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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 multiparty).
– 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).