THE STATE, GROWTH AND DEVELOPMENT

Readings• *Thirlwall, A.P., 2011, Economics of Development, Palgrave

Macmillan, Chapter 4.• Daniel Berkowitz and David N. DeJong, 2001, Policy Reform and

Growth in Post-Soviet Russia, William Davidson Working Paper Number 405.

• Eichengreen, B., Gupta, P, Kumar, R, 2010, Emerging Giants: China and India in the World Economy, Oxford University Press, chapter 5, 7, 10.

• Knight,J., and Ding, S., 2012, China’s Remarkable Economic Growth, Oxford University Press, chapter 3.

• *Winters,A., and Yusuf, S., (Eds), 2007, Dancing with the Giants: China, India and the Global Economy, World Bank and Institute of Policy Studies, chapter 7.

Defining the State• state necessary to ‘accomplish the economical development of the nation

and to prepare it for admission into the universal society of the future’ (List, 1885). – ‘....a perfectly developed manufacturing industry, an important

mercantile marine, and foreign trade on a really large scale, can only be attained by means of the interposition of the power of the state’ (List, 1885, p.178).

• The state’s involvement in the economy has ranged from production in public enterprises and investment in infrastructure to regulation of the private sector, welfare provisions and taxes as well as the strategic planning of resource utilisation in an economy.

• influences the economy, polity and society of a country. – self-evident political role and is the explicit expression of the formal

politics of a country—authoritarian or democratic (single-and multi-party).

– The state is therefore an all-pervasive aspect of modern life and has become an integral part of the process of development.

• How do we define the state?– in terms of the institutions comprising it – in terms of the functions it performs? – Is the state an independent actor able to do as it (or its main

components) wishes? Or is it instrumental in that it has to do what society wishes?

• The functions of the state are carried out by a set of institutions that can command a legitimate use of force, rule over an area and seek to maintain sovereignty, maintain control and the rule of law and oversee economic development (Haynes, 1996, p.27).

• The state is often discussed as a homogenous entity with a common purpose. – in reality, many internal rifts and divisions especially in developing

countries where state formation has preceded nation-building (Haynes, 1996, p.28).

• State seen to have a role in providing a legal framework, ensuring law and order, protecting the nation from external aggression and upholding moral values.

• Also, an economic role – regulating and managing production, providing public goods and so on.

• The state criticised by both left and right: – Marxist critique: state is a parasite (which extracts resources

to sustain a privileged, bureaucratic elite); – Criticism from the right: the increasing role of the state in all

aspects of modern life. • gives rise to nepotism, corruption, rent-seeking and other

unproductive or negatively productive activities.

The State and the Economy• The state has played a significant role in the economy since the

industrial revolution.

• Reinforced by two phenomena in the early 20th century – – the Russian revolution and the establishment of Socialist states in Eastern

Europe and China: state controls the economy and undertakes all economic activities

– the ‘Keynesian Revolution’ and the rise of the ‘welfare state’ in the West: state regulates the economy and is the primary redistributive force within it.

• Developing countries: – increasing emphasis on state intervention in the 1950s, Sixties and

Seventies. – ranged from periodic/regular plans to allocate resources, direct production

through public enterprises in a number of strategic (economically and politically) industries to the regulation of the economy by the state.

• In the 1980s, breakdown of the Soviet Bloc and growth of Washington Consensus led developing countries (often under pressure from the World Bank and the IMF) to liberalise their economies.

Planning• In mixed and centrally planned economies, state intervention

can occur at many different levels: – correct for market failures through taxes, subsidies and regulations. – plan for dynamic progress (i.e. plan for growth and technical

progress) through involvement in resource allocation.– direct the economy so closely that there is little or no role for the

market to play.

• Centrally planned economies: – prices set by the state because market failures seen as all-pervasive. – state determines resource allocation at the national, regional, local,

sectoral and enterprise level. • requires an enormous institutional infrastructure and involves the state in

all aspects of the economy including in setting prices.• Free market resource allocation only in supply side of the labour market

i.e. workers are free to choose where they work and on the demand side of the product market i.e. consumers are free to choose what they buy.

China: The Logistics of Planning• China: an entire hierarchy of planning bodies with the central party at the top.

– planning machinery included the state planning commissions, state economic commissions, the state council and the bureau for material allocation (BMA).

– Similar bodies at provincial level to directly control enterprises and companies.

• long term (5-10 years) plans and short-term ones: targets for growth rates of major economic aggregates like national income, consumption, investment and foreign trade amongst others.

• Guidelines are then sent to the ministries, which formulate draft plans, to be submitted to the state planning councils.

• The BMA prepares the assignment plans indicating the needs and supplies of various materials and products broken down by branch and province. Many materials are allocated locally.

• Each enterprise receives 8 targets - volume of output, quality, product mix, consumption of raw materials and fuel, costs of production, wage bill, profits and the permitted amount of working capital.

• State Statistical Bureau and People's Bank have responsibility for monitoring economic activity.

Problems with Planning: 1. Poor market discipline and inability to monitor: so targets fulfilled by

roundabout means. – Tractors in China, for example, were heavier than elsewhere because it

was easier to fulfil volume targets with heavier output. – persistent over-investment, long construction periods and inadequate

controls over costs led to inefficiency.

2. Distortions in the price system: so prices could not be used to set targets.

3. Emphasis on non-material incentives decreased people’s incentive to work and invest.

4. Planning is only as good as the data that it is based on.

5. Unanticipated external and internal shocks - war, drought, oil price increases, institutional problems as well as corruption, bureaucracy, inefficiency, rent-seeking of civil servants and lack of political will - all decrease the efficiency of the planned system.

6. Lack of flexibility: because responses to changes in costs, demand or international conditions are not automatic.

• Free markets advantaged by efficient use of information. – no central body sets prices, so no need for the central

collection of information. – greater flexibility regarding prices and quantities

because decisions are decentralised to firm and individual level.

– The costs of price setting are minimal and – fewer problems arise from inefficient bureaucracies and

interest groups. – Finally, the emphasis of most planned economies on

specific strategies like heavy industrialisation, though initially successful, created a number of distortions in the system in the long run.

• These include the scarcity of consumer products, which manifests itself in queues, shortages and price increases.

Transition from Planning to Markets

• Late 1980s and early 1990s: transition of most centrally planned economies (CPEs) towards the free market system.

• Began with attempts at perestroika and glasnost in the USSR; gained momentum when these attempts at gradual reforms failed.

• By the early 1990s, the system had broken down in most of Eastern Europe and Central Asia. – Both economic and political change in the region.– Required large scale institutional changes too.

• moves towards market allocation of resources has required new price systems, new tax systems, new legal frameworks (for corporate law, property rights, competition policy and so on), new accounting conventions etc.

Overall, many measures undertaken as part of transition:

1.Price Liberalisation: reform of the pricing system towards market determined prices.

– Resource allocation is therefore also market determined.

2.Macroeconomic Stabilisation: strict monetary and fiscal policies to control any inflation that the price liberalisation may have caused.

3.Privatisation: the sale of state-owned firms to the private sector. Various processes:

– voucher privatisation in Czechoslovakia– sale of assets in East Germany through the Treunhandanstaldt– sales to foreign investors in Hungary– internal privatisation in Russia.

4. Trade Liberalisation: decreasing or removing the barriers to trade and freeing up exchange rates.

5. Financial Liberalisation: reform of the banking and financial system so that interest rates are market determined and investment decisions reflect market criteria.

6. Institutional Reforms: include tax, accounting reforms, legal reforms and setting up a welfare infrastructure.

• ‘Big bang’ or gradual and organic reform? – Varied across countries. – China went for very gradual reforms; Russia for

quicker reforms – pushed by domestic conditions.

• factor determining success of reforms: not speed, but the focus and single-mindedness of governments. – Countries that have vacillated and in which

commitment to reforms has been uncertain are ones in which reforms have taken longer to be successful.

Developmental States• The East Asian region has provided the most successful examples of transition

from developing to developed country status in the 20th century. – Japan– 1st round of Tigers – Hong Kong, Singapore, Taiwan, South Korea– 2nd Round – Malaysia, Indonesia, Thailand– Now, China

• debate on their strategies in the last two decades– less interventionist than the Socialist economies but more interventionist than

early writers (World Bank, 1983) had suggested. – state intervention in these economies is highly selective and strategic and is

therefore much more effective than it has been in most other economies.

• White and Wade (1984): East Asian states carry ‘the historical legacy of a strong and economically active state’– developmental state.

‘states whose politics have concentrated sufficient power, autonomy and capacity at the centre to shape, pursue and encourage the achievement of explicit

developmental objectives.’ (Leftwich, 1995).

• components of a developmental state: – determined developmental elite

• core of developmentally determined senior politicians or bureaucrats, who have more influence over policy making than the political and legislative elites.

• These elites are not fixed and represent shifting coalitions of interests.

– relative autonomy from special interests (class, regional and sectoral) means that these states can work in the ‘national interest’ (Jenkins, 1992; Johnson, 1985).

– the economic bureaucracy in developmental states is very powerful and has the authority, technical competence and insulation to make its strategies effective.

Contrast cases of S. Korea and Brazil:

South Korea - a single body, the Economic Planning Board (EPB), was responsible for planning, budgeting, price controls, foreign aid, loans and investment, transfers of technology and collection of statistics.

Brazil: •Trade policy (Ministry of Finance with influence from Planning and Foreign Affairs); •Export policies and fiscal incentives (Finance and Planning together with the Ministry of Industry, Commerce and Tourism and Ministry of Foreign Affairs). •Investment regime (Ministry of Planning and the National Development Bank) •R&D (Ministry of Science and Technology).

Thus, the direction of policy oscillated depending on which ministry was in control (Sercovich et al, 1999, p.231).

• many developmental states have survived by controlling and weakening civil society especially the media and labour organisations. – East Asia has more politically quiescent labour movements than Latin

America (Jenkins, 1992 and Chowdhury and Islam, 1993).

• developmental states consolidated their power and autonomy before national and foreign capital became influential. – Unlike in Latin America, where landlord and foreign capitalist interests did

not allow the emergence of state economic power.

• Critiques:– Kohli (1994): notion of developmental states focuses more on a state’s

capacity to implement goals and less on the origins of these goals. – Jenkins (1992): high degree of autonomy of the state in East Asia and of

the bureaucracy arose from historical factors • resulted in a large volume of industrial capital falling into the hands of the

Korean state when the Japanese withdrew. • The state then had considerable funds that it could distribute at will. • It could therefore always subordinate the industrialists to its own will (though

this broke down in the 1990s and has contributed to the Asian crisis in the late 1990s)

Role of the State in the 21st Century

• “Crucial to politics is the re-definition of the role of the state. The state, as is increasingly understood is not the creator of wealth, but facilitator and catalyst of development” (As UN Secretary General Kofi Annan in Cheema, 1998).

• 1997 World Bank Report (p.15) argued that ‘good government is not a luxury – it is a vital necessity for development.’.

• Asking for a ‘rethinking of the state’s role’, the Bank argued that the state can:

– intervene to correct market failures (public goods, externalities, natural monopolies, incomplete markets, imperfect or asymmetric information and moral hazard).

– provide pure public ‘goods’ (property rights, macro economic stability, control of infectious diseases and safe water, roads and protection of the destitute) though sometimes together with the private sector.

– continue with intermediate functions: management of externalities (pollution), regulation of monopolies and provision of social insurance.

– help set up missing markets. – can intervene to increase equity through taxes etc.

(World Bank, 1997, p.111).

• The state’s unique strengths are its powers to tax, to prohibit, to punish and to require participation.

• ‘Good’ state intervention has helped many countries in East and South East Asia to grow and develop at unprecedented rates.

• ‘Bad’ state intervention however, has held back many more developing countries elsewhere in the world.

Rolling Back the State• Many countries (including the BRICs) saw a rolling back of

the state under the structural adjustment (SAPs) and stabilisation programmes.

• To transit from regulated to market economy, 5 conditions:– Prices must be reasonably stable (inflation decreased)

• Requires macro stability

– Goods and services must be bought and sold through market mechanisms rather than allocated

– Competition (domestic or through trade) to increase productivity• So, tariffs decreased; exchange rates floated etc.

– Relative prices must reflect relative scarcities– Firms must be able and willing to respond to market signals.

• Note similarity to transition from central planning to markets.

Stabilisation Programmes

• Core to IMF loans and part of IMF conditionality

• an attempt to control inflation through:– Reduction in government fiscal deficits– Control growth of money supply– Devalue exchange rate (or possibly float it)– Remove price controls including interest rates, food

prices, transport and utility prices– Removing wage controls

• decrease government involvement in economy.

Structural Adjustment• Led by World Bank; largely working on the

microeconomy.

• Reducing controls on production, marketing and consumption – both quantitative and prices– Reducing licenses– Reducing subsidies

• Liberalisation reforms undertaken by the BRICs are partly of this kind.– But, many variants and each country retained aspects

of the previous state-led regimes in some things.

Post Structural Adjustment States

Brazil • 1980s – ‘lost decade’ due to debt crisis in 1982.

• 1990s - growth was again erratic; instability and inflation.

• 1994 - Plano Real– To control inflation by aligning its currency, the real, with the US dollar.– However, fixed exchange rate with a loose fiscal policy persistent

deterioration of the trade balance major balance of payments crisis in January 1999.

• forced to negotiate an adjustment programme with the IMF. – adoption of a floating exchange system for the Real, – an inflation-targeting regime, and – a tight fiscal policy including a Fiscal Responsibility Law.

• Lula’s government maintained this prudent macroeconomic policy – committed to keeping inflation under control and high primary surpluses.

• Lower inflation rates reduction in interest rates credit expansion increased purchasing power of the poor (together with Lula’s social reforms).

• ↑ed household consumption + ↑ed investment + public spending ↑er GDP growth.

• demand for Brazilian exports (especially commodities) and ↑e in their price has also helped.

• Note: AD = C + I + G + (X-M)

• steep fall in the public debt/GDP ratio (to 35.8% in December 2008), allowing Brazil to repay all its liabilities to the IMF. – structure of debt has improved: smaller share now in foreign

currency. – achieved by raising taxes.

• President Lula succeeded in stabilising policy in Brazil; – less fear of constant see-saw of policies longer-run economic

decisions being made (Paiva Abreu and Werneck, 2008).

• However, problems persist: – sustainable rate of growth in Brazil at present < 5%.

• surprisingly low, given its potential (↑e in the working-age population; ↑e in female labour force participation; advancing urbanization; ↑er average schooling).

– Public investment in infrastructure low. • decreased from 2.5% of GDP to just over 1% (between 1995-2003),

particularly for transport. • According to the World Competitiveness Report, Brazil lags behind other

Latin American countries in terms of road and port infrastructure (Hausmann, 2008).

China• Officially, the Chinese economic model =

‘Building socialism with Chinese characteristics’ or a ‘socialist market economy’– markets important for the functioning of the

economy, – but public ownership, direct government

interference and state-led industrial policies remain integral part of the system.

– export-led development strategy, following the NICs in Asia.

• state has dual function: owner of large public enterprises and powerful regulator of the economy.

• market-oriented reforms in China – gradual process – not the ‘shock therapy’

undertaken by the Central and East European countries ten years later.

– started in agriculture in 1978 industrial sector after 1985 services only 2001 when China entered the WTO.

– a number of reform steps still incomplete: • rules for the acquisition and transfer of ‘land use

rights’ (all land still owned by state), • price reform (prices of grain, energy and other

utilities set by state), • new social security, health and legal systems to be

set. • enforcement of laws relatively weak.

• Public enterprise Reforms: – Public Enterprises in China heterogenous:

• Part controlled by central government, part by local government and partly collectively owned.

• Some are fully state-owned and in others the state has a controlling stake.

• Hard to estimate the size of the Chinese public sector, but ~ 30% - 40% of GDP produced by public enterprises.

– Despite reforms, no proper process of ‘privatization’ in China. • In the beginning, private enterprises simply ‘outgrew’ the

inefficient public sector. • After 1997, comprehensive ‘state-owned enterprise reform’:

– large numbers of small enterprises sold off by various methods (including auctions),

– Some allowed to go bankrupt or – merged with bigger ones.

• important SOEs were retained and restructured. – Many were turned into joint stock companies and

accepted private partners eg. automotive industry). – Some listed on the stock exchange. – No sales to foreign owners

• ‘Guidelines for state-owned enterprise reform’ (December 2006) provide list of sectors in which state should be sole owner or have majority: – power generation and distribution, oil, petrochemicals

and natural gas, telecommunications and armaments, coal, aviation and shipping industries.

• Chinese Government uses: long-term development plans, ‘five-year plans’, sectoral policies (eg. energy plans), industrial development plans and specific industry plans (e.g. the automotive sector).