Download First, that the history of the twentieth century was

Economic Development, the Market,
and the State:
A Look at the Past Century
J. Bradford DeLong
U.C. Berkeley and NBER
Second Draft: March 21, 2003
When historians one or two thousand years from now look back on the just-completed
twentieth century, they will--if there are historians, and if humanity manages to avoid
using its weapons of mass destruction on itself--write that the twentieth century was a
unique century, the first century of truly rapid economic growth, the century that for the
first time made visible the possibility that, in Max Singer's (1989) words, we might attain
a truly human world without mass hunger or deep poverty. This story of economic
history will--if we do avoid blowing ourselves up--be seen as the key narrative of the
twentieth century.
That--if things go well--this will be seen as the key narrative of the twentieth century is
somewhat paradoxical. That future epochs will see the most important aspects of the
twentieth century's history as economic history is something to which many can already
assent. That the key story of twentieth century economic history is the extraordinary
explosion of wealth and productivity in the industrial core coupled with its rapid but
uneven and very partial diffusion to the developing periphery is something that few
would dispute. Yet our collective institutions of self-government and economic
management--the states that have ruled over the various regions of the globe in the
twentieth century--have been remarkably incompetent and inept at their tasks of
economic management.
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Whether it is the unbalancing of the U.S. long-run budget in the early 1980s and again in
the early 2000s, the collapse of Argentina's currency board at the end of 2001 (a collapse
that was in many respects a retelling of a story already told in 1929, see della Paolera and
Taylor (2003)), the failure of Japan to deal with the after math of the collapse of its
bubble economy and the consequent more than a decade of stagnation (see Kashyap
(2002) and Posen (1998)), it is very hard to be impressed by ruling politicians' grasp of
basic economic principles or their ability to apply those basic principles to the problems
of economic governance that they have faced. Whether the disaster of communist central
planning, the inability of governments to recognize the existence of budget constraints,
restrictions on trade that impose a very heavy cost on economies that find they must do
without foreign-made goods or pay a huge corruption tax to politically-powerful elites, it
is hard to avoid the conclusion that governments have been an extraordinary drag on
economic growth.
States have been incompetent at economic management. Yet development has not been
without its successes. And those successes are--at least once our expectations have been
lowered by comparing the past century to previous epochs--extraordinary and
encouraging. That is the paradox. This paper cannot claim to resolve it, but the best guess
is that governments that have overseen successful development have managed to get a
few important things right, however much they have gotten wrong.
What are these important things? They appear to be a trust in the market to allocate
resources; an openness to international trade, to capital flows, and to technology transfer.
Successful growth seems to require an understanding that that government governs best
which sets rules that provide a framework for the discovery procedure that is the market
(see Hayek (1978), Hausmann and Rodrik (2002). In addition, successful growth may be
encouraged by successful policies of redistribution--policies that create an effective
political safety valve for pressures that would otherwise destroy the social consensus on
which a market economy must be built. In some ways this path looks easy: it is clear
what institutions have to be. But in another way it looks very difficult: a growth-
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promoting neoliberal government is not a limited government. It is an immensely
powerful government. The state must be able to enforce contracts--it must have, in
reserve, sufficient authority and force that what its judges command actually happens.
The state must be able to control local notables--it must be able to keep them from
applying pressure to sign over property or other rights that those without local wealth,
authority, prestige, and dependents cannot resist. Most important, the state must be able
to control its own functionaries so that they do their jobs rather than take large bribes. All
of these require immense institutional power and organization.
But this is getting ahead of the story. The first step is to back up in order to perform two
tasks: to emphasize how extraordinary the growth performance of the twentieth century is
compared to all previous epochs and ages. Then it will be possible to set out the paradox:
to describe how growth rapid in historical perspective has been accompanied by policies
that seem, at best, half-baked and inept. After that paradox has been set out, it will then
be possible to take a further step backward, and speculate about this paradox's solution.
The Twentieth Century's Pace of Economic Growth
Whenever we look back at most centuries, we rarely focus on their economic history. The
economic history is the background. The core of history--the most interesting and
important parts--is found elsewhere, in politics, or religion, or culture, or ideas. You
cannot write the history of the seventh century in the Mediterranean and the Middle East
or of the sixteenth century in Europe without focusing on the spread of Islam and on the
Protestant Reformation (see . You cannot write the history of the late eighteenth century
without focusing on politics: the American and French Revolutions and their
consequences. The core of history is largely unrelated to the economy because economic
factors change only slowly:
But in the twentieth century things have been very different indeed. The pace of
economic growth has been extraordinarily great, and for the first time it is the changes in
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the making and the using of the necessities and conveniences of daily life that has been
the motor of history.
There had been much technological progress before the twentieth century. The windmills,
dikes, fields, crops, and animals of Holland in 1700 made its economy very, very
different indeed from the marshes of 700 (de Vries and van der Woude (1997)). The
eighteenth and nineteenth centuries were the age of the spinning jenny, power loom,
steam engine, coal mine, and iron works (Landes (1969), Mokyr (1990). But preindustrial and even technological progress led to little improvement in the standard of
living of the average human: improvements in technology and productive power by and
large raised the numbers of the human race, not its material standard of living (Livi-Bacci
(1992)). Consider that a well-nourished and land-abundant population like the European
settlers of North America could double in numbers in twenty-five years even though
standards of public health, sanitation, and medicine were barely beyond medieval.
Malthusian forces thus soaked up all but a smidgeon of total factor productivity
improvements, and prevented them from generating increases in median incomes. Were
there large differences in standards of living between Marcus Tullius Cicero's slaves in
the first century B.C.E., and Thomas Jefferson's slaves 1800 years later? It is doubtful.
The eighteenth and nineteenth centuries were the first that saw production begin to outrun
population: by the last quarter of the nineteenth century the average inhabitant of a
leading economies--a Briton, a Belgian, a Netherlander, an American, a Canadian, or an
Australian--had perhaps three times the material wealth and standard of living of their
ancestors. It was unprecedented. It was an Industrial Revolution. But even the first
century of the Industrial Revolution saw "improvements" rather than "revolutions."
Literary intellectuals in the first half of the nineteenth century debated whether this
industrial revolution was worthwhile. Was it an improvement or a degeneration in the
standard of living? And opinions were genuinely divided, with as optimistic a liberal as
John Stuart Mill coming down on the “pessimist” side as late as the end of the 1840s
(Boyer (1998)).
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And nineteenth-century growth was close to next to nothing when compared to how
productivity levels and standards of living in the world economy's industrial core have
exploded since.
The growth in wealth--the productivity of workers and the standards of living of
consumers, especially of those who live in the industrialized democracies that make up
the core of today’s world economy--over the twentieth century has been unprecedented.
No previous era and no previous economy has seen material wealth and productive
potential grow at such a pace. The bulk of the OECD's population today achieves
standards of material comfort and capabilities that were beyond the reach of even the
richest of previous centuries.
One place to look to get a sense of the explosion of productivity and wealth in the
twentieth century is the 1895 Montgomery Ward Catalogue.1 At the turn of the last
century Montgomery Ward supplied rural and small-town households around the country
with goods produced in America’s factories. Shipping by mail order from centralized
warehouses, Montgomery Ward would supply goods from sterling silver teaspoons to
sets of the Encyclopedia Britannica to drill presses.
In terms of the time it takes an average worker in the United States to earn the money to
buy one, one-speed bicycles have become 45 times cheaper over the slightly more than a
century from 1895 to 1990. Other commodities would tell a different story. A cushioned
office chair has become only 14 times cheaper, in terms of the time the average worker
requires to produce enough to pay for it. A Steinway piano or an accordion is only twice
1
1895 Montgomery Ward Catalogue, intro. Edited by Boris Emmett (New York: Dover Books, 1969
facsimile edition: 0486223779), cited in William Baumol, Sue Anne Batey Blackman, and Edward Wolff
(1989) Productivity and American Leadership: The Long View (Cambridge: MIT Press: 0262521636).
Baumol et al. (1989) contains a very nice discussion of productivity growth through this particular lens.
Boris Emmett’s introduction to the facsimile edition of the Catalogue is very well done. Also well done is
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as cheap. A sterling-silver teaspoon is 25 percent more expensive. The answer to "how
much wealthier are Americans today than their counterparts of a century ago?" depends
on which set of commodities you choose. This is the index number problem (see Allen
(1975), Fisher (1922)). It has no single unambiguous resolution. If you care about
personal services--having a butler to answer the door and polish your silver--then almost
by definition you would find little difference in national average wealth across the
twentieth century: on the butler-hiring standard Americans are no richer than a century
ago. But on the manufactured-bicycle standard the multiple is 45.
Historical Statistics of the United States tries to strike a balance, and will tell you that the
average American worker at the start of the twenty-first century receives--earns-produces--something like eight times as much per hour as his or her counterpart of a
century ago. Historical Statistics strikes its balance, essentially, by conducting a simple
conceptual experiment: take everything produced in some past year, stuff it into a time
machine, move it forward to today, and sell it; how much would it be worth? Such a
conceptual experiment is certain to be an understatement. Human beings today can not
only buy the goods they could make in the past more cheaply--for less implicit labor-time
cost. We today can also buy goods and utilize services that could not have been made at
any price a century ago. We are effectively infinitely better than our predecessors at
producing floating-point arithmetic operations, or airplane flights, or antibiotics. Franklin
Delano Roosevelt was crippled by polio. Nathan Meyer Rothschild—the richest man in
the world in the first half of the nineteenth century—died of an infected abscess (see
Landes (1998)).
How much of his wealth would Nathan Mayer Rothschild have been willing to sacrifice
for access to modern antibiotics? How much of an extra boost does the invention of new
goods and new kinds of goods provide to an "accurate" estimate of economic growth over
the past century? There is no way to reach a consensus answer, but surely the gap
W. Michael Cox and Richard Alm (1997), Time Well Spent (Dallas: Federal Reserve Bank of Dallas).
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between what Historical Statistics tells us and what the measurement we would ideally
like to construct would tell us is not small.
Moreover, the extraordinary twentieth century upward jump of productivity and wealth
has not been confined to the industrial core of the world economy. Even as early as 1987,
thirty-two out of every thirty-three households in Greece owned a television set. Even as
early as 1987, in Mexico there was one automobile for every sixteen people, one
television for every eight, one telephone for every ten (Economist (1990)). The world has
become more unequal in the twentieth century, yes. But that is primarily due to the speed
of advance inside the industrial core, not to loss of ground and stagnation outside of it.
Suppose one decides that one has to have a number for the pace of global growth. The
figure below shows estimates that are barely more than guesses at what the century-bycentury pattern of growth in world average GDP per capita has been. The central message
is clear: little improvement before the nineteenth century, an impressive nineteenth
century as the industrial revolution takes hold, and a truly remarkable twentieth century.
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Let's give the last word on the pace of modern economic growth to a young German
philosopher writing in the middle of the nineteenth century. He and his coauthor wrote
that the modern epoch was:
...the first to show what man’s activity can bring about. It has accomplished
wonders far surpassing Egyptian pyramids, Roman aqueducts, and Gothic
cathedrals; it has conducted expeditions that put in the shade all former Exoduses
of nations and crusades.... created more massive and more colossal productive
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forces than have all preceding generations together. The subjection of nature's
forces to man, machinery, the application of chemistry to industry and agriculture,
steam-navigation, the railways, electric telegraphs, the clearing of entire
continents for cultivation, the canalization of rivers, the conjuring of entire
populations out of the ground—what earlier century had even a presentiment that
such productive forces slumbered in the lap of social labor?
The young Karl Marx was dumbfounded at the pace of the economic transition he saw
around him (Marx and Engels (1848)). Yet compared to the pace of economic growth in
the twentieth century, all other centuries—even the nineteenth century that so impressed
Karl Marx—were standing still.
The twentieth century has also seen the relative gulf between rich and poor economies
grow. As of 1980 the relative gap was surely larger than at any time in humanity's
previous experience. In Lant Pritchett's words, it was "divergence, bigtime" (Pritchett
(1997)). Since 1980 there have been extremely hopeful signs that convergence rather than
divergence has begun to take hold. The extraordinarily rapid growth in China since the
overthrow of Mao Zedong's chosen successors in the mid-1970s and in India since the
mid-1980s accession of Rajiv Gandhi as prime minister of the last government of the
Nehru Dynasty has been extraordinarily heartening. Even though China and India are
only two governments with only two seats in the United Nations, they are forty percent of
the human race.
The extraordinary growth of the twentieth century coupled with remarkable divergence is
a glass can be viewed either as half empty or as half full: half empty because we live
today in the most unequal world ever; half full because most of the world has already
made the transition to sustained economic growth; most people live in economies that
(while far poorer than the leading-edge post-industrial nations of the world’s economic
core) have successfully climbed onto the escalator of economic growth and thus the
escalator to modernity. The economic transformation of most of the world is less than a
century behind the of the leading-edge economies—only an eyeblink behind from a
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millennial perspective (but though the millennial perspective is one that human beings
can adopt only when contemplating the long-dead past).
On the other hand, one and a half billion people live in economies that have not made the
transition to economic growth, and have not climbed onto the escalator to modernity. It is
hard to argue that the median inhabitant of sub-Saharan Africa is better off in material
consumption terms than his or her counterpart of a generation ago. Substantial progress in
life expectancy and health is being eaten away by AIDS. It seems likely that soon only
the progress in literacy and education will remain.
Paradox: Growth Coupled with Mismanagement
The heartening if extraordinarily uneven growth record of the twentieth century is
welcome, for what some economies did in the past others that are less prosperous now
can certainly do in the future. But the heartening if uneven growth record of the twentieth
century is also a paradox. The record of economic policy during the twentieth century is
one of ineptness. The failures and half-successes of economic policy make us surprised
that growth has been as strong as it has.
The twentieth century saw the century-long economic disaster of communism, and the
quarter-century-long disaster of fascism. In the industrial core of the world economy, the
twentieth century has also seen governments from Herbert Hoover’s to Jimmy Carter’s
that proved themselves singularly inept at managing market economies: inept at coping
with the economic shocks that threatened to and did cause mass unemployment or raging
inflation. Among the developing countries, a number of governments appear to have
possessed the inverse of the Midas touch: everything they touched turned to lead. Some
of it is because twentieth century economists did not know what to prescribe: the history
of economic policy reads like alchemy, not chemistry. The greatest economic policy
catastrophes in largely market economies came during the Great Depression of the 1930s,
when, worldwide, it seemed as if economic policies were geared to amplify the size of
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the Great Depression as much as possible--and when those policies had the imprimatur of
economists as eminent as Lionel Robbins and Josef Schumpeter (Eichengreen (1992),
DeLong (1998)).
There is a perspective that sees governments as the major obstacle to economic growth in
the twentieth century. Communism was a century-long economic disaster that brutally
retarded the economic development of half the human race, and as a bonus inflicted what
can only be called autogenocide as well. Nazism and its tamer fascist cousins were nearly
as inept as Communism at nurturing economic growth, were worse than Communism in
starting wars--but were, fortunately for all of us, extremely inept at mobilizing for the
wars that they had started.
Among the worst of twentieth-century major-country governments was that of Mao
Zedong. The Chinese Communist Party won the Chinese Civil War in the late 1940s. Its
opponent, the Chinese Nationalist Kuomintang, retreated to Taiwan, massacred
everybody on Taiwan it regarded as a potential threat to its rule, reformed itself, and then
became a model of post-World War II economic development and slow democratization.
The People’s Republic of China followed a different road, one of increasing
centralization and developing dictatorship.
Chinese agriculture appears to have recovered from the devastation of World War II and
the 1945-1949 civil war in the first years of Mao’s rule. Official statistics reported a
seventy percent increase in wheat and rice production between the end of the civil war
and the mid-1950s. The small share of China’s population resident in the cities did worse,
as private enterprise was destroyed and "social parasites" were executed. The late 1950s,
however, saw the beginning of a downward spiral. Agriculture was collectivized:
individual farms replaced by village communes dominated by local party officials. The
collectivization of agriculture was followed by the “Great Leap Forward”: a policy that
sprang from Mao’s visionary inspiration to lessen China’s industrial and human
underdevelopment by making use of the human resources of the whole country—to
replace the "material" factor by the "spiritual". People would make steel in backyard
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furnaces. China would industrialize village-by-village, without imports of foreign capital
goods or the advice of foreign engineers.
Of course it was a disaster. To command--from the center--that peasants go out and build
backyard blast furnaces guarantees that you will get little steel and less grain. Because the
dictator had set out this policy on his own, everyone reported that the Great Leap
Forward was proceeding magnificently. But gradually the extent of the disaster became
known, Mao’s principal lieutenants began to move slowly and cautiously to curb his
power. In December 1958 Mao was replaced by Liu Shaochi as head of state, with Deng
Xiaoping as Liu’s right hand man. In July 1959 Peng Dehuai, one of the highest ranking
military officers and Minister of Defense, was reported to have accused Mao of
"subjectivism" and "petty bourgeois idealism," and to have sought Mao’s effective
retirement. Mao indeed was retired, but Peng Dehuai was condemned for "rightism" and
dismissed from the party and the government. Even after more than forty years, the
events of this internal Chinese Communist Party power struggle remain uncertain and
murky (MacFarquhar (1974-1988)).
Perhaps forty million people died in the famine that accompanied the Great Leap
Forward. Perhaps twenty million. Perhaps eighty million. We really do not know. And
we also have little knowledge of the economic cost of the Great Leap Forward
It took six years before Mao could arrange a counterstroke, using his power as symbol of
the regime to launch the Cultural Revolution. We do not know either the human or the
economic cost of the Cultural Revolution.
Mao's government was at the extreme edge of the twentieth century's record of bad and
destructive regimes. More common were regimes like those of Juan Peron in post-World
War II Argentina. The first thing to know about Argentina is that it should not today be a
"developing" or an "emerging market" economy today. In 1913 Buenos Aires was one of
the world's top twenty cities in telephones per capita. In 1929 Argentina ranked fifth in
the world in automobiles per capita. Argentina was still, according to standard statistics,
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as rich as any large country in continental Europe in 1950, when western Europe had for
the most part reattained pre-World War II levels of national product.
Yet after World War II it all fell apart. In response to the social and economic upheavals
of the Depression, Argentina adopted policies of demand stimulation and income
redistribution. These policies were coupled with a distrust of foreign trade and capital,
and an attraction to the use of controls. Argentina's growth performance in the postWorld War II period has been very poor. Even in the 1950s, and even relative to Britain,
Argentine growth was slow.
Carlos Díaz-Alejandro (1970) provided the standard analysis of Argentina’s post-World
War II economic stagnation. According to his interpretation, the collapse of world trade
in the Great Depression was a disaster of the first magnitude for an Argentina tightly
integrated into the world division of labor. While Argentina continued to service its
foreign debt, its trade partners took unilateral steps to shut it out of markets. The
experience of the Depression justifiably undermined the nation’s commitment to free
trade. In this environment Juan Perón gained mass political support. Taxes were
increased, agricultural marketing boards created, unions supported, urban real wages
boosted, international trade regulated. Perón sought to generate rapid growth and to twist
terms of trade against rural agriculture and redistribute wealth to urban workers who did
not receive their fair share. The redistribution to urban workers and to firms that had to
pay their newly increased wages required a redistribution away from exporters,
agricultural oligarchs, foreigners, and entrepreneurs.
The Perónist program was not prima facie unreasonable given the memory of the Great
Depression. It produced roughly half a decade of very rapid growth. Then exports fell
sharply, in part as a result of the international business cycle but mostly as the enforced
reduction in real prices of rural exportables reduced supply. Production fell because of
low prices offered by government marketing agencies. Consumption rose. Squeezed
between declining production and rising domestic consumption, Argentinian exports fell.
By the first half of the 1950s real Argentine exports were only 60 percent of Depression-
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era levels and only 40 percent of pre-1929 levels. Peron twisted the terms of trade against
agriculture and exportables. So when the network of world trade was put back together,
Argentina found itself largely excluded.
The consequent foreign exchange shortage presented Perón with only unattractive
options. He might try to balance foreign payments by devaluing. Devaluing would bring
imports and exports back into balance in the long run via the price mechanism. The
temporary larger trade deficit induced by devaluation in the short run could have been
covered by borrowing from abroad. Devaluation, however, would have entailed raising
the real price of imported goods and therefore cutting living standards of the urban
workers who made up Peron's political base. Foreign borrowing meant betrayal of
nationalism. This option was thus ruled out.
He might try to balance foreign payments by contracting the economy. A recession would
raise unemployment and so reduce consumption and imports. Coupled with expanded
incentives to produce for export by decontrolling agricultural prices, such policies might
have solved the foreign-exchange crisis. But this also would have required a reversal of
the distributional shifts that had been Peron's central aim. And few governments since
World War II have ever found themselves wishing to balance their foreign-exchange
positions by attacking the economy.
With devaluation and recession ruled out, there remained one and only one option open
to Juan Peron: that of controlling and rationing imports. Not surprisingly, Perón and his
advisors concluded that a dash for growth and a reduction in dependence on the world
economy was good for Argentina. Díaz Alejandro (1970) writes:
First priority was given to raw materials and intermediate goods imports needed
to maintain existing capacity in operation. Machinery and equipment for new
capacity could neither be imported nor produced domestically. A sharp decrease
in the rate of real capital formation in new machinery and equipment followed.
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Hostility toward foreign capital, which could have provided a way out of this
difficulty, aggravated the crisis...
Subsequent governments did not fully reverse these policies, for the political forces that
Perón had mobilized still had to be appeased. Thus post-World War II Argentina saw
foreign exchange allocated by the central government in order to, first, keep existing
factories running and, second, keep home consumption high. Third and last priority under
the controlled exchange régime went to imports of capital goods for investment and
capacity expansion. As a result, the early 1950s saw a huge rise in the price of capital
goods. Each percentage point of total product saved led to less than half a percentage
point’s worth of investment. Díaz Alejandro found: “[r]emarkably, the capitalin
electricity and communications increased by a larger percentage during the depression
years 1929-39 than 1945-55,” although the 1945-55 government boasted of encouraging
industrialization. Given low and fixed agriculture prices, hence low exports, it was very
expensive to sacrifice materials imports needed to keep industry running in order to
import capital goods. Unable to invest, the Argentine economy stagnated.
In Díaz-Alejandro’s estimation, four factors set the stage for Argentina’s relative decline:
a politically-active and militant urban industrial working class, economic nationalism,
sharp divisions between traditional elites and poorer strata, and a government used to
exercising control over goods allocation that viewed the price system as a tool for
redistributing wealth rather than for regulating the pattern of economic activity.
Argentina's fall from relative economic grace has been remarkably large, remarkably
long-lasting, and remarkably terrifying. Yet we can see similar patterns at work
elsewhere, perhaps most clearly in the relatively disappointing events that have followed
decolonization.
When the major European colonial powers Britain and France withdrew from their
empires, the bureaucracies and structures of government left behind seemed to be those
institutions that had proved so successful in nurturing growth and prosperity in the
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industrial core: representative parliamentary institutions, independent judiciaries, laws
establishing freedom of speech and of assembly, and a strong civil service tradition
among the bureaucracy. The hope was that, freed from the oppressive controlling hand of
colonial rule, democracy in the newly-independent former colonies was thought likely to
flourish. And since their economies would no longer be controlled in the interests of the
imperial power, economic prosperity should follow as well.
Westminster-style parliamentary politics and independent judiciaries proved fragile in
many places In many places the economic aftermath was also a near-catastrophe.
Relatively less oppressive modern dictatorships produced rapid and impressive economic
growth in Pacific Asia, and in Saharan Africa. India with great tenacity maintained its
hold on parliamentary democracy (but its economic growth was unimpressive until the
mid-1980s). But in a large belt beginning in South America, taking up almost all of
tropical Africa, and including chunks of southern Asia, economic growth has been next to
impossible to find in the past generation and a half.
In Africa south of the Sahara, Kenya, Mali, Malawi, Zimbabwe, Guinea, the Côte
d’Ivoire, Nigeria, and South Africa among others in Africa have seen rising living
standards, but a rising relative income gap vis-a-vis the industrial core. In these countries
the glass is still half-full: increasing relative income gaps vis-a-vis the industrial core
have been nevertheless accompanied by rising living standards and productivity levels.
But in another group of countries the average person is probably poorer in absolute terms
than their counterparts back in 1965: Mozambique, Togo, Ethiopia, Tanzania, Senegal,
Ghana, Madagascar, Chad, Zaire, Zambia, and Niger, among others in Africa; Argentina,
Jamaica, and Venezuela among others in Latin America. In Africa, especially, the postindependence news has been bad for material output (although good for education, and
until recently good for health). Perhaps most discouraging was the relatively rapid fall in
the production and exports of crops that had been the staples of African exports. As
Robert Bates (1981) wrote at the beginning of the 1980s: "Palm oil in Nigeria,
groundnuts in Senegal, cotton in Uganda, and cocoa in Ghana were one among the most
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prosperous industries in Africa. But in recent years, farmers of these crops have produced
less, exported less, and earned less…" Africa south of the Sahara Desert faced the
paradox that the only continent in which farmers still perhaps made up a plurality of the
workforce was spending an ever-increasing portion of its export earnings on imported
food.
Why did this happen? What went wrong? The storehouse of industrial technologies
developed since the Industrial Revolution is open to all. The forms of knowledge and
technologies that make the industrial west today so rich are public goods. The benefits
from tapping this storehouse are enormous, and have the potential to multiply the wealth
of all social groups and classes--property owners and non-property owners, politically
powerful and politically powerless alike--manyfold.
One too short and much too-simple answer is that the fault--where there is fault--lies in
governments: kleptocracy--government by the thieves, as it has been named in analogy
with aristocracy (goverment by the best), monarchy (goverment by the one), and
democracy (government by the people)--has impoverished much of the third world over
the past generation. Most governments at most times in most places have followed
policies that show great interest in boosting the incomes of functionaries and little interest
in nurturing sustained increases in productivity. Why should we modern governments to
be any different? We would expect that governments would take great care to prevent
food riots in the capital (and they do), and would follow the advice of the Roman
Emperor Septimius Severus and keep the army well-fed, well-paid, and well-equipped
(and they do). But the lifespan of the average government is too short to expect it to take
a serious interest in the project of long-run economic development.
We need a better answer, however. Bureaucrats, army officers, and politicians buy and
large love their countries and would like to see their neighbors' descendants (and their
own!) prosperous. We need to understand why bureaucrats, army officers, and politicans
anywhere, have so often sacrificed economic development and the long-run interests of
all to the short-run interests of a relative few. One answer is that many modern states are
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vulnerable, especially to urban discontent. Popularly-elected Argentine governments with
electoral legitimacy have been overthrown by small street demonstrations. Even in
France in the 1930s, Premier Edouard Daladier resigned when confronted with an angry,
rioting right-wing mob. If a first priority of a government is to keep its own armed forces
happy with the current order, its second priority is to avoid urban riots, and its third
priority must be to keep notables--bureaucrats, politicians, and those with substantial
regional authority--content, and thus keep potential opposition quiet or disorganized.
The pursuit of these aims comes prior to the formation of policy. All rulers believe they
are the best people for the job: alternative ruling groups are at best incompetent, and most
likely wrongheaded and corrupt. Only after the government believes that its seat is secure
can debates about development policy even begin to take place take place. But the pursuit
of a secure hold on power almost always takes up all the rulers’ time, energy, and
resources. And it requires that the government grab hold of the flow of goods and
services throughout the economy and redistribute it to those--urban workers, the army,
and the bureaucracy--whose favor and support it needs.
Why aren't potential entrepreneurs--those who would benefit most from pro-development
policies, and whose enterprises would in turn employ and sell to and thus benefit many
others--work change a redistributive state into something more friendly to economic
growth? Political scientist Robert Bates asked this question of a cocoa farmer in Ghana,
seeking to learn why successful cocoa farmers did not lobby and agitate for a reduction in
the huge gap between the price the government paid them for cocoa and the price at
which the government sold the cocoa on the world market. “He went to his strongbox,”
Bates (1981) reports:
and produced a packet of documents: licenses for his vehicles, import permits for
spare parts, titles to his real property and improvements, and the articles of
incorporation that exempted him from a major portion of his income taxes. "If I
tried to organize resistance to the government’s policies on farm prices," he said
19
while exhibiting these documents, "I would be called an enemy of the state, and
would lose all these."
A similar micrologic of bureaucracy and politics can be seen at work in the details of
economic development and stagnation around the world. Market-driven growth may not
be the best way to assemble dominant political coalitions--either because special-interest
propaganda deceives voters about the value of the market, because psychological flaws
drive people to seek community and solidarity rather than liberty and prosperity, because
maintaining coalitions requires that supporters be given jobs where they can squeeze
bribes out of entrepreneurs, or for any of a number of other reasons. And where the hand
of government weighs too heavily, it is what Brink Lindsey calls a dead hand.
One of the most telling examples of the dead hand of government--tariffs that keep
people from buying the vehicles they need from outside, regulations that keep people
from building the vehicles they need inside at anything but the most inefficient scale, and
yet the attempts of entrepreneurs to find a way to still get things done--comes in Brink
Lindsey's (2001) description of India's "informal" small-scale vehicle-production
industry:
With a billion people, India has only around 40 million vehicles.... Total duties on
used cars, for instance, are 180 percent.... Known alternately as a "jugaad," a
"maruta," or a "boogi," the vehicle offers barebones transportation for Indian
farmers. It has no roof. The 10-14 horsepower engine must be hand-cranked. It
maxes out at 15 miles per hour. The driver sits on a wooden bench. But the rear
compartment--a plywood bed with wood-paneled sides--has plenty of room for
passengers or cargo. And the price of only around $1000 makes it an unbeatable
bargain. We found boogi manufacturers... no assembly lines, no factories... just
three small mechanics' garages spaced out along the semi-paved road.... The
mechanics buy minivan spare parts--wheels, axles, transmissions, gear boxes, and
steering--from markets in Delhi. They get their engines, made to power water
pumps, from Agra. And they pick up steel for the chassis and wood for the framing
20
from Jaipur.... One shop can turn out four or five boogis a month. Technically,
these vehicles are illegal (pp. 163-4)...
Because these vehicles are illegal, any shop that tries to expand--to make more than four
or five a month--will find itself attracting the attention of the state. An honest magistrate
will shut it down. A dishonest magistrate will squeeze it dry through extortion. Only by
staying small enough to evade the gaze of the state can the cheap-alternative-vehicle
industry survive. And thus it is perhaps two or three times expensive as--with reasonable
scale economies--it could be. Here the dead hand has produced enormous social waste:
first with the extremely high tariffs on vehicle imports (which are fine with domestic
truck and conventional automobile manufacturers), and second with the regulatory hand
that cripples the efficiency and the scale (although not the existence) of the alternativevehicle industry.
Yet it is not just too much government, but too little--or, rather, the wrong kind. Not a
"dead hand," but a "missing hand." Lindsey also considers the commodity trading firm
Phibro's involvement in Argentina, in Tucuman. An Argentine sugar mill wanted to
expand. Phibro offered $20 million in financing "...secured by the sugar inventory. When
the mill ran into problems, workers seized the factory.... Months went by before an
accomodation was reached, and Phibro never returned to Tucuman" (p. 173). The next
time an Argentine sugar mill wants to borrow on the world capital market to expand, it
will be out of luck: the word in New York is that Argentina has no judges who will
enforce contracts. If you think that foreign investment is a source of oppression, surplus
value extraction, and "unequal exchange," you cheer the revolutionary sugar mill
workers. But for a low- or medium-income country to assemble from its own savings the
financing needed to accumulate the capital stock necessary for a modern post-industrial
economy is a nearly impossible task.
The natural conclusion is that successful economic development is difficult without either
a limited government--but still a government, a source of property rights and contract
enforcement--or a successful developmental state. The logic of politics is that of favors
21
performed, wealth redistributed, influence exercised, and taxes collected. That is very
different logic from the logic of economic growth. Why should they be compatible? The
jaws of the trap grip very tightly. They seem inescapable.
Speculations and Conclusions
Yet throughout a wide range of countries in the twentieth century there has been not only
growth, but extraordinarily impressive growth. Japan (before its recent decade of
stagnation) wins the prize for greatest material progress over the century as a whole.
China wins the prize for greatest material progress over the last quarter century. The
United States wins the prize for most productive economy. The nations of the OECD win
a prize of their own for closing the gap vis-à-vis the world's post-industrial leader, the
United States. And the economies of East Asia win the prize for the most rapid industrial
revolution seen anywhere, anytime.
What have been the paths that economies and their governments have followed in order
to avoid the jaws of the political development trap?
One path has been followed by the countries of the Pacific Rim of Asia. In the countries
of the Pacific Rim, the state appears to have been autonomous and developmental.
Government bureaucracies appear to have been secure enough, independent enough, and
(somehow) committed to rapid economic growth. As a result, private rent-seeking
interests became more the tools of a government seeking development and growth rather
than the masters of a government turned to hobbling the public interest in growth in order
to divert wealth to the politically powerful.
In the early 1990s the World Bank issued a study of the extraordinary success of East
Asia's economies, The East Asian Miracle (1993). The conclusions, broadly, were
sixfold:
22

Yes, East Asia's economies have grown extraordinarily rapidly.

Yes, they have grown under the aegis of a government and institutional regime that
does not look at all like limited-government laissez-faire.

Yes, government bureaucrats have used their knowledge of past patterns of industrial
development to guide resources into industries where they think rapid productivity
improvement and comparative advantage are attainable.

Yes, they have used selection mechanisms--rewarding successful exporters with large
subsidies, for example--to "choose winners" among firms in ways that mimic market
selection processes.

Yes, they have twisted price structures heavily in favor of investment and against
consumption.

Yes, corruption has been limited, and many decisions have been made not with an eye
toward enriching a particular political group or lineage but to aiding the development
of the country.
The link between powerful incentives to boost investment and retard consumption and
more rapid growth is clear, although curmudgeons mutter about whether the extra growth
in East Asia has been fast enough to be worth the sacrifice of current consumption. In the
World Bank team's estimation, the use of success at exporting as a yardstick to allocate
subsidies has played a market-like role in rewarding industrial efficiency. But the piece of
magic in the East Asian experience--the thing that makes it so different from similar
attempts at developmental states elsewhere around the globe--has been that corruption
and rent-seeking have been kept within bounds, kept low enough that the state has been
more a helping rather than a grabbing hand for economic development.
Why is this so? Is it because East Asia found itself at mid-century with relatively
egalitarian income distributions, and so there weren't sharp cleavages between classes
and interest groups that are the motor of rent-seeking and of grabbing hand policies? Is it
because "Asian values" served the role of a governor limiting corruption and rent
extraction? We have little insight into the details where the devil is. East Asia's industrial
development has been extraordinarily impressive. However, it was also clear that neither
23
economists, sociologists, political scientists, nor politicians had any idea how to establish
the institutional preconditions for the successful application of this Pacific Rim
development model where it did not already exist.
Moreover, there were many who worried that the developmental-state institutional
pattern would prove less effective for growth at the world's technological frontier than it
had at catch-up. Even the centrally-planned Soviet government could direct the
construction of infrastructure and investment in the capital stock when the country was
poor and was following in the footsteps of earlier industrializers, and when the path to
electrification, rail transport, basic metallurgy, and textiles was clearly marked out. But
closer to the frontier, where there are no long-tested historical examples, the path
becomes much murkier. You can guide the allocation of capital through market signals.
You can guide the allocation of capital by mimicking historical patterns. But what if you
have neither?
And there are lingering worries. The Pacific Rim institutional pattern may have been a
factor that helped leave left East Asian economies so vulnerable to the 1997-1998
financial crisis (Goldstein (1998)). The institutional performance of East Asian
developmental states since the mid-1980s has been much worse than before, and raises
the fear that whatever went right in the first generation of East Asian industrialization is
no longer reliable.
The inescapable conclusion, I believe, is that the Pacific Rim "developmental state"
model would be extremely attractive if we had any clue as to how to replicate it. But we
don't. And the experience everywhere else in the world is that it is extremely dangerous
to try to replace the market with the state as the guide to the path of economic
development.
So it is necessary to turn to the alternative road, the neoliberal road. The path followed is
one in which pressure is put on the state to shrink it back to its core competencies: law,
order, infrastructure, justice, and social insurance. Depending on the balance struck
24
between social insurance and infrastructure construction on the one hand and the
provision of the underlying rules to govern market-based economic activity on the other,
this road comes in "neoliberal" or "social democratic" variants. And it is the road that, by
and large, the most successful economies in the world outside of East Asia have
followed.
Perhaps the most interesting and certainly the most important example of countries
changing course to take this particular developmental road is the transformation of
western Europe after World War II. In Eichengreen and DeLong's (1993) estimation,
western Europe in the interwar period looked like it was proceeding down the same
destructive path that Juan Peron took Argentina. The same institutional patterns seemed
to be emerging after World War II--until the United States appeared with strong beliefs
about the form that post-World War II reconstruction should take, backed up by the large
carrot of Marshall Plan aid.
Eichengreen and DeLong wonder what would have happened had western European
political economy after World War II continued along its prewar course:
…would the market economy have been allowed to do its job?… Many feared the
return of the Depression… a live possibility in the absence of the Marshall Plan
was that governments would not … allow the market… to do its job… no matter
how damaging “government failure” might be to the economy, it had to be better
than the “market failure” of the Depression.
They go on to argue that:
In the absence of the Marshall Plan, might have Western Europe followed a
similar trajectory? In Díaz Alejandro's estimation, four factors set the stage for
Argentina’s relative decline: a politically-active and militant urban industrial
working class, economic nationalism, sharp divisions between traditional elites
and poorer strata, and a government used to exercising control over goods
25
allocation that viewed the price system as a tool for redistributing wealth rather
than for determining the pattern of economic activity. From the perspective of
1947, the political economy of Western Europe would lead one to think that it
was at least as vulnerable… The war had given Europe more experience than
Argentina with economic planning and rationing. Militant urban working classes
calling for wealth redistribution voted in such numbers as to make Communists
plausibly part of a permanent ruling political coalition in France and Italy.
Economic nationalism had been nurtured by a decade and a half of Depression,
autarky and war. European political parties had been divided substantially along
economic class lines for a generation…
A look at western Europe's successful post-World War II reconstruction teaches five
tentative lessons about what form their successful government policies took:

The market was given a large--in fact, the dominant--role in guiding resource
allocation. Prices were by and large signals of scarcity and value, not (as in postWorld War II Argentina) tools to redistribute income.

The government's tax and spending policies were tools to provide social insurance
and redistribute income in the interest of making sure that growth was universally
beneficial. They were not tools to guide resource allocation.

Government control of the "commanding heights" of the economy--whether coal,
petrochemicals, or steel--seemed to be more damaging the more complete it was.
Government-owned enterprises could not replace the capitalist logic of investmentfor-profit with the social logic of investment-for-productivity-growth. Instead, they
replaced the capitalist logic of investment-for-profit with the political logic of no
investment, as the investment funds of government-owned enterprises were raided to
help Finance Ministers meet their own targets.

As long as employment was high and growth was rapid, pressures on states to
succumb to rent-seeking were relatively small and largely limited to particular
sectors, agriculture being the most important. Developmental success became a
virtuous circle.
26

To the extent that bureaucracies, courts, and judges could be trusted to follow their
own formal procedures, economic development was more successful.
The extraordinary success of western Europe with its development model after World
War II--whether you call it "mixed economy" or "neoliberal" or "social democracy" is a
very heartening example.
However, it was also clear that the limited-government "neoliberal" model has its own
paradoxes. At the limit, the claim is that the limited night-watchman need do nothing
more than enforce contracts and protect property. But, as Brink Lindsey (2001) and many
others have pointed out, protecting property and enforcing contracts is hardly a "limited"
thing to do. For a government to announce that so-and-so owns such-and-such, and to
make that assignment and its judgments stick in spite of whatever roving bandits, local
notables, and most important the government's own functionaries try to do requires an
enormous amount of social power. Such a government is by no means weak. It is strong,
but also self-restrained.
Moreover, even a limited government is still a government: that is, it is a political
coalition that holds itself together through successful economic management but also
through redistribution of wealth and income to key supporting interest groups. The state
must not only restrain itself from actions that will gravely harm the economy, it must also
find a set of effective redistributionist policies that allow it to both function as a political
system and also keep its self-restraint.
These appear to be the two roads to successful rapid development: "neoliberalism," on
the one hand; and the so-called "developmental state" approach that has been so
successful in East Asia on the other. Either insulates the economy from the (semipredatory) government so that the government’s attempts to tilt the distribution of income
in favor of the politically powerful are relatively ineffective and do little harm, or create a
government bureaucracy whose first goal is development, and which views interests as its
tools to be used in promoting economic growth, rather than as its masters.
27
One way to read the economic history of much of the post-World War II third world is as
repeated attempts to produce the second: to create a pro-growth "developmental state."
Yet in the last analysis there is nothing worse than state-led development led by an antidevelopmental state. And that was what too many post-independence Asian and African
and too many post-World War II Latin American states turned out to be.
Thus in recent years hopes for development--outside of the Pacific Rim, where the
successful "developmental state" has been a reality--have shifted in the direction of
"neoliberalism." It seems better to try to limit the state’s involvement in the process of
development because its interventions are more likely to be destructive than constructive.
It seems next to impossible to figure out how to duplicate whatever institutions and
patterns have allowed for the East Asian developmental state-led miracle.
But the neoliberal road has its own problems. A government can fail by doing "too
much," and adopting destructive policies that transfer wealth and cripple
entrepreneurship. A government can fail by doing "too little," and failing to protect
property rights and enforce contracts. The work of building market institutions is
"mundane but critical." The classical-liberal "night watchman" state that neoliberals wish
for--the government that has only two employees: a judge to decide who is right when
contracts are disputed, and a constable to make sure nobody steals anything after dark--is
a historically-unique, unusual, sophisticated, and immensely powerful politico-social
institution. Think of it: The state must be able to enforce contracts--it must have, in
reserve, sufficient authority and force that what its judges command actually happens.
The state must be able to control local notables--it must be able to keep them from
applying pressure to sign over property or other rights that those without local wealth,
authority, prestige, and dependents cannot resist. Even the United States government
cannot keep WalMart managers from forcing their employees into mandatory, and unpaid
overtime. Most important, a successful government along the neoliberal road must be
able to control its own functionaries: they must do their jobs, rather than either taking
bribes or strangling the economy in red tape.
28
The next decade or so will tell us whether the neoliberal path the world is now on will
prove practicable. I am hopeful and optimistic, but not certain.
29
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