A re development objectives better served by (imperfect) markets than by (imperfect) states? According to one approach to development policy—termed “neo-liberalism” in this book, and deemed to be the prevailing orthodoxy at the World Bank and IMF—the answer is an unqualified “yes.” The 15 papers in this book try to test that answer.
It is plainly preposterous to say that markets alone can deliver all that could reasonably be wanted out of economic development; that position is easy to dismiss, as a number of papers in this volume show. It is also hard to accept as a characterization of what the World Bank and IMF advocate and do; virtually all of their lending is, after all, to governments.
So the various authors of this book might be accused of setting up and knocking down a straw man. But that would be unfair, since a number of these authors are actually struggling with one of the most difficult and important issues in development policy: the optimal level of state intervention. During the 1970s and 1980s, a number of economists (Balassa, Bauer, Krueger, Lai and Little, among others) advocated far greater reliance on market forces in shaping economic development than has been typical of government policies in developing countries. Their views were influential at the Bank and IMF. The authors of this volume argue that the policies advocated by these “neo-liberals” have been neither well supported by theory or evidence nor particularly successful in practice. Instead, they advocate a “structuralist” approach, emphasizing the scope for successful state intervention in industry and trade, with the specific forms of intervention being determined by country specific circumstances.
While unhesitatingly critical of the neo-liberal policy agenda, the book is quite eclectic in method. The criticisms of reform policies relate in part to issues that lie well within the gamut of the mainstream theoretical and empirical underpinnings of the reform agenda (the determinants of long-run growth; the existence and significance of increasing returns to scale; the dynamics of market adjustment; the causes of unemployment; behavioral responses to policy reform) and partly to issues of varying importance that have been largely neglected by the mainstream (state ideology; class structure; the human dimensions of workplace organization; political freedoms; the politics of reform). For example, Davis Evans’ chapter brings out both types of criticism in the context of the neo-liberal agenda for trade policy reform. But these authors are at their best when they discuss specific policy reform experiences rather than theory. The chapters by Charles Harvey and Raphael Kapinsky are good examples. I would particularly recommend Harvey’s chapter for its analysis of the political and economic factors that determined whether or not reform programs were sustained in Africa during the 1980s.
States or Markets?
Christopher Colclough and James Manor (editors)
Neo-liberalism and the Development Policy Debate
IDS Development Studies Series, Oxford University Press. New York, NY, USA, 1991, ix + 359 pp., $75.
The authors correctly point out in a number of contexts (David Evans on trade, Michael Lipton on agriculture, Christopher Colclough on education, Gerald Bloom on health, among others) that much of the neo-liberal policy agenda rests on empirically testable assumptions. They are often quite effective at pointing out the inadequacies of the past empirical basis for policy reforms; offering convincing new evidence is clearly more difficult. (For example, while Colclough is right to point out the need to be wary of the estimates that are often quoted for the rate of return to schooling, his own revisions are a strictly back-of-the-envelope effort, which has no more obvious credibility as a guide to policy.)
It is unfortunate that the various sides in this debate have often taken a one-dimensional view: you are either (1) for states and against markets, or (2) for markets and against states. These extremes are simply untenable. As both Michael Lipton and Robert Chambers point out in their chapters in this volume (both in the context of rural development), there are potential gains from combining liberalization with an expanded, though changed, role for public action. The problem is not “too much government” but too much of government doing the wrong things; producing trucks when they should be providing roads; suffocating enterprise and initiative when they should be encouraging it. As Robert Chambers puts it: “The task is to dismantle the disabling state … [and] … establish the enabling state” (pp. 276-7).
Thus, what these authors seem to be striving for is a kind of “market friendly” in-terventionism, guided by a far more pragmatic, and wholly undogmatic, approach to development policy. Clearly, the old structuralist faith in states is starting to be healthily constrained by a better understanding of the capabilities of government. This approach will, presumably, avoid undue pre-commitment on the “states” or “markets” issue, and it will almost certainly leave room for both allocative instruments.
That seems like a palatable enough conclusion, on which there will surely be wide agreement. But it is barely a start to the task of forming good policies. Among other things, we will also need a normative theory of policy, clearly spelling out objectives and constraints. This will identify appropriate policy instruments, guide evaluation, show what data are needed, and make clear what is being assumed when such data are unavailable. And it will need to be a broader framework—in terms of what it allows as both “objectives” and “constraints”—than has typically propelled the neo-liberal policy agenda. Without that framework, there is a real risk that, in practice, this emerging “neo-structuralism” will turn into another policy pastiche in which just about anything goes, and just about nothing works.
Governing the market
Economic Theory and the Role of Government in East Asian Industrialization
Princeton University Press, Princeton, NJ, USA, 1990, xx + 452 pp., $65 ($18.95 paper).
The extraordinary performance for the past two decades of the East Asian economies of Japan, Korea, Taiwan Province of China, Singapore, and Hong Kong has contributed significantly to our understanding of the process of economic development. At first, consistent with the observation that rapid export growth lay at the heart of success (and consistent with the prevailing political and ideological winds), the East Asian miracle was interpreted as a vindication of the neoclassical paradigm of development and the central importance it ascribed to free markets, “getting the prices right,” and sound macroeconomic management but otherwise limited government.
Yet this interpretation did not square with the observations of those with a more intimate knowledge of East Asia: that most of these societies appeared tightly controlled—economically as well as politically. Over the past decade, debate over the role of the state in East Asian development has become increasingly more vigorous.
Robert Wade’s book represents a milestone in that debate. The book combines a definitive analysis of the policy underpinnings of Taiwan’s economic development with a conceptually sophisticated challenge to the neoclassical development paradigm.
Wade is thoroughly persuasive on three central points. The first is that the roots of Taiwan’s economic success lie in its history and politics. Both the import substitution of the 1950s, and the earlier experience of industrial and agricultural development under Japanese rule were crucial in providing Taiwan with an industrial base on which to build. Its political legacy was just as important in shaping the class structure of Taiwanese society in a way that ensured that the island’s abundant entrepreneurial energy would be directed to productive industrial investment.
The centrality of this industrial investment to Taiwan’s success is the second point on which Wade is persuasive. Unlike most of the existing literature on Taiwan, Wade emphasizes the important relationship between investment and long-run economic growth, highlighting the island’s remarkably high levels of investment of around 25-35 percent of GDP annually since the mid-1950s.
Finally, Wade is convincing in arguing that a neoclassical explanation for Taiwan’s success that gives primacy to market liberalization as opposed to government activism is prima facie inadequate. He details a broad array of economic interventions by Taiwan’s government that run contrary to the neoclassical canon—state investment in industry and other forms of sectoral targeting, import restrictions, export promotion, discretionary controls over foreign investment, a strictly controlled banking system (even to the point of inflexibility), and the creation of industry-specific technology support institutions. Wade makes a good case for his view that, while market forces, at home and abroad, have been given much play, the government has also played a central role.
Wade has some clear (and provocative) ideas about which nonneoclassical interventions matter for development—and which do not—both for Taiwan and more generally. He distinguishes between “free market” and “simulated free market” theories of East Asian success (the latter makes some room for activist government, but only in functional, market-enhancing interventions), and his own “governed market” theory, which calls on government to undertake and maintain control over some central tasks. For Taiwan, Wade emphasizes in particular the crucial roles of government in initiating exports and nurturing selected upstream subsectors of industry.
Wade recognizes that the evidence in support of his conjectures remains weak. There is no convincing evidence one way or the other as to whether direct government interventions accelerated exports beyond what would have been achieved anyway, given the broader incentive policies. Further, Wade recognizes that the interventions that might have mattered most in Taiwan were quite different from those that might have had the most impact in, say, Korea (where the conglomerate-centered private sector called for a different pattern of government intervention than Taiwan with its myriad dynamic small and medium firms) or Japan (where, according to Wade, public-private cooperation went much further than in Taiwan).
But to raise these problems is not to diminish what Wade has achieved. On the contrary, the strength of his book is precisely that it poses the empirical and conceptual questions that should be at the center of research on economic development over the next decade.
The Politics of Economic Adjustment
Stephan Haggard and Robert R. Kaufman (editors)
Princeton University Press, Princeton, NJ, USA, 1992, vii + 356 pp., $49.95 ($16.95 paper).
Both this volume—and the one to which it is a sequel (Economic Crisis and Policy Choice, 1990)—are representative of a genre that emerged in the wake of the debt crisis of the early 1980s and in which political analysts sought to understand the radical changes in ideologies and in the strategies of economic development in the Third World. This volume has the advantage of taking account of the outpourings of other analysts, as well as the deepening insights that this closeknit group of contributors were able to garner from their own decade-long involvement in exploring the political determinants of economic policy choice, cross-nationally and over time. The task they set themselves was to explain differences in the timing of reform initiatives, the degree to which orthodox prescriptions were adopted, and the extent to which the reforms were sustained and consolidated. Three principal issues are addressed in the book: the relative weights to be assigned to international factors and to domestic variables in explaining policy choices; the role of state institutions and governing elites in initiating and consolidating reform processes; and the influence of broader political and institutional settings in mediating the distributive conflicts among contending social groups that arise inevitably whenever fundamentally new policy directions are being pursued.
The first issue is addressed in two essays by Barbara Stallings and Miles Kahler. Not surprisingly, they end up giving somewhat different answers. Stallings argues convincingly that the differences in policy choices in the 1970s and the 1980s were explicable in terms of changing international market forces (terms of trade, interest rates, commercial banking flows) and the greater political leverage exerted in the latter period by external actors—official creditors, the key international financial institutions (IFIs), notably the IMF and the World Bank Group, and the commercial banks. Kahler is not persuaded that the power of creditor groups was ever strong enough to enforce the terms of the “conditionality bargain.” While Stallings is surely correct when looking at the broad variations over time, Kahler’s doubts arise in the context of specific country situations. Although employing different vocabulary—“linkages” by Stallings and “social learning” by Kahler, both emphasize the need for a wide diffusion of ideas before a consensus can be established for successful adjustment. The IFIs must take to heart one special insight: transnational alliances between them and like-minded technical policy-making groups within member countries will not deliver reforms that endure unless the adjustment rationale is acceptable to “broader segments of the political elites and relevant publics.”
The second issue is covered by contributions from Peter Evans and John Waterbury. The fundamental problem they address is how to explain the undertaking of a reform process in a situation where the would-be losers can clearly apprehend their losses while the beneficiaries are unable to quantify or even perceive their gains. Waterbury focuses on “change teams” that have, under economic crisis conditions, a high degree of discretionary authority and are insulated by the highest level political authorities from the pressures of “rent-seeking” interests. Evans has a broader concept of autonomy or “embeddedness”: the bureaucratic elites must possess a kind of institutional cohesion that allows them to build bases of support among private sector beneficiaries without becoming captives of such groups. An important insight that emerges from these essays is the inherent difficulty of applying through the State a set of market-oriented reforms that are designed to reduce the power of the State. For many reforms to work, the administrative and technical capabilities of the State must be strengthened, not weakened. Indeed, recent experience of adjustment desiderata in Eastern Europe suggests that the tasks that the State apparatus must undertake are even more basic than are typically discussed in the context of the Third World.
The third set of issues is explored in a separate essay by Joan Nelson and in two joint ones by Haggard and Kaufman. While the latter are concerned with the political aspects of inflation and stabilization and the compatibility of economic liberalization with political democratization, Nelson analyses the politics of income distribution in the adjustment process. She points to the paradox that confronts those seeking to shield the very poorest. While it is technically possible to devise carefully targeted “safety nets,” the political incentives for so doing are much too weak unless the benefits can be extended to more influential “popular sector” groups; however, bringing them into the net produces additional budgetary strains, which the adjustment program is typically seeking to reduce. Nelson points out ways to deal with the problem through program design that can be used to create new coalitions of support. Her analysis, as indeed prescriptions of other political analysts, raises a special dilemma for the IFIs; for while their mandates require them to serve their membership on the basis of strictly technical criteria, taking account of political considerations in program design may well be the key to successful adjustment.
Trade Policy, Industrialization, and Development
Gerald K. Helleiner (editor)
Oxford University Press, New York, NY, USA, 1992, xi + 324 pp., $87.
This book is a collection of 11 essays that emerged from a research project supported by the World Institute for Development Economics Research (WIDER). The papers are of uniformly high quality, combining conceptual analyses with case studies. Two unifying threads run through the volume: skepticism about the efficacy of markets as the sole guarantor of economic development; and an admission of ignorance about the determinants of successful growth and industrialization experiences. Cautionary words about the limits of our knowledge pepper virtually every paper in the book.
It is this blend of skepticism about markets and acknowledged deficiencies in our understanding of the true ingredients of success that highlight the volume’s most glaring omission as a guide to policy—consideration of the political economy of government intervention. A discussion of why governments might want to be cautious about supplanting the market in the presence of uncertainty and imperfect markets for political influence would have made the volume more complete. The old promotional technique of working the word “new” into the book’s title is no justification for excluding a discussion of public choice theory’s contribution to the debate.
Papers by Dani Rodrik and Howard Pack contain interesting discussions about trade policy and productivity. Neither piece argues that trade liberalization is hostile to enhanced productivity and technical efficiency, but Rodrik suggests it might not matter, while Pack concludes that it is not enough.
The view that direct government involvement of one kind or another is essential for economic advancement pervades the book; the prescriptions offered are diverse. Frances Stewart and Ejaz Ghani make a traditional case for intervention on grounds of externalities, showing great faith in governments, but they draw back in the end from the temptation of arguing that governments will unfailingly get it right. Donald Keesing and Sanjaya Lall make a case for government involvement in export market development, but there the government is seen as a facilitator of market solutions and promoter of privatization. Among the case studies, the one by Chang-Ho Yoon runs counter to many of the other papers in the volume. He argues that Korea’s successful semiconductor industry relied extensively on market forces and the entrepreneurial efforts of firms, and emphasizes the shortcomings of government planners—especially in a dynamic setting with rapidly changing market conditions.
Overall, this is a book to be read, but in conjunction with an understanding of how information gaps and administrative shortcomings, together with the personal agendas of politicians and bureaucrats, might conspire to produce outcomes distressingly divergent from national development objectives. One might also ponder what kind of government and sociopolitical system it takes to ensure that once support has been given to an industry, the beneficiary does not acquire unassailable claims to its privileges, making flexible and constructive industrial policy an oxymoron.
Reviving the American Dream
Alice M. Rivlin
Brookings Institution, Washington, DC, USA, 1992, vii + 196 pp., $15.95.
The American dream is invoked every political season—usually to complacent applause, but sometimes, as happened this past US election season, to anxious reserve. Feeling overwhelmed by a litany of social and economic ills and by confusion over US responsibilities abroad, Americans are openly questioning the viability of a sacred national image—an expanding material life in a society offering opportunity and social justice. In her book, Alice Rivlin sees this juncture in US political history as an opportunity to recast American governance. Her recommendations for doing so bear hearing not only because of her high academic standing but also because her ideas have the ear of US President Clinton, who read this book during his campaign and subsequently made Rivlin Deputy Director of the Office of Management and Budget.
For those readers who want a plainly written and balanced account of the US economic dilemma—in particular, the collapse of national saving, stagnating productivity growth, rising income inequality, and the crisis in health care—Rivlin’s first few chapters describe how the United States stumbled into its present mess and how these circumstances imperil the American dream. Rivlin renders this epoch fairly and clearly, avoiding the rhetoric of the apocalypse while still conveying the seriousness of the country’s long-term problems. As a caveat to those who observe the economy closely, Rivlin presents little that is new in these overview chapters.
Midway through the book, however, the author takes a bolder tack by arguing for a new federalism as a solution to the US economic malaise. The fifty states, she contends, should be the purveyors of economic development—responsible for infrastructure, education, housing, and business development. The states, according to Rivlin, can meet local needs more effectively than can the national government, and the federal government ought to restrict itself to ensuring national security and the nation’s social insurance programs. Although not the first policy expert to endorse a clearer separation of fiscal responsibilities, Rivlin’s presentation of these issues is succinct and persuasive.
Matters do turn more complicated, however, when Rivlin becomes specific about how to pay for stronger states. Among the several schemes she outlines, Rivlin favors a national consumption tax, which she likens to a value-added tax. The tax would likely be collected at the federal level, distributed back to the states according to an agreed formula, and would replace the myriad state sales taxes now used to raise revenue. Other user taxes, a national corporate tax, and a gasoline tax are also supported by the author. Rivlin argues that a single flat rate would simplify the conduct of interstate retail business, force states to compete on the quality of their services rather than on tax incentives, and make tax collection more efficient. But the national tax, which would be set at around 6 percent (plus any additional user taxes), could constitute a significant tax increase in some states, and perhaps a regressive one; the net effect of the tax is not clear.
As a follow-up to her case for a new fiscal federalism, Rivlin proposes reforming the nation’s social insurance programs, which she believes, for reasons of equity and efficiency, are best managed by Washington. Her proposal for a new health insurance policy aims to control the costs of medical care—the fastest growing costs in government budgets—and to provide health care to those who cannot afford it. The states, as a consequence, would be relieved of their current medicare and medicaid burden, which would help free up resources for local programs. With regard to social security, Rivlin believes the federal government should stop using this program’s budget surplus to pay for general government expenses. The money would be better spent buying back government debt from the public, thus increasing the funds available for investment and lowering interest rates.
Rivlin proposes earnest and well-reasoned solutions to some real flaws in the US fiscal system. The only question is how much change do Americans really want. Are the fifty states likely to sit down with Congress and agree to raise taxes uniformly across the country, and perhaps disproportionately on the middle class and poor? Would the states agree to equitably redistribute the revenue from that tax? What would ensure that deficit reduction is aggressive, as Rivlin implies it should be? And, most crucial, who will provide the necessary political leadership for this massive relandscaping? President Clinton cannot raise taxes on the middle class without inviting serious political challenge, and some state governors have equal reason to fear for their jobs if they raise taxes. Rivlin, who acknowledges these difficulties, may underestimate the political resistance, or simple inertia, that would face her proposals. Nonetheless, her informative book serves as an excellent starting point for the deep policy dialogue that Americans said they wanted in November. And her new appointment suggests the country will see some of her proposals debated and implemented.
Economic Interdependence in Southern Africa
From Conflict to Cooperation?
St. Martin’s Press, New York, NY, USA, 1992, vii + 187 pp., $45.
This book considers economic and political relations among the countries of southern Africa. Inevitably, the analysis is dominated by the relationship between countries with white minority rule (South Africa and, earlier, Zimbabwe) and the other countries in the region. The focus is on the economic and political implications of interdependence, and the circumstances in which governments might want to either limit or promote economic interdependence with other states in the region.
The book is divided into three sections of approximately equal length. The first provides a brief historical overview of economic relations up to independence, centering on the contrast between the economic forces toward greater regional integration and political tendencies toward separation. The latter reflect two underlying factors—the extremely unequal development of the region (grounded in the location of mineral deposits), which provoked fears of South African economic domination, and the structure of the economies, which, being based on exports of raw materials, are in many ways competitive rather than complementary.
The second section considers the political economy of interdependence. Two theories are contrasted, the dependency theory, which argues that economic relations with “colonial” powers (in this case South Africa) are inherently biased against the “peripheral” country, and the laissez-faire view that economic interactions are voluntary, and hence must imply a gain in welfare. The author argues that neither theory is adequate; dependency ignores the gains from integration while the laissez-faire approach ignores potential costs, and a more balanced approach is outlined. While interesting, this section has some curious lapses. Blumenfeld suggests that the ratio of trade to output is not a good measure of dependence, but no alternative measure is provided. There is a considerable discussion of political manipulation of the terms of trade, but no references to the economic literature on optimal tariff levels. The most curious lapse is the absence of any discussion of intertemporal factors when discussing recent relations between black African states and South Africa. I doubt whether many governments believed that cutting ties with South Africa would improve “welfare” in the short run, rather, they believed that they would gain in the future from having a more amenable neighbor.
These limitations continue into the third section, which deals with the current situation. The lack of a measure of economic integration confines the discussion to generalities, while the importance given to the dependency hypothesis limits the usefulness of the analysis of economic sanctions. This is a pity, because the basic point being made—that the economic conflicts in the region have structural causes that will not be solved simply by the end of white minority rule—is a valuable lesson for all those interested in the future of southern Africa.
Exchange Rate Targets and Currency Bands
Paul Krugman and Marcus Miller (editors)
Cambridge University Press, Cambridge, MA, USA, 1992, xxii + 247 pp., $49.95.
Attention in academic and policy-making circles is returning to institutional arrangements that limit the flexibility of exchange rates. This volume collects papers that formally model such arrangements, ranging from the classic gold standard to the European Monetary System (EMS).
The starting point for the essays in this book is a framework of uncertainty: we do not know exactly what determines the exchange rate (this is not for lack of trying; the past two decades have not yielded a satisfactory model of exchange rate determination), but whatever it is, let’s call it a “fundamental” variable, and assume that we know its stochastic properties. The target zone approach that follows from these assumptions promises a nonlinear relationship between fundamentals and the exchange rate, opening up renewed possibilities to restore previously misspecified linear exchange rate models. It is surprising how far this methodology carries: from explaining reduced volatility of exchange rates in the EMS to dynamics of entering or exiting the gold standard.
The book is divided into five parts. In the first part, Krugman gives a useful and accessible introduction to the field of target zone models. Some extensions are discussed in the second part, including an elaboration by Flood and Garber on the link between speculative attack and target zone models. The third part focuses on regime shifts. Miller and Sutherland study the difference in the behavior of the pound sterling between the anticipation of it joining the gold standard in the 1920s, and the anticipation of the pound joining the EMS. Their conclusion is that the degree of credibility varied, with Thatcher’s opposition to sterling’s entrance contributing to a costly transition.
Credibility issues appear in virtually all papers in this volume, especially in the fourth part, in which the ability to defend the currency with limited reserves becomes the crucial element. Focusing on the availability of reserves, Krugman and Rotemberg point to the special nature of the target zone solution. Bertola and Caballero, after studying the relations between intervention, reserves, and realignments, find that a sustainable intervention policy leads to the disappearance of non-linearities in the long run. The final chapter of the book, by Smith and Spencer, is devoted to estimating parameters in a target zone model.
The book is at times too technical for the insights it provides, something that frequently happens when a new tool is developed. As a result, it would not qualify as a layperson’s introduction to the field. However, it is to be welcomed as a timely dissemination of some of the essential contributions to the study of target zones.
Innovation and Growth in the Global Economy
M. Grossman and Elhanan Helpman
The MIT Press, Cambridge, MA, USA, 1991, xiv + 359 pp., $29.95.
This book offers a comprehensive tour of endogenous growth theory using general equilibrium techniques as the mode of analysis. The authors review traditional growth theory—which posits economic growth as a function of the accumulation of factors of production (especially physical capital) and some exogenously given rate of productivity increase—before introducing the reader to a simple model of endogenous growth.
Endogenous growth theory includes the increase in productivity as an economic activity—call it research and development (R&D)—whose inputs are labor, capital, and the current stock of knowledge, and whose outputs are technical change and more knowledge. Unlike other inputs, knowledge is a quasi-public good in that it can be used by many agents at the same time. Endogenous growth theories can produce long-term sustainable growth because the increasing stock of knowledge lowers the cost of technical change, and technical change forestalls diminishing returns to other economic inputs. Moreover, the rate of growth of economic activity is endogenous to the economy and depends on economic actions, particularly the level of resources devoted to R&D.
The authors devote most of their book to introducing successive enrichments and refinements to the basic model, albeit in a highly stylized way. For example, they analyze a range of issues: differing types of knowledge where general technical knowledge is easily accessible to others but product-specific knowledge is not; differing types of technical change (new products versus improved quality in existing products); and the effects of trade among countries of different sizes or with differing factor endowments.
While the analyses presented show that strong assumptions produce strong results, these results do not lead to simple rules of thumb for policy. Instead, appropriate policy interventions depend critically on the specific assumptions embodied in the underlying economic framework. For example, based on their assumption that R&D produces knowledge, one might imagine that having a nation subsidize R&D would improve national welfare. Bui in some of their formulations, subsidizing R&D is harmful because excessively rapid innovation leads to rapid obsolescence of production capacity and reduces profits.
Grossman and Helpman do find, however, that subsidizing R&D is a better way to increase innovation than subsidizing the production of high technology goods. In their framework, increasing the production of high technology products often reduces the production of R&D because both activities use similar inputs (highly skilled labor). Given the public good nature of knowledge in their model, they typically find that the world is better off when knowledge can move freely across national boundaries.
The authors use sophisticated mathematics to develop their insights. Frequent policy summaries and a concluding chapter, however, synthesize and make accessible their findings. The elegant theorizing, however, needs to be buttressed by empirical work if the specific policy advice offered is to be taken seriously. For example, the assumption that the use of labor to carry out R&D is highly substitutable with labor used to produce high-tech products should be empirically tested.