steve D o w r i c k and N o r m a n Gemmell, "Industrialisation, C a t c h i n g U p and E c o n o m i c G r o w t h : A Comparative S t u d y Across the W o r l d ' s Capitalist Economies," Economic Journal 101 (March 1991): 2 6 3 - 2 7 5 ; and DeLong, "Have Productivity Levels Converged?" 65. T h e term is that of Abramovitz, " C a t c h i n g Up, Forging Ahead, a n d Falling B e h i n d . " 66. See David Dollar and Edward N. Wolff, "Convergence of Industry L a b o r Productivity A m o n g Advanced E c o n o m i e s , 1 9 6 3 - 1 9 8 2 , " Review of Economics and Statistics 7 0 ( N o v e m b e r 1988): 5 4 9 - 5 5 8 , for this methodology applied to the most advanced countries. 67. T h e s e f i n d i n g s are the product of the first stage of a larger research project I am undertaking on Asian integration and productivity for E S C A P . The data on income distribution are generally from United Nations Statistical O f f i c e , "Special S t u d y " (1985) or United Nations, Human Development Report (1990). The data on value added and number of employees are from UNIDO, Yearbook of Industrial Statistics (various years). The data on hours of work are f r o m International L a b o u r Organisation, Yearbook of Labour Statistics (various years). 68. O E C D , Industrial Policy in OECD Countries: Annual Review, 1990 (Paris, 1990). 69. Alice H. A m s d e n , "The Division of Labor Is Limited by the T y p e of Market: T h e Case of the Taiwanese Machine Tool Industry," World Development 5, no. 3 (1977): 217-233. 70. See, however, Lance Taylor, Income Distribution, Inflation, and Growth (Cambridge, Mass., M I T Press, 1991). 71. S e e the literature survey by Irma A d e l m a n and Sherman R o b i n s o n , " I n c o m e Distribution and D e v e l o p m e n t , " in Hollis Burn Chenery and T . N . Srinivasan (eds.), Handbook of Development Economics, vol. 2 ( A m s t e r d a m : North Holland, 1989): 9 4 9 - 1 0 0 3 . 72. A m s d e n , Asia's Next Giant. 73. In South K o r e a , the largest big business groups have pressured the g o v e r n m e n t to reduce its controls over them. In some cases, the Federation of Korean Industries, the mouthpiece of big business, has even appeared willing to f o r e g o subsidies in o r d e r to m i n i m i z e g o v e r n m e n t monitoring. Nevertheless, even as aggregate economic concentration has increased and even as the political system has been d e m o c r a t i z e d , the Korean government still maintains strong discipline over capital. In 1991, for example, it made preferential support to the largest b u s i n e s s g r o u p s contingent on their each specializing in only three product areas. The aim is to increase efficiency and equality by freeing up more industries for small- and medium-sized enterprises. Even if this condition for preferential subsidization is subsequently rescinded, which is quite possible and probably desirable, its p r e s u m p t u o u s n e s s says a lot about the state's residual disciplinary p o w e r s .

.6.

The Role of Governments and Markets: Comparative Development Experience GUSTAV RANIS

In attempting to tackle the hoary issue posed in the title of this chapter, it is deceptively easy to be drawn into purist stances. Deepak Lai, 1 for example, considers all development economics to be misguided because it at times advocates a role for government in overcoming market failure, while Gunnar Myrdal, 2 on the other hand, sees the absence of intervention as inevitably causing systems to cycle away from both growth and equity because of the prevalence of market failure. When one looks beneath the polemics, one usually finds that those who come down on the side of markets don't really mean laissez-faire and those who come down on the side of governments don't really mean centralized planning. Thus, there is hope. And we indeed find Peter Bauer discussing the need for suitable institutional frameworks that must be creatcd by government,3 in addition to government's providing the agreed-upon basic public goods and the effective administration of monetary and fiscal policies. And we have Raul Prebisch praising the role of the market in order to keep the import-substituting policies of Latin American governments subject to some discipline by international prices.4 Shouldn't we then yield to temptation, waive the entire question or agree to some papered-over convergence? Not quite yet—even if the search for a reasonably time- and place-specific compromise undoubtedly takes us closer to the truth than do the extreme archetypical positions taken by some of our more polemical colleagues. In other words, and not surprisingly in our profession, there is no the answer; equally unsurprisingly, it depends— specifically on a developing country's initial conditions as well as on the stage of transition it has managed to reach. We intend to illustrate this point by appealing to some comparative country experience. It is probably not necessary here to replay the fact that the typical East Asian society has done extremely well in terms of development performance over the past four decades; or that the typical Latin American country, by and large, in spite of its superior initial material wealth, has done less well; or that at least some Southeast Asian countries

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are fast threatening to become successors to the East Asians in terms of what is normally called developmental success. It might instead be more worthwhile to examine the whys and wherefores of this differential historical performance in relation to the basic issue to which this paper is addressed. In other words, we believe that the relative roles of markets and government can only be sensibly addressed in a typologically and historically sensitive context. Let us be a bit more specific. It is not very controversial to observe the empirical, stylized fact that developing countries, in navigating their respective paths to modern economic growth, seem to pass through certain subphases, i.e., a seemingly metamorphic process characterized by changing rules of the game, occurring in a more or less well-defined, if not monolithic, sequence. The existence of such subphases and various systems' success or failure as measured by some agreed-upon combination of growth and equity objectives is, we believe, strongly influenced by a number of exogenous factors, including, prominently, the so-called initial conditions among which one must include dimensions of the resource endowment as well as some relevant organizational/institutional features of the landscape. Still speaking inductively, we may also note that different types of developing countries seem to choose somewhat different sequences of these subphases; i.e., there is no inevitability about any universal or fixed historical path. And this brings us to our basic hypothesis—that the characteristics of the critical early subphase as well as the sequence subsequently chosen are both related to differences in the initial conditions when the developmental "curtain" rises. This, we hope to show, is highly relevant to the central topic of this chapter. It is realistic to imagine a variety of developing countries emerging from their colonial antecedents at different points in time and each somehow forced to create an economy out of a mixture of disparate economic agents spread across a sometimes ill-defined set of boundaries, with mercantilist natural resource, transport, and trade patterns having to be cut and reliance on the market, associated with that colonial regime, having to be abandoned. Let us also assume, not unrealistically, that the newly independent government typically does not start out as predatory, with its own venal objectives, but is essentially platonic in character. Wherever it turns, the tasks facing it are formidable. The creation of a physical infrastructure that serves the perceived development objectives of the society instead of those of a foreignerdominated colonial system, the capture and reallocation of export earnings, the building of new financial institutions catering to private households, the structuring of educational and health services to serve the needs of a developing society—all this plus much more represent elements of a daunting assignment for an inexperienced set of politicians and bureaucrats. Even the recognition of property rights, the establishment of a generally recognized commercial code, the removal of internal trade barriers, the

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acceptance of one official language, and the sovereignty of one central government represent by no means trivial tasks in many contexts. Add to this a certain admixture of euphoria and overconfidence on the part of the new government in its ability to not only "throw the colonial rascals out" but to restructure resource flows and institutions quickly and efficiently, and one has all the elements necessary for the excessive interventionism that has been empirically observed. The latter is thus seen to be partly due to the ideological rejection of a market that seems to have "failed" by virtue of its colonial "guilt by association" and partly due to the practical requirements of socioeconomic overheads, institutions, etc., which need to be created virtually overnight. The early import substitution subphase may therefore be viewed in part as a nationalistic act, e m b o d y i n g the repudiation of market-oriented dependency but with ideology and economic expediency reinforcing each other. The new domestically oriented industrial sector is seen as the only way of creating an alternative to the colonial agrarian past, in addition to achieving the well-known Listian economic objectives. T w o additional points need to be emphasized. One is that the extent of the perceived or actual need of governments to take care of things by acrossthe-board interventions will, of course, differ markedly across space and time. The more deficient the post-colonial "preconditions," the more governments will feel that they have to try to patch things up and assert themselves—and consequently, ceteris paribus, the more severe the critical interventionist subphase of early import substitution is likely to be. Moreover, for countries starting out somewhat later, we can reasonably assume (and observe) that some learning has taken place. But we must also recognize that the initial extent of government intervention, i.e., during early import substitution, should not be viewed as an isolated event but as likely to affect habits and expectations in the future. It may even effect a change in the nature of the government, from platonic to predatory, as it achieves a taste for the potential direct and indirect benefits of setting its own agenda. Although early import substitution, if with varying degrees of severity, seems to have been a shared experience of virtually all developing countries, what happens at its inevitable end represents an important societal decision instructive for our purposes. The majority of developing countries, including the Latin American and Southeast Asian cases, continued with a n e w (secondary) import substitution subphase, shifting production toward durable consumer and capital goods and the processing of intermediates, while the East Asians opted for an export substitution pattern, basically focusing on the exportation to international markets of the same nondurable consumer goods previously supplied to domestic markets. The fact that import substitution therefore proved to be briefer and milder in East Asia than in Southeast Asia and Latin America, in that order, is, we believe, not an accident. Nor is the fact that there has been a continuing marked divergence in

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the roles of markets and governments in these three types of developing countries since. In the next section of this chapter, I explore the impact of differing initial conditions on these choices during the (common) early import substitution subphase. From there, I carry that story forward into the (diverse) export orientation period. Some final thoughts are offered in a concluding section.

Government and Markets During Early Import Substitution It is time to be more specific. In addition to such initial conditions as size and endowment, which can be more easily measured, systems differ with respect to their institutional/organizational heritage, i.e., national cohesion, geographic situation, cultural homogeneity, etc. Here the contrast a m o n g developing countries in the early stages is quite clear. For example, at one e x t r e m e the Philippines, having suffered two demoralizing colonial e x p e r i e n c e s , was, and continues to be, characterized by substantial geographic, cultural, regional, topographic, and language diversity, plus a lack of secure integrated national moorings, all of which adds up to a formidable obstacle to its development. The Latin American countries clearly are similarly situated, and while they gained political independence m u c h earlier and there exist, of course, large differences among them, we frequently find a persistent wide gap between their indigenous and immigrant populations, as well as pronounced regional diversities in language, culture, ethnicity, etc., illustrated perhaps most vividly by the cases of Brazil and Peru. In Latin America, moreover, the colonial regimes were typically interested mainly in extractive enclaves, with most of the infrastructure focused on facilitating these activities, as a consequence leaving less of value for independent development in their wake. The East Asians find themselves at the other extreme. As is well known, they inherited a relatively poor natural resource base and a heavily surplus labor condition; but they also found themselves with a substantial amount of physical and organizational infrastructure, especially in the rural areas, as a consequence of the Japanese colonial regime's historical interest in increased yields from food-producing agriculture. This manifested itself in substantial attention to irrigation, rural power, and road construction, and the creation of farmers' associations. The colonial power also exported to its colonies its preference for a fairly equal distribution of land. Moreover, the East Asian populations must be considered extremely homogeneous in spite of some early tensions (e.g., between mainlanders and Taiwanese), with an internal solidarity further cemented by outside threats. Southeast Asia finds itself in an intermediate position. Thailand had no direct colonial experience from which to break away and had a reasonably homogeneous population; plus it had the advantage of a monarchy and a top-

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d o w n "restoration," if not quite Japanese style. This helped provide a focal point for national reforms, permitted the system to overcome the opposition of disparate interest groups and a succession of military coups, and yet rendered feasible the maintenance of a national social contract. Prior to World War II, rice and silk were the major colonial exports, but there was much less attention paid to such things as irrigation and farmers' organizations, i.e., the construction and maintenance of physical and organizational infrastructure in the rural areas. Ethnic homogeneity was markedly less pronounced in Indonesia and Malaysia, although centrifugal geographic, ethnic, and ideological pulls were much more pronounced. In summary, we may conclude that the initial conditions in place in Latin A m e r i c a and, to a lesser extent, Southeast Asia required more reorientation toward the rural sector and toward national development objectives generally than in East Asia. Thus, there probably existed a larger objective need for postcolonial governments to play an interventionist role in these more "typical" circumstances in terms of both the social and physical infrastructural deficit that had to be made up. A second, related, if more ephemeral, component of these initial conditions, which undoubtedly affects both the length and severity of the import substitution subphase across our three types of developing countries, is what Simon Kuznets defined as the extent of "nationalism" (i.e., "a claim of a community of feelings crowned on a common historical past and its historical heritage—in its extreme form, an overriding claim of allegiance of the m e m b e r s to the larger community and sovereignty vis-à-vis all groups beyond that national unity"). 5 This can be translated into such issues as welldefined geographic boundaries, a common language, ethnic homogeneity and cultural cohesion, all images that make for the existence of an organic unity, a kind of cultural cement, which, to the extent it preexists, does not have to be created. As we have noted, this is very much less in place in the Latin American countries where there are strong ethnic and language diversities, from large Indian populations to white immigrant classes, very much in evidence, especially in the Andean countries. Clearly, while Latin America has had more time since its earlier political independence to provide the societal cement, it is fair to say that many regional and ethnic minorities (Brazil's northeast and Peru's Altiplano) continue not to feel full partners of the larger national community. There consequently has existed a much stronger need to address these heterogeneities in race, geography, and language. While it is hard to quantify such so-called institutional/organizational factors, there can be little doubt that a felt need to create a synthetic type of nationalism, where the organic variety did not sufficiently preexist, very much affects the size of the government effort relative to the use of markets during this early, generally interventionist, subphase. There is a naturally strong tendency for governments to overpromise and overcommit and, often

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as a consequence, to be less able to carry out their basic developmental functions successfully. This, in turn, may result in a loss of credibility early in the game. Therefore, the gift of an initially strong national identity, coupled with substantial freedom of individual action, can be contrasted with the need to search for such identity, often coupled with much posturing and indeed even intentionally "visible" interventions by governments on behalf of a usually increasingly skeptical public. Perhaps one way of putting it is that the typical East Asian citizen thinks of himself as having certain obligations to the state, feels the need to reach a consensus with his fellow citizens, and endeavors not to make too many unreasonable demands on his government. The state is viewed as more than an honest traffic cop—as having its o w n highly moral platonic objectives. All this stands in some contrast to the typical Latin American citizen w h o thinks of himself more as having to exercise his rights in a struggle with other interest groups, while petitioning an increasingly suspect government to provide this or that favor as quickly as possible and for as long as possible. The same basic confidence in the state does not exist because it is viewed as a dishonest traffic cop, favoring the Cadillacs on the road or, worse, having its own predatory agenda. T h e epoch of modern economic growth has been associated with an attitude that emphasizes the use of science and technology as a routinized way of generating substantial changes in the per capita product. The implied massive flow of new products and technologies is usually associated with a gradual increase in the role of various markets. Yet, perversely perhaps, in the process of transition to that very modem growth epoch, the inheritance of initial conditions may bias societal choices excessively against such a trend and in favor of continued government intervention. The claims of a community to be grounded in a common historical and cultural heritage arise in part as a natural consequence of its opposition to colonialism. The community therefore often rejects not only the objectives of colonialism but also its instruments and thus intrinsically inherits a bias against the market, embodying a greater faith in the powers of government intervention in both the economic as well as the more obvious political spheres. The understandable desire to break down regionalism and feudalism and to create what used to be called those essential "preconditions" for moving forward are, moreover, often accompanied by the avowed desire to achieve quickly some degree of ex post equality among individuals that can only be guaranteed by g o v e r n m e n t intervention. M a n y of the intrusions of government during the early postindependence era, such as the direct allocation of credit, foreign exchange, and food rations, indeed often carry such official egalitarian justifications. Here again, that concept has a very different meaning in East Asia than in Latin America, with Southeast Asia once more in an intermediate position. Egalitarianism in East Asia means "to each according to his contribution," tantamount to a plea for equality of

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opportunity—as evidenced in the competitive school examinations system, civil service appointments and promotions, etc. Egalitarianism in Latin America, on the other hand, comes close to a plea for an "after the fact" equalization of income and wealth through the redistributive fiscal and/or confiscatory powers of government. Governments can help create the institutions under which the East Asian type of egalitarianism can flourish; they find it very difficult—even on the assumption that they really try—to convert Latin American-type egalitarian promises into any sort of reality. All this provides additional reasons for governments to assume a seemingly larger, if in fact increasingly ineffective, role in the Latin American case. In short, unduly high expectations typically culminate in unusually brief honeymoons, followed by a downward cycling period of skepticism and disillusionment with a government that just does not have the requisite capacity to make all those expected wise judgments and allocative decisions. We should also recall that there usually exist considerable doubts in the early postindependence period with respect to the availability of the required human resources in the private sector and their ability to accept risks and to p e r f o r m well on other aspects of the entrepreneurial function. T h i s accentuates the tendency to look to the public sector to carry out the early entrepreneurial function, banishing not only colonial objectives but also neocolonial monopolistic temptations. Thus, in order to assure, by means of a careful selection of instruments, the safeguarding of the patrimony of nature for good national purposes, to assist the downtrodden working class in its struggle against predatory TNCs, to enact welfare legislation and thus shift the burden of safety nets from the family, the state feels it has to step in. And, in the realm of ideology, all this is usually coupled with a strong natural tendency to try to assert intellectual and economic independence, along with the political. It should be clear how all this is likely to add up to the adoption of a very understandable potpourri of policies and habits that, once embedded, may be hard to break out of. In contrast, the developmentalist states of Roy Hofheinz and Kent Calder, 6 relatively insulated from political pressure groups, do not just happen but are very much a function of the kind of preexisting organic nationalism that leads to an attempt to effect the regional, political, and ethnic integration of a population that supports the g o v e r n m e n t without e x p e c t i n g too much from it. Lloyd R e y n o l d s , 7 reviewing the record of forty LDCs, concludes that the single most important e x p l a n a t o r y variable for success was political organization and the administrative competence of government. Thus, when various constituencies early on have great faith in a government's ability to utilize its resources for the common good, based on technocratic and not just political principles, the decision seems easy. But once this faith erodes, the choices become much more difficult. Once the easy import substitution subphase of development eventually runs out of steam, those who can afford to persevere, because they have good

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natural resources and/or good foreign friends, are apparently inclined to do so—even when the bottom line performance is found wanting. This is where the Latin American model becomes most relevant. On the other hand, systems that have more severe resource constraints will earlier on begin to recognize the possibility of government failure along with market failure and m o v e more quickly toward a more flexible "mixed economy" setting, including the provision of a larger role for markets. Thus, the extent to which we see a continued reliance on government intervention and a shift toward the greater use of the market as an instrument for achieving postcolonial objectives is very much related to the natural resource endowment, as well as, over time, the ability to attract foreign capital, no questions asked, to keep the system going. But the empirical fact is that there seems to exist some tendency, virtually everywhere, if proceeding at different rates of speed and with smaller or larger oscillations, to move toward policies that tend to accommodate rather than replace or obstruct the market. But as virtually all developing societies emerge from this early subphase and adopt a more open and export-oriented stance, once again the aforementioned differences in initial conditions affect the specific economic/ organizational choices that emerge, as well as the bottom line success of the effort.

Government and Markets During Export Orientation Turning to the marked divergence in performance once different types of countries are forced to move outward at the end of early import substitution, we are all familiar with the fact that East Asia did very much better than Latin America, with Southeast Asia again somewhere in between. What can we say about the relative roles of government and markets versus the continued heavy hand of the initial conditions during this period? There are those who wax eloquent about what they perceive as the unique shift in East Asia to pure laissez-faire, in contrast to continued extreme interventionism in Latin America, hinting at a simple causal relationship that is likely to be way off the mark. For one thing, it seems clear that if one bluntly measures the extent of the overall intrusiveness of government, the East Asians have hardly been less active than their Latin American counterparts. For another, in spite of trying very hard, World Bank and IMF economists have not been able to establish econometrically valid relationships between market orientation and developmental success. It is therefore perhaps more useful to examine whether or not the habits and rigidities of an earlier day continue to restrict the degree of freedom of governments over time and determine not so much the extent of intervention but the extent to which changing policy mixes accommodate or obstruct underlying conditions of domestic growth and international competitiveness. The amount of government intervention, in other words, clearly needs to be

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weighed by some measure of the flexibility and pragmatism of those interventions, not their absolute number and size, i.e., how they help people to organize themselves in both the public and private sectors and with what effectiveness. The East Asian cases are again found at one extreme. Starting off with a much larger dosage of organic nationalism and thus a relatively shorter, milder version of the import substitution syndrome, they were able to move gradually outward, with the help of the continued liberalization of various markets. This is, however, a far cry from anything necessarily approaching a reduced role of government or an ideological commitment to laissez-faire. In fact, I would be prepared to argue that the role of government became increasingly important in the course of the 1960s, 1970s, and 1980s in East Asia. The critical issue then became the government's capacity to institutionalize policy change in the sense of being able to effectively redirect a society's human and natural resources at a few critical (vertical) pressure points rather than attempting to continue to control a large number of horizontal decisions across the board. Most observers are familiar with the famous Nineteen Points of reform on Taiwan in the early 1960s, including the establishment of a unitary and relatively flexible exchange rate system, the reduction of deficit financing, the control of monetary expansionism, interest rate reform, the shift from quantitative restrictions to tariffs, etc. But what is perhaps less well understood is that there never occurred anything approaching full elimination of protection, which even today remains substantial. The government continued to provide political favors to specific industries, both overtly and covertly, increasingly through credit allocations, or interest rate differentials, extended to favored firms through the government-owned banking system and by exempting certain new strategic industries from corporate taxes, for example. The pattern of government interventions has indeed reflected an awareness that the increased competitiveness of domestic producers is crucial for the ultimate penetration of foreign markets, initially with labor-intensive goods, while domestic consumers could continue to be exploited as long as politically feasible. Only when domestic entrepreneurs had demonstrated their enhanced competitiveness in foreign markets could they be expected to overcome their fear of going head to head with foreigners in the domestic market, especially when some ease of domestic entry had been permitted. Part of the pragmatism of government intervention in evidence here is that as a system becomes more complicated in terms of both the domestic and the exported output mix made possible, it also becomes increasingly difficult for that government to make sensible decisions on selective import controls, preferential target industries, tariff allocations, etc., just because of the increased complexity of the industrial structure. Thus, a system's very success in terms of growth and moving along the so-called flying geese pattern means that import controls must be gradually liberalized, tariffs must

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be increasingly harmonized, credit allocations rendered less individual-fimi oriented, and tax rebates increasingly standardized. Such public-sector flexibility is also illustrated by the continued encouragement of the decentralization of industry (i.e., the rural off-farm activities so crucial to the success of Taiwan's development), through not only the allocation of government infrastructural facilities—roads, electricity, etc.—on an "even keel" (i.e., not favoring the urban areas), but also the creation of industrial estates and other facilities in the rural areas. The establishment of export processing zones and the encouragement of bonded warehousing as an extension of the export processing concept should also be cited, as should the credit and technology network provided through the JCRR at the center, linked to local farmers' associations, encouraging the growth of off-farm industrial and service activity, based on domestic as well as imported raw materials. The credit market is another case in point. In both Korea and Taiwan, there has persisted a system of direct credit allocations throughout the period until this day. In fact, the so-called "commercial" banking system in both countries is very much a misnomer, i.e., domestic banking remains largely a public-sector activity, with allocations continuing to be directed toward particular firms, especially in the case of Korea. The same may be said for the relative role of public enterprises, which continues to be fairly substantial relative to other developing countries generally viewed as less market oriented. With capital markets still relatively underdeveloped in East Asia, governments appear to be willing to continue to invest in so-called natural monopoly areas, when that concept is extended to include working under the constraints of a still-inadequate private financial intermediation network. Such an increased role of government in the midst of continued liberalization became even more evident in East Asia once the successful labor-intensive industrial export drive had culminated in the exhaustion of the initial rural labor surplus, a rise in wages, and a shift toward what might be called secondary import and export substitution. We can see this most clearly in the fields of education, science and technology, as well as in agriculture, all areas sensitive to the continuous emergence of new problems, as transition growth entered a new subphase. In Taiwan, for example, compulsory education was extended to nine years in 1968, with vocational education and manpower training increasingly promoted. In Korea, the Korea Institute of Science and Technology was established in the late 1960s. In both countries, traditional science and technology institutes were revamped, with new organizational criteria established, i.e., linking performance to the ability to attract private-sector contracts rather than being allowed to pursue internal "big science" oriented objectives. The increased role of the government in responding to the squeeze on physical infrastructure as a consequence of rapid past growth is conventional enough. Less conventional is the need to devise a coherent strategy (and provide the fiscal and human

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resources) for encouraging research and development, for introducing new financial structures, for providing for education, health, and other public goods as required by a changing endowment picture. In other words, appropriate institutional policy change is increasingly essential to the flowering of productive private activities as the economy moves up the ladder and becomes a would-be producer and exporter of more sophisticated technology and skill-intensive industrial and service-sector activities. The same flexibility in the type of intervention by government needed to accommodate changes in the private economy and thus permit the market mechanism to function better can be illustrated in T a i w a n ' s agricultural sector. In the early 1950s, a well-known, three-tier land reform was instituted, which consisted of a reduction in rents, the parceling out of government land, and the redistribution of land to the tillers. By 1970, once labor surplus had been exhausted, a new land reform had to be initiated, this time including the promotion of joint farm management, contract farming, the enlargement of farm size through land consolidation schemes, and other realistic responses to the changing factor endowment. The East Asians seem to generally have had the capability of avoiding the strategy of forcing growth beyond its "natural" levels by pursuing growth-activist policies and by the extensive deployment of covert means of transferring incomes from one group to another. Thus, in addition to the specific interventions of government being more vertical, flexible, and pragmatic, it is also true that, in contrast to Latin America, there was in evidence a persistent, continuing emphasis on relatively lower government deficits, a greater sensitivity to inflation, relatively lower rates of money growth, more positive real rates of interest, and the maintenance of more flexible exchange rates. This pronounced trend toward the depoliticization of macroeconomic policies went hand in hand with an increasingly important role for g o v e r n m e n t in institution building and the a c c o m m o d a t i n g organizational policies already referred to. There were, of course, differences between Korea and Taiwan that can also be instructive in the context of this discussion. In Taiwan, for example, growth rates were permitted to decline after each of the two oil shocks of the 1970s before recovering to their "normal" high levels. In Korea, on the other hand, the macroeconomic policies of government were geared more toward trying to maintain growth following such shocks, with the help of statesupported investment programs, especially in the heavy and chemical industries, financed to a large extent by foreign borrowing. There was much more evidence in Korea of an impatience with any reduction in historical performance rates of growth of output or exports and a greater willingness to push the accelerator of expansionist government policies. The extent to which this might have been related to the apparently stronger relative historical performance of North Korea relative to mainland China must be left to speculation.

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The Latin American case, in contrast, fueled by a much longer period of import substitution and leading to a much fuller ossification of the habits of government, has also been witness to a much more persistent, across-theboard type of intervention, not necessarily accommodating but more likely frustrating enhanced market activity. Typically, growth has been promoted during good times and an effort made to maintain it at high levels at all costs in the face of deteriorating external environments. Such a strategy has clearly involved patterns of increased expenditures through deficit financing and additional money creation by the banking system, plus a greater willingness to engage in external borrowing leading to debt crisis problems in the more recent period. The usual consequence has been balance-of-payments crises, followed by renewed liberalization efforts, but overall lower, sometimes even negative, growth rates. Until the last few years, Mexico constituted a good example of such an era of expansionary macroeconomic policies combined with an unwillingness to make accommodative institutional changes, such as reexamining the ejido system in agriculture, tackling forbidding quantitative import controls, and refusing to accept the pressure to join G A T T . The ability of Mexico not only to use its own traditional export earnings, especially oil, but also to be the object of ample capital inflows, especially c o m m e r c i a l bank capital, during the 1970s permitted an essentially unchanged package of government interventionist policies to be sustained. This meant a very narrowly based monopolistic private sector, supported by a substantial volume of government across-the-board interventions, most famous of which was Rule 24, forbidding importation of anything that could remotely be produced domestically, virtually regardless of relative costs. Balance-of-payments crises, bound to occur in this setting, were responded to by reimposing controls and thus spawning inevitable major devaluations. S u c h g o v e r n m e n t growth, "activist" behavior through e x p a n s i o n a r y macropolicies, continued across-the-board interventions, and the relative absence of institutionalized policy change, while temporarily successful, proved ultimately self-defeating. This has been more than fully recognized in the most recent past, with Mexico showing signs of a m a j o r reversal in government policy and attitude toward the market during the Salinas administration. For Latin America generally, and certainly before the severity of the debt crisis began to concentrate minds in earnest, there has been a marked tendency in evidence to prefer tried-and-tested, politically convenient solutions favoring a rather narrow segment of the large-scale private industrial sector, instead of emphasizing participation by large, hitherto disenfranchised segments of that sector. T h i s , I believe, constitutes part of the distinction b e t w e e n accommodating and obstructing government interventions as they affect private-sector performance. It usually means at least temporary retreats into old-fashioned import substitution types of interventionism, punctuated by short liberalization episodes, including a preference for inflation over explicit

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taxation, negative real interest rates, continued high trade barriers, etc. Key, once again, is the revealed preference for staying with comprehensive, if ineffective, controls. In Southeast Asia, the so-called intermediate LDC type, one, of course, encounters examples like Thailand, which approaches the East Asian case, as well as the Philippines, which approaches the Latin American case. These two countries indeed continue to stand in sharp contrast to each other. Both Thailand and the Philippines were encouraged by the international boom of the 1960s and the private capital flows of the 1970s to expand government functions along with government expenditures and consequently ran up large deficits. But the total tax effort was almost twice as high as a percentage of G D P in Thailand as in the Philippines. Then, once the situation reversed in the late 1970s, Thailand was able, like the East Asians, to gradually change the quality of its interventions, tighten its belt, and reduce its public-sector activities, while the Philippines attempted to maintain g r o w t h by a combination of budget deficits and continued foreign capital inflows, now mostly concessionary. Although both countries give evidence of a lot of direct government intervention, the extent to which the Marcos regime, for example, entered into individual bargains with firms, even on tariffs, was not in evidence in Thailand. The Philippines was also much more ready to reimpose import controls following its inevitable balance-of-payments crises, even though it was subject to much more international surveillance—by the IMF, the World Bank, the United States, and Japan—and, unfortunately, had access to large volumes of foreign financing made available virtually "for the asking."

Conclusion It thus seems clear that any discussion about the role of markets and government can only be addressed in a typologically and time-sensitive context. Moreover, it requires more than an examination of the quantity of interventions and controls, it must extend to their quality and into the more subtle political e c o n o m y - t i n g e d processes underlying them. What is basically at issue, especially once an economy has moved out of its import substitution subphase and become export oriented, is whether or not the government's attention is shifting, first, to finding ways to take its hands off prices while letting quantities adjust (watching the quantity of money and forgetting about trying to control the rate of interest), and, subsequently, to paying a lot more attention to the institutional side of policy (the construction of branch bank facilities in the countryside, vocational and engineering institutions, the construction of overhead facilities, and research and development). A related important consideration is that when we discuss governments and markets, we should really distinguish between types of governments: is

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it a centralized or decentralized public sector, and does it permit local participation or does it not? There clearly seems to have been in evidence a much greater ability on the part of East Asian governments to construct appropriate institutions and change them as required to accommodate changing economic environments than was the case in Latin America. By these criteria, there has been more government intervention in East Asia but also of a much more helpful, participatory, and accommodating type. Many—though certainly not all—Latin American governments, on the other hand, have continued to be heavily centralized and have become too fixed in deeply entrenched habits of "stop-go" intervention/liberalization cycles to respond sufficiently quickly and innovatively. Another dimension that ought not to be lost sight of is that the issue of the average level of interventions versus permitting markets to operate is perhaps less important than the oscillations along that average trend. The stop-go experience of Latin America, alternating between larger, horizontally focused interventionist roles for the government and market-oriented episodes, undoubtedly provides for an overall much worse development experience than a more consistent, if higher, average level of interventions with less fluctuations. This has very much to do with the issue of credibility of any particular regime and its consistency over time, so that the private sector can count on particular rules of the game, even if it considers them onerous, to be maintained for a substantial period of time. Risks associated with the constant oscillation of both the kind and extent of government interventions so prevalent in the parade of Latin American finance ministers not long ago are but a case in point. In most LDC situations, some under-the-table interventions are probably going to be necessary at an early stage just because of g o v e r n m e n t s ' recognized initial inability to raise taxes to the extent necessary. Once a relatively neutral tax reform, involving a shift from indirect, international trade-related taxes to direct and indirect domestic taxes, can be carried out, the necessity for such interventions is lessened. In other words, the debate on the relative roles of the market and the government takes place on a quite different plane once the s y s t e m ' s fiscal capacity has been sufficiently strengthened (i.e., the need to resort to hidden inflation taxes, hidden exchange rate taxes, and hidden internal terms of trade taxes is diminished). In this sense, there exists a strong connection between macroeconomic and specific sector and project-oriented policies. Once increased revenues become possible, the question, of course, becomes one of whether governments are able to hold the line on household expenditures and allocate additional resources to education, science, technology, and R&D, as well as to remove overhead bottlenecks to private-sector activity, thus providing income-earning opportunities to the market economy at large. Here once again the question of the nature of the government in terms of its possible centralized versus decentralized configurations becomes critical.

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Our simple knowledge about the size of the public sector either in ternis of various overheads or directly productive activities does not by itself tell us very much about the appropriateness of the decisionmaking location and process. Government really should not be treated as a homogeneous entity any more than the private sector. Observers all too often carry in their heads a fictitious contrast between the workings of a decentralized, competitive market economy and that of a centralized, fully planned system. While this may be appealing to ideologues on the right and left (e.g., our Deepak Lais and Gunnar Myrdals), it is not very helpful to those who really want to understand the appropriate roles of the public and private sectors and to assist in improved policy formation in the Third World. The reality often comes closer to having to choose between an oligopolistic rent-seeking private sector and a predatory elitist government. Once fiscal revenues are plentiful enough, governments can undertake the construction of institutions and organizations, especially in the financial markets sphere, to accommodate the need for the growth of larger-scale industrial activities subject to economies of scale. The challenge then becomes one of matching up large numbers of relatively small savers with the large-scale investment needs of an increasingly technology- and capitalintensive output and export mix. Here government intervention is indeed required to help create a continuously changing organizational infrastructure, either in the form of public-sector entrepreneurs o r in a directly interventionist mode vis-à-vis the private sector. Most observers agree on the necessity for government intervention in agricultural research and development because the appropriability of the returns from science and technology is normally restricted by the inherent competitiveness of the activity, while the need to create temporary innovation profits in private hands in the nonagricultural sector, through, for example, patenting and trademark systems, is clearly recognized. But here again the role of government intervention can be quite crucial in fashioning the appropriate legal structure and property rights, reducing transactions costs, and possibly establishing a blue-collar utility-model alternative to the full-blown patent as an inducement for innovations appropriate to mediumand small-scale entrepreneurs, especially in the rural areas. In addition, while the arguments for restructuring government science and technology institutes in a market direction are well known, it should be emphasized that such institutions often lay claim to a substantial volume of public-sector human and fiscal resources. Thus, a more astute form of government action and intervention can, in fact, help remove important bottlenecks to private-sector innovative activity, not just in agriculture but also in nonagriculture. Institutional construction and the avoidance of such institutions' becoming encrusted and bureaucratized is an important component of this challenge. It is indeed sensible to think in terms of a contrast between an imperfect, perhaps too centralized, government and an imperfect, undoubtedly too

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monopolistic, market. There is a need for enhanced decentralization and greater sensitivity by governments to the needs of the market, but at the same time ensuring more workably competitive pressure on markets through the assurance of increased entry, both from abroad and at home. Alice Amsden goes too far when she says that governments should aim at getting prices wrong. 8 That is as distant from being the end of development as getting prices right. A better way of putting it, I think, would be to suggest that we be more concerned with government failure if it refuses to decentralize and with market failure if the private sector fails to yield to workably competitive pressures. Early in the transition, there is likely to be a greater need for the organizational and investment contributions of government; later on, given the increased complexities of the development process, the lower transactions costs of markets will begin to carry more weight—but in the context of a changed, not a diminished, role for government.

Notes Helpful comments on this chapter by Morris D. Morris and Louis Putterman are gratefully acknowledged. 1. Deepak Lai, The Poverty of Development Economics (London: Hobart Paperbacks, No. 16, 1984). 2. Gunnar Myrdal, Asian Drama: An Inquiry into the Poverty of Nations ( N e w York: Pantheon, 1968). 3. Peter Bauer and Basil S. Yamey, The Economics of Underdeveloped Countries (Cambridge: Cambridge University Press, 1957). 4. Raul Prebisch, "Dependence, Development and Interdependence," in Gustav Ranis and T. Paul Schultz (eds.), The State of Development Economics (London: Basil Blackwell, 1988): 3 1 - 4 8 . 5. Simon Kuznets, Modern Economic Growth (New Haven, Conn.: Yale University Press, 1966): 14. 6. Roy Hofheinz and Kent E. Calder, The East-Asian Edge (New York: Basic Books, 1982). 7. Lloyd G. Reynolds, "The Spread of Economic Growth in the Third World: 1850-1950," Journal of Economic Literature 21 (September 1983): 9 4 1 - 9 8 0 . 8. Alice Amsden, Asia's Next Giant: South Korea and Late Industrialization (Oxford: Oxford University Press, 1989).

• 7International Aspects of the Role of Government in Economic Development HENRY J. BRUTON

In this chapter, I examine a variety of concerns that bear on the role of government in some of the international contexts of economic development. They are numerous, and it is necessary to be selective. The main issue to be discussed is that of the openness of the economy to the rest of the world. The principal theine to be developed is that there can be such a thing as too much openness, and, if it is appropriate to limit the openness of the economy, then the government is faced with the task of deciding how and how much to limit it. Similarly, it must decide how much and what kind of economic activity to leave to the private sector. I discuss these matters in a fairly general way, although I will refer frequently to experiences of specific countries. From the mid-1970s, a strong and, to many, compelling argument has been pushed in a variety of places—especially in the international organizations—that an outward-looking, export-oriented strategy is a much more effective approach to development than was the more inward-looking strategy that many countries followed during the 1950s and 1960s. Although special emphasis is placed on the importance o f exporting, especially the exporting of nontraditional items, "openness" is usually defined as a set of policies that favor neither exports nor imports. Presumably, free trade is the most obvious such policy. With such a policy, the role of government is modest and the burden of the development effort is left to the private sector. Comparative advantage, perhaps the most fundamental, nonobvious argument of economics, provides powerful theoretical support for this general position. T h e argument, in general, places primary weight on the allocation of resources, apparently existing resources, and it seems fair to say, there is little attention given to the exact mechanism by which development takes place. A few years back, it seemed that the proponents of openness had carried the day. More recently, however, evidence and argument have been accumulated that give reason to think that openness is not without its problems and, indeed, is often a source of major difficulties. Similarly, it has

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been argued that the role of effective government can hardly be characterized as minimal. Governments in the Republic of Korea and Taiwan, both always cited as models of how development should take place, have been found to have played and to continue to play important and extensive roles. At the same time, it is recognized by almost everyone that the import substitution strategy, as implemented in the 1950s and 1960s, created a great many problems and the emphasis on formal, comprehensive plans and detailed government regulations and direct controls put the economies in such straitjackets that they could not respond to the opportunities that were present. In this chapter, I want to study these various issues, not from the perspective of one or the other of the two strategies just discussed but rather from the perspective of the prior questions of what constitutes an appropriate development strategy with respect to openness and to the division of labor between the government and the private sector, insofar as it bears on the issue of openness. The general position that I defend can be stated as follows: The distinction between import substitution and export promotion as alternative development strategies has been greatly exaggerated, as has the distinction between minimal government and a more direct and intensive role for the government. The objective is to understand the economy and society well enough to be able to identify where and how protection is effective and where and how the division of labor should be arranged between the public and private sectors in order to produce growth of well-being. I go on to present a short statement about the conditions necessary for a country to achieve an economy whose routine functioning produces rising well-being for its people. The basic argument in favor of protection, and a certain form of protection, is made and defended subsequently, and then I discuss what the role of government should be to ensure that the protection really works.

The Evolution of Inward-Looking/Outward-Looking Thinking It is useful to begin with a brief history of the distinction between outwardand inward-looking (or import substitution) strategies. The Dominance of Import Substitution The development strategy that became known as import substitution began almost by accident. There does not appear in the literature or in policy papers that I have seen an argument that led governments to decide explicitly and consciously to follow an import substitution strategy. 1 Indeed, it is difficult to pin down exactly what the basic thinking was that informed the policies followed in those countries that began efforts to develop in the late 1940s and early 1950s. Something like the following may provide a very broad picture of how import substitution began. In general, it appears that most countries thought simply in terms of

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establishing new activities, manufacturing for the most part. To do this required protection behind which new activities would emerge and would— although this was largely implicit—at some point, as productivity rose, become able to survive in world markets without protection. 2 Little attention was given to how increased productivity would come about. There was attention given to project evaluation, but most of this literature concentrated on the use and definition of shadow prices, the appropriate discount rates, problems of projecting costs and revenues, what should be included in each, and so on. It is unusual to find any reference to the reasons for and policies necessary to encourage productivity growth. There is not much evidence that many countries used formal benefit-cost analysis or estimates of internal rates of return to govern which activities were to be established. The World Bank and other international organizations began to push the use of these instruments quite early, but their use was limited and sporadic. The new activities required protection, but few countries had any sort of general policy of protection. In many instances, it seemed as if an activity was decided on in some manner or other, and then protection was designed so that the activity could exist. Protection—tariffs, quotas, exchange control of various forms, and various other means—evolved in a rather haphazard fashion in most countries. Two other widely held assumptions are relevant to understanding import substitution. The first refers to the argument that technology was so dominant in the determination of input combinations that factor prices did not really matter. Added to this was the view, emerging from the growth model of R. F. Harrod, 3 that capital formation was the driving force of development. These two assumptions made it appropriate to keep the price of capital low in order to encourage investment and not worry much about wage rates because they had virtually no impact on the choice of technique for the reasons just stated. Employment growth was a function of the rate of investment, so achieving a very high rate of investment not only would produce a high rate of growth of GDP but also help relieve the employment problems. Because most physical capital was imported, a very effective way to keep the cost of capital low was an overvaluation of the country's currency. It was not expected that exports of the new products would occur until later, when the new industries had reached adulthood, so the overvaluation was not a concern in dampening the capacity to export. The balance of payments would, in turn, be protected by import controls of one kind or another. Also, for many countries, an inelastic demand for traditional exports made overvaluation less costly in terms of foreign exchange losses. Finally, there was foreign aid and loans to help break any foreign exchange bottleneck. Two other views affecting the thinking and policy about development are relevant to the story. The first refers to the idea that in most LDCs there was an entrepreneurial bottleneck. The argument was that due to religious and

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other traditions, to centuries of nongrowth, to colonialism, and to a variety of other things, people in developing countries were unwilling, and indeed did not appreciate how, to act as entrepreneurs. Hence, the government had to intervene in a way that was inappropriate in economies with long traditions of markets and market-oriented activities. Second, the view was equally widespread that the market was not an effective instrument of development in these countries. This was explained in part by the same factors that were used to account for the entrepreneurial bottleneck. Other factors were also noted: markets were at best incomplete; there was a great deal of subsistence activity; the West had great monopoly power; in order to get investment underway, there had to be substantial amounts at any time; comparative costs and most of the rest of formal economics were static, and so on. In some countries, and among some economists, it was believed that a main reason for underdevelopment was in fact the reliance on the market in the past. So then planning was necessary—largely physical planning—in recognition of the fact that the market operating on its own could not get the j o b done. Added to these arguments was the evidence that, since the outbreak of World War I, the world economy had been subjected to vast dislocations that had penalized all countries in a very severe way. For many governments and many economists, it seemed clear that the postwar years would be equally disruptive and uncongenial to profitable international trade and cooperation. 4 There were, of course, economists who disputed all this and who pushed hard for the traditional approach to international trade and reliance on the market. 5 It is argued, however, that the preceding paragraphs describe the general ambience of development as the nations of Africa, Latin America, and Asia gained independence and began to seek to achieve economic parity with the West. It may be emphasized, then, that there was no conventional wisdom among economists that was being violated. To put it differently, the profession did not offer a theory or strategy or approach to development that led to alternative policies. The available theory of growth was that which R. F. Harrod had produced as an extension of the Keynesian system. Its use had the consequence already noted: capital formation became the source of growth, and production coefficients were assumed to have little flexibility because of the dominance of Western technology. At the beginning of the 1990s, it seems abundantly clear that such policies would necessarily produce great distortions and result in an economy in which sustained growth would be virtually impossible. It was not as clear in the 1950s. Indeed, the most popular of the specific m o d e l s of development, the dual economy models of Arthur Lewis, of John Fei and Gustav Ranis, 6 and of others, made a hopeful case of this situation. The basic outline of these models is well known. The developing economy consisted of two sectors, a very small m o d e m sector and a very large traditional sector. In the former, productivity was quite high and the usual market conditions prevailed. In the traditional sector, productivity was low and stagnant, and the

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sector was largely dominated by tradition rather than by market processes. Development meant expanding the modern sector until it encompassed the whole economy. Thus, all investment was to take place in the modem sector, and this investment would in turn pull labor into that sector from the traditional sector. The technology employed and the capital used were to be those of the West, and the idea of development was thus that of reproducing the West in as complete and rapid a fashion as possible. Accomplishing this objective required simply (I use the word advisedly) a high rate of investment. 7 To the extent that the appropriate level of investment could not be achieved from domestic saving, foreign aid could supply the difference, and aid could also relieve any problem that might arise from earnings of foreign exchange that were inadequate to purchase the foreign capital goods and technology that were deemed essential for modernization. The distortions, capital intensity, inequality, inability to export, etc., did not matter if investment were high enough, and adequate aid or loans could make it high enough. In a relatively short time, one could expect that the modern sector would encompass the entire economy, the problems of being underdeveloped would end, and those of being developed would begin. Development became a displacement exercise: the existing arrangements with respect to the economy, society, political system, etc., of the low-income countries were to be replaced by those of the West, those that had proved to work well in the GDP-rich countries. The other side of that definition was that the traditional sectors were not to develop, they were just to die away.8 The Fall of Import Substitution

and the Rise of

Openness

There were, as already noted, many obvious difficulties with the way the import substitution strategy was designed and implemented. 9 It became especially clear that the approach did not create the fundamental basis for an economy which, by its routine functioning, produced rising well-being for its people. The most convincing argument that import substitution was a failure, however, came not from its internal inconsistencies but rather from the great success stories of the Republic of Korea and of Taiwan. The most evident difference between these two countries and most of the other developing countries more completely committed to import substitution was the truly remarkable rates of growth of exports achieved by the former two. These rates of growth were accompanied by equally impressive rates of growth of GDP and employment and fairly stable price levels. Therefore, great weight came to be placed on the role of exports as the strategic factor in the development effort. It is important to observe that the emphasis given to exporting in the literature arose largely as a consequence of the success of Taiwan and Korea. That emphasis did not appear as a consequence of the emergence of a wellconceived new theory of development. Once the success of Taiwan and Korea was observed, along with their rapid growth of exports, economists began to seek explanations of why exports seemed to matter so much.

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There of course had been references to exporting in the import substitution literature and in other earlier discussions, but such discussions were largely concerned with earning foreign exchange in order to import the capital goods assumed necessary for the expansion of the modern sector of the developing country. There were also discussions of the instability of the demand for traditional exports, how dependence on a few major export items made a country extremely vulnerable, and whether exports were still (or had ever been) an engine of growth or a handmaiden of growth. 10 Basically, however, exports had been deemed of importance (in the 1950s) because they enabled the importation of capital goods from the West. As noted above, it had been generally appreciated by most observers that import substitution, as usually practiced, penalized exporting. Just as import substitution was associated with a large and direct role for government and the public sector, the outward-looking approach has been linked to an emphasis on "minimal" government and a strong reliance on the market over all segments of the economy. Again in this case, it seems that the main argument in favor of greater reliance on the market arose from the failures of government planning and other interventions in the 1950s and 1960s. Nothing new had emerged about the workings of the market in the 1970s that had not been known in the two previous centuries. So it was not that the profession learned something new about the market that led it to conclude that the market was the correct instrument after all; rather it was that government intervention had so often and so evidently failed." The main new ideas about the role of government that began to enter the development literature at this time were rent seeking and the questioning of the disinterestedness of government officials. The notion that the government was above the battle and looked down on the economy and acted to correct market failures was replaced by the notion that government officials were as self-seeking and as committed to maximizing their personal gains as were private-sector actors. The problem was not simply the ignorance of government officials but something much deeper that created problems for government interventions: namely, government officials simply were, for the most part, unable to perform as disinterestedly as necessary for the conventional argument about the government being a reliable source of correcting market failures to hold. Thus "government failure" appeared more intractable than market failure, and therefore a "minimal" role for government seemed less likely to penalize the economy, even in the presence of a market failure, than did government interventions beyond the maintenance of law and order, the correct supply of money, and similar things. When the government failure argument was added to the more conventional arguments about the ignorance of government officials with respect to detailed information about costs, demand, opportunities, technologies, etc., the argument to leave everything to the market was made even stronger. Rent seeking was also identified as a consequence of the import

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substitution approach early on, and numerous people have contributed to an elaboration of its causes and consequences in the last decade or so. 12 Thus, producers would seek to convince the government to create policies—tariffs, subsidies, tax breaks—that benefited a particular person or group. To so persuade would require the use of resources for essentially unproductive activities, as well as distort production and allocation away from anything approaching a social optimum. The very fact of government intervention m a d e rent seeking possible. Were it established that there would be no intervention by the government whatever, presumably rent seeking would cease, as allocating resources for such activities would yield no returns. The Questioning of Openness and of Minimal Government General arguments about the advantages of foreign trade have of course been available for many years. Foreign trade is a means of transferring and spreading technical and managerial knowledge; it is a means of acquiring products and services not known about in a given country; and, of course, it allows the specialization on which comparative advantage is based. Free trade and minimal government have traditionally been linked. These arguments have a general validity that few economists doubt, but they do not necessarily mean that at a given time, in a given world circumstance, a country should engage in free trade. The problems of openness. There are two general arguments that have been used to dispute the free trade answer for most developing countries. The first is that the countries of Western Europe and northern North America began their growth at a time when there were no overpoweringly strong, rich countries already in existence. Today's LDCs must establish their growing economies in a world in which enormously rich, aggressive economies are firmly in placc, ready and eager to take advantage of any opportunity that appears. In a world of rapid changes in technology and demand, of rapid transportation and communication, of inexperienced economic actors operating in an economy with inadequate infrastructure, poorly trained and extremely poor workers need protection to leam to see and respond to opportunities and to create opportunities for economic gain. Too much openness would not allow this learning time. Inexperienced economies in a world dominated by economic giants must then have more, much more, learning time than free trade would allow. The other general argument refers to the absence of a very convincing, well-developed explanation of how exports matter in development. Put differently, we do not have a development theory that leads directly to openness or to the importance of exports. One can, for example, argue that the direction of causation of the observed relationship between exports and growth of G D P is from growth to exports rather than the other way around. 1 3 Because almost any sustained rapid growth of G D P must be accompanied by increasing productivity of resources, a rate of growth of G D P producing a

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high rate of growth of exports is indeed to be expected. In the absence of such a theory, we fall back on empirical bits and pieces that are, of course, always open to question w h e n we seek to generalize on the basis of them. 1 4 S i m i l a r l y , it is d i f f i c u l t to put the a r g u m e n t in t e r m s of t h e H a r r o d / L e w i s sort of model, i.e., that a country should export in order to import capital goods to expand the m o d e m sector. 1 5 That it is difficult to d o this is due partly to the evidence of the 1950s and 1960s when the arguments w e r e w i d e l y accepted and did not produce the intended results. M o r e fundamentally, however, the evidence that productivity growth is the heart of the d e v e l o p m e n t process and that such growth is due to a great variety of factors in addition to investment m e a n s that capital formation as such does not play the d o m i n a n t role that it was once thought to play. In particular, importing capital to expand the m o d e m sector will not, ordinarily, contribute to the creation of an economy in which productivity is increasing as a matter of routine. Indeed, it m a y well defeat efforts to create such an economy. One must conclude that we have yet to understand exactly how openness matters in a d e v e l o p m e n t theory, and building a policy around openness therefore rests on shaky ground. T w o m o r e s p e c i f i c points about the nature of an o u t w a r d - l o o k i n g strategy are relevant. T h e years from the late 1940s to the mid-1970s were years of spectacular growth in world trade, with rates much higher than in any other period of such length for which there is reliable data. 1 6 There are many reasons offered for this exceptional growth. The most general, perhaps, is that there was a great deal of catching u p to do after the dislocations of the Great D e p r e s s i o n , two world wars, and other calamities of the 4 0 years b e t w e e n 1910 and 1950. Growth rates of trade since the mid-1970s have declined sharply and show few signs of any resurgence. There are also signs of increased protectionism a m o n g the Western countries. For an exportoriented growth strategy to prevail for many countries necessarily requires that international trade grow rapidly. In a world where such trade is sluggish and rich countries are tending toward more protection of various kinds, an o u t w a r d - l o o k i n g strategy is o n e of great risk. A country or two might succeed in such an environment, but a great n u m b e r cannot, virtually by definition. A f u r t h e r question about openness is much less specific but is perhaps the m o s t important issue of all. In m o s t of the developing countries, the societies are still quite fragile, have yet to become firmly identified, firmly in place. T h e societies are, in a real sense, in the process of searching for and establishing their o w n places in the world. This is an extremely complex task. Societies, all societies, are a composite of diverse groups and interests and ambitions and ideals. Even in those L D C s with a long national history— Egypt, Ethiopia, Thailand, most of Latin A m e r i c a — t h e r e is yet to be put firmly in place a set of social arrangements that permits an u n a m b i g u o u s d e f i n i t i o n of d e v e l o p m e n t . A s i g n i f i c a n t part of d e v e l o p m e n t is the

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establishment of this sort of national ethos that is the real basis of a nation—and doing this in the context of the diversity just referred to. 17 Governments, even the most sincere and committed, often have difficulties evaluating options and determining what will in fact enhance the well-being of the population. Individuals, too, have difficulties deciding what it is that they really want, really should want, and must learn to make choices. 18 Too much openness can defeat the task of learning what is really wanted from development. One may risk a stronger statement: too much openness can defeat the awareness that there is a question, a major question, that must be addressed. The temptation simply to imitate the West can be too great to resist. There is increasing evidence that many countries, even those generally said to be successful, have found that development did not bring what was really wanted. One may argue that much of the turmoil observed in developing countries arises out of the disappointment with development. It is then argued that choicemaking capacity must be learned, just as new technology must be learned, and too much exposure to the rich West can make that learning very difficult to achieve. 19 The people in the modem LDCs must seek to learn from the West how to create an economy that is increasingly productive of goods and services, but the process by which this is achieved must be consistent with and contribute to the social and economic arrangements and routines that reflect the deeper values and traditions and ideas of the good life that prevail among the various categories of society. This is the heart of the public choice problem. The issue also illustrates in another guise the notion that an economy (and indeed a society) that is in some ways closed and in other ways open is an idea that merits a great deal of attention. MinimaI government and its problems. Much of what has just been said applies to the issue of the role of government. Minimal government, though now a buzzword, has little specific content. Similarly, laissez-faire is a term more of the emotions than of specific policy content. The fact, already noted, that in the 1950s and 1960s government interventions frequently had unfortunate results led many observers in the 1980s to push hard to get the government "completely" out of the economy. A great variety of government failures were identified. Especially costly for the society were governmentowned and operated enterprises; they often constituted a major drain on the state treasury and were hard to kill off once in existence. The apparent widespread rent seeking and the argument that government bureaucrats are not disinterested arbiters have already been noted. Recently, however, closer looks at success stories have revealed significant and far-reaching roles of the government in economic matters. Thus in Korea, Malaysia, Botswana, Thailand, Taiwan, and Indonesia, the government's role has been and continues to be of great importance and, in general, has been effective. The role that the government has played in these countries has varied widely.

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In addition, there is evidence suggesting that the simple notions of rent seeking by the private sector and maximizing bureaucrats are hardly adequate. There is, for example, evidence that many bureaucrats do, in fact, recognize their public duty. It is quite common to find governmental officials who enjoy the power and other advantages of public office but who also take their responsibilities seriously. In many newly independent countries, a wide range of public goods may be more important to the society than are most private goods. People can wish that their country be taken seriously, be recognized by the rest of the world as a significant polity. They may have the wrong idea how to accomplish this, but nevertheless they seek those public goods that they think do contribute to such objectives. In such a case, the government's role is necessarily paramount, and leaving things to the private sector will not succeed. In many kinds of activities, the public official does know, or can know, things that private-sector people cannot find out. It seems, for example, that in most instances health and education activities cannot get off the ground without some specific government role. 20 History must matter as well. For example, any government in Sri Lanka in the 1950s and 1960s that tried to eliminate the rice subsidy would have been defeated. For many reasons, the Sri Lankans believed that everyone in the population should have rice, and to dispute this was to violate this feeling that it was really out of the question to do so. It would probably have not been possible for India to have not aimed at a socialist economy in the early years of its independence, simply because of the nature of its relationship with Britain and its cultural heritage. Thus, to push the market in circumstances where the society is ill-prepared for it and unacquainted with its rationale is to create tensions and instability, as well as a market that will not work very well. 21 From this quick review, several hypotheses, perhaps presumptions is more accurate, may be identified as having emerged over the decades about the role of government in development: 1. Government ownership and operation of enterprises has not worked very well in general. There are, one must note, exceptions. In Egypt, where there have been, and still are, many extraordinarily costly public firms, the Suez Canal has been run extremely well. Several firms in Botswana are publicly owned and well run. In Latin America, one can find firms well run by the government. Nevertheless, the general statement holds. 2. Governments in most LDCs are inexperienced and their personnel illtrained. This fact is often cited as a reason for a minimal government role in the economy. It takes a strong government, however, to say no to the demands of powerful constituents, to follow its own rules, and to act in other than an ad hoc manner. Development thus includes the establishment of an effective government, and this takes time and requires learning. 3. The most common way that a government gets itself and its country

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into difficulties is to try to do too many things and hence do none of them well. The government must learn to look at its society and economy and identify a few, a very few, policies or activities that it can take on that would induce significant response from the rest of the economy. Exactly what such policies and activities are depends on the state of the economy and how it is working at the particular time. In particular, it depends on the identification o f bottlenecks that, if broken, would result in economic growth. 22 This in turn means that the "theory" of development should help identify bottlenecks and other barriers that are, at a given time, blocking growth of well-being. 4. The emergence of an effective bureaucracy is a time-consuming process. It is time consuming because it is a learning process. The development effort must therefore be one that does not impose demands on the government that it cannot perform and one that also results in the government's learning about how to be a government. It hardly need be said that we know very little about how bureaucracies learn. 5. The last item follows from all the others. One of our duties, therefore, as development economists, is to try to understand what governments can do at a given time and how governments can learn to do other things well. This argument is obviously quite different from pushing privatization or minimal government or any other single thing. It is also different from constant condemnation of government because it is new and inexperienced and ill-trained. Conclusions This historical discussion calls attention to the fact that many of the policies followed in the 1950s and 1960s were consistent with what many, perhaps most, economists were urging at the time. Similarly, the views of both the policymaker and the economist were strongly affected by historical events of the first half of the twentieth century. So too have present-day views been affected by the great boom in world trade in the 1 9 5 0 - 1 9 7 3 period. In most instances, it seems, our ideas of development and our idea of the division of labor between the government and the private sector follow events in the world rather than lead them. As already emphasized, it was the apparent failure of import substitution and the fact that the success stories were associated with high rates of growth of exporting that brought about the shift in conventional wisdom in the 1970s. One may argue that both the failure of import substitution and the increasing questioning of exporting and openness have arisen because neither strategy emerged from a convincing understanding of the development process. The early success of import substitution—often referred to as the easy phase—occurred because there were obvious ways to increase the output of some sectors without changing, in any fundamental way, the economic and social system of the country. When these few ways were exhausted, problems immediately appeared. The same holds for openness and liberalization. A heavily distorted economy that is characterized by idle

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resources and obvious and severe misallocations offers many opportunities for quick improvements. Correcting these distortions and misallocations does not necessarily—and certainly not automatically—create a sustained growth process. When g o v e r n m e n t policies and regulations are built on misunderstandings or misinformation about how the economy works and how effective the government can be, then correcting these mistakes also creates new, quick opportunities. Just as there appeared to have been an easy phase of import substitution, there also appears to be an easy phase for liberalizing and opening and a changing role for government. Such results, however, tell us very little about the role of government and the division of labor between it and the private sector in any fundamental sense. This argument does not dispute that rent seeking, bureaucratic profiteering, etc., have harmed the search for enhanced social well-being. It does argue that something else, much more fundamental, is involved. The following sections suggest a way of thinking about these more fundamental things.

Some Fundamental Things The basic objective of development economics is to explain how a country that has long suffered extreme mass poverty can be converted into one in which the growth of well-being occurs as a consequence of the routine operation of the economy. Increased well-being is to become built into the system; it is to become indigenous. To seek to accomplish this objective, we need some general notion of the basic characteristics of sustained growth. The following seem to be the most important: 1. The productivity of both capital and labor rises in a fairly regular and consistent way year after year after year. 2. The rate of investment is generally at least 10-12 percent. 23 3. The economy has considerable transformation capacity. This means that resources—labor and capital—can move readily into those activities where productivity is rising and out of those where it is stagnant or falling. 4. There is a fairly constant appearance of new, nontraditional exports. 5. The macro conditions are such that the economy does not have to stop or slow down to "correct" a balance-of-payments problem or to eliminate inflation or to solve some other macro problem. 6. The government and the population appreciate and recognize the complexity and importance of the public choice problem. In particular, both groups appreciate the dangers of simply trying to imitate the West. 24 Both groups must be genuinely committed to development.

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7. The growth of output and per capita output that takes place is consistent with the values, traditions, institutions, and culture of the community. To respect these deeply embedded characteristics of the society is necessary so that well-being, as well as measured goods and services, increases. These conditions will doubtless produce growth of well-being. 2 5 The growth that occurs will be indigenous—internally generated. Items six and seven assure that this is in fact the case. Virtually everything here must be learned. No country or group of people is created with these characteristics already in place. They do not come with independence, nor do they come automatically with laissez-faire (however defined) or with openness. The failure of import substitution in the 1950s and 1960s occurred because its implementation failed to produce the learning that was required to achieve the conditions for sustained growth. The questions about openness and liberalization now widespread arise because it is not clear that policies associated with these strategies produce the learning that results in the establishment of the conditions just listed. There are also three recently identified phenomena that are relevant to the argument. Productivity levels in the West (including Japan) and in the LDCs are not converging. Such convergence is occurring among the Western countries. It would therefore seem that there is no mechanism now at work that will bring about a convergence of productive levels between the West and the developing countries. 26 Second, there appears little relationship between physical capital formation and productivity growth. Productivity growth does not seem to be embodied in new machines, equipment, etc. 27 Third, there is evidence that saving and investment rates within countries are closer than the frequently noted efficiency of the "world capital market" would suggest should be the case. 28 This finding (open to question, as are all of these items—and all other empirical findings in economics) is closely related to the failure of productivity levels to converge. If the productivity of capital in the LDCs approached that of the West, then, given the relative amounts of capital in the two areas, all investment should take place in the LDCs. It obviously does not. These three observed phenomena of the world, combined with the seven conditions for the achievement of sustained increasing social well-being, along with the argument that the seven conditions are learned, not dropped from the sky, make clear that developing countries are very much on their own. They must create an environment where learning is the overwhelming presence, and they must learn the right things. I want now to concentrate directly on the role of the government and international trade and capital movements in creating an economy that produces growth of well-being.

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The Role of Government in Producing Well-Being The specific question is, What is the role of international trade and other foreign contacts (e.g., aid, private capital movements, foreign training, etc.) in creating the kind of economy just described? Then the next question is, What is the role of government in that process? Protection, Trade, and Learning There are many forms of protection that can be devised that do not distort the economy in a severe and damaging way. One form of protection that is worth considerable attention is an undervalued exchange rate. 29 It seems especially effective in contributing to the creation of the seven characteristics of a growing economy listed earlier. The basic argument is straightforward. In the most unambiguous case, the exchange rate is maintained at a level that results in an export surplus, and there are no other items in the balance of payments. 3 0 The country will then accumulate foreign exchange reserves that are to be sterilized in some way or other to prevent monetary expansion. The export surplus also means that domestic absorption must be less than domestic output, i.e., private saving plus taxes must exceed domestic investment plus government spending. This probably means that the government must maintain a budget surplus, not the most common occurrence in the world. More on this point later. The export surplus (and the corresponding budget surplus) imposes a cost on the community, as does all protection. This cost is to be looked upon as an investment in searching and learning. The return on this investment is the contribution that is made to the creation of a society in which well-being is continually increasing. There are numerous arguments and some empirical evidence that support the view that this form of protection will in fact make several contributions to the basic objective. 1 . T h e undervalued exchange rate of course makes imports more expensive than they would be with an exchange rate that simply maintained an equality between exports and imports. It does this without significant distortion. 3 1 T h u s competition from abroad is reduced but not eliminated. In particular, if productivity is growing in other countries, domestic activities are constantly threatened, but the threat is less immediate and less widespread than with the "equilibrium" exchange rate. 2. An undervalued exchange rate obviously increases the range of goods and services in which a country may be competitive relative to the equilibrium rate. More important, it provides incentives to producers to search for ways to take advantage of the increased range of potentialities. There will then be an inducement for resources to move into new activities, both import replacements and nontraditional exports. The basic idea is to expand opportunities for learning new skills, activities, and production

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techniques. This is equivalent to increasing the transformation capacity of the economy. More accurately, it creates an environment in which transformation capacity can be learned. This argument is different from the more usual notion of diversification. The latter notion as such means that the country is sacrificing the advantages of specialization more or less indefinitely. The creation of transformation capacity, on the other hand, means that the country has gained, or is gaining, the capacity to shift resources quickly and at low cost from activity to activity. It is becoming able therefore to exploit its comparative advantage without being vulnerable to changes in technology, tastes, political arrangements, etc. 3. It is also argued that the undervalued exchange rate can make an important contribution to the kind of search and learning that results in the routinization of productivity growth. The literature on productivity growth is, of course, extensive, but one must acknowledge that our understanding of its origins remains very primitive indeed. The most appealing hypothesis is that productivity growth comes from education and training and from outlays on R&D. This argument is by no means nonsense, but for most developing countries it may not be the most immediately relevant argument. 32 There are three specific points to make with respect to the effect of protection in the form of an undervalued exchange rate on productivity growth. a. The most immediate source of productivity growth in developing countries is on-the-job training. The most obvious requirement for on-the-job training is to have a job. It must be a job, however, with new opportunities and new experiences. Repetition as such may increase dexterity and familiarity, but after some time no further learning is likely to take place. Thus new exposures, new activities seem necessary. 33 The appearance of new activities, therefore, creates significant opportunities for the kind of learning that results in rising productivity. b. Productivity growth is encouraged by continued, uninterrupted growth of output. To put the point a bit differently, a stop-go economy seems sure to dampen productivity growth for a number of reasons. A balance-of-payments problem is one of the main reasons why an economy must be stopped or slowed down. The undervalued exchange rate is an effective way to prevent balance-of-payments problems and therefore prevent the stop-go sequence. By the same argument, the undervalued exchange rate permits the government to press the economy hard without fear of creating a balance-of-payments problem. An aggregate demand that presses hard against resource limitations not only maintains the demand for labor but also encourages firms to seek ways to increase output without new inputs. 34 c. The undervalued exchange rate is, obviously, an export promotion policy. There is accumulating evidence that exports, especially of new nontraditional goods and services, are an effective form of learning from abroad. 35 The added profitability of exporting induces the producer to leam as quickly as possible about what foreign importers are demanding in terms of

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quality and nature of product, as well as ways to get costs down. The essential point here seems to be that the exporter sees a specific opportunity to profit and sees specific problems that have to be overcome in order to capitalize on that profit opportunity. Therefore, the exporter is looking for the answers to fairly specific questions, and this is much more likely to lead to increased productivity than simply seeking general knowledge. It also requires a great deal of understanding and informal knowledge about how o n e ' s own enterprise functions. It is illuminating to compare this role of exporting to the one more frequently perceived in the 1950s and 1960s and referred to earlier. Then the argument was that exporting was crucial in order to earn the foreign exchange necessary to import the capital goods thought essential for the expansion of the m o d e m sector of the developing economy. The present argument is quite different and represents a different way of thinking about the development process. Exporting is important because it contributes in several ways to the learning that results in increasing productivity, not because it permits a high rate of imports of capital goods from the West. 4. It was stated earlier that presently LDCs are greatly tempted simply to imitate the West. It was further stated that this temptation must be resisted because the history, traditions, knowledge, religion, and culture of a society are so fundamental in the determination of well-being that simple imitation will usually create tensions and unrest that defeat the effort to achieve rising well-being. The inclusion in the list above of choicemaking capacity and respect for the social, cultural, traditional environment is meant to recognize this basic argument. This is a mighty issue and deserves a great deal of attention by economists. In the present effort, attention is limited to how protection, afforded by an undervalued exchange rate, can contribute to learning to choose and to increase productive capacity of goods and services in a way that is consistent with other sources of well-being. Arthur Lewis's statement, already noted, that "the advantage of economic growth is not that wealth increases happiness, but it increases the range of human choice" is often accepted. 3 6 This argument requires that people can make choices as their incomes rise that do in fact result in an enhancement of their well-being. There is a lot of evidence to suggest that this capacity is often lacking in all societies, but especially in new societies. Where little social change has occurred over the centuries and where most of the population has long been convinced that increased well-being is not possible, choicemaking capacity is sure to be limited, at best rusty, and difficult. For such entities to be suddenly exposed without preparation to the great array of consumer goods, of life-styles, etc., that the West offers—many of which are alien, if not antagonistic, to the prevailing ambience—is to create an extremely difficult choice situation. A similar argument applies on the production side, especially in the

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choice of technology. Few owners, managers, or foremen who are currently using an older and simpler technology can make an informed choice about technologies that are much more complex and quite different from any that they have ever experienced. To be exposed abruptly to a range of techniques that are very new and different is to be in a situation where it is virtually certain that serious mistakes will be made. Somehow, then, a way must be found to begin the process of technological improvement by building in small steps from what is already available and known. The new technology must be "near" the existing technology, must be understandable in terms of prevailing knowledge of basic information about production. One m a y express these ideas, with respect to both consumption and production, by saying that a newly developing country must "find its own way" but do so in a world dominated by the already rich and mighty. It must leam from these rich and mighty, while making sure that it is not dominated in any way by them. That development should be consistent with the deeper values of the community is, in general, clear enough, but when it comes to including this notion in a specific plan or model or formula of growth, ambiguities appear immediately. It is easy to appreciate why many economists find discussions of these matters disturbing. At this stage of our understanding, perhaps the most useful approach is to cite arguments and examples of what the issues really are and, in the present context, how they lead to the necessity for protection. There are two sides to the issue. On one side, there is the argument that some of these deeper values and institutions directly affect what kind of policies can work and what kind cannot. To try to force policies on a society that cannot accept them is to ask for failure and tension. On the other side, there is the argument that the deeper values directly affect what the society wants from development. In particular, they affect what the society is willing to give up in order to have more G D P and thereby affect what efficiency means in the society. Some illustrations may help make these general arguments clearer and more relevant to the protection issue. V e m o n Ruttan notes that "the traditional moral obligation in the Japanese village c o m m u n i t y to cooperate in c o m m u n a l infrastructure maintenance has m a d e it less costly to implement rural development programs than in societies lacking such traditions." 37 Cooperative marketing and the sharing of agricultural implements are also more likely to succeed in such an environment. Ruttan also notes that in areas where the caste structure prevails, any sort of general cooperation is greatly inhibited. Ranis makes a similar point: "Perhaps another way of putting it is that typical East Asian citizens think of themselves as having certain obligations to the state, feel the need to reach a consensus and not to make too many unreasonable demands on the government." 3 8 Other developing countries are quite different in this respect. 3 9

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Ronald Dore suggests that in Latin America "there was a much more distinct differentiation between Europeanized enclaves of the towns and countryside than was ever found within the Asian countries." 4 0 He goes on to argue that the higher income groups in Japan, Korea, and China created a big demand for the output of domestic artisans, while upper income consumption in Latin America had been dominated by imports. Thus the internalization of demand had a m a j o r impact on how the Asian countries could build from what was in place and known. Dore has other similar examples of differences between the East Asian countries and the Latin American countries. The rentseeking problem is less severe in countries where there is a shared national interest among all groups, but especially between the public and private sectors. Similarly, a bureaucracy dominated by extremely able people is going to gain more respect in the private sector than one made up of less qualified people. This is obvious, of course, but it is important to note here because, in the East Asian countries at any rate, the high quality of government personnel is, in significant part, due to the great Confucian heritage that gave prestige and distinction to serving in the government as well as to education. Another example is Egypt under Mohammed Ali in the first half of the nineteenth century. Ali was eager for Egypt to imitate Europe. He tried (as did the Shah of Iran much later and Peter the Great of Russia m u c h earlier) to force the process of imitation (of "modernization") on a society that was incapable of absorbing it. He did this by hiring foreign "experts," importing capital goods, and establishing schools and training programs. None of these worked because the Egyptian society was (and still is) ill-prepared to accept such fundamental changes in its environment. Ali was unwilling to seek a development process that was compatible with this environment, that took advantage of and built onto, or that tried to create an internal dynamic within, the existing Egyptian system. So the efforts of Ali went for naught. 4 1 One is reminded of an observation of Kenneth B o u l d i n g to the effect that it is not survival of the fittest but survival of the fitting that seems to apply in current development analysis. 4 2 Compare the Egyptian story with that told by Michio Morishima about Japan. He argues that the ethical system that was Confucianism was widely pervasive in Japan and gave to the society the kind of cohesiveness and commitment that enabled it to meet the West in the late nineteen century without s u c c u m b i n g to it. Morishima argues from this that Japanese capitalism "started as state capitalism, an economy guided and driven by bureaucrats." 4 3 It has, of course, continued to be guided and driven in this manner. The bureaucrats who did the guiding and driving, however, were part of this cohesive and committed society and understood the importance of maintaining its basic characteristics and its deeper values. Morishima concludes, " T h u s a capitalist economy which was managed in an entirely

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different spirit from English capitalism—an economy combining Japanese soul and Western technology—was set up in Japan." 44 These examples do not lead to the conclusion that African and Latin American and other Asian countries should seek to imitate Japan, Korea, and Taiwan. Given that the societies of most other countries are much less organized and centralized, imitating these three countries is simply not feasible. These summaries have been noted in order to make as clear as possible the importance of a country's development effort being compatible with its deeper values. Morishima concludes his powerful book with the observation, " N o country can progress while it disregards its own past which constrains its subsequent course of development." 4 5 That progress in African, Latin American, and other Asian countries seems more difficult to achieve than in Japan, Korea, and Taiwan means that the latter countries had in place an environment—political, social, cultural—that facilitated learning from the West without simply imitating or seeking to imitate. They could, as noted, borrow but not succumb. And they protected themselves. This conclusion—protection—is one that can be applied to other developing countries. 4 6 Protection with some exposure and some threat of more exposure and obvious profit opportunities creates the kind of situation in which the economic actors are much more likely to be forced to make specific choices than in an open economy where it is easy to succumb to imitation. The idea is to set up a choice situation, but one with enough familiarity and understanding that it is possible to appreciate the nature of the choice problem. Put in a different way, the undervalued exchange rate creates opportunities for gain in several ways and therefore elicits action on a variety of fronts. T o realize these opportunities simply by imitation is costly in many ways; therefore, the economic actors are induced to make efforts to find ways to exploit the opportunities without simply imitating. To do this they must search and learn and make decisions. The fact that the decisions are within their terms of understanding contributes to their learning and to their making the "right" decisions, to their finding their own way. Government and Learning Arthur Lewis distinguishes nine functions of the government that are relevant to economic growth: maintaining public services, influencing attitudes, shaping economic institutions, influencing the use of resources, influencing the distribution of income, controlling the money supply, controlling fluctuations, ensuring full employment, and influencing the level of investment. 4 7 Such lists are difficult to make, and Lewis's has some rather obvious omissions—correcting market failures, supplying information—and some of the categories obviously overlap with others, i.e., controlling fluctuations and influencing the rate of investment. The list, however, points out the difficulty of coming down from generalizations to specific statements and recommendations. It is also a good reminder of the argument, previously

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noted, that one of the main reasons for government failure is that the government often seeks to do too much and hence does nothing well. 48 In the present context, our concern is not with the whole range of government activities for development but with those that bear directly on foreign trade and other forms of foreign economic relationships. In particular, I want to concentrate on the role of the government in the kind of protected economy that has been described in previous pages. Once the large-scale, comprehensive plans and government ownership and control of individual producing units are ruled out, the role of the government in very general terms can be expressed easily: It is to create an "environment" that induces all economic agents to search and learn in a way that contributes to the emergence of the kind of economy described by the seven characteristics listed earlier. The most immediate requirement for the government to perform such a role is that it be committed to seeking development. It is evident, for example, that the Korean government from the early 1960s was very committed and that the Taiwanese government that came from the mainland felt great pressure to make Taiwan into an unusually successful economy. It is difficult to find additional countries where the evidence of such a commitment has obtained for any length of time. 49 Beyond this basic requirement, one may identify three main duties for the government in the context of the approach to development outlined in this paper: 1 . T o maintain price stability at " f u l l " employment levels of production. It was argued earlier that a major advantage of the undervalued exchange rate is that it helps to create an environment in which the government can push the economy hard without causing a balance-ofpayments problem. Thus, an important role for the government is to exploit this situation and thereby seek to maintain as strong a demand for labor as is possible. To repeat a fundamental theorem: on-the-job learning requires a job. 5 0 2. To seek to establish incentives that induce firms to search for ways to increase productivity. "Getting prices right" in the present context means setting prices and other incentives such that economic units find it profitable to keep productivity growing regularly. 3. To consider what kinds of public goods best serve the objective of the quest for well-being. One of the major rationales for protection is that it provides learning time about these matters. A government committed to development would, behind this protection, help the community become aware of the issues at stake and recognize that they can be affected by study and by policies. These three roles more or less follow directly from the previous

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discussion, and only an additional comment or two is necessary at this point. Maintaining

Aggregate

Stability

Carrying out the task of maintaining aggregate stability links up with a number of the items on Arthur Lewis's list—controlling money supply, influencing investment, and controlling fluctuations. The export surplus, of course, results in continuing demand pressure, and the government may be able to concentrate all its attention on achieving and maintaining a budget surplus. Budget surpluses are rare, and there is little doubt that a lot of effort and learning is necessary before a government can manage this issue with confidence. At the same time, it is not appropriate just to rule it out as impossible. The task is to increase our understanding of how macro pressure can be managed and directed. The macroeconomics of developing countries— like that of more fully developed countries—is in a state of disarray at the moment. Even so, it seems that there is a great deal that policymakers can learn if they can function in a quiet environment, i.e., one in which they are not always confronting an urgent problem. At this stage of our understanding, two rather truistic remarks may be allowed. The recognition that the macro policy objective is to maintain a strong demand for labor throughout the economy rather than to achieve some GDP growth rate target is important. This situation may allow the government to be more flexible in its spending plans and to be able to curtail spending when appropriate without wide and severe adverse effects on the way the economy is operating. Evidently government investments are important in almost all countries; infrastructure is generally a public investment, and expenditures on these and other public investments is part of the development effort. But it does seem that maintaining a strong demand for labor by specific government action may have less complicating effects on the economy if the burden of the development effort is being carried by the private sector. It may also be possible for a country to establish a sort of list of questions or items of relevance about which a government needs specific information if it is to act effectively in this context. 51 This issue is different from the more common one of structural readjustment or trying to reestablish stability after a severe bout of instability. One should be reminded that, in this chapter, no attention has been given to the task of getting to the undervalued exchange rate with stability from the point where the economy is at the moment. That is a basic question, the discussion of which would require a separate effort. 52 Getting

Prices

Right

Governments have, since the very beginning of the development efforts, offered a range of incentives to encourage investment and increases in output. These incentives have included tax holidays, subsidized prices for intermediate goods and services, overvalued exchange rates to make capital cheap, and

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many others. Almost all such incentives have been in the form of making the price of the good or service less costly than it would have been in the absence of the subsidy. More recently, subsidies have been generally condemned. Many are thought not to have the desired effect. For example, most observers seem to doubt that tax holidays induce higher rates of investment. The subsidies are also criticized because they often are the source of budget deficits that lead to inflation and balance-of-payments difficulties. Then there are the frequently emphasized effects of distortion. There is, however, nothing inherently wrong with subsidies. One that induces productivity growth and that does not violate macrostability conditions can in fact be an extremely valuable instrument. The conventional approach has been to rely on the lure of cheaper prices for various capital and intermediate goods. The argument of this chapter is that the inducement should take the form of attractive profits that encourage search and learning to increase productivity. The undervalued exchange rate does this, and it alone can be sufficient in some cases. Where it is deemed inadequate, subsidies can be a very powerful instrument. Several examples may help to make the argument clearer. Suppose the undervalued exchange rate is in effect, but additional incentives are deemed necessary. There are no other forms of government activity in the market and no form of subsidies existing. The undervalued exchange rate needs help because of incomplete markets, because information flows slowly, because many agents are risk averse, etc. In a particular country, the Ministry of Agriculture has a great deal of data on individual farms. In this case, the ministry can design and implement, in a fairly straightforward way, a system of subsidies that rewards increased yields. This is all that the government does. In particular, it does not provide fertilizer at prices below their real cost, it charges for water, for information, etc. The subsidy system does make it extra profitable (in addition to the effect of the undervalued exchange rate) to find ways to increase yields. 53 Similarly, a manufacturing firm can be subsidized by cheap power; therefore, it uses extra amounts of power. It can also be subsidized by rewarding it for finding ways to use less power per unit of output. If the demand for labor is lagging behind the full employment rate, a subsidy built around the growth of employment may be appropriate. A tax advantage arising from increasing labor intensity may have the effect of pointing the search in the direction of increasing the productivity of labor relative to other inputs and thus encouraging employment of labor. Other examples could be provided, but perhaps the general point is clear. Subsidies can be designed that push economic agents to seek those things that contribute to the establishment of the conditions for sustained growth of well-being. Three further points may be made. The first is to recognize that subsidies are difficult to administer, and cash subsidies can make corruption easier than otherwise. The response to this has already been noted: if government limits

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itself to a few activities and has some learning time, there is reason to think that the approach is not necessarily doomed to failure. The second point is that the government must leam to provide such subsidies only to those economic units that do in fact earn them. This requires that the government have considerable capacity and autonomy, and this, of course, is no small order. It seems clear, for example, that the various subsidies that have been used in Korea have in fact been provided only to the firms that did contribute in the manner desired. The third point is more general and refers to the effectiveness of the undervalued exchange rate as well. We need to know more about effort response and the success of that effort than we now know. Incentives to search must not only produce searching, they must also produce finding, and we need more insight on this issue. 54 Government and Choice The choice issue arises because almost any society is culturally distinct from any other—almost by definition. In some cases, that distinction is modest enough to ignore, but between most developing countries and most GDP-rich countries, the distinction matters greatly, with the consequences already noted. There are many sources of the distinctiveness—religion, traditions, history, geography—but one of the most important sources arises from the fact of long periods of nongrowth and consequent mass poverty. The term culture of poverty is often used to describe this situation. Perhaps better is the more awkward term culture of nongrowth. The attitudes, ideas, and arrangements that have evolved over the past have done so in part to make such poverty bearable. These and similar institutions often take on a life of their own and indeed become sources of well-being, so that their destruction may well reduce the level or growth of well-being. The society must then choose which of the institutions it wishes to preserve, which it wishes to allow to wither away, and which it wishes to kill off at once. It is a major contention of this chapter that it is extremely advantageous if a society finds it possible to address these questions specifically and consciously. Put differently, it is a significant part of the creation of an economy in which well-being is rising to in fact explicitly consider these questions. The ideas on these matters, which a person or a society may have at any given moment, are sure to be vague and ill-defined; thus, to create an environment in which they can be considered is, of course, difficult. If the capacity to choose is not learned, then the advantages of increased choice that Arthur Lewis emphasizes may well be wasted or even make matters worse. Too much openness makes this process of learning to choose extra difficult and hence dangerous. The basic rationale of using increased productive capacity as a measure of growth and development rests on the assumption that both individuals and the community know what is wanted from such increases. Where this assumption is not applicable, this rationale is not adequate and must be supplemented.

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What then is the role of government in this sort of situation insofar as it applies to international relations? Several examples illustrate the kind of issues that are necessarily the province of the government. An undervalued exchange rate will make it cheaper for foreign firms to buy existing domestic productive resources. The government then must decide the extent to which this should be allowed. This is always a question, of course, but the lower the cost of local currency to the foreign investor, the more tempting such purchases are. So the issue is more acute with the kind of protection studied in this chapter. Given that the objective is indigenous growth, the presumption is that such purchases are to be kept quite low, perhaps even at zero. The government must find a way to do this that is at once feasible and does not create significant distortions in the system. Foreign investment is similar, and the presumption is that foreign investment will be relied on only to a very limited extent. There is one difference that is worth noting. The undervaluation makes the cost of the currency of the developing country lower than it would be with an "equilibrium" rate and should encourage certain forms of any foreign investment that takes place. The foreign investor would, however, find it more profitable to concentrate efforts to use domestic inputs, including labor, and to export. All this is favorable to the basic objective. At the same time, competition from the already-established foreigners is likely to usurp many opportunities that local producers could exploit given a little more time and a little more experience. Yet delays will exacerbate the macrostability problem and possibly the achievement of the strong demand for labor that is essential. The presence of foreigners will also annoy in other ways—life-styles, new consumer goods, etc.—that tend to defeat the objectives. The government then must decide. The presumption seems to be that foreign investment is best made an exception rather than a common practice. In this case, the government must have a policy to keep foreign investment under control. 55 Similar issues arise with respect to tourism. What these examples show is the necessity of the government's taking explicit action to counter the effects of the undervaluation where such effects are deemed contrary to the basic objectives of creating indigenous growth. The government's actions are necessary in order to prevent the market from working out its full effects. For none of the last items mentioned—foreigners buying existing units, foreign investment, and tourism—is the exchange rate the best instrument, yet exchange rate policy aimed at other targets has an effect on certain other variables that must be countered. Consider two further examples. Economies of scale are increasingly identified as a major source of growth of output and of the capacity to compete abroad and hence can have major consequences for international trade. Large-scale firms are also the source of power, of urban problems, of labor/management problems, etc.

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And some societies may just not like large factories and may be willing to pay a price, maybe a high price, to avoid them. So a government may seek to prevent the emergence of large firms in response to the wishes of the community, even where it means passing up opportunities to achieve higher rates of growth of G D P or more exports. The objective is to achieve increasing well-being, not to become more competitive. Consider the kind of work that is available. Perhaps there is no more important source of well-being than an interesting job, in which learning occurs regularly and continuously. Jobs that have no meaning or little meaning, even with a relatively high income, contribute much less to wellbeing than do j o b s that seem to provide interest and content that is compatible with prevailing ideas of an appropriate life-style. Such an argument does not mean that people are not—or should not be—interested in money and higher incomes, but again recognizes that the search for increased productivity must take place in an environment that has many other characteristics that are important sources of well-being. A final example has to do with technology. That technology has many side e f f e c t s — o n culture, on morality, on social organization, on patterns of behavior, and on living styles—is generally recognized by most observers but also generally ignored by analysts and policymakers. It is also accepted that technology can degrade the human spirit, but it is difficult to find examples where technology has been explicitly considered an argument in the search for well-being. Taking these issues into account in the design of a technological policy is surely part of the development task. What can one make of these sorts of examples? They illustrate more clearly perhaps than anything else the point that a modem developing country needs to find its own way in a world where there are rich and powerful economies already in existence. More fundamentally, perhaps, the examples bring home the importance of a community and its individuals addressing specifically and consciously what is wanted from development. In the effort to do this, the government and the public sector in general have a central role that can hardly be performed by any other agency. Not only must the government concern itself with designing and implementing policies that impede the market—especially the one with an undervalued exchange rate— from producing unwanted results brought in from the outside but it must also lead the population into thinking about the basic objectives that development can and should achieve. 5 6 This latter point is a major reason why it is so difficult for outsiders to advise the government of the developing country about what constitutes appropriate development policy and strategy, as well as objectives. Socrates taught us centuries ago that the unexamined life is not worth living. One may add to that noble thought that unexamined growth is not worth achieving, and it certainly is not development.

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Notes l . O n e of the earliest statements of the import substitution strategy is in J o h n H. P o w e r , "Industrialization in Pakistan: A Case of Frustrated T a k e O f f ? " Pakistan Development Review 3 (Summer 1963): 1 9 1 - 2 0 7 . This is a l s o a r e m a r k a b l y c l e a r , a n d e v e n by current s t a n d a r d s , c o m p l e t e statement. 2. Carlos Diaz-Alejandro argues powerfully for a m o r e or less permanent delinking of the L D C s f r o m the more developed countries. See his "Delinking North and South: U n s h a c k l e d or U n h i n g e d , " in Albert Fishlow (ed.), Rich and Poor Nations in the World Economy (New York: McGraw-Hill, 1978): 8 7 - 1 6 2 . This notion is not what import substitution was all about. 3. R . F. Harrod, Towards a Dynamic Economics (London: Macmillan, 1949). 4. T h e r e were n u m e r o u s other items that entered the argument in f a v o r of import substitution. T h e s e included elasticity pessimism, deterioration of terms of trade, and fragility of the balance of payments. 5. P e r h a p s the most potent were J a c o b Viner, International Trade and Economic Development (Glencoe, 111.: Free Press, 1952); and Gottfried Haberler, International Trade and Economic Development (Cairo: National Bank of Egypt Fiftieth Anniversary C o m m e m o r a t i o n Lecture, 1959). 6. W . Arthur Lewis, " E c o n o m i c Development with Unlimited Supplies of L a b o r , " Manchester School 22, no. 2 (1954): 139-191; John C. H. Fei and Gustav Ranis, Development of the Labor Supply Economy ( H o m e w o o d , III.: Richard D. Irwin, Inc., 1964). 7. W . A r t h u r L e w i s , in a sentence often quoted, states that the "basic problem in the theory of economic growth is to understand the process by which a c o m m u n i t y is converted from being a 5 percent saver to a 12 percent saver—with all the changes in attitudes, institutions and in techniques which accompany this conversion." The Theory of Economic Growth (London: George Allen and Unwin, 1955): 2 2 5 - 2 2 6 . T h i s s t a t e m e n t up to the dash had a m a j o r impact on professional thinking and on the policymakers. 8. The notion of development as displacement is explored further in Henry J. Bruton, " T h e Search for a Development Economics," World Development 13 ( O c t o b e r / N o v e m b e r 1985): 1 0 9 9 - 1 1 2 4 . 9. Such difficulties were noted early on. See Albert O. Hirschman, "The Political E c o n o m y of Import Substitution in Latin America," Quarterly Journal of Economics 82 (1968): 1 - 3 2 ; Henry J. Bruton, "The Import Substitution Strategy of E c o n o m i c Development: A Survey," Pakistan Development Review 10, no. 2 (1970): 1 2 3 - 1 4 6 ; John Sheahan, "Import Substitution and E c o n o m i c Policy: A Second R e v i e w , " Research Memorandum No. 50 (Williamstown, Mass.: Center for E c o n o m i c Development, 1972). 10. In general, trade does seem to have been an engine of growth in earlier centuries, although the evidence is not beyond dispute. The real question is, of course, why this engine (if trade was so) did not result in the creation of an internal growth mechanism. Chapters by James Riedel and Chris Milner in David G r e e n a w a y (ed.), Economic Development and International Trade (New York: St. M a r t i n ' s Press, 1988). 11. S o m e recent d e v e l o p m e n t s in economic theory question the validity of conventional wisdom about the effectiveness of the market. Joseph E. Stiglitz, in particular, has developed a number of arguments that qualify the usual conclusions about the market. See, for example, Joseph E. Stiglitz, " E c o n o m i c Organization, Information, and D e v e l o p m e n t , " in Hollis B. Chenery and T. N. Srinivasan (eds.),

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Handbook of Development Economics, vol. 1 ( A m s t e r d a m : North Holland, 1988): 9 0 - 1 6 0 . 12. A recent convenient survey is Anne O. Krueger, "Government Failures in D e v e l o p m e n t , " Journal of Economic Perspectives 4 (Summer 1990): 9 - 2 4 . 13. T h e World Development Report (Washington, D.C.: O x f o r d University Press for the W o r l d Bank, 1987) made a major effort to convince readers of the c l o s e link b e t w e e n o p e n n e s s and g r o w t h . T h e r e are g e n e r a l l y r e c o g n i z e d p r o b l e m s with the b a n k ' s arguments, largely because of the dominating role of Korea and T a i w a n in its analysis. See, for example, for some doubts about the b a n k report, N i c h o l a s Stern, " T h e E c o n o m i c s of D e v e l o p m e n t : A S u r v e y , " Economic Journal 99, no. 397 (1989): 5 9 7 - 6 8 5 . 14. There are many such studies. See Gary Feder, "On Exports and Economic G r o w t h , " Journal of Development Economics 12 (1983): 5 7 - 7 3 ; Henry J. Bruton, " I m p o r t Substitution," in Handbook of Development Economics, vol. 2, 1 6 0 1 1644; Bela A. B a l a s s a , " E x p o r t s and E c o n o m i c G r o w t h : Further E v i d e n c e , " Journal of Development Economics 11 (1978): 2 3 - 3 5 ; and Bela A. Balassa, " O u t w a r d Orientation," in Handbook of Development Economics, vol. 2, 1 6 4 5 1689. 15. S e e H a r r o d , Towards a Dynamic Economics; and W. Arthur Lewis, " E c o n o m i c Development with Unlimited Supplies of Labor." 16. A n g u s Maddison has published numerous quantitative studies that have greatly helped our understanding of the unusualness of the 1950-1975 years. See, for e x a m p l e , his Economic Growth in the West (New York: Twentieth Century F u n d , 1964), and "Growth and S l o w d o w n in Advanced Capitalist C o u n t r i e s , " Journal of Economic Literature 25 (June 1987): 6 4 9 - 6 9 8 . 17. Gustav Ranis discusses a similar issue in his chapter in this volume. 18. Frank Knight argued strongly long ago that the origin and development of preferences should be a m a j o r part of economic theory. See his The Ethics of Competition and Other Essays (New York: Harper and Brothers, 1935). 19. Albert O . Hirschman has many illuminating things to say on this issue in Shifting Involvements (Princeton, N.J.: Princeton University Press, 1982). 20. H e l p f u l general surveys on these matters are Peter Self, " W h a t ' s W r o n g with G o v e r n m e n t ? " Political Quarterly 61, no. 1 (1990): 2 3 - 3 5 ; and M. DattaC h a u d h u r i , " M a r k e t Failure and G o v e r n m e n t Failure," Journal of Economic Perspective 4 ( S u m m e r 1990): 2 5 - 3 9 . See also Warren J. Samuels and Nicholas M e r c u r i o , "A C r i t i q u e of R e n t - S e e k i n g T h e o r y , " in Neoclassical Political Economy: The Analysis of Rent Seeking and DUP Activities (Cambridge, Mass.: B a l l i n g e r P u b l i s h i n g Co., 1984). An especially clear d i s c u s s i o n with m a n y a d d i t i o n a l r e f e r e n c e s is Helen Shapiro, " R e n t Seeking or Rent Distribution? A u t o m o b i l e F i r m s a n d the B r a z i l i a n State, 1 9 5 6 - 1 9 6 8 , " in F. D e s m o n d M c C a r t h y (ed.), Problems of Developing Countries in the 1990s, vol. I, World B a n k D i s c u s s i o n Papers No. 97 (Washington, D.C.: World Bank, 1990): 1 2 5 142. 21. S e e A b b a P. L e r n e r , " T h e E c o n o m i c s and Politics of C o n s u m e r S o v e r e i g n t y , " American Economic Review 62, no. 2 (1972): 2 5 8 - 2 6 6 , for a c o n v i n c i n g a r g u m e n t with n u m e r o u s illustrations of h o w the s u c c e s s f u l f u n c t i o n i n g of a market requires learning and accumulated experience. Lerner e m p h a s i z e s (p. 2 5 9 ) in particular that "an e c o n o m i c transaction is a solved political p r o b l e m . " This means that the community must have c o m e to accept certain rules and practices and institutions that are compatible with a functioning market. T h e market was not invented and imposed on the West. It evolved with the historical development of the West. 22. N o t e that this is an argument with links to Albert O. Hirschman, The

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Strategy of Economic Development (New Haven, Conn.: Yale University Press, 1958). 23. W. Arthur Lewis argues strongly that "no nation is so poor that it could not save 12 percent of its national income if it wanted to." The Theory of Economic Growth, 236. At the time Lewis wrote this s t a t e m e n t , it w a s exceptional. N o w I think most economists would agree. 24. W . Arthur Lewis is again a useful reference. He argues that e c o n o m i c growth is desirable because it "increases the range of human choice." The Theory of Economic Growth, 420. Such a statement clearly requires that the various individual e c o n o m i c agents can in fact make the "right" choices a n d that the public choice is under control. 25. T h e a c h i e v e m e n t of the conventional marginal equalities that e n s u r e efficiency are not included. Later discussion explains why. 26. There is a large and rapidly increasing literature on this issue. William J. Baumol, Sue Anne Blackman, and Edward N. Wolff, Productivity and American Leadership ( C a m b r i d g e , M a s s . : M I T Press, 1989); M o s e s A b r a m o v i t z , " F o l l o w i n g and L e a d i n g , " in Horst Hanusch (ed.), Evolutionary Economics ( C a m b r i d g e : C a m b r i d g e University Press, 1988): 3 2 3 - 3 4 1 ; and R i c h a r d A. Easterlin, " W h y Isn't the Whole World Developed?" Journal of Economic Histoiy 4 1 (March 1981): 1 - 1 9 . 27. F o r data a n d d i s c u s s i o n on this point, see N i c h o l a s S t e r n , " T h e E c o n o m i c s of Development: A Survey," Economic Journal 99, no. 397 (1989): 5 9 7 - 6 8 5 ; a n d Hollis B. C h e n e r y , Sherman Robinson, and M o s h e S y r q u i n , Industrialization and Growth (New York: Oxford University Press, 1986). 28. This a r g u m e n t was first made by Martin Feldstein, " D o m e s t i c Saving and International Capital F l o w s , " Economic Journal 90 (June 1990): 3 1 4 - 3 2 9 , and has since been examined extensively by many economists. 29. This m e t h o d of protection was first explored by W. M a x C o r d o n , Protection, Growth and Trade: Essays in International Economics (Oxford: Basil Blackwell, 1985). See also Henry J. Bruton, "Protection and D e v e l o p m e n t , " Research Memorandum No. 116 (Williamstown, Mass.: Center for Development Economics, 1989), for an application of it to developing countries. 30. With significant capital flows, the notion becomes more complex, so it is helpful to use the simplest assumption to try to get the argument clear. 31. It does discriminate in favor of tradables. This is surely an advantage in most instances. 32. T h e r e are m a n y examples in developing countries of well-staffed and well-funded research institutes that are essentially white elephants. 33. T h e s t a t e m e n t is s o m e t i m e s m a d e that a person has o n e year of e x p e r i e n c e , r e p e a t e d ten times. This kind of experience has little e f f e c t on productivity growth. 34. T h e r e is m u c h e v i d e n c e on this point. See, for e x a m p l e , H e n r y J. Bruton, "Productivity Growth in Latin America," American Economic Review 57 ( D e c e m b e r 1967): 1 0 9 9 - 1 1 1 6 . 35. In various articles, Larry Westphal provides a great deal of evidence on this point. See, for e x a m p l e , his "Industrial Policy in an E x p o r t P r o p e l l e d Economic E c o n o m y : L e s s o n s f r o m South K o r e a ' s E x p e r i e n c e , " Journal of Perspective 4, no. 3 (1990): 41-60. 36. L e w i s , " E c o n o m i c D e v e l o p m e n t with Unlimited Supplies of L a b o r , " 420. 37. V e r n o n Ruttan, "Industrial Innovation and Agricultural D e v e l o p m e n t , " World Development 17, no. 9 (1989): 1375-1387, quoted here from p. 1385. 38. Gustav Ranis, " T h e Role of Institutions in Transition Growth: The East

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A s i a n N e w l y Industrialized C o u n t r i e s , " World Development 17, no. 9 (1989): 1 3 7 5 - 1 3 8 7 , quoted here from p. 1445. See also his chapter in this volume. 39. For especially interesting discussions of similar issues, see also H u n g C h a o Tai, Confucianism and Economic Development (Washington, D.C.: W a s h i n g t o n Institute Press, 1989); and J a m e s K. Boyce, Agrarian Impasse in Bengal (Oxford: O x f o r d University Press, 1987). 40. Ronald Dore, "Reflections on Culture and C h a n g e , " in Gary Gereffi and D o n a l d L. W y m a n (eds.), Manufacturing Miracles (Princeton, N.J.: Princeton University Press, 1990): 360. 41. T h e r e are m a n y sources on M o h a m m e d Ali. The most f u n is David S. Landes, Bankers and Pashas (London: George Allen and Unwin, 1955). See also David S. Landes, " W h y Are W e So Rich and They So Poor?" American Economic Review 80, no. 2 (1990): 1 - 1 3 . Both have ample references. 42. See K e n n e t h Boulding, "Ecology and E c o n o m y , " in Collected Papers, vol. 2 (Boulder, Colo.: Colorado Associated University Press, 1971): 49. 43. Michio Morishima, Why Has Japan Succeeded? (Cambridge: C a m b r i d g e University Press, 1982): 8 6 - 8 7 . 44. Ibid., 87. 45. Ibid., 2 0 1 . 4 6 . W h e n o n e a p p r o a c h e s the q u e s t i o n f r o m this p e r s p e c t i v e , t h e e x p e r i e n c e s of a n u m b e r of countries b e c o m e especially illuminating. India, roundly berated by most observers, presents a case that is clearly a m u c h more c o m p l e x m a t t e r than simply i n w a r d - l o o k i n g failure c o m p a r e d with o u t w a r d looking success. A n i n f o r m a t i v e examination is Ashok Guha (ed.), Economic Liberalization, Industrial Structure and Growth in India (Delhi: Oxford University Press, 1990). S a n j a y a L a l l ' s work is particularly h e l p f u l . Brazil, M a l a y s i a , Thailand, and Sri Lanka are also turning out to be more complex cases than early analyses would have suggested. 47. Lewis, The Theory of Economic Growth, 376. 4 8 . T h e role of the state has been a f r e q u e n t topic in r e c e n t years. Particularly helpful to me are Joan M. Nelson (ed.), Economic Crisis and Policy Choice (Cambridge: C a m b r i d g e University Press, 1990); Dieter Helm (ed.), The Economic Borders of the State (Oxford: Oxford University Press, 1989); Arnold Heertji (ed.), The Economic Role of the State (Oxford: Basil Blackwell, 1989); Albert Fishlow, " T h e Latin American State," Journal of Economic Perspectives 4, no. 3 (1990): 6 1 - 7 4 ; Peter Evans, Dietrich Rueschemeyer, and Theda Skocpol (eds.), Bringing the State Back In: States and Structures: Research Implications of Current Theories (Cambridge: C a m b r i d g e University Press, 1985); and Robert Bates, Beyond the Miracle of the Market ( C a m b r i d g e : C a m b r i d g e U n i v e r s i t y Press, 1989). 49. L l o y d R e y n o l d s concludes that "the single most important explanatory v a r i a b l e [for the a c h i e v e m e n t of growth] is political o r g a n i z a t i o n and the administrative c o m p e t e n c e of the government." "The Spread of Economic Growth to the Third World," Journal of Economic Literature 21, no. 3 (1983): 9 4 1 - 9 8 0 , quoted here from p. 976. It seems one should add that the government must be committed to growth. 50. O n e should note that all forms of u n e m p l o y m e n t cannot be solved by strong d e m a n d , but if there is little threat of a b a l a n c e - o f - p a y m e n t s p r o b l e m , strong d e m a n d can solve a lot of it. 51. Lance Taylor presents a rather complete list of this kind in his Varieties of Stabilization Experience (Oxford: Clarendon Press, 1988): 6 9 - 7 4 . Such a list facilitates p o l i c y m a k i n g , but p e r h a p s m o r e important, it facilitates learning about the m a c r o e c o n o m y .

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52. Lance Taylor has produced extra helpful work on the macroeconomics of development. See also Christopher Allsopp "The Macro-Economic Role of the State," in Helm, The Economic Borders of the State: 180-217. 53. An example or two of how such a subsidy could work may help make the argument clear. The government may buy a great deal of farm output (as it does in Egypt, for example) at a price that it sets. In such a case, it is a simple administrative matter to link the price the government pays to the increase in yields. Where taxes are levied and collected, they can be used to reward increased yields. A guaranteed price for agricultural products is also a possible approach in many countries. 54. There is abundant evidence that there is considerable underutilized knowledge that can be found through informal efforts of searching and learning. The idea of underutilized knowledge is found in a number of places; for example, Robert Chambers, Rural Development: Putting the Last First (London: Longman, 1983). 55. Foreign investment in minerals has, in many cases, failed to get a sustained growth process underway. The oil-rich countries of the post-1973 years are only one example. 56. One does not wish to imply that the rich and powerful countries have accomplished these objectives very well.

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.

The Effect of Government Intervention on Growth and Equity: Lessons from Southern Asia GUSTAV F. PAPANEK

A remarkable consensus developed in the 1980s that L D C s and other economies will achieve both more rapid growth and more rapid alleviation of poverty if they adopt a market-oriented strategy with minimal direct control and ownership o f the economy by government. Economists, journalists, politicians, and international civil servants have joined the previous devotees of that prescription, the business community of the O E C D countries. The disputes that remain have to do with marginal issues: how fast to move from dirigiste to private enterprise systems and the extent to which there is a residual role for government in dealing with market imperfections and influencing some aspects o f industrial development through taxes and subsidies. There remain a few unregenerate interventionists, especially in South Asia, but they are definitely a beleaguered minority. Even more remarkable is that the consensus exists not only with respect to the economic efficiency of the market but is nearly as great on its effectiveness in reducing poverty. " A rising tide lifts all the boats" or "Trickle down is all in poverty alleviation" seem to be widely accepted. One useful means for analyzing the effect of greater reliance on markets or government intervention in raising the rate of growth and reducing the extent of poverty is to compare the experiences of similar countries with different strategies in that respect. A comparison of the experiences of five poor, labor-abundant countries in Southern Asia (Sri Lanka, Pakistan, India, Bangladesh, and Indonesia) during the last 30 to 4 0 years can be particularly fruitful for a number of reasons: 1. The economies of the five countries were quite similar in the 1950s: they had per capita incomes around $100; agriculture contributed about half of GDP, employed more than half of the labor force, and provided most of the exports and government revenues; population pressure and employment and a substantial current account deficit were key problems throughout their recent history (except for the Outer Islands of Indonesia with one third of

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Indonesia's population). Four of the countries share a climate, and all five are similarly affected by world fluctuations in prices of foodgrains, which they imported, and nonfood crops, which they exported. There were differences: two of the countries (Indonesia, Sri Lanka) had a large plantation sector; India had a better-developed industrial base in the 1950s; and Indonesia had important revenues from oil exports since the 1970s. But the similarities dominated. 2. Three of the countries were one for more than a century, and Sri Lanka was administered with them, so four share a heritage of similar institutions and even statistical systems. 3. All of the countries except India had periods of massive direct government controls of the economy and increased public ownership and periods of substantial deregulation and of greater reliance on the market. W i t h roughly similar e c o n o m i e s and problems and c o m p a r a b l e institutions, the effects of differences in economic strategies can be seen more readily than in comparisons between countries that have little in common. One can therefore fruitfully compare the same time periods in different countries while they followed different economic strategies. In addition, one can compare the periods of a more market-oriented (or more competition-oriented) strategy in four of the countries with the more directly interventionist or dirigiste strategy in the same country. 1 Comparing different time periods in the same country holds roughly constant the basic economic, social, and political structures, while comparing different countries at the same time holds roughly constant exogenous forces, such as world recessions and booms in commodity prices or favorable agricultural weather.

Growth Under More Dirigiste and More Market-Oriented Strategies In Pakistan and Bangladesh, one can identify four rather distinct periods. T w o were characterized by more dirigiste strategies, when governments intervened more heavily in the economy by expanding government ownership of firms and increasing direct quantitative controls over the remaining private firms. During the other two periods, there was heavier reliance on market forces, with no nationalization of enterprises and greater reliance on price incentives and on indirect forms of intervention through taxes and subsidies. India's policy has been quite consistent in contrast, with its mixture of socialist rhetoric, subsidies for some producers and consumers, and tight controls over the economy, accompanied by a vigorous private sector, in some fields dominated by larger firms. Beginning in 1978, and somewhat accelerating in the m i d - 1 9 8 0 s , there was some m o v e m e n t toward deregulation, with massive deregulation starting in 1991.

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133

In Sri Lanka, the rather regular alternation in power of the two m a j o r political parties until the 1980s resulted in three periods of more dirigiste and two periods of more market-oriented strategy. 2 Indonesia had one fundamental shift in the period 1966-1968, from the highly controlled system under President Sukarno to substantial deregulation under President Suharto. There were periods of somewhat greater control and of deregulation under both governments, but these changes were dwarfed by the basic shift in strategy and the influence of exogenous factors, such as the change in oil prices. 3 By d i s t i n g u i s h i n g periods w h e n internal strategy o r e x t e r n a l circumstances changed and limiting periods to a maximum of about a decade, the history of the five countries since Independence can be divided into 22 time periods. C o m p a r i n g the same country at times when it followed different economic strategies and different countries at the same time when they adopted different strategies leads to the unequivocal conclusion that the more market-oriented periods produced a far higher rate of economic growth (Table 8.1). On the average, the rate of growth was almost twice as great in the market-oriented than in the dirigiste periods. Clearly, factors other than the strategy followed influenced the growth rate; any single-causal-variable explanation of such a complex phenomenon should be suspect. So one can explain the low growth rate in Bangladesh in the early 1970s in large part by the effects of the civil war and war that led to that country's independence. By contrast, Pakistan's high growth rate in the 1960s was certainly helped by increased inflows of aid compared to the 1950s. But it is not reasonable to explain the completely consistent correlation of economic strategy and growth rates by such exogenous factors: in every single observation, the growth rate is lower during dirigiste strategies than during more market-oriented policies in the same country in the preceding or succeeding periods. Almost as consistently, the rate of growth is substantially higher in comparable countries following a more market-oriented strategy than in those with more dirigiste policies during the same time period. A summary of growth rates brings this out clearly (calculated from Table 8.1): • •

Pak, Ban, Indo, SL dirigiste: Pak, Ban, Indo, SL market:

3.2%; 6.9%;

India dirigiste (same time): India dirigiste (same time):

3.8% 3.8%

Population growth was about 2.5 percent a year in these countries. Therefore, during the dirigiste periods in the four countries other than India, per capita incomes on average barely increased (growth less than 1 percent) while they grew at more than 4 percent in the more market-oriented periods. That is obviously a very significant difference. India, with a better endowment at Independence and better able to manage a dirigiste economy,

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GUSTAV F. PAPANEK

Table 8.1 Growth Rates Under Dirigiste and Market-Oriented Strategies (GDP, annual percentages) 1949/501959/60 1) India

1959/601969/70

2) Pakistan

3.8 3.5?

3.8 6.9*

3) Bangladesh

1.7?

4.7*

4 ) Indonesia

5) Sri Lanka

1977/781987/88

1969/701976/77 3.8 4.7 2.0

4.5* 6.6* 3.9*

1955-60

1960-67

1968-71

1972-80

1981-89

1.7-3.8?

1.9?

9.5*

7.9*

4.9*

1950-60

1961-65

1966-70

1970-77

1978-83

3.1

3.9

5.7*

3.1

7.7*

* = Relatively more market oriented strategy followed. AVERAGES More market oriented: 6.2 percent More dirigiste: 3.2 percent Sources: India, Pakistan, and Bangladesh for the 1950s: Muhammed Khan Niazi, "Economic Growth in South Asia." Ph.D. dissertation, Boston University, 1984. Indonesia for the 1950s: Lower estimate calculated by the author from scattered data for 1955-1960. Higher estimate from World Bank, "World Tables, 1971" for 1951-1961. Indonesia for 1960-1967: from Arsjad Anwar, Ph.D. dissertation, University of Indonesia, 1983, using BPS (Central Bureau of Statistics) data. Sri Lanka for the 1950s: Official data, primarily Central Bank annual reports. Other years: World Bank, "World Tables," various years, and its data base. Notes: ? indicates data are less reliable. Pakistan and Bangladesh during these periods were one country and provincial accounts tend to be much less accurate than national accounts. However, the combined average is not significantly less reliable. Indonesian National Income data in the 1950s at best indicate orders of magnitude and the range of estimates is clearly great. No official data seem to exist and the original source of both estimates is unclear. For the calculation of multicountry averages in this paper, the figure of 3.0 has been used since the higher estimate may well be closer to the truth. For the 1960s more accurate calculations exist. They too have a considerable margin of error, however, partly because widely differing deflators for inflation were used by various scholars. For Sri Lanka the last period ended with 1983, because riots in that year were followed by increasing destruction and uncertainty due to civil war. Growth rates for all subsequent years were substantially affected by this fact. Inclusion would lower the average for market-oriented strategies by a negligible amount.

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135

achieved an unspectacular but nevertheless clearly positive 1 percent rate of growth per capita throughout. 4

Causal Factors in Higher Growth During Market-Oriented Periods These findings are not surprising because they are in line with the current consensus mentioned earlier, although the consistency of the results in rather comparable countries is interesting. But there has been less analysis of the specific mechanism that explains why deregulation leads to higher growth. References to "the miracle of the marketplace," to the incentive effects of the capitalist system and the inefficiencies of direct controls have only limited explanatory powers because they do not indicate precisely how and in what ways these factors work, especially in the relatively short run. The periods analyzed in Table 8.1 are generally seven to ten years. This is long enough to average the effects of particularly good and bad harvests, important in countries where agriculture contributes about half the GDP and is subject to the vagaries of a monsoon climate. But the periods are not really long enough to reflect fundamental changes in attitudes of managers, entrepreneurs, or workers. They are barely long enough for changes in investment patterns to begin to have an impact on output, because the gestation period of major industrial investments is often four to eight years from conception to production. What factors, then, operate in the medium term to substantially increase the rate of growth when economies are deregulated? 5 The Effect of More Aid As is clear from Table 8.2, aid (and other resource inflows that are foreign savings) increased during the periods of market-oriented strategy. This is not surprising. Most of the aid came from the market economies and their multilateral institutions and was more readily available in support of market-oriented strategies. Aid was also related to economic performance: higher growth during market-oriented periods led to higher aid. Commercial banks preferred lending to booming economies carrying out an IMF-approved deregulation program. Private investors also financed more projects during market-oriented periods but their role was major only in Indonesia. Aid, however, explains only a small part of the difference in growth rates. For all countries and time periods, over one-seventh of the greater foreign resource inflows to market-oriented periods and countries went to offset the higher rate of domestic savings in dirigiste periods and countries. The remaining 2.9 percent of GDP of greater inflows contributed to a higher rate of investment during market-oriented periods. With a typical capital output ratio of about 3.5 (see Table 8.3), this would account for less than one percentage point of the difference in growth rate of 3 percentage points. More careful econometric analysis leads to the same result. 6 It also

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Table 8.2 Foreign and Domestic Savings (percent of G D P at current prices)

India

1950s

1960s

Early 1970s

Late 1970s

D o m . For. Total

Dom. For. Total

D o m . For. Total

D o m . For. Total

11.2 - 0 . 4 10.8

Pakistan 7.8a

1.7

17.4

18.0

1.1 19.1

20.9

0.4

20.5

11.6

5.8

17.4*

11.1

4.4

15.5

11.9

3.6 15.5*

7.9

2.6

10.5*

2.3

4.7

7.0

7.4

4.8 12.0*

0.5a 8.3a

Bangladesh 1950s Indonesia Sri Lanka Sri Lanka

15.7

(7.6) (3.4X11.0) 13.6 - 0 . 8 12.8

Early 1960s 4.2 12.4

3.1 2.4

7.3 14.8

Late 1960s 3.8 13.5

1970s

10.5*

19.2

4 . 3 17.8*

13.7

6.7

1.3 20.5* 2.2 15.9

12.8 13.2 26.0*

(1978-1981) * = Relatively more market oriented strategy followed. AVERAGES

More market oriented More dirigiste

Domestic

Foreign

Total savings= Investment

11.0 11.5

5.3 1.9

16.3 13.4

Sources: Data generally calculated from official country sources, not from World Bank data. Main sources: for India, Pakistan, Bangladesh: "Statistical Yearbook" and "Economic Survey"; for Indonesia: "Statistical Pocketbook"; for Sri Lanka: Central Bank "Annual Report." Notes: Indonesia 1950s is theaverageof 1950,1955,1960 from World Bank "World Tables." These data are of dubious reliability, hence in parentheses. Without them the conclusions would be slightly stronger. a. Combined data for Pakistan and Bangladesh; no separate estimates available for the 1950s

shows that a greater deficit on current account/greater aid flows during the market-oriented period was a contributory, but by no means the major, factor in higher growth. Finally, a comparison of India, Pakistan, and Bangladesh, the most closely comparable of the five economies, also supports that conclusion. 7 In large part, the additional aid permitted Pakistan to have a rate of investment almost equal to India's, despite a much lower rate of savings, and to have defense expenditures double those of India as a percent of income. The difference in aid levels does not explain the principal reason for different growth rates. With roughly the same rate of investment in the first marketoriented period, Pakistan had an 80 percent higher growth rate. In the second market-oriented period, when India had partially deregulated and investment in

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Table 8.3 Rate of Investment and Incremental Capital-Output Ratios (at constant prices) 1950s Invest ICOR India

11.8%

3.1

Pakistan 8.8% a

16.9%

4.4

20.0%

5.3

24.3%

5.4

18.4%

2.7*

15.5%

3.3

17.4%

2.6*

10.1%* 2.1*

8.6%

4.3

13.1%

3.4*

3.5 a

Bangladesh 1950s Indonesia+ Sri Lanka Sri Lanka (1978-1981)

1960s 1969/70-1976/77 1977/78-1987/88 Invest ICOR Invest ICOR Invest ICOR

(11.0)% (3.7) 12.9% 4.2

Early 1960s 8.9% 14.7%

4.7 3.8

Late 1960s

1970s

9.4%* 1.0* 16.1%* 2.8*

15.5%* 2.0* 14.1% 4.5% 26.0%* 3.4%*

* = Relatively more market oriented strategies followed.

Market oriented Dirigiste

AVERAGES Investment: 15.8 percent Investment: 14.0 percent

ICOR: 2.5 ICOR: 4.2

Pak, Bangla market oriented India, same periods

Investment: 15.8 percent Investment: 20.6 percent

ICOR: 2.5 ICOR: 4.9

Pak, Bangla dirigiste India, same periods

Investment: 11.0 percent Investment: 15.9 percent

ICOR: 3.7 ICOR: 4.2

Sources: Investment: For India, Pakistan, Bangladesh, 1950s and 1960s: Niazi, op.cil. 1970s onward for these countries as well as Indonesia and Sri Lanka: generally calculated from World Bank "World Tables" various years. For ICOR: Investment taken from this table, divided by growth rates from Table 8.1. Notes: "Invest" = investment as percent of GDP "ICOR" = Incremental Capital-Output Ratio; rate of investment divided by rate of growth + = For Indonesia 1950s investment is the average of 1950, 1955, 1960. Regular annual data are available for 1965-1980 only. Missing years interpolated. Investment data differ from Table 8.2 because of the different sources used. a. Combined data for Pakistan and Bangladesh; no separate data estimates available for the 1950s

Pakistan was 30 percent below India's, Pakistan nevertheless had a growth rate nearly 50 percent higher, while Bangladesh, with investment barely more than half India's, had a growth rate only slightly lower. The reasons for higher growth per unit of investment lay in a series of interconnected policy decisions, most indeed involving deregulation and greater market orientation.

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Using Idle Capacity All five countries for almost all of their postindependence history have had idle capacity in industry and in a variety of trade and service activities. Output can then be increased dramatically and quickly by putting this capacity to work. The principal constraint causing idle industrial capacity has been foreign exchange for imported inputs. The foreign exchange constraint also limited demand, the principal reason for idle capacity in some industries and in much of trade and services. The supply of foreign exchange available to the economy increased during the market-oriented period because of the already-mentioned increase in foreign aid and because of policies that increased export earnings. The latter, discussed below, released both the foreign exchange constraint on inputs and the limits on demand of the domestic market. Expansion of Exports The data on exports are particularly affected by exogenous factors and by statistical artifact. Total export earnings for Indonesia and Sri Lanka depend heavily on the price of their primary goods on the world market—oil and plantation crops for Indonesia, tree crops for Sri Lanka. The comparison among the other three countries is therefore more meaningful. Even India, Pakistan, and Bangladesh are substantially affected by nonpolicy factors. For instance, growth of Pakistan's exports in the 1950s (Tables 8.4A and 8.4B) appears rapid because statistical coverage improved and the base was extremely small. Conversely, in the early 1970s, Indian exports appear to grow very rapidly. Part of this is real but reflects the discovery and development of an oil field. Part of it is overstated. The statistics record the total value of gem and jewelry exports, but the value added was much smaller because the industry imported uncut gems. Nevertheless, the market-oriented periods show a one-third higher growth rate in exports on average. Particularly dramatic is the spurt in Pakistan's manufactured exports in the 1960s, thanks to the effective devaluation under its export bonus voucher system. Another dramatic reversal occurred in the 1970s. During their dirigiste period in the early 1970s, export growth for Pakistan and Bangladesh combined was less than half that for India. But in the period 1977-1986, as Pakistan and Bangladesh did far more in deregulating imported inputs and providing incentives for export (e.g., Bangladeshi garment exporters benefited from a large, hidden subsidy), they achieved a growth rate that was about 50 percent higher than India's.

139

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Table 8.4A Export Earnings, 1949/50 to 1969/70 (annual compound rates of growth, percentages with exports measured in US$ at current prices) 1949/50-1959/60

1959/60-1964/65

1964/65-1969/70

India

Pakistan

India

Pakistan*

India

Pakistan*

Primary products Manufactures Invisibles

3.7 0.1 5.3

0 Infinite 3 11.5

4.0 6.4 0.5

5.0 8.7 12.9

-2.0 6.5 4.1

-2.3 16.5 5.3

Total earnings

2.6

4.5

4.1

7.4

2.5

5.5

Table 8.4B Export Earnings, 1969/70 to 1986/87 (annual compound rates of growth, percentages based on US$ at current prices) 1969/70-1976/77 India

1977/78-1986/87

Pakistan Bangladesh

India*

Pakistan* Bangladesh*

Primary products (inc. fuels) 15.3 Manufactures 19.7 Invisibles 29.9

6.8 7.3 12.6

8.1 b 5.0 b -2.4

5.3 8.4 10.0

9.4 14.0 11.1

6.6 8.3 10.2

20.8 49.4

8.6 13.3

0.3 (6.6) c Infinite^

7.8 6.4

11.6 7.3

9.3 22.1

Total exports Remittances

* = Relatively more market oriented strategy followed. AVERAGES More market oriented More dirigiste

8.3 percent 6.2 percent

Pakistan, Bangladesh market Pakistan, Bangladesh dirigiste

8.5 percent; 4.5 percent;

India, same periods 4.8 percent India, same periods 11.7 percent

Source: Ministry of Finance, Economic Survey, of the countries for the various years. Notes: Pakistan rate overstated in the 1950s, partly reflecting improved statistical coverage. In 19691970, political disturbances damaged real exports and caused export earnings to be underreported, because exporters moved capital out of the country. Therefore, the growth rate between 19591960 and 1969-1970 is almost certainly understated and affected by political factors. a. Zero in 1949/50. b. 1971/72 to 1976/77. c. 1970/71 to 1976/77; figure in parentheses for 1971/72 to 1976/77. d. 1973/74.

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Exports rose more during market-oriented periods because, consistently: 1. 2. 3. 4.

Export prices were more favorable; Favorable export prices were assured for some period of time; Imported inputs were more readily available to exporters; Controls were reduced on foreign investment, domestic investors, and foreign travel, enabling exporters to respond more quickly to world market changes.

Incentives to Use More Inputs in Agriculture It is clear that a m a j o r cause of differences in overall growth were differences in agricultural growth rates. Again, the most useful comparison is among the three large South Asian countries that tend to have quite similar climates. Another summary provides striking evidence of the effect of greater reliance on the market: • •

Pakistan, Bangladesh dirigiste: Pakistan, Bangladesh m a r k e t :

1.6%; 3.6%;

India (same periods): 2.4% India (same periods): 1.2%

W h e n all followed dirigiste strategies, Indian growth was 5 0 percent higher. W h e n Pakistan and B a n g l a d e s h f o l l o w e d more market-oriented strategies, their agricultural growth rate was 200 percent higher. Even more persuasive is a comparison of the two Bengals and the two Punjabs, where exogenous factors have virtually identical effects. A careful study has s h o w n that the difference during different policy periods was a growth rate in Gross Value Product of about 8 percentage points, a massive difference due to policy. 8 Several factors explain w h y growth was higher during the marketoriented periods: 9 1. Input to output price ratios were more favorable, encouraging more input use. 2. Compulsory procurement of foodgrains at fixed prices was abandoned. This had discouraged use of commercial inputs and the growing of foodgrains. During the market-oriented periods, government allowed prices to rise to compensate for poor harvests. However, government reduced the risk of this move to market price setting by guaranteeing minimum prices for foodgrains, reducing the risk of new technology. 3. Competitive distribution of inputs was permitted and proved more effective than a government or cooperative monopoly. 4. Investment was more profitable as a result of the greater availability of cheaper imported parts for wells and pumps and the higher, more stable prices for output. 5. T h e shift to higher-value crops was eased by fewer governmentimposed distortions in crop prices.

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141

6. More efficient use of inputs was possible because they were available when needed. During the market-oriented periods, more favorable and more stable prices were the indispensable base that made it profitable to increase input use, including increased investment in water control. More efficient distribution and easier access to inputs, especially to tubewell water and fertilizer, then speeded the adoption of modem technology, including highyielding seed varieties. Fertilizer yields results in four months to a year and tubewells in a comparable period. There were, therefore, quick output increases from changed price and input policies. Long-term effects resulted from greater investment during the more profitable market-oriented periods. Capacity Utilization and More Efficient Investment in Industry The higher industrial growth rate during the market-oriented periods was due, in the short term, primarily to two factors already discussed: the greater availability of crucial imported inputs for industry with the relaxation of the foreign exchange constraint, as both foreign aid and exports increased; and the relaxation of the demand constraint for many industries as exports became profitable as a result of a more favorable effective exchange rate and better access to imported inputs under a more flexible foreign trade regime. In addition, owners and investors were less concerned with political risk and more willing to invest in rehabilitation, working capital, and small improvements, all of which had short-term effects. In the longer run, higher growth in the market-oriented periods was substantially due to a pattern of investment that was more efficient, more attuned to the relative scarcity of different factors. Garments and textiles grew rapidly as did labor-intensive miscellaneous industries (wood products in Indonesia, metal working in Pakistan, leather products in Bangladesh). During more dirigiste periods, industry became increasingly capital intensive, using more capital and less labor than was desirable for social efficiency, for a number of reasons: 1. The cost of labor in the large-scale industrial sector was raised by making it very difficult and costly for a large firm to fire any workers and by extending the coverage of the minimum wage. 2. The cost of capital was lowered by providing it free as equity to the public enterprises and at below market interest rates through the nationalized banks to many private firms. 3. For managers of public firms, maximum profit was not the principal goal; avoiding trouble was more important and was easier with fewer workers. In addition, capital intensity was increased in dirigiste periods by a consensus on the importance of capital-intensive "heavy industry" and the

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equally widespread belief that it was very difficult to expand export earnings. The result was emphasis on import-substituting industrialization. It was increasingly capital intensive because the labor-intensive industries had been developed earlier. (See Table 8.5 for data on increasing capital intensity in India.)

Table 8.5 Capital Intensity in Indian Manufacturing Industry Fixed Capital per Worker, in the year 1959/60

Growth in Fixed Capital, Number of Sectors

1 9 5 9 - 1 9 7 9 (weighted average)

2.5

14

7.7

2.5-5.0 5.0

12 12

10.9 12.9

Source: Calculated by Robert E. B. Lucas from "Annual Survey of Industries," various issues, unpublished background for Robert E. B. Lucas, "India's Industrial Policy," in Robert E. B. Lucas and Gustav F. Papanek, The Indian Economy: Recent Developments and Future Prospects (Boulder, Colo.: Westview Press, 1988).

Moreover, dirigiste governments tended to give higher priority to goals other than efficiency or growth, especially employment at high wages to their supporters in organized labor, protection to domestic small firms, and limits on foreign investment and on imports. Resulting policies sometimes caused economic losses. India, for instance, protected a large number of existing jobs in handloom weaving by restricting the modern power-loom sector. This greatly weakened India's ability to compete in the world market. Indonesia greatly overstaffed government-owned plantations during the Sukarno era. 1 0 More generally, the larger role for government, and particularly government enterprises, meant that market pressures for efficiency were muted and political pressures to avoid economic costs for any powerful group were amplified. For instance, pressure from regional constituencies were greater. India, as a result, pursued a more effective policy of dispersing investments among the states than Pakistan. For many industries, this had costs in smaller, less well-sited, and therefore less-efficient factories. Unable to compete in the world market as a result, India had slower growth in these industries. Pakistan (and Indonesia in one of many departures from efficiency criteria) set up an inefficient steel mill. Indonesian and Sri Lankan plantations were handed to well-connected, but not necessarily efficient, managers and were overstaffed during their dirigiste periods.

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143

Summing Up the Effect on Efficiency: The ICOR Under Different Strategies T h e ICOR is a very crude measure of efficiency. It indicates how much output was generated by each unit of investment—how efficiently investment was used—if all other factors affecting output remained unchanged. In fact, those factors obviously change a good deal. In any one year, output is usually affected much more by weather, international prices, the completion of investments made earlier, and other accidental or exogenous variables than by changes in efficiency. The most significant factor, besides the weather, that usually affects output with a given capital stock is the extent to which installed capacity is used. Capacity use in turn depends primarily on domestic demand; on foreign demand, dependent on the state of the world economy and the effective exchange rate; and on the availability of imported inputs, dependent on exports and foreign inflows. In the short term, only some of these are affected by government policy; in the longer run, all of them are. An annual ICOR is therefore a meaningless figure because it is primarily detennined by exogenous variables. But over a five- or ten-year period, the influence of weather should be average and other factors are increasingly policy determined. ICORs presented in Table 8.3, therefore, are a meaningful, although not very precise, measure of policy-influenced efficiency. Accuracy of data is a problem. However, by making comparisons of several countries' performance at the same time and of the same country over time, a clear conclusion emerges: the higher rate of growth achieved by market-oriented regimes has more to do with the efficiency of investment than with its high rate. For all five countries and all periods, the lower ICOR during the more market-oriented periods yielded about 70 percent more output for each unit of investment. Greater investment during these periods increased output growth by less than one percentage point, while the greater efficiency with which that investment was used accounts for over 2 percentage points."

Income Distribution and Poverty Under Different Strategies That a market-oriented strategy can be favorable for growth is widely accepted. It has been argued, however, that this will be at the cost of a less equal income distribution, in part because policies designed to achieve rapid growth will provide greater rewards to the rich who control scarce factors of production. Indeed, several analysts argue that this is precisely what happened in Pakistan in the 1960s: rapid growth was achieved at the cost of rising inequality, producing tensions that eventually resulted in the breakup of the country. 12 Income Distribution Trends The income distribution data do not support this argument. Only scattered data exist. For Indonesia, they are also of especially dubious reliability and

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are therefore not used here. 13 Tables 8.6 and 8.7 summarize data on the other four countries. Given the sporadic nature of the data, one can, by judicious selection of years for comparison, support different conclusions. But for all countries and time periods for which data exist and unambiguously indicate the direction of change in income distribution, the relationship is quite clear: during all five periods of rapid growth, income distribution improved, and in five out of six periods of slow or negative growth, income distribution became less equal (see Table 8.7). From these data one could argue that rapid growth is very favorable for more equal income distribution (and greater market orientation is favorable for more rapid growth). But given the weakness of the data, it is better to claim only that available facts lend no support to the argument that rapid growth is accompanied by deteriorating income distribution in the five countries under consideration. Rate of Growth in GDP and Changes in Real Wage Data as an Index of Poverty Additional evidence on income distribution and poverty can be derived from data on changes in the real wage of unskilled labor on the following, quite plausible, assumptions: 1 . T h e poor derive most or all of their income from the sale of essentially unskilled labor. They possess little human or physical capital. If real income of unskilled labor increases more rapidly than per capita income, then income distribution is likely to have improved and vice versa. 2. The labor income for different groups of unskilled workers moves generally in the same direction and by similar magnitudes because of migration among activities. This parallel movement affects not only wage earners but also the self-employed. The major exception is workers in "protected" activities, where governments or unions substantially influence labor income. In the five countries under study, these protected activities account for less than 10 percent of the labor force. 3. There are essentially no unemployed among the poor because they cannot afford to remain without work and income for any length of time. Their income is therefore not affected by the rate of unemployment. 4. Income of unskilled workers is affected by the number of hours a month for which they find work or by the number of units of services or goods they are able to sell. But the same supply and demand factors that determine the compensation per hour, day, or unit of services provided also determine the n u m b e r of hours or days worked or units sold. Therefore changes in the wage per day/hour/unit are an accurate measure of labor income. If one can find a consistent and comprehensive time series for the income of any group of unskilled labor, therefore, one can use that as a fair index of

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T a b l e 8 . 6 T r e n d s in I n c o m e Distribution in F o u r Countries A. Gini coefficients India

Pakistan Rural

Urban

Bangladesh

Rural

Urban

Rural

1958/59

.340

.348

.38

1959/60

.314

.357

.38

1960/61

.321

.350

.38

1961/62

.312

.357

1963/64

.297

.360

1964/65

.294

.349

Urban

1953

National .50

.339

.347

.313

.342

.261

.326

1969/70

.292

.323

1970/71

.284

.315

1971/72

.293

.332

1965/67 1967/68

.293

.345

1968/69

.310

.350

1973/74 1978/79

Sri Lanka

.33

.41

.33

.39

.31

.38

.27

.37

.44 .319

.380

1981/82

.49

.41 .49 .52

1984/85

.343

1985/86

.331

.379 .354

1986/87

.312

.357

1987/88

.307

.366

Sources: India: National Sample Survey data cited by Pranab K. Bardhan "The Pattern of Income Distribution in India," in T. N. Srinivasan and Pranab K. Bardhan, Poverty and Income Distribution in India (Calcutta: Statistical Publishing Society, 1974). Pakistan: Nasim M. Sadiq, "Statistics of Income Distribution in Pakistan" (unpublished), cited in Stephen Guisinger and Norman L. Hicks, "Long-term Trends in Income Distribution in Pakistan," World Development, Vol. 6, 1978, pp. 1271-1280, for data until 1979. Thereafter from calculations of Dr. Nadeem Burney, Pakistan Institute of Development Economics, personal communication. Bangladesh: Mohiuddin K. Alamgir, "Some Analysis of Distribution of Income, Consumption, Saving and Poverty in Bangladesh," Bangladesh Development Studies, Volume 2, No. 4, October, 1974 (Bangladesh Institute of Development Economics). Sri Lanka: Punchi Bandara Jayasundera, "Economic Growth, Income Distribution and Welfare Expenditures: The Case of Sri Lanka," Ph.D. dissertation, Boston University, 1986, drawing on Central Bank of Ceylon "Report on C o n s u m e r Finances" and "Socio-Economic Survey," various issues. (continues)

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Table 8.6 ( c o n t i n u e d ) B. Shares of Poorest India Gini

Share

1953/57

.343

20.2%

1960 1963

.473

13.6%

and Gini Coefficients Pakistan Share

Bangladesh Share

13.0%

1953

12.0%

1963/64

19.2%

18.4%

19.3%

19.6%

1968/69 1969/70

20.1% 20.6%

22.4%

1970/71

21.1%

1971/72

20.4%

1964/65

.421

17.2%

1966/67 1967/68

.478

13.1%

1973 1973/74

15.0%

18.2%

1976/77 1979

17.1%

1981/82

17.3% or 22.4%

12.2%

11.8%

1982 1985/86

Sri Lanka Share

23.7%

Sources: India: Sheil Jain, "Size Distribution of Income," World Bank 1975 for national household income. Pakistan: Sadiq, op.cit. Bangladesh: Alamgir, op.cii. for 1963/64 to 1968/69. Later data from World Bank, World Development Report, various issues. Sri Lanka: Jayasundera, op. cit. Note: Alamgir data are by personal income. World Bank data for 1973/74 to 1981/82 (first estimate) for household income and 1981/82 (second estimate) to 1985/86 for per capita expenditure. Therefore they are not necessarily fully consistent, although major changes are probably indicative.

the income of most unskilled labor. The income of unskilled labor is also a good proxy for the income of the poor. 14 Wage data are available annually to trace the effect of policy changes quite closely. It is also possible to carry out econometric analyses of factors affecting wage changes. The data are of mixed quality. For India and Bangladesh, data on agricultural wages are available from large sample

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T a b l e 8.7 A S u m m a r y o f Changes in Income Distribution in Four Countries A . S l o w Growth Periods 1. India + a. 1953/57 to 1964/65

Deterioration o f 2 3 % in Gini Deterioration o f 1 5 % in Share

b. 1 9 6 0 t o 1967/68

Deterioration o f 1 % in Gini Deterioration o f 4 % in Share

c. 1958/59 to 1968/69

Deterioration o f 1 % in urban Gini Improvement o f 9 % in rural Gini

2. Sri L a n k a + a. 1 9 5 3 to 1 9 6 3

Improvement o f 2 % in Gini Deterioration o f 8 % in Share

b. 1 9 7 3 to 1 9 7 9

Deterioration o f 2 0 % in Gini Deterioration o f 1 9 % in Share

3. Pakistan + a. 1970/71 to 1 9 7 9

Deterioration o f 1 2 % in rural Gini Deterioration o f 2 1 % in urban Gini

B . M o r e R a p i d Growth Periods 1. P a k i s t a n * a. 1963/64 to 1970/71

Improvement o f 9 % in urban Gini Improvement o f 1 6 % in rural Gini Improvement o f 1 0 % in Share

b. 1 9 7 9 to 1987/88

Improvement o f 4 % in rural Gini Improvement o f 4 % in urban G i n i

2. B a n g l a d e s h * a. 1958/59 to 1968/69

Improvement o f 2 9 % in rural Gini Improvement o f 1 0 % in urban G i n i

b. 1976/77 to 1985/86

Improvement of 3 9 % in S h a r e 2

3. Sri L a n k a * a. 1 9 6 3 to 1 9 7 3

Improvement o f 1 6 % in Gini Improvement o f 2 5 % in Share

b. 1 9 7 9 to 1 9 8 2

Deterioration o f 6 % in Gini Deterioration o f 3 % in Share

C . Negative Growth Period 1. B a n g l a d e s h + a. 1968/69 to 1973/74

Deterioration o f 6 3 % in rural Gini Deterioration o f 1 9 % in Share

* = Relatively more market oriented

ategy followed.

+ = M o r e dirigiste strategy

(continues)

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Table 8.7 ( c o n t i n u e d )

SUMMARY (number of periods)

Slow or negative growth Rapid growth

Deterioration Improvement in income distribution 5 0 1

5

Sources: Table 8.6 and its notes. For sections A. 1. a and b, Jain op. cit. was used; for section A . l . c , Bardhan op. cit. was used. Notes: Gini = Gini coefficient of inequality Share = share of poorest 40% in national income Periods when different measures gave different results were not included in the Summary Table (e.g., the Gini improved but the Share deteriorated or the urban index improved but the rural deteriorated). a. The comparison in section B.2.b. is of dubious accuracy, since data are not fully comparable. However, the following data are fully comparable: 1976/77 to 1981/82 showing a 1% improvement in Share and 1981/82 to 1985/86 showing a further 2% improvement, a cumulative improvement of 4%. The results using comparable data are therefore consistent with the results shown in the table, but they are less clearcut.

surveys. Such data are available for Indonesia and Sri Lanka only since the mid- or late-1970s; longer series are therefore less reliable and relate less clearly to unskilled labor. But with 35 observations in Table 8.8, one can draw reasonably firm conclusions, even though a few of the observations seem seriously flawed. There is a strong relationship between more rapid growth in per capita income and in real wages. Real wages of unskilled workers declined in 9 cases out of 13 when per capita income was rising slowly (1 percent or less) or declining. Conversely, in 11 out of 13 cases, real wages rose more than 1 percent a year when per capita income rose more than 2 percent a year. The same relationship can be expressed more precisely in a simple regression. In another paper that includes 4 observations for Egypt, 15 a regression for all 34 time periods (excluding the 1950s to 1980s summary) suggests that if per capita growth is stagnant—that is, zero—real wages on average will decline by 2.5 percent a year (see the intercept of Regression 1 below). For every percentage point that growth exceeds zero, real wages on the average will rise by 1.6 percent. On the average, therefore, at a per capita growth rate of about 1.6 percent per year, real wages will remain unchanged. If the same relationship is tested but with the exclusion of the two periods for which exogenous factors can explain an unusual relationship (Pakistan and Indonesia in the early 1970s), the impact of growth is even more pronounced: real wages decline at 2.9 percent in a stagnant economy and rise

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T a b l e 8.8 C h a n g e s in National Income and in Real Wages, 1950s to 1980s India

Pakistan

1950s (generally late 1950s) Wages -1.0 P e r capita G D P 1.3

Bangladesh

Indonesia

Sri Lanka

-5.3 (0.9)

0.5 -0.7

-2.6 0.0

-0.6 0.0

3.9 4.4

6.1 2.1

-12.0

0.1

-0.2

1.4

L a t e 1960s or late 1960s early 1970s Wages 0.1 P e r capita G D P 1.5

2.5 3.8

-2.7 0.9

7.0 5.2

0.9 3.2

E a r l y 1970s Wages P e r capita G D P

-3.8 0.2

6.6 1.1

-19.0 -2.9

-0.3 7.5

-1.6 1.4

L a t e 1970s Wages P e r capita G D P

9.3 3.9

1.1 3.5

6.9 1.9

3.1 9.6

5.8 4.0

0.4 1.0

-0.2

0.5

2.9 1.8

-1.1 0.7

2.3 4.1

1.0 2.0

E a r l y 1960s Wages

2.0

P e r capita G D P

1.9

L a t e 1970s to early 1980s •5.2 Wages 1.1 P e r capita G D P 1980s Wages Per capita G D P

5.3 3.2

1950s to 1980s Wages Per capita G D P

1.2 1.7

3.9 2.5 SUMMARY

C h a n g e s in Real W a g e s Greater Decline Per capital i n c o m e growth 1 % o r less (inc. negative) 9 G r e a t e r than 1 - 2 % 2 G r e a t e r than 2 % 1

0-1% 2 3 1

than 1 % 2 4 11

Total O b s e r v a t i o n s (F) 13 9 13

Source: Gustav F. Papanek, "Growth, Poverty and Real Wages in Labor Abundant Countries" (Background paper for the World Bank, World Development Report, December 1989), corrected for growth rates from Table 8.1 Note: For most countries and time periods, statistics are available for wages of agricultural workers; whenever available, such wages have been used.

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by 1.9 percent per year for every percentage point increase in per capita income growth (Regression 2).

Regression 1 (t-statistic)

Constant -2.46 (-2.2)

Per cap G D P growth 1.57 (4.6)

Adj R2 0.38

DW 2.44

N 34

Regression 2 (t-statistic)

-2.93 (-2.8)

1.86 (5.5)

0.49

2.58

32

Certainly these regressions provide only a very partial explanation of changes in real w a g e s (a rather low r 2 ); that is what one would expect. N o single variable can be expected to capture all the factors that influence wages. T h e general c o n c l u s i o n is clear, however, and contradicts m u c h of the conventional w i s d o m of the 1970s that the poor do not benefit from rapid growth. Contrary to the widespread belief at that time, these data support the notion that, at least in the labor-abundant countries analyzed, rapid growth disproportionately benefits the poor in most, but not all, cases. A more disaggregated analysis of factors correlated with changes in real wages clarifies the nature of the linkage between growth in G D P and changes in real wages. 1 6 It also shows, however, that the relationship can break d o w n if growth is capital intensive. In that case, demand for unskilled labor can g r o w s l o w l y or not at all, even if g r o w t h in national income is rapid. Stagnation in real wages can then accompany rapid income growth. That is what seems to have happened in Indonesia in the early 1970s. Summing Up: A Market-Oriented Strategy and Poverty Alleviation Putting the various pieces together leads to the conclusion that most of the time a more market-oriented strategy is actually more favorable for the poor t h a n the d i r i g i s t e s t r a t e g y that is o f t e n j u s t i f i e d b e c a u s e it h e l p s the d i s a d v a n t a g e d groups. There are several reasons for these beneficial effects: 1. T h e greater efficiency of the market-oriented strategy results in higher average rates of growth in per capita incomes. Absent any sharp deterioration in i n c o m e distribution, the income of the poor will obviously rise more rapidly when the e c o n o m y grows at 4 percent per capita a year than when it grows at less than 1 percent. There is no evidence that a more market-oriented strategy or higher rates of economic growth are accompanied by deterioration in income distribution. 1 7 2. In a market-oriented economy, factor and product prices tend to reflect e c o n o m i c scarcity m o r e accurately than in one where prices are set or influenced by government. In labor-abundant economies, prices set by the

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market mean that labor is relatively cheap, capital expensive. Moreover, in a market-oriented economy, decisionmakers have a strong incentive to respond to these relative prices and to produce labor-intensive goods. The countries' comparative advantage in labor-intensive exports is reflected in prices, and such goods are produced not only for the domestic but also for the international market. By creating demand for unskilled labor, the resulting labor-intensive pattern also raises the income of the poor. Dirigiste economies tend to be more capital intensive. 3. W h e n government intervenes in specific allocation decisions, they tend to b e c o m e increasingly politicized. Almost inevitably over time, decisions increasingly favor the rich and powerful over the powerless poor. T h e original rationale for government sales of fertilizer or water may have been to assure that smallholders received these inputs. Controls over imports and investment may have been designed to help small and indigenous firms. In all five countries, however, inputs and licenses were largely allocated to the politically well connected and those able to exert influence and provide favors in return, which meant the larger firms and farms. Deregulation reduced the discrimination against small firms, backward regions, and newcomers, who were often poorer. In short, greater market orientation resulted in more rapid poverty alleviation because it tended to speed growth, increase its labor intensity, and reduce discrimination against less powerful firms and farms. Because it is the conclusion of this analysis that a move toward a private-enterprise economy was good for growth and good for the poor in these five low-income, laborabundant economies of Southern Asia, does it follow that the analysis supports the consensus view that the less the role of government in the economy the better? Not quite. In Southern Asia, as in East Asia, some forms of government intervention had important benefits. It is important to distinguish between those forms of intervention that were counterproductive and those that were beneficial for both growth and equity.

The Effect of Government Intervention on Growth and Equity T h e story so far has been one of g o v e r n m e n t intervention b e i n g counterproductive, of instances when a reduction of the government's role and an increased reliance on market forces increased efficiency and growth and speeded the alleviation of poverty. That is because in all five countries, g o v e r n m e n t intervention generally worsened distortions and m a r k e t imperfections. Inherent Market Imperfections and Existing Distortions in the Economies T h e r e were, in fact, a n u m b e r of important market imperfections and distortions in all five economies. Compensating for them would have been a

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desirable role for government. Among the most important were the following: 1. There is some evidence that unskilled labor received an income that was above its equilibrium price. This was the result of the rents that many wage earners and self-employed received as the result of barriers to entry into particular labor submarkets. The best known and most obvious of these are barriers to the entry of nonfamily members into family-owned small businesses and farms, which are widespread in the informal sector. 18 In effect, informal-sector workers, or rather those in the work- and income-sharing (WIS) sector, frequently form informal cartels that extract a rent by limiting access to the segment of the labor market over which they exercise some control (e.g.; only men from certain villages or districts are given access to bicycle-rickshaw-pulling jobs). The consequence is that the commercial, or formal, sector will have to pay a wage above the marginal product of labor in the WIS sector to attract workers from that sector where they receive a rent in addition to their marginal product. The result will be that the commercial sector will employ fewer workers than socially desirable. 19 Under these circumstances, there is a rationale for subsidies to unskilled labor in commercial-sector firms. Direct subsidies are difficult to administer without the danger of efficiency losses. But the kind of indirect subsidies provided to labor by some East Asian governments through export subsidies to labor-intensive industries can then be justified. A rationale exists for them on both efficiency and equity grounds as a result of labor rents in the WIS sector. 20 2. The arguments for infant-industry protection are well known. For four of the five countries, with India the lone exception, those arguments applied with particular force because modem and large-scale industry was virtually nonexistent at Independence. Indonesia and Sri Lanka had been plantation and rice economies in the colonial period; Pakistan and Bangladesh were the agricultural regions of British India. All lacked even a welldeveloped textile industry; none had industrial entrepreneurs; and none had the institutional and physical infrastructure needed for efficient industrial development. 3. The infant-industry argument applies with particular force to exports, also handicapped by external diseconomies. Exporting is inherently more difficult than producing for the domestic market because the exporter a. lacks the automatic advantage of low transportation costs; b. needs to service unknown markets whose tastes and other preferences it is costly to learn; c. has to overcome well-established prejudices about presumed low quality of Southern Asian industry; and

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d. faces greater risk of nonpayment, pilferage, and rejection on spurious grounds. Establishing a reputation, so crucial in most industrial exports, is greatly facilitated by the presence of other, well-known firms from the same country. 2 1 There are therefore quite persuasive arguments that government should provide greater infant-industry subsidies to nontraditional exports than it provides for new domestic producers through protection against import competition. All these arguments apply with considerable force to all five of the countries, and especially to the four other than India. They had never exported anything other than standard primary products. They therefore had no reputation, or rather a poor reputation, for producing industrial goods; they had no established marketing channels or contacts; and they lacked all knowledge of the world market. Finally, their very poverty after Independence meant they did not have an attractive domestic market for most foreign investors and therefore would have found it difficult to attract multinational companies at that time. 4. External e c o n o m i e s and diseconomies were important in three activities, especially where operating units were very small. First, research and diffusion of knowledge with respect to agricultural technologies was a crucial issue in these countries, given the importance of agriculture in the e c o n o m y and of small and subsistence farms. Second, provision of infrastructure to support industrial development and technological change in agriculture was particularly compelling in the absence of a significant industrial sector and the prevalence of agricultural units not part of the commercial economy (and, for Pakistan and Bangladesh, the loss of access to part of the existing infrastructure that now was located in India). Third, provision of training for rapidly growing activities was similarly important for the same reasons. 5. Owners and operators of agricultural units were highly risk averse. Smallholders lacked reserves and therefore faced the daunting risk of losing their land during years of inevitable bad weather or bad prices. They therefore underinvested in new technology, commercial inputs, or water control structures. Reducing the individual risk could increase efficiency. In most of these cases, the need for government intervention was increased by the existence of a threshold. For traders to take the major step of investing in industry, for industrialists to become exporters, for subsistence farmers to shift to cash crops and to a new technology requiring purchased inputs required overcoming inertia, fear, and, above all, the reluctance to try something new and possibly quite risky. Once some individuals had taken the leap, it was easier for others to do so; therefore, the possible benefits of taking the leap had to be made obvious and compelling to the pioneers. This

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often required substantial subsidies initially, which could quickly declinc. At first, government policies that resulted in 50 to 100 percent rates of return on industrial investment were probably necessary to induce Pakistani traders to become industrialists. Such massive incentives were not needed in either India, with its well-established industrialists, or in Pakistan ten years later. In short, there were a number of policies involving government intervention for which there is a well-established economic rationale and which could be justified especially in these countries. Government as an Agent of Greater Distortions In fact, less government intervention and a greater reliance on the market was more efficient in all five countries because government intervention generally did not counter these market imperfections and distortions but worsened them for a number of reasons: 1. Unskilled labor was not subsidized; it was made substantially more expensive. The price of labor was raised in the organized sector by making it difficult to dismiss workers, by a plethora of labor legislation, and by expanding the coverage of minimum wage legislation. These measures were of particular importance in India throughout the period and in Indonesia during the Sukarno government. Moreover, labor unions were powerful in both countries in a few sectors and further raised the cost for the labor elite who belonged to them. Finally, an important real cost of labor for managers of public enterprise was that workers could cause trouble—the one thing governments expected managers to avoid at all costs. Of course, it is the wage-rental ratio that really matters and that was determined not only by the high cost of labor but also by the low cost of capital. A principal reason for the latter was an overvalued exchange rate. The cost of other imports was raised by tariffs, but capital goods were widely exempt. Because most machinery was imported, the combination of an overvalued exchange rate and exemption from tariffs made for low-cost capital goods. In addition, funds for the fixed capital of the public-enterprise sector were largely provided through the budget, with the rest coming from state-owned banks. For the manager of an enterprise, these funds generally were seen as having no cost because there was no compelling reason to pay back loans or to pay anything for budgetary grants. Even interest charges could usually be rolled over. Public enterprises dominated large-scale industry, at least during the dirigiste periods, and if they treated capital as a free good, this obviously made for a very capital-intensive technology in an important part of the economy. Large private firms often borrowed at low interest rates from state banks, and if they were well connected, they too could have their loans rolled over indefinitely. As a result, they saw capital as having a low and variable cost. 2. Instead of compensating exporters for the negative externalities and

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infant-industry problems they faced, government policy discriminated against them most of the time in all of the countries. A study of Bangladesh showed that the highest E f f e c t i v e Rates of Protection (ERP) on average went to activities that had the least comparative advantage, generally producing for the d o m e s t i c m a r k e t . Activities that actually lost the c o u n t r y f o r e i g n e x c h a n g e by operating enjoyed especially high levels of protection. 2 2 On the o t h e r hand, exporters had to face negative effective protection, that is, an e f f e c t i v e tax. S i m i l a r e v i d e n c e can be mustered for m o s t of the o t h e r countries. 3. T h a t scarce foreign e x c h a n g e was m a d e c h e a p by an overvalued e x c h a n g e rate was probably the most serious distortion. It required a whole well-known arsenal of controls over imports (and more limited incentives for exports) to balance the foreign accounts. The result was an equally pervasive r a n g e of i n e f f i c i e n c i e s , s o m e of w h i c h have already been m e n t i o n e d : nontraditional, labor-intensive exports were uncompetitive; entrepreneurs had p o w e r f u l incentives to b e c o m e rent and permit seekers and not pursue opportunities for innovation and cost cutting; foreign exchange was wasted by license holders; more important, most industries were high cost and operated below capacity because they could not obtain the needed imported inputs; and investment, especially foreign investment, was reduced because the system c r e a t e d great uncertainty. Enterprises flourished or f a c e d b a n k r u p t c y at the whim of officials controlling the allocation of foreign exchange. T h e s e and other p r o b l e m s have been extensively d o c u m e n t e d . 2 3 One estimate was that the shadow price of foreign exchange for Bangladesh was nearly two-and-a-half times the official rate, and this after a series of massive devaluations. 2 4 4. Infant-industry protection was widely granted in all countries and was effective. Substantial distortions occurred in cases where protection continued for mature industries and/or was not based on rational economic criteria but benefited enterprises that lacked comparative advantage or even wasted scarce foreign exchange. W h e n government worsens distortions, then deregulation, reducing the role of government, can increase efficiency and growth. The history of the five c o u n t r i e s o v e r the last 4 0 years suggests that m a n y g o v e r n m e n t interventions indeed worsened distortions, so that deregulation speeded growth. Why Did Government Intervention Worsen Distortions? T h a t much of government intervention was counterproductive to economic e f f i c i e n c y w a s not accidental and was not due to ignorance. Rather, these policies were continued in most cases because the specific interventions that generated the m o s t immediate political support were those that provided visible, clear, and m a j o r benefits to a particular group. Those were also the

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interventions that generally created the most serious economic distortions (e.g., import licenses to favored firms, higher wages to an organized l a b o r elite, allocation of price-controlled goods to particular enterprises, protection against competition to large firms). On the other hand, interventions that compensate for existing market imperfections tend to provide gains that are small, d i f f u s e , and distributed in the economy as a whole (e.g., a h i d d e n subsidy to labor-intensive exports). The political support for these types of interventions is t h e r e f o r e o f t e n weak. G o v e r n m e n t s naturally t e n d e d to intervene in w a y s that garnered them strong political support from p o w e r f u l organized groups. 2 5 A l t h o u g h g o v e r n m e n t intervention can in theory be structured to be w h o l l y b e n i g n , in fact, in the recent history of Southern Asia, it w a s p r i m a r i l y c o u n t e r p r o d u c t i v e in t e r m s of e c o n o m i c e f f i c i e n c y but not necessarily in terms of short-term political objectives. 2 6 Government as a Crucial Positive Actor in Development: Efficiency T h e s e e c o n o m i c costs have fueled the enthusiasm for "the m a g i c of the m a r k e t p l a c e . " As a result, the positive contribution of g o v e r n m e n t in economic development is sometimes forgotten. In South Asia, as elsewhere, that contribution involved, as economists might expect, dealing with market imperfections. 1. Compensation for externalities and threshold effects with respect to nontraditional exports was important in Pakistan and was crucial to the rapid growth of garment exports in Bangladesh. Exports in Pakistan began their rapid rise w h e n the Export Bonus Voucher S c h e m e introduced a m a s s i v e subsidy, quite c o m p a r a b l e to the subsidy to production for the d o m e s t i c market implicit in the typical exchange rate, import licensing, and the tariff regime in early stages of import-substituting industrialization. T h e r e was a huge implicit subsidy to garment exports in Bangladesh through gray and black market sales of part of the imported cloth. In both cases, the implicit subsidy was sufficient to induce industrialists to learn how to produce for a demanding international market, to establish marketing channels, and to look beyond the familiar domestic market for their customers. In Indonesia a strong incentive to nontraditional exports was provided by a m a s s i v e devaluation in the late 1980s, followed by a crawling peg that gradually devalued further, accompanied by deregulation of imported inputs and a reduction in effective protection for domestic production. Manufactured exports b o o m e d . 2 7 T h e devaluation in Sri Lanka in 1977 was also massive and produced dramatic results in exports, until the process was aborted by greatly increased political and security risks in 1983. 2. In the early stages of industrial development, massive infant-industry protection compensated for the great risk of industrial investment in Pakistan (then including Bangladesh). For the traditional traders who were to b e c o m e

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industrialists, 2 8 the perceived risks of investing in fixed capital rather than in quickly moving commodities were even greater than the real risks, which were large enough, given political uncertainty and the lack of an industrial tradition. The massive subsidy implicit in a rigorous import control system, which assured profits in some industries in the 50 to 100 percent range, induced the shift into industry. Once investment in industry had taken place, the perceived risk shrank to more realistic dimensions. The real risk also diminished as entrepreneurs became familiar with industry and saw the state survive. Indonesia subsidized infant industry more indirectly with cheap credit and government investment and by providing access to a highly protected and attractive domestic market. Both countries demonstrated the feasibility of launching industrial development in an economy with little m o d e m industry, as long as the incentives are great enough. The supposed near-absolute constraint imposed on the process in the short run by entrepreneurs, skilled personnel, and lack of experience proved not as absolute as many analysts have argued. An industrial class could be created by government incentives in a decade or so. In these countries, as almost universally in the rest of the world, some infants were protected who should not have been and some were protected long after they had reached senility. During the liberalization periods in both countries, however, these distortions were sharply reduced, and the original protective episodes therefore represented a positive intervention. 3. Reducing the risk of crop price fluctuations by a guaranteed minimum price scheme speeded the adoption of modern seed varieties and the investment in fertilizer and water control that that required. In the absence of that guarantee, there was asymmetry in risk perception. Cultivators with limited land holdings faced the risk, if prices dropped, of forever losing their land, a risk that many might not be prepared to bear, even if the likely benefits of investing in modern inputs were substantial in a typical year. Pakistan (then including Bangladesh) and Indonesia introduced guaranteed prices for major food crops, with good results. 4. Subsidies for modem inputs for agriculture also reduced the risk of adopting these inputs and were vital in overcoming the initial hesitation to adopt what cultivators considered untried and high-risk technology. Once the benefits were clearly established, the subsidies could be reduced (although naturally it was in the farmers' interest to keep them as long as possible). All five countries adopted such subsidies at one time or another. The crucial policy problem, of course, was determining when they could be reduced or eliminated safely and then having the political courage and ability to do so. In most countries, some subsidies were continued too long, with predictably undesirable effects in terms of the budget deficit. All of the examples cited in items 1 through 4 share three characteristics:

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Government used the price mechanism to intervene in the economy, not the far cruder and more distorting instrument of quantity controls. The risk to the individual was greater, or was perceived to be greater, or both, than the risk for society as a whole, and government intervened to reduce the risk to the individual. There were substantial positive externalities that resulted from the actions that government intervention was designed to encourage— inducing traders to become industrialists, industrialists to become exporters, or farmers to adopt modem inputs benefited others as a result of the learning that took place.

These characteristics are those that even traditional neoclassical economics recognizes as justifying government intervention. 5. Another category of interventions is equally well established in theory: government construction of the infrastructure and development of the institutional framework. These usually also involve substantial externalities and risk plus some decreasing cost activities (natural monopolies). The importance of an effective government role in this respect can be seen clearly in a study of agricultural output growth in the two Punjabs. 2 9 The importance of market incentives and market efficiency in explaining the higher rate of agricultural growth in Pakistan and Bangladesh in the early 1960s and late 1970s has been stressed earlier. As also noted, however, the g o v e r n m e n t ' s role remained important in guiding the process and in performing a series of vital functions. India made the larger and more effective effort in developing both the institutional and the physical infrastructure for agriculture. The differences with respect to the institutional effort are difficult but important to quantify. One simple and undoubtedly quite inaccurate index of institutional development is given by loans extended by the cooperative system. In the Punjabs, the Indian cooperatives disbursed about double the loans on the Pakistan side in the early 1950s, but by the late 1970s their credit was over 20 times that on the Pakistan side. Another quantitative measure of institutional development is the proportion of children in primary school. Even in 1960, the proportion of children in primary schools was about twice as large in India as in Pakistan, with Bangladesh almost exactly in between. The proportion of girls attending primary school, however, was three times larger in India than in Pakistan, and twice as large in India as in Bangladesh. By 1981, Pakistan had caught up quite a bit, with the Indian proportion 50 percent above that of Pakistan, and Bangladesh only about 10 percent ahead of Pakistan. For girls, the gap between Pakistan and India had shrunk to twofold, with Bangladesh again almost exactly in between. Although school enrollments can readily be measured, one can only guess as to their impact on the rate of growth of agricultural output.

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India actively developed the extension service, a community development machinery, and, somewhat later, the Intensive Agricultural Development Program. In terms of coverage and importance, one might guess that Pakistan followed about 10 years later in most of these fields. The consensus of people in the field is that the structure for agricultural research was substantially better developed in India as well. As a result, India was more effective in developing seeds adapted to different areas and resistant to pests and diseases. This was an important difference between the two countries, because seeds have to be kept ahead of constantly changing threats. The differences in physical infrastructure can be measured more readily. Throughout much of the 1960s and 1970s, electrification in India covered 10 times the proportion of villages electrified on the other side of the border. 30 By the late 1970s, the Indian Punjab had electrified all its villages, while even in the early 1980s Pakistan's electrification reached less than one quarter of its villages. With electricity available, it was no longer necessary to use a separate diesel engine for each well or pump, reducing costs and, even more important, eliminating the major problem of managing, maintaining, and repairing a diesel engine. This development was beneficial for equity, discussed below, as well as for efficiency. It also facilitated the spread of machinery to process agricultural products, making easier the shift to highervalue cash crops and keeping a higher proportion of agriculture-generated income in the rural area. Finally, it helped with the development of local industry by providing employment and income in the agricultural off-season. The main benefit of more widespread electrification, however, was lower-cost wells and pumps. Expansion of the road network also served a multiplicity of purposes, mainly in lowering the cost of inputs and raising the cost of outputs to the cultivator. The change in cost was significant in some cases, 31 where roads allowed a shift from human or bicycle to bullock cart or pickup truck transportation. Roads increased the speed with which fertilizer, pumps, and wells spread. On the output side, they made possible the cultivation of highvalue, perishable cash crops, especially fruits and vegetables, as well as a more general shift from lower-value subsistence to higher-value cash crops. Finally, they greatly eased access and therefore helped spread various services, especially extension and credit. The two Punjabs started with almost identical road mileage, but by 1980 the Indian side had four times the mileage of the Pakistan side. In the Bengals, the rate of growth was higher on the Bangladesh side. From having more than twice the mileage in 1950, Indian Bengal was only 50 percent ahead in 1970. Because the area of Bangladesh is far larger, however, that still represents a considerable discrepancy. The more rapid development of the physical and institutional infrastructure in India was one factor in the higher growth rate in agricultural output over the whole 30-year period of the Indian Punjab and may help explain why the growth rate in Indian Bengal lagged only modestly behind

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that in Bangladesh, despite the more favorable policy environment in the latter for about one third of the period under review. In the years when both Punjabs were under dirigiste regimes or under more market-oriented ones, the growth rate on the Indian side was quite regularly higher. A large part of the explanation, possibly most of it, is related to the better physical and institutional infrastructure created by the Indian government. Government as a Crucial Positive Actor in Development: Equity Government also has a well-established role in helping the poor and disadvantaged. The Indian government on the whole was the least effective of the five countries in framing policies that used the market as a tool to achieve efficiency and growth. It also intervened most extensively and consistently in ways designed to achieve equity but which in fact slowed growth, with negative consequences for the poor. Over the years, however, it was probably the most consistent in intervening to help the poor directly. Measures included the Guaranteed Employment Scheme, various laborintensive public works programs, and community development efforts. The participatory political system also assured that large groups of the poor were taken into account in framing policies and programs. The political system also assured that regional interests were important in the allocation of government development funds. This frequently had costs in terms of economic efficiency. At the same time, it muted some regional conflicts, with political benefits in the short term. In the longer term, by helping to contain the regional conflicts that tore Pakistan apart, India avoided the major economic costs of such conflict. These programs seemed to have helped raise real wages in India over the last 40 years, despite slow economic growth. At India's 1.7 percent per capita average annual G D P growth rate, according to the econometric analysis, a typical country would show no increase in real wages (see Table 8.9 and Regressions 1 and 2). In fact, there was a 1.2 percent rate of increase in wages of agricultural workers. This better-than-expected performance may have been due to poverty-alleviation programs that indirectly raised the real wage. For most of its history, Sri Lanka was by far the most successful country, not only in Southern Asia but probably among all LDCs, in transferring income from some of the rich to the poor. 32 By capturing much of the rent from the plantation sector and using it to heavily subsidize rice and to provide health, education, and other social services, Sri Lanka achieved an outstanding record in social welfare or quality of life indicators. There was, however, a considerable cost in terms of slow growth. Investment in the plantation sector dropped, and even current operations suffered from the nationalization that enabled government to extract the resources. Slow growth was a major factor in losing the election for the government in power and bringing to power a government that placed more emphasis on growth and less on equity.

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For a number of years, Indonesia and Bangladesh each carried out a laborintensive, locally administered public works program, targeted specifically at the poor. 3 3 By creating jobs and demand for labor in the agricultural offseason, the program raised real wages and increased employment. By pegging its own wages low, it assured that the work would go to those most in need. Both countries also developed a successful small-loan program that provided credit to very poor people. Indonesia used the second oil price increase in the 1980s to finance the expansion of primary education to achieve virtually universal primary education in a short period. Although the programs in these four countries were relatively large and successful in targeting the poor, it is noteworthy that they could not overcome the consequences of macroeconomic developments in the economy that were unfavorable for the poor. In Indonesia, real wages stagnated or declined during two periods. In 1971-1978, the problem was highly capitalintensive development. In 1984-1988, the wage decline was caused by a cutback in development expenditures in general and in the labor-intensive works program in particular after the oil price decline sharply reduced government income. In Bangladesh, real wages stagnated in the 1980s because growth was too slow to maintain a tight labor market. There probably was also a decline in the extent of work and income sharing. In Sri Lanka, slow growth made it virtually impossible by the late 1970s to continue to finance extensive welfare measures. In India, the rise in real wages came during the periods of higher growth, while real wages stagnated or declined when the economy stagnated. 34 Pakistan did the least f o r its poor through direct g o v e r n m e n t intervention, except in the early 1970s. At that time, employers temporarily raised wages, despite slow growth, because they were frightened by government threats of nationalization and land reform and by the rising power of labor unions. This, however, was a temporary phenomenon; basic e c o n o m i c forces reasserted themselves even before the government changed. In short, government intervention specifically targeted to help the poor was effective for some time in all of the countries. Only in Sri Lanka were the effects large enough to make a significant difference in their income. In other countries, what mattered more was the speed and labor intensity of growth. Even in Sri Lanka, the costs in growth were sufficiently large to encourage widespread support for a change in government policy in the election of 1977. Pakistan, the country that did the least to develop specific poverty-alleviation programs and expand social services, nevertheless seems to have had the highest rate of growth in real wages over the last 40 years (see Table 8.8). Its rapid and labor-intensive economic growth provided enough benefits to outweigh failure in specific programs. Now that an educated work force may be necessary, it remains to be seen if this will continue.

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An Appropriate Role for Government: A Summary One can sum up the conclusions of this study concerning an appropriate role for government in poverty alleviation in Southern Asia: 1. Even if competition is provided only by imports, government should withdraw as rapidly as it can from the management and ownership of enterprises selling in a competitive market and dismantle as quickly as possible the apparatus of direct quantitative controls. Both have introduced inefficiency and slowed growth, which has harmed the poor without significant compensatory benefits. Decisions by government inevitably are political decisions, and because the poor wielded little political influence, the control structures benefited primarily the rich and powerful. How to dismantle this complex system with minimal disruption to the economy and polity is a complex issue, but the experience of Southern Asia and other countries suggests that a crucial early step is to substitute appropriate prices for quantity controls in the management of the balance of payments. 2. That step will free government resources, especially in terms of scarce competent and honest officials, for tasks that only the government can carry out. 3. The government's role can then be expanded in building the necessary physical and institutional infrastructure. Of special importance in this respect are institutions that provide services with strong external economies for sectors of the economy dominated by small firms, including research, extension, and other services for smallholder agriculture and for some industrial activities dominated by small firms. 4. At least equally important are government steps to subsidize infantindustry activities and those with major external economies and to tax those with external diseconomies. The most important aspect of this role is to support nontraditional exports, where both infant-industry and externality considerations are important. 5. If possible, government should also subsidize the employment of unskilled labor to compensate for a wage in the informal WIS sector that has an element of rent. This can best be done indirectly. 6. One means of providing an indirect subsidy to unskilled labor, to infant industry, and to activities with externalities is to provide subsidies to nontraditional exports. They will generally be labor intensive because that is where the comparative advantage of these labor-abundant economies lies. 7. Government should also mount specific programs targeted at the poor. The most effective have been locally administered public works programs that pay primarily for low-wage labor, especially in the agricultural off-season. Small credit programs insisting on repayment have been quite successful in two countries. 8. Finally, government needs to tax (and perhaps restrict) the consumption of the rich. This can encourage savings, finance government

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p r o g r a m s for the poor, and ease the political tensions that otherwise accompany most deregulation/liberalization programs. 35 T h e suggested steps to directly alleviate poverty and restrict the consumption of the rich may have some chance of being adopted, in part because they do not call for major sacrifices by the rich and powerful, as land reform or nationalization of their property does. They have a greater chance of adoption in a rapidly growing—that is, a largely market-oriented—economy, where benefits to all groups can swamp the relatively minor transfers suggested. Even under these circumstances, they are likely to be adopted only because the elite see some important benefits from doing so. In India and Sri Lanka (and during brief periods in the other countries), the benefits were clear: the poor were a major electoral constituency, and any party that wanted to gain or retain power had to promise them some benefits. But there is good evidence that even authoritarian governments that do not face elections need to be concerned with the economic well-being of the poor majority because their economic suffering leads to riots and other political problems. 3 6 On the other hand, massive government intervention in the form of government allocation or management usually does not benefit the poor for three m a j o r reasons. First, the resulting distortions slow growth, which harms everyone. Second, with slow or no growth, the elite is naturally far more reluctant to countenance any transfers to the poor. Third, when economic decisions are made through a political process, it is naturally the politically powerful who benefit. Inspired by a powerful egalitarian ideology, they may for a period take actions counter to their self-interest and benefiting the poor, but at least in the five countries analyzed (and in other countries as well), before too long the "revolutionary vanguard" will increasingly be the principal beneficiary of government-determined allocations in a scarcity economy. Enterprises may have been nationalized initially so that profits accrue to society, especially the poor rather than the wealthy owners. Before too long, however, the principal beneficiaries are likely to be the managers who run them, the bureaucrats and politicians who control their destinies, and a handful of elite workers who found jobs in the most profitable enterprises. Not subject to competition because government cannot and will not allow them to fail, their potential profits will increasingly turn into the deadweight losses of inefficiency, with the cost imposed on nonelite consumers and taxpayers. Land reform has not been discussed here, although it is a form of government intervention that can improve both efficiency and equity. If the political obstacles can be overcome, transfers of land to owner-operators from large holdings operated by tenants or difficult-to-supervise workers have increased output and benefited a middle peasantry at the cost of wealthy landlords in some countries. This has not been discussed because significant land reform has never occurred in the five countries under review, despite

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m u c h i m p a s s i o n e d rhetoric and g l o w i n g p r o m i s e s . At the s a m e t i m e , the rhetoric has d i s c o u r a g e d investment in agriculture and s o m e t i m e s served as a s m o k e s c r e e n f o r g o v e r n m e n t ' s failure to act o n steps that w o u l d m o r e e f f e c t i v e l y h e l p the poor. In short,

a pure market e c o n o m y will provide f e w e r b e n e f i t s to the p o o r

than o n e that is m o d i f i e d to restrict the c o n s u m p t i o n o f the rich and directly p r o v i d e t a r g e t e d a s s i s t a n c e to the poor. E x t e n s i v e direct

intervention,

h o w e v e r , creates scarcities and concentrates e c o n o m i c p o w e r in the hands o f a s m a l l e l i t e , w h i c h t e n d s to u s e that p o w e r to b e n e f i t its o w n interests. Greater reliance o n the market, then, c a n — a n d d i d — h e l p the poor.

Notes I am grateful to an unusually large number of persons and organizations for support and helpful comments in connection with the research and presentation of this paper. W o r k on it was originally started with support from U S A I D . Dr. Michael Crosswell provided particularly stimulating and helpful comments. Dr. Eshya M u j a h i d ' s research on agriculture in the Punjabs and the Bengals was supported by the Ford Foundation; that of Dr. Harendra Dey on labor income determination by the ILO. Initial results were presented in one of three lectures in a series sponsored by the Pakistan Institute of Development Economics (PIDE) and published by that institution as Lectures on Development Strategy: Growth, Equity and the Political Process in Southern Asia. The participants in the PIDE series, and especially the director, Professor S. N. H. Naqvi, contributed substantially to my thinking on the issues raised. Of course, the issues dealt with in this chapter are usually seen to have a considerable ideological component. It is therefore especially important to stress that, although I am grateful to all of those mentioned above, they obviously bear no responsibility for any of the ideas expressed here. Participants in Brown University's conference "The State and the Market in D e v e l o p m e n t , " April 9 - 1 0 , 1991, provided many useful comments, for which I am most grateful. The commentator, James Boyce, was especially helpful. l . T h e terms used here are dirigiste, and market oriented, although neither is ideal for distinguishing the two systems. The principal differences in the five countries were the extent to which 1. g o v e r n m e n t allocated foreign e x c h a n g e through import licenses or adopted an exchange rate that made it possible for allocation to be largely market determined; 2 . a g r i c u l t u r a l o u t p u t prices were fixed, and output was subject to compulsory purchase by government; 3 . prices of other goods were controlled by government, resulting in formal or informal rationing; 4 . large-scale industrial firms were owned and managed by government; 5 . investment decisions were determined by government or left to private firms; 6 . the e c o n o m y was open to international trade and foreign investment or isolated from them.

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2. Analysis of Sri Lanka is not carried beyond 1983. In that year, there w e r e m a s s i v e riots, f o l l o w e d by ethnic c o n f l i c t that at t i m e s had the characteristics of a civil war. This affected both the statistics, because none could be collected in a substantial part of the country, and most m a j o r e c o n o m i c variables. Security expenditures shot up, and investment dropped sharply, for instance. In the course of this s u m m a r y paper, it is not possible to distinguish these special circumstances, which continue to this day, from the effects of policy changes. 3. It has been argued that a substantial part of Indonesian growth since the change in strategy has been d u e to the depletion of natural resources, in e f f e c t c o n s u m p t i o n of assets. During the Sukarno era, as well, there was rapid asset c o n s u m p t i o n b e c a u s e irrigation systems, transportation, buildings, and even plantations deteriorated substantially. 4. In theory, one could assume that the direction of causality ran the other way, that an improvement in the economic situation caused by exogenous factors resulted in reduced government intervention. But historically the sequence has always been the reverse: a deterioration in the economic situation led to a change in government, f o l l o w e d — s o m e t i m e s with a small lag—by a change in policies and, with a further short lag, by an improvement in the economy. That was the sequence in Pakistan/Bangladesh in 1959 and in the mid-1970s, in Sri Lanka in 1977, and in Indonesia in 1966/1967, for instance. 5. These factors are discussed at greater length with respect to three of the c o u n t r i e s in G u s t a v F. P a p a n e k , " M a r k e t or G o v e r n m e n t : L e s s o n s f r o m a C o m p a r a t i v e A n a l y s i s of the E x p e r i e n c e of Pakistan and I n d i a , " Pakistan Development Review 30, no. 4 (1991): 6 0 1 - 6 4 0 . T h e a r g u m e n t is o n l y summarized here. 6. M u h a m m a d - K h a n Niazi, "Economic Growth in South Asia" (Ph.D. diss., Boston U n i v e r s i t y , 1984). 7. P a p a n e k , "Market or G o v e r n m e n t . " 8. Gustav F. Papanek, Eshya M u j a h i d , and Oldrich Kyn, " A g r i c u l t u r a l D e v e l o p m e n t Strategy, Growth and Equity: Lessons f r o m the P u n j a b s and the Bengals" (Paper prepared for U N F A O , June 1986). 9. Ibid.; and Eshya Subho Mujahid, " E f f e c t s of Policies on Agricultural Development: A Case Study of the Punjabs and the Bengals" (Ph.D. diss., Boston University, 1985). 10. Gustav F. Papanek, " T h e Effects of Economic Growth and Inflation on W o r k e r s ' I n c o m e , " in Gustav F. Papanek (ed.), The Indonesian Economy (New York: Praeger, 1980): 8 4 - 9 1 . 11. O n e criticism sometimes made of such a comparison of I C O R s is that they are still affected by lags. For instance, the dirigiste government in Pakistan made m a s s i v e investments in projects with long gestation periods in the early 1970s that yielded their output largely in the following market-oriented period. The criticism may well be true, although by comparing periods of seven to ten years, this p r o b l e m is eliminated for nearly all investments. Even for longgestation investments, it is, first of all, not clear to what extent the high ICOR is due to lags and to what extent it is due to inefficiency. The Pakistani steel mill not only took a long time to build but it was probably also a costly mistake. Second and more important, it is not clear that projects with long gestation periods were concentrated in the dirigiste periods in all five countries. The steel mill, copper mine, petrochemical, and oil investments in Indonesia occurred in the marketoriented period. In Sri Lanka, the big dams of the Mahaweli were accelerated by the market-oriented g o v e r n m e n t coming to power in 1977. In B a n g l a d e s h , the Karnaphuli Dam was constructed in the market-oriented 1960s.

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12. Keith G r i f f i n and A. R. Khan, Growth and Inequality in Pakistan ( L o n d o n a n d B a s i n g s t o k e : M a c m i l l a n , St. M a r t i n ' s Press, 1971). S e e , in particular, the preface, pp. i x - x , and " C o m m e n t a r y " to part 4, pp. 199-207. 13. See David O . Dapice, " T r e n d s in Income Distribution and Levels of Living, 1 9 7 0 - 7 5 , " in Papanek (ed.), The Indonesian Economy, 6 7 - 8 1 . 14. E v i d e n c e for these propositions has been provided elsewhere. See, in particular, G u s t a v F. P a p a n e k , " G r o w t h , Poverty and Real W a g e s in L a b o r Abundant Countries" (Background paper for the World Bank, World Development Report, December 1989); and Sarthi Acharya and Gustav F. Papanek, "Agricultural W a g e s in India: A M o d e l of Rural Labor Markets," Discussion paper (Boston University: Center for Asian Development Studies, December 1988). 15. P a p a n e k , " G r o w t h , P o v e r t y and Real W a g e s in L a b o r A b u n d a n t C o u n t r i e s . " T h e r e g r e s s i o n s in the r e f e r e n c e d o c u m e n t have been slightly m o d i f i e d to correct the growth rate for per capita income for Indonesia for the 1950s and for 1960-67. This change does not significantly affect the results, nor does the exclusion of the flawed data for Indonesia in the 1950s. 16. I b i d . 17. For the s a m e conclusion from a cross-section and time-series analysis worldwide, see also Gustav F. Papanek and Oldrich Kyn, "The Effect on Income Distribution of Development, the Growth Rate, and Economic Strategy," Journal of Development Economics (June 1986): 5 5 - 6 5 ; and Gustav F. Papanek and Oldrich K y n , " F l a t t e n i n g the Kuznets Curve: T h e C o n s e q u e n c e s for I n c o m e Distribution of Development Strategy, Government Intervention, Income and the Rate of G r o w t h , " Pakistan Development Review (Spring 1987): 1 - 5 4 . 18. See Michael M a n o v e and Gustav F. Papanek, "Tied Rents and W a g e D e t e r m i n a t i o n in L a b o r A b u n d a n t C o u n t r i e s , " D i s c u s s i o n paper ( B o s t o n University: Center for Asian Development Studies, 1987). See also Harendra Dey, Gustav F. Papanek, and David Wheeler, "Labor Income Determination in Labor Abundant C o u n t r i e s — A n Alternative Model," Discussion paper (Boston University: Center for Asian Development Studies, February 1984). 19. T h e e x i s t e n c e of w o r k e r s who do not have access to rents does not negate the model if the demand curve for labor from the commercial sector lies in a region of the WIS labor supply curve where workers do benefit from rents. 20. A s u b s i d y is j u s t i f i e d until the marginal product of labor in the commercial sector equals the marginal product in the WIS sector. Labor income in the WIS sector would also equal the wage in the commercial sector, with the latter paid partly by the employer, partly by the government subsidy. 21. Contrast, for instance, the current situation of a new Japanese exporter, almost universally presumed to produce goods of high quality, with his situation b e f o r e and shortly a f t e r World W a r II, when he would equally universally be presumed to be producing shoddy goods. 22. See A. B. M. Md. Azizul Islam, "Comparative Advantage of Bangladesh" (Ph.D. diss., Boston University, 1980.) See also Gustav F. Papanek and Daniel M. Schydlowsky, " S h a d o w Prices, Comparative Advantage and Trade Policy for Bangladesh I n d u s t r y , " E x e c u t i v e S u m m a r y of Reports for the G o v e r n m e n t of Bangladesh and World Bank (Boston University: Center for Asian Development Studies, 1980). for 23. S e e J a g d i s h N . B h a g w a t i and P a d m a Desai, India: Planning Industrialisation; Industrialisation and Trade Policies Since 1951 (Oxford: Oxford University Press, 1970); and Gustav F. Papanek, Pakistan's Development: Social Goals and Private Incentives ( C a m b r i d g e , Mass.: Harvard University Press, 1967). 24. M o h a m m e d Farashuddin, "Shadow Price of Labor, Investment, Foreign

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E x c h a n g e and Fiscal Resources: A Second Best Disequilibrium Approach for Bangladesh" (Boston University: Center for Asian Development Studies, 1980). 25. For the serious but often not appreciated political costs of interventions which slowed growth and worsened income distribution, see Gustav F. Papanek, Lectures on Development Strategy, Growth: Equity and the Political Process in Southern Asia (Islamabad: PIDE, 1986). 26. Ibid, for other countries as well. 27. Rizal Ramli, "Preventing the Dutch Disease: The C a s e of I n d o n e s i a " (Ph.D. diss., Boston University, 1991). 28. P a p a n e k , Pakistan's Development. 29. F o r d e t a i l s , see Eshya S u b h o M u j a h i d " E f f e c t s of P o l i c i e s on A g r i c u l t u r a l D e v e l o p m e n t " ; P a p a n e k , M u j a h i d , and K y n , " A g r i c u l t u r a l D e v e l o p m e n t Strategy, Growth and Equity"; and Gustav F. Papanek and Eshya Mujahid, " E f f e c t of Policies on Agricultural Development: A Comparison of the Bengals and the Punjabs," American Journal of Agricultural Economics 65, no. 2 (May 1983): 4 2 6 ^ 3 7 . 30. T h e discussion in this section is drawn from Papanek, Mujahid, and Kyn, "Agricultural Development Strategy, Growth and Equity." 31. J o h n W o o d w a r d Thomas, "Rural Public Works and East P a k i s t a n ' s D e v e l o p m e n t , " in Walter Falcon and Gustav F. Papanek (eds.), Development Policy II: The Pakistan Experience (Cambridge, Mass.: Harvard University Press, 1971): 1 8 6 - 2 3 6 . 32.. See P. B. Jayasundera, " E c o n o m i c Growth, Income Distribution and W e l f a r e Expenditure: T h e Case of Sri L a n k a " (Ph.D. diss.. Boston University, 1986). See also Papanek, Lectures on Development Strategy: Growth, Equity and the Political Process in Southern Asia. 33. Richard Patten, Belinda Dapice, and Walter Falcon, "An Experiment in Rural E m p l o y m e n t Creation: The Early History of I n d o n e s i a ' s K a b u p a t e n Development P r o g r a m , " in Papanek (ed.). The Indonesian Economy, 155-182; and Thomas, "Rural Public Works and East Pakistan's Development." 34. Acharya and Papanek, "Agricultural Wages in India." 35. This aspect has not been discussed in the text for lack of space, but see Papanek, Lectures on Development Strategy. 36. Ibid.

• Part 3 • The Political Economy of Systemic and Policy Choice

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9

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State, Cooperative, and Market: Reflections on Chinese Developmental Trajectories MARK SELDEN

The 1980s was the decade of the market. From the triumph of Reaganism and Thatcherism in the West to the demise of the ideological orthodoxies and the collapse o f core institutions associated with Stalinism and Maoism in the Soviet Union, Eastern Europe, and China, state- and collective-centered approaches to the political economy were discredited and in full retreat. Amid the celebration at the demise o f Marxism-Leninism and existing socialism and the near universal recognition of their economic as well as political bankruptcy, it seems almost churlish to note that the central developmental issues that spurred the challenges to capital and the market over the last century—problems of core and periphery, of poles of inequality o f wealth and poverty, of exploiter and exploited, of powerful and powerless—are as salient as they have been at any moment in human history. If socialism is dead and all but buried, evidence is elusive to show that capitalism has achieved significant developmental breakthroughs on a global scale. In particular, I find no evidence that unfettered market forces in the Reagan-Thatcher manner, recently touted by many, East and West, has anywhere proved effective in advancing the developmental clock for poor and peripheral nations or, for that matter, for rich and powerful ones. We know, moreover, that in every single example of the "miracles" of Japan and the newly industrializing economies, whose economic dynamism has been widely heralded if rarely emulated successfully, substantial and sustained state intervention has controlled markets and restricted the domain of international capital, particularly in early and fragile stages of the development process. This chapter explores three distinctive if overlapping approaches to Chinese political economy framed over half a century in the revolutionary base areas and in the People's Republic, assessing their economic and sociopolitical implications and reflecting on the possibilities and limits of socialist development alternatives. In the process, we range widely over issues pertaining to accumulation and growth, industry and agriculture, city and countryside, equity, income and consumption, and empowerment. The

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discussion explores the role of plan and market, and of household, cooperative, collective, and state. Can we find in China's long and tortuous developmental experiences any clues to a viable socialist development path or is the socialist road a dead end as its critics assert? To anticipate our conclusion, Chinese experience provides valuable perspectives on the possible mix of state, collective, and market options for a peripheral agrarian society. The wide swings from the political economy of people's war (1937 to the early 1950s), to mobilizational collectivism in the years 1955-1978, and to market- and household-driven economic reforms leading to a mixed economy in the years since the late 1970s permit us to gauge the outcome of a range of approaches for economic growth, security, and welfare. Our discussion focuses on the countryside, where Chinese approaches have been most original and where the sweep of institutional changes has been most dramatic.

The Political Economy of People's War Historians of China remain deeply divided over the assessment of the Republican era (1911-1949) economy, yet it seems clear that whatever dynamic one attributes to nascent Chinese bourgeoisie, the countryside suffered from multiple problems of population pressures on overworked land, technological stagnation, oppression associated with the landlord order, and the ravages of a century of civil war and foreign invasion. 1 The political economy of people's war that took shape in China in the 1940s constitutes a quintessential response of the periphery under duress, one more fully developed in China than in any other nation. We consider it not only because it represents a consequential mode of political economy in its own right but also because its stamp was indelibly printed on the subsequent course of Chinese development. Specifically, the approach centers on mobilization in the face of extreme duress experienced in Chinese revolutionary base areas subject to blockade and attack. While the origins of the approach can be traced to the Jiangxi period (1927-1935), I focus on the period of maturity in the anti-Japanese resistance. It was then that Mao Zedong framed his most fruitful contributions to the theory and praxis of political economy, while building and administering rural bases that grew in the years 1937-1945 to encompass 100 million people. The discussion that follows highlights four guiding principles of the political economy of people's war and assesses their economic and social implications, looking beyond the survival of guerrilla bases to the problematic of development in peripheral agrarian societies. 2 Self-Reliance The political economy of the base areas was a response to conditions of extreme scarcity, deprivation, and instability. To assure the subsistence of peasant producers and a modest surplus to support the resistance military and

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administrative apparatus, which were under blockade and attack, the partyarmy stressed labor mobilization, including tapping underused sources of labor, such as women and the elderly. In contrast to its Guomindang rivals at the time, and to most Third World developmental states subsequently, the base areas, cut off from international and even Chinese coastal and urban markets and external sources of capital and technology, placed a premium on self-reliance but not, as we will observe, on autarchy. Silent Revolution During the anti-Japanese resistance, the party, stepping back from its own earlier approaches to confiscatory, violent, and divisive land revolution, implemented gradual redistributive measures emphasizing tax reform (China's first progressive tax) and reduction of rent and interest. This approach fostered broad popular unity, a hallmark of the resistance, and strengthened the rural economy. At the same time, in a silent revolution, it gradually undercut the wealth and power of the landlord and rich peasant classes and enhanced the economic position of the poor and landless. As a result, an independent cultivator majority was fostered, the ranks of both the landless and the most prosperous were reduced, and the credibility and penetration of the party-army was increased. Cooperation During the Japanese offensive and blockade in 1942 and 1943, the party promoted mutual aid and small-scale cooperation as supplements to the dominant household economy. Mao viewed cooperation not merely as a response to crisis but as the key to the ultimate transformation of the rural economy, culminating in collective agriculture. Describing the individual economy as "the basis for feudal control" and "permanent impoverishment," he argued that "the only method to overcome such a situation is to gradually collectivize [jithihua], and the only road to achieve collectivization, as Lenin said, is through cooperatives [hezuoshe]." Mao distinguished the party's wartime program from Stalin's collective farms. "Our economy is a new democratic one, and our cooperatives, built using collective labor, rest on the foundation of the individual economy (on the foundation of private property)."3 Mao's discussion of wartime cooperatives is among the earliest formulations of a stage theory looking beyond the household economy toward a socialized future. By 1943, Mao had concluded that Soviet-style collectivization was the essence of the socialist transition in the countryside, the road that China would eventually travel. And just as Marx had been intrigued with the possibility of building socialism in Russia on the cooperative foundations of the mir, Mao pondered the possibility that protosocialist cooperative institutions, derived from and rooted in traditional peasant forms of mutual aid, could provide a bridge to a future socialism in China's countryside.

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The Mixed Economy The focal point of the wartime economy was private ownership and cultivation of the land and household sidelines. But in the late war years, with the growth of cooperatives and a state- and military-directed institutional economy, a new mix of state, cooperative, and household emerged. Facing constant blockade, the party looked to the private, cooperative, and institutional sectors of the economy to break through and assure sources of vital supplies such as salt and weapons. Self-sufficiency was not an absolute; it was to be supplemented by trade. The party-army took the lead in framing and protecting markets as it did in fostering cooperation, tax and rent reform, and the health of the household economy. By 1943, Mao proclaimed the emergence of a new model "that is neither the old Bismarckian model of the national economy nor the new Soviet model of the national economy but it is the national economy of the New Democracy." 4 The political economy of people's war fostered self-reliant, cooperative, and egalitarian development, introducing a significant administrative-mobilizing component into a mixed economy, centered on the dominant household and a small but growing cooperative sector. In the years 1937-1949, the Chinese communists applied limited mobilization approaches to the rural economy within a milieu of dual constraints: those imposed, on the one hand, by the poverty, blockade, and attacks on rural base areas located for the most part in poor mountain regions and, on the other, by the imperative of securing broad-based peasant support in order to pursue the anti-Japanese resistance and to compete effectively with the rival Guomindang. Given its high sensitivity to peasant interests and values, its approaches to mutual aid and cooperation generally consistent with peasant values and interests and sensitive to the free-rider problem, and its ability to direct nationalist sentiments toward widely shared economic goals, the approach produced strong party-peasant bonds at a time of extreme duress. The political economy of people's war embodies many of China's most important contributions to the theory and praxis of development. It achieved impressive success in sustaining the predominantly subsistence wartime economy. We note, however, that its achievements lay principally in the realms of economic survival, welfare, and military and political mobilization rather than being based on its ability to assure accumulation or promote industrialization and agrarian development. We return below to its neglected implications as a development model. Mobilizational Collectivism The transformation of the Chinese countryside from the 1940s onward differed in essentials from Soviet collectivization, yet China's leaders neither claimed originality in this arena nor seriously questioned the goal of building large-scale, mechanized collectivization of the Soviet type as the foundation for China's socialist agriculture. The Bolshevik Party, which came to power with no significant rural roots and failed to establish any in its first decade in

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power, brutally imposed collectivization on a peasantry that had virtually no experience with cooperative agriculture. The Chinese Communist Party's road to p o w e r , by contrast, encompassed more than two decades of administering rural revolutionary bases on the basis of the political economy of people's war and a land reform that firmly established the party as the dominant force in villages throughout China. By the mid-1950s, the Chinese leadership had worked out a detailed rural program whose centerpiece was cooperation leading by stages, in step with improved technology, toward large-scale collectivization. The goal was a reciprocally reinforced process of technological advance facilitated by cooperation, which would in turn smooth the way to expanded accumulation, higher peasant incomes, and more advanced forms of cooperation. 5 Collective-centered rural accumulation would then pave the way for China's far-reaching industrializing goals, emphasizing heavy industry as formulated in the first Five Year Plan. The projected sequence linked stages of rural social organization and technological advance with each advance in technology, facilitating and providing incentive for higher foims of cooperation: • • • •

Temporary mutual-aid teams: traditional agricultural implements Permanent mutual-aid teams: improved agricultural implements Elementary cooperatives: new-style animal-drawn implements Advanced cooperatives (collectives): mechanization (tractors), electrification, chemicalization (fertilizers and pesticides), and scientific farming

This sophisticated concept required that the scope of voluntary, smallscale cooperation be perfected and expanded to create a basis in trust, c o m m u n i t y bonds of solidarity, and managerial, technological, and accounting expertise as preconditions for expanded accumulation and largescale, scientific agriculture. Success hinged on the ability of the system to win the support of skeptical peasants by assuring rising incomes. But from where would the resources come to fuel a costly long-range development program that would transform agrarian China into an industrial power? From the early 1950s, when China launched its first Five Year Plan, the party looked to cooperative transformation, both to stimulate rural development and to facilitate state control of the rural surplus to secure rapid accumulation. The countryside would in turn provide markets for the industrialization drive focused initially on nationalized heavy industry. Mao Zedong targeted 1967, the completion of the third Five Year Plan, as the point of intersection of these twin processes to open the way to a transition from small-scale elementary cooperatives that preserved private land ownership to mechanized collectives of the Soviet type. The keys to the success of this noncoercive strategy lay in assuring popular support through rising rural incomes and provision of m o d e m

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technology. The prospect of immediate economic benefits for the peasantry, made possible by mechanization, electrification, irrigation, chemical fertilizers, and pesticides—all provided through the cooperatives—would then and only then overcome aspirations to private land ownership that were rooted in peasant experience and worldview. Collectivization was to emerge logically from this traditional experience as the common goal and mutual interest of state and peasantry, much as the party had encouraged the formation of wartime mutual-aid teams and small-scale cooperatives a decade earlier. In this vision, mobilization would assure industry of large markets for manufactures, while facilitating the ability of the state to tap the rural surplus through tax and purchase mechanisms in order to fulfill plans for accelerated industrialization. A critical tension was inherent, however, in a strategy whose success hinged on assuring the promised mutual prosperity for the peasantry on the one hand and on extracting the rural surplus to fuel heavy industry on the other. The harmonious vision of gradual, voluntary cooperation coordinated with technological development was shattered in the summer of 1955 when Mao broke with many of the gradualist premises discussed above, overrode opposition by the Central Committee majority, and initiated a course of instantly imposed collectivization, legitimated by a logic of class struggle. The central components of Mao's mobilizational collectivism, which were implemented in the decades after 1955, shared much with those in place in the Soviet Union and elsewhere within the orbit of Stalin's power. State-Imposed, Large-Scale Collectives Collectives imposed by the state institutionalized the preference for giantism, assured direct state control over the surplus, and provided an institutional framework for mechanization. Collectivization transferred control over land, labor, and produce from one hundred million peasant households to collectives and concentrated power and authority in the hands of local cadres and the state. The Private Plot A compromise between the collective and peasant producers, the private plot was the essential quid pro quo that made possible peasant acquiescence in collective agriculture and provided critical sources of food for city and village and a major source of cash income for the collectivized peasantry. Initially an expedient measure to prevent famine and reduce peasant opposition to collectives, it was subsequently institutionalized as a subordinate but essential factor in collective agriculture. Centralized Procurement and Allocation, and Curbing the Market Compulsory purchases at fixed (low) state prices and agricultural taxes, in exchange for such inputs as machinery and fertilizer, replaced the market as the principal vehicle for urban-rural exchange and the transfer of

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significant portions of the rural surplus to the state for industry and the cities. Bondage to the Land T h e institutional constellation associated with collectivization, expressed in bondage to the land, carried state penetration and control of rural economy and society beyond that of the Soviet Union. China's population registration (hukou) system, initiated in 1955 simultaneously with collectivization and applied with great intensity from the failure of the Great Leap Forward in 1960, bound peasants to the village of their birth and created an urban-rural hierarchy that profoundly shaped every aspect of C h i n a ' s subsequent development. We return to this issue later. Whereas the Soviet Union, confronting a perennial labor shortage, encouraged the transfer of peasants to industry and the cities, the Chinese leadership, facing an immense surplus labor pool, bound peasants to the land and even transferred some 40 million people from city to countryside in the years 1962-1977. 6 Collectivization in China shared common elements of coercion with Stalin's Soviet Union, a fact ignored by many analysts because China collectivized without m a j o r bloodshed. Earlier successes in rural policy, including a decade of experimentation with small-scale cooperation and the party's deep penetration of the natural village, made it possible for China to accomplish collectivization more rapidly than the Soviets. Nevertheless, in China collectivization preceded rather than followed mechanization, and in contrast with earlier cooperative experiments, it enjoyed no significant peasant support as evidenced in the widespread slaughter of livestock and pigs in 1955-1956. Imposed collectivization in tandem with curbs on the market in China, as in the Soviet Union, set the tone for coercion above and passivity below that characterized the state-peasant relationship in subsequent decades. 7 Stated differently, imposed collectivization is the very antithesis of the cooperative ideal that would empower rural producers, an ideal that the party had earlier worked so effectively to promote. T h e e c o n o m i c p e r f o r m a n c e and social consequences of Chinese collectives remain the subjects of significant debate, although the basic facts are widely known. At the heart of the debate is the disjuncture between two apparently contradictory sets of empirical data critical to evaluating the performance of the Chinese economy in general and the countryside in particular. In 1980, after 25 years of collective agriculture, China's per capita income remained a low 376 yuan—less than US $200 by official reckoning. At 166 yuan, rural per capita income was far lower. 8 By World Bank calculation, this income level was marginally higher than that of India but lower than that of Indonesia, Pakistan, Thailand, and the Philippines. 9 Other data, however, point to a far more robust economy and society. With the critical exception of the early 1960s following the Great Leap Forward, when an estimated 20 to 30 million people died of famine-related causes, China

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achieved exceptionally high industrial and moderately high agricultural growth rates, fueled by some of the world's highest rates of accumulation. 10 From the 1950s forward, China invested heavily in agricultural infrastructure, and in the 1970s new high-yielding seeds and substantial improvements in irrigation, electric power, and chemical fertilizers produced China's own version of a green revolution. 1 1 The World Bank credits China with a 5.4 percent annual growth rate in per capita GNP in the years 1965-1988, by far the best performance among low-income countries and three times the 1.8 percent figure for India. 12 China's gross value of agricultural output increased by more than 4 percent per year throughout the 28 years from 1952 to 1980, except during the disastrous reverses of 1959 to 1961. 13 By 1979, China's grain yields had reached high levels: rice yields of 4,245 kilograms per sown hectare were more than twice those of India, 50 percent above the Asian average, and not far behind Japan's 5,128. China's wheat and corn yields also compared favorably with those of India and with Asian averages, and in the case of wheat, they were approximately those achieved by the United States. 14 (See Table 9.1.)

Table 9.1 Food Grain Production and Consumption in China, 1 9 5 2 - 1 9 8 9

1952-1957 1958-1960 1961-1965 1966-1970 1971-1975 1976-1980 1981-1985 1986-1989

Grain

Grain

Production (mil. tons)

Production per Capita (kg.)

179 171 172

293 258 249

218 263 305 371 399

278 295 317 362 374

Grain Consumption per Capita (kg.) 200 183 171 182 186 200 236 250

Sources: China Statistical Abstract 1990 : 27,91; Changes and Development in China I949-1989-.

120, 235.

Significant agricultural growth rates and accumulation processes that restrained consumption and transferred large portions of agricultural surplus to industry fueled consistently high industrial growth rates, far outpacing those in agriculture. Yet given controls on population movement and substantially higher rural fertility rates, there was no concomitant shift in the

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labor-force structure from countryside to city and from agriculture to industry. Between 1952 and the late 1970s, the share o f agriculture in combined industrial and agricultural output dropped from 64 to 24 percent, while the share of industry rose from 36 to 74 percent. In 1979, the nearly three-fourths o f the Chinese population that farmed produced only one-fourth of GNP. 1 5 In short, the years o f mobilizational collectivism produced significant industrialization paid for in good part by hard work, high accumulation, and restricted consumption o f the peasantry. Elsewhere industrialization and urbanization have been two sides of a coin; in China, however, into the 1980s, the population and labor force remained overwhelmingly rural, well over 8 0 percent. Quality o f life indicators highlight China's considerable achievements vis-à-vis other nations with comparable and even with significantly higher income levels as well as with other poor countries. B y 1985, China had achieved life expectancy at birth of 69 years, provided 2,600 calories of food a day, reduced infant mortality rates to 35 per thousand live births, and between 1980 and 1985 lowered the birth rate to 1.2 percent. Between 1965 and 1985, by the measure of these social indicators, China surpassed the achievements o f all countries classified by the World Bank as low income and in many cases surpassed middle-income countries. 16 China, moreover, has been widely credited with achieving high levels of food self-sufficiency and sharply reducing levels of income inequality in the course of the collective era. How then should we evaluate the overall character and performance of China's antimarket collectivism and state-centered industrialization? We focus again on the countryside. Collectivization transferred control of rural resources and initiative from subsistence peasant producers and the market, supplemented by small-scale cooperatives, to large administrative institutions rooted in local communities but predominantly responsive to the state. Over a quarter of a century, the collective-state system secured extraordinarily high rates o f accumulation, maintaining levels well above 2 0 percent and often above 30 percent. This was the institutional basis for significant advances in agricultural infrastructure, including soil improvement, irrigation, and electrification, even as substantial portions of the rural surplus were transferred from countryside to city and from agriculture to heavy industry. At the same time, the collectivized rural population was bound to land it did not own and could not leave, and, most important, no significant per capita income or consumption gains and no advances in labor productivity accompanied significant advances in productivity of land. China's development strategy in the era o f mobilizational collectivism was predicated on state-enforced low levels o f peasant consumption, high levels o f labor and resource mobilization, and tight restrictions on market activity. The creation of a vast cadre-administrative apparatus rooted in China's villages but extending upward to the center resulted in loss o f initiative, autonomy, and even the

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myriad skills of farming and marketing that were previously the capital of hundreds of millions of peasant producers. Knowledge and power became concentrated in cadre hands as modern agricultural techniques began to transform China's large-scale collective agriculture. Land reform and collectivization had eliminated the dominant prerevolutionary patterns of inequality of income and power rooted in the landlord order, giving rise to relatively high levels of intravillage income equality. But land reform left intact and collectivization, with its corollary of population control, sharply exacerbated spatial income inequality— differentiating the city from the countryside and suburban from plains and mountain areas, indeed creating a dual and hierarchical economy and society. 17 Collective self-reliance, meaning the virtual absence of state welfare allocations for the countryside and with the provision of few resources to assist poorer localities, lay behind rising spatial inequality. In 1976, the year of Mao's death, one-fourth of all teams (the lowest echelon of the collective structure) had per capita collective incomes below 40 yuan, the state's official hard-core poverty level; an additional 19 percent were under 50 yuan—less than US $25 per person per year—virtually all of it income in kind in the form of grain and other produce. 18 Moreover, several decades of collective agriculture created a deep divide between cadres who monopolized power and largely powerless collective producers bereft of control over crop choices, labor processes, and options associated either with the market or with migration. Intrarural patterns of income and power inequality were mirrored in the widening chasm between city and countryside and between state industry and collective agriculture. In the early 1950s, with free movement between city and countryside and between village and market, the urban-rural per capita income gap favored the city by a margin of approximately 1.5 to 1. By the late 1970s, after two decades of state-enforced urban to rural migration and rigorous measures barring urban migration, the gap had increased to approximately 4 - 6 to l. 1 9 State-enforced population control measures, together with unequal welfare and subsidies favoring the state sector and the cities, assured and underwrote this outcome. Our discussion has chipped away at the conventional wisdom emphasizing the uniquely egalitarian character of the Mao era. Far from producing an egalitarian community of associated producers, collectives gave rise to a deeply stratified society with power concentrated in the hands of collective and state cadres and with a large and growing gulf between them and the countryside. Chinese collectives also generated weak positive incentives to produce because the workpoint system provided only the crudest measures of income differentiation, and highly successful units aside, the free-rider problem remained unresolved even as disguised rural underemployment soared to a level at which the agricultural labor of 100 to 300 million people became superfluous except during the several weeks a

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year of the busy season. The collectivized peasantry experienced a situation in which more work produced little or no income gain and in which such cherished cultural practices as festivals and popular religion faced persistent attack. Collectives and the state did assure high levels of accumulation and investment in agriculture. Growth of m o d e m and traditional inputs under conditions of virtually unlimited supplies of labor yielded growth of grain output permitting China to feed one billion people but brought no gains in per capita rural consumption or in productivity of rural labor. From the 1960s onward, collectives guaranteed subsistence, but with the exception of suburban and model units, they rarely achieved the promised mutual prosperity. At the same time, the countryside did register gains in provision of basic education and health services and increased life expectancy. Throughout the collective era, most notably in the famine years of the early 1960s following the collapse of the Great Leap Forward, collective producers pressed for greater autonomy for the household sector and the revival of the market. The household contract system, which has been the centeipiece of the rural economy since the early 1980s, originated (briefly) as a crisis response to famine in the early 1960s and was widely practiced in poorer areas that were hardest hit, before being suppressed during the Socialist Education Movement of 1963-1965 and the subsequent Cultural Revolution. With economic recovery from 1963, the state was sufficiently powerful to sustain the predominance of the antimarket collective regimen, conceding only autonomy at the margins in the form of private plots and limited market activity. Throughout the 1970s, high rates of accumulation and investment translated into technical advances and sustained agricultural growth. By the late 1970s, however, the new administration of Deng Xiaoping faced a severe crisis of legitimacy centered on the failure of collective agriculture to significantly improve the livelihood of most of its m e m b e r s and frustrations derived from collective controls limiting or eliminating traditional income-earning activities associated with the household, the market, and with economic crops and sidelines. Viewed from the perspective of China's rural majority, 25 years of collectivization produced no significant gains in food consumption levels or per capita income, while requiring increased labor input and creating new forms of hierarchy and control to police a growing urban-rural gap. Following the death of Mao, this constituted the economic and social basis for an attack from above and below on the institutional fabric of mobilizational collectivism.

The Mixed Economy: Household Contracts, the Market, and the State In the early 1980s, China dismantled significant elements of the collective structure, implemented a system of household contracts administered through

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the collectives, expanded the scope of the market, encouraged diversification in agriculture and rural industry, and relaxed elements of the populationcontrol structure. With the state retaining control over the commanding heights of industry, commerce, foreign trade, banking, and key prices, but with the private sector booming most notably in agriculture and commerce, a dynamic mixed economy emerged, or rather reemerged. In this system, collectives contracted use rights of the land on a roughly equal per capita basis to households for periods initially of three years and, from the mid1980s, fifteen years or longer. Land is not (yet) freely alienable because residual ownership rights reside in village collectives, and contracting households are barred from selling or even renting contract land. Moreover, in practice, despite fifteen-year contractual obligations, many communities reallocate land annually or every few years so that households have no guarantee that they will benefit from land improvement even within the contract period. If the power of local cadres over the peasantry has been reduced through cadre authority to distribute land and other means of production, through compulsory sales quotas at low fixed state prices, and in numerous other ways, elements of the command structure remain. Contracting households are obligated to provide stipulated quantities of produce both to the collective (now the village) and to the state in the form of tax and compulsory sales quotas much as before. Under the contract system, however, the organization of productive processes and the responsibility to fulfill tax and quota obligations have shifted primarily from the collective/village to the household. After fulfillment of quotas, households are free to consume or sell the remainder of the harvest. 20 With repression of their own labor power and state encouragement for a wide range of sideline, industrial, and commercial activities, tens of millions of rural households have shifted substantial energies from subsistence grain production to a host of other, more lucrative activities. The household contract system embodies elements of land rent in which the collective constitutes a de facto landlord, and contracting households are, in effect, tenants who enjoy rights to cultivate the land in exchange for a share of the product. In a few regions, the collective remains directly involved in agricultural production processes, such as plowing, irrigation, and harvesting, as well as in overseeing industrial and commercial activities. Viewed from the perspective of labor process, however, the contract system marks a transition from large-scale collective agriculture to householdcentered production on tiny garden-like strips, typically eight to twelve plots per household, each a fraction of an acre and scattered throughout the village. The collective vision that modem agriculture requires large-scale, mechanized production has been abandoned, at least for the near term. The scale of agricultural production in the 1970s was actually far smaller than it was prior to the land reform of the 1940s as a result of population pressure and the division of farms into scattered strips of land. Transformation of the

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collective system, distribution and sale of substantial quantities of collective equipment such as tractors and pumps, expanded opportunities for off-farm employment and mobility, and accompanying sea changes in state policies toward the countryside have touched every aspect of rural economy and society. The rapid gains in agricultural yields and in rural industrialization and the general dynamism of the Chinese economy in the initial years of the reform (1978-1984) led most analysts in China and abroad to hail its success. They pinpointed the household contract system and the surge of market activity as the keys to accelerated development, a conclusion fully consistent with the dominant market-oriented paradigms of the era. The reality has been far more complex. Between 1978 and 1984, per capita grain output advanced at the solid rate of 3.8 percent per year, compared with only negligible increases of 0.2 percent per year in the course of the collective era, from 1957 to 1978. Per capita food grain output increased from an average of 317 kilograms in the years 1976-1980 to a relatively comfortable level of 374 kilograms in the years 1986-1989 (see Table 9.1). During the collective years, per capita production of cotton and edible oil registered declines in average annual growth (-0.6 percent and - 0 . 9 percent, respectively). In the early reform era, by contrast, production and yields on important economic crops tripled in less than a decade: peanuts from the 1973-1978 average to 1985; cotton from 1976-1977 to 1984; sugarcane from the 1973-1976 average to 1985. And tea, oil-bearing crops, jute, silk cocoons, and rapeseed grew at even faster rates from the late 1970s to 1985.21 These impressive agricultural growth rates of the early years of China's reform were not, however, sustained in the last half of the 1980s. China's 1989 grain production of 408 million tons narrowly edged the 407 million tons of 1984, and in the interim the population had increased by 73 million people; cotton reached an extraordinary 6.3 million tons in 1984, more than twice the highest level achieved prior to the early 1980s, but never exceeded 4.2 million tons in the next five years; oil-bearing crops, sugar, and hemp also peaked in 1984 or 1985 before declining. On the other hand, although the growth surge of the first half of the 1980s was not sustained in the remainder of the decade, and in some grain crops and cotton the peak levels of 1984 were not exceeded, in all of the above-mentioned cases, indeed in virtually every branch of agriculture, the average productivity and yields of 1984-1989 substantially exceeded those of the first half of the decade. (See Table 9.2.) China has begun a transition to a second stage of agrarian development in which the primacy of grain self-sufficiency gave way to production of a more varied and nutritious diet and a range of economic crops, and the rate of commodification of agriculture registered rapid gains. Advances in the rural economy in the 1980s were by no means restricted to agriculture. In the course of the decade, 70 million people, or 19 percent of

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Table 9.2 China's Agricultural Performance, 1957-1989 (per capita output in kilograms)

1957 1970 1978 1984 1989

Grain

Cotton

Edible Oil

301 289 317 393 367

2.5 2.7 2.3

6.0

6.5 4.5 5.4 11.5

3.4

11.6

Aquatic Meat Products (port, beef, (fish, shellfish) mutton)

6.2

4.8 3.8 4.8

7.2 8.9 14.8 19.0

6.0 9.4

Average Annual Growth Rates (in percentages; per capita annual growth rates in parentheses) 1957-1970 1970-1978 1957-1978 1978-1984 1984-1989 1978-1989

1.6 (-0.3) 3.1 (1.2) 2.1 (0.2) 4.9 (3.8) 0.0 (-1.4) 2.7 (1.3)

Sources: China Statistical 120-124.

Abstract

2.5 -0.2 1.3 18.7 -9.5 5.0

(0.6) (-2.0) (-0.6) (17.5) (-10.7) (3.6)

1990:1,27,32;

- 0 . 9 (-2.8) 4.2 (2.3) 1.0 (-0.9) 14.6 (14.0) 1.5 (0.2) 8.6 (7.2)

3.1 4.6 3.7 10.1 6.6 8.5

Changes and Development

(1.2) (2.7) (1.7) (9.0) (5.1) (7.1) inChina

0.1 4.9 1.9 4.6 10.9 7.7

(-1.8) (3.0) (0.0) (3.3) (9.4) (6.3)

1949-1989:

Note: G r o w t h rates calculated using endpoints of relevant periods.

the 1985 rural work force, left agriculture to enter village and township enterprises. By 1989, these enterprises employed 94 million workers, 23 percent of the rural labor force, and produced 840 billion yuan gross output value, amounting to 58 percent of total rural output value. 2 2 The value of rural industry and sidelines substantially surpassed the value of agricultural production, despite severe reverses in the recession of 1988-1989. Rural industry, the most dynamic sector of the Chinese economy in the 1980s, was closely linked to the explosive urbanization of the decade. According to official figures of the decade 1978 to 1988, the number of people living in cities and towns increased from 172 million to 541 m i l l i o n — f r o m 18 percent of the population, the level at which it had remained for more than a decade, to 49 percent of the population. 2 3 These figures reflect the unprecedented burst of population m o v e m e n t and urbanization that China experienced with partial relaxation of population controls in the 1980s. They also, however, exaggerate the speed of change because the increase is in part a response to changing definitions of the urban population. In 1988, the state classified 200 million people, 18 percent of the

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total population and 37 percent of those living in cities and towns, as "nonagricultural population." Only this minority had secured urban registration that assured access to state-subsidized grain and other benefits reserved for those whom the state officially recognized as urban residents. 24 The dual system dividing the privileged of the urban-state sector from all others remains intact even as the surge of people into the cities subjects the system to great strain. In the reform decade, productive advances were evident in all sectors of the Chinese economy, including agriculture, industry, and commerce, in city and countryside, in the domestic economy, and in foreign trade and investment. Nor were the gains restricted to the spheres of production and commerce. In the years after 1978, China achieved the first significant consumption gains in 25 years. The gains were shared by both city and countryside; indeed, the countryside began to reverse its relative income decline of the preceding quarter century. Rural per capita grain consumption, which had fallen from 204 kilograms in 1957 to 195 kilograms in 1978, rose to 251 kilograms in 1984. The gains were even greater in the case of edible oil, meat, fish, sugar, and other staples of the Chinese diet. 25 Between 1978 and 1989, net rural per capita income quadrupled from 134 yuan to 602 yuan at current prices, at least doubling in real terms following 25 years of rural income stagnation. 26 Rising rural income contributed to the reduction of both urban-rural inequality and significant pockets of rural poverty. The number of rural residents living below the official poverty line—200 yuan in 1986 prices—dropped from 200 million in 1979 to 70 million in 1986, an impressive achievement, particularly in comparison with that of the collective era. 27 The number of rural households with per capita incomes below 100 yuan dropped from one-third of the total to just 1 percent between 1978 and 1985, while those reporting per capita incomes exceeding 300 yuan rose from 2.4 percent to 62 percent in the same years. Moreover, in the 1980s, China effectively targeted hard-core rural areas for poverty alleviation with a public works program centered on road construction rather than food handouts. Together with the overall income gains widely shared throughout the countryside, these measures were instrumental in reducing the numbers of chronically poor households in remote mountain regions. 28 At the other end of the income scale, by 1988, 47 percent of rural households had per capita net incomes exceeding 500 yuan. 29 Critics of household contract and market-oriented reforms have stressed the fact that their consequences will surely include growing intrarural inequality, class polarization, and revival of patterns of exploitation. The results appear to be complex and contradictory. By the government's own measures, rural income inequality did increase in the early years of the reform, with gini coefficients calculated for a substantial national sample of households rising from .212 in 1978 to a still-modest level of .264 in 1985. But almost no one anticipated the subsequent decline, with the 1988 level of

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.231 below that of 1980. 3 0 Pending the outcome of several ambitious surveys presently under way, these official findings are plausible. T h e available evidence suggests that despite the new concentrations of wealth, access to off-farm and industrial jobs in many regions enabled low-income groups to advance as well. Overall rural income distribution remains relatively egalitarian. Roughly equal land shares constitute one bulwark of rural income equality by comparison, for example, with substantially higher levels of rural inequality in India and Pakistan. 31 Most Chinese and Western analysts have credited the substantial gains in rural productivity and income in the 1980s primarily to the shift from collective-centered to household-centered agriculture, and there is reason to believe that this factor was significant, particularly in the first half of the decade. Certainly the incentive for peasant labor increased dramatically as a result of implementation of the contract system. However, we note a range of other favorable policy and environmental vectors quite independent of changes in the collective structure. First, in the years 1979-1981, the Chinese state increased purchasing prices of grain and other agricultural commodities by approximately 50 percent, providing windfall gains for the peasantry or, viewed from a different angle, reversing the long-term decline in the relative purchasing power of the countryside. Moreover, in response to price and market incentives, average annual grain marketing, which had declined from 30 percent of grain harvests in the mid-1950s to just 20 percent in the late 1970s, increased rapidly from an average of 57 million tons in the years 1976-1978 to 113 million tons in 1984-1986. 3 2 Second, the relaxation of grain-first policies in favor of encouragement of diversification of agricultural production, the growth of village and township industries, and booming trade all opened new or expanded avenues of economic activity and income. Particularly in more prosperous areas, such as Guangdong province on the Hong Kong border and in suburban areas, much of the new industry was owned and operated by thriving collectives, not by individual entrepreneurs. In other words, a significant factor in high growth in these regions was the invigoration of collective industrial activity. Third, agriculture in the 1980s reaped benefits from the high accumulation and infrastructure investment of the 1960s and 1970s. Between 1970 and 1980, the number of tube wells more than quadrupled, from fewer than 600,000 to 2,600,000; rural electric consumption tripled from 9.5 billion kilowatt hours to 32.0 billion; and China began to import large quantities of chemical fertilizer and, using U.S. technology, built the first large-scale synthetic ammonia/urea complexes. 3 3 (See Table 9.3.) These strong technical foundations for rapid growth in the 1980s rested on the contributions of the earlier collective era. Indeed, the gains of the 1980s built on the high growth rates of national income, foreign trade, and agricultural and industrial output of the 1970s. 34 Stated differently, significant gains in

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Table 9.3 Growth of Modern Agricultural Inputs in China, 1957-1987 % Chemical Electricity Cultivated Total Used Pesticide Area Fertilizer Rural Output Use (mil. Plowed per Mu Areas (mil.

1957 1960 1965 1970 a 1975 1979 a 1987 a

by Tractor

tons)

(kg.)

2.4

1.79 3.16 8.81 15.35 26.58 52.48 83.77

1.0 2.0 5.7 10.5 17.8 35.2

6.8 15.0 18.0 33.3 42.4 38.4

—

(bil. kwh) 0.14 0.69 3.71 9.57 18.31 28.27 65.88

No. of Tubewells Total Outfitted (1,000 units)

tons) 65 162 193 321 422 537 —

_

_

—

—

100 590 1,700 2,599 2,674

— — —

2,089 2,364

Average Annual Growth Rates (in percentages) 1957-1965 1960-1970 1965-1970 1965-1975 1970-1979 1975-1979 1979-1987

25.7 10.2 6.3 8.3 10.0 6.2 -1.2

22.0 17.1 41.6 11.7 14.6 18.5 6.0

24.3 18.0 41.8 13.0 14.4 18.6 —

50.6 25.3 32.1 20.9 12.8 11.5 11.2

14.6 7.1 10.8 8.1 5.9 6.2

—

42.6 32.8 17.9 11.2 0.4

— — — — — —

Sources: Carl Riskin, China's Political Economy: 238; China Statistical Abstract 1990: 34; Bruce Stone, " D e v e l o p m e n t s in Agricultural Technology," China Quarterly 116: 772. Notes: G r o w t h rates calculated using endpoints of relevant periods, a. Figures for tubewells are for 1971, 1980, and 1986.

the 1980s stemmed from collective investment through the 1970s and new collective activities in the realm of industry and sidelines in the 1980s. We began by noting a number of striking achievements of the reforms, particularly in the years 1978-1984. We now consider their limits and reverses with particular reference to agriculture and the countryside. First, the high agricultural investment in the course of the era of mobilizational collectivism (1957-1978) gave way to a dearth of investment and even net disinvestment in agriculture following the reforms of the early 1980s. As collectives divided up both the land and the major means of production, including tractors, diesel engines, and pumps, peasants invested their o w n resources in sidelines, in commerce, in industry, or in new houses or consumer durables—in anything except agriculture where compulsory

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sales at low state prices assured low profitability. State investment in agriculture declined from 10 percent of the capital construction budget in most of the 1960s and 1970s, and 14 percent in 1978, to 3 percent in the years 1985-1988. 3 5 The decline in agricultural investment at the village level was undoubtedly more precipitous but difficult to quantify. The consequences of declining investment include disrepair and even abandonment of irrigation facilities and deterioration of the soil. This has been coupled with accelerated environmental destruction. For example, deforestation and water pollution disasters mounted as collective restraints collapsed and the drive for instant profit propelled the economy forward, disregarding nature and the future. The strong agricultural performance of the early years of the reforms was not replicated after 1985, particularly with respect to grain and cotton. Nor are the prospects for agriculture in the years ahead particularly bright in the absence of further institutional and policy changes. Second, although the reforms contributed to reducing the urban-rural polarity of income and opportunity that was a legacy of the collective era and although predictions of dramatic increases in rural inequality cannot be confirmed, certain new forms of class polarization and spatial differentiation have appeared. Reform opened the way to the creation of highly visible concentrations of private wealth in the form of wealthy entrepreneurs on the one hand and a growing class of hired laborers as well as unemployed people on the other. The Chinese state has thus far been unable or unwilling to devise an equitable tax structure that will siphon off a portion of the wealth acquired by a rising if still small bourgeoisie without stifling the energies associated with the private sector in a mixed economy. There is also evidence of new forms of spatial inequality, particularly the rising income gap between the ten booming coastal provinces and municipalities and the eleven lagging inland provinces to the west. Between 1981 and 1987, the gap in per capita rural incomes between these two groups of provinces increased fourfold, from 72 yuan to 321 yuan. 3 6 We conclude then that contradictory tendencies have been at work with respect to inequality, and the fact that the pie has grown larger for most rural households has mitigated some of the tensions that might otherwise accompany new forms of inequality of income and opportunity. Issues of inequality nevertheless have the potential to become politically explosive in the context of a third set of problems associated with reform: the c o m b i n a t i o n of serious i n f l a t i o n , o f f i c i a l c o r r u p t i o n , and rising unemployment surfaced in China in the years 1988-1989. China's overheated economy and the inability to solve the problem of prices led in the years 1 9 8 8 - 1 9 8 9 to the most acute inflation in the history of the P e o p l e ' s Republic—rising to an annual rate of 28 percent by official estimate in the early months of 1989—threatening in particular those on fixed state salaries. Inflation was coupled with rising unemployment in the late 1980s as state efforts to curb inflation led to a credit contraction and forced numerous

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bankruptcies involving an estimated 20 percent of the booming rural enterprises. In addition, deep public anger was directed against official corruption in a society in which officialdom continued to dominate important sectors of the economy. These factors lay behind the explosive urban protests of the spring of 1989. The decline of the collective in many communities resulted in the collapse of important community services. For example, China's villagebased cooperative medical system, one of the few genuine achievements of the decade of the Cultural Revolution, largely disintegrated in the 1980s. Between 1978 and 1986, 3.7 million rural paramedics, midwives, and medical workers left their jobs in the health area. Rural school enrollments also fell in the 1980s as the state cut back on educational allocations to the countryside and many parents withdrew their children from school to save tuition costs and secure their labor. Primary school enrollments dropped from 151 million in 1975 to 128 million in 1987; junior high school enrollments dropped from 50 million to 42 million; and high school enrollments from 18 to 8 million. The decline was almost entirely a rural phenomenon. 37 In the 1980s, the household and enteiprise replaced the collective as the primary locus of rural economic activity. In 1978, 66 percent of rural income derived from the collective and 27 percent from household production; by 1985, 81 percent of household income originated in household production and only 8 percent came from the collective sector, a ratio that remained steady throughout the decade. 38 Yet such figures understate the continued importance of the collectives. This is particularly true in dynamic industrializing and in commercial rural areas where strong collective economic activities are found. Overall, it would be a mistake to underestimate the continued capacity of state and collective units to set much of the direction and tone of rural development. The contract system involves a new mix of state, collective, and household authority, with state and collective retaining residual land ownership, including the power to redistribute the land, to set quotas and prices, to allocate means of production, to command labor, and to determine urban entitlements. State and collective continue to play important economic roles in collectively run industries and in the allocation of fertilizer, fuel, water, seeds, and other resources—although no longer in administering agricultural production. In the absence of a firm legal structure or the institutionalization of a broad range of democratic rights, state and collective are likely to play a significant, and perhaps decisive, role in shaping the future of the system. By the late 1980s, problems associated with the reform agenda had raised fundamental questions about the prospect of the reforms and strengthened the hand of those who sought to halt the reform agenda and reverse it through recollectivization. These difficulties were compounded by the political crisis symbolized by the state's repression of the democratic movement of spring 1989 and the severe economic recession that left many enterprises bankrupt

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and swelled the ranks of the unemployed. The economic and political crisis of the late 1980s and early 1990s reminds us that despite advances in the countryside in overcoming weaknesses of the collective order and even in moving to a higher stage of agrarian development, as yet no nation has charted a successful course out from an entrenched collective agriculture.

Agrarian Options: Socialist Legacies and the Future of China's Countryside This chapter has considered three distinct but overlapping approaches to problems of Chinese rural development: the political economy of people's war that emerged as a response to problems associated with long-term rural decline, c o m p o u n d e d by Japanese invasion in the 1930s and 1940s; mobilizational collectivism in the years 1955-1978; and contractual reforms and a mixed economy since the late 1970s. People's war strategies of selfsufficiency, cooperation, silent revolution, and egalitarian distribution provided bases for solidarity in the course of the anti-Japanese resistance and suggested possibilities for egalitarian and cooperative foundations for subsequent development resting on shared interests of the rural populace and the state. Mobilizational collectivism assured subsistence for a population approaching one billion people and permitted the state and collectives to channel substantial parts of the rural surplus for investment in industry and agriculture. However, significant growth rates were bought at the price of income stagnation, growing urban-rural inequality, and deep disaffection on the part of the rural majority with heavy-handed state controls. The centralized and market-oriented reforms of the 1980s injected new life into the rural economy, producing rapid growth of agricultural, sideline, and industrial production, coupled with substantial income gains and a reduction in urbanrural inequality, and made possible a flourishing of the private sector and an emerging civil society. Yet by the latter half of the 1980s, there was evidence of agrarian stagnation, manifest in declining growth rates and net disinvestment, new forms of inequality, and, following the crushing of the 1989 democracy movement, renewed state pressures for recollectivization. In m y v i e w , the most hopeful long-term a p p r o a c h e s to rural development are likely to involve the creation of mixed cooperative and private economies that institutionalize state support for agriculture while creating space for the autonomous activities of both cooperatives and household producers. Such approaches could draw on the most hopeful elements that have been conceptualized and tested, both within the socialist tradition and beyond it, while rejecting the commandism, giantism, and heavy-industry priorities that have long been associated with Stalinist and Maoist mobilizational collectivism. At their best, such initiatives will e n c o u r a g e sound accumulation and productive investment, gains in productivity of land and labor, rising incomes and security guarantees, and

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nonexploitative and ecologically sound outcomes that place a premium on community welfare. China and other poor agrarian or industrializing societies that have experienced mobilizational collectivism will find such policies enormously difficult to implement given well-founded popular suspicions of collective agriculture, the proclivities o f cadres to transform genuine cooperation into statist collectivization, and the extractive designs of states that have tended to equate modernization and progress with industrialization. Yet elements of the policy constellation associated with what we have called the political economy of people's war, and indeed certain components o f the reforms o f the 1980s, suggest fruitful possibilities. 3 9 A mixed economy might embrace elements of the following approaches, finely tuned to Chinese social realities: • Through the use of positive incentives and a supportive institutionallegal structure, encouragement of gradual, voluntary transition from smallscale household farms to cooperative production, trade, distribution, and consumption, in step with maturation of technology and the productive forces. This would involve state technical, administrative, and financial support to promote autonomous, noncoercive institutions embodying principles of mutual aid, self-organization, and democratic decisionmaking— in short, institutions conducive to the cooperative empowerment o f rural producers. It would also guarantee the right to choose the option o f household agriculture. The primary danger will lie in state pressures to extract too much of the surplus, to control productive processes, and to assume (and impose) the inexorable superiority of large-scale organization. The mix of supply, marketing, credit, or production cooperatives best suited to China with its long historical traditions of mutual aid can only be discovered through experimentation of the type that was cut off by imposed collectivization in the 1950s. • Maintenance of a mixed economy involving private and state, local, regional, national, and international markets in which rural producers enjoy latitude to choose crops to plant, the outlet for their products, and the sources o f supply of agricultural inputs. The greatest danger will lie, again, in state pressures to dominate and dictate all. • State policies and subsidies conducive to overcoming the urban-rural gap and assisting the rural poor by means of technology transfer, education, and welfare policies sensitive to rural needs, within the context of a broad national development strategy directed toward serving agriculture and the countryside. This will require leaders who recognize the costs o f excessive extraction o f the rural surplus in the service of heavy industry and the cities. State controls on population movement and the existing urban-rural income gap cannot and should not be eliminated in one fell swoop—for example, by drastically cutting industrial wages and benefits. But measures, including national welfare programs, previously limited to the urban population and

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price adjustments favorable to the countryside should be implemented step b y step. S u c h general f o r m u l a t i o n s o f a s o c i a l i s t d e v e l o p m e n t strategy rooted in voluntary c o o p e r a t i o n and a m i x e d e c o n o m y at best l e a v e the central issues o f viable cooperation, appropriate scale, and the relative roles o f plan and market to b e s o l v e d at the l e v e l o f d e m o c r a t i c practice, s u p p l e m e n t e d by state c o n c e r n to protect the w e a k and the poor. T h e y n e v e r t h e l e s s s u g g e s t a v i s i o n r o o t e d in d e m o c r a t i c and c o o p e r a t i v e p r o c e s s e s that c o u l d e m p o w e r and s u s t a i n rural p r o d u c e r s and e a s e s o m e o f the c o n f l i c t s — l o c a l , r e g i o n a l , national, and international—inherent in the d e v e l o p m e n t process.

Notes 1. An introduction to the contentious issues on the rural economy is found in the e x c h a n g e between M y e r s and H u a n g , in R a m o n Myers, " H o w Did the Modern Chinese E c o n o m y Develop? A Review Article," Journal of Asian Studies 50, no. 3 (1991): 6 0 4 - 6 2 3 ; a n d Philip H u a n g , " A Reply to R a m o n M y e r s , " Journal of Asian Studies 50, no. 3, (1991): 6 2 9 - 6 3 3 ; cf. Edward Friedman, Paul P i c k o w i c z , and M a r k Seiden, Chinese Village, Socialist Slate (New H a v e n , Conn.: Yale University Press, 1991), for my own views. 2. 1 d e v e l o p t h e s e t h e m e s in M a r k S e i d e n , The Yenan Way in Revolutionary China (Cambridge, Mass.: Harvard University Press, 1971); Mark Seiden, " M a o Z e d o n g and the Political E c o n o m y of Chinese D e v e l o p m e n t , " in Arif Dirlik and M a u r i c e M e i s n e r (eds.), Marxism and the Chinese Experience ( A r m o n k , N.Y.: M. E. Sharpe, 1989); Friedman, Pickowicz, and Seiden, Chinese Village, Socialist State; a n d Mark Seiden, The Political Economy of Chinese Development (Armonk, N.Y.: M. E. Sharpe, 1992). 3. M a o Z e d o n g , " Z u z h i c h i l a i " (Get organized), in Takeuchi Minoru (ed.), Mao Zedong ji (Collected Works of Mao Zedong), vol. 9 (Tokyo: Kokubosha, 1943): 8 8 - 8 9 . 4. Ibid., vol. 9, 25. 5. K o j i m a Reiitsu, Chugoku no keizai to gijutsu ( C h i n a ' s E c o n o m y and T e c h n o l o g y ) (Tokyo: Seiso Shobo, 1975): 61. 6. C h e n g T i e j u n , " D i a l e c t i c s of C o n t r o l : T h e Household Registration ( H u k o u ) System in C o n t e m p o r a r y C h i n a " (Ph.D. diss., State University of N e w Y o r k at B i n g h a m t o n , 1991); and Seiden, The Political Economy of Chinese Development. 7. Mark Seiden, The Political Economy of Chinese Socialism (Armonk, N . Y . : M . E . S h a r p e , 1988); S e i d e n , The Political Economy of Chinese Development; and Louis Putterman, "Dualism and Reform in China," in Economic Development and Cultural Change (in press). 8. State Statistical B u r e a u , Chinese Trade and Price Statistics (Beijing, 1987): 7; and State Statistical Bureau, China Rural Statistics 1988 (Beijing, 1988): 112. 9. World Bank, World Development Report (New York: O x f o r d University Press, 1987): 202; Matson and Seiden evaluate the limits of national income data and explore other yardsticks for assessing Chinese performance in Jim Matson and Mark Seiden, "Poverty and Inequality in India and China" (Unpublished paper, 1991).

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10. Penny Kane, Famine in China (London: Macmillan, 1988); Selden, The Political Economy of Chinese Development. 11. B r u c e S t o n e , " D e v e l o p m e n t s in A g r i c u l t u r a l T e c h n o l o g y , " China Quarterly 116 ( D e c e m b e r 1988): 7 6 7 - 8 2 2 ; Friedman, Pickowicz, and Selden, Chinese Village, Socialist State. 12. World Bank, World Development Report (New York: Oxford University Press, 1990): 178. 13. D w i g h t P e r k i n s and Yusuf Shahid, Rural Development in China (Baltimore: Johns Hopkins University Press, 1984): 33. 14. I b i d . , 3 8 . 15. Carl Riskin, " W h e r e Is China Going?" in Peter Nolan and Dong Fureng (eds.), The Chinese Economy and Its Future (London: Polity Press, 1990): 43. 16. World Development Report (1987): 202, 254, 258, 260. 17. Selden, The Political Economy of Chinese Socialism, and The Political Economy of Chinese Development; cf. Putterman, " D u a l i s m and R e f o r m in China." 18. E. B. Vermeer, " I n c o m e Differentials in Rural China," China Quarterly 8 9 (March 1982): 1 - 3 3 , quoted here from pp. 2 5 - 2 9 ; Carl Riskin, China's Political Economy (New York: Oxford University Press, 1987): 233; Matson and Selden, "Poverty and Inequality in India and China." 19. Selden, The Political Economy of Chinese Development. 20. W i d e d i v e r g e n c e s in e x p e r i e n c e — a n d a s h a r p d e b a t e — r e m a i n concerning the continued strength of the collectives and the scope of access to the market. In general, it appears that weaker collectives, including most of those in p o o r e r areas, have disintegrated as productive units; on the other hand, particularly in p r o s p e r i n g coastal areas and in the suburbs of large cities, collectives have thrived, diversified, and now, operating at the village level, preside over complex industrializing and commercial economies. It is interesting to note that the f o r m e r team, the primary level of accounting and organization of labor, has essentially disappeared. Thus, the level of collective accounting has been raised from the team (twenty to thirty households) to the village (often several hundred households) in the era of household contracts and market-oriented reforms. 2 1 . B r u c e S t o n e , " T h e N e x t S t a g e of A g r i c u l t u r a l D e v e l o p m e n t : I m p l i c a t i o n s for I n f r a s t r u c t u r e , T e c h n o l o g y , a n d I n s t i t u t i o n a l P r i o r i t i e s , " International F o o d Policy Research Institute Reprint No. 191 (1990): 8 1 - 8 2 ; Changes and Development in China ¡949-1989 (Beijing: Beijing Review Press, 1 9 9 0 ) : 120. 22. China Statistical Abstract (New York: Praeger, 1990): 35. 2 3 . Changes and Development in China 1949-1989: 96, 98; William Parish, " W h a t M o d e l N o w ? " in R. Yin-Wang Kwok, William Parish, Anthony Gar-On Yeh, with Xu Xueqian (eds.), Chinese Urban Reforms: What Model Now? (Armonk, N.Y.: M. E. Sharpe, 1990): 6 - 8 . 24. Parish, " W h a t Model N o w ? " 25. China Trade and Price Statistics (Beijing, 1990): 6, 9; Jeffrey Taylor and Karen Hardee, Consumer Demand in China (Boulder, Colo.: Westview Press, 1986): 1 0 9 - 1 1 4 . 26. Changes and Development in China 1949-1989: 242; China Statistical Abstract (1990): 91. 27. Carl Riskin, " W h e r e is China G o i n g ? " 53. 28. Zhu Ling and Jiang Zhong-yi, "Impact of Public Works in Poor Areas of the P e o p l e ' s Republic of C h i n a " (International Food Policy Research Institute, 1990).

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29. Changes and Development in China 1949-1989'. 242. 30. Calculated f r o m Changes and Development in China 1949-1989: 242. 31. Matson and Seiden, "Poverty and Inequality in India and China." 32. Changes and Development in China 1949-1989: 163; Riskin, China's Political Economy: 262. 33. Stone, " T h e Next State of Agricultural Development": 7 0 - 7 1 . in China 1949-1989: 8 6 - 9 4 ; Stone, " T h e 3 4 . Changes and Development Next Stage of Agricultural Development": 6 5 - 7 5 . 35. B r u c e Stone, "Evolution and Diffusion of Agricultural T e c h n o l o g y in C h i n a , " in Neil Kotler (ed.), Sharing Innovation: Global Perspectives on Food, Agriculture, and Rural Development (Washington, D.C.: Smithsonian Institution, 1990): 37, 75. 36. China Rural Statistics 1988: 225. 37. D e b o r a h Davis, " C h i n e s e Social W e l f a r e : Policies and O u t c o m e s , " China Quarterly 119 (September 1989): 5 7 7 - 5 9 7 , quoted here from pp. 582, 587. 38. State Statistical Bureau, Statistical Yearbook of China (Beijing, 1990): 97. 39. C f . L o u i s P u t t e r m a n , " A M o d i f i e d C o l l e c t i v e A g r i c u l t u r e in R u r a l G r o w t h - w i t h - E q u i t y : R e c o n s i d e r i n g the Private, U n i m o d a l S o l u t i o n , " World Development 11 (1983): 7 7 - 1 0 0 .

.10. The Logic and Unfulfilled Promise of Privatization in Developing Countries THOMAS J. BIERSTEKER

Privatization has been at the policy forefront in recent efforts to reduce the role o f the state and redefine its relationship with the market. It has been closely identified, and in some instances virtually equated, with the processes of economic liberalization and reform. The highly charged initiative that was introduced in Margaret Thatcher's Britain in 1979 and was later extolled by Ronald Reagan in the United States spread throughout the developing world during the 1980s and most recently into Eastern Europe and the former Soviet Union. B y the end o f the decade, more than 8 0 countries in the developing world had some form of privatization program in place. 1 Because of the rapid change and transformation of economic policy underway throughout Eastern Europe and the former Soviet Union, governments in those countries have introduced the idea into their current debates about the process of economic reform. Every one of the former Soviet republics currently has some form o f privatization program in place. Although countries vary significantly in the degree to which they have embarked on (and actually implemented) programs o f privatization, "an abrupt shift . . . became visible in the early 1980s and grew rapidly thereafter." 2 Privatization has been deliberately encouraged in the developing world by international organizations such as the World Bank (and, to a lesser degree, the I M F ) , as well as by regional development banks and bilateral aid agencies. Indeed, the World Bank routinely undertakes studies of the feasibility o f privatization prior to releasing funds for its structural (and sectoral) adjustment loans. 3 Privatization was also an important component of economic reform in both the Baker and the Brady plans for the Third World debt problem. Both plans promised substantial resources, either in the form of new funding or major debt relief in the case of the Brady Plan, for countries pursuing comprehensive programs of economic reform, programs that ordinarily include privatization. 4 In spite o f the fact that privatization has profound implications for the relationship between states and markets, it has often been little more than an

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abstract idea or a broad slogan rather than a coherent program for, or approach to, development. 5 The definitions of the private sector and of the privatization process more generally have tended to be rather narrow in most of the literature and public discussion of the subject to date. An uncritical, or unqualified, pursuit of privatization may therefore accomplish short-term ideological objectives but often at the expense of longer-term development goals. This chapter engages in a critical exploration of the meaning of privatization and its implications for development. After a definitional discussion of different forms of privatization and the problematic diversity of the private sector itself, this chapter examines the principal economic and political arguments for privatization. Next, it considers some of the longterm consequences, problems, and pitfalls associated with efforts to privatize in developing countries by reviewing the findings of the growing number of empirical studies of the phenomenon, both comparative and country case studies. The chapter concludes with some suggestions of ways of redefining the concept and redirecting the debate about privatization to appropriate the concept in a manner that is more consistent with a general process of development. What Is Privatization? Many different conceptions of privatization exist in the burgeoning academic and policy literature on the subject. They range from broad, encompassing definitions that incorporate virtually any increased reliance on market mechanisms to much narrower conceptions that focus exclusively on the sale of SOEs. For some, privatization is defined as a means toward some end, such as greater productivity, cost effectiveness, or "development." For others, it is an end in itself. Most of the more theoretically oriented and empirical case studies of the subject have employed a relatively narrow conception of privatization as the sale of the assets of SOEs. 6 Although most scholars clearly recognize the varied forms privatization can take, they tend to prefer narrower definitions of privatization as asset sales because such definitions are more manageable and focused analytically, 7 making it possible for them to describe a tangible phenomenon and readily distinguish privatization from the more general process of liberalization. However, when considered as an instrument for development, there can be some benefits from broadening the definition of privatization to include more than just the sale of SOEs. For the purposes of this discussion, privatization will be defined as something more specific than economic liberalization but broader than the sale of the assets of SOEs. Privatization will be considered as a means to an end (development) rather than as an end in itself. Privatization is certainly consistent with, and often serves to reinforce, a process of liberalization.

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Under certain conditions, it can open an industry to competitive pressures and can enhance greater reliance on market mechanisms more generally. However, it should not be equated with liberalization. As Paul Starr has argued (and as will be considered in more detail below), "It is entirely possible to privatize without liberalizing," just as "it is also possible to liberalize without privatizing." 8 One observer has defined privatization as "the transfer of assets or service functions from public to private ownership or control." 9 This conception extends the definition from the sale of assets of SOEs to include the transfer of service functions. However, the definition of privatization can be broadened still further to include the effective participation of segments of the private sector in certain public-sector decisions, some examples of which will be discussed in greater detail below. Thus, for the general purposes of this discussion, privatization will be considered as the transfer of assets, service functions, and/or decisionmaking from the domain of the public sector to the domain of the private sector. 10 Most countries are pursuing a program of privatization that includes a variety of f o r m s of privatization, three of which are distinguishable analytically. First, there is the sale of SOEs to the private sector. As suggested, this is the form of privatization that has received the greatest attention in the scholarly literature on the subject to date. The sale of other state-owned assets, such as land, would be a variant of this form of p r i v a t i z a t i o n . " Recent examples of this form of privatization in the developing world would include the sale of AeroMexico, of Flour Mills of Nigeria, and of state-owned land in Chile. The sale of a minority of the shares of an enterprise (where effective managerial control unambiguously remains with the state enterprise) will, however, not be considered privatization in this discussion. The subcontracting of public-sector activities to private-sector entities is a second important form of privatization in many developing countries. Gabriel Roth suggested a variety of examples of this form of privatization in his 1987 World Bank study of the private provision of public services. 1 2 Enterprises in the private sector might receive production or service contracts from public agencies; they might operate monopoly franchises in regulated utilities; or they might receive management contracts for the delivery of certain services. R o t h ' s conception of the private sector extends beyond private enterprises, and he also considers the distribution of vouchers and the operation of consumer cooperatives as other examples of the subcontracting of public-sector activities. Examples of this form of privatization in the developing world include the use of private-sector franchises for electricity supply in Barbados and Ecuador; the issuance of contracts for training programs for traditional birth attendants in Ghana; the use of telephone equipment supply contracts in India, Malaysia, and Chile; and the private vending of nonpiped fresh water supplies in the Philippines. 1 3 Divisible

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monopolies, such as local transport and refuse collection, are probably most amenable to subcontracting to the private sector. 14 Load shedding, or the transfer of services or operations from the public sector to the private sector (without any guarantee of continued state responsibility for—or involvement with—the activity), is a third distinguishable form of privatization in developing countries. It can be distinguished from subcontracting because there is no longer any pretense that the state should be accountable to perform these functions or provide these services. This form of privatization is not as visible as the sale of the assets of a major S O E because it is often designed as a part of (or might be an outgrowth of) the fiscal cutbacks and general expenditure reductions that accompany most economic reform programs. It is what some scholars have referred to as "state s h r i n k a g e . " 1 5 However, this form of privatization may have some of the most far-reaching effects on development. The elimination of the state marketing boards for agricultural produce in Nigeria and Zambia are important illustrations of load shedding, as is the privatization of much of the social security system in Chile. The adoption of specific policy measures deliberately designed to support the expansion of some elements of the private sector (by creating special incentives, removing particular disincentives, or pursuing some general form of deregulation) is sometimes equated with privatization in many developing countries. It is here, however, where the line between privatization and liberalization begins to blur. Deregulation, or the removal of specific barriers to economic activity, such as Mexico's easing of some of its restrictions on foreign investment or Nigeria's relaxation of its indigenization requirements through its privatization decree, are examples of economic liberalization but should not be considered aspects of privatization in the ensuing discussion. 1 6 Although it is possible to define privatization in general terms and distinguish between different forms of privatization in developing countries, the "private sector" itself remains elusive and difficult to define. A number of researchers interested in the privatization process have described the connections between the private sector and the state as extremely varied and complex. 1 7 However, when they discuss the virtues of the private sector, it is by no means clear that different advocates of privatization are necessarily talking about a unitary (or even the same) entity. Different conceptions of the private sector need to be clarified and distinguished before one can begin to evaluate either the rationales for privatization or the benefits and potential costs of the privatization process. In the most general sense, the private sector is everything that is not formally part of the public sector. While this may provide a fairly simple definition, it leaves an extremely complex, fragmented, and elaborate "sector" to think about. Most scholars of privatization draw a sharp distinction between the "public" and the "private" and tend to view the process of privatization as the movement away from the public sector as the producer of

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goods and services. 18 However, this conception is drawn directly (and without m u c h adaptation) from the experience of the market economies of the advanced industrial world. As a result, it effectively equates the private sector with enterprises engaged in the formally registered, profit-making private sector and excludes consideration of important segments of the private sector that coexist with formal, profit-making enterprises in most developing countries today. First, it makes no explicit reference to the large, and in many instances, growing, private, profit-making, informal sector in developing countries. There is a tremendous variety of informal-sector profit-making activity, ranging from the individual street vendor to large-scale, well-organized drug cartels. The informal sector is clearly an important part of the private sector in most developing countries and has a significant role to play in the distribution of goods and services in most economies. Second, the activities of nonprofit, private, NGOs are usually excluded from most discussions of privatization. There are a great many avenues for potential subcontracting to the nonprofit NGOs because they are often so well placed to provide efficient delivery of services to the public. There are potential costs associated with this form of delivery system, particularly in the case of religious-based distribution networks established by missionaries or in the case of poorly managed (and/or underfunded) distribution networks established by NGOs, subject to uncertain funding and sudden closure. However, nonprofit NGOs are clearly an important part of the private sector and can be a potential participant in the privatization process. Third, and most significantly, virtually every scholar writing on the subject excludes consideration of the private household economy as an important part of the private sector. 19 The household economy is one of the most significant components of the private sector in terms of its scale and range of activities because so much of production is organized (and reproduction assured) within its domain. The household economy is also central to any longer-term consideration of the impact of privatization on development. Therefore, for the purposes of this discussion, the private sector will be considered as composed of four different, overlapping identifications and segments: formal, profit-making enterprises (with their wide variation in scale, ownership patterns, and sectoral characteristics); informal, largely unregulated, profit-making enterprises (with their even wider variation in scale and sectoral characteristics); nonprofit, private NGOs; and households. The private sector is therefore clearly not a monolithic, single, or unitary entity. It is highly fragmented, decentralized, and does not represent or articulate a single interest. Individuals within the private sector simultaneously occupy several different segments within it (as members of firms, professional associations, and households). The private sector is fragmented along a number of different dimensions: functionally, by scale of

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activity, and within each of the segments described above. Accordingly, a change in macroeconomic policy, such as a major devaluation, is not going to affect all of the formal, profit-making private-sector enterprises in the same manner. It will reward some (those with access to liquid assets or with little reliance on imported components), while it penalizes others. Its potential effects on other segments of the private sector are equally varied and complex. This means that the private sector does not exist in fundamental opposition to the public sector in many developing countries, as advocates of privatization writing from their own experience in advanced industrial countries often assume. As will be discussed below, the expansion of the state into the economy has historically been undertaken with the active support of important elements of the private sector. Adversarial relations between the public and private sectors, when they have existed, have tended to divide along lines other than "public versus private" (often pitting parts of the public sector against parts of the fragmented private sector). This broadened conception of the private sector increases the complexity of the discussion of privatization and its consequences. At the same time, however, by not restricting itself to the consideration of large, formal, profitm a k i n g enterprises only and by considering a variety of fragmented components (and possible coalitional arrangements involving the private sector), it increases the range of developmental possibilities for a comprehensive program of privatization. As will be suggested in the conclusion, it also enables a mobilization of important segments of the population located outside the public sector in the common enterprise of development.

Why Pursue Privatization? In the most general sense, privatization was designed to reverse the direction and/or constrain the magnitude of the rapid growth of the state sector during the post-1945 period. The 1970s and 1980s saw a major expansion of the state in the economy throughout the developing world, as it proceeded to influence, regulate, plan, mediate, distribute, and even produce goods and services. 20 State-led industrialization—the creation of SOEs, nationalizations, indigenization, and experimentation with state socialism—increased the nature and magnitude of state intervention in the economy. To evaluate the prospects for (and implications of) privatization, 2 1 it is important to understand the history of state intervention. Over the last 40 years, the state intervened in the economy as it did for a number of reasons. At the most general level, state intervention is explained by non-Marxist scholars as an effort to maintain legitimacy, to overcome modest levels of economic performance when confronted with electoral competition, 2 2 or to assure that businessmen perform their appointed tasks. 23

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Marxist scholars have tended to emphasize that states intervene to overcome the c o n t r a d i c t i o n s created by capitalism, 2 4 to sustain the process of accumulation (and capitalism itself). 2 5 or to satisfy the interests of a selfinterested state. 26 The postindependence inheritance from the colonial state provided the basis for state intervention in Africa and Asia, 2 7 while d e v e l o p m e n t p e r f o r m a n c e was increasingly equated with regime legitimacy in many instances, a fact that gave state officials a direct stake in the outcome of d e v e l o p m e n t . 2 8 In many countries, a deep suspicion about the activities of the primarily foreign-owned private-enterprise sector encouraged greater state e c o n o m i c intervention 2 9 and also fueled the economic nationalism of the 1960s and 1970s, a movement that further reinforced the expansion of the state. 3 0 Finally, in some instances, there have been direct political (as well as material) benefits that accrue to the leadership from some forms of state economic intervention. 31 In many parts of the developing world, state economic intervention has been intentionally encouraged by groups within the private sector. This has been the case when local entrepreneurs have entered into nationalist alliances with the state to protect themselves from foreign competition or when they have grown to depend on access to the state through contracts, sales, licensing, and/or joint ventures as the basis for their accumulation. Many local entrepreneurs have also welcomed the establishment of state enterprises in large, capital-intensive projects that they themselves could not hope to enter. Large, state enterprises have provided them with potential sales outlets and local sources of supply. Although important segments of the formal private sector have historically supported state economic intervention, others have not. Indeed, one way of viewing the current global shift toward privatization is not as a comprehensive movement from public to private but rather as the ascendance of one faction of the fragmented private sector over another (i.e., over the early advocates of state economic intervention who have become increasingly discredited by corruption and macroeconomic mismanagement). Explanations of why, historically, the state has intervened, however, are different f r o m the justifications provided by political economists, who identify three principal theoretical justifications for state intervention: to provide a genuine public good; to correct or remedy a market failure, and to control the "commanding heights" of the economy for some greater public good. When considering general arguments for privatization, it is fair to say that most advocates of privatization would consider the first justification the most legitimate and the third the least legitimate. Although the distinction among justifications for state economic intervention may appear relatively clear at the outset, the definition of a "market failure" is highly subjective, as is any notion of "the greater public good," and both are subject to considerable debate and inteipretation. For

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example, the establishment of a state corporation to produce steel in a large country like Brazil or Nigeria could be justified as a case of market failure but would probably not be recognized as such by most World Bank officials writing t o d a y , 3 2 because it has been so easy to identify large n u m b e r s of ineffective, wasteful SOEs and inefficient delivery services in developing c o u n t r i e s . 3 3 For these reasons, most advocates of privatization tend to be wary of claims of "market failure" or view with cynicism the idea that the state can intervene for "the greater public good," a point that will be taken u p in greater detail below. T h e private sector c o n v e y s the impression of efficient m a n a g e m e n t . M o r e o v e r , it provides an alternative to the o b v i o u s failure of so m a n y previous state economic interventions. Accordingly, privatization has been i n t r o d u c e d as the solution for a b u n d l e of interrelated p r o b l e m s and difficulties. The huge expansion of state fiscal deficits (often exacerbated by large external borrowing by SOEs), 3 4 along with the global debt crisis of the 1980s, hastened the exhaustion and demise of the postwar/postindependence import-substitution model of industrialization throughout the d e v e l o p i n g world. W h a t was already creaking, therefore, was brought d o w n with the accumulation of the debt and fiscal crises. 3 5 With the prevailing model in disarray, privatization, liberalization, and " o r t h o d o x " e c o n o m i c r e f o r m provided the elements of a new approach. E x p l a i n i n g w h y c o u n t r i e s h a v e m o v e d t o w a r d p r i v a t i z a t i o n in recent years is not the same as presenting a theoretical argument for why the state should voluntarily dismantle state enterprises, reduce its intervention, a n d / o r r e d e f i n e its role in the e c o n o m y . A d v o c a t e s of p r i v a t i z a t i o n h a v e s u g g e s t e d a n u m b e r of e c o n o m i c and political a r g u m e n t s f o r privatization. Economic Arguments T h e principal economic rationale for privatization is that the private sector is generally more efficient than the public sector. 3 6 Privatization is intended to promote both allocative-efficiency gains within an economy and productiveefficiency gains within the firm. Some of the broadest efficiency claims for privatization have been qualified significantly in recent theoretical literature on the subject because allocative efficiency is more likely to be a function of regulatory reform and liberalization than the product of privatization taken alone. 3 7 Therefore, the strongest efficiency claims for privatization rest on arguments about the productive-efficiency gains likely to be realized within the firm. Productive-efficiency gains are often anticipated following privatization because the profit motive in private firms creates incentives for a more e f f i c i e n t use of inputs, the d e v e l o p m e n t of new technologies, and the g a t h e r i n g of the i n f o r m a t i o n n e c e s s a r y to p r o v i d e the g o o d s and services desired by the c o n s u m i n g p u b l i c . 3 8 T h e private sector is also generally better able than the g o v e r n m e n t to attract and retain skilled

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m a n a g e r s , 3 9 and the constraints o n its m a n a g e r s are likely to be f e w e r than the m u l t i p l e c o n s t r a i n t s (and d e m a n d s ) faced by public m a n a g e r s . 4 0 T h i s g i v e s p r i v a t e e n t e r p r i s e s g r e a t e r incentive and flexibility to r e s p o n d to external shocks (through their production or marketing) than their c o u n t e r p a r t s in the public sector. Furthermore, private-sector firms are likely to be m o r e e f f i c i e n t in their operations because they have to satisfy private financial m a r k e t s and cannot d r a w on state resources to subsidize inefficient activities. 4 1 A related e f f i c i e n c y c l a i m f o r p r i v a t i z a t i o n is that e x i s t i n g p u b l i c s e r v i c e s will be delivered m o r e e f f e c t i v e l y if s u b c o n t r a c t e d o r g i v e n o v e r c o m p l e t e l y to t h e private sector. T h e theoretical basis f o r this c l a i m is s i m i l a r to the a r g u m e n t presented above about the likely productivity gains f r o m the sale of S O E s . Privatization should increase productivity and e n h a n c e the q u a l i t y of g o v e r n m e n t services because the private sector is g e n e r a l l y b e t t e r able to o p e r a t e e f f i c i e n t l y and secure i n f o r m a t i o n a b o u t c o n s u m e r p r e f e r e n c e s . 4 2 T h e s u b c o n t r a c t i n g of existing public s e r v i c e s should also p r o v i d e l o w e r prices for c o n s u m e r s . 4 3 Furthermore, even where the g o v e r n m e n t can p r o v i d e better services, s o m e have argued that it m a y be b e n e f i c i a l to t r a n s f e r activities to the private sector, "if such action w o u l d enable the administrators to concentrate more fruitfully o n activities that only g o v e r n m e n t can provide." 4 4 A second e c o n o m i c a r g u m e n t f o r privatization is that it can help resolve the p r e s s i n g fiscal d e f i c i t s c o n f r o n t i n g so m a n y states of the d e v e l o p i n g w o r l d . 4 5 T h e sale of S O E s can generate immediate public revenues, w h i l e subcontracting existing services m a y eliminate costly subsidies and prove to be m o r e cost e f f e c t i v e o v e r the m e d i u m and longer term. T h e reduction in total p u b l i c o u t l a y s f o r services c a n significantly i m p r o v e the b u d g e t a r y position of the state. 4 6 A third consideration is that privatization can p r o m o t e the d e v e l o p m e n t and e x p a n s i o n of the private s e c t o r m o r e g e n e r a l l y , a n o t h e r b e n e f i c i a l o u t c o m e f r o m t h e p e r s p e c t i v e of those who view the private s e c t o r as inherently better positioned than the public sector to provide g o o d s of h i g h q u a l i t y at r e a s o n a b l e prices f o r c o n s u m e r s . R e d u c i n g the total v o l u m e of public s p e n d i n g c a n prevent the state f r o m " c r o w d i n g o u t " the private sector in capital and financial m a r k e t s and thus r e m o v e a disincentive f o r privates e c t o r e x p a n s i o n . 4 7 F u r t h e r m o r e , privatization can m a k e external f i n a n c e m o r e readily available f o r p r o d u c t i v e investment activities (particularly in Latin A m e r i c a ) and thus provide a basis f o r private-sector e x p a n s i o n m o r e generally. 4 8 Political Arguments In a d d i t i o n to t h e e c o n o m i c a r g u m e n t s j u s t c o n s i d e r e d , a d v o c a t e s of privatization h a v e also suggested several important political rationales f o r p r o c e e d i n g with the p r o c e s s . First and f o r e m o s t is the a r g u m e n t that the private sector t e n d s to be less penetrated by corruption and relatively less

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subject to rent-seeking behavior than the public sector. 49 This is the basis of public choice critiques of public-sector activities that argue that public agencies are likely to be more responsive to political pressures and to individuals with the ability to organize and channel their interests effectively than they are to consumer preferences or those who are less well organized politically. 5 0 The governmental regulation that does exist in the developing world may be used to protect a regulated industry or the interests of the most vocal pressure group within an industry rather than the more general interest of the consuming public. 5 1 A second political argument for privatization is that government failure is just as prevalent as the market failure that is often used as a pretext for state intervention. In many developing countries, white elephants, prestige projects, bloated state bureaucracies, and inefficient (or nonexistent) state services abound. S O E s are often beset with contradictory objectives, bureaucratic meddling, centralized decisionmaking, inadequate capitalization, managerial ineptitude, excessive personnel costs, and high labor turnover. 5 2 They are frequently used to support or extend the political interests of the officials in power. Governments also tend to subsidize loss-making SOEs, 5 3 a point that has made the removal of subsidies a primary objective of many World Bank-supported structural adjustment loans to Africa. 54 As some have argued in their analyses of the deficiencies of SOEs, government remedies may therefore be worse than the market failures they were initially designed to correct. 55 For those who favor privatization as an end in itself, ideological objectives are employed to justify privatization. For some, the purpose of privatization has been to reduce the bureaucratic power of the state, 5 6 while for others the principal objective has been to reduce the power of publicsector unions. 5 7 Privatization has also been justified in the n a m e of the preservation of individual f r e e d o m 5 8 and in the pursuit of economic liberalization more generally. 59 Fourth and finally, a n u m b e r of populist objectives have been included a m o n g the political rationales for privatization. For some, privatization is desirable because it will encourage political decentralization g e n e r a l l y 6 0 and contribute to an important decentralization of decisionmaking in particular. 6 1 For others, privatization is supported because it can theoretically empower local-level, small-scale entities and expand the range of choices for consumers. 6 2 Some argue that privatization can also contribute to an important redistribution of resources in d e v e l o p i n g countries because the rich often have the best access to the supply of services furnished by the public sector and are the principal beneficiaries of m a n y g o v e r n m e n t subsidies. 6 3 Finally, privatization is supported because it can promote popular capitalism and economic democratization by p r o v i d i n g a wide o w n e r s h i p of assets of firms t h r o u g h o u t the society. 64

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The Unfulfilled Promise of Privatization A fair amount has been written about the short-term implications and d i f f i c u l t i e s of implementing programs of privatization in developing countries. A number of scholars have considered how governments can pursue privatization in the face of internal bureaucratic resistance, labor and legislative opposition, and/or ideological antagonism. 6 5 Others have written extensively about technical problems associated with privatization, such as the determination of the value of shares sold by SOEs, 6 6 the limited size of domestic capital markets in some developing countries, 6 7 and the fact that transition costs may be considerable 6 8 and are often underestimated, 6 9 especially when SOEs have to be made attractive before they can be sold. 7 0 Although these are all important issues—particularly for individuals and institutions interested in promoting privatization—they are not central to a consideration of the longer-term developmental consequences of privatization. T h e discussion that follows concentrates instead on the longer-term consequences of privatization for development. Sweeping Theoretical Claims T o begin, it is important to note that some of the principal theoretical claims for privatization are either unfounded or must be qualified in most instances. First and foremost, the performance of enterprises in the private sector is not always better than the performance of enterprises in the public sector. As Raymond Vernon suggested in the introduction of his book The Promise of Privatization, "Neither the literature of state owned enterprises in general nor the studies in the chapters that follow lay the basis for a broadside attack on such enterprises." 7 1 The private sector might not prove to be any more efficient than the public sector in instances where the public sector provides true public goods, such as national defense, or merit goods, such as health, education, and housing. 7 2 Moreover, the private sector is not likely to be any more efficient than the public sector in the case of natural monopolies, such as water supply, or in instances where the economies of scale are so great that a sector can support only one or a limited number of enterprises, a structural feature common to many small developing countries. 7 3 There are already some important instances in which privatization has transformed giant public monopolies into giant private monopolies. 7 4 Indeed, some of the developing countries with the longest experience with privatization have found themselves forced to engage in a costly "restatization" (or renationalization) of some sectors of their economies because of the inadequate performance of enterprises in the private sector. This is precisely what happened with the privatization of the Chilean financial sector after the concentration of ownership of financial institutions contributed to speculative tendencies, a decline in new investment, and the virtual collapse of the economy in 1983. 75 The Chilean state ended up with a large share of the Chilean corporate sector, "as well as its domestic and

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foreign d e b t s , " 7 6 a development that dwarfed any potential immediate budgetary gains from privatization in the country. On second consideration, some of the efficiencies historically associated with private-sector enterprise may owe more to the state-supported (and often protected) environment in which the private sector operated than to the inherent e f f i c i e n c i e s of the privately managed firm. M e a s u r i n g the improvements in enterprise efficiency is an extremely difficult undertaking, and there is evidence from the experience with privatization in a number of countries that most of the efficiency gains anticipated from privatization are based on assertions and expectations of enterprise performance rather than on detailed (and extremely difficult) calculations that would be required to demonstrate the efficiency improvements resulting from privatization. 77 It is also important to broaden the criteria employed to evaluate the potential economic benefits from privatization beyond those of economic efficiency alone. The social (and even political) costs and benefits of SOEs also need to be included in such calculations. 7 8 For in addition to their economic production, SOEs produce some positive externalities, such as industrialization, the creation of new jobs, the defense of national interests, and a reduction in regional inequalities. 7 9 The degree to which these are legitimate and important developmental objectives will vary from country to country and are subject to reasonable debate in most instances. However, they need to be included in assessments of the economic benefits of privatization, particularly in those instances where privatization is likely to eliminate large numbers of jobs or increase regional inequalities. Beyond efficiency arguments, other theoretical claims for privatization can be equally problematic in practice. The extent to which privatization can reduce g o v e r n m e n t fiscal deficits tends to be limited, short term, and genuinely ambiguous. 8 0 Immediate budgetary gains depend largely on the existence (and size) of prior subsidies to SOEs, the costs of sustaining them, and the conditions of sale of the shares of state-owned firms (especially the valuation of the shares sold). Counterfactual estimates of the potential budgetary savings from the cost of future subsidies need to be balanced with estimates of the cost of underpriced sales, preprivatization sweeteners, and p o s t p r i v a t i z a t i o n c o n c e s s i o n s to p u r c h a s e r s that a c c o m p a n y most transactions. Accordingly, there are a number of instances in which the budgetary effects of privatization have been limited 8 1 or highly dubious. 8 2 This has prompted one observer to comment, "There may well be a tradeoff between budgetary and efficiency gains from privatization." 8 3 Others have suggested that some of the principal budgetary goals of privatization, such as revenue enhancement and expenditure reduction, "have been shown to be more successful when tackled directly through SOE reform." 84 Furthermore, privatization does not necessarily eliminate rent-seeking practices, particularly when the privatization process itself is used as a vehicle for corruption. 8 5 Finally, as will be elaborated in greater detail below.

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m a n y of the p o p u l i s t c l a i m s f o r privatization h a v e r e m a i n e d l a r g e l y u n a t t a i n e d . T h u s , while there are a n u m b e r of persuasive a r g u m e n t s for considering privatization, the experience of many countries with the exercise is neither as compelling nor as straightforward as it may initially appear. It is increasingly apparent that the benefits of privatization are not going to be automatic in developing countries. This is especially true when privatization is p u r s u e d in an e n v i r o n m e n t w i t h o u t g e n u i n e l i b e r a l i z a t i o n ( t h e i n s t i t u t i o n a l i z a t i o n of c o m p e t i t i v e practices) and/or in an e n v i r o n m e n t without effective institutions of government regulation. Privatization Without Liberalization F e w of the potential gains f r o m privatization are likely to be obtained if privatization is pursued without extensive liberalization. Gains in allocative e f f i c i e n c y f r o m p r i v a t i z a t i o n d e p e n d o n p a r a l l e l c h a n g e s in the m a c r o e c o n o m i c e n v i r o n m e n t that include economic liberalization and that r e i n f o r c e c o m p e t i t i v e practices. 8 6 Indeed, "unless it is accompanied by a l i b e r a l i z a t i o n p r o g r a m , the e f f e c t s of privatization o n both e c o n o m i c efficiency and government expenditures are likely to be modest." 8 7 In sectors with an oligopolistic o r nearly monopolistic structure, costs to individual c o n s u m e r s m a y increase, while high levels of protection and m a n y other implicit subsidies may remain largely unchanged. T h e r e are s o m e things governments can do to ensure that competitive practices are introduced into sectors being privatized, such as breaking u p natural m o n o p o l i e s by auctioning franchises to the private sector or by subcontracting additional activities to the private sector. 8 8 However, recent experience has demonstrated that it has often been easier for governments to sell the s h a r e s of individual enterprises than to ensure that competitive practices are introduced in the sector of the economy in which they operate. This scenario was first observed in the case of privatization in the United K i n g d o m , 8 9 and a similar sequence of events has developed more recently in Mexico, where S O E s have been privatized to meet I M F performance criteria without serious consideration of the degree of competition in the markets into which the newly privatized firms enter. T h e need to pursue privatization with liberalization is painfully obvious in the p r o c u r e m e n t p r o c e s s for m a j o r i n f r a s t r u c t u r e p r o j e c t s , w h e r e privatization is already fairly routine in most d e v e l o p i n g countries. T h e procurement process is easily (and frequently) corrupted in most countries of the d e v e l o p i n g world 9 0 and would undoubtedly benefit from a liberalization that i n t r o d u c e d a tendering p r o c e s s of genuinely o p e n and c o m p e t i t i v e bidding. Privatization Without Effective Regulation Pursuing privatization without effective regulation can create nearly as m a n y p r o b l e m s as p u r s u i n g privatization without liberalization. Most scholars agree that the private provision of public services must be undertaken within

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the framework of rules established and enforced by government, particularly in the case of utilities, 91 and many of their arguments apply equally well to the private production of goods. 9 2 A number of problems can emerge if privatization is pursued without an effective regulatory framework—that is, in the absence of institutions or agencies capable of preventing the formation of new monopolies, of guaranteeing minimal employee and consumer safety standards, and of ensuring the minimal provision of key public goods (such as water supply and a power infrastructure) throughout the country. First, "cream skimming" may take place. Newly privatized enterprises may find it profitable to drop product lines or services designed for small or less lucrative markets and concentrate instead on an expansion of the range of goods and services provided to wealthier neighborhoods or market segments. The state may previously have subsidized some of these goods and services when it was responsible for production and distribution. Without an appropriate regulatory environment that directs private firms into all areas, privatization could contribute to a cream skimming that reduces or eliminates the provision of basic goods and services for some segments of the population. Second, without an effective regulatory environment to maintain competition, there is a danger that privatization could undermine the process of economic liberalization and effective competition in developing countries. S o m e private-sector enterprises have demanded special protection, concessionary financing, and/or have resisted the introduction of competitive practices into their industry as a condition of purchase of public-sector enterprises. Case study evidence suggests that this has been a relatively frequent occurrence, as indicated by the experience with privatization in Great B r i t a i n , 9 3 as well as in a number of countries in Africa, Asia, and the Caribbean. 94 Third, the expansion of private-sector activities occasioned by privatization can contribute to a number of negative externalities that require enhanced regulation. The sale of major portions of Chile's national forests reduced the rate of reforestation in the country and led the government to consider special interventions to encourage replanting. 95 Similarly, the sale of water rights to private associations in Chile reduced infrastructure investment that has negatively affected the performance of the irrigation system as a whole. 9 6 Throughout the developing world today, the potential dangers of pursuing privatization without effective regulation are very real. Privatization is being pursued by governments confronting massive fiscal deficits and undergoing dramatic deflation and economic contraction. These are precisely the conditions in which a state is likely to lack the financial wherewithal to provide and enforce an effective regulatory framework (as recruitment, training, and resources of potential regulators are cut). In the final analysis, as George Yarrow has noted, "Competition and

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regulation are more important determinants of economic performance than ownership. . . . Indeed, preoccupation with the ownership issue is likely to be damaged if it distracts attention from the more fundamental issues." 9 7 T h e r e is little point in pursuing privatization without liberalization and effective regulation. Few, if any, of the economic and political benefits of the exercise are likely to be attained without these complementary policy reforms in the macroeconomic environment. Other Difficulties In addition to the facts that some of the theoretical claims for privatization are unfounded (or need important qualification) and that the theoretical b e n e f i t s of the exercise require both liberalization and regulation, privatization also has a number of other potentially harmful features that need careful consideration before it is adopted as policy. Most significant is the fact that privatization is likely to increase inequality in most developing countries. As one observer has suggested, "There are reasons to prefer democratic politics to markets in the making of some decisions. Most obviously, each citizen gets one vote, but in the marketplace people with more money have more 'votes.'" 9 8 The effects of increased inequality are likely to be felt at the national, regional, enterprise, and household levels of the economy. At the national level, only those with considerable prior accumulation are likely to be in a position to acquire the bulk of the shares of the enterprises sold by the state. Even in instances where the initial sale of shares is widely dispersed, concentration is likely to increase markedly in the secondary market following the initial sale of s h a r e s . " Because so many developing economies lack efficient and competitive capital markets, privatization is likely to reinforce the concentration of ownership through several different mechanisms. First, cronyism may increase because those with privileged access to the existing state elite are likely to gain preferred access to the shares of SOEs being sold. 100 Ironically, rather than eliminating rent-seeking practices, the process of privatization may provide an effective vehicle for them. 1 0 1 Moreover, under the deflationary macroeconomic policy conditions that currently prevail in so many developing countries pursuing privatization (where tight monetary policy and fiscal policy constraints are combined with recurring domestic currency devaluations), foreign exchange has become a principal source of new finance. 1 0 2 Only those with established financial positions and networks of contacts abroad (i.e., those associated with the largest enterprises: the grupos of Latin America and the chaebols of East Asia, or former Communist Party officials in Eastern and Central Europe and the former Soviet Union) are likely to be in a position to have access to external financing, a fact that may concentrate the proceeds from privatization even further. At the regional level, the distribution of long-term gains f r o m privatization is likely to favor disproportionately those regions and ethnic

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groups that have the greatest amount of prior success with capital accumulation. In Kenya and Tanzania, it is the Asians and resident Europeans who are likely to benefit the most from the privatization process, 1 0 3 while in Nigeria, the Lebanese and African entrepreneurs resident in the southern regions of the country are likely to benefit most. 1 0 4 Similar patterns and concerns exist in the multiethnic societies of South and Southeast Asia. 1 0 5 Moreover, as discussed above, the SOEs that provide public goods for the entire economy are more likely to service remote regions than recently privatized firms that may be reluctant to reach them, further exacerbating regional inequalities. 1 0 6 Prices for services might also increase in such circumstances. Inequality at the enterprise level is also likely to increase following privatization. In instances where privatization and economic reform have been used to weaken the political influence of labor groups and/or relax regulations originally developed to defend the interests of working people, there is likely to be a further intensification of the use of labor. In general terms, worker layoffs and retrenchment are anticipated consequences of most privatization programs. Finally, in instances where privatization has involved extensive load shedding by the state, the elimination of some public services and/or the reduction of certain subsidies has increased pressure on the household economy. Load shedding has forced many principal wage earners employed in the formal sector to seek employment in informal-sector activities. At the same time, the number of hours worked by women and children (principally in the informal sector) has increased as a response to the decline in subsidies and services. 1 0 7 The ultimate effects of most load shedding tend to fall disproportionately on the poor and can also have important effects on the gender division of labor within the household economy, as women add informal-sector hours to their working day without reducing the number of hours they work within the household. 1 0 8 In addition to increasing inequality, privatization in developing countries is also likely to contribute to a number of other unintended consequences, problems, or difficulties. If market forces are allowed to operate freely and the privatization process is not restricted to domestic enterprises, foreign enterprises may become the major beneficiaries of the process. Debt-equity swaps have increased foreign ownership in Latin America, while in Africa, privatization is viewed by some as a Trojan horse for the reconquest (or r e c o l o n i z a t i o n ) of the c o n t i n e n t . 1 0 9 A recent comparative study of privatization in eight Commonwealth countries concluded that the absence of extensively developed capital markets "frequently means that foreign participation becomes the only means of raising finance for divestiture." 110 Furthermore, previously stable corporatist arrangements can be disrupted by the process of privatization. Major shifts in the balance of power between the public and the private sector (or between capital and labor) may create

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new possibilities for the transformation of an economy. At the same time, however, they create new difficulties, especially where the changing rules of the game disproportionately affect the influence of one actor (urban labor) and create a basis for its opposition to economic reform efforts more generally. Finally, there may be some important opportunity costs associated with the process of privatization. The acquisition of SOEs may prove to be more attractive to local businesses than embarking on activities that involve new capital formation. As the Chileans have experienced, the bulk of new direct foreign investment is likely to be channeled into the acquisition of former SOEs rather than into new productive investments. 111

Conclusions: Appropriating Privatization for Development T h e unfulfilled promise of privatization should not be used to dismiss its potential for development. It would be difficult to think of development without extensive private-sector participation, especially as the private sector has been conceptualized in this paper. However, there is good reason to raise some questions about the ideological pursuit of privatization as an end in itself and to recognize that the benefits from privatization will not be automatic in developing countries. Many of the economic and political arguments for privatization are based on assumptions grounded in the experience of the advanced industrial countries. For most developing countries, public and private sectors do not coexist in opposition (casting doubt on assertions about the "crowding out" of the private sector). Moreover, the private sector in developing countries cannot be equated with formal, profit-making enterprises: financial markets are neither sufficiently developed nor competitive to ensure many of the efficiency gains anticipated from privatization, the regulatory capacity of government is severely limited, and income distribution remains sharply skewed. Thus, not only will privatization require complementary policy reforms (both liberalization and effective regulation) but the mobilization of the potential of the private sector is also likely to require much more than the "simple" retreat of the state. In the final analysis, if privatization is going to make a positive contribution to development, private-sector activities will have to be protected, enhanced, monitored, and even regulated by the state, not left entirely to the whims of the market. The task is not going to be an easy one. Developing countries have been motivated to consider privatization for a variety of largely negative reasons (e.g., to reduce public-sector deficits, to slow high rates of inflation, and/or to shed costly redistributive programs). At the same time, they have introduced privatization programs in generally adverse circumstances with overt external pressure, large foreign debts, deflated economies, and extremely limited capital markets. 1 1 2 The state has been weakened and increasingly has

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lost credibility precisely at a time when it has assumed a number of new and difficult responsibilities (such as paying debts while trying to maintain acceptable levels of growth and launching ambitious new liberalization and privatization programs). In general terms, it will be easier to accomplish the goals of both privatization and development if a broader conception of the private sector and the privatization process is employed. As discussed earlier, the private sector consists of much more than just formal-sector, profit-making enterprises. The informal sector, nonprofit enterprises, professional associations, and households are all vital components of the private sector in the developing world. A broader conception of the private sector is important both for a sophisticated analysis of the consequences of privatization and for an identification of private-sector participants in the solution of many of the problems discussed above. Privatization involves far more than the sale of SOEs and should be evaluated in all of its dimensions. There are a number of different ways in which a broader conception of the private sector and of the privatization process can be employed to address some of the most common problems with privatization and channel the process to promote broader development objectives. At the most general level, given the ample evidence that privatization does not automatically engender competition, it is important that developing countries guarantee and reinforce liberalization practices while pursuing privatization. There are several different ways of introducing competitive practices into n a t u r a l m o n o p o l i e s . " 3 Rather than simply selling the assets of such enterprises to private-sector entrepreneurs, the subcontracting of maintenance services or the introduction of product and service franchises could be considered. When selling state-owned enterprises, privatizing states can resist the pressures for special monopoly privileges frequently requested as a condition of sale. It is also important that the state maintain its monitoring capabilities and even consider upgrading some of its capabilities for effective budgeting and regulation to guarantee the continuation, or in some instances the introduction, of effective competition in the economy. In the case of the procurement process where private-sector participation is already considerable, there are creative ways of involving elements of the private sector to maintain competitive practices. For example, private-sector professional associations could be engaged to participate in and to monitor the tendering process. Employing independent units to monitor activities could reinforce competitive practices in countries that have significant problems with rentseeking behavior. 1 1 4 With regard to the sequencing of privatization within comprehensive programs of economic reform, there is growing evidence that countries might do well to delay privatization until after a m a c r o e c o n o m i c policy liberalization is already fairly far along and reasonably well institutionalized. A number of the problems associated with privatization (such as the demand

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for special concessions and the highly concentrated acquisition of privatized shares) could be minimized if liberalization practices were already well established. Maintaining (or even upgrading) certain regulatory functions of the state is also important to ensure that the process of privatization contributes to development. Enhancing regulation does not have to mean adding layers of bureaucratic interference to the economy but can be directed to reinforce competitive practices (as described above) as well as to limit or compensate f o r s o m e of the most apparent negative externalities associated with privatization. It is important that government decisionmakers consider social costs and benefits when contemplating the potential benefits of privatizing an SOE. Relying on criteria of economic efficiency and/or short-term budgetary considerations alone may prove to be highly misleading over the longer term. Many of the potential problems associated with privatization (such as the exacerbation of regional inequalities or the disruption of stable corporatist patterns) could be limited if a broader calculation of the costs and benefits of the exercise were undertaken. Regulation can be directed to ensure that services of high quality continue to be provided to all regions of the country, particularly to those areas where some form of cross-subsidization is w a r r a n t e d . 1 1 5 Regulation can also be employed to assure that inequality, pollution, and deteriorating product quality are not the principal products of privatization. In those areas where the state lacks the capability to regulate effectively, the potential social costs of privatizing certain government services could be considerable. Finally, there are a number of ways a broadened conception of the private sector can help address many of the problems associated with the process of privatization in developing countries. For example, when privatization takes the form of increased subcontracting of government services, it might be possible to employ networks of private NGOs for the distribution of essential public services (such as health care, pharmaceuticals, and medical supplies). Although some of these organizations have externalities of their o w n (particularly in the case of missionaries), their e f f e c t i v e n e s s as distribution networks should not be overlooked. There are also many opportunities for the subcontracting of government services to small-scale, informal-sector transportation and delivery services in developing countries. Privatization need not be limited to the creation of incentives for the formal, large-scale, profit-making private-enterprise sector alone. There are several different private sectors that can be supported in developing countries. While some of the populist objectives of privatization (e.g., providing support to small-scale enterprises) are not likely to be achieved automatically, there is no reason why they cannot be included as part of the design of programs of privatization. To do so, it will be important to understand the conditions under which the private sector will respond to incentives, and to design incentives that will promote small-scale (formal or

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informal, profit or nonprofit) private-sector activities that have extensive backward linkages to the rest of the economy. With regard to load shedding by the state, social cost-benefit analysis should be undertaken along with estimates of the potential fiscal benefits of load shedding. For while load shedding will reduce the public-sector deficit and enhance privatization in the short term, it is likely to undermine development over the long term when development is evaluated by the provision of basic needs. This is especially the case in those instances where viable alternatives to public-sector services simply do not exist. Under these conditions, the immediate consequence of load shedding will be to increase substantially the pressure and demands on the household economy, and particularly on women, given the prevailing gender division of labor in developing countries." 6 In the final analysis, a number of the potential problems associated with privatization in developing countries can be ameliorated by paying careful attention to the sequencing of privatization programs within the framework of more comprehensive economic reform efforts. As suggested above, it is probably best to delay privatization until after liberalization and liberalized practices are more firmly entrenched. Furthermore, major privatization efforts should probably not be launched while a country is undergoing a deflationary economic stabilization program. In a deflationary environment, the budgetary and fiscal benefits of privatization will be minimized, the full-market value of enterprises is not likely to be attained, and inequality in the distribution of shares is a near certainty (because only those with access to foreign sources of finance are likely to have sufficient liquidity to acquire privatized firms). These conclusions about the sequencing of privatization suggest that it is probably too soon for most countries of the developing world to embark on ambitious privatization programs. Liberalization efforts are still in the initial, experimental stages in many countries, and liberal practices have hardly begun to be institutionalized. Moreover, many countries that have completed economic stabilization programs remain deflated, in large part due to the burden of their significant and continuing debt overhang. Thus, international organizations and bilateral aid agencies concerned with development might do well to consider the issue of the appropriate sequencing of privatization before insisting on a short-term ideological objective that fails to achieve the principal objectives of the exercise. Indeed, without proper sequencing, privatization could mobilize opposition to economic reform and make it more difficult to expand constructive privatesector involvement in development over the longer term.

Notes Earlier versions o f this paper were presented at the annual m e e t i n g of the International S t u d i e s A s s o c i a t i o n in London, England, March 1989, and at the W o r k s h o p on E c o n o m i c R e f o r m s and Institutional C h a n g e at the U n i v e r s i t y of

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Southern C a l i f o r n i a ' s Center for International Studies, February 25, 1989. I am grateful to Vinod Goyal and Jeffrey Hawkins for research assistance, and to the Center for International Studies at the University of Southern California and the A s s o c i a t i o n for the P r o m o t i o n of International C o o p e r a t i o n in T o k y o for financial support. I have also benefited from helpful criticisms and suggestions from Chris Adam, Gary Dymski, Nancy Gilgosch, Nora Hamilton, Eun Mee Kim, John Odell, Manuel Pastor, V. Spike Peterson, Konrad Stenzel, Ernest Wilson, and especially from Penelope Walker. 1. N i c o l a s van de Walle, " P r i v a t i z a t i o n in D e v e l o p i n g C o u n t r i e s : A Review of the Issues," World Development 17 (May 1989): 6 0 1 - 6 1 6 , referenced here f r o m p. 601. 2. R a y m o n d Vernon, "Introduction: T h e Promise and the C h a l l e n g e , " in R a y m o n d V e r n o n (ed.), The Promise of Privatization (New York: Council on Foreign Relations Books, 1988): 1 - 2 2 , quoted here from p. 3. 3. Robert E. Christiansen, " E d i t o r ' s Introduction," World Development 17 (May 1989): 5 9 7 - 5 9 9 , referenced here from p. 597. Indeed, I have conducted one of these privatization studies myself, and it was that experience that initially gave rise to many of the ideas considered in this paper. 4. W o r l d Bank and U N D P , Africa's Adjustment and Growth in the 1980s ( W a s h i n g t o n , D.C.: World Bank, 1989): 2 5 - 2 6 . 5. For the purposes of this discussion, development will be defined as the p r o c e s s by w h i c h a highly i n t e g r a t e d e c o n o m y and society, c a p a b l e of substantially providing for the basic needs of the vast majority of the population, are created. 6. This is true of virtually all of the essays included in the volume edited by R a y m o n d Vernon, The Promise of Privatization, as well as most of the articles in the special issue of World Development, May 1989, devoted to the subject. 7. van de Walle, "Privatization in Developing Countries." 8. P a u l Starr, " T h e Limits of Privatization," in Steve H. H a n k e (ed.). Prospects for Privatization (New York: Academy of Political Science, 1987): 125— 126. 9. Steve H. Hanke, "Privatization Versus Nationalization," in Hanke (ed.), Prospects for Privatization: 2. 10. Privatization ordinarily entails a transfer of both risk and accountability to the p r i v a t e sector. An e x c e p t i o n , to be considered later, w o u l d be the subcontracting of public services, for which the state continues to be principally a c c o u n t a b l e , even if it no l o n g e r carries the entire risk. I w o u l d like to a c k n o w l e d g e conversations with Chris Adam for this insight. 11. Robert W. Bailey, " U s e s and Misuses of Privatization," in H a n k e (ed.), Prospects for Privatization: 140. 12. Gabriel Roth, The Provision of Public Services in Developing Countries (Oxford: O x f o r d University Press, 1987): 2-4. 13. Ibid., 91, 134, 1 7 7 - 1 8 0 , 2 4 3 - 2 4 4 . 14. Heidi Vernon-Wortzel and Lawrence H. Wortzel, "Privatization: Not the Only A n s w e r , " World Development 17 (May 1989): 6 3 3 - 6 4 2 , referenced here from p. 639. 15. Chris S. A d a m and William P. Cavendish, "Can Privatization Succeed? E c o n o m i c Structure and P r o g r a m m e Design in Eight C o m m o n w e a l t h C o u n t r i e s " (Paper prepared for the C o m m o n w e a l t h Secretariat by the Finance, Industry and Trade Centre, Queen Elizabeth House, University of Oxford, June 1990): 1. 16. T h e same can be said for the adoption of certain private-sector practices within p u b l i c - s e c t o r e n t e r p r i s e s (such as the introduction of p r i v a t e - s e c t o r

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m a n a g e m e n t and operations systems). They should be considered elements of public-sector reform rather than privatization per se. 17. E. S. Savas, Privatization: The Key to Better Government (Chatham, N.J.: C h a t h a m H o u s e Publishers, 1987): 3 - 4 . 18. Roth, The Provision of Public Services in Developing Countries: 1. 19. Veronika Bennholdt-Thomsen, ' " I n v e s t m e n t in the P o o r ' : An Analysis of W o r l d B a n k P o l i c y , " in Maria Mies, V e r o n i k a B e n n h o l d t - T h o m s e n , and C l a u d i a von W e r l h o f (eds.), Women: The Last Colony (London: Zed Books, 1988). 20. T h o m a s J. Biersteker, "Reducing the Role of the State in the E c o n o m y : A Conceptual Exploration of I M F and World Bank Prescriptions," International Studies Quarterly (December 1990). 21. H e n r y B i e n e n a n d J o h n W a t e r b u r y , " T h e Political E c o n o m y of Privatization in D e v e l o p i n g C o u n t r i e s , " World Development 17 (May 1989): 6 1 7 - 6 3 2 , referenced here from pp. 618, 6 2 8 - 6 2 9 . 22. D a v i d R . C a m e r o n , " T h e E x p a n s i o n of the Public E c o n o m y : A Comparative Analysis," American Political Science Review 72 (December 1978): 1243-1261. and Markets: The World's Political2 3 . C h a r l e s L i n d b l o m , Politics Economic Systems ( N e w York: Basic Books, 1977). 24. R a l p h M i l i b a n d , The State in Capitalist Society ( N e w York: Basic B o o k s , 1969). 25. N i c o s Poulantzas, Political Power and Social Classes (London: Verso B o o k s , 1978). 26. Claus O f f e and V. Ronge, "Theses on the Theory of the State," New German Critique 6 (1975). 27. H a m z a Alavi, " T h e State in P o s t - C o l o n i a l S o c i e t i e s — P a k i s t a n a n d B a n g l a d e s h , " New Left Review 74 (1972): 5 9 - 8 1 ; John R. Nellis and Sunita Kikeri, "Public Enterprise R e f o r m : Privatization and the World B a n k , " World Development 17 (May 1989): 6 5 9 - 6 7 2 , referenced here from p. 660. 28. A l b e r t O. H i r s c h m a n , A Bias for Hope (New Haven, C o n n . : Y a l e University Press, 1971); Dieter Senghaas, The European Experience: A Historical Critique of Development (Dover, N.H.: Berg Publishers, 1985). 29. van de Walle, "Privatization in Developing Countries," 6 0 2 - 6 0 3 . 30. T h o m a s J. B i e r s t e k e r , Multinationals, the State and Control of the Nigerian Economy (Princeton, N.J.: Princeton University Press, 1987). 31. T h o m a s M. Callaghy and Ernest J. Wilson III, "Africa: Policy, Reality, or Ritual?" in Vernon (ed.). The Promise of Privatization: 179-230; and R o g e r Leeds, " M a l a y s i a : G e n e s i s of a Privatization Transaction," World Development 17 (May 1989): 1 4 9 - 1 7 8 . 32. Ironically, their p r e d e c e s s o r s in the World Bank 15 to 20 years a g o might well h a v e p r o v i d e d the initial financing for such a venture; Lynn K. Mytelka, "The U n f u l f i l l e d P r o m i s e of African Industrialization," African Studies Review 32, no. 3 (1989). 33. John R. Nellis, Public Enterprise in Sub-Saharan Africa ( W a s h i n g t o n , D.C.: W o r l d Bank, 1986); and Nellis and Kikeri, "Public Enterprise R e f o r m , " 659. 34. V e r n o n , " I n t r o d u c t i o n , " 4. 35. S a v a s , Privatization: The Key to Better Government: 5 - 6 ; Vernon, "Introduction." 36. H a n k e , "Privatization Versus Nationalization," 1 - 3 ; Louis D e Alessi, "Property Rights and Privatization," in Hanke (ed.). Prospects for Privatization; and Bailey, "Uses and Misuses of Privatization."

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37. Richard H e m m i n g and Ali M. Mansoor, "Is Privatization the A n s w e r ? " Finance and Development 25 (September 1988): 3 1 - 3 2 ; Peter S. Heller and Christian Schiller, "The Fiscal Impact of Privatization, with S o m e Examples f r o m Arab Countries," World Development 17 (May 1989): 7 5 7 - 7 6 7 , referenced here from p. 758. 38. Vernon, " I n t r o d u c t i o n , " 17. 39. Nellis and Kikeri, "Public Enterprise R e f o r m , " 663. 40. Bailey, "Uses and Misuses of Privatization." 4 1 . Yair A h a r o n i , " T h e United K i n g d o m : T r a n s f o r m i n g A t t i t u d e s , " in Vernon (ed.), The Promise of Privatization, 36; van de Walle, "Privatization in Developing Countries," 605; Nellis and Kikeri, "Public Enterprise R e f o r m , " 663; Heller and Schiller, "The Fiscal Impact of Privatization," 758. Countries: xiv; 4 2 . Roth, The Provision of Public Services in Developing Hanke, "Privatization Versus Nationalization," 1-3. 43. Aharoni, " T h e United K i n g d o m , " 24. 4 4 . R o t h , The Provision of Public Services in Developing Countries, 5 (emphasis in original). 4 5 . Vernon, " I n t r o d u c t i o n , " 5; Savas, Privatization: The Key to Better Government: 5 - 6 ; Roth, The Provision of Public Services in Developing Countries: xiv; van de Walle, "Privatization in Developing Countries," 6 0 2 - 6 0 4 . 4 6 . S t a r r , " T h e L i m i t s of P r i v a t i z a t i o n , " 1 2 5 - 1 2 6 ; a n d Hanke, "Privatization Versus Nationalization," 1 - 3 . 4 7 . Starr, " T h e Limits of Privatization," 125-126. 4 8 . Aharoni, " T h e United K i n g d o m , " 27; Bienen and W a t e r b u r y , " T h e Political E c o n o m y of Privatization in Developing Countries," 619. 49. Roth, The Provision of Public Services in Developing Countries: 65; and Hanke, "Privatization Versus Nationalization," 1 - 3 . 50. Nellis and Kikeri, "Public Enterprise Reform." 663; Heller and Schiller, "The Fiscal Impact of Privatization." 758. 51. Roth, The Provision of Public Services in Developing Countries: 7. 52. Mary Shirley, " M a n a g i n g State O w n e d Enterprises," World Bank Staff Working Paper No. 577 (Washington, D.C.: World Bank, 1983). 53. Nellis and Kikeri, "Public Enterprise Reform," 661. 54. World Bank and U N D P , Africa's Adjustment and Growth in the 1980s: 25-26. 55. Roth, The Provision of Public Services in Developing Countries: 7; van de Walle, "Privatization in Developing Countries," 605. 56. Savas, Privatization: The Kev to Better Government: 7 - 9 . 57. H a n k e , " P r i v a t i z a t i o n Versus Nationalization," 1 - 3 ; A h a r o n i , " T h e United Kingdom," 37. 58. Roth, The Provision of Public Services in Developing Countries: 65. 59. van de Walle, "Privatization in Developing Countries," 607. 60. Stuart M. Butler, "Changing the Political Dynamics of G o v e r n m e n t , " in Hanke (ed.). Prospects for Privatization. 6 1 . L. G r a y C o w a n , " D i v e s t m e n t , P r i v a t i z a t i o n a n d D e v e l o p m e n t , " Washington Quarterly 8 (1985): 4 7 - 5 6 . 62. Savas, Privatization: The Key to Better Government: 10. The use of school vouchers as discussed in Roth, The Provision of Public Services in Developing Countries, and Starr, "The Limits of Privatization," would be one example of this. 63. Roth, The Provision of Public Services in Developing Countries: xiv. 6 4 . H a n k e , " P r i v a t i z a t i o n Versus N a t i o n a l i z a t i o n , " 1 - 3 ; A h a r o n i , " T h e United K i n g d o m , " 27; Pan A. Yotopoulos, "The (Rip) Tide of Privatization:

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L e s s o n s from Chile," World Development 17 (May 1989): 6 8 3 - 7 0 2 , referenced here f r o m p. 684. 65. Callaghy and Wilson, "Africa: Policy, Reality, or Ritual?"; Bienen and Waterbury, " T h e Political E c o n o m y of Privatization in Developing Countries," 6 2 3 - 6 2 8 ; Leeds, " M a l a y s i a , " 741, 751. 66. C o w a n , " D i v e s t m e n t , Privatization and D e v e l o p m e n t " ; Guy P f e f f e r m a n n , Private Business in Developing Countries: Improved Prospects ( W a s h i n g t o n , D.C.: International Finance Corporation of the World Bank, 1988). 67. R o g e r S. Leeds, "Turkey: Rhetoric and Reality," in Vernon (ed.), The Promise of Privatization: 149-178; Janet Kelly de Escobar, "Venezuela: Letting in the Market," in Vernon (ed.), The Promise of Privatization: 57-90. 68. Bailey, "Uses and Misuses of Privatization." 69. Nellis and Kikeri, "Public Enterprise Reform," 669. 70. P f e f f e r m a n n , Private Business in Developing Countries. 71. Vernon, " I n t r o d u c t i o n , " 20. 72. Roth, The Provision of Public Services in Developing Countries: 7 - 1 1 . 73. van d e Walle, "Privatization in Developing Countries," 605; Kelly de Escobar, "Venezuela." 74. Aharoni, " T h e United Kingdom," 51. 75. Y o t o p o u l o s , " T h e ( R i p ) T i d e of P r i v a t i z a t i o n , " 6 9 5 - 6 9 8 ; K o n r a d Stenzel, " T h e Crisis as a Blessing in Disguise: E c o n o m i c A d j u s t m e n t and A u t h o r i t a r i a n R u l e in Chile, 1 9 8 2 - 1 9 8 7 " (Ph.D. diss, draft. Department of Political Science, Yale University, 1989). 76. Yotopoulos, "The (Rip) Tide of Privatization," 698. 77. A d a m and Cavendish, " C a n Privatization Succeed?" 13. 78. Aharoni, " T h e United Kingdom," 35. 79. V e r n o n - W o r t z e l and Wortzel, "Privatization," 636. 80. H e l l e r a n d S c h i l l e r , " T h e Fiscal Impact of P r i v a t i z a t i o n , " 7 5 7 ; Yotopoulos, " T h e (Rip) Tide of Privatization," 699. 81. Heller and Schiller, " T h e Fiscal Impact of Privatization," 7 6 5 - 7 6 6 ; Adam and Cavendish, "Can Privatization Succeed?" 15. 82. Yotopoulos, " T h e (Rip) Tide of Privatization," 699. 83. van de Walle, "Privatization in Developing Countries," 604. 84. A d a m and Cavendish, " C a n Privatization Succeed?" 28. 85. Callaghy and Wilson, "Africa: Policy, Reality, or Ritual?" 86. Heller and Schiller, " T h e Fiscal Impact of Privatization," 766. 87. van de Walle, "Privatization in Developing Countries," 610. 88. H e m m i n g and Mansoor, "Is Privatization the Answer?" 32. 89. Aharoni, " T h e United Kingdom," 44^15, 52. 90. W i l l i a m G l a d e , " P r i v a t i z a t i o n in R e n t - S e e k i n g S o c i e t i e s , " World Development 17 (May 1989): 6 7 3 - 6 8 3 , referenced here from p. 678. 91. Nellis and Kikeri, "Public Enterprise Reform," 667. 92. Roth, The Provision of Public Services in Developing Countries: 7; van de Walle, "Privatization in Developing Countries," 607. 93. John Kay and David Thompson, "Privatization: A Policy in Search of a Rationale," Economic Journal 96 (March 1986): 18-32. 94. N e l l i s a n d Kikeri, " P u b l i c E n t e r p r i s e R e f o r m , " 6 6 8 ; A d a m a n d Cavendish, "Can Privatization Succeed?" 12. 95. Yotopoulos, " T h e (Rip) Tide of Privatization," 687. 96. Ibid., 6 8 8 . 97. G e o r g e Y a r r o w , "Privatization in T h e o r y and Practice," Economic Policy 1 (April 1986): 364.

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98. Starr, " T h e Limits of Privatization," 132. 99. A l e j a n d r o Foxley, Latin American Experiments in Neo-Conservative Economics ( B e r k e l e y : University of C a l i f o r n i a Press, 1983); B i e r s t e k e r , Multinationals', Aharoni, "The United Kingdom"; A d a m and Cavendish, " C a n Privatization S u c c e e d ? " 21. 100. Callaghy and Wilson, "Africa: Policy, Reality, or Ritual?" 101. Nellis and Kikeri, "Public Enterprise R e f o r m , " 668. 102. Yotopoulos, " T h e (Rip) Tide of Privatization," 694, 699. 103. Callaghy and Wilson, "Africa: Policy, Reality, or Ritual?" 104. Biersteker, Multinationals. 105. Bienen and Waterbury, " T h e Political E c o n o m y of Privatization in Developing C o u n t r i e s , " 620. 106. van de Walle, "Privatization in Developing Countries," 606. 107. Giovanni Cornia, Richard Jolly, and Frances Stewart, Adjustment with a Human Face (Oxford: Clarendon Press, 1987). 108. Michael Watts, "The Manufacture of Dissent: Culture and Production Politics in a Peasant Society," Africa 60, no. 2 (1990). 109. Callaghy and Wilson, "Africa: Policy, Reality, or Ritual?" 189. 110. A d a m and Cavendish, "Can Privatization Succeed?" 20. 111. Yotopoulos, " T h e (Rip) Tide of Privatization," 695. 112. Bienen and Waterbury, " T h e Political E c o n o m y of Privatization in Developing Countries," 619-620. 113. H e m m i n g and Mansoor, "Is Privatization the A n s w e r ? " 32. 114. Savas, Privatization: The Key to Better Government: 188. 115. van de Walle, "Privatization in Developing Countries," 606. 116. B e n n h o l d t - T h o m s c n , " ' I n v e s t m e n t in the P o o r . ' "

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The State in the Initiation and Consolidation of Market-Oriented Reform STEPHAN HAGGARD & ROBERT KAUFMAN

During the 1980s, severe fiscal and balance-of-payments crises pushed the question of structural adjustment to the top of the political agenda in many developing countries. The call for a market-oriented conception of adjustment came from a wide array of international and domestic forces, including the I M F and the World Bank, the governments of the advanced industrial states, and economists and segments of business and finance in both the developed and developing countries. Not all countries have responded to these pressures in the same way, and there is substantial debate over the effects of such reforms on both growth and equity. Whatever their impact, however, there has been widespread change in the nature of economic discourse and the direction of public policy itself. In this chapter, we focus on the role played by government officials and the state apparatus in the initiation and consolidation of such policy changes. Several assumptions and caveats should be made explicit at the outset. We will use the term "structural adjustment" to refer to "orthodox" policy packages that include macroeconomic stabilization, with an emphasis on fiscal and monetary policy; the liberalization of goods and factor markets through deregulation and reduction of external barriers and controls; and the privatization of the state-owned enterprise sector. A broader definition would encompass alternative adjustment strategies: more "activist" forms o f macroeconomic management that rely on wage and price controls or industrial policies that place greater emphasis on targeted sectoral interventions and the state-owned enterprise sector. We do have an interest in examining why such alternative strategies have persisted or prevailed in particular countries. But in the 1980s, the concept of "structural adjustment" was generally associated with a neoliberal policy project, and it is the political economy of that project that is the subject of this chapter. It is also important to underline that we do not seek to enter directly into the normative debate over the economic or social wisdom of such reforms; these issues are addressed competently by other chapters in this volume. 221

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Although we are skeptical about both the economic and distributional consequences of radical laissez-faire conceptions of adjustment, we do share the assumption of many "mainstream" economists that developing countries need to pay greater attention to exports, fiscal and monetary discipline, and the price mechanism. Our purpose, however, is empirical and analytic: to examine the role of the state as a political institution in the adjustment process. At the beginning of the 1980s, many assumed that market institutions and state power were inversely related: the expansion of the first required a diminution of the second. Even for the most committed advocates of structural adjustment, however, it did not take long to recognize the oversimplifications of this formulation, captured neatly by Miles Kahler's idea of the "orthodox paradox." 1 Kahler's paradox contains both an administrative and a political dimension. The administrative dimension goes back to the long-standing recognition of the importance of the provision of public goods for sustaining markets. Many "market-oriented" reforms in fact rest on strengthening the state's administrative capabilities. We therefore explore the argument that the capacity of the state itself might be an important variable in explaining the range of adjustment options that state officials can entertain and implement. Our main emphasis, however, will be placed on the political dimension of the orthodox paradox: the prescription that governments refonm themselves by abandoning control over a variety of policy instruments and reducing their role in the allocation of resources. This clearly raises the important question of why politicians would have an incentive to do this. Why would the neoliberal prescriptions constitute a political equilibrium? This chapter explores these paradoxes by distinguishing between two phases of the adjustment process. We focus first on the initiation of policy reforms: the formulation and announcement of policy changes and the management of the initial political reaction to them. We argue that because of the free-rider problem facing potential beneficiaries of the reform process, initiation is usually associated with a concentration of executive authority and its independence from particularistic interests. We examine four political parameters that might affect such executive autonomy, including the capacity of the bureaucracy, regime type, the party system, and the electoral cycle. We then turn to a second phase of the reform process, one in which reform initiatives are either consolidated, transformed, or derailed. We argue that just as no reform can be initiated without some autonomy from the pressures of rent-seeking groups, no reform can succeed unless it appeals to, or even creates, a new coalition of beneficiaries. This is true even of reforms that have as their objective a reduction of the state's role in the economy. We examine the construction of such bases of support both at the level of discrete interest groups and their relationship to the bureaucracy, and in the broader organization of support within the political system as a whole.

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T h e empirical base of our arguments are findings drawn from a collaborative research project on the politics of stabilization and structural adjustment, with a primary emphasis on middle-income countries in Asia and Latin America. Our presentation of evidence is illustrative and is aimed primarily at establishing the plausibility of the general argument; more systematic analyses have been developed elsewhere, particularly with reference to the problem of stabilization. 2 Here, however, we draw broadly on policy reform experiences that include trade policy reform and privatization as well.

The State in the Initiation of Policy Reform In thinking about the role of the state in the initiation of adjustment measures, it is useful to begin with Douglass North's observations on the implications of the theory of collective action for understanding the provision of public goods. North suggests that institutional innovations, such as the state's enforcement of property rights, will come from rulers rather than constituents because the latter are likely to face collective-action problems. On the other hand, "the free rider accounts for the stability of states throughout history," because individuals and groups are also generally unwilling to pay the costs of challenging existing arrangements. 3 N o r t h ' s observation is useful because a number of adjustment-policy changes are characterized by problems of collective action. Although society as a whole may benefit over the long run from stable prices, individuals and firms can benefit from policies that undermine stability, yielding the wellknown Prisoners' Dilemma game structure. Similarly, they may be reluctant to bear costs if others don't as well, the central problem of an "assurance game." This argument cannot be extended without some caution. Gametheoretic analysis tends to ignore the question of power, and the barriers to introducing some reforms might better be seen in terms of overcoming resistance from losers. For example, trade liberalization or state enterprise reforms generate overall efficiency gains, but individual firms or sectors can be expected to lobby to retain particularistic benefits. Yet power relations are in large part precisely a function of organizational capabilities; the potential beneficiaries of the policy reform have difficulties organizing. N o r t h ' s approach is empirically plausible. There are a number of cases where elite decisions appear to have been motivated by broad concerns that a f f e c t the d e c i s i o n m a k e r s ' survival in o f f i c e : overall m a c r o e c o n o m i c performance, the level of international reserves, political stability, and diffuse support. The ideological predispositions of the chief executive were crucial factors in understanding structural adjustment measures in such countries as Chile, Mexico, Turkey, and Korea. However, in Venezuela, Bolivia, Ghana, and a n u m b e r of other African countries, rulers previously identified with interventionist policies initiated reforms where they were deemed necessary

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for the maintenance of political stability. T h e main puzzle to be explained, therefore, is the way decisionmakers calculate the political risks in initiating such adjustments. This leads to a second theoretical observation that is akin to N o r t h ' s but introduces a temporal dimension into the analysis. M a n y policy r e f o r m s c o n f r o n t what e c o n o m i s t s have called timeinconsistency problems. Policymakers often have incentives to renege on the implementation of an optimal policy in order to exploit the opportunity for short-term economic or political gains. This observation has been at the heart of the growing analytic and empirical work on political business cycles in the a d v a n c e d industrial states. 4 Conversely, if the time horizon of the politician is longer, if she is temporarily (or permanently) freed from shortrun political constraints or challenges, she may be willing to take initiatives in anticipation of capturing the political benefits of reform, which, it is assumed, will unfold only gradually. T h e analysis of the provision of public goods and of time-inconsistency p r o b l e m s suggests that s o m e autonomy from political pressures m a y be a precondition for the initiation of reform efforts. T o avoid tautology, any conception of autonomy should specify institutional or situational conditions that enhance the ability of state elites to withstand opposition challenges to their incumbency. F o u r main sources of autonomy are explored here. W e b e g i n w i t h the a r g u m e n t that state a u t o n o m y is a f u n c t i o n of the administrative capacity of the government, and that such capacity can be expected to have a systematic e f f e c t on reform efforts. We then turn to a r g u m e n t s that have to do with the broader representation of interests, including regime type, patterns of conflict and competition within the party system, and changes of government or regime. The Influence of Administrative Capacity on State Autonomy and Reform Economic reforms vary in their organizational intensity and in the nature and extent of the skills required to implement them. Brian Levy notes that dismantling various f o r m s of intervention poses a "negative challenge for bureaucracies—to refrain from actions that had hitherto been part of their o r g a n i z a t i o n a l f u n c t i o n . " 5 Such administrative r e f o r m s can in and of themselves alter the nature of the state's relationship with interest groups. The dismantling of marketing boards or boards of investment that dispense licenses are e x a m p l e s . Rule-based f o r m s of intervention that reduce the discretionary power of bureaucracies can also reduce the opportunities for rent seeking. T h e shift f r o m quantitative restrictions to tariffs, the abolition of licensing requirements, and the initiation of auctions for the allocation of foreign e x c h a n g e are several e x a m p l e s of r e f o r m s that can, at least in p r i n c i p l e , u n d e r c u t the f o r m a t i o n of r e n t - s e e k i n g a l l i a n c e s b e t w e e n bureaucrats and the private sector. Yet it is frequently overlooked that many economic reforms, including those aimed at expanding the role of market forces, demand administrative and

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technical capabilities that are in short supply in developing countries: adequate education among middle- and low-level personnel; specialized training for higher-level and technical staff; and information-gathering, processing, and communication capabilities. Liberalization itself demands a strengthening of the state's capabilities. Moreover, reform demands the ability to coordinate and reconcile conflicting claims within the bureaucracy itself. Even "nondiscretionary" policies will be undermined if private-sector actors are able to use alternative bureaucratic channels to secure exceptions. Examples abound. The control of public expenditure and investment requires the establishment of multiyear public investment programs, the capacity to monitor projects once launched, and institutional mechanisms that make expenditures transparent and permit a reconciliation of spending and revenue decisions. Improving tax collection is similarly demanding on organizational capabilities. Privatization calls for technical expertise in financial restructuring, rehabilitating companies, and preparing them for divestiture, as well as in the creation of procedures that guarantee equal access by potential buyers. Entities created to manage privatization must also be positioned to resist claims from the SOEs themselves. Drawback and exemption schemes, the provision of overseas market information, and the management of export-processing zones are examples of export-oriented reforms that demand new bureaucratic structures or a significant reorientation of existing ones. How do variations in the capacity to implement such measures affect the timing and content of state initiatives? Although both aspects of policy reform are conditioned by state capacity, the effects are complex. 6 With respect to the initiation of reforms, a low level of technocratic competence can be associated with longer periods of policy drift. It is plausible, for example, that such factors account for the policy inaction that long characterized the economic histories of such countries as Haiti, Bolivia, Zambia, and Zaire, although weak economies and poorly institutionalized political systems contributed as well. On the other hand, low technical capacity has not been an impediment to comprehensive policy reforms of certain sorts. The Ghanaian government, for example, was able to use expatriates and to lean heavily on IMF and World Bank staff to design a broad-gauged reform package. In Bolivia, Harvard professor J e f f r e y Sachs worked closely with a small team of Bolivian economists in designing that country's sweeping stabilization effort. If governments with a low level of technocratic and administrative capability do decide to launch reforms, their need to rely on international agencies will strongly influence the design of their programs. Both the influence of these agencies and limited administrative capacity tend to encourage them to select reforms that are comparatively simple to administer, such as trade reform or changing administered prices, rather than those that demand complex

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oversight or the provision of complementary state services, such as privatization or complex schemes for export promotion. Higher levels of technocratic or administrative capacity have more ambiguous implications for program design. On the one hand, the formation of transnational technocratic alliances with strong roots in the national bureaucracy can work to narrow the range of debate over adjustment questions; this argument is advanced by Robin Broad in her analysis of the P h i l i p p i n e s . 7 On the other hand, states with greater technocratic and administrative capacity also have a wider menu of policy options open to them because they can c o m b i n e liberalization with supportive state intervention more effectively and have the capacity to explore more heterodox responses. It clearly cannot be assumed that all technocrats are supporters of liberalization. Most governments are characterized by splits between " e c o n o m i s t s " and " p l a n n e r s " who favor state intervention to achieve development objectives. Even where relatively orthodox measures are adopted, administratively developed governments have been able to tackle more complex reforms or to implement them in more complex ways. As we suggest later, any analysis that focuses on the independence of the state must come to grips with the central role played by ideology; we return to this problem by way of conclusion. We turn next, however, to the role of broader political institutions in providing state elites with increased freedom of maneuver. Regime Type Perhaps the most heated and long-standing debate in the literature on the politics of stabilization and structural adjustment concerns the relationship between regime type and various measures of policy and economic p e r f o r m a n c e . 8 There now appears to be some consensus on a number of points. T h e most comprehensive structural adjustment initiatives have generally c o m e under the auspices of authoritarian regimes. Control or repression of opposition was undoubtedly part of the explanation for the ability of Chile, Korea, Turkey, and Ghana to initiate broad reforms. Corporatist organization of interests may also facilitate the launching of extensive reforms, but in the developing world such political structures have generally been associated with authoritarian rather than democratic politics, as in Mexico. Bolivia under the elected government of Victor Paz Estenssoro constitutes p e r h a p s the most dramatic exception to the pattern of authoritarian governments launching the broad, orthodox reforms, but it should be noted that the stabilization and liberalization programs in that country did involve the declaration of a state of siege and the arrest of hundreds of opposition and labor leaders. Bolivia was also the only one of these six governments to adopt a confrontational position with creditors over the servicing of external debt. 9 At a broader level of comparison, however, it is also evident that

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authoritarian regimes d o not necessarily guarantee the executive autonomy required to impose unpopular adjustment programs, nor do the processes of electoral d e m o c r a c y necessarily impede them. As T h o m a s Callaghy has s h o w n f o r a n u m b e r of weak African states, formally hierarchical political s y s t e m s , such as Z a m b i a ' s one-party state, are frequently penetrated by c o m p l e x n e t w o r k s of patronage that undermine the coherence of policy. 1 0 H a g g a r d reached similar conclusions in studies of the Philippines and of the I M F ' s Extended Fund Facility." Conversely, compared to rulers in " w e a k " authoritarian governments, o f f i c i a l s in institutionalized democracies often have considerable security against p o p u l a r protest and military coups. In C o l o m b i a , this security contributed to an extraordinarily rapid response by the Belisario Betancur g o v e r n m e n t to the stabilization problems emerging in 1984. Similar factors allowed the newly elected government of Carlos Andres Perez to withstand w i d e s p r e a d rioting o v e r a very harsh stabilization p r o g r a m in 1989. 1 2 Although, generally, democracies have not been able to launch the sweeping a d j u s t m e n t p r o g r a m s undertaken by some " s t r o n g " authoritarian regimes, there are some important exceptions, such as J. R. Jayawardene's liberalizing r e f o r m s in Sri Lanka in the late 1970s. 1 3 More incremental but nonetheless significant steps have also been taken in Costa Rica, the Philippines, and Jamaica under democratic auspices. 1 4 As we have suggested elsewhere, the democratic and authoritarian labels are too inclusive to capture the range of variation in responses to adjustment crises, and closer attention is required to other aspects of the political system if they are to have analytic utility. 1 5 Political Alignments T h e apparently contradictory findings about the relative success of different types of regimes can be reconciled by paying greater attention to the broader political settings in which distributional conflicts are played out. As we have suggested elsewhere, it is useful to distinguish countries in which long-term patterns of partisan conflict reinforce class and sectoral cleavages from those in w h i c h distributional g r o u p s are co-opted into stable, multiclass party systems or penetrated and controlled directly by the state. 1 6 These patterns of interest organization and representation cut across the authoritarian-democratic d i s t i n c t i o n to s o m e extent. In political settings w h e r e state or party institutions have suppressed or co-opted distributive groups, there has been little difference in the capacity of state decisionmakers to initiate adjustment policies. Multiclass parties have played a pivotal role in insulating political elites f r o m distributive pressures in such democratic countries as Colombia, Costa R i c a , V e n e z u e l a , M e x i c o , and Malaysia. Potential p o p u l a r - s e c t o r opposition groups were neutralized either because they had been incorporated into parties dominated by governing elites or because they were deprived of electoral influence, or both. In contrast, in settings where partisan alignments are more polarized or f r a g m e n t e d , political l e a d e r s h a v e strong i n c e n t i v e s to appeal to the

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distributive interests of labor and business groups or to revert to broad populist appeals. In these circumstances, regime type has had an impact on adjustment initiatives. Democratic governments in Peru, Argentina, and Brazil have faced particularly high risks in launching difficult stabilization measures and have had considerable difficulty establishing credibility. During the 1980s, state elites in these countries tended to delay stabilization measures, despite the costs in doing so. In such politically polarized or f r a g m e n t e d settings, i n c o m i n g authoritarian regimes have been important for breaking social and political stalemates and imposing broad policy initiatives in a n u m b e r of cases, usually at great cost to the urban working class. The most recent examples are provided by the Turkish military intervention of 1980 and Jerry Rawlings's coup in Ghana in 1981, but other examples include the Korean military "revolution" of 1961, the Indonesian coup of 1966, the Brazilian military intervention of 1964, and Chile under Augusto Pinochet. Electoral Cycles and Changes of Government T h e willingness of state elites to initiate new adjustment policies is also connected with changes of government or political regime. Governments facing upcoming electoral challenges, not surprisingly, have generally been reluctant to impose unpopular programs. Incoming governments, by contrast, have capitalized on honeymoon periods and the disorganization or discrediting of the opposition to launch ambitious new reform initiatives. 17 Such policy initiatives cannot simply be understood as the result of the victory of a new policy coalition. In many cases, the reform initiatives cut across the short-run interests of followers, suggesting the relative importance of the cycle itself over the constellation of group interests. The most dramatic example of this pattern came in Bolivia under Victor Paz Estenssoro, but similar episodes occurred in Costa Rica under Alberto Monge in 1982, in Brazil and Argentina under Fernando Color de Mello and Carlos Saul M e n e m , respectively, and in Poland under the new Solidarity government in 1990. The evidence of electoral cycles and the effects of changes of government can be seen across a wide range of both democratic and authoritarian political systems, although the effects of electoral cycles and changes in government will also depend on the underlying level of conflict between political groups. New democratic governments in political systems characterized by a high level of party conflict and polarization have had greater difficulty exploiting honeymoons in order to launch reform initiatives, perhaps because of their fragility and the perceived risks of undertaking costly policy actions. The second or third posttransition government is more likely to launch initiatives: Brazil under Color and Argentina under Saul M e n e m again provide examples. It should be noted, however, that by the time these leaders came to office, there had already been long delays in the formulation of adjustment programs and a significant deepening of the economic crisis. The

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electoral victories of the opposition forces were therefore not exogenous to economic events; worsening economic circumstances induced a broad cross section of the population to support efforts by the incoming government to apply shock treatment. Elections in authoritarian regimes are, by definition, not wholly competitive; nonetheless, political elites often see them as referenda and use them to legitimate their rule. There is evidence of a political-business cycle in Mexico, for example, despite the monopolization of political power by the PRI. 1 8 In less institutionalized military regimes, the broad pattern of political cycles evident in democracies is frequently reversed. Incoming authoritarian r e g i m e s play a role in breaking political l o g j a m s , but in contrast to democratic governments, the chances of bold reform initiatives diminish rather than increase over time as military governments seek social bases of support and confront pressures for political liberalization. In the 1980s, for example, authoritarian governments in the Philippines, Argentina, and Brazil all engaged in expansionist wage and credit policies in order to maintain power or control the pace and direction of the democratic opening. 19

Consolidating Economic Reform W h e n economic reform is viewed over the long run, the biggest challenge is not simply to initiate new policies but to sustain and consolidate them so that they gain credibility among economic agents. Because government policies are continually being adjusted at the margin, it is difficult to specify exactly what is meant by "sustaining" and "consolidating" a reform. One indicator is simply whether the policy measures are maintained over time by the government in power. Are fiscal controls relaxed prematurely when the political setting changes or inflation appears to ease? A second more d e m a n d i n g criterion is w h e t h e r a given r e f o r m has b e c o m e an institutionalized feature of government behavior, one that survives changes of government, or even of regime. C o n t i n u i t y in policy b e h a v i o r , e s p e c i a l l y a c r o s s c h a n g e s of administration or regime, implies different patterns of state-society relations from those that facilitate policy innovation. The initiation of reform implies a rupture with the past that is more likely when the discretionary power of decisionmakers is high. Major initiatives appear to be associated with the achievement of some degree of executive autonomy from the pressure of specific distributional groups. In consolidating reform, by contrast, political leaders are faced with the challenge of stabilizing expectations around a new set of incentives. For reforms to be credible, economic agents must believe that they cannot be reversed at the discretion of individual decisionmakers. Such consolidation ultimately rests on political support from discrete groups of private-sector beneficiaries and at least the acquiescence of the m a j o r political forces competing within the political system. Without such

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tacit or explicit alliances between politicians, technocratic elites, and those gaining from the reform effort, reform attempts will necessarily falter. It is too early to assess whether the many reform efforts of the 1980s have been successfully consolidated. We can, however, draw on evidence from previous periods of successful macroeconomic management and trade policy reform in East Asia and Latin America, and we can speculate on the basis of the limited evidence that is available since the debt crisis. Again, we focus on two levels of the political system: the relationship between the economic bureaucracy and the private sector and the broader mechanisms for organizing political support and opposition. The Economic Bureaucracy and the Private Sector In situations where the personal power of a particular individual has become entrenched over a long period of time, the commitments of the ruler may in themselves be sufficient to provide credible guarantees of policy continuity. This was the case in Taiwan under Chiang Kai-shek and his son, Chiang Ching-kuo, in Singapore under Lee Kuan Yew, in Indonesia under Sukarno, and in Korea under Park Chung Hee from 1964 through 1979. But because autocrats can also b e c o m e predatory and have the power to change commitments and because countries change rulers, the consolidation of reform is more likely when accompanied not only by supportive institutional and administrative changes but also by the construction of bases of societal support. Peter Evans has proposed the concept of "embedded autonomy" to capture the combination of both independence and support that is required for the c o n s o l i d a t i o n of s u c c e s s f u l e c o n o m i c r e f o r m s . 2 0 S u c c e s s f u l "developmental states" in East Asia, Evans argues, were characterized by high levels of internal cohesion and corporate autonomy but also, paradoxically, by dense external networks connecting the state with the private sector. On the one hand, entry and promotion into the civil service depended heavily on formal standards of achievement, which were in turn reinforced by informal peer networks that placed a high value on performance and organizational goals. At the same time, insulation was accompanied by the development of policy instruments and channels of communication that enabled technocratic groups within the state apparatus to build a base of constituent support among private-sector beneficiaries. Comprehensive organizational coherence of the sort that Evans identified in the state apparatus in Japan, Korea, and Taiwan appears rare in the developing world. Nevertheless, both in earlier periods and in the present one, the development of centralized and relatively insulated bureaucratic agencies has been an important feature of successful reforms elsewhere. A pivotal feature of Colombia's stabilization and trade reforms of the late 1960s, for example, was a constitutional change that transferred both fiscal and exchange-rate authority from Congress to technocratic executive agencies. 21 During Mexico's long period of "stabilizing development" (1955-1970), a

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strong Central Bank, backed by the Finance Ministry, and close relations with the IMF served as important forces for fiscal and monetary stability. Following the model of the currency board, postcolonial central banks have been relatively independent in a number of former British colonies, including India, Pakistan, and Malaysia. 2 2 Evidence from a broader range of cases collected by Robert Lacey suggests the advantages of centralized administrative structures, or at least effective coordination between spending and control ministries: "ceteris paribus, combining planning and budgeting offices under one ministry is likely to improve coordination of expenditure programs." 2 3 A necessary feature of such reforms, however, has been the formation of external links to strategic producer or commercial or financial interests. In the Colombian and Mexican cases cited above, technocratic agencies in the executive mobilized strong support from coffee growers and the private banking sector, respectively. And although the contemporary emphasis on liberalization may imply the attenuation of the state's direct intervention in markets, this by no means obviates the need for tacit or explicit alliances between political and bureaucratic elites and new clienteles. This simple point is routinely missed by neoclassical analysis. Yet where the privatesector beneficiaries of reform are scattered or politically unimportant, the consolidation of reform is unlikely to occur. Zambia provides an example. The wrenching adjustment of the early 1980s cut across most bases of President Kenneth K a u n d a ' s support, particularly within the government and ruling party, while the economic response to the reforms that were undertaken proved relatively limited. This naturally undercut any incentive to sustain the reform effort. 2 4 The Zambian experience suggests that the consolidation of reform will be precarious in very poor countries, such as Ghana and Bolivia, where the state has limited technical capabilities and the private sector is economically and politically weak. Diffuse public support for the reform programs has clearly helped to sustain them in both countries, and in Ghana the extraordinary support from international financial institutions has been important. In the absence of concrete bases of support, however, it is doubtful that such reforms can be institutionalized by small groups of technocrats and expatriate advisers who are dependent on executive officials. The need for a base of support does not require any particular form of institutional linkages with private-sector beneficiaries. Korea and Taiwan present an interesting contrast in this regard. 25 In both countries, fundamental reforms in the structure of incentives in the early 1960s favored the emergence of export-oriented domestic firms. In Korea, the government also developed an extensive network of consultative organs and sectoral associations that were used to monitor export performance and provide information. In Taiwan, by contrast, business-government relations were more informal and, because of the ethnic split between mainlanders who

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dominated government and the Taiwanese private sector, substantially more distant. In both cases, however, the new private sector provided a base of support for the maintenance of outward-oriented economic policies. Chile in the post-1984 period provides a more recent example of reforms that show signs of consolidation. Prior to the crash of the early 1980s, the Chilean state maintained a very strained relationship with all but a handful of the largest financial conglomerates in the private sector. Between 1984 and 1990, efforts were made to build a wider network of support among business groups as a component of the recovery strategy engineered by Finance Minister Heman Buchi. Policies used to accomplish this purpose included the extension of special credits to export-oriented agricultural enterprises, subsidies for the construction industry, and expanding opportunities for stock ownership in privatized state firms for substantial portions of the middle class. 2 6 In the final months of the Pinochet regime, the government also won support of both the business community and the incoming Patricio Aylwin coalition for the establishment of an independent Central Bank headed by a president appointed for a seven-year term, institutionalizing the fundamental shift in Chilean macroeconomic policy that Pinochet had achieved. Signs of similar alliances elsewhere have been spotty at best, even in those countries considered relatively successful adjustors or in which governments favorable to the private sector have come to power. After being on the defensive through most of the 1970s, orthodox technocrats increased their power during the 1980s in Mexico. Although the new group of technocrats has garnered public support from big business, private investment was still relatively low at the end of the decade. Despite the center-right and probusiness orientation of the Turgut Ozal government in Turkey, private investment was also depressed during most of the 1980s, (n the Philippines, the noncrony private sector formed a crucial base of Corazon Aquino's support, and prominent members of the business community were included in the Aquino cabinet. Yet levels of private investment through 1990 were below those in the late Marcos period. 27 Political Elites and the Structuring of Social Interests Policy reforms require institutional changes and support from the private sector if they are to succeed, but this alone is not enough to deflect broader political challenges. Unlike the initiation phase, when new governments can capitalize on "honeymoons" to push through reform packages, consolidation and the ability to delegate decisionmaking to technocratic agencies will depend on the mechanisms through which politicians mobilize support and deal with opposition. We thus concentrate on the way political groups are organized and on the rules by which they compete for power, beginning as we did in the previous section with the question of the respective capabilities of authoritarian and democratic governments before turning to alternative possibilities for consolidating economic reform under democratic auspices. It is theoretically plausible that authoritarian governments could more

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easily restructure decisionmaking routines than democratic ones. In several of the cases of the consolidation of policy reform discussed above—Korea, Taiwan, Chile, Mexico—authoritarian rule facilitated the reorganization of decisionmaking routines and the insulation of technocrats; this was the essence of O ' D o n n e l l ' s model of "bureaucratic authoritarianism." 2 8 But authoritarian regimes can also undermine consolidation by facilitating executive interference in economic policymaking. In an excellent study of Brazil's national development bank, Eliza Willis shows how the military turned a relatively insulated, technocratic institution developed under democratic auspices in the 1950s to its own political ends in the 1970s and 1980s. 2 9 In Mexico, Luis Echeverria extended the power of the presidency over m a c r o e c o n o m i c decisionmaking and weakened the p o w e r of the conservative Ministry of Finance and Central Bank in order to pursue a quasipopulist program. In Korea, Park Chung Hee's personal decision to push a heavy- and chemical-industry plan resulted in a restructuring of the bureaucracy that undermined the influence of more market-oriented technocrats. In the Philippines and in Zaire, networks of cronyism created highly dualistic decisionmaking structures in which technocrats were increasingly marginalized. 30 Moreover, authoritarian leaders are also subject to political challenges, and in the 1980s, these increased considerably as a broad range of authoritarian regimes confronted demands for political liberalization. A small number of one-party states, such as Mexico and Taiwan, were able to manage these pressures through a combination of political liberalization and cooptation, but military regimes have had much greater difficulties responding to these c h a l l e n g e s , in part because of their inability to create institutionalized systems of party or interest-group representation. This failure has important implications for the consolidation of reform. "Late authoritarian" periods are frequently accompanied by extensive executive interference in policy and a weakening of bureaucratic insulation as military elites seek to control the transition or handpick their democratic successors. In a substantial number of Latin American countries, this created a legacy of political and economic disorganization that eventually impeded the adjustment efforts of new democratic governments. Argentina, Brazil, Peru, and Nicaragua are cases in point. There are, however, important exceptions to this pattern. In Chile, the brutal economic restructuring begun in the 1970s substantially weakened the social base of import-substituting industrialists and the Marxist left. On the other hand, the government's reform program contributed to a substantial economic recovery, an accomplishment even recognized by opponents of the military. If these economic gains are to be consolidated, it will depend on pragmatic agreements forged among Pinochet's centrist and leftist opponents to continue his emphasis on fiscal balance and export-led growth. Turkey and Korea both show that such agreements can be difficult to

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reach in new democratic regimes. In Turkey, the military did not undertake a radical industrial restructuring as in Chile, but it did change the political rules in ways that substantially reduced the power of extremist groups on both the left and the right and weakened militant unions. As in Chile, a strong emphasis on exports and financial liberalization created new constituents in the manufacturing and financial sectors. Yet Ózal has sustained these policies in part by continuing the government's commitment to a large state-owned enterprise sector. By the end of the 1980s, this was once again an important source of fiscal imbalance. In Korea, Chun Doo Hwan left his democratic successors a strong and stable economy, and the basic orientation toward exports is now deeply entrenched. But the regime's highly repressive stance toward the labor movement and the opposition resulted in an explosion of new demands, both from the shop floor and from the legislature, that has severely complicated macroeconomic management and efforts to liberalize further. 31 What, more generally, are the prospects for consolidating adjustment policies in a democratic context? Many democratic governments, especially those that have recently succeeded authoritarian regimes, are confronting macroeconomic problems that are much more severe than those faced by the new democratic governments in Chile, Turkey, and Korea. The key political puzzle is how to strike a balance between technocratic decisionmaking and popular participation; this is the dilemma of democratic reformism. Effective oversight of the economic bureaucracy is clearly an essential feature of such a balance not only for the maintenance of democratic control but also to deter the kinds of reckless policy blunders that characterized so m a n y outgoing dictatorships. On the other hand, the historical record suggests that effective m a c r o e c o n o m i c m a n a g e m e n t can be seriously jeopardized if technocratic agencies are undermined by extensive politicization of redistributive conflicts or by the use of political patronage to mobilize electoral support. Albert Hirschman, William Ascher, Joan Nelson, and John Waterbury have all focused in different ways on the tactics of reform and how the sequencing of reform efforts, the strategic use of compensation, and "packaging" can contribute to the consolidation of reform efforts. 3 2 Although such tactics are no doubt important, we argue that the consolidation of policy reforms will ultimately depend on institutional patterns of representation that have been inherited from the past or constructed in the process of the transition to democratic rule. The key challenge is the organization of political conflict in ways that allow successive administrations to organize relatively stable electoral and legislative majorities and thus to avoid sharp policy discontinuities or fundamental conflicts over the underlying policy project. A number of such possibilities can be sketched briefly. One option, widely favored during the democratic transitions in the early 1980s, involved attempts to resolve conflicts over macroeconomic issues

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through the direct negotiation of social pacts among organized economic interests, political parties, and government officials. With few exceptions, however, social pacts did not work well as a mechanism for adjustment during the 1980s. In contrast to the centralized peak associations that concluded successful "corporatist bargains" in small European democracies, 3 3 organized interests in most developed countries are fragmented among rival factions that seek to outbid one another for rank-and-file support. Legacies of distrust between labor, business, and government undermine cooperation. In most instances, therefore, the search for consensus over income policies and other instruments of adjustment have either been stillborn or a recipe for stalemate. A second strategy, often linked to the social pact option discussed above, might be labeled "social democratic" and would involve the long-term management of adjustment processes through a dominant political coalition with strong roots in the labor movement. In some countries, it is conceivable that governments organized along these lines could effectively legitimate the popular-sector sacrifices involved in the adjustment process, because their links to the labor movement would enhance the credibility of the argument that blue-collar workers would gain a fair share of future b e n e f i t s . 3 4 Where union movements are weak or internally fragmented, however, a situation c o m m o n in most developing countries, social democratic options encounter barriers similar to those discussed with reference to the construction of social pacts. Furthermore, as Nelson has emphasized, 3 5 it is far from clear that efforts to win the political support of workers can be wholly reconciled with broader attempts to maximize equity in the adjustment process. Given the difficulty of negotiating social pacts and sustaining social democratic experiments during periods of austerity, it may be appropriate to consider other, less inclusive models that allow greater scope for technocratic decisionmaking. Systems based on two broadly based, catchall parties may be conducive to the institutionalization of reform because of their potential for reducing the electoral salience of class and sectoral interests. To the extent that this is true, the prospects for the consolidation of reform should be high in Costa Rica and Venezuela, as well as in Colombia, if this type of system can solve the crippling problems associated with the rising power of the drug traffickers. Even in countries where there has been considerable class and sectoral polarization in the past, broad, catchall parties may pull party platforms toward the interests of the median voter, as has been the case in Jamaica and Turkey in recent years. Colombia's 1968 administrative reforms, to which we alluded in the previous section, provide a useful illustration of how this sort of electoral alignment can facilitate delegation of economic decisionmaking. 3 6 The reforms transferred control of fiscal and exchange-rate policy from Congress to executive planning agencies. This was accepted by the governing liberal

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and conservative parties of the National Front only under the duress of economic crisis and threats from the president to resign if the reforms were not enacted. Because the two parties shared governmental responsibility, however, they also stood to gain from the depoliticization of divisive and potentially explosive distributive issues. Once in place, the institutional reforms gained the support of most party leaders and remained unchallenged even after the return to more open forms of electoral competition in the mid1970s. Barbara Geddes has found similar patterns in the initiation of civil service reforms in Latin America: when parties are relatively equally balanced in the political system, they are more likely to agree to reforms for rationalizing bureaucratic recruitment. 37 Such broad forms of political self-denial will obviously be more difficult to achieve in systems that have been characterized by extreme party fragmentation or deep ideological divisions between parties. This has been the case in the polarized political systems of Latin America's Southern Cone and poses the greatest challenge to designing representative political systems where there are sharp ethnic divisions, as in Africa. The resurgence of fragmented or polarized party systems clearly increases the risk of unstable coalitions, populist appeals, favoritism, and wide swings in policy. In such settings, center-right governing alliances might provide the best opportunity for the institutionalization of reform efforts. Historically, this is the model that characterized postwar Japanese politics, 3 8 is implicit in measures undertaken by Carlos Salinas in Mexico, and in d i f f e r e n t organizational forms appears to be the model toward which both Korea and Taiwan are moving. The major disadvantage of such a system—and it is a large one—is that it tends to deprive the leftist opposition of the opportunity to govern or even participate meaningfully and thus increases the risk of political radicalization; such a process is well under way in Korea. On the other hand, it could also provide a democratic basis for policy continuity, and as the economy recovered, it would not necessarily preclude the reorientation of budget priorities toward expenditures for health and education in order to maintain the support of lower-income groups. The viability of any of these models must be assessed case by case, because they are not simply the result of institutional engineering but of long-standing political traditions. Nonetheless, we can conclude that the institutionalization of reform is most likely in systems that have the following three characteristics: a significant segment of competitors within the party system have opportunities to share in governance; they find it in their political interest to reduce the stakes of competition by delegating economic authority to portions of the economic bureaucracy; and the reforms themselves generate the economic payoff to broad segments of the population in terms of macroeconomic stability and economic growth.

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Conclusion The analysis of this chapter has been broadly structural. We have attempted throughout to isolate antecedent conditions—international shocks, bargaining games, political institutions and processes—and link them to variations in the timing, content, and implementation of policy reforms. In such an approach, the substantive content of ideas is devalued as an explanation of policy; policymakers are seen primarily as responding to various constraints. Yet it is also plausible that the consolidation of reform rests on the evolution of a broader consensus and social learning among leaders, interest groups, party elites, and attentive publics. Such consensus does not imply stasis; distributive conflicts will always arise over policy. However, some convergence of thinking about fundamental means-ends relationships in the economy does appear necessary for policy consolidation. T h e appropriate historical analogy would be to previous periods of fundamental change in economic thinking in the advanced industrial states. The consolidation of Keyensian policies depended on such a change in discourse, from assumptions about self-equilibrating market systems to the idea that the state had a positive role in correcting market failures. The same set of assumptions took root in regard to import-substituting projects during the period from 1930 through 1960 across a wide range of developing countries. Neither of these new models eliminated policy conflict, but they did provide new cognitive maps against which those conflicts unfolded. In the 1980s, a similar sea change took place in economic thinking in the developing world. Although different groups clearly had different policy preferences, few could argue, as many did in the 1950s, that fiscal imbalances or inflation were not causes for concern. Similarly, there was a growing perception of the limits of state intervention in markets and of inwardlooking development strategies, although substantial debate remained about how far to go in a more liberal direction. The extent to which such common understandings about cause and effect relationships have emerged among political and economic actors is likely to have implications for the kinds of demands that are made within the political system and the way distributive conflicts are fought out. As Peter Hall has commented, new ideas do not "simply rest on top of other factors already there. Rather, they can alter the composition of other elements in the political sphere, like a catalyst or binding agent that allows existing ingredients to combine in new ways." 3 9 This raises the question of what determines national receptiveness to different ideas. Interest-based explanations, whether Marxist or pluralist, are likely to emphasize the congruity between orthodox ideas and the interests of particular groups. There can be little doubt that liberalizing reforms benefit some groups more than others, but broad changes in the nature of ideological discourse are unlikely to take root unless they resonate broadly with national experience. Crises are likely to be crucial in this regard, revealing

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limits

on

previous

ways

of thinking.

In t h e

1930s,

the

d e p r e s s i o n w a s f e l t a c r o s s c l a s s l i n e s , s t i m u l a t i n g a b r o a d c h a n g e in the a s s u m p t i o n s a b o u t the p o s s i b i l i t i e s o f state i n t e r v e n t i o n . T h e h y p e r i n f l a t i o n s a n d d e e p d e p r e s s i o n s o f the 1 9 8 0 s m a y h a v e a s i m i l a r f u n c t i o n , but o n l y if b r o a d s e g m e n t s o f t h e p o p u l a t i o n h a v e r e a s o n t o b e l i e v e that o r t h o d o x r e f o r m s d o in f a c t p r o v i d e a w e l f a r e - i m p r o v i n g

alternative.

For

some

countries, this m a y h a v e b e e n proven. For other countries, the w e a k n e s s o f the e c o n o m i c r e s p o n s e d o e s not rule o u t c o u n t e r v a i l i n g i d e o l o g i c a l trends that o n c e a g a i n c a l l into q u e s t i o n the a d v a n t a g e s o f m a r k e t - o r i e n t e d p o l i c i e s .

Notes 1. M i l e s K a h l e r , " O r t h o d o x y and Its A l t e r n a t i v e s : E x p l a i n i n g A p p r o a c h e s to S t a b i l i z a t i o n a n d A d j u s t m e n t , " in J o a n N e l s o n (ed.), Economic Crisis and Policy Choice ( P r i n c e t o n : P r i n c e t o n University Press, 1989): 3 3 - 6 2 , q u o t e d h e r e f r o m p. 55. 2. S e e S t e p h a n H a g g a r d and R o b e r t K a u f m a n , " T h e Politics of Inflation and S t a b i l i z a t i o n in M i d d l e - I n c o m e C o u n t r i e s , " in H a g g a r d and K a u f m a n (eds.), The Politics of Adjustment: International Constraints, State Structures, and Distributive Conflicts ( P r i n c e t o n : P r i n c e t o n U n i v e r s i t y Press, 1992). 3. D o u g l a s s C . N o r t h , Structure and Change in Economic History (New Y o r k : W . W . N o r t o n , 1981): 3 1 - 3 2 . 4. M o n e t a r y p o l i c y is the a r c h e t y p a l e x a m p l e . If e c o n o m i c a g e n t s are fully f o r w a r d l o o k i n g , m o n e t a r y authorities can only i n f l u e n c e o u t p u t b y e n g i n e e r i n g i n f l a t i o n a r y s u r p r i s e s that a r e not a n t i c i p a t e d ; this g i v e s the p o l i c y m a k e r an i n c e n t i v e to d e v i a t e f r o m any stated m o n e t a r y rule. F o r a review of the literature, see K e i t h B l a c k b u r n a n d M i c h a e l C h i s t e n s e n , " M o n e t a r y P o l i c y a n d P o l i c y C r e d i b i l i t y : T h e o r i e s a n d E v i d e n c e , " Journal of Economic Literature 27 ( M a r c h 1909): 1 - 4 5 . 5. Brian L e v y , " T h e Design and S e q u e n c i n g of Trade and I n v e s t m e n t Policy R e f o r m , " W o r l d B a n k P R E W o r k i n g Paper (1990): 25. 6. J o a n N e l s o n , " C o n c l u s i o n s , " in N e l s o n (ed.), Economic Crisis and Policy Choice: 321-361. 7. R o b i n B r o a d , Unequal Alliance: The World Bank, the International Monetary Fund, and the Philippines ( B e r k e l e y : U n i v e r s i t y of C a l i f o r n i a Press, 1988). 8. S e e T h o m a s S k i d m o r e , " T h e Politics of E c o n o m i c Stabilization in Post W a r Latin A m e r i c a , " in J a m e s Malloy (ed.). Authoritarianism and Corporatism in Latin America ( P i t t s b u r g h : U n i v e r s i t y of P i t t s b u r g h Press, 1977): 1 4 9 - 1 6 0 ; K a r e n R e m m e r , " T h e Politics of E c o n o m i c Stabilization: I M F S t a n d b y P r o g r a m s in Latin A m e r i c a , 1 9 5 4 - 1 9 8 4 , " Comparative Politics 19 ( O c t o b e r 1986): 1 - 2 5 ; R o b e r t K a u f m a n , " D e m o c r a t i c a n d A u t h o r i t a r i a n R e s p o n s e s to the D e b t Issue: A r g e n t i n a , B r a z i l , a n d M e x i c o , " a n d S t e p h a n H a g g a r d , " T h e P o l i t i c s of A d j u s t m e n t : L e s s o n s f r o m t h e I M F ' s E x t e n d e d F u n d F a c i l i t y , " b o t h in M i l e s K a h l e r (ed.), The Politics of International Debt (Ithaca, N.Y.: C o r n e l l U n i v e r s i t y P r e s s , 1986): 1 5 7 - 1 8 6 ; a n d Scott Siddell, The IMF and Third World Political Instability ( L o n d o n : M a c m i l l a n , 1987). 9. See C a t h e r i n e M . C o n a g h a n , J a m e s M. M a l l o y , and Luis A. A b u g a t t a s , " B u s i n e s s a n d the ' B o y s ' : T h e Politics of N e o l i b e r a l i s m in the C e n t r a l A n d e s , " Latin American Research Review 25, no. 2 (1990): 3 - 3 0 . 10. S e e T h o m a s C a l l a g h y , " L o s t B e t w e e n State and Market: T h e Politics of

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E c o n o m i c Adjustment in Ghana, Zambia, and Nigeria," in Nelson (ed.), Economic Crisis and Policy Choice: 2 5 7 - 3 2 0 . 11. See Stephan Haggard, "The Political E c o n o m y of the Philippines Debt C r i s i s , " in Nelson (ed.), Economic Crisis and Policy Choice, and "The Politics of Adjustment: Lessons from the I M F ' s Extended Fund Facility." 12. On Colombia, see Barbara Stallings, "Politics and E c o n o m i c Crisis: A C o m p a r a t i v e Study of Chile, Peru, and Colombia," in Nelson (ed.), Economic Crisis and Policy Choice: 1 5 4 - 1 6 1 ; on V e n e z u e l a , see D a n i e l L e v i n e , " V e n e z u e l a : T h e Nature, Sources, and Future Prospects of D e m o c r a c y , " in L a r r y D i a m o n d , Juan Linz, and Seymour Martin Lipset (eds.), Democracy in Developing Countries: Latin America (Boulder, Colo.: Lynne Rienner, 1989): 247-290. Stabilization: 13. S e e J o a n N e l s o n , " T h e P o l i t i c a l E c o n o m y of C o m m i t m e n t , Capacity, and Public Response," World Development 12, no. 10 ( O c t o b e r 1984): 9 0 3 - 1 0 9 6 . 14. See Joan Nelson, " T h e Politics of Adjustment in Small Democracies: Costa Rica, the Dominican Republic, and Jamaica," and Stephan Haggard, " T h e P o l i t i c a l E c o n o m y of the P h i l i p p i n e Debt C r i s i s , " both in N e l s o n (ed.). Economic Crisis and Policy Choice: 169-215, 2 1 5 - 2 5 7 . 15. Stephan Haggard and Robert Kaufman, "The Politics of Stabilization and Structural A d j u s t m e n t , " in J e f f r e y D. Sachs (ed.), Developing Country Debt and Economic Performance: The International Financial System (Chicago: University of C h i c a g o Press, 1989): 5 3 3 - 5 3 9 . 16. See Haggard and K a u f m a n , "The Politics of Inflation and Stabilization." 17. For a sample of Latin American countries, Barry Ames finds evidence of e x p a n s i o n prior to elections, but also finds evidence of e x p a n s i o n f o l l o w i n g elections, which he explains in terms of efforts to consolidate new bases of support. See his Survival Politics (Berkeley: University of California Press, 1988). 18. E d w a r d F. Buffie, " E c o n o m i c Policy and Foreign Debt in M e x i c o , " in Sachs (ed.). Developing Country Debt and Economic Performance, vol. 2: 3 9 3 552. 19. H a g g a r d and K a u f m a n , " T h e Politics of Stabilization and Structural Adjustment," 244-245. 20. Peter Evans, "The State as Problem and Solution: Predation, E m b e d d e d Autonomy and Structural Change," in Haggard and Kaufman (eds.), The Politics of Adjustment: 139-181. 21. D a v i d R. Mares, " D o m e s t i c Institutions and S h i f t s in T r a d e a n d D e v e l o p m e n t Policy: C o l o m b i a 1 9 5 1 - 1 9 6 8 , " in John Odell and T h o m a s D. Willet (eds.), International Trade Policies: Gains from Exchange Between Economics and Political Science (Ann Arbor: University of Michigan Press, 1990): 1 9 3 - 2 2 3 . 22. W e are indebted to Max Corden for this point. 23. S e e R o b e r t L a c e y , " T h e M a n a g e m e n t of Public E x p e n d i t u r e s : An Evolving Bank Approach," World Bank, Policy, Planning and Research Working Paper No. W P S 46 (January 1989): 19. 24. See Callaghy, "Lost Between State and Market"; and Eugenia West, "The Politics of Hope: Z a m b i a ' s Structural Adjustment Program 1 9 0 5 - 1 9 0 7 " (Ph.D. diss., Yale University, 1989). 25. See also Stephan Haggard, Pathways from the Periphery: The Politics of Growth in the Newly Industrializing Countries (Ithaca and L o n d o n : Cornell University Press, 1990): 9 7 - 9 9 . 26. Barbara Stallings, "Political E c o n o m y of Democratic Transition: Chile

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in the 1980s," in Stallings and Robert Kaufman (eds.), Debt and Democracy Latin America (Boulder, Colo.: Westview Press, 1989): 181-200.

in

27. For a general review of the problem of investment in the adjustment process, see W o r l d Bank, Country Economics Department, Adjustment Lending Policies for Sustainable Growth, Policy and Research Series N o . 14 (Washington D.C.: W o r l d Bank, 1990): 81-91. 28. Guillermo O'Donnell, Modernization and Bureaucratic Authoritarianism: Studies in South American Politics (Berkeley: Institute o f International Studies, 1973). 29. Eliza Willis, " T h e State as Banker: The Expansion o f the Public Sector in Brazil" (Ph.D. diss., University of Texas, 1986). 30. On Korea, see Stephan Haggard with Chung-in Moon, "Institutions and Economic P o l i c y : Theory and a Korean Case Study," World Politics (January 1990): 210-237. On Mexico, see Robert Kaufman, "Stabilization and Adjustment in Argentina, Brazil, M e x i c o , " 65-112; on Zaire, see Callaghy, " L o s t Between State and Market," 257-320; and on the Philippines, see Haggard, " T h e Political E c o n o m y o f the Philippines Debt Crisis," 215-256, all in Nelson (ed.), Economic Crisis and Policy Choice. 31. See Haggard and Moon, "Institutions and Economic P o l i c y . " 32. Albert O . Hirschman, Journeys Toward Progress ( N e w York: W . W . N o r t o n , 1973); W i l l i a m Ascher, Scheming for the Poor: The Politics of Redistribution in Latin America (Cambridge, Mass.: Harvard University Press, 1984); Joan Nelson, " T h e Politics o f Stabilization," in Richard Feinberg and Valeriana Kallab (eds.), Adjustment Crisis in the Third World ( N e w Brunswick, N.J.: Transaction Books, 1984), John Waterbury, " T h e Political Management o f Economic Adjustment and R e f o r m , " in Joan Nelson (ed.), Fragile Coalitions: The Politics of Economic Adjustment ( N e w Brunswick, N.J.: Transaction Books, 1989): 3 9 - 5 6 . 33. See Peter Katzenstein, Small States in World Markets: Industrial Policy in Europe (Ithaca, N . Y . : Cornell University Press, 1985). 34. Peter Lange, "Unions, Workers, and W a g e Regulation: The Rational Bases o f C o n s e n t , " in John H. Goldthorpe (ed.). Order and Conflict in Contemporary Capitalism (Oxford: O x f o r d University Press, 1984): 90-123. 35. See Joan Nelson, "Poverty, Equity and the Politics of Adjustment," in Haggard and Kaufman (eds.), The Politics of Adjustment: 221-269. 36. Mares, "Domestic Institutions and Shifts in Trade." 37. Barbara Geddes, "Democratic Institutions as a Bargain A m o n g S e l f interested P o l i t i c i a n s " (Paper presented at the American Political Science Association, San Francisco, September 1990). 38. For different interpretations, see Gerald Curtis, The Japanese Way of Politics ( N e w Y o r k : Columbia University Press, 1980); and Kent E. Calder, Crisis and Compensation: Public Policy and Political Stability in Japan: 1949-1986 (Princeton: Princeton University Press, 1988). 39. Peter Hall, "Conclusion: The Politics of Keynesian Ideas," in Peter Hall (ed.), The Political Power of Keynesian Ideas: Keynesianism Across Nations (Princeton: Princeton University Press, 1989): 361-392, quoted here from p. 367.

• Part 4 • Conclusion

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In this conclusion we attempt to develop further the conception of the role of states and markets in development that we see emerging from the previous chapters. W e seek to move the discussion from an either-or format, however modified by sophisticated qualifications, to inquiries into how market and state can complement each other in furthering growth and development. W e discuss first the specific contributions of market and state to economic life as well as the complex conditions of both market creation and state building. This is followed by a review of major types of state policies. A third section looks at the special conditions of late industrialization. We then consider the features of the state and of state-society relations that are most conducive to developmental state action. The conclusion briefly restates the core of the argument.

Markets and States Are Not Natural Givens The promise of the market can be simply stated. In principle, it accomplishes a number of things at once, many of them critical for economic efficiency. It smoothly coordinates the activities of a multitude of economic units and uses their varied knowledge and energy in ways that elude any form o f administrative coordination. It signals supply conditions—shortage and abundance—as well as variable needs and wants, provided the latter are backed by purchasing power. It provides incentives for responding to changing demand and supply situations. And it channels resources required for such responses. Yet at the same time it also allocates income in disregard of prevalent notions of equity, leaving some needs unmet, and it creates concentrations of economic power that coexist tensely, at best, with democratic political life. At its best, finally, the market maximizes economic efficiency under given conditions; whether it also fosters growth and structural transformation is—even with ideal assumptions—open to further questions.

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While many are ready to discount the adverse impacts of market functioning on equity and political equality as secondary flaws or even as irrelevant, there is more agreement that other shortcomings of the market mechanism are serious and must be addressed. First, problems that do not make themselves felt to the individual economic units as costs are left untouched or, if it is to individual advantage, magnified; environmental issues are a paradigmatic example and so is, in a somewhat broader sense, the protection of workers' health. Second, collective goods, such as public roads and ports or the national armed forces, cannot be supplied by the market mechanism except under very specific conditions, even if they are urgently needed. In competitive markets with many participants, rational, profitoriented actors will opt not to contribute to such collective or public goods; they will opt to be "free riders." 1 Ironically, the very institutional infrastructure necessary for functioning markets—securing property rights, guaranteeing contracts, establishing the legal foundations for the incorporation of collective enterprises, providing a more or less stable currency, etc.—represents exactly a series of such collective or public goods that are beyond the reach of economic actors in competition with each other. Emile Durkheim made these noncontractual bases of contract a centerpiece of his case against utilitarianism as a general social theory. 2 It is here that we encounter one contribution of the state to economic growth and development on which there has been agreement a m o n g economists since the Scottish Enlightenment. The state is expected to establish and maintain the framework within which the pursuit of individual advantage in the market plays itself out. The state is viewed as specially suited for that task because—with its monopoly of legitimate coercion and the associated claim to make and implement binding collective decisions— the state is the foremost agency capable of overcoming the free-rider problem. The institutional infrastructure required for functioning competitive markets cannot be taken for granted in many less developed countries as it can be in most advanced industrial economies. This goes far beyond the mere securing of property rights and contractual obligations. It is hard to exaggerate the importance of market-creating and market-facilitating activities of the state. 3 The establishment of an institutional framework undergirding market functioning is one of the central problems of m o d e m economic growth. Here lies one major reason why the problems of development have occasioned a renaissance of "political economy" as the intellectual approach of choice. Other rationales for state action on issues of socioeconomic development are m o r e politically controversial but no less cogent in principle. Development necessitates many institutional innovations and structural transformations in society and economy other than the creation and ordering of markets. In addition, it raises major socioeconomic policy issues not

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satisfactorily addressed by the sheer interplay of market forces. How to overcome stagnation at a given, low level of productivity and specialization is one problem of this kind; how to address demands for distributional equity another. These issues are likely to be contested, they may not have singular and obvious solutions, but they require in various ways action by the state as the source of binding collective decisions. However, the very establishment of an effective state apparatus and of functioning relations of the state to various parts of civil society is equally problematic in m a n y less developed countries. And so is the s t a t e ' s commitment to a development-oriented provision of the required institutions and policies rather than to clientelistic favoritism and sheer self-interest. The assumption that one can count on the existence of a state capable of and prone to doing what is economically rational must be abandoned. State building has its own particular logic that is very different f r o m — and often at odds with—the logic of the market. The first problem of state building is to create a corps of competent officials with strong commitments to the state and to collective goals. The emergence of such commitments, which involve a profound restructuring of individual interests, seems contingent on a variety of complex historical conditions. Only a body of officials with such an orientation makes coherent corporate state action possible and prevents the free-riding pursuit of individual advantage on the part of these officials. As Peter Evans puts the point, even "a protection racket whose triggermen cut individual deals at the first opportunity does not last very long." 4 These officials have to be organized in a structure of offices and departments that is flexible and responsive to steering from the executive center. The second issue is that the state has to secure a minimum of control over its territory, raise minimally sufficient revenues, and establish viable relations with the major centers of societal power. Third, it has to develop a sustainable position vis-à-vis other states (as well as other corporate agents outside its own borders, such as large foreign corporations). Only then do other, more ambitious goals come into view. T h e first problem—that of building a staff of competent officials willing, in case of conflict, to subordinate their short-run individual interests to the pursuit of public policy—is the most fundamental; it is ultimately indispensible for solving the others, even though to some extent it presupposes their preliminary solution. Historically, it represented an institutional innovation of the first order, based on t r e m e n d o u s political, economic, and cultural resources and guided by trial and error in the pursuit of large-scale p o w e r interests. 5 In the twentieth century, the problem is somewhat eased by the fact that the comparative advantage of a well-functioning state apparatus is apparent to any group with ambitions to rule. H o w e v e r , d i f f e r e n t countries are blessed or cursed with very different historical inheritances in this respect—compare only East Asian to sub-Saharan A f r i c a n countries—and it is still extremely difficult to

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build a f u n c t i o n i n g state apparatus from scratch, without historical precedent. Wherever the efforts at state building fall short of these minimal goals, not to mention the attainment of greater capacities for effective state action, issues of securing state power are likely to take precedence over other tasks one might reasonably expect the state to meet in the development process. The provision of the institutional guarantees necessary for functioning markets, the building of a physical and technical infrastructure aiding development, and the design and implementation of other developmental policies will either be sidelined or dealt with in a manner that gives priority to the consolidation of state power. Many of the resulting activities will be considered opportunistic, lacking in impartiality, and "corrupt" when judged by expectations derived from more-established states. In addition, there is the simple corruption of individual officers, the pursuit of private gain with official means. But it is important to note that the improvised substitutes for a competent, loyal, and disciplined civil service, for an effective system of taxation, for an impartial and speedy system of justice, for unquestioned control of violence, for widespread acceptance by the citizenry, and for a minimum of autonomy vis-à-vis powerful interests inside and outside the country show a very untidy and unsavory face that is hard to distinguish from corruption plain and simple. States, and especially states caught up in the process of construction and consolidation, must be analyzed in a broader context of power. In fact, they stand at the intersection of two power fields. States are their societies' foremost agents in the field of interstate and international power relations. And they are one major component of the internal landscape of organized interests within their own societies. 6 In both fields, they have to make alliances in order to be effective; yet in both fields, they have to attain a modicum of autonomy if they are to act coherently in the pursuit of any policy. Acting in both dimensions at once can be used as an initial advantage for a minimal autonomy in either. Why should an even moderately autonomous state attend to the needs of the market rather than serve the greed—or the sense of glory—of politicians and officials? We will return to this question when we discuss the conditions favoring "developmental" state action. For now, the briefest answer is found in Max Weber's insight that state and market stand in a relation of symbiosis to each other or, as he put it, of "elective affinity." Most fundamentally, the state's interest in revenue, even where a portion is to become personal wealth of the ruling elite, translates into an interest in a flourishing economy, and this mirrors the dependence of the market on the guarantees against force and fraud that only the state can provide. 7 Our argument so far is easily summarized. In principle, the market has unparalleled advantages for the coordination of a multitude of economic actors with complex needs and assets. State action can provide public goods not

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easily attainable by competing economic actors. A third proposition links the first two: The very institutional infrastructure required for functioning markets, as well as developmental state policies, is a prime example of public goods that are beyond the reach of individual market participants. While these claims may seem rather innocuous and perhaps even trivial at first, they acquire more complexity as well as theoretical weight when it is recognized that state machineries suited for laying the foundations of economic growth and prone to pursue it assiduously cannot be taken for granted. They have to be constructed; they are built on complex historical foundations; and different countries enjoy or have to labor with very different historical heritages favoring or obstructing the emergence of an efficient and development-oriented state. To this first set of complications we must now add another, arising from the nature of public goods. Public and collective goods are not ready-made potential goals of joint action that exist in a platonic heaven, as it were, eternal forms of collective advantage to be realized or not. Rather, they are socially constructed in the very historical process in which the free-rider problem is overcome by collective organization of one kind or another. 8 This proposition has a number of relevant corollaries. First, even the public goods that are part of the broadly accepted canon of infrastructural requirements of the market—property, contract, the coiporate construction of firms, provision of a currency—are implemented differently in different countries. In all cases, moreover, their institutionalization affects some interests adversely while it favors others. It is never impartial and thus requires controversial political choices. Morton Horwitz has shown how drastically the transformation of US law before the Civil War, in such areas as property law, contract law, and negligence law, hurt the interests of farmers, workers, and consumers while it favored entrepreneurs.9 Second, what belongs to the indispensible canon of state economic tasks is controversial. There is no agreement, for example, on the limitations of private property rights, on regulatory protection of consumers, on workers' occupational safety regulations, or—most important here—on developmental policies beyond the creation and regulation of markets. Virtually all states, including state and federal government in the United States, do more than the most restrictive, normative arguments of economists find acceptable. The third corollary is an analytic moral drawn from the first two: Even the most plausible state functions must be analyzed in a context of political choice and thus of social and economic power. This casts a shadow of doubt and potential irrelevance on theoretical and normative arguments that proceed as if a common good could be identified objectively and then realized, at least in principle, independent of the play of power and political choice.

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Different Kinds of State Intervention We now turn to some comments on debates about major types o f state action. The academic as well as the political discussion has moved decisively away from the assumption that one can (normally) count on a state with the capacity and the commitment to devise and implement rational policies. This shift might have led to lively inquiries about state building and state reform. That, however, has not been the main direction to which attention has turned. Instead, debate has focused on the degree to which the state is needed at all. The spectrum o f policy opinion now includes positions radically skeptical of any benefits of state action. Yet one can still speak, as we have done above, of a minimalist canon of state economic tasks. Although economic analysis of law and organization has recently emphasized the importance of "private ordering"—that is, of contractual relationships not reliant on recourse to the courtroom 10 —even the imaginary world of perfectly competitive markets presumes a foundation of enforceable ownership and contractual arrangements. The same can be said for a second primitive state role, the creation and management of a currency. A vast array of measures facilitating and regulating market exchange may be controversial in detail and may differentially protect different group interests, but there is no market economy that could exist without some bundle of such measures. Admitting externalities, increasing returns to scale, and publicness of some goods lead to the final members of this least-controversial class of state roles, commonly referred to as "correcting market failures." Economists have long agreed that a perfectly informed and perfectly benign state could replace inefficient with efficient outcomes by appropriately taxing (subsidizing) noxious (beneficial) externalities, regulating or breaking up monopolies, and exercising the power o f taxation to collect revenues to be used in the provision of public goods. T o be sure, the textbook consensus of a generation ago has yielded to some controversies. An imperfectly informed state will be incapable of discovering precisely efficient policies, and errors may lead it to make matters worse instead of better. An insurgent view (already venerable enough to have its Nobel Prize in the name of James Buchanan) has raised the question of why the state should be assumed to act in the social interest when everyone else is more or less self-seeking. This is a useful question indeed, but it does not obviously have the single answer presumed by its more radical advocates. T o vigorous questioning by some economists of the magnitude of the efficiency losses from monopoly, others have added theoretical arguments about latent competition and potential entry. The paucity of examples of pure public goods has been noted, and there has been much talk, and some action, with regard to the " p r i v a t i z a t i o n " o f education, communications, transportation, and other spheres once felt to lie in the public domain. Despite all this, much of the old consensus about government's role with

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respect to the correction of market failures seems to be alive and well. Indeed, this might be seen as providing support for Goran Ohlin's view in this volume that the role of the state in the economy is destined to become a matter of broad international convergence. Something similar might be said about macroeconomic policy. Here, Keynesianism represented a dramatic departure from the classical economic view o f the self-regulating market economy: where before the Invisible Hand was counted on to blend the chords of self-interest into a balanced and harmonic concert, conscious (and once again benign) manipulation o f national aggregates (through public finance and monetary policy) was now deemed necessary. However, the triple pursuit of growth, price stability, and full employment has seemed more and more elusive to economists and policymakers alike, even though some countries have done much better than others. Faith in both government capacity and government benevolence has eroded in many quarters, as has academic consensus on the underlying models. Nevertheless, the idea that it is the task of government to respond to macroeconomic imbalances is pervasive in virtually all countries. Beyond the domains of the minimalist consensus—the patching up of the most standard market failures and macroeconomic management of the economy—controversy replaces consensus as the norm. A generation ago, for example, there seemed to be widespread agreement within the industrialized democracies that the state had a role to play in moderating the extremes of inequality created or perpetuated by markets; today, the "welfare state" is widely attacked. It is often accepted that equity matters—whether on purely ethical grounds or for reasons of social stability—when assessing economic arrangements. Although precisely what constitutes equity is controversial, a considerable spectrum of opinions at one time concurred that the outcome of the free-market process is not automatically equitable in nature. A marketclearing wage may, after all, fail to save people from starving. Among students of economic development, distribution-centric concerns rose to prominence in the 1970s, spurred by evidence that economic growth could be coupled with increasing poverty, but also that relative equality and growth were by no means incompatible. Effective redistribution is, however, extremely difficult to achieve, and the egalitarian growth cases—e.g., Taiwan, South Korea—do not easily serve as models for other countries. Taiwan and South Korea, states that were extraordinarily independent of the dominant interests, imposed land reform and at the same time repressed labor organization. Some expressly redistributive states, for their part, fostered little or no e c o n o m i c growth, while providing examples o f gross inefficiency, corruption, or coercion—e.g., Tanzania under Julius Nyerere or Ethiopia under Mengistu Haile Mariam. Welfare state policies are costly, in their full-blown version probably too costly for all but the richest countries. This does not mean, however, that

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policies that effectively endow the poor with valuable assets—e.g., skills, land, and even credit—are either unaffordable or economically ineffective. Nor are social policy choices simply determined by per capita income. Bureaucratization, deadening of incentives, and creation of dependency are widely perceived as costs of the welfare state in advanced industrial nations. That this assessment is strongest in the United States relates oddly to the fact that the welfare state is here less developed than in most industrialized nations. Mikhail S. Gorbachev, among others, has claimed that the existence of the communist states deserves some credit for the rise of the welfare state in the West. S o m e hope that the corollary will be that the collapse of communism is fast followed by the end of the marriage between capitalism and the redistributive state. A less provincial view of the advanced capitalist world might lead to very different conclusions, however. It is quite possible that the future competitiveness of the United States depends on effective reforms and expansions of public social services broadly conceived. Welfare state tasks of the safety net variety are after all intimately related to such infrastructural services as better schooling for the less privileged, vocational training, and retraining for the unemployed. Both redistribution and purposive management of fiscal and monetary policy have in actual fact been everyday realities for decades, even in the United States. Where most economists and mainstream US politicians have drawn the line on government involvement in the economy, however, is at the doorstep of industrial policy and planning. Such planning is conceptually different from the state's more accepted macroeconomic roles in that it is industry- and sometimes even firm-specific, and it is active and prospective, whereas macroeconomic management reacts to imbalances after they have arisen. While most economic historians would argue that the US government did play a leadership role in fostering the country's economic development in the eighteenth and nineteenth centuries, the twentieth century's philosophy has been distinctly laissez-faire. 11 That sector-specific planning need not be incompatible with capitalism and the profit motive has been demonstrated, in this century, both by the indicative planning model of postwar France and by the industrial policy model of Japan. In fact, Japanese policies have been so successful that the old capitalist nations now see themselves confronted with a threatening competitor. Some argue that the US stance is a reflection of the c o u n t r y ' s industrial prominence during the period, whereas French and Japanese activism typify the recovering or late-developing industrial economy. An alternative view points to the peculiar and peculiarly disjointed structure of the state in this country. 1 2 And although the influence of French and Japanese planning has perhaps waned in recent decades, arguments that the United States needs an active industrial policy to combat economic decline and eclipse by foreign competitors are heard even from pragmatic, probusiness quarters. 13 Also beyond bounds in the US debate, but a common sight on the

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landscapes of Europe and other continents, is the SOE. Such enteiprises have played dynamic roles in the industrial passages of Germany and South Korea, to give two prominent examples, and well-performing SOEs are to be found in numerous other countries—e.g., in France and Italy. To be sure, the direction of change is toward denationalization virtually all over the world. Yet the examples of successful SOEs (and, as Paul Streeten points out, of unsuccessful private firms) suggest that something other than ownership type (e.g., exposure to market competition, financial autonomy and accountability, managerial competence and professionalism) may explain the lion's share of variation in comparative performance. Be that as it may, Biersteker argues compellingly in his chapter in this volume that denationalization as soon as possible and at all costs is not always the most beneficial approach, although at the moment it may be the most fashionable. 14 Industrial policies and state-owned industrial enterprises may be problematic because in many less-developed countries state action is extremely unlikely to stay a coherent and developmental course; rather, it will be mired in corruption and inefficiency. Whether this objection holds depends to a large extent on the character of the state apparatus, on its support in society, and on the relative strengths of powerful private interests. We will return to these issues below. Here we note just two points. First, the clout of interested parties vis-à-vis the state may be just too great for rational industrial policies to be possible. As in the advanced industrial nations, "welfare for the rich" can easily become more costly than welfare for the poor. Second, states and state-society relations vary considerably across developing countries, and it would hardly do to discuss industrial policy and state-owned enterprises on the assumption that all states are weak and corrupt. The Special Conditions of Late Industrialization The idea that a state leadership role is especially important to a lateindustrializing country at an early stage of development is both familiar and controversial. A first, primarily political issue is closely related to laying the infrastructural foundations for a market economy: developmentally oriented elites may use the power of the state to overcome resistance from landowners with little interest in economic transformation. Early economic arguments, by contrast, centered either on industrial interdependence and the scale of needed investment or on the need for protection from foreign competition. For example, it was suggested that entrepreneurs who might potentially invest in various industries could not act singly, because the viability of given enterprises depended on the positive externalities created by the existence of firms in related industries. Not only was governmental provision of infrastructure and support for education crucial, in this view, but so was

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g o v e r n m e n t coordination of the investment process (if not outright substitution of government for the private entrepreneur). The arguments for protection of domestic infant industries date to Hamilton and List in the late eighteenth and early nineteenth centuries and were long accepted by economists as valid exceptions to the general prescription of free trade. Some of the old arguments have not held up well. Hirschman long ago suggested that industrial interdependence did not mean a need for coordination and balance; on the contrary, he claimed, imbalances are prime stimuli of entrepreneurial effort. 1 5 Interdependence arguments have been effectively attacked for b e i n g premised on autarky, and their use to support industrialization under state auspices is now moot. Although the infantindustry argument is not entirely disreputable, the postwar ISI approach in which it figured prominently has for many become an object of scom. For some economists and international policymakers, this skepticism extends to virtually all policies designed to overcome a disadvantageous position in the world economy. But several of our authors urge us to take a closer look. Henry Bruton, an important early critic of ISI, 16 suggests in his chapter that while developed countries may have an obligation to help less-developed countries to achieve economic development, the latter countries do not have a reciprocal obligation to adopt Western ways indiscriminately. They must find their own way, and this implies, to Bruton, that complete openness is not necessarily desirable. The weaknesses of ISI may point to the ineffectiveness of the policy bundle that included high tariffs, overvalued exchange rates, and import-licensing schemes, yet it does not necessarily invalidate the classical case for infant-industry protection. That case is developed for South Asia by Gustav Papanek, who—despite his unfavorable findings regarding dirigisme more broadly defined—concludes in his chapter that "protective episodes . . . represented a positive intervention," at least in Pakistan and Indonesia. And Gustav Ranis appears to take import substitution for granted as a stage on the path to development. Departing from the standard policy package, Bruton himself suggests that a moderately undervalued exchange rate would be a good way to provide minimally distorting protection of domestic industry while simultaneously encouraging exports. In her chapter, Alice Amsden sees subsidization as the crucial task of developmental states. Rather than "getting prices right," in the sense of allowing the forces of supply and demand to determine prices, she says that "getting prices wrong," including subsidies to firms even in labor-intensive industries, has proven to be critical to successful late industrialization. 17 This is because firms, in her view, cannot compete initially against the higher productivity of more advanced countries, even in "leading sectors" like cotton textiles. T h e developmental state should not, then, sit back and wait for society's low labor costs to propel it automatically into the industrial league of nations, because no such automatic mechanism exists or at least operates to a satisfactory degree.

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Even the most fervent free marketeer must concede that the great nonEuropean industrial success stories—Japan, South Korea, and Taiwan—are far from being exemplars of laissez-faire. Each went through many decades of import protection, and states were—and are—active in formulating industrial strategies and in designing incentive schemes to reward private firms that successfully contributed to the success of those strategies. Neoclassical true believers might argue that growth would have been faster still without state interventions, but such arguments are purely speculative; they are statements of faith without empirical foundation. The real question seems to be why industrial protection and state involvement in the preferential dispensing of subsidies, credits, and tax remissions did not lead in these cases, as in, for example, South Asia and Latin America, to gross inefficiency and lackluster growth. 18 This question needs to be answered on two different levels. On the level of policies, the eventual outward orientation of the East Asian economies, even if not a manifestation of laissez-faire, does appear to have had a highly favorable effect. Exporting implied access to larger markets, as well as the competitive stimulus to improve product quality and marketing capabilities. Although governments played a major role in deciding which industries would be promoted when and in managing the distribution of rewards to private-sector participants, use of success in the international marketplace as a yardstick of achievement had the virtue of rewarding genuine economic efficiency rather than mere adeptness at the manipulation of a system of bureaucratically administered licensing schemes, import preferences, and so forth. Implementation of this policy, however, was anything but a simple withdrawal of the state in favor of the discipline of the market. Rather, it required a strong state, capable of independent action and effective monitoring, and it represented something beyond a simple dualism of state or market: it was a case of "the simultaneous and . . . mutually reinforcing importance of both states and markets." 19 The second level on which the question must be addressed is that of the political will and the capacity for effective state action. Very similar instruments were at one time or another used by Japan and India, by South Korea and Pakistan. Why is it that the East Asian cases became Amsden's success stories, whereas the South Asian countries are Papanek's showcases of dirigiste failure? What caused more judicious selection of economic goals and more scrupulous implementation of reward schemes (of the type emphasized by Amsden) in one set of countries and not the other? 20 This leads us from a discussion of types of policies to questions about the state itself and its relations to society. Before addressing these questions in the next section, a few words are appropriate on the far end of the spectrum of state involvement, the case of state socialism and central planning. 21 Where speech is free, few defenders of such a system are still to be found at this writing, making it harder to remember that a mere generation ago, the West fretted over Nikita

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Krushchev's prediction of its burial, and one frequently heard the argument that economic growth was no longer possible in the dependent peripheries of the Third World, save by following the Soviet model. Although past Western assessments of the economic status of Eastern Bloc countries have been called into question by the condition in which the economies of those countries were found at the end of communist rule, it remains possible to contend that certain basic tasks of industrialization were accomplished with great dispatch in the early decades of the command economies of, for example, the Soviet Union and China. The view that the comparative advantage of such systems is exhibited precisely at that stage of development is still supportable, and one might even suppose that the system was capable of fostering growth as rapid as its alternatives (in certain countries, at least) in those first decades. The reasons for rejecting it may lie elsewhere—in its high cost in human liberty and political expression and in the realization that more market-friendly approaches have worked at least as well in at least some settings. Another reason for questioning the long-term virtue of the Soviet approach to development relates to the problem of transition. If the command economy were demonstrably more capable than the market alternative of accomplishing certain basic tasks of industrialization under social conditions of one sort or another, but if it were nonetheless agreed that the system functioned poorly at a more mature stage of development, the choice of whether to use the system in the initial stage might depend on the difficulty of accomplishing a systemic transition later on. Recent evidence from the Soviet Union and Eastern Europe indicates that this is indeed a problem of enormous gravity. However sensible such reasoning may appear to us, it may prove less than compelling to some of the Third World's poorest if the market's "magic" fails to deliver miracles in the near term—a not unlikely prospect. If reenactments of communist-type experiments remain rare in the future, this could reflect inhibiting external pressures as much as it does domestic social consensus. In any event, before rejecting out of hand the Soviet approach, or variants thereof, a good and hard look at its social, distributive, and political, as well as its economic, dimensions is in order. The case of the People's Republic of China is a good place to begin. In its more orthodox form of a dozen or so years ago, it was hailed as an alternative both to inegalitarian and economically dependent Third World models and to the more bureaucratized and patently corrupt Soviet forerunner. Mark Selden, in his chapter, gives us a picture of China that emphasizes the rural context in which a large majority of Chinese were, and still are, to be found. Selden brings out the competition between different economic and political ideals in post-"liberation" China and argues that elements of a more participatory and liberal variant on Chinese socialism, which saw only limited application under communist rule, may be both viable and attractive. Whether or not a "third way" exists is one of the questions frequently

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raised in discussions of the former and still communist-ruled countries. C h i n a ' s success at sustaining high growth rates in its halfway-house economy of the past dozen years and the contrast with the agony of Eastern E u r o p e ' s postcommunist economies, have recently reopened questions of both the speed of transition and the viability of intermediate systems. 2 2 Whatever the answer regarding more radical variants of market socialism, which retain a dominant role for public ownership, 2 3 Alec Nove reminds us that the alternative to the Soviet model is not necessarily the capitalism of Ronald Reagan and Margaret Thatcher. Like Paul Streeten, he advocates a lively role for the state, despite his agreement with mainstream economists that the decentralized pursuit of profit, rather than centralized planning, is the only viable basis for a healthy and dynamic economy.

Varieties of States Institutions that can deliver public goods can also deliver public disasters. Positive results of state action are not ensured by any visible or invisible hand. Rather, they are contingent, in large part at least, on the character of the state and the nature of state-society relations. These issues have been the s u b j e c t of m u c h discussion and research under the heading of the "developmental state." 24 To be effective, we have argued earlier, the state needs organizational resources that cannot be developed overnight and that are favored by historical conditions not universally present. Max Weber's model of bureaucracy identified major issues that are still critical today. 25 If a state's capacity to act coherently and effectively is very limited, it is a prescription for disaster to assign m a j o r policy tasks to it. Corruption will be magnified and the implementation of theoretically beneficial policies will be haphazard at best. One can also put this point in sheer quantitative terms: wall-to-wall state intervention is likely to fail because of scarce administrative resources in most less-developed countries. Given limited organizational capacity, careful selection of manageable policy interventions is imperative. Here may be one of the factors explaining Papanek's empirical results, which showed negative correlations between overall measures of dirigisme and both growth and equity. It bears reiteration, however, that the response of simply betting on the private sector instead of the state is no solution to the problem. Building an efficient state is necessary whether one favors a very limited or a more expansive role of the state in development. A second requirement for a "developmental state" is that the state apparatus devote its resources to social and economic development rather than to war and expansionism, the greater glory of the state's elites, or their sheer material self-interest. This question is different from the control of corruption among state officials; effective organization entails the containment of such

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individual free-riding tendencies. Yet even given such organization, why should the state become the servant of economic development rather than act like a disciplined pack of thieves? 2 6 Alice Amsden expands on the answer of Max Weber, briefly noted earlier: state managers will pursue this policy out of rational self-interest because they, their organizations, and their projects will benefit from a thriving economy. The state's own continued existence, as well as any of its political goals, depends on the revenues derived from the economy. In addition, its popular acceptance is likely to be strengthened by successful e c o n o m i c d e v e l o p m e n t . 2 7 Thus, unless the prospects of the e c o n o m y are desolate (a condition that may explain the economically counteiproductive and even predatory actions of some states in less developed countries), this symbiotic relation between state and economy will stimulate and sustain the political will for development-oriented state action. This is a powerful thesis, although we will return to some complications below. A high degree of "state autonomy," of independence of the state from p o w e r f u l interests in the society, is a third indispensible condition of developmental state action. Autonomy contributes first of all to the state's capacity for corporate action; without it, coherent state policies are rendered difficult or impossible because different parts of the state apparatus can easily become captives of divergent vested interests. C o h e r e n c e , h o w e v e r , is not enough. T h e c o n c e p t i o n and the implementation of policies in pursuit of public goods require both autonomy and sufficient power resources of the state. The state must not only be able to formulate its policies with some independence, it must also have the capacity to pursue them even against resistance from powerful partial interests. Where the state is weak and/or dominated by particular interests, we frequently find wasteful policies whose prime effect is to line the pockets of powerful actors and/or to buttress the shaky authority of the state. Robert Bates has argued convincingly that economically irrational agrarian policies in Africa were the result of quite rational political actions of weak states and their political elites. 28 State strength and autonomy of this kind are not necessarily at odds with democracy, nor does authoritarianism ensure the required independence. As Bardhan puts it, "Authoritarianism is neither necessary nor sufficient for this insulation." 2 9 What is at stake is a measure of independence from powerful, but often numerically small, interests. 30 T o the conditions of developmental state action discussed so f a r — organizational capacity, state autonomy and power vis-à-vis dominant interests, and the state's interest in seeking development rather than static exploitation of economy and society—we must now add another feature of state-society relations that may seem at first blush paradoxical. State autonomy and a power balance that gives the state a chance to prevail against partial opposition must be complemented by rather close relations between policymakers and business elites. This delicate combination of independence

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and cooperation—dubbed "embedded state autonomy" by Peter Evans 31 — secures the flow of necessary information to the policymakers as well as the willingness of both sides to cooperate. It critically enhances the state's capacity for transforming socioeconomic relations as distinguished from mere coercive, repressive power. 32 "The logic of the developmental state rests precisely on the combination of bureaucratic autonomy with an unusual degree of public-private cooperation." 33 Kaufman and Haggard, in their chapter, conclude from their analysis of the political conditions of marketoriented reforms that state autonomy is of prime significance in the phase of design and initiation of such policies but that coalitions with powerful socioeconomic interests are needed to implement and to sustain them. There are still many open questions in the analysis of the conditions of developmental state action. One such question of considerable importance for the compatibility of state autonomy and democracy concerns the relations between state policy and the organizations representing working-class and other broad-based subordinate interests. In cases of developmental success, such as Taiwan and South Korea, policy formulation and implementation rested on the political exclusion and even repression of subordinate class interests. Surely, "embedded autonomy" and effective state action are easier to obtain when only a limited set of interests are fully articulated and enter the decision process. However, state autonomy based on repression of labor and peasants may be efficient but is also likely to be unstable in the long run. Furthermore, when we consider the impulses for developmental state action—as distinct from the implementation of policy measures—pressure from subordinate classes and their organizations may be an important factor pushing for growth. Quite different forces potentially shape the political will for developmental state action. Pressure from below (actual or anticipated), power maintenance concerns of political elites, revenue interests of the state, and the demands of dominant economic actors may, but surely do not necessarily, point in the same or even compatible directions. If it is true that democracy rests in the long run on the organizational empowerment of subordinate class interests, 34 some tension exists between exclusionary models of the developmental state and democracy. And rollbacks of democracy, as witnessed during recent decades in the Southern Cone of Latin America, were often motivated by contradictory class interests and justified in terms of development goals. Yet close public-private cooperation is not necessarily exclusionary and antidemocratic in character. Various small European countries (and some larger ones, such as Germany) offer examples of a "democratic corporatism," 35 with the promise of effective economic policy and considerable stability. Here strong and centralized organizations of major interests, including both capital and labor, are drawn into close cooperation under the leadership of the state. 36 Haggard and Kaufman discuss a variety of other democratic patterns undergirding economic state action.

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The relations between the state and the wider society may have an impact on the chances of developmental state actions in other, more diffuse, ways that are less often at the center of political economic analyses. Gustav Ranis offers suggestive observations about the different attitudes toward the state prevailing in East Asia and in Latin America, which have their roots in different historical developments of state-society relations, different cultural traditions, and different degrees of ethnic homogeneity (or diversity and fragmentation). Alice Amsden argues—for reasons of state autonomy as well as on broader grounds—that economic inequality in a society has a decisive effect: the less inequality, the better the chances of developmental state action. 37 Depending on historically contingent conditions, states may lack the ability to control corruption; they may be deficient in the organizational resources necessary for any decisive action; they may not mobilize (or may even obstruct) the political will for developmental policies; they m a y overextend themselves and fail; they may fall short in the knowledge as well as the subtle ties to economic decisionmakers needed for effective economic policy; or they may be so hemmed in by partial social and economic interests that they become incapable of developmental action. Yet they may also enjoy more favorable conditions and launch successful economic interventions, overcoming lesser handicaps in the pursuit of stakes that are high indeed. For the political economy of development, the existence of wide variation in the character of states and state-society relations may be decisive. This variation offers the chance to study the conditions of effective developmental state policy. Although much has been learned about these, our understanding is both tentative and fragmentary. The conditions of effective developmental state action surely ought to rank high on the agenda of the socioeconomic analysis of development.

Conclusion This essay, building on discussions in the three workshops that culminated in this volume, leads us to a number of simple conclusions that, however, point to many not so simple questions and few definitive answers. First, the existence of a well-functioning state, capable of efficient economic policies, cannot be taken for granted. Neither must one take for granted the opposite. States in the Third World vary tremendously in character. Second, the existence of functioning competitive markets cannot be taken for granted either. Markets, and competitive markets in particular, are not the natural outgrowth of civil societies undisturbed by state intervention. In fact, a virtual reversal of this proposition has a better claim to truth: efficient markets require strong state action. Taken together, these two points lead to the third and central conclusion.

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Rather than arguing about more or less state action and more or less market freedom, development analysis must inquire into the conditions under which state action and market functioning combine to advance growth and development. These questions concern, in the first place, market-creating and marketfacilitating state actions, as well as the conditions under which effective and developmental state action becomes possible, but they go far beyond that. They must deal in particular with the issues of state policies designing and implementing a strategy for growth and not simply providing the institutional infrastructure of a market economy. If the first set of questions involves many open problems—about the conditions of effective markets beyond the securing of property rights and contractual obligations, about state autonomy and state capacity, about historical persistence in state structures and state-society relations and the feasibility of their conscious transformation—controversy and open questions dominate once the discussion goes beyond them. Moving beyond them is, however, imperative because some of the most dramatic cases of recent developmental success—Korea and Taiwan in particular—involved much more complex and unorthodox interactions of state decision and market allocation. Careful comparative work on different patterns of market functioning and state action in concrete cases of success, stagnation, and failure in development holds perhaps the greatest promise, provided such case comparisons do not remain parallel narratives but are focused on the decisive analytic issues.

Notes Earlier drafts of this chapter were read by Jesse Biddle, Vedat Milor, and Morris Morris, as well as by the authors of this volume. We thank them for their comments. 1. Mancur Olson, The Logic of Collective Action: Public Goods and the Theory of Groups (Cambridge, Mass.: Harvard University Press, 1965). 2. Emile Durkheim, The Division of Labor (New York: Free Press, 1964; first published in French in 1893). 3. In the workshop discussions, this point was especially stressed by Fred Carstensen, University of Connecticut. 4. Peter B. Evans, "Predatory, Developmental, and Other Apparatuses: A Comparative Political E c o n o m y Perspective on the Third World State," Sociological Forum 4, no. 4 (1989): 5 6 1 - 5 8 7 , quoted here from p. 565. 5. The classic analysis of this process is found in Max Weber, Economy and Society, vols. 1 and 2 (Berkeley: University of California Press, 1978). See also S. N. Eisenstadt, The Political System of Empires (New York: Free Press, 1963); Charles Tilly, The Formation of National States in Western Europe (Princeton: Princeton University Press, 1975); and Dietrich Rueschemeyer, Power and the Division of Labour (Cambridge: Polity Press, 1986; Palo Alto, Calif.: Stanford University Press, 1978): chap. 4. For s o m e conclusions on the conditions of effective state action in development, see Dietrich Rueschemeyer and Peter B. Evans, "The State and Economic Transformation: Toward an Analysis

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of the Conditions Underlying Effective Intervention," in Peter B. Evans, Dietrich Rueschemeyer, and Theda Skocpol (eds.), Bringing the Stale Back In (Cambridge: C a m b r i d g e University Press, 1985): 4 4 - 7 7 . 6. T h e d a Skocpol, States and Social Revolutions (Cambridge: C a m b r i d g e University Press, 1979). 7. See also Charles L i n d b l o m , Politics and Markets ( N e w York: Basic Books, 1977). Like m a n y e c o n o m i s t s . Max W e b e r worked with a c o m p e t i t i v e model of capitalism and a bureaucratic, minimalist model of the state. Thus, his a r g u m e n t about the elective affinity of capitalist market and modern state holds best for the conceptions and realities of nineteenth-century E u r o p e and c a n n o t simply be extended to twentieth-century state intervention in either more- or lessdeveloped countries. 8. A union, for instance, may aim for higher wages, but it may also seek to transform the authority structure of enterprises, d e m a n d more free time, and look for m o r e j o b security. The c h o i c e a m o n g these goals and their rank order are strongly shaped by the process of constituting the union and by its alliances, and so are choices about the scope of membership and relations to political goals and o r g a n i z a t i o n s . F o r m o r e d i s c u s s i o n see Dietrich R u e s c h e m e y e r , E v e l y n e H. S t e p h e n s , and J o h n D. S t e p h e n s , Capitalist Development and Democracy (Cambridge: Polity Press; Chicago: University of Chicago Press, 1992): chap. 3. 9. M o r t o n H o r w i t z , The Transformation of American Law, 1780-1860 (Cambridge, Mass.: Harvard University Press, 1977). 10. O l i v e r W i l l i a m s o n , The Economic Institutions of Capitalism (New York: Free Press, 1985). 11. In actuality, this did not, of course, mean that the state kept out of all i n d u s t r y - s p e c i f i c d e c i s i o n m a k i n g . T h e d e f e n s e industry is p e r h a p s the m o s t obvious, but not the only, counterexample. 12. S t e p h e n G r i f f i n , " B r i n g i n g the State into A m e r i c a n C o n s t i t u t i o n a l Theory: Public Authority and the Constitution," Law and Social Inquiry 16, no. 4 (1991); and Stephen Skowronek, Building a New American State: The Expansion of National Administrative Capacities (Cambridge: Cambridge University Press, 1982). 13. Ira C . M a g a z i n e r and Robert Reich, Minding America's Business: The Decline and Rise of the American Economy ( N e w York: H a r c o u r t B r a c e J o v a n o v i c h , 1982); and Lester C. Thurow, The Zero-Sum Solution: Building a World-Class American Economy (New York: Simon and Schuster, 1985). 14. L i k e w i s e , H a r v a r d ' s J e f f r e y S a c h s has written that " s u c c e s s f u l d e v e l o p m e n t might be helped as m u c h by raising the quality of public sector m a n a g e m e n t as by privatizing public enterprises or liberalizing markets." J e f f r e y S a c h s , " T r a d e a n d E x c h a n g e R a t e Policies in G r o w t h - O r i e n t e d A d j u s t m e n t P r o g r a m s , " in Vittorio C o r b o , M o r r i s G o l d s t e i n , and M o h s i n K h a n (eds.), Growth-Oriented Adjustment Programs (Washington, D.C.: I M F and World Bank, 1987); also cited in J. Dirck Stryker, "Nontraditional Export Growth in Response to Policy R e f o r m in S u b - S a h a r a n A f r i c a " (Paper presented at the N o r t h e a s t Universities Development C o n s o r t i u m Conference, October 4 - 5 , 1991). 15. Albert O. H i r s c h m a n , The Strategy of Economic Development (New Haven, Conn.: Yale University Press, 1958). 16. H e n r y B r u t o n , " T h e I m p o r t S u b s t i t u t i o n S t r a t e g y of E c o n o m i c Development: A S u r v e y , " Pakistan Development Review 10 (1970): 1 2 3 - 1 4 6 . 17. There is of course room for terminological disagreement: if impediments to industrialization are conceptualized as "market failures," providing the required subsidies can also be viewed as "getting prices right." But this is more a problem of rhetoric than of substance.

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18. See also in this context the important discussion of Robert W a d e , Governing the Market: Economic Theory and the Role of Government in East Asian Industrialization (Princeton: Princeton University Press, 1990). 19. Peter B. Evans and John D. Stephens, " D e v e l o p m e n t and the W o r l d E c o n o m y , " in Neil J. Smelser (ed.), Handbook of Sociology (Beverly Hills, Calif.: Sage Publications, 1988): 7 3 9 - 7 7 3 . 20. Gustav Papanek (personal c o m m u n i c a t i o n ) argues that d i f f e r e n c e s in policy were crucial: "East Asian countries intervened to correct distortions, that is why they were successful; Southern Asian countries during various p e r i o d s intervened in ways that w o r s e n e d distortions. Indeed, d u r i n g other periods when Southern Asian countries intervened to correct distortions and e x p o s e d their industry to standards of quality and the c o m p e t i t i o n of the world market, they were successful too (e.g., Pakistan in the 1960s when it had a d u a l e x c h a n g e rate, w h i c h h e a v i l y s u b s i d i z e d n o n - t r a d i t i o n a l e x p o r t s ; I n d o n e s i a since 1983 when it achieved the same by a partly c o m p e n s a t e d devaluation)." 21. This p a r a g r a p h and the next d r a w in part on a p a p e r by B r a n k o Milanovic presented at the working group meeting, Brown University, April 9 10, 1991. 22. Questions on the former were raised at the World Bank in the summer of 1991. Talk by Lawrence Summers, chief economist of the World Bank, Northeast Universities Development Consortium conference, Harvard University, October 4, 1991. See also Inderjit Singh, "Is There Schizophrenia About Socialist Reform T h e o r y ? " Transition: The Newsletter About Reforming Economies (World Bank) 2, no. 7 (1991): 1 - 4 . On whether China is succeeding or failing in its transition, see, inter alia, the p a p e r s in the S y m p o s i u m on Institutional B o u n d a r i e s , Structural C h a n g e and Reform in China, in Modern China, January and April 1991. For a negative view on "third ways," see Janos Kornai, The Road to a Free Economy. Shifting from a Socialist System: The Example of Hungary (New York: W. W. Norton, 1990). 23. See Pranab Bardhan and John E. Roemer (eds.) Market Socialism: The Current Debate (New York: Oxford University Press, forthcoming). 24. See, among others, Chalmers Johnson, MIT1 and the Japanese Miracle (Palo Alto, Calif.: Stanford University Press, 1982); Alice H. Amsden, "The State and T a i w a n ' s Economic D e v e l o p m e n t , " in Evans, Rueschemeyer, and Skocpol, Bringing the Slate Back In: 7 8 - 1 0 6 ; Frederic C. Deyo, The Political Economy of the New Asian Industrialism (Ithaca, N.Y.: Cornell University Press, 1987); Alice (Oxford: H. Amsden, Asia's Next Giant: South Korea and Late Industrialization O x f o r d University Press, 1989); Robert H. Bates, Beyond the Miracle of the Market: The Political Economy of Agrarian Development in Kenya (Cambridge: C a m b r i d g e University Press, 1989); Evans, "Predatory, D e v e l o p m e n t a l , and Other Apparatuses"; P r a n a b Bardhan, " S y m p o s i u m on the State and Economic D e v e l o p m e n t , " Journal of Economic Perspectives 4, no. 3 (1990): 3 - 8 ; Robert Wade, Governing the Market: Economic Theory and the Role of Government in East Asian Industrialization (Princeton: Princeton University Press, 1990); and Ziya Onis, " T h e Logic of the Developmental State," Comparative Politics (October 1991): 109-126. 25. O n l y one of these issues is corruption, a subject long recognized but still understudied. The analysis of a South Indian state, in W a d e ' s "The Market for Public O f f i c e , " suggests that in this case corruption in official-client relations linked u p with internal corruption dominating the assignment and transfer of officials and that this corruption-transfer linkage was in turn related to the high expenditures in electoral campaigns. Corruption was here systemically embedded

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in the operation of the state apparatus, and, Wade argues, it had a substantial negative impact on development. 26. Albert O. Hirschman supplies some historical depth in his description of how the earliest arguments in favor of a positive evaluation of the pursuit of s e l f - i n t e r e s t in e c o n o m i c life w e r e based on an opposition to the p a s s i o n s g o v e r n i n g political life and its elites in his The Passions and the Interests: Political Arguments for Capitalism Before Its Triumph (Princeton: Princeton University Press, 1977). 27. L i n d b l o m , in Politics and Markets, e m p h a s i z e s the i m p o r t a n c e of e c o n o m i c p e r f o r m a n c e to the survival of politicians in o f f i c e in d e m o c r a t i c polities. A l t h o u g h s o m e t i m e s less relevant w h e r e d e m o c r a c y is absent, the c o n n e c t i o n with political survival may still be important: witness the strong concern with economic growth in Augusto Pinochet's Chile and Deng Xiaoping's China. 28. Robert Bates, Markets and States in Tropical Africa: The Political Bases of Agricultural Policies (Berkeley: University of California Press, 1981). 29. Bardhan, " S y m p o s i u m on the State and Economic Development," 5. 30. S o m e such differentiation of the state from the structure of power in society is actually requisite for any fully developed democracy. Only in a state relatively autonomous from the economic and social interests of the powerful few can the many acquire a meaningful say in collective decisionmaking. 31. Evans, "Predatory, Developmental, and Other Apparatuses." 32. The distinction between transformative capacity and coercive power w a s emphasized earlier by Talcott Parsons, "On the Concept of Power," Proceedings of the American Philosophical Society 107, no. 3 (1963); reprinted in Robert Bendix and S. M. Lipset (eds.), Class, Status and Power (New York: Free Press, 1 9 6 6 ) . M i c h a e l M a n n m a d e t h e d i s t i n c t i o n — i n his w o r d s b e t w e e n " i n f r a s t r u c t u r a l " a n d " d e s p o t i c " p o w e r — c e n t r a l to his b r o a d h i s t o r i c a l investigations of p o w e r in " T h e A u t o n o m o u s Power of the State: Its Origins, M e c h a n i s m s and Results," Archives Européennes de Sociologie 25 (1984): 1 8 5 213, and The Sources of Social Power, vol. 1 (Cambridge: Cambridge University Press, 1986). Ziya Onis, in " T h e Logic of the Developmental State," links M a n n ' s conceptualization to embedded state autonomy. 33. Onis, " T h e Logic of the Developmental State," 115. 34. Rueschemeyer, Stephens, and Stephens, Capitalist Development. 35. P h i l i p p e Schmitter and Gerhard L e h m b r u c h (eds.), Trends Toward Corporatist Intermediation (Beverly Hills, Calif.: Sage Publications, 1979); and Gerhard L e h m b r u c h and Philippe C. Schmitter (eds.), Patterns of Corporatist Policy Making (Beverly Hills, Calif.: Sage Publications, 1982). 36. Peter Katzenstein, Small States in World Markets: Industrial Policy in Europe (Ithaca, N.Y.: Cornell University Press, 1985). 37. The World Development Report 1991 also finds a positive correlation between equality of income and the rate of economic growth (New York: Oxford University Press, 1991): 137. Due to the detailed state-control and nonmarket orientation of industry in Communist China, it is unclear whether Amsden would extend her argument to that country. Yet even a modest linking of that c o u n t r y ' s state and collective e c o n o m i c structures to internal and international market forces led to o n e of the best e c o n o m i c growth p e r f o r m a n c e s of the 1980s, c o r r o b o r a t i n g the notion of an e q u i t y - g r o w t h linkage as well as that of the i m p o r t a n c e of m a r k e t s and exports and of state activism in the provision of education, health care, and industrial infrastructure.

About the Authors

A L I C E H. A M S D E N is Leo Model Professor of Economics and professor of political science, Graduate Faculty, New School for Social Research. Her latest book is Asia's Next Giant: South Korea and Late Industrialization. She recently coauthored with Takashi Hikino "Borrowing Technology and Innovating: Explorations of T w o Paths of Industrial Development," in Learning and Technological Change. Amsden is interested in how the state and the enterprise influence competition in late industrialization. S h e is c u r r e n t l y w o r k i n g on a book about the p r o c e s s of late reindustrialization in East Central Europe with Jacek Kochanowicz and Lance Taylor.

is Henry R. Luce Professor of International Relations at Brown University. He was previously director of the School of International Relations at the University of Southern California and has also taught at Yale University. He has recently been writing on the economic reform process and the role of the state in the economy. He is the editorauthor of Debt: International Financial Negotiations and Adjustment Bargaining.

T H O M A S J. BIERSTEKER

has been professor of economics at Williams College since 1962. He has worked in various capacities in Iran, Pakistan, India, Chile, Malaysia, and Egypt for extended periods. The recently published book (with collaborators), Poverty, Equity, and Growth in Malaysia and Sri Lanka, studies in some detail the way in which developing countries can leam from the rich countries without sacrificing their culture and autonomy. HENRY J. BRUTON

S T E P H A N H A G G A R D is a professor of political science in the Graduate School of International Relations and Pacific Studies, University of California, San Diego. He taught at Harvard University from 1983-1991 and is the author of Pathways from the Periphery: The Politics of Growth in the Newly

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Industrializing Countries and coeditor, with Robert Kaufman, of The of Adjustment.

Politics

is professor of political science at Rutgers University. He has written extensively on the political economy of Latin America and on the politics of economic adjustment. With Stephan Haggard, he is co-editor of The Politics of Economic Adjustment: International Shocks, Distributive Conflicts, and the State. He is also author of The Politics of Debt in Argentina, Brazil and Mexico, and coeditor, with Barbara Stallings, of Debt and Democracy in Latin America. ROBERT KAUFMAN

is professor emeritus, University of Glasgow; visiting professor at the University of California, Berkeley; and a fellow of the British Academy. He is the author of The Soviet Economic System, An Economic History of the USSR, Economics of Feasible Socialism, and Stalinism and After. ALEC NOVE

is professor of economics, Uppsala University, Sweden. He was assistant secretary-general in the Department of International Economic and Social Affairs of the United Nations from 1985-1992. He was executive secretary of the Brandt Commission from 1978 to 1980, and has been an advisor to the OECD, the World Bank, and other international organizations. Among his publications are "Negotiating International Economic Order," in The Theory and Experience of Economic Development: Essays in Honor of Sir W. Arthur Lewis, and "Does Development Economics Have a Future?" in Entwicklungsthoerie-Entwicklungspraxis: Eine kritische Bilanzierung. GORAN OHLIN

F. P A P A N E K is professor of economics at Boston University and president of the Boston Institute for Developing Economics (BIDE). He has directed major research and advisory projects, several during the twenty years he was on the Harvard University faculty. Among his publications are "The Effect on Income Distribution of Development, The Growth Rate and Economic Strategy," in Journal of Development Economics; "Market or Government: Lessons from a Comparative Analysis of Pakistan and India," in The Pakistan Development Review; Lectures on Development Strategy: Growth, Equity and the Political Process in Southern Asia; and Pakistan's Development: Social Goals and Private Incentives. GUSTAV

L o u i s P U T T E R M A N is professor of economics at Brown University and associate director of the University's Center for the Comparative Study of Development, a Watson Institute affiliate. He is the author of numerous articles in the fields of economic systems and economic development. His books include Division of Labor and Welfare and Continuity and Change in China's Rural Development.

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is the Frank Altschul Professor of International Economics at Yale University. He was director of the Pakistan Institute of Development Economics and of the Economic Growth Center at Yale. Between 1965 and 1967, he served as assistant administrator for program and policy in the U.S. Agency for International Development. He has written extensively on theoretical and policy-related issues of development, including "The Role of Government: Comparative International Experience" in International Competitiveness and "The Role of Institutions in Transition Growth: The East Asian Newly Industrializing Countries" in World Development.

GUSTAV RANIS

is professor of sociology at Brown University and director of the University's Center for the Comparative Study of Development, a Watson Institute affiliate. He is the author of Power and the Division of Labour, coauthor of Capitalist Development and Democracy, and coeditor of Bringing the State Back In. DIETRICH RUESCHEMEYER

S E L D E N is chair of the Department of Sociology at the State University of New York, Binghamton. He is the author of The Political Economy of Chinese Development, coauthor of Chinese Village, Socialist State, and of Re-Thinking Vietnamese Socialism: Doi Moi in Comparative Development. MARK

P. STREETEN is a consultant with the UNDP and has been a consultant with the World Bank. He has held positions with the Economic Development Institute; the Institute of Commonwealth Studies, Queen Elizabeth House, Oxford; and the Overseas Development Council. Among his numerous publications are What Price Food?; Mobilizing Human Potential; Development Perspectives; and The Frontier of Development Studies.

PAUL

Index

A d e n a u e r , K o n r a d , 49 A f r i c a : centralized a u t h o r i t y , 12; c i r c u m v e n t i o n of loan c o n d i t i o n a l i t y , 33; egalitarianism, 90-91; e t h n i c c o m p l e x i t y , 12; real w a g e s , 67; wage differentials, 66 A g r i c u l t u r e : colonial heritage, 87; d i v e r s i f i c a t i o n , 182; e x t e n s i o n services, 16, 158; g r o w t h rates, 178, 187(tab); i n c e n t i v e s , 1 4 0 - 1 4 1 , 157; i n f r a s t r u c t u r e , 88, 158, 178; i n v e s t m e n t , 164, 181, 1 8 7 - 1 8 8 ; labor force, 131; land distribution, 75; options, 190-192; o u t p u t prices, 1 6 4 ( n l ) ; research and d e v e l o p m e n t , 99, 159; s e l f - s u f f i c i e n c y , 179; s m a l l h o l d e r , 162; s u b s i d i z a t i o n , 154, 157; s u b s i s t e n c e , 153, 181; wages, 146 A m s d e n , Alice, 2, 3, 5, 5 3 80, 100, 2 5 2 , 2 5 6 , 2 5 8 Argentina: productivity g r o w t h rate, 56; wages, 67 Ascher, W i l l i a m , 2 3 4 Asia, East: citizen o b l i g a t i o n s to state, 90, 117; g o v e r n m e n t intervention, 93; NICs, 1, 2, 12; s h i f t to laissezfaire, 92 Asia, S o u t h e a s t : a d j u s t m e n t aid, 33; i m p o r t substitution, 87 Assets: r e d i s t r i b u t i o n , 35; transfer, 197 A u t h o r i t a r i a n i s m , 5, 233; elections under, 2 2 8 229; and structural adjustment, 226

Authority: centralized, 12; disintegration in Russia, 2; private sector, 28; public sector, 27, 28 A u t o n o m y : embedded, 230, 257; sacrificing, 25; state, 256, 257 Baker, James, 195 B a l a n c e - o f - p a y m e n t s , 47, 96, 97, 103, 112, 114, 115, 120, 122, 2 2 1 Bangladesh: exports, 138, 139(tab), 156; government intervention, 131-164; growth rates, 134(tab), 137; income, per capita, 131; income distribution, 145(tab), 147-148(tab); investment, 137(tab); market orientation, 1 3 1 164; n o n g o v e r n m e n t a l o r g a n i z a t i o n s , 21; poverty alleviation, 161; real wages, 149(tab), 161; state intervention, 4 Banking: commercial, 94, 135; currency creation, 96; nationalization, 141; public sector, 9 4 Baran, Paul, 60 Barone, Enrico, 39, 41 Bauer, Peter, 85 Bhagwati, Jagdish, 19, 30 Biersteker, T h o m a s , 4, 195-214 Birth rates, 179 Bolivia, structural adjustment, 2 2 3 Borrowing: for consumption, 44-45; productive, 44; for speculation, 4 4 - 4 5 Botswana: government intervention, 109; public sector, 110 Boulding, Kenneth, 118 Boyes, Roger, 49

267

Brady, Nicholas, 195 Brazil: h y p e r i n f l a t i o n , 76; i n c o m e distribution, 76; regional diversity, 88; w a g e differentials, 66 Brezhnev, Leonid, 40 Broad, Robin, 2 2 6 Bruton, Henry, 4, 5, 1 0 1 125, 2 5 2 B u c h a n a n , James, 31, 35(n5), 2 4 8 B u d g e t : balancing, 44; deficits, 44, 9 7 ; m a i n t e n a n c e , 121; surplus, 114 Bureaucracy: central, 22; d i s i n t e r e s t e d n e s s , 106; economic, 230-232; hierarchical, 40; recognition of public duty, 110; red tape in, 20; socialist, 40; state as agent, 26 Calder, Kent, 91 Callaghy, Thomas, 227 C a n a d a , health p r o v i s i o n s , 42 Capital: a c c u m u l a t i o n , 60; costs, 141; d i s c i p l i n e by state, 61; f o r e i g n i n f l o w s , 97; f o r m a t i o n , 108; international, 171; source of growth, 104; variable cost, 154 Capitalism: competitive, 260(n7); contradictions, 2 0 1 ; introduction, 48; peripheral, 26; vs. planning, 9 Cartels, 71; drug, 199, 235; i n f o r m a l , 152; legislation against, 3 0 Centralization, 98, 176177, 190 C h i l e : h y p e r i n f l a t i o n , 76; i n c o m e distribution, 12; p r i v a t i z a t i o n , 197, 198, 2 0 5 ; productivity g r o w t h rate, 56; r e f o r m consolidation, 232;

268

•

INDEX

special interest groups, 17; structural a d j u s t m e n t , 223 C h i n a : agricultural p r o d u c t i o n , 182, 183, 184(tab), 185, 187(tab); c o l l e c t i v i z a t i o n , 174— 181; Cultural R e v o l u t i o n , 181; development, 171-192; F i v e Y e a r Plans, 175; Great L e a p Forward, 177, 181; g r o w t h rates, 178; h o u s e h o l d contracts, 1 8 1 - 1 9 0 ; industrial g r o w t h , 178; i n v e s t m e n t , 181; land r e f o r m , 182; liberalization e f f e c t s , 29; mixed e c o n o m y , 174, 1 8 1 - 1 9 0 , 191; p e o p l e ' s war, 1 7 2 - 1 8 1 ; poverty alleviation, 185; rural d e v e l o p m e n t , 4, 173; self-reliance, 1 7 2 - 1 7 3 ; tax r e f o r m , 173, 174; u r b a n i z a t i o n , 184, 185 Civil service: r e f o r m , 236; w a g e inflation, 67 C o l l e c t i v i z a t i o n , 173, 176; Chinese, 174-181; decline, 189; disintegration, 193(n20); large-scale, 176; m o b i l i z a t i o n , 174— 176, 179; Soviet, 1 7 4 175; s t a t e - i m p o s e d , 176, 177 Colombia, reform consolidation, 235 C o l o n i a l i s m , 12, 54, 67, 86, 87, 88, 90, 104, 201, 210 C o m m o d i t y e x c h a n g e s , 48 Communication t e c h n o l o g y , 10, 13 C o m p a r a t i v e a d v a n t a g e , 58, 6 2 , 101, 155 C o m p e t i t i o n , 54; capacity for, 124; c h e a p labor a d v a n t a g e , 55; d e v e l o p i n g countries, 58; f o r e i g n , 46, 55, 56; incentives, 16, 56, 57; international, 1, 55; lack o f , 46; m a i n t a i n i n g , 22; m a r k e t function, 16, 48; o p e n n e s s in, 6 9 ;

protection, 20, 156; public sector, 19, 30; real, 44; reduction, 114; in rent seeking, 30, 31; stimulating, 47; wasteful, 27 C o n f l i c t : cooperative, 21, 32; of interest, 32; resolution, 2 3 4 - 2 3 5 Contracts: antisocial, 36(n20); commercial, 48; private allocation, 18; state enforcement, 16; voluntary, 31 C o n v e r t i b i l i t y , 47 Cooperation: publicprivate, 19, 20, 23, 117; in rural economy, 173; self-interest in, 32 C o o p e r a t i v e s , 46, 173, 174; advanced, 175; c o n s u m e r , 197; elementary, 175; smallscale, 179 C o r r u p t i o n , 20, 249, 255, 258, 2 6 1 ( n 2 5 ) ; official, 12, 188, 189; private sector, 203; in privatization, 206; in subsidization, 122 Costs: capital, 141; consumer, 207; labor, 141, 154; social, 109, 206; tariffs, 154 Credit: allocations, 90, 93, 94; consumer, 44; to poor, 161 C r o w d i n g - i n effect, 19, 36(nl0) Culture of poverty, 123 Currency: competition, 69; c o n v e r t i b i l i t y , 47; costs, 124; creation, 48, 96, 2 4 8 ; depreciation, 6 7 - 6 8 ; devaluation, 73, 209; fixed, 67; limits, 48; overvaluation, 103; pegged, 67; supply, 106, 119, 121; undervaluation, 119 C z e c h o s l o v a k i a : exchange rates, 48; industrial structure, 45; political c h a n g e , 41; u n e m p l o y m e n t , 44 Datta-Chaudhuri, Mrinal, 30 Debt: crises, 96; foreign,

67; public, 29; United States, 44 Decentralization, 98, 204; condition for loans, 33; industrial, 94; interregional disparities in, 22; of power, 15; private sector, 199 D e c i s i o n m a k i n g , 233, 234; centralized, 22, 2 0 4 ; decentralized, 22, 204; Russian, 48; structure, 26 Deficits: current account, 131; public- sector, 211; state fiscal, 201, 202, 203 Deflation, 67 de Gaulle, Charles, 49 Deindustrialization, 61 Demand: fall in, 44; internalization, 118; for labor, 121, 124, 150 Democracy, e f f e c t on economic growth, 10 Deregulation, 132, 137, 151, 155, 156, 198; condition for loans, 33; consumer credit, 44; growth in, 135; in housing, 43; India, 132; Korea, 81(n27) de Soto, Hernando, 12 Devaluation, 73, 156; exchange rate, 58; and labor costs, 6 7 - 6 8 ; Mexico, 9 6 Development: capital formation in, 103; capital-intensive, 161; Chinese, 1 7 1 - 1 9 2 ; c o m m u n i t y , 160; comparative, 8 5 - 1 0 0 ; as displacement exercise, 105; domestic saving in, 63, 136(tab); early phases, 8 5 - 1 0 0 ; foreign savings, 136(tab); human, 12, 16; international conflict in, 11; low-wages in, 58; of markets, 3; openness in, 102; privatization in, 1 9 5 - 2 1 4 ; role of exports, 1 0 5 - 1 0 7 ; role of income equality, 3; rural, 175; social, 108; state role in, 3; tax influence, 131

INDEX

Diaz-Alejandro, Carlos, 69, 126(n2) Dictatorship, military, 11 Dirigiste. See Intervention, government Discrimination, price, 28 Disequilibrium, investment, 45 Dislocations: from Depression, 108; world economic, 104 Distortion: economic, 151154; government intervention in, 2 4 - 2 5 , 155-156; labor market, 66; price, 15, 35(n2), 53; private, 35(n2); public, 35(n2); wage, 67 Distribution: income, 7 2 75, 73, 74(tab), 75, 76, 77, 78, 79, 83(n62), 119, 143-151, 211; land, 75; in technology, 10 Diversification, 115 Dore, Ronald, 118 Downs, Anthony, 24 Economic: bureaucracy, 2 3 0 - 2 3 2 ; development, 1; efficiency, 2; liberalization, 5 Economic growth: democratic effects, 10; technological effects, 10; Western, 10 Economy: collectivecentered, 171; domestic, 4; East Asian, 17; external, 42; household, 199; low-wage, 58; market, 48, 60; mixed, 3, 46, 48, 174, 181190, 191; political control, 1; protection, 4; socialist political, 1; state role, 1; transformation capacity, 112, 115 Education, 158, 225; compulsory, 94; funding, 160, 161; Japan, 12; state responsibility, 27, 34, 42, 49; universal, 161 Efficiency: achievement process, 31; allocative, 202; government intervention and, 156-

160; market, 17, 131, 158; political base, 32; private sector, 202, 205, 206; in resource allocation, 15; subsidies in, 61; suppliers, 55 Egalitarianism, 90-91, 180 Egypt: modernization, 118; public sector, 110 Employment subsidization, 162 Empowerment, of poor, 32 Engels, Friedrich, 39 Entrepreneurship, 41; Eastern European, 46; postcolonial, 152; and public ownership, 46; willingness, 104 Ethnic: diversity, 89; divisions, 236; integration, 89; regional policies, 46 Europe, Eastern: market mechanisms in, 1; private capital in, 46; privatization, 47, 195; public sector employment, 29; social organization, 9 Europe, Western, health provisions, 42 Evans, Peter, 230 Exchange rates, 70; devaluation, 58, 67, 68; dual, 261(n20); equilibrium, 114, 124; flexible, 57, 93, 95; foreign, 45, 58; free floating, 63; Japan, 67; Latin America, 58; overvaluation, 121, 154; and purchasing power, 48; real, 53; undervalued, 4, 5, 114, 115, 119, 122, 123, 124 Exchanges, commodity, 48 Expenditures: defense, 29; reduction, 44; state, 44 Exports, 4; agricultural, 131; agro-industrial products, 65; capital, 75; earnings, 86, 139(tab); expansion, 138-140; growth, 105-107; importance, 101; incentives, 19; laborintensive, 94; manufactured, 65; monitoring, 231;

•

269

negative protection, 155; nontraditional, 101, 112, 114, 115, 153, 155, 156, 162, 261(n20); oil, 65, 132, 133; orientation, 9 2 - 9 7 ; processing zones, 94, 225; promotion, 5, 102, 115; risks, 152-153; role in development, 105-107; substitution, 87, 94; surplus, 114, 121; traditional, 103, 106; union involvement, 17 Externalities, 42 Fei, John, 104 France, public enterprise competition, 22 Free rider problem, 42, 174, 180, 222, 223, 256 Friedman, Milton, 39, 41, 42 Frydman, Roman, 5(nl) Fungibility, 33 Geddes, Barbara, 236 Germany: flexible specialization, 20; state role in, 10; welfare in, 49 Gerschenkron, Alexander, 53, 54, 55, 76, 78 Getting prices right, 15, 16, 19, 20, 68-70, 100, 120, 121-123, 2 6 0 ( n l 7 ) Getting prices wrong, 54, 61, 62, 65-78, 100 Ghana: privatization, 197; reform consolidation, 231; structural adjustment, 223 Gorbachev, Mikhail, 23, 40 Government: and choice, 123-125; competence, 91, 129(n49); confiscatory power, 91; control by wealthy, 12; credibility, 90, 98, 175; deficits, 95; electoral cycles, 228-229; encouragement of rent seeking, 27; during export orientation, 9 2 97; macroeconomic policies, 95; overcommitment, 89; participation in production, 11; reform

270

•

INDEX

initiating, 32; size and economic growth, 31. See also State Great Britain: demobilization effects, 29; inflation, 44; nongovernmental organizations, 2 3 - 2 4 ; privatization, 42, 47, 207, 208; regional imbalance, 46; state role in, 10 Growth: agricultural, 187(tab); aid effects, 135-137; causal factors, 135-143; differing rates, 61; effect of government intervention, 131-164; employment, 103; indigenous, 113; and openness, 127(nl3); per capita, 148; population, 66; productivity, 103, 115; public expenditure in, 31; rates, 40, 6 4 - 6 5 , 66, 70, 76, 134(tab); state role in, 119-120; of well-being, 113, 125 Haggard, Stephan, 2, 5, 2 2 1 - 2 3 8 , 257 Harrod, R. F„ 103, 104 Hayek, Frederich, 42 Health services, 86; cooperative, 189; funding, 160; Japan, 12; state responsibility, 49 Hirschman, Albert, 234, 252 Hobbes, Thomas, 25 Hofheinz, Roy, 91 Hong Kong: government intervention, 79; infrastructure, 63 Horwitz, Morton, 247 Housing: state responsibility, 49; subsidized, 43 Hungary: industrial structure, 45; market reform, 40, 46; political change, 40 Hyperinflation, 76 IMF. See International Monetary Fund Imports: capital goods, 108; competition with foreign, 56; controls, 93, 97, 103, 157;

exchange rate effect, 68; liberalization, 30; prices, 67; protection, 253 Import substitution, 3, 71, 85, 87, 91, 92, 93, 96, 102, 126(nl), 126(n4), 142, 201, 202; decline, 105-107, 111, 113; dominance, 102-105; government role, 106; Latin American, 87; rent seeking in, 106-107 Income: allocation, 243; distribution, 12, 17, 35(n2), 72-75, 73, 74(tab), 75, 76, 77, 78. 79, 83(n62), 119, 143151, 211; earning opportunities, 17; equality, 3, 75, 83(n63), 91, 179, 180; in kind, 180; national, 149(tab); redistribution, 3, 26, 44; rural, 175, 185, 186; stagnation, 190; transfer, 160; unequal distribution, 34 Incremental Capital Output Ratio, 143 India: deregulation, 132; devaluation, 33, 39(n38); education, 158; exports, 138, 139(tab); government intervention, 131-164; growth rates, 134(tab), 136, 137; income, per capita, 131; income distribution, 75, 145(tab), 147—148(tab); industrial base, 132; infrastructure, 159; investment, 137(lab); market orientation, 131164; nongovernmental organizations, 21; poverty alleviation, 160, 161; private sector, 132; privatization, 197; public sector, 19, 20; real wages, 149(tab), 161; reform consolidation, 231; socialist economy, 110; state intervention, 4; subsidization in, 132 Indigenization, 198,

200

Indonesia: asset consumption, 165(n3); exports, 138, 139(tab), 156; government intervention, 109, 131— 164; growth rate, 64, 134(tab); income, per capita, 131; investment, 135, 137(tab); market orientation, 131-164; oil revenues, 132; plantation sector, 132, 142, 152; poverty alleviation, 161; real wages, 149(tab); state intervention, 4; subsidization, 157 Industrial: commitment by investors, 45; estates, 94; investment, 141142; relocation, 62, 63; subsidization, 3; zoning, 46 Industrialization: distorted structure, 45; gestation periods, 135, 165(nll); laws of, 56; productivity growth rate, 56; rural, 184; state-led, 200; and wage increases, 62 Industrialization, late: comparative, 85-100; government intervention, 5 3 - 8 0 ; income distribution, 74(tab); investment opportunities, 6 2 - 6 5 ; Korea, 3; labor supply, 66; macroeconomic shock, 78-80; political systems, 66; productivity, 69; rent seeking in, 59-61; special conditions, 2 5 1 255; technology borrowing, 53 Industrial Revolutions, 53, 54, 56, 62, 77 Inflation, 70, 95, 112, 188-189, 211; British, 44; cost-push, 73; effect of welfare state, 17; and subsidies, 122; vs. taxation, 9 6 - 9 7 Informal sector, 23-34, 152, 199, 210 Infrastructure: agricultural, 88, 178; financing improvements, 45;

INDEX

human, 55; institutional, 158; investment, 17, 19, 186; market, 48; nonexcludable, 28; nonrivalrous, 28; organizational, 88, 89; physical, 17, 55, 86, 88, 89, 158, 159; as public investment, 121; quality, 55; social, 17; state responsibility, 9, 34, 41-42, 43 Interest groups, 21, 43, 107, 224; control of resources, 75; disparate, 89; manipulation of state, 75 Interest rates, 69; commercial, 69, 70; controlled, 97; crowding-out effect, 19; curb market, 69; differentials, 93; Latin America, 58; negative, 97; payments, 29; raising, 44; real, 95; reform, 93; subsidized, 20 International Monetary Fund (IMF), 92, 97, 221; comparitive advantage theory, 58; deregulation program, 135; devaluation policy, 18; Extended Fund Facility, 227; performance criteria, 207; privatization views, 195 Intervention, government: Asian, 93, 131-164; Botswana, 109; and capital markets, 54; costs, 59; distortion effects, 15, 24, 155156; in economic development, 1; effect on economy, 1-21, 4; effect on growth, 131164; efficiency, 156160; in entrepreneurship, 104; equity, 131-164, 160161; excessive, 87; Hong Kong, 79; income distribution, 17; Indonesia, 109; Japan, 19; justifications, 34; Korea, 79, 109; in late industrialization, 53-80;

Latin American, 96; Malaysia, 109; in market failure, 34; market function contribution, 16; objections to, 34; Philippines, 97; power groups, 21; for pressure groups, 26; price formation, 16; purposes, 200-202; quality, 7 2 75; rationale, 59; reduction, 29; rent seeking, 30, 107; Singapore, 79; Taiwan, 79, 109; tax activities, 16; Thailand, 97, 109; theories, 2; types, 2 4 8 251; variation in quality, 54; and wages, 4 Investment, 58; agricultural, 164, 181, 187-188; capital, 60, 69; commitment to industry, 45; computerprogrammed, 47; controls, 140; discouraging, 44; disequilibrium in, 45; domestic, 140; in education, 73; efficient, 141-142; and employment growth, 103; foreign, 17, 48, 62-65, 64(tab), 124, 140, 153, 164(nl), 198; gross, 64(tab); incentives, 121; influencing, 121; infrastructure, 17, 19, 186; labor-intensive, 62-65; modern sector, 105; multinational, 63; plantation, 160; private, 135; public, 19, 44, 47, 121, 225; rates, 112, 113, 137(tab); relocation, 64; restrictions, 198; risk, 156; state-supported, 95; stimulation, 19, 53; strategy, 49 ISI. See Import substitution Italy: flexible specialization, 20; regional imbalance, 46 Japan: economic policies, 12; exchange rate policy, 67; human

•

271

development in, 12; industrialization problems, 57; integrated production, 55; publicprivate cooperation, 19, 117; state role in, 10; subsidization, 54, 72; trade surplus, 45 Kahler, Miles, 222 Kaufman, Robert, 2, 5, 2 2 1 - 2 3 8 , 257 Keegan, William, 44 Keynes, John Maynard, 44, 45 Klitgaard, Robert, 29 Korea: deregulation, 81(n27); devaluation, 53, 67; economic success, 1; export growth, 105-107; foreign investment, 63; government intervention, 61, 79, 109; industrialization problems, 57; late industrialization, 3; productivity, 53; public enterprise competition, 22; public-private cooperation, 19; public sector enterprises, 19; reform consolidation, 231; state role, 2; structural adjustment, 223; subsidization, 54, 67, 68, 71, 72; wage differentials, 66 Kuznets, Simon, 89 Labor: cheap, 55; costs, 6 7 - 6 8 , 141, 154; demand for, 44, 121, 124, 150; discipline by state, 61; division of, 6 2 , 102, 111, 2 1 0 ;

excess, 66; incentives, 39, 186; intensification, 151, 210; intensive goods, 54, 55, 57, 61, 65, 67; intensive investments, 6 2 - 6 5 ; legislation, 154; lowwage, 162; management problems, 124; marginal product, 152; market, 44, 55, 69; migration, 66; mobilization, 173; opportunity cost, 35(n2); productivity, 77,

272

•

INDEX

7 8 ( t a b ) , 112, 179; r e l a t i o n s , 57; repression, 66; s u b s i d i e s , 152, 154; s u p p l y , 66; surplus, 88, 9 4 ; f r o m traditional sector, 105; turnover, 2 0 4 ; underused sources, 173; u n i o n s , 6 6 , 154, 161; u n s k i l l e d , 144, 146, 150, 152, 162 Lacey, Robert, 231 L a i s s e z - f a i r e , 15, 22, 34, 45, 46, 92, 9 3 , 109 Lai, D e e p a k , 17, 35(n5), 85 Land: bondage, 177-181; in c o l l e c t i v i z a t i o n , 176; d i s t r i b u t i o n , 75, 88; o w n e r s h i p , 176; r e f o r m , 75, 9 5 , 161, 163, 175, 180, 182, 2 4 9 Latin A m e r i c a : a d j u s t m e n t aid, 33; centralization, 9 8 ; d e b t crises, 96; development obstacles, 88; e g a l i t a r i a n i s m , 9 1 ; f o r e i g n e x c h a n g e rates, 58; g o v e r n m e n t credibility, 90; government intervention, 92, 96; i m p o r t s , 118; i m p o r t substitution, 85, 87, 96; interest rates, 58; inward migration, 66; oligarchy in, 12; private sector, 9 6 ; public sector, 110; role of state, 11; subsidization, 67 L e a d i n g sector, 5 3 L e g i s l a t i o n : anticartel, 30; a n t i m o n o p o l y , 30; labor, 154; w a g e , 154 Lerner, A b b a , 2 4 L e v y , Brian, 2 2 4 L e w i s , A r t h u r , 6 6 , 104, 116, 119, 121, 123, 126(n7) L i b e r a l i s m vs. p l a n n i n g , 11 L i b e r a l i z a t i o n , 195, 2 0 2 ; c o n d i t i o n f o r loans, 33; e c o n o m i c , 196, 197, 198; i m p o r t , 30, 9 3 ; negative effects, 29 Licensing, marketdamaging, 20 L i f e e x p e c t a n c y , 179, 181; e f f e c t of liberalization, 29

Lipton, Michael, 16, 30 Loans: circumventing c o n d i t i o n a l i t y , 33; structural adjustment, 33, 73, 195, 2 0 4 L o b b i e s , 21 L o c k e , John, 2 5 Malaysia, 63; g o v e r n m e n t i n t e r v e n t i o n , 61, 109; growth rate, 64; p r i v a t i z a t i o n , 197; r e f o r m consolidation, 2 3 1 ; subsidization, 72 Management: i n e x p e r i e n c e d , 110; initiative, 47; k n o w l e d g e , 116; selfinterest, 47; separated f r o m ownership, 46; systems, 57; in t e c h n o l o g y , 10 M a o Zedong, 172, 175, 176 Market, 1; allocative f u n c t i o n , 17; a l t e r n a t i v e s , 39; behavior, 22; bias against, 90; black, 30; capital, 47, 94; cartelized, 35(n5); c o l o n i a l , 86; c o m p e t i t i v e , 48, 56, 57; creative function, 17; curb, 69, 1 7 6 - 1 7 7 ; dependence on c o m p e t i t i o n , 16; d e v e l o p m e n t , 3; as disciplinarian, 56-57; d o m e s t i c , 19, 58, 87, 153, 155, 157; d o m i n a t i o n , 45; e f f i c i e n c y , 17, 131, 158; failure, 17, 34, 54, 59, 68, 92, 100, 106, 201, 2 0 2 , 204, 2 6 0 ( n l 7 ) ; fluctuations, 47; free, 22, 26, 31, 34; g o v e r n m e n t bond, 69; illegal, 31; imperfections, 151-154; i n c e n t i v e s , 158; infrastructure, 48; international, 87; labor, 44, 48, 55, 69; in mixed economy, 181-190; need f o r states, 20; open capital, 69; orientation, 33; parallel, 30; prices.

15; protection, 19, 174; reform, 4 0 , 2 2 1 - 2 3 7 ; regulations, 20; relationship to state, 9; reliance on, 104; role in u n e m p l o y m e n t , 44; segmented labor, 80(n 11); s e l f - c o r r e c t i o n , 44; s h o r t c o m i n g s , 54; speculation in, 4 7 ; state role, 5 ( n l ) ; world capital, 113 Marshall, Alfred, 9 M a r x i s m , 25, 39, 171, 201. 233 Meade, James, 24 Melman, Seymour, 47 Mercantilism, 9 Mexico: devaluation, 96; government intervention, 96; m a c r o e c o n o m i c policies. 96; p r i v a t i z a t i o n , 197, 207; r e f o r m consolidation, 230-231; regional i m b a l a n c e , 46; structural a d j u s t m e n t , 223; trade union m o v e m e n t , 66; wages, 67 Military rule, 11, 12, 89 Mill, John Stuart, 27 M i n i m a l i s m , 3, 5, 1 5 - 3 5 , 1 0 9 - 1 1 1 ; and pricism, 16-20 Minorities: castes, 6 6 , 117; ethnic, 21, 55, 89; in l a b o r - i n t e n s i v e industry, 55; w o m e n , 21, 5 5 Modern sector: capital in, 108; investment, 105; p r o d u c t i v i t y , 104, 105 M o n o p o l i e s , 198; e f f i c i e n c y losses, 2 4 8 ; legislation against, 30; natural, 28, 41, 49, 94, 158, 205; power, 35(n2); p r e v e n t i o n , 2 0 8 ; reduction, 17; regulation, 48; state, 11 M o r i s h i m a , M i c h i o , 118 Mortality rates, 179; e f f e c t of liberalization, 2 9 Motivation: complexities, 43; m a n a g e m e n t , 75, 83(n63); worker, 73, 7 5 Myint, Hla, 58 Myrdal, Gunnar, 11, 27, 8 5

INDEX

Nationalism, 87, 89, 91, 93, 201 Nationalization, 132, 160, 163, 200 Nelson, Joan, 234 Neocolonialism, 60 Newly Industrializing Countries (NICs), 1, 2, 12 NGOs. See Organizations, nongovernmental NICs. See Newly Industrializing Countries Nigeria, privatization, 197 North, Douglass, 35(n5), 223 Nove, Alec, 2, 3, 5, 3 9 ^ t 9 Ohlin, Goran, 2 - 3 , 9 - 1 3 , 249 Oligarchy, Latin American, 12 Olson, Mancur, 25, 35(n5) Openness: competition in, 69; definition, 101; excessive, 123; and growth, 127(nl3); problems, 107-109; rise, 105-107 Organizations: coherence, 230; hybrid, 23-24; nongovernmental, 2 0 21, 2 3 - 2 4 ; participatory forms, 32; political, 91; private voluntary, 2 0 21; social, 125; voluntary, 2 3 - 2 4 , 199 Overcentralization, 41 Overvaluation, 121, 154 Pakistan: devaluation, 138; education, 158; exports, 138, 139(tab), 156; government intervention, 131-164; growth rates, 134(tab), 136-137; income, per capita, 131; income distribution, 145(tab), 147-148(tab); infrastructure, 159; investment, 136, 137(tab); market orientation, 131-164; poverty alleviation, 161; real wages, 149(tab), 161; reform consolidation, 231; state intervention, 4

Panichapat, Chackchai, 71 Papanek, Gustav, 1-2, 4, 5, 252 Patronage, 227 People's war (China): political economy, 172— 181; self-reliance, 172173 Performance, effect of motivation, 43 Personnel: managerial, 22, 118; technical, 22 Peru: regional diversity, 88; wages, 67 Philippines: development obstacles, 88; government intervention, 97; performance standards, 73; privatization, 197; reform consolidation, 232 Pigou, A. C„ 24 Pinsker, Boris, 49 Planning: alternatives, 3; central, 3, 10, 11, 40; enterprise, 3 9 ^ 0 ; failures, 10; regional, 46; town, 46; vs. capitalism, 9; vs. liberalism, 11 Plantation sector, 132, 142, 152, 160; investment in, 160 Poland: exchange rates, 48; industrial structure, 45; political change, 41; unemployment, 44 Policies: benchmarks, 68; organizational, 95; pricing, 16; public, 46, 58; regional, 46; variety, 9 - 1 3 Political economy: neoclassical, 29-31; normative, 29, 31-32 Political: instability, 11; organization, 91; repression, 64, 66, 75, 172, 177, 189 Politics: endogenizing change, 20; ethnic constraints, 12; in late industrialization, 66; repression and unions,

66 Population: control, 180; growth, 183; homogeneous, 88;

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immigrant, 88; indigenous, 88; pressure, 131, 172 Poverty: alleviation, 150— 151, 162-164, 185; effect of government intervention, 131; and income distribution, 143-151; index, 144; policies for reduction, 26; postcolonial, 153 Power: dominant group, 21; government confiscatory, 91; misuse, 24, 39; monopoly, 35(n2); purchasing, 48; redistribution, 35; social, 21; sources, 124 Prebisch, Raul, 85 Pressure groups, 21; creating, 32; state action for, 26 Prices: accounting, 15; agricultural, 164(nl), 186; collusion, 56, 75; discrimination, 28; distortion, 53; factor, 103; fluctuations, 132, 157; formation, 16; free market, 35(n2); getting right, 15, 16, 19, 20, 68-70, 100, 120, 121123, 2 6 0 ( n l 7 ) ; getting wrong, 54, 61, 62, 100; government-controlled, 164(nl); international, 85; manipulation, 68; market, 15; politicized, 20; shadow, 15, 103, 155; social, 68; stability, 120; theories, 54, 57, 59, 69 Pricism, 15, 33; and minimalism, 16-20 Private sector: authority, 28; complementarity with public, 19; corruption, 203; definition, 198; division of labor with government, 102; and economic bureaucracy, 2 3 0 - 2 3 2 ; efficiency, 202, 203, 205, 206; encouragement of privatization, 201; expansion, 203; flexibility, 203, foreign

274

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owned, 201; fragmentation, 199; household economy, 1 9 9 ; I n d i a , 132; p a r t i c i p a t i o n in p u b l i c sector, 197; relationship to state, 12; r e l a t i o n to markets, 22; rent s e e k i n g , 18, 2 7 , 9 9 , 110, 2 0 4 ; w e a l t h c r e a t i o n in, 2 7 Privatization, 248; British, 42; condition for loans, 33; consequences for development, 205-211; c o r r u p t i o n in, 2 0 6 ; d e f i n i t i o n , 1 9 6 - 2 0 0 ; in developing countries, 195-214; Eastern E u r o p e a n , 4 7 , 195; economic arguments, 2 0 2 - 2 0 3 ; f o r m s , 197; in housing, 43; l i b e r a l i z a t i o n in, 2 0 7 , 2 1 2 ; l o a d s h e d d i n g , 13, 198, 2 1 0 , 2 1 4 ; personnel required, 22; political arguments, 2 0 3 - 2 0 4 ; r e f o r m in, 2 1 1 ; r e g u l a t i o n in, 2 0 7 ; R u s s i a n , 195; s o c i a l costs, 4; subcontracting, 197-198, 203, 213, 215(nl0) Production: codification, 5 8 ; c o e f f i c i e n t s , 104; costs, 54, 57; diversified quality, 20; full e m p l o y m e n t l e v e l s , 120; integrated, 55; mass, 62; n e e d s of u s e r in, 4 0 , 4 4 P r o d u c t i v i t y : of c a p i t a l , 112; c o n v e r g e n c e , 113; g a p s , 5 5 , 5 6 , 58; g r o w t h r a t e s , 5 6 , 70, 7 6 , 103, 115; i n c r e m e n t a l , 7 5 ; international levels, 57; j o b t r a i n i n g in, 115; l a b o r , 7 7 , 7 8 ( t a b ) , 112, 179; in l a t e industrialization, 69; r e l a t i o n s h i p to c a p i t a l f o r m a t i o n , 113; t o t a l factor, 54 Protection: from aggression, 25; f r o m competition, 20; d o m e s t i c , 19, 1 4 2 ; e x p o r t , 155; i n f a n t -

i n d u s t r y , 5, 152, 153, 155, 156, 162; m a n u f a c t u r i n g , 102, 103; m a r k e t , 174; t r a d i n g o f f , 25; u n d e r v a l u a t i o n , 114, 115 Public sector: anonymity, 46; authority in, 2 7 , 28; banking, 94; Botswana, 110; c e n t r a l i z e d , 98; c o m p e t i t i o n in, 19; c o m p l e m e n t a r i t y with p r i v a t e , 19; d e c e n t r a l i z e d , 98; direct p r o v i s i o n of s e r v i c e , 41; E g y p t , 110; e m p l o y m e n t r e d u c t i o n , 29; e n t r e p r e n e u r s h i p in, 4 6 ; flexibility, 94; India, 19, 2 0 ; i n v e s t m e n t , 4 4 , 47; K o r e a , 19; L a t i n A m e r i c a , 110; overextension, 31; poverty alleviation, 161, 162; r e f o r m , 2 1 6 ( n l 6 ) ; regional p o l i c i e s , 4 6 ; rent s e e k i n g , 18, 27, 2 9 , 30; r o l e in i m p o r t s u m s t i t u t i o n , 106; selfinterest in, 22, 4 3 ; s o u r c e of capital, 41, 45; wages, 29 Putterman, Louis, 1 - 5 , 192(n7), 193(nl7), 194(n39), 2 4 3 - 2 5 9 Pyasheva, Lyudinila, 49 R a n i s , G u s t a v , 3, 5, 8 5 100, 104, 252, 2 5 8 Rapaczynski, Andrzej, 5(nl) Rawls, John, 25 Reagan, Ronald, 28, 44, 171, 195 R e c e s s i o n , 4 4 , 189 R e c i p r o c i t y , in s u b s i d y a l l o c a t i o n , 61 R e f o r m : civil service, 2 3 6 ; consolidating, 229-236; g o v e r n m e n t initiated, 32; g u i d e s , 31; interest r a t e , 9 3 ; land, 3 8 ( n 3 8 ) , 7 5 , 9 5 , 161, 163, 175, 180, 182, 2 4 9 ; m a r k e t o r i e n t e d , 2, 40, 4 6 , 2 2 1 2 3 7 ; in p r i v a t i z a t i o n , 2 1 1 ; p u b l i c sector, 2 1 6 ( n l 6 ) ; regulatory.

2 0 2 ; rent, 174; s t a t e autonomy, 224-226; tax, 98, 173, 174; t r a d e policy, 223 Regional inequality, 210, 211 Regulation: marketd a m a g i n g , 20; of m o n o p o l i e s , 4 8 ; in p r i v a t i z a t i o n , 2 0 7 ; state, 41; w o r k e r s a f e t y , 2 4 7 Relationships: foreign e c o n o m i c , 120; N G O s and g o v e r n m e n t , 2 0 - 2 1 ; in p u b l i c e n t e r p r i s e s , 2 0 ; state and p r i v a t e sector, 12, 7 3 Renationalization, 205 Rent avoiding, 3 0 - 3 1 R e n t s e e k i n g , 18, 2 7 , 2 9 30, 4 3 , 5 9 - 6 1 , 7 2 , 106, 107, 109, 112, 2 0 4 , 206, 209, 222; e n t r e p r e n e u r s in, 155; government i n t e r v e n t i o n , 107; interest g r o u p s , 7 5 ; postcolonial states, 60; p r i v a t e sector, 9 9 , 110; in p r i v a t i z a t i o n , 2 1 1 ; risks, 70; s o c i a l c o s t s , 30 Research and development, 10, 9 5 , 115; a g r i c u l t u r a l , 9 9 , 159; institutionalization, 56 R e s o u r c e s : a l l o c a t i o n , 15, 101; a v a i l a b i l i t y , 9 1 ; in c o m p e t i t i o n , 4 4 ; as competitive assets, 8 0 ( n l ) ; constraints, 92; c o n t r o l by i n t e r e s t g r o u p s , 75; e n d o w m e n t , 86, 92; h u m a n , 16; inequitable allocation, 2 4 ; m o v e m e n t , 112, 114; public s e c t o r drain o n , 27; in rent s e e k i n g , 30; rural, 179 Reynolds, Lloyd, 91 R i g h t s : h u m a n , 33; p r o p e r t y , 16, 8 6 , 9 9 , 247 R o t h , G a b r i e l , 197 R o u s s e a u , J e a n - J a c q u e s , 25 Rueschemeyer, Dietrich, 1 5, 2 4 3 - 2 5 9 Rural: associations, 94; d e v e l o p m e n t , 175;

INDEX

economy, 173; income, 145(tab), 175, 185, 186; industry, 94, 184; inequality, 190; labor surplus, 94; poverty alleviation, 185; resources, 179; work force, 184 Russia: decisionmaking, 48; disintegration of public authority, 2; exchange rates, 48; market economy, 48 Rutskoi, Alexander, 48 Ruttan, Vernon, 117 Sachs, Jeffrey, 225 Schumpeter, Joseph, 56, 57 Seers, Dudley, 26 Selden, Mark, 4, 5, 171192, 254 Sen, Amartya, 32, 34 Short-termism, 47 Singapore: foreign investment, 63; government intervention, 61, 79; subsidization, 72 Smith, Adam, 9, 18, 30, 34, 43, 44, 46 Social: benefits, 49; choices, 90; contracts, 25, 89; costs, 109, 206; development, 108; indicators, 179; infrastructure, 17; interdependence, 34; interests, 2 3 2 - 2 3 6 ; organization, 125; pacts, 235; peace, 49; power, 21; security, 29; services, 17, 160; stratification, 180; welfare, 160 Socialism, 2; decline, 1, 171; feasible, 46; innovation in, 46; market, 40; Marxian view, 39; mixed economy, 4; state, 200; transition to market economy, 41, 48 Society: civil, 2 0 - 2 1 ; organization, 9 Soviet Union: central planning, 10, 40; economic decline, 40; privatization, 195;

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social organization, 9. See also Russia Specialization, flexible, 20 Sri Lanka: exports, 138, 139(tab), 156; government intervention, 131-164; growth rates, 134(tab); income, per capita, 131; income distribution, 145(tab), 147-148(tab); investment, 137(tab), 165(n2); liberalization effects, 29; market orientation, 131-164; plantation sector, 132, 142, 152, 160; poverty alleviation, 160, 161; real wages, 149(tab); state intervention, 4

enforcement, 16; defense, 27, 34; economic, 1, 101-125, 119-120; education, 27, 42, 49, 110; employment stability, 27; health services, 42, 49, 110; housing, 49; infrastructure, 9, 41^12, 43, 158, 162; institution building, 95; international aspects, 101-125; maintenance of order, 9, 16, 106; monetary stability, 27; production of wellbeing, 114-116, 125; property rights, 16; social service, 17; transportation, 41, 42; welfare, 13, 49

Stabilization, 223 Stagnation: technological, 172; in USSR, 40 Starr, Paul, 197 State: as agent of bureaucracy, 26; authority, 24, 28; autonomy, 256, 257; building, 245-246; corruption, 60; as disciplinarian, 6 1 - 6 2 , 71, 73, 75, 84(n73); failure, 17, 92, 100, 106, 120, 204; investment, 95; minimalism, 3, 5, 109111; mixed economy, 3, 181-190, 191; monopolies, 11; need for markets, 20; obligations to, 90; platonic, 87, 90; and policy reform, 2 2 3 229; power in, 27; predatory, 24, 26, 31,

States, developmental, 255-256 Streeten, Paul, 2, 3, 5, 1535, 251 Structural adjustment, 221; electoral cycles in, 2 2 8 229; regime type, 2 2 6 227 Subsidization, 5, 22, 107, 130(n53), 157; administration, 122; agricultural, 154; allocation, 61, 72; budget deficits, 122; corruption in, 122; earning, 123; employment, 162; government role, 16; housing, 43; Indian, 132; indirect, 162; industrial, 3; infantindustry, 153, 162; interest rates, 20; Japan, 54, 72; Korea, 54, 67, 68, 71, 72; Malaysia, 72; management, 78; necessity for growth, 54; necessity in

72, 86, 87, 90, 256; promotion of common good, 24, 25; regulation, 41; relationship to market, 9; rent seeking, 18, 27, 29-30, 60; socialism, 200; soft, 27; and supernational bodies, 28; theories of, 24—27; universal membership, 27; welfare, 3, 17. See also Government State role, 48; contract

industrialization, 61; to offset inefficiency, 61; performance standards for, 70-72; phasing out, 78-80; preferential, 84(n73); reciprocity, 61; Singapore, 72; Taiwan, 71; Thailand, 71; transportation, 42; to unskilled labor, 152

276

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Supply, relation to d e m a n d , 44 Sweden, welfare in, 49 Symbiosis, public and private sector, 19 Taiwan: compulsory education, 94; devaluation, 53, 67; e c o n o m i c success, 1; export growth, 1 0 5 107; g o v e r n m e n t intervention, 61, 79, 109; industrialization problems, 57; Nineteen Points of reform, 93; productivity, 53; reform consolidation, 231-232; state role, 2; subsidization, 71, 72 Tariffs, 107; allocations, 93, 94; cost, 154; protective, 71 Tax: agricultural, 176; breaks, 107; c o n s u m p t i o n , 162; corporate, 93; e x e m p t i o n s , 93; g o v e r n m e n t activities, 16; holidays, 121; income, 71; indirect, 22; influence on d e v e l o p m e n t , 131; reform, 98, 173 Taylor, Lance, 35(n5) T e c h n o l o g y : borrowing, 53, 55, 57; capitalintensive, 154; changes, 62; choices, 117; c o m m u n i c a t i o n , 10, 13; differing, 58; as disciplinarian, 57; distribution in, 10; globally e f f i c e n t , 54; international, 70; m a n a g e m e n t in, 10; mismodeling, 57-58; new, 6 2 - 6 5 ; original, 56; pioneering, 53, 54, 61, 75; proprietary, 56; side effects, 125; social requirements, 3; transfer, 55, 56, 70; underinvestment in, 153; Western, 104, 105 Thailand, 63; g o v e r n m e n t intervention, 61, 97,

109; growth rate, 64; subsidization, 71 Thatcher, Margaret, 3, 23, 28, 42, 43, 44, 47, 171, 195 Theories: competitive price, 59; dependency, 60; dual economy, 104; flying geese, 62, 64, 93; growth, 104; Listian, 87; Marxist, 25; neoclassical, 27, 2 9 - 3 1 , 58, 59; neodependency, 64; neo-Marxist dependency, 25; normative political economy, 31-32; PaleoMarxist, 26; Platonic, 24, 25; price, 57; product life cycle, 64; public choice, 24, 31, 43, 112; Ricardian, 58, 59; of second best, 30, 34; social contract, 25; standard price, 54, 69; of the state, 2 4 - 2 7 Tinbergen, Jan, 24 Trade: barriers, 86, 97; decline, 108; deficit, 44, 45, 79; foreign, 104, 107, 120; free, 101; growth rates, 108; liberalization, 223; policy reform, 223; restrictions, 70; stimulation, 53; surplus, 45 Traditional sector, 104, 105 Turkey: reform consolidation, 232; structural adjustment, 223 Undervaluation, 114, 115, 119, 122, 123, 124 U n e m p l o y m e n t , 35(n2), 188, 190; among poor, 144; government assistance, 16; market role, 44 Unions, trade, 66, 154, 161; depressed wages, 66; inflation causing, 17; organizing, 66; political repression,

66

United States: debt, 44; executive salaries, 47; trade deficit, 45, 79 Urban: income distribution, 145(tab); problems, 124; protests, 189 Venezuela: reform consolidation, 235; structural adjustment, 223; wages, 67 Vernon, Raymond, 205 Wages: agricultural, 146; as competitive asset, 5 4 55, 57, 58, 59, 65; differentials, 62, 66, 75; distortions, 67; effect of state intervention, 4; ceiling, 48; in industrial development, 53; legislation, 154; low money, 66-67; minimum, 67, 141, 154; public sector, 29; rates in unemployment, 35(n2); real, 44, 67, 144, 148, 149(tab), 1 60, 161; vs. productivity, 53, 56. See also Income Warren, Bill, 26 Waterbury, John, 234 Wealth, creation in private sector, 27 Weber, Max, 246, 255, 260(n7) Welfare: legislation, 91; of politicians, 25; promotion, 25; social, 12, 160; special interest groups, 25; state, 13, 17, 49, 249 Work and income sharing sector, 152 Work, incentives in welfare state, 17 World Bank, 92, 97, 103, 177, 178, 221; comparitive advantage theory, 58; on openness, 1 2 7 ( n l 3 ) ; privatization views, 195, 197; structural adjustment loans, 33, 73, 195, 204 Yarrow, George, 2 0 8 - 2 0 9

About the Book

In the wake of the triumph of neoclassicism in the development economics of the 1980s and the collapse of state socialist economies at the end of that decade, reassessment of the role of the state in development is the order of the day. The authors of this volume resist without exception the temptation to put the question as a simple choice of state or market. Rather, most of the chapters inquire into the conditions under which state action and market functioning can combine to advance growth and development. The book includes theoretical chapters, as well as regional and comparative analyses.

BROWN

U N I V E R S I T Y ' S T H O M A S J . W A T S O N J R . INSTITUTE FOR

INTERNATIONAL

was established in 1 9 8 6 to ensure the continuous development of the University's international dimension, for the benefit of students, faculty, and, ultimately, society. The institute supports faculty teaching and research and sponsors lectures, conferences, and visiting fellows. Its thirteen affiliated centers and programs engage in a broad range of activities, from improving the teaching of international relations and area studies to contributing to policy-oriented research and public outreach.

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