Economic Development <Lecture Note 3> 13.03.22

1. Economic Development <Lecture Note 3> 13.03.22 ED: Development Strategies * Some parts of this note are borrowed from references for teaching purpose only. Semester: Spring 2013 Time: Friday 9:00~12:00 am Class Room: No. 322 Professor: Yoo Soo Hong Office Hour: By appointment Mobile: 010-4001-8060 E-mail: yshong123@gmail.com Home P.: //yoosoohong.weebly.com

2. Overview

3. North-South Divided World

4. Development Economics: Rise to Demise • Less developed countries fundamentally different • Special conditions meant neo-classical economics doesn’t apply • Characterized by “excess labor” • Arthur Lewis argued excess labor, low productivity and wages couldbe tapped to accelerate economic development • Export pessimism • Unfavorable and declining terms of trade (price of imports to exports) • Trade can’t be engine of growth

5. Decline in Africa’s Terms of Trade Source: “The State of Agricultural Commodity Markets.” Food and Agriculture Organization of the United Nations (FAO), Rome, Italy, 2004.

6. Comparison of the Terms of Trade Source: “The State of Agricultural Commodity Markets.” Food and Agriculture Organization of the United Nations (FAO), Rome, Italy, 2004.

7. ViciousCircle Export-drive may break the vicious circle, but the problem or difficulty is that most developing (in fact, underdeveloped countries) cannot drive export. As observed, agriculture cum natural resource based exports are not helpful for the deteriorating terms of trade. How to mobilize savings?

8. Neoclassical Economics Argued that underdevelopment due to wrong-minded government policies: Distort incentives Inhibit market forces • Government failure

9. Government Failure • Not different economies in nature • Nor a “vicious cycle” • But government failure • Hence, • Market openness • Fiscal discipline • Wrong intervention Lead to growth

10. Neo-Liberal Explanation of East Asian Miracle South Korea, Taiwan, Hong Kong, Singapore (ANIEs-I or Four Asian dragons) “Market conforming” strategies Opened economies to the world, reduced the role of the state, pursued export-led strategies

11. Washington Consensus “Broad agreement among government officials in both the industrial economies and international institutions on the importance of the neo liberal program for economic development and its emphasis on free markets, trade liberalization, and a greatly reduced role of the state in the economy.” – Gilpin

12. The State Needed to Initiate “Big Push” Overcome market failures • lack of entrepreneurship • low national savings • poor educational systems • little consensus on which industries to assist among economists or states

13. The Developmental State • Government incentives for private investment in strategic industries • Created an entrepreneurial class • Identified key industries • Exposed them to the global market • Concern of “late” industrialization • Market failure necessitating the state • Challenged neo-liberal consensus • Japan and East Asia • State governed / led the market

14. What to Do? How to Do?

15. World Economy and Development  Globalization of the world economy has changed the terms of development. It has transformed: - The nature of world markets and what it takes to be competitive in them - The nature of the national state and the relations between states and other levels of governance - The possible paths of development  In terms of the factors promoting economic development globalization increases the importance of: - International trade (and thus the need for export-oriented economies) - Knowledge, skills and technology transfer for development in the global ‘knowledge economy’ - MNCs and FDI in knowledge and technology transfer - Education and skills (as argued in endogenous growth theory)

16. Neo-Liberal Development Theory and Policy  The Washington Consensus model, prescribed by the international agencies, and backed by the most developed economies, has emphasized: - Minimal government intervention including through Industrial Policy - Free-trade (no tariffs, subsidies and free capital flows) - Structural adjustment policies to reduce state spending  The policies are based on neo-liberal policies for economic development which go back to Adam Smith.  As Ha-Joon Chang has argued, successful developing economies often have more to learn from Frederick List than Adam Smith. Liberal free trade policies have generally advantaged the already powerful economies. Advocacy of ‘free trade’ policies to poorer countries is often a case of rich countries tending to ‘kick away the ladder’ on which they ascended.

17. Role of the State in Development  List criticised Smith for ignoring the historical evidence of how the rich countries had developed through harnessing the power of the state. He advocated using the power of the state to develop manufactures and to old in world trade through the nurturing and protection of infant industries and the use of mercantilist strategic trading policies. • Late development theorists, from Alexander Gerschenkron to Alice Amsden, have built on List’s insights. They argued that nations that industrialized after Britain had to do it differently since technology was more advanced, and more easily transferred, and since industries were on • a larger scale.  Industrialization could happen more quickly - Required more state intervention - Relied heavily on skills and skills transfer

18. Problems of Liberal Development Theory  Neo-liberal policies are based upon myths about how the now rich countries actually developed and there is little evidence that they work well now.  Historically, most successful developing countries, including the recent cases in East Asia, have used substantial state intervention in industrial, trade and education policy and so on to assist development.  The current world economic crisis is also reinforcing the need to reconsider dominant model of development. • The crisis suggests that the neo-liberal model of finance-driven, debt-based capitalism in developed countries has serious problems and suggests that the neo-liberal model of development - encapsulated in the ‘Washington Consensus’ - may need to be re-thought. Many of those which grew fastest ignored liberal policies of the Washington Consensus.

19. Growth, Distribution and Well Being - Between 1960 and 1998 real income pc in Japan and tigers increased x 4. - Life Expectancy in HPAEs grew from 56 years in 1960 to 71 in 1990. - Proportions living in absolute poverty declined between 1960 and 1990 from 58% to 17% in Indonesia and from 37% to 5% in Malaysia (compared with 54% to 43% in India) - HPEAs also achieved low and often declining levels of income inequality, particularly in Japan and Taiwan but also, until the 1980s, in S. Korea and Singapore.

20. Role of Education in East Asia  General view: Capital accumulation (savings) and education played major role in East Asian Miracle.  According to WB: ‘far and away the major difference in predicted growth rates between HPAEs and sub-Saharan Africa derives from variations in primary school enrolment rates.’  Investment focused initially on universalizing primary education which had highest rate of return.Secondary and higher education were developed sequentially when growth and higher rates of return to higher levels encouraged private investment.  Growth, private investment and declining birth allowed increase in per capita spending and higher enrols in education without excessive public cost.  Skills contributed significantly to productivity growth and technology transfer.

21. Paradigm for Development GROSS NATIONAL HAPPINESS(GNH) POVERTY REDUCTION FOREIGN DIRECT INVESTMENT TRADE GROWTH OPENNESS GOOD GOVERNANCE ENABLING ENVIRONMENT ODA LOCI OF DEVELOPMENT PRO-POOR POLICIES MACROECONOMIC STABILITY

22. Fundamental Trade-offs in Development Strategies • Radical vs. Gradual • Balanced vs. Unbalanced • Closed vs. Open • Foreign Resources vs. Domestic Resources • Government (planning) vs. Market • Growth-first vs. Shared Growth • Imitative vs. Innovative (Creative) • Authoritarian vs. Democratic 22

23. Rapid economic growth Kuznets’ Model High investment ratios Small public sectors? Labor market competition? Export orientation Government intervention

24. Substitution Strategy Concept by Gerscenkron • Gerschenkronian Thesis - “The more backward a country’s economy, the greater was the part played by special institutional factors…(and) the more pronounced was the coerciveness and comprehensiveness of those factors.” - The patterns of industrialization was a combined result of: ① The technological trends, ② Degrees of backwardness (=underdevelopment), ③ The necessity and will for latecomers to compete with forerunners.

25. - “The more backward (underdeveloped) a country’s economy, the more pronounced was the stress…on bigness of both plant and enterprise..(and) the greater was the stress upon producer’s goods as against consumer goods.” - Different institutional patterns among country’s were a result of different catching-up strategy. Implications - A main driver in Gerschenkronian thesis is the competition among countries. - The different strategies and institutions adopted by latecomers were substitutes for the lack of ‘prerequisites’ of development such as capital, technologies or financial intermediaries.⇒ a substitution strategy.

26. Gerschenkron’s Late-Comer’s Advantage  Characteristics of late industrializing countries - Industrialization starts by sudden high growth - Preference for large-scale factories and firms - The capital-good sector is more emphasized than the consumption-good sector. - There is a tendency to restrict people’s consumption - Utilization of centralized financial institutions  Emphasis on diversification of growth types - Late industrializing countries do not necessarily follow the same stages of growth and trials and errors of developed countries. They have more opportunities in technology selection and learning, so that their growth can be faster and they can catch up with developed countries. The later starters should find more innovative or radical development strategies.

27. Cases of Gerschenkron and Shin -G took and compared England, Germany and Russia whereas S compared US, Japan and ANIEs (Korean, Taiwan, Singapore).

28. East Asian Development Model  East Asian countries had achieved high economic growth. • Japan, Korea, Taiwan (Chinese Taipei), Hong Kong, Singapore • SE Asia • Now China (PRC.) and Vietnam is growing very rapidly • Companies (business organizations) of those late industrialized countries (LICs) have to compete with those of early industrialized countries (EICs).  Why? • Comparing to “Western” countries, the industrialization of those countries was late. • Those countries, which experienced “late industrialization,” can absorb advanced technologies from the countries which have already experienced industrialization.

29. LICs may fail to establish its own industry because of foreign direct investments (FDIs). - In order to achieve economic development, LICs have to conduct policies somewhat different from those of EICs. • Not all of LICs can achieve economic development, however. - Some Asian countries have succeeded, but many African countries and some other Asian countries failed to industrialize their own countries.  Why some LICs could achieve economic development while others could not?

30. Growth of World Exports

31. Outward-looking (Export Promotion) vs. Inward-looking(Import Substitution) Strategies: Two Contrasting Strategies of EA and LA • A Comparison of Two Industrialization Strategies

32. Import-Substituting Industrialization • From World War II until the 1970s many developing countries attempted to accelerate their development by limiting imports of manufactured goods to foster a manufacturing sector serving the domestic market. • The Infant Industry Argument - The most important economic argument for protecting manufacturing industries is the infant industry argument. - It states that developing countries have a ‘potential’” comparative advantage in manufacturing and they can realize that potential through an initial period of protection. - It implies that it is a good idea to use tariffs or import quotas as temporary measures to get industrialization started. • Example: The U.S. and Germany had high tariff rates on manufacturing in the 19th century, while Japan had extensive import controls until the 1970s.

33. Problems with the Infant Industry Argument -It is not an easy job to move today into the industries that will have a comparative advantage in the future. - Protecting manufacturing does no good unless the protection itself helps make industry competitive.  Market Failure Justifications for Infant Industry Protection - Two market failures are identified as reasons why infant industry protection may be a good idea:

34. Imperfect capital markets justification • If a developing country does not have a set of financial institutions that would allow savings from traditional sectors (such as agriculture) to be used to finance investment in new sectors (such as manufacturing), then growth of new industries will be restricted. • Appropriabilityargument • Firms in a new industry generate social benefits for which they are not compensated.  Why didn’t import-substituting industrialization work the way it was supposed to? • The infant industry argument was not as universally valid as many people assumed.

35.  Import-substituting industrialization generated: • High rates of effective protection • Inefficient scale of production • Higher income inequality and unemployment • Implications • Outward-looking strategy should be implemented in parallel with infant • industry protection and immediately after short period of import substitution. • Infant industry protection should be ended as soon as possible. (Under • the WTO system, it is more difficult to protect infant industries.) • Economic development requires a process of a certain period of • protection → learning → catching up with developed countries by • technological capability building • Government intervention should be based on clear performance criteria.

36. The Making of a Miracle(WB. 2003. “The East Asian Miracle”) • High and Sustained Economic Growth - In 1965~1990, East Asian economies grew faster than all other regions of the world. - This is due to seemigly miraculous growth in 8 high-performing Asian economies including 4 tigers (Korea, Hong Kong, Taiwan, Singapore), 3 Southeast ANIEs(Malaysia, Thailand, Indonesia) and China. (Philippines was not good) - The HPAEs have grown more than twice as fast as the rest of East Asia; about three times as fast as LA and South Asia; and 25 times faster than Sub-Saharan Africa. - The growth of HPAEs was higher than developed countries and oil-producing Middle Asian countries.

37. Rapid Growth with Equitable Income Distribution - HPAEs are unique in that they combined the rapid and sustained growth with higher equal income distributions. (‘Shared Growth’) • Welfare Enhancement - The average life expectancy of HPAEs rapidly increased from 56 years in 1960 to 71 in 1990. - Reduction of the absolute poverty class • Factors of the Success of HPAEs - “Getting the basis right”. (To be explained) o The principle engines of growth were private domestic investment and rapidly growing human capital.

38. East Asian Miracle: Explanation According to the World Bank • “Getting the fundamentals right”, with highly selective interventions

39. Asian Miracle –WB Summary Selective intervention Market-based competition Contest-based competition

40. East Asia Growth: Why Is It an Economic Miracle? • Rapid growth, sustained over long periods–30 years or more in some–unprecedented • Very low income inequality–unprecedented • Low endowment of natural resources • Lack Western-style democratic institutions • Strong intervention in markets • Defied received (western) wisdom, hence, a “miracle”

41. Implication of the East Asian Economic Development • Lessons for Developing Countries (World Bank. 1993. The East Asian Miracle ) • Stable macroeconomic policy • Investment in education on the earlier development stage • Consideration of agricultural sector • Sound financial system • Open to foreign ideas and technology • Minimization of price distortions • Successful export push

42. Things to Avoid: • Promoting specific industries or attempting to leapfrog stages of • technological development • Negative interest rates of providing large subsidies to borrowers • Providing direct credit without adequate monitoring • Three Factors of the East Asian miracle • Outward orientation • Macroeconomic stability • Investment in human capital

43. Four Key Factors for the East Asian Miracle • Sound macroeconomic policy. • An efficient bureaucracy that can implement long-term • development policy. • Active government policies for industrialization and export • promotion. • Flexible, pragmatic policy approach with error-correcting • mechanism.

44. East Asian Miracle, Growth and Income Distribution • Economic growth in East Asia contributed to decrease absolute • poverty in general, but the process did not necessarily improve • income distribution. • The impact of growth on poverty reduction has not been uniform • across the economies. It depends on the following. • - Sources of growth: Internally generated or externally sustained by • foreign trade and investment? • - Composition of output: Main drivers was the agriculture or light • manufacturing? • Labor market: restrictions and regulations of the labor market • - Market and non-market institutions: How they generate growth? • impulses

45. Key Factors • The most critical factor that underlay the miracle process, both growth • and poverty reduction, was these countries’ openness to trade and • technology. • Openness helped them overcome the limitations of domestic markets, • provided new economic opportunities to exploit in international markets, • created competitive pressures for the domestic economy, and allowed • access to new technology through imports of new machinery and • equipment. • Supplementary Factors • Economic openness is largely unfruitful unless complemented by other • factors, such as macroeconomic stability, labor market flexibility, and • good economic governance. • These latter primary factors together helped to create a domestic • economic environment that encouraged productive investment and production.

46. Virtuous Circle • The outward-oriented policies created a virtuous circle of • accumulation and assimilation. • The rapid accumulation of capital and acquisition of new • technology went hand in hand with the formation of new skills. • The new demand and supply impulses that outward orientation • helped to create facilitated the process of skills formation. • On the one hand, export-oriented policies helped to raise the • economies’ income levels, which in turn increased both private • and public investment in education. • The availability of new technology led to new pressures on the labor • force to upgrade its skills to meet the evolving demands of the new • range of equipment.

47. In addition, the economic success of these economies led to rising • expectations of international competitiveness that was accompanied by • greater demands for new and sophisticated skills. • □ Difference in the Initial Conditions • Favorable initial conditions, such as high educational attainment, equitable • income and asset distribution, and a dynamic agriculture sector, did not • exist in all the miracle economies to the same extent, nor did they all • undergo a process of comprehensive land reform. • Thus these were not the primary factors hat initiated the miracle growth • process, but to the extent that these favorable initial conditions existed, • they might have helped make the growth process more equitable, or may • even have enhanced it.

48. East Asia and Latin America • Performance of LAC (Latin America and Carrebian) - Despite its lead in terms of industrial development (and its location advantages for export-proximity and historical links with US the largest market for developing world exports), LAC’s response has been much less vigorous than that of East Asia. - Export success in LAC has been highly concentrated, with a few major success combined with many others losing market shares. This suggests that it was not liberalization as such that drove its export acceleration but other, more country specific, factors.

49. The structure of exports in LAC is less conductive to long-term growth than in East Asia. Most of the growth was in resource-based products, growing slowly in world trade. Success in dynamic high-tech products was confined to a tiny few. In fact, the integrated production systems that drove export growth in East Asia largely bypassed LAC, even of the served US markets. • The few outstanding success in LAC in manufactured exports face severe competitive challenges. Export activity is often delinked from local industry and capabilities, and the competitive base will be eroded unless these links are greatly strengthened. While this is also true of some East Asian countries, others have built impressive local capabilities and even the weaker ones are acutely conscious of the need to develop local capabilities and are investing in doing so more assiduously than the leaders in LAC.

50. East Asia versus Latin America