T H E S T A T E A N D E C O N O M I C D E V E L O P M E N T
The Debt Crisis and Structural Adjustment
The international debt problem that surfaced in the Mexican ﬁnancial
crisis of 1982 spread rapidly throughout the developing world, especially
in Latin America and a number of African and East European
countries. When Arab oil-producing countries had suddenly and
sharply raised oil prices in 1973, severe balance of payments deﬁcits
were incurred by LDCs. Recycling of the resultant OPEC surplus to
deﬁcit LDCs through loans by large international banks increased the
likelihood of an eventual crisis. The decision of the Federal Reserve
in the fall of 1979 did precipitate a crisis when it shifted from a loose
to a tight monetary policy in order to defeat hyperinﬂation. LDC
debtors then suddenly found themselves saddled with huge interest
payments on their debt and were unable to service their debt because
of the global recession and loss of income from their exports.
The consequent LDC debt crisis during the 1980s had a devastating
impact on a large number of developing countries and, subsequently,
also had profound consequences for the economic policies of the
LDCs, the role of the International Monetary Fund in economic development,
and the relations between industrial and developing economies.
In effect, the debt crisis signaled the failure of the development
strategy based on import-substitution and of the idea that the state
should play a substantial role in the less developed economy.
Throughout the 1970s, LDCs had ﬁnanced their economic development
through “sovereign borrowing,” that is, government borrowing,
in Western capital markets, a strategy that permitted escape from dependence
on both northern MNCs and the “conditionality” policies
of the IMF and the World Bank.15
By the mid-1980s reliance on bank
loans had become impossible. Later in the decade, the collapse of
the Soviet Union and the failure of its command economy further
strengthened belief in the superiority of the market system. However,
it was the LDC debt crisis, more than any other development, that
led to the triumph of the doctrine of neoliberalism and the policy of
structural adjustment.
When Mexico informed the United States in 1982 that it could no
longer service its huge debt, the Federal Reserve launched a concerted
effort to contain the crisis so as to prevent damage to the American
banking system and extension of the crisis to other debtor countries
in Latin America. While the Fed arranged for short-term loans to
15
“Conditionality” refers to the imposition by the IMF of certain requirements that
must be met before assistance is forthcoming.
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prevent a Mexican default, the IMF assumed responsibility for working
out a long-term solution. The arrangement for dealing with the
Mexican debt crisis became the model followed with other LDC debtors.
Although the debtors attempted to present a united front against
imposition of the strict terms dictated by the lender countries, the
latter were in ﬁrm control. However, it soon became apparent that
the initial assessment of the debt crisis had been deeply ﬂawed. The
debt problem in many countries was really one of insolvency—they
could not service their debts without major economic and structural
reforms—rather than a liquidity problem that could be solved by
short-term lending and policy adjustments. Many debtors could not
possibly repay or even service (pay the interest on) their debts under
the best of circumstances. It became obvious that a long-term, more
fundamental solution to the debt problem was required.
In 1985, responding to this reassessment of the nature of the debt
crisis, U.S. Secretary of the Treasury James Baker initiated the policy
of structural adjustment.16
This doctrine, resulting from the neoorthodoxy
of the 1970s, assumed that the debtor countries’ persistent trade
and ﬁscal imbalances had deep structural causes. Therefore, along
with changed macroeconomic policies, such structural reforms as a
shift toward export-led growth, reductions of the role of the state in
the economy, and public sector reforms were required. This approach
was also based on the lessons drawn from the East Asian successes in
the 1960s and 1970s. This new conventional wisdom coincided with
rising opposition to big government in the United States, the United
Kingdom, and elsewhere.
The doctrine of structural adjustment meant that a debtor country
applying for ﬁnancial assistance from the IMF and/or World Bank
had to commit itself to a number of stringent economic and structural
reforms. Over the short term, these reforms were intended to achieve
balance of payments adjustment; over the long term, restructuring of
these economies would be necessary if they were to return to successful
economic development. Underlying this signiﬁcant policy reorientation
of lender governments and the IMF was the realization that
only more rapid rates of economic growth would enable the debtors
to overcome the problem of national insolvency.
The doctrine of structural adjustment was based on what John Williamson
called the “Washington Consensus.”17
This term refers to
16
Joan M. Nelson, ed., Economic Crisis and Policy Choice: The Politics of Adjustment
in the Third World (Princeton: Princeton University Press, 1990).
17
John Williamson, “Democracy and the ‘Washington Consensus,’” World Development
21, no. 8 (1993): 1329–36.
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Williamson’s perception of broad agreement among public ofﬁcials
in both the industrial economies and international institutions on the
importance of the neoliberal program for economic development and
its emphasis on free markets, trade liberalization, and a greatly reduced
role for the state in the economy. Although some LDCs
charged that the demand for structural adjustment was a new form
of capitalist imperialism, the LDCs had little choice other than compliance
if they wanted ﬁnancial assistance. While later developments
complemented or supplemented the policy of structural adjustment,
this basic approach soon deﬁned the position of the industrial countries
and the IMF toward the LDCs and economic development.
Belief that the role of the state in the economy should be drastically
reduced and the economy should be opened to the outside world was
a vital component of this neoliberal consensus; governments should
deregulate and privatize the economy as well as shift from an importsubstitution
to an export-led growth strategy. Another component of
structural adjustment was that governments should pursue prudent
ﬁscal and monetary policies and should deﬁnitely maintain balanced
budgets in order to eliminate runaway inﬂation. It was particularly
important that the economy should “get prices right” and not permit
government policies to distort them. After such reforms, it was argued,
private initiatives and desirable social outcomes would be likely
to emerge. Nations were encouraged to recognize that economic development
requires an “effective” state, meaning a government run
by incorruptible economic technocrats. Although a number of important
disagreements (primarily of a political nature) persisted within
this broad neoliberal agenda, the Washington Consensus became the
principal approach of the developed countries to the less developed
countries.18
The debt crisis transformed the international role of the IMF and
the World Bank. The IMF had originally been established as a monetary
institution to manage the Bretton Woods system of ﬁxed exchange
rates; for example, it provided short-term loans to deal with
balance-of-payments problems. To receive such a loan, the recipient
country had to fulﬁll certain macroeconomic policy conditions (conditionality).
These conditions were imposed to force the country to
bring its international payments back into equilibrium. In response to
the debt crisis, the role of the IMF changed dramatically as it began
18
These political disagreements have been over such matters as economic priorities,
the speed and sequencing of economic liberalization, and how to reform the civil service.
These highly controversial issues are at the core of the political problems that
must be resolved if economic development is to succeed.
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to make medium-term loans. In addition, implementation of the doctrine
of structural adjustment meant that conditionality was expanded
from requirements of changes in macroeconomic policy to
fundamental changes in microeconomic policies and in the overall
economy. This made the IMF become an economic development
agency with considerable inﬂuence over the economic affairs of less
developed countries.
With its response to the debt crisis, the Fund joined the World
Bank to play a major role in the affairs of both developing economies
and the transitional economies in Eastern Europe and the former Soviet
Union. Warranted or not, the Fund became known as the “bad
guy,” and was subjected to severe criticism by many economists, less
developed countries, and politicians on both the political left and
right. The Left turned against the IMF because of its inﬂexible demands
that governments seeking assistance had to carry out major
reforms and austerity programs, whose impact proved heaviest on the
poor. The Right believed that IMF policies had actually harmed less
developed countries and thus preferred a market solution to the ﬁnancial
troubles of developing and transitional economies. Opposition
to the Fund reached its zenith during the 1997 East Asian ﬁnancial
crisis and led to proposals for fundamental reforms.
Theory of the “Developmental State”
In the late 1980s and early 1990s, the theory of the developmental
state arose to challenge neoliberal orthodoxy explaining the rapid and
successful industrialization of the Newly Industrializing Economies
(NIEs) in East Asia. According to this position, the outstanding economic
success of Japan and other East Asian countries was due to
their adoption of the developmental state model in which the state
had to play the central role in guiding economic development and
had to lead rather than follow the market. The acrimonious debate
between proponents of the developmental state and proponents of
the neoliberal, market-centered approach has become central to determination
of the best route to successful economic development.19
19
Two useful analyses of this debate are Stephan Haggard, Pathways from the Periphery:
The Politics of Growth in the Newly Industrializing Countries (Ithaca: Cornell
University Press, 1990); and Richard F. Doner and Gary Hawes, “The Political Economy
of Growth in Southeast and Northeast Asia,” in Manochehr Dorraj, ed., The
Changing Political Economy of the Third World (Boulder, Colo.: Lynne Rienner,
1995), Chapter 6.
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The neoliberal interpretation of the extraordinary economic success
of the NIEs (South Korea, Taiwan, Hong Kong, and Singapore) was
that these economies had pursued “market conforming” economic
development strategies; markets rather than government policies had
determined the path of development. The extraordinary performance
of these “miracle” economies, neoliberal thinkers believed, provided
strong support for the Washington Consensus, the doctrine of structural
adjustment, and neoclassical reliance on the market. According
to this interpretation, East Asian governments had followed neoliberal
policy prescriptions; they had opened their economies to the
world, reduced the role of the state in the economy to permit markets
to function properly, and pursued export-led growth strategies. This
interpretation of Japanese and East Asian economic success, however,
was challenged by theorists of the developmental state, who argued
that success was due to the crucial role played by the state and its
industrial policies in the process of economic development.
The theory of the developmental state is really a collection of several
theories sharing important ideas. These several theories assert
that East Asian governments have played a central role in the development
of their economies. Two outstanding interpretations of East
Asian economies as developmental states are found in Alice Amsden’s
Asia’s Next Giant (1989), which analyzes the industrialization of
South Korea, and Robert Wade’s Governing the Market (1990),
which deals with the industrialization of Taiwan.20
Although Amsden’s
and Wade’s ideas differ on a number of issues, I shall emphasize
those points on which they and most other proponents of the developmental
state are in agreement.
Theories of the developmental state argue that the governments of
Taiwan, South Korea, and the other NIEs devised an array of incentives
that encouraged private investment in strategic industries. Also,
through a variety of techniques, these governments played a key role
in creating an entrepreneurial class, identiﬁed critical economic areas
for development, and exposed priority sectors to international competition
that forced them to become efﬁcient. These state policies encouraged
development of an industrial and economic structure that
would not have arisen merely in response to market signals. According
to the theory of the developmental state, the policies of these
governments deliberately got prices “wrong” in order to change the
20
Alice H. Amsden, Asia’s Next Giant: South Korea and Late Industrialization (New
York: Oxford University Press, 1989); and Robert Wade, Governing the Market: Economic
Theory and the Role of Government in East Asian Industrialization (Princeton:
Princeton University Press, 1990).
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behavior of ﬁrms; they also used nonprice means to alter ﬁrm behavior.
Scholars argue that this state-led industrialization strategy
worked by using the price mechanism to encourage private entrepreneurs
to take actions that the government considered to be in the
interest of rapid industrialization.
The industrial, protectionist, and other policies employed by the
developmental state were based on the assumption (which had been
shared by members of the ﬁrst generation of development theorists)
that these economies suffered from the consequences of “late, late
industrialization.” Market failure was assumed to be prevalent
among these less developed economies, and market failure necessitated
an active role for the state. Governing elites believed that their
societies faced “collective action problems”; that is, they had to ﬁnd
a way to motivate members of their societies to work together. State
policies were needed to bring private returns in line with public returns.
States had to create an incentive structure to ensure that private
entrepreneurs invested in those economic activities that would be the
most socially beneﬁcial. In addition to trade protection and government
subsidies, their industrial policies included such “ﬁnancial repression”
policies as selective credit allocation and deliberate distortion
of interest rates in order to channel cheap credit to favored
economic sectors. Elites also believed that government policies should
anticipate the future comparative advantage of the economy and that
industrial policy should lead rather than follow the market.21
Although proponents of the developmental state agree with neoclassical
economists that the strategy of export-led growth was a key
factor in the economic success of the East Asian economies, they argue
that neoclassical analysis is not sufﬁciently comprehensive. For
example, they ask why business ﬁrms selected particular products for
export.22
As Amsden points out in her study of South Korean industrialization,
that government used a number of mechanisms to promote
particular industrial sectors and encourage export drives, including
export contests to promote rapid industrialization of those sectors
considered of strategic importance to the overall economy. Those industries
that performed best in export markets were especially favored
by government industrial policies and programs of ﬁnancial assistance.
21
Richard Auty makes the interesting point that industrial policy was a consequence
of the uncertain political situation after the defeat of the United States in Vietnam.
Richard M. Auty, Economic Development and Industrial Policy: Mexico, Indonesia,
and China (New York: Mansell, 1994).
22
Another area of disagreement has been the relationship of exports and growth.
Did exports cause growth, as neoclassical economists assume, or did growth cause
exports, as proponents of the development state believe?
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Proponents of the developmental state maintained that the theory of
the “governed market,” to use Wade’s appropriately descriptive term,
rather than the neoclassical theory of the free market, accounted for
the outstanding economic success of the East Asian NIEs.
The theory of the developmental state maintains that the East Asian
state was able to play a guiding role in economic development because
of a number of unique domestic and international factors. In
all these societies, the state has been relatively autonomous and therefore
able to pursue policies free from public pressure. Yet, this state
autonomy was deeply embedded in a society where the state worked
very closely with business interests to promote rapid industrializa-
tion.23
Some observers believe that such Asian social values as hierarchical
deference, a tradition of hard work, and subordination of the
individual to the community played a crucial role; celebration of
Asian values also provided ideological support to the authoritarian
regimes of the region. The national political economy was based on
trust and subordination rather than Western-style compliance and accountability.
Although these states were authoritarian, they also carried
out important reforms and implemented policies favorable to
economic growth and social harmony; for example, they promoted
land reform, education, and income equality.
At the core of the developmental state and the reason for its outstanding
success were close ties among government, local banks, and
industry. These intimate relationships, which Wade calls “alliance capitalism,”
facilitated channeling bank capital into promising industries
and thus promoted rapid industrialization. At the same time, domestic
governments frequently restricted both foreign direct and portfolio investments
by international ﬁrms and thus insulated their economies
from disruptive external inﬂuences. Although this system produced liabilities
disproportionate to their assets in the larger enterprises such as
the South Korean chaebol, the system worked very effectively and was
stable as long as local governments controlled domestic ﬁnancial markets
and the capital account, a situation that changed dramatically in
the 1990s and was a signiﬁcant factor in the post-1997 East Asian
ﬁnancial crisis. Development of these economies was also supported
by a number of sociological and political factors, such as a hard-working
labor force and only moderate levels of inequality.
In addition to these domestic features, a number of international
factors were of beneﬁt to the Newly Industrializing Economies
(NIEs). As Cold War allies of the United States, they received special
23
Peter Evans, Embedded Autonomy: States and Industrial Transformation
(Princeton: Princeton University Press, 1995).
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treatment in American economic and other policies. National security
concerns motivated Taiwan and South Korea, in particular, to place
a high priority on rapid economic development. Moreover, as some
writers have pointed out, Japanese imperialism had left a legacy of
physical infrastructure, an educated population, and effective institutions
that favored economic development. Another very important
factor was that these economies were able to pursue an export-led
growth strategy because of the global free-trade environment.
Despite the importance of East Asia’s unique domestic and international
circumstances, governments in other parts of the world have
looked to this Asian experience for guidance and have sought to incorporate
key components of that developmental model into their own
strategies. Although many developing economies have been strongly
inﬂuenced by the neoliberal agenda of export-led growth and structural
reforms and have made important market-conforming reforms,
many also have tended to be very pragmatic and have not been prepared
to adopt completely the neoliberal emphasis on open markets
and noninterference in the economy by the state. Also, they continue
to be wary of what Stephan Haggard calls “deep integration” in the
global economy.24
As a consequence, industrializing economies and
even most developed countries tend to pursue strategies of selective
opening to the world economy, in which the state mediates between
domestic and international markets and thereby attempts to guide the
economy so as to promote the nation’s economic and political interests.
For example, although Brazil has given up its futile effort to create
its own computer industry, it has continued to use protectionist devices
to promote the development of a Brazilian automobile industry.
For Latin America and other industrializing countries, the ultimate
attractiveness of the theory of the developmental state is that it appears
to be the appropriate means for combining economic development
with political independence.25
Economic development and industrialization
have never been considered ends in themselves. The
ultimate goal of developing economies has always been to achieve
economic autonomy and political independence. In a world of highly
concentrated market power, states desire to control their national
economies as much as possible and do not want their position in the
24
Stephan Haggard, Developing Nations and the Politics of Global Integration
(Washington, D.C.: Brookings Institution, 1995).
25
I am indebted to Peter Kingstone of the University of Vermont for his assistance
in my understanding of these matters. A relevant interpretation is Luiz Carlos Bresser
Pereira, Economic Crisis and State Reform in Brazil: Toward a New Interpretation of
Latin America (Boulder, Colo.: Lynne Rienner, 1996).
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international division of labor to be determined solely by the free play
of market forces.
Despite the strong support in many LDCs for the theory of the
developmental state, most neoclassical economists reject it. Paul
Krugman, writing in the Foreign Affairs journal (1994), attacked the
idea that East Asian governments had succeeded because government
policies had substantially raised the productivity levels of their econo-
mies.26
Krugman argued that these societies were successful primarily
because of their rapid accumulation of capital and labor, the basic
factors of production. He further argued that the development experience
of these countries supported the neoclassical growth model;
there was no “miracle.” While there had been a one-time leap forward,
future growth would require increased emphasis on innovation
and productivity growth, except in China. Whether or not Krugman’s
critique is correct, these societies should at least be credited for effective
mobilization of their human and material resources.
The East Asian Miracle Project
The developmental state interpretation of East Asia’s economic success
could have remained an academic dissent from the Washington
Consensus; however, the Japanese government’s agreement with the
theory’s basic assumption about the important role of the state in
economic development gave prominence to the theory.27
In the 1980s,
26
Paul R. Krugman, “The Myth of Asia’s Miracle,” Foreign Affairs 73, no. 6 (November/December
1994): 62–78. The emphasis on factor accumulation rather than
technological progress was first set forth by Alwyn Young in the 1992 NBER Macroeconomic
Annual. Krugman, drawing upon Young’s finding, downplayed the East
Asian “miracle.” The success of East Asia, he argued, was attributable mainly to capital
investment and high population growth rather than to technological innovation and
productivity growth. This argument is extended in Alwyn Young, “The Tyranny of
Numbers: Confronting the Statistical Realities of the East Asian Growth Experience,”
Quarterly Journal of Economics 110 (August 1995): 641–80. Other economists have
given support to the important role of technological progress in the “miracle.” This
work is discussed in Robert J. Barro, “The East Asian Tigers Have Plenty to Roar
About,” Business Week, 27 April 1998, 24. A report by the Paris-based Organization
for Economic Development supports the Krugman-Young position that these economies
suffered from serious weaknesses in technological development, skilled workers,
and other technology-related matters. Organization for Economic Development, Asia
and the Global Crisis: The Industrial Dimension (Paris: Organization for Economic
Development, 1999). And thus the argument continues.
27
The Japanese criticism of the Washington Consensus is set forth in The Overseas
Economic Cooperation Fund, Issues Related to the World Bank’s Approach to Structural
Adjustment: Proposal from a Major Partner (October 1991), OECF Occasional
Paper No. 1 (unpublished).
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the World Bank (WB), having subscribed to the Washington Consensus,
rejected what the Japanese believed to be their own superior
model of economic development based on the central role of the state
in the economy. The Japanese had been especially irked by the WB’s
World Development Report 1991, which praised the neoliberal position
and had little good to say about the Japanese model.28
As John
Page, a high World Bank ofﬁcial, had told a Princeton University
audience, the Japanese continued to sign the checks, but they felt that
the World Bank did not appreciate the reasons for Japan’s own outstanding
economic success. Japan wanted the bank to pay greater
attention to the distinctive features of the East Asian economies. It
also wanted greater emphasis in World Bank policy on the important
and necessary role of the state in economic development rather than
a nearly exclusive emphasis on macroeconomic issues and structural
adjustment. Therefore, the Japanese insisted that the World Bank
carry out an empirical study to determine the speciﬁc reasons for the
economic success of the East Asian economies before deciding on policy
advice for other developing countries. This Japanese demand generated
what became known as the East Asian Miracle Project.
The East Asian Miracle Project was intended not only to meet Japanese
concerns but also to review the World Bank’s policies toward
less developed countries and to evaluate alternative approaches to
economic development. John Page, director of the Project, labeled one
possible approach “fundamentalism”; that is, the Solow or neoclassical
theory of economic growth, which attributes economic growth
primarily to “getting the prices right” and to accumulation of the
basic factors of production.29
The alternative approach, pejoratively
labeled “mystical” by Page, was based on the theory of endogenous
growth set forth by Paul Romer and other economists. This “new
growth theory” implied that state interventionism could accelerate
the process of economic growth and that, through industrial and
other policies, the state could expedite technological innovation and
productivity growth. The Project was intended to determine once and
for all whether economic growth is better explained by factor accumulation,
and thus accords with neoclassical theory and World Bank
orthodoxy, or by technological advance and productivity growth,
which would be in accord with endogenous growth theory and the
idea of the “developmental state.”
28
World Bank, The Challenge of Development: World Development Report 1991
(Washington, D.C.: World Bank, 1991).
29
As the reader will recall, according to this theory technological change and productivity
growth are exogenous and the role of the state in economic growth is negligible.
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The Project concentrated on the East Asian NIEs and their unique
development experience. Economic growth in these economies had
been rapid and persistent; moreover, the beneﬁts of economic development
had been broadly distributed throughout the societies. The
study looked for answers to particular questions: What did the process
of economic development actually look like in these economies?
What, if anything, did the industrial and other economic policies of
various governments contribute to the process of economic growth?
And, was the experience of the NIEs in any way transferrable to the
great majority of less developed countries that were falling farther
behind rather than converging as economic theory predicted? Answers
to these questions would greatly facilitate World Bank decisionmaking
regarding the economic policies it should pursue in promoting
development. Unfortunately, the study and its report did not
resolve the issue, at least not to the satisfaction of proponents of alternative
explanations of East Asian economic development.
Report on the Project
The World Development Report’s main ﬁnding was that there had
been no East Asian miracle. It concluded, instead, that the outstanding
success of the East Asian NIEs was due to the fact that these
economies had pursued market-conforming economic policies and
had fostered such economic fundamentals as high rates of savings/
investment, education, and prudent macroeconomic policy.30
These
economies were successful because they conformed to the Solow
model of economic growth based on factor accumulation. Neither
state intervention, technological progress, nor the theory of endogenous
growth, the Report concluded, had much to do with the rapid
industrialization of these economies. The Report included the following
speciﬁc conclusions:
(1) The East Asian economies followed prudent macroeconomic policies
that kept government deﬁcits down or even reduced accumulated
deﬁcits, kept inﬂation low, and held foreign debt to modest
levels. Pursuing market-conforming economic policies and minimizing
price distortions, they got prices right by allowing domestic
prices to fall into line with international prices, thereby encouraging
industries with a natural comparative advantage to
ﬂourish.
30
World Bank, The East Asian Miracle: Economic Growth and Public Policy (New
York: Oxford University Press, 1993).
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(2) They maintained higher levels of savings and investment and had
harder working and more skilled workers than did other LDCs.
For example, 7 to 10 percent of Gross Domestic Product (GDP)
went into investment; this high rate of investment greatly facilitated
rapid capital accumulation.
(3) The export push or export-led growth strategy of these economies
was another reason for their success. Focus on foreign markets
promoted economic efﬁciency by keeping domestic prices
closely in line with international prices and also accelerated introduction
of foreign technologies; this then facilitated increased
productivity.
The Report was very critical of the “mystics,” the theory of endogenous
growth, and the idea of the developmental state. Although it
acknowledged that industrial policy and other forms of state intervention
might indeed have assisted the process of economic development,
its message was quite negative about the efﬁcacy of state intervention.
The Report reached the following conclusions about the developmental
state:
(1) Industrial policies to promote particular sectors, to determine the
structure of the economy, and thereby to accelerate development
and productivity growth failed to explain the region’s rapid
growth. State intervention was ineffective at best and counter–
productive at worst. The major source of economic growth was
capital accumulation, which accounted for 60 to 70 percent of
the growth, whereas productivity growth—technological input—
accounted for only about 30 percent of economic growth.
(2) Even without public-sector intervention, market forces by themselves
would have brought about the changes in industrial structure
that were encouraged by governments.
(3) Government controls of ﬁnancial markets, the Report did point
out, had lowered the cost of capital and directed credit to favored
sectors. In light of the crisis of 1997, it is ironic that the Report
had praised governments’ interventions in ﬁnancial markets.
The World Development Report, based on such ﬁndings, described
the theory or model of economic growth it used to explain East Asian
economic success as functionalist and concluded that a developing
country would be successful if it carried out speciﬁc mutually reinforcing
functions. The country had to ﬁnd a way to rapidly accumulate
such assets as human capital and capital investments. It had to
allocate resources efﬁciently. And the country also had to achieve
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rapid productivity growth by catching up technologically with advanced
countries. Although the Report gave some credit to effective
state intervention in the economy, this was played down due to concern
that LDCs with less competent and/or more corrupt governments
might attempt to use the Report to defend undesirable interventionist
policies. Ironically, this project that began as an attempt
by the Japanese to support their heterodox concept of an Asian model
of economic development had been transformed into a defense of
neoliberal orthodoxy and was hailed as a decisive vindication of neoliberal
emphasis on the central role of the market in economic devel-
opment.
Criticisms of the Report
Release of the World Development Report 1991 precipitated debate
between its supporters and its critics.31
Although some neoclassical
economists believed that the Report had erred in giving even minimal
credit to East Asian governments for promoting rapid economic development,
the most severe critics were proponents of the developmental
state who ﬁercely denounced it as blatantly ideological, representative
of the laissez-faire position of the United States and the
interests of private capital, and as an effort to assuage growing Western
fears of competition from the rapidly industrializing countries of
East Asia. The following criticisms of the Report are especially note-
worthy.
The Report’s emphasis on fundamentals suggests that economic
growth is a fairly straightforward process of factor accumulation
through private domestic investment, education, and exports. Such a
view is contradicted by the emphasis in the new-growth models on
the importance in the developmental process of imperfect information,
increasing returns, multiple equilibria, path dependence, self-reinforcing
mechanisms, historical lock-ins, and other dynamic properties.
Critics argue strongly that growth processes are so complex that
there can be no single explanation and that therefore the Report’s
considerable emphasis on factor accumulation was inappropriate.
Furthermore, the Report’s assumption that one can disentangle
macro basics or fundamentals—investment, education, exports—
31
Excellent evaluations of the Report are Albert Fishlow, Catherine Gwin, Stephan
Haggard, Dani Rodrik, and Robert Wade, Miracle or Design? Lessons from the East
Asian Experience, Policy Essay no. 11 (Washington, D.C.: Overseas Development
Council, 1994); and Robert Wade, “Japan, the World Bank, and the Art of Paradigm
Maintenance: The East Asian Miracle in Political Perspective,” New Left Review 217
(May/June 1996): 3–36.
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from their micro foundations, or supporting sociopolitical institutions,
is deeply ﬂawed. Critics charge that fundamentals and institutions
cannot be separated from one another; a high savings rate does
not just happen but is the result of government policies and ﬁnancial
institutions. When one factors in domestic policies and institutions,
the growth process becomes as complex as the new growth models
suggest.
The authors of the Report deliberately played down their own
ﬁndings regarding the important role of the state and of industrial
policies in expediting rapid industrialization, and they also neglected
the crucial importance of public ﬁnancial institutions in mobilizing
savings, evaluating projects, managing risk, monitoring managers,
and facilitating transactions. For example, although the Report acknowledged
that the most successful interventions by the state were
the generous subsidies provided for manufactured exports, critics of
the Report charge that this important point was not accorded appropriate
weight in the overall assessment of industrial policy. In fact,
many of the “market-friendly” policies praised by the Report, such
as export contests, are actually examples of successful industrial pol-
icy.32
According to Report critics, these contests proved a very effective
method for the state to “pick winners” and thus to accelerate
economic development.
Moral of the Tale
A close reading of the World Development Report 1991 brings to
mind the sage advice to literary critics set forth by D. H. Lawrence
in his Studies in Classic American Literature (1964).33
The critic,
Lawrence admonished, should always contrast the author’s proclaimed
moral with the moral of the tale itself, as derived from a close
reading of what the author had actually written. The proclaimed
moral of the Report is that state interventionism did not work; however,
this moral is contradicted over and over again as the Report
describes the successful policies actually followed by East Asian gov-
32
Under the terms of these contests, the government set forth certain conditions
under which private firms competed for a valuable asset controlled by the government,
such as access to easy credit or foreign exchange. The contest was organized so that
the companies most likely to make successful use of the resource would win. Thus, an
important criterion of success was export penetration of foreign markets. The state, it
should be added, also protected these sectors from imports and foreign direct invest-
ment.
33
D. H. Lawrence, Studies in Classic American Literature (New York: Viking,
1964).
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ernments. The Report’s own assessment of the results strongly suggests
that state intervention and industrial policy were indeed vital
factors in the economic success of the East Asian economies. And
there was a particularly excellent example of this in South Korea’s
export contests.
However, the most basic weakness of the Report is its assumption
that one can disentangle economic fundamentals—investment, education,
exports—from government development strategies and the overall
society in which an economy is embedded. The Report assumes
that markets already exist and that economic development takes place
in an economic and social vacuum. This approach totally neglects the
national system of political economy—ideology, public institutions,
and private business practices—that nurtures, facilitates, or frustrates
the efﬁcacy of markets. Although there is no single East Asian model,
the countries’ economic and political institutions have set the East
Asian economies apart and produced their economic fundamentals.
Would or could the economic fundamentals in East Asia have been
put into place if there had been no developmental state or certain
sociopolitical institutions? That is unlikely! The economic fundamentals
and the developmental state are closely interrelated. Recognizing
that the state and the fundamentals are integrated with one another
and that economic fundamentals are anchored in their institutional
context really supports the new growth theory. It is clear that understanding
economic development requires greater knowledge of a society’s
economic and political system than the Report indicates. Although
the fundamentals provide the sufﬁcient causes of successful
economic development, a well-functioning state is the necessary
cause; without an effective state, the fundamentals would not even
exist.
The Report erred by separating national economic policies from the
fundamentals of these economies. In these societies, the state played a
crucial role in accumulation of the factors emphasized by neoclassical
economists. The high savings rate, the skilled and disciplined workforce,
and large investments in education were all promoted by the
state and did not just happen in response to the invisible hand of the
market. Moreover, the Report relies excessively on Solow-type capital
accumulation and ignores the importance of technological innovation
and productivity growth. Despite the argument put forth by some
prominent economists, the rapid and successful industrialization of
these economies was due to both factor accumulation and technological
progress. And both capital accumulation and productivity gains,
at least indirectly, resulted from effective government policies.
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This interpretation of the important part played by the developmental
state in the East Asian Miracle Project is supported in part by
Paul Krugman’s qualiﬁed vindication of the insights of early postwar
development economics. “High development theory,” Krugman points
out in Development, Geography, and Economic Theory (1995), was
essentially correct in its emphasis on “strategic complementarity”
with respect to investment and the problem of coordination.34
Early
development economists recognized the need for coordinated investment
to assure individual ﬁrms that other ﬁrms would make complementary
or supportive investments. The less developed countries, economic
development theorists believed, are at a decided disadvantage
in their attempts to develop in the world of the strong. How could
these impoverished nations possibly develop industries capable of
competing in world markets against such strongly established ﬁrms
as Mitsubishi and General Motors!
Krugman argues that economies of scale and imperfect competition
were missing from development theory and that without these two
central ideas, the theory and policies for economic development could
not be sustained. Development theorists did recognize the need for
economies of scale at the plant level to give the less developed economy
the comparative advantage it needed for economic development
and international competitiveness. However, these theorists ignored
the importance of scale economies and of imperfect competition at
the national level.35
Development requires promoting strategic complementarity
through investment decisions, supporting domestic ﬁrms
until they achieve scale economies in their production, and breaking
the vicious cycle of poverty in which the LDCs have been trapped.
These tasks in turn require the guiding hand of a strong state. Economic
development cannot be left to the market alone. The state must
play the key role in starting and managing the process of economic
development. Solow himself has written that neoclassical growth theory
tells us what determines the rate of economic growth, but Solow
does not tell us what gets growth started in the ﬁrst place.36
34
Paul R. Krugman, Development, Geography, and Economic Theory (Cambridge:
MIT Press, 1995).
35
Economists identify two types of economies of scale: internal and external. The
former refers to the expansion of production by an individual firm and the resulting
reduction of production costs. The latter refers to expansion of an industry that makes
possible greater specialization and other benefits that reduce the costs of the whole
industry. David W. Pearce, ed., The MIT Dictionary of Modern Economics, 4th ed.
(Cambridge: MIT Press, 1992), 12.
36
Quoted in IMF Survey, 16, December 1991, 378.
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A few comments are in order about a highly controversial issue in
economic development. The initial success of the East Asian economies
raised the important but unresolved issue of the relationship
between development and democracy. Successive American administrations,
following Milton Friedman although not necessarily knowingly,
have believed that development and democracy proceed hand
in hand.37
During East Asia’s miracle period, conservatives such as
Nobel Laureate Gary Becker attributed the outstanding success of the
East Asian economies to their “democratic” regimes; subsequently,
conservatives blamed the problems following the 1997 ﬁnancial crisis
on the “authoritarian” nature of these political regimes. From the
other side of the intellectual/political spectrum, Laureate Amartya Sen
also argued that democracy and development complement, or at least
should complement, one another.38
Other scholars are not convinced
that there actually is a close connection between democracy and development.
Robert Barro believes that the relationship of democracy
and development is ambiguous, and political scientist Atul Kohli,
after a careful review of the literature, ﬁnds the connection equally
elusive.39
A United Nations report released in April 2000 concludes
that successful economic development requires “good” government,
a quality scarce in too many LDCs.40
The East Asian Financial/Economic Crisis
In the summer of 1997, the East Asian economies suffered a severe
blow when a serious ﬁnancial crisis and subsequently a much more
general economic crisis brought the East Asian miracle to an abrupt
halt. By the summer of 2000, the stricken nations had rapidly recovered
from the crisis and its consequences. Nevertheless, it will take
many years for the full social and political effects of this economic
37
Alberto Alesina and Roberto Peroti, “The Political Economy of Growth: A Critical
Survey of the Recent Literature,” World Bank Economic Review 8, no. 3 (1994):
351—71.
38
Amartya Sen, Development as Freedom (New York: Alfred A. Knopf, 1999).
39
Robert J. Barro, Getting It Right: Markets and Choices in a Free Society (Cambridge:
MIT Press,1997), 3; and Atul Kohli, “Democracy Amid Economic Orthodoxy:
Trends in Developing Countries,” Third World Quarterly 14, no. 4 (1993): 671–89.
40
United Nations Development Program, Overcoming Human Poverty: UNDP Poverty
Report 2000. Included in the Report’s definition of good government were free
elections, accountable and noncorrupt officials, and ambitious national programs to
alleviate poverty. For LDC governments that tend to blame the rich countries for their
economic difficulties, the Report was not well received. New York Times, 5 April
2000, A11.
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disaster to be fully understood. Despite the inconclusive nature of this
situation, there has been an acrimonious debate over the explanation
and meaning of the crisis. The devastating setback of these miracle
economies was immediately seized by many Western economists,
public ofﬁcials, and commentators as a convincing indictment of the
developmental state; it is clear, they proclaimed, that the East Asian
economies should adopt the neoclassical development model based
on free markets and minimal state intervention in the economy. Many
defenders of the East Asian developmental state model charged, in
turn, that these economies were hapless victims of international ﬁnancial
interests and the reckless policies of the Clinton Administration.
They contended that the developmental state model remains the
most appropriate model for successful economic development.
According to the prominent Western “crony capitalism” interpretation,
the East Asian developmental state contained the seeds of its
own destruction. Those characteristics of the Asian model of economic
development that have been credited with the extraordinary
success of these economies and their rapid industrialization were alleged
to be the very ones that led to the ﬁnancial crisis and to subsequent
economic disaster. Critics, who have included high ofﬁcials in
the IMF and the American Treasury, blamed the following “ﬂawed”
components of crony capitalism: (1) the intimate ties among local
politicians, banks, and industry; (2) bank rather than stock market
ﬁnancing of economic development; and (3) nontransparent (or secret)
ﬁnancial arrangements involving government-favored businesses
and banks. This government-manipulated system encouraged questionable
overinvestment, especially in particular economic sectors, by
appearing to guarantee investors, at least implicitly, that their investments
were not at risk. In this way, the developmental state created
moral hazard that ultimately led to the crisis.
Proponents of the developmental state reject the above analysis and
instead blame the crisis on the pernicious behavior of international
ﬁnancial markets. As had happened many times before, investors became
caught up in a frenzy of investment in these “miracle economies.”
The excitement surrounding the possibility of “easy money”
caused investors to throw caution to the winds and ignore such obvious
signs of impending trouble as the large number of short-term
liabilities that had been assumed by East Asian borrowers. The huge
investments in the region, well above rational proﬁt expectations,
were driven by the irrational euphoria of international investors. In
addition, the premature liberalization of ﬁnancial markets and capital
accounts (freedom of capital movements) in these countries (for
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which the United States bears a large responsibility) must be assigned
much of the blame. Thus, the crisis was due to the irrational functioning
of international ﬁnancial markets along with certain irresponsible
policies of the U.S. Treasury.
And, thus, the controversy over the developmental state continues.
The Future of the Developmental State
It is obviously too early to reach ﬁnal conclusions regarding the future
of the East Asian developmental state and the proper role for the state
in the process of economic development.41
Yet there is strong evidence
to support the idea that states must be very involved in economic
development. It is worth noting that several months prior to the crisis,
the World Bank had devoted its annual World Development Report
1997 to the crucially important issue of the political prerequisites of
successful economic development.42
In this report, titled The State in
a Changing World, the World Bank declared that economic development
is dependent on a society’s getting its political as well as its
economic fundamentals “right.” Without the former, such characteristics
of the latter as openness to trade and sound macroeconomic
policies cannot work because social norms, institutions, and customs
determine how economic inputs will be used and whether success will
in fact be forthcoming.43
The Report rejected the implicit logic of the “retreat-of-the-state”
doctrine that the minimal state is the optimal state; a minimal state,
the Report pointed out, can do no harm, but a weak state can do
no good either. Neither state-dominated nor stateless development
constitute the means to successful economic development. Although
the Report refused to set forth “a single recipe for state reforms
worldwide,” it did provide a two-part strategy to forge an effective
state capable of supporting rather than distorting economic development:
(1) the state must match its activities with its capabilities and
not attempt to do too much; and (2) improvement of the state’s effec-
41
Economists tried to assess these matters in the symposium, “The State and Economic
Development,” Journal of Economic Perspectives 4, no. 3 (summer 1990).
42
World Bank, World Development Report 1997: The State in a Changing World
(Washington, D.C.: World Bank, 1997).
43
As Dani Rodrik has argued, contrary to the impression given by some economists,
trade by itself will not lead to economic development. Dani Rodrik, The New Global
Economy and Developing Countries: Making Openness Work (Washington, D.C.:
Overseas Development Council, 1999).
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tiveness requires vigorous public institutions and includes “restraints
to check corrupt behavior” by public ofﬁcials.44
In the same report, the World Bank recognized that economic development
entails much more than solution of technical economic
problems and is, at its core, a social and political problem. In its early
years, the World Bank had followed the prescriptions of economists
that economic development results when crucial economic and technical
obstacles have been overcome. During the 1980s, under the reign
of neoliberalism and the Washington Consensus, the doctrine of
structural adjustment assumed that economic reforms and elimination
of state interventionism would release economic forces that
would speed development. The Bank and its economists have since
learned to appreciate that more than “economic fundamentals” are
necessary to achieve economic development.
The World Development Report 1997 returned to a truth ﬁrst set forth
in 1952 by Moses Abramowitz, a pioneer in the study of economic
growth.45
The fundamental requirement for economic development,
Abramowitz wrote, was “social capacity.” Economic development is
not a technical economic problem involving factor accumulation and
getting the “fundamentals right”; it is a social process that cannot be
completed unless the state creates economic institutions, fosters social
behavior, and pursues policies favorable to economic development.
The then-new formal modeling of economic growth, Abramowitz
pointed out, deals with the immediate source of economic growth
and not with the social and other factors behind the immediate factors.
His emphasis on the social and political aspects of economic
development suggested that there was no single best way for a society
to foster economic development.
At the turn of the century, efforts to understand the task of economic
development again emphasized the need for a national development
strategy.46
Ofﬁcial thinking about economic development has,
44
World Bank, World Development Report 1997: The State in a Changing World.
A valuable history of the central role of states in economic development is Linda Weiss
and John M. Hobson, States and Economic Development: A Comparative Historical
Analysis (London: Polity Press, 1995).
45
Abramovitz first set forth his notion of social capacity in Thinking About Growth
and Other Essays on Economic Growth (Cambridge: Cambridge University Press,
1989); a restatement of his position is “Following and Leading,” in Horst Hanusch,
ed., Evolutionary Economics: Applications of Schumpeter’s Ideas (New York: Cambridge
University Press, 1988), 339.
46
Dani Rodrik in his book, The New Global Economy and Developing Countries,
argues that a country needs a strategy for domestic investment and a sound framework
for resolving political conflict. Also, see Rodrik, “Getting Interventions Right: How
South Korea and Taiwan Grew Rich,” Economic Policy (April 1995): 55–107.
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in fact, passed through several distinct stages. In the 1960s, the World
Bank regarded economic development as a matter of solving a number
of discrete technical problems regarding efﬁcient use of resources
and capital transfers. In the 1970s and early 1980s, emphasis was on
trade liberalization and elimination of market dislocations caused by
government intervention (structural adjustment). Later in the 1980s,
the focus shifted to macroeconomic adjustment intended to eliminate
inﬂation and macroeconomic instability (the Washington Consensus).
In the 1990s, the World Bank and many experts began to appreciate
that development requires transformation of the society. Joseph Stiglitz,
an economist’s economist, is purported to have conceded at a
meeting that economists are beginning to understand that development
is complex and that there is more to development than trade
liberalization and macroeconomic adjustment. Similar lessons are applicable
to the problems facing transitional economies.
Transitional Economies
The transition of the former command or communist economies of
China, the Soviet bloc, and elsewhere to democratic, market-based
societies is one of the most important issues of the post–Cold War
era. I use the term “transition” advisedly. As Stephen Holmes has
pointed out, transition suggests that these economies are on a known
and predictable trajectory from communism to democratic capital-
ism.47
The truth is that no one really knows what economic, political,
and other factors led to the overthrow of communism, and even less
is known about the forces at work in these “postcommunist societies”
or about the direction in which economic and political forces are propelling
them. Theories and speculations of various kinds abound as
scholars, intellectuals, and public ofﬁcials attempt to provide an overall
explanation of this extraordinary and historically unprecedented
situation. Yet, as Holmes suggests, no guidelines can help us to determine
where these unfortunate postcommunist societies are heading:
democracy, fascism, or even a return to communism. Nevertheless,
despite its misleading implications, I shall follow convention and use
the term “transitional societies.”
The mere size of the transition problem is overwhelming. The magnitude
and diversity of the swath of countries from the Baltic to the
Balkans and from Eastern Europe across the steppes of central Asia
to the Paciﬁc Ocean defy comprehension. The twenty-seven or more
47
Stephen Holmes, “Cultural Legacies or State Collapse? Probing the Postcommunist
Dilemma,” in Michael Mandelbaum, ed., Postcommunism: Four Perspectives (New
York: Council on Foreign Relations, 1996), 22–76.
333