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Norton Media Library
Chapter 5
States and
Markets
Dwight H. Perkins
Steven Radelet
David L. Lindauer
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The Story of Ghana
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in 1957 Ghana gain independence, with great
hope for future: the world’s largest cocoa
producer, the highest per capita income, large
foreign exchange reserves... with plans to be
industrialized economy, state intervene in the
economy, controlled P, restrictions on trade and I,
state-owned enterprises, heavy borrowing, import
substitutions
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in mid 1960s, cocoa prices collapsed
the state heavy hand led to corruption, poor
investment decisions, distorted prices, and
growing instability
coups and countercoups for 17 years
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economic fluctuations due to unstable cocoa
prices
economic growth fluctuates as a result:
-6%, 7%, -5%, -14%,
in 1983 the economy collapsed
cocoa production was half as large as before
inflation 120%+, growth rate -6% for 3 years
per capita income 30% than 26 years before
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in 1983, an economic recovery program was
introduced by IMF and WB
modest outcome: less inflation 20%, lower
trade deficit, more stable and positive
economic growth
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Ghana’s experience is typical to many developing
countries
in 1980s: a shift away from government
intervention to more market-based reforms
through stabilization and structural adjustment
programs
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The 1980s were called the “lost decade” of
Africa. These was also applied to Latin America
due to state driven excessive control on the
economies
Ghana led the way in economic reforms followed
by others. Later the collapse of the Berlin Wall in
1989 enable many African countries make
reforms along market system.
The end of the cold war and demise of the
former Soviet Union led to fall of African dictators
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African Economic Reforms
The 1980s were called the “lost decade” of
Africa. These was also applied to Latin America
due to state driven excessive control on the
economies
Ghana led the way in economic reforms followed
by others. Later the collapse of the Berlin Wall in
1989 enable many African countries make
reforms along market system.
The end of the cold war and demise of the
former Soviet Union led to fall of African dictators
such as in Ethiopia, and Somalia, etc
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I. Markets and Market Failures
Market economics well developed in Introductory
Principles of Economics (Microeconomics &
Macroeconomics)
Markets under certain conditions provide the
“invisible hand” to the economy
The Power of Markets in organizing national
economies have been proved in successful
market Economies
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Arguments for Markets
1.Allocate resources efficiently. Under
competitive economy economic welfare is
maximized under free working markets
2.Market system is more flexible and able to
adjust to business cycles than government
control
3.Market promote competition which motivate
consumers and producers guided by enlightened
self interest.
4.Reliance in Markets disperses economic and
political power and therefore consistent with
democracy.
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I. Areas of Market Failure
Markets can fail due to numerous reasons
1.Monopoly or oligopoly control..
2..Presence of Externalities ( Positive Spill Over effects)such as public education, etc
3. Negative Externalities (negative spill over effects- such
as pollution
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4. Markets may not facilitate change in economic
structure- Infant Industry argument at early stages
5. Missing or underdeveloped Institutions rules/laws
6. Macroeconomic Imbalances
7.Misguided National Goals promoted by autocratic
governments especially in Dictatorship. examples
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II. Market Pessimists & Market Optimists
Some Roots of Market Pessimism:
“Great Depression of the 1930 & 1940’s when
war led blocked trade barriers
Arguments for intervention and control
(balanced growth, big push arguments)
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Forced structural transformation of economies by
States justified by Lewis theory of labor surplusthe Soviet Union was the model 1950 &60’s,
Marxist, Leninist, Mao ideologies of central
control and direction of the economies..
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Market Optimism
Intellectual basis for Market Optimism
Economic Theory provides the basis for market
supremacy.
Powerful theories by the Chicago School of
Economists such as Friedman, Schultz, etc
The historic collapse of the Soviet Union in 1991
and the end of the Cold War
East Asian Miracle of Asian Tigers such
Singapore, South Korea, Taiwan, Malaysia, etc.
(See BOX 5.1 Decline of state control over time)
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Implementing Market Reforms
Due to regulations and control that led to rent
seeking that diverted investors and
entrepreneurs to unproductive activity and
corruption, it became necessary to promote
markets and the private sector
The World Bank and IMF helped to countries
economic reforms: structural adjustment and
stabilization reforms.
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Stabilization of the Macro-economy
Stabilization refers to correcting imbalances in
budgets, & money supply aimed at controlling
inflation.
It also means the need to devalue the currency
or exchange rate to avoid currency controls.
With inflation and uncertainty investors divert
resources from productive activities such as
transfers to overseas, etc
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IMF Stabilization Programs
There are five such remedies
1.Reducing government budget deficit via higher taxes,
reduce spending, financing by borrowing which crowds
out private investment.
2.Restrictions on central credit-control of money supply
3.Adjust exchange rate via devaluation to stimulate
exports.
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4.Remove price controls on consumer goods including
food prices
5.Restrain wage increases since wages greater than
productivity increase costs and contributes to inflation
Case of Bolivia stabilization program Box 5.2. 1985-86
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Structural Adjustment Program (SAP)
by the World Bank
Trade reform- opening the economy to trade
Adjusting Prices” Getting Prices Right”
Promoting market competition
Fostering Privatization
Creating Market Support Institutions (Legal
system, financial system, well define property
rights rules that promote long term investment
and productivity.
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Timing of Market Reforms
Faster reform- shock therapy often recommended by the
IMF. This may work under new regimes- Russian &
Eastern Europe case.
Graduate reform-based on sequencing of reforms- China
and Vietnam
China began with household responsibility system in the
rural sector (Box 5-3 A case of China reform 1999-2001)
Attempted reforms in Africa with varying results;
(Uganda, Kenya, Ghana, Mozambique, and Tanzania)
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Credibility of Reforms
How do we evaluate and monitor credibility of
reforms.
Public perception matters:
IMF & World Bank are supposed to evaluate
reforms
IMF & World Bank reliability of evaluation is
questionable especially in dictatorships.
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The Washington Consensus
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Economist Williamson labeling of growing
agreement among Washington Institutions ( US
Government, World Bank, IMF)
There are 10 components of these consensus
(See Box 5.4 –Washington Consensus case of
Brazil)- abolished by most recent government of
Lula)
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The ten Components of the Washington
Consensus
1.Fiscal discipline-Balance budget, deficit l to2%
2.Reordering public expenditure and prioritiesreduce subsidies including Military expenditure
3.Tax Reform: Reduce taxes, improve incentives
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4.Liberalize interest rates: Nominal rate should be
higher than the rate of inflation, real interest rate
should be positive
5. Promote competitive exchange rate. Avoid
currency controls, aimed at expanding exports
6. Trade Liberalization: Reduce or eliminate tariffs
(export and import taxes)
7. Liberalization of Foreign Direct Investment (FDI):
Attract inflow of capital, skills and knowledge
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8.Privatization: State enterprises should be privatized
since they are more efficient under private ownership
than state.
9.Deregulation: reduce government regulations including
entry and exit of firms. Also ensure safety of the
environment.
10. Secure Property Rights in the private sector. Provide
long term property rights that is secure and transferable.
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The future Economic Reforms
While implementing the Washington Consensus
helps the challenge remains along these lines:
1. The need for strong democratic institutions
and good governance necessary to implement
development policies
2. The need to for transparency in national and
international institutions including global
institutions that re-solve peacefully and promote
sustainable peace and justice.
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