M
CHAPTER 6
Trade and Development I: Import
Substitution Industrialization
exico has experienced an economic revolution during the last 20
years. Until the mid-1980s, Mexico was one of the most heavily
protected and highly directed nonsocialist economies in the world.
Importing anything into the country required formal government approval.
Even with such approval, tariffs were very high, averaging over 25 percent
and rising as high as 100 percent for many goods. Moreover, Mexico did
not belong to the General Agreement on Tariffs and Trade (GATT), and it
was hard to imagine any conditions under which Mexico would seek a
free-trade agreement with the United States. Behind these high tariff walls,
the Mexican government intervened deeply in the domestic economy.
Government-owned financial institutions channeled investment capital to
favored private industries and projects. The government created stateowned
enterprises in many sectors of the economy (about 1,200 of them
by 1982) that together attracted more than one-third of all industrial
investment (La Porta and López de Silanes 1997). Today, by contrast,
Mexico is one of the most open developing countries in the world. Mexico
entered the GATT in 1987 and the North American Free Trade Agreement
(NAFTA) in the early 1990s. The Mexican government has retreated
sharply from involvement in the domestic economy. It has sold stateowned
enterprises, liberalized a wide variety of market-restricting
regulations, and begun to integrate Mexico deeply into the global
economy. In less than 10 years, the Mexican government opened Mexico
to foreign competition and drastically scaled back its role in managing
Mexican economic activity.
Mexico’s experience is hardly unique. Governments in India, China,
much of Latin America, and most of sub-Saharan Africa opted out of the
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global trade system following World War II. Most governments erected
very high trade barriers, and to the extent that they participated at all in the
GATT, they sought to alter the rules governing international trade.
Convinced that the GATT was biased against their interests, developing
countries worked through the United Nations to create international trade
rules that they believed would be more favorable toward industrialization
in the developing world. Like Mexico, most governments intervened
extensively in their economies in an attempt to promote rapid
industrialization. Drawing on the logic of the infant-industry case for
protection, governments used the power of the state to pull resources out
of agriculture and push them into manufacturing. And, like Mexico, these
policy orientations have changed fundamentally since the late 1980s. Most
developing countries have dismantled the protectionist systems they
maintained in the first 30 years of the postwar period, have become active
participants in the World Trade Organization (WTO), and have abandoned
the quest to institute far-reaching changes to international trade rules. Most
have greatly reduced the degree of government intervention in the
domestic economy.
This chapter and the next examine how political and economic forces
have shaped the adoption and evolution of these new trade and
development policies. This chapter examines why governments in so many
developing countries intervened deeply in their domestic economies,
insulated themselves from international trade, and sought changes in
international trade rules. The next chapter focuses on why so many
governments have dismantled these policies during the last 30 years. We
look first at how economic and political change throughout the developing
world brought to power governments supported by import-competing
interests. We then examine the economic theory that guided policy during
those times. As we shall see, this theory provided governments with a
compelling justification for transforming the protectionism sought by the
import-competing producers that supported them into policies that
emphasized industrialization through state leadership. Having built this
base, we turn our attention to the specific policies that governments
pursued during that period, looking first at their domestic strategy for
industrialization and then examining their efforts to reform the
international trade system.
DOMESTIC INTERESTS, INTERNATIONAL
PRESSURES, AND PROTECTIONIST
165
COALITIONS
Developing countries’ trade policies underwent a sea change in the first
half of the twentieth century. Until World War I, those developing
countries that were independent, as well as those regions of the world held
in colonial empires, adopted liberal trade policies. They produced and
exported agricultural goods and other primary commodities to the
advanced industrialized countries and imported most of the manufactured
goods they consumed. Governments and colonial rulers made little effort
to restrict this trade. But by the late 1950s, these liberal trade policies had
been replaced by a protectionist approach that dominated the developing
countries’ trade policies until the late 1980s, and whose remnants remain
important in many countries today. We begin our investigation of
developing countries’ trade and development policies by looking at this
initial shift to protectionism.
Trade and development policies in developing countries have been
strongly shaped by political competition between rural-based agriculture
and urban-based manufacturing. Developing countries pursued liberal
trade policies prior to World War I because export-oriented agricultural
interests dominated politics. In general, developing countries are
abundantly endowed with land and poorly endowed with capital (Lal and
Myint 1996, 104–110).
The relative importance of land and capital in developing countries’
economies can be appreciated by examining the structure of those
economies, together with exports, as presented in Table 6.1 and Table 6.2.
For the time being, we will focus on 1960, as this will allow us to put to
the side the consequences of the development policies that governments
adopted during the postwar period. With a few exceptions (particularly in
Latin America), between one-third and one-half of all economic activity in
developing countries in 1960 was based in agriculture, whereas less than
15 percent was based in manufacturing. By contrast, agriculture accounted
for only 5 percent of gross domestic product (GDP) in the advanced
industrial economies. If we include the “other industry” category, which
incorporates mining, then in all regions of the developing world other than
Latin America, agriculture and nonmanufacturing industries accounted for
more than half of all economic activity.
A similar pattern is evident in the commodity composition of
developing countries’ exports (Table 6.2). In 1962, developing countries’
exports were heavily concentrated in primary commodities: agricultural
products, minerals, and other raw materials. Roughly speaking, in each
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developing country, primary commodities accounted for more than 50
percent of exports, and in more than half of the listed countries, primary
commodities accounted for more than 80 percent of exports. In addition,
each country exported a narrow range of primary commodities. Some
countries were monoexporters; that is, their exports were almost fully
accounted for by one product. For example, more than 80 percent of
Burundi’s export earnings came from coffee, and cocoa accounted for 75
percent of Ghana’s export earnings (Cypher and Dietz 1997, 339). Similar
patterns were evident in Latin America: in 1950, coffee and cocoa made
up about 69 percent of Brazil’s exports, and copper and nitrates constituted
about 74 percent of Chile’s exports (Thorp 1999, 346). The structure of
their economies and the composition of their exports thus underline the
central point: developing countries are abundantly endowed with land and
have little capital.
TABLE 6.1
Economic Structure in Developing Countries (Sector as
a Percent of Gross Domestic Product)
Notes: Figures may not sum to 100 because of rounding.
Other Industry Includes mining, construction, gas, and water.
Sources: Data for 1960 from World Bank, World Tables, 3rd ed. (Washington, DC:
The World Bank, 1983). Data for 1980 and 1995 from World Bank, World
Development Indicators (Washington, DC: The World Bank, 1997).
TABLE 6.2
Developing Countries’ Export Composition (Sector as a
167
Percent of Total Exports)
Note: n.a. = not available.
Sources: Data for 1962 from World Bank, World Tables, 3rd ed. (Washington, DC:
The World Bank, 1983). Data for 1980 and 1993 from World Bank, World
Development Indicators (Washington, DC: The World Bank, 1997).
The precise form through which landowners dominated politics prior to
World War II differed considerably across regions. In Latin America, an
indigenous landowning elite dominated domestic politics. In Argentina
and Chile, for example, the landowners controlled government, often in an
alliance with the military. Even though these political systems were
constitutionally democratic, participation was restricted to the elite, a
group that amounted to about 5 percent of the population, in a system that
has been characterized as “oligarchic democracy” (Skidmore and Smith
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1989, 47). In other Latin American countries such as Mexico, Venezuela,
and Peru, dictatorial and often military governments ruled, but they
pursued policies that protected the interests of the landowners (Skidmore
and Smith 1989, 47). With landowners dominating domestic politics, Latin
American governments pursued liberal trade policies that favored
agricultural production and export at the expense of manufactured goods
(Rogowski 1989, 47). As a result, most Latin American countries were
highly open to international trade, producing and exporting agricultural
goods and other primary commodities and importing manufactured goods
from Great Britain, Europe, and the United States.
In Asia and in Africa, export-oriented agricultural interests dominated
local politics through colonial structures. In Taiwan and Korea, for
example, Japanese colonization led to the development of enclave
agriculture—that is, export-oriented agricultural sectors that had few
linkages to other parts of the local economy (Haggard 1990). Agricultural
producers bought little from local suppliers and exported most of their
production. In both countries, agricultural production centered on the
production and export of rice; in Taiwan, sugarcane was a staple crop as
well. India produced and exported a range of primary commodities,
including cotton, jute, wheat, tea, and rice. In exchange, India imported
most of the manufactured goods it consumed from Britain. In Africa,
colonial powers encouraged the production of cash crops and raw
materials that could be exported to the mother country (Hopkins 1979;
Ake 1981, 1996). In the Gold Coast (now Ghana), the cocoa industry was
a small part of the economy in 1870. Under British rule, Ghana became the
world’s largest cocoa producer by 1910, and cocoa accounted for 80
percent of its exports. In Senegal, France promoted groundnut (the
American peanut) production, and by 1937 close to half of all cultivated
land was dedicated to this single product (Ka and Van de Walle 1994,
296). Similar patterns with other commodities were evident in other
African colonies (Hopkins 1979).
These political arrangements began to change in the early twentieth
century. As they did, the dominance of export-oriented interests gave way
to the interests of import-competing manufacturers. In many instances, the
most important triggers for this change originated outside of developing
societies. In Latin America, international economic shocks beginning with
the First World War and extending into World War II played a central role
(Thorp 1999, Chapter 4). Government-mandated rationing of goods and
primary commodities in the United States and Europe during the two
World Wars made it difficult for Latin American countries to import many
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of the consumer goods they had previously purchased from the
industrialized countries. In addition, falling commodity prices associated
with the Great Depression and the disruption of normal trade patterns
arising from World War II reduced export revenues. The interruption of
“normal” Latin American trade patterns led governments in many
countries to introduce trade barriers and to begin producing many of the
manufactured goods that they had previously imported. The rise of
domestic manufacturing in turn produced a growing urban middle class as
workers and industrialists began to move out of agricultural production
and into manufacturing industries.
The emergence of manufacturing industries gave rise to interest groups,
industry-based associations, and labor unions that pressured the
government to adopt economic policies favorable to people working in the
import-competing sector. The creation of organized groups to represent the
interests of import-competing manufacturing generated its own political
logic. On the one hand, the groups that saw their incomes rise from
protection had a strong incentive to see protectionist policies continued in
the postwar period (see Rogowski 1989; Haggard 1990). On the other
hand, the emergence of new organized interests and a growing urban
middle class created an opportunity for politicians to construct new
political coalitions based on the support of the urban sectors. In Argentina,
for example, Juan Perón rose to power in the late 1940s with the support of
labor, industrialists, and the military. A similar pattern was evident in
Brazil, where Getúlio Vargas was elected to the presidency in 1950 with
the support of industrialists, government civil servants, and urban labor.
Nor were Argentina and Brazil unique: throughout Latin America, postwar
governments were much less tightly linked to landed interests than
governments had been before World War I. Instead, governments rose to
power on the basis of political support from interest groups whose incomes
were derived from import-competing manufacturing (Cardoso and Faletto
1979). Such governments had a clear incentive to maintain trade policies
that protected those incomes.
A similar dynamic is evident in India. The global economic collapse of
the 1930s forced India to become increasingly self-reliant. Markets for
Indian exports constricted sharply, thereby greatly constraining Indian
export revenues. Unable to earn foreign exchange, India had to reduce
imports of manufactured goods as well. Under this forced self-reliance,
India began to create an indigenous manufacturing sector. By the end of
World War II, India had emerged as “the tenth largest producer of
manufactured goods in the world” (Tomlinson 1979, 31). The indigenous
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urban manufacturing sector then fused with the burgeoning nationalist
movement during the late 1930s to lead the push for Indian independence
and to supplant the predominantly foreign-owned export sector at the
center of the Indian political system. By the time India achieved
independence in 1947, it was committed to a strategy of autonomous
industrialization.
In Pacific Asia, the shift in political power came about as a product of
de-colonization. In Korea and Taiwan political change resulted from the
defeat of Imperial Japan in World War II (see Haggard 1990). In South
Korea, Japan’s defeat transferred power from a foreign colonizer to
indigenous groups. Although the landowners initially dominated postwar
politics, the Korean War of the early 1950s and a series of land reforms
implemented during that same decade greatly reduced the landowners’
power and increased the relative power of the emerging urban sector. On
mainland China, Japan’s defeat was followed by the defeat of the
nationalist Chinese government and the migration of the Chinese
nationalists to the island of Taiwan. Once installed in Taiwan, the Chinese
nationalists instituted land reforms to assert their authority over indigenous
landowners and to prevent a repeat of their experience on the mainland,
where the rural sector had supported the Communists. As in South Korea,
land reforms reduced the power of landowners and increased the power of
the urban–industrial sector.
Africa’s transition came later, as decolonization began only in the
1950s, and it took a slightly different form. The push toward
decolonization was led by a coalition of indigenous professionals who had
been educated by the colonial powers and had then acquired positions in
the administration of colonial economic and political rule. One factor
motivating Africa’s push for independence was dissatisfaction with the
discriminatory practices of colonial administration. Colonies were run for
the profit of the colonists, with colonial economic enterprises staffed and
managed by men from the colonial power. The local population had
limited opportunities to participate in these economic arrangements other
than as workers. The nationalist struggles for independence that emerged
in the 1950s sought to transfer control over existing economic practices
from the colonial governments to indigenous elites.
The period demarcated by the start of World War I and the end of
decolonization in sub-Saharan Africa thus brought a fundamental change
to patterns of political influence in developing countries. Political
structures once dominated by export-oriented agricultural interests were
now largely under the control of import-competing manufacturing
171
interests. Consequently, governments beholden to the import-competing
sector had a clear incentive to abandon liberal trade policies and to
continue the protectionist arrangements they had built during the 1930s.
As we will see, the political interest in protectionism was reinforced by an
elaborate theoretical structure that argued that protectionism was the only
path to the establishment of industrialized economies.
THE STRUCTURALIST CRITIQUE: MARKETS,
TRADE, AND ECONOMIC DEVELOPMENT
Although protectionism reflected the interests of the politically influential
import-competing manufacturing sector, it did not represent a coherent
economic development strategy. And most governments were committed,
at least rhetorically, to the adoption of policies that would promote
economic development. Most governments wanted to shift resources out of
agricultural production and into manufacturing industries because they
believed that poverty resulted from too heavy a concentration on
agricultural production. Higher standards of living could be achieved only
through industrialization, and according to what was then the dominant
branch of development economics, called structuralism, the shift of
resources from agriculture to manufacturing would not occur unless the
state adopted policies to bring it about (see Lal 1983; Little 1982).
The belief that the market would not promote industrialization provided
the intellectual and theoretical justification for the two central aspects of
the development strategies adopted by most governments throughout much
of the postwar era. Because structuralism played such an important role in
shaping developing countries’ trade and development policies,
understanding the policies governments adopted requires us to understand
the structuralist critique.
Market Imperfections in Developing Countries
Structuralists argued that market imperfections inside developing countries
posed serious obstacles to the reallocation of resources from agriculture to
manufacturing industries. Structuralists argued that markets would not
bring about the necessary shift of resources because developing economies
were too inflexible.
Most important, according to the structuralists, was the belief that the
market would not promote investment in manufacturing industries
(Scitovsky 1954). The structuralists pointed to two coordination problems
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that would limit investment in manufacturing industries. The first problem,
called complementary demand, arose in the initial transformation from
an economy based largely on subsistence agriculture to a manufacturing
economy (Rosenstein-Rodan 1943). In an economy in which few people
earned a money wage, no single manufacturing firm would be able to sell
its products unless a large number of other manufacturing industries were
started simultaneously. Suppose, for example, that 100 people are taken
out of subsistence agriculture and paid a wage to manufacture shoes,
whereas the rest of the population remains in non-wage agriculture. To
whom will the new factory sell its shoes? The only workers earning money
are those producing shoes, and these 100 workers are unlikely to purchase
all of the shoes that they make. In order for this shoe factory to succeed,
other factories employing other people must be created at the same time.
Suppose instead, that 500,000 workers are taken out of subsistence
agriculture and simultaneously employed in a large number of factories
producing a variety of different goods; some make shoes, others make
clothing, and still others produce refrigerators or processed foods. With
this larger number of wage earners, manufacturing enterprises can easily
sell their goods. Shoe workers can buy refrigerators and clothes, workers
in the clothing factory can purchase shoes, and so on. Thus, a
manufacturing enterprise will be successful only if many manufacturing
industries began production simultaneously.
Structuralists doubted that uncoordinated market behavior would
produce simultaneous investment in multiple manufacturing industries. No
single entrepreneur has an incentive to invest in a manufacturing enterprise
unless he or she is certain that others will invest simultaneously in other
industries. People willing to invest will thus wait until others invest and, as
a consequence, no one will invest in manufacturing unless all potential
investors could somehow coordinate their behavior to ensure that all will
invest in manufacturing at the same time. The problem of complementary
demand thus meant that if investment were left to the market, there would
be little investment in manufacturing industries.
The second coordination problem, called pecuniary external
economies, arose from interdependencies among market processes
(Scitovsky 1954). Think about the economic relationship between a steel
plant and an automobile factory. Suppose that the owners of a steel factory
invest to increase the amount of steel they can produce. As steel
production increases, steel prices begin to fall. The automobile factory,
which uses a lot of steel, begins to realize rising profits as the price of one
of its most important inputs falls. These increasing profits in the
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automobile industry could induce the owners of the car plant to invest to
expand their own production capacity. Such a simultaneous expansion of
the steel and auto industries would raise national income.
The two firms face a coordination problem, however. The owners of the
steel plant will not increase steel production unless they are sure that the
auto industry will increase car production. Yet, the owners of the auto
plant will not increase auto production unless they are certain that the steel
producer will make the investments needed to expand steel output. Thus,
unless investment decisions in the steel and auto industry are coordinated,
neither firm will invest to increase the amount it can produce. Once again,
structuralists argued, the market could not be expected to solve this
coordination problem.
The structuralists’ assertion that coordination problems would prevent
investment in manufacturing was a serious problem for governments intent
on industrialization. Fortunately, the structuralists offered a solution to the
problem. Structuralists argued that the way to overcome these coordination
problems was with a state-led big push. The state would engage in
economic planning and either make necessary investments itself or help
coordinate the investments of private economic actors. Thus, what the
market could not bring about, the state could achieve through intervening
in the economy. The structuralist critique of the market therefore provided
a compelling theoretical justification for state-led strategies of
industrialization.
Market Imperfections in the International Economy
Structuralists also argued that international trade provided few benefits to
developing countries. This argument was formulated during the 1950s,
principally by Raul Prebisch, an Argentinean economist who worked for
the United Nations Economic Commission for Latin America (ECLA), and
Hans Singer, an academic development economist. According to the
Singer-Prebisch theory, participation in the GATT–based trade system
would actually make it harder for developing countries to industrialize by
depriving them of critical resources.
The Singer-Prebisch theory divides the world into two distinct blocks—
the advanced-industrialized core and the developing-world periphery—and
focuses on the terms of trade between them. The terms of trade relate the
price of a country’s exports to the price of its imports. An improvement in
a country’s terms of trade means that the price of its exports is rising
relative to the price of its imports, but a decline in a country’s terms of
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trade means that export prices are falling relative to its import prices. As a
country’s terms of trade improve, it can acquire a given amount of imports
for a smaller quantity of exports. Thus, an improvement in its terms of
trade makes a country richer, but a decline in its terms of trade makes it
poorer.
The Singer-Prebisch theory argues that developing countries’ terms of
trade deteriorate steadily over time. When they developed this theory,
developing countries exported primary commodities and imported
manufactured goods. Singer and Prebisch argued that primary commodity
prices steadily fell relative to manufactured goods prices, thereby steadily
reducing the incomes of developing countries. The periphery’s terms of
trade deteriorate, according to this theory, in large part as a result of
differences in the income elasticity of demand for primary commodities
versus industrial goods (see Lewis 1954; United Nations 1964; Gilpin
1987, 275–276).
The income elasticity of demand is the degree to which a change in
income alters demand for a particular product. For a product with a low
income elasticity of demand, a large increase in income produces little
change in demand for the good. For a product with a high income elasticity
of demand, a small increase in income produces a large change in demand
for a particular good. Structuralists argued that the income elasticity of
demand for primary commodities was quite low, but income elasticity of
demand for manufactured goods was relatively high. Thus, as incomes rise
in the core countries, a smaller and smaller percentage of those countries’
income will be spent on imports of primary commodities. But as incomes
rise in the periphery countries, a larger percentage of those countries’
income will be spent on manufactured imports from the core. Falling
demand for primary commodities will cause the periphery countries’
export prices to fall, whereas rising demand for manufactured goods will
cause the periphery countries’ import prices to rise. Rising import prices
relative to export prices yields deteriorating terms of trade.
Most research disputes the claim that developing countries face a
continuous decline in their terms of trade (see, for example, Borensztein et
al. 1994; see also Bloch and Sapsford 2000). Yet, the objective validity of
the Singer-Prebisch hypothesis is not the central consideration. What
mattered was that governments in developing countries believed the
hypothesis. Governments of developing countries were convinced that
industrialization would not occur if they participated in the GATT–based
international trade system. This conviction played an important role in
shaping the trade and development policies that developing countries
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adopted.
DOMESTIC AND INTERNATIONAL ELEMENTS
OF TRADE AND DEVELOPMENT STRATEGIES
Structuralism enabled governments to transform the protectionist trade
policies that benefited their principal political supporters into
comprehensive state-led development strategies. The trade and
development policies that most governments adopted following World
War II had both a domestic and an international dimension. At home, the
desire to promote rapid industrialization led governments to adopt state-led
development strategies that were sheltered by high protectionist barriers.
In the international arena, concern about the distributional implications of
international trade led developing countries to seek far-reaching changes to
the GATT–based trade system. We examine each dimension in turn.
Import Substitution Industrialization
Structuralism provided the intellectual justification for a state-led
development strategy. Confidence that the state could achieve what
markets would not was based in part on evidence of the dramatic
industrialization that the Soviet Union had achieved between 1930 and
1950 with an approach based on centralized planning and state ownership
of industry. In developing societies outside the Soviet bloc, this statecentered
approach to development came to be called import substitution
industrialization, or ISI. The strategy of ISI was based on a simple logic:
countries would industrialize by substituting domestically produced goods
for manufactured items they had previously imported.
Governments conceptualized ISI as a two-stage strategy (see Table 6.3).
Its initial stage was “wholly a matter of imitation and importation of tried
and tested procedures” (Hirschman 1968, 7). Easy ISI, as this first stage
was often called, focused on developing domestic manufacturing of
relatively simple consumer goods, such as soda, beer, apparel, shoes, and
furniture. The rationale behind the focus on simple consumer goods was
threefold. First, there was a large domestic demand currently satisfied by
imports. Second, because these items were mature products, the
technology and machines necessary to produce them could be acquired
easily from the advanced industrialized countries. Third, the production of
relatively simple consumer goods relies heavily on low-skilled labor,
allowing developing societies to draw their populations into manufacturing
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activities without making large investments to upgrade their skills.
Governments expected to realize two broad benefits from easy ISI.
Initially, the expansion of manufacturing activities would increase wagebased
employment as underutilized labor was drawn out of agriculture and
into manufacturing. In addition, the experience gained in these
manufacturing industries would allow domestic workers to develop skills,
collectively referred to as general human capital, that could be applied
subsequently to other manufacturing businesses. Of particular importance
were the management and entrepreneurial skills that would be gained by
people who worked in and managed the manufacturing enterprises
established in this stage. Success in the easy stage would therefore create
many of the ingredients necessary to make the transition to the second
stage of ISI.
TABLE 6.3
Stages of Industrialization in Mexico and Brazil, 1880–
1968
Commodity
Exports,
1880–1930
Primary ISI,
1930–1955
Secondary ISI, 1955–
1968
Main
Industries
Mexico:
Precious
metals,
minerals, oil
Brazil: Coffee,
rubber, cocoa,
cotton
Mexico and
Brazil: Textiles,
food, cement,
iron and steel,
paper, chemicals,
machinery
Mexico and Brazil:
Automobiles,
electrical and
nonelectrical
machinery,
petrochemicals,
pharmaceuticals
Major
Economic
Actors
Mexico:
Foreign
investors
Brazil:
National
private firms
Mexico and
Brazil: National
private firms
Mexico and Brazil:
State-owned
enterprises,
transnational
corporations, and
national private firms
Orientation
of the
Economy
World market Domestic market Domestic market
Note: ISI = import substitution industrialization.
Source: Gereffi 1990, 19.
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Easy ISI would eventually cease to bear fruit. The domestic market’s
capacity to absorb simple consumer goods would be exhausted, and the
range of such goods that could be produced would be limited. At some
point, therefore, governments would need to shift from easy ISI to a
second-stage strategy characterized by the development of more complex
manufacturing activities. One possibility would be to shift to what some
have called an export substitution strategy, in which the labor-intensive
manufactured goods industries developed in easy ISI begin to export rather
than continue to produce exclusively for the domestic market. Many East
Asian governments adopted this approach, as we shall see in Chapter 7.
The second alternative, and the one adopted by most governments
outside of East Asia, was secondary ISI. In secondary ISI, emphasis shifts
from the manufacture of simple consumer goods to consumer durable
goods, intermediate inputs, and the capital goods needed to produce
consumer durables. In Argentina, Brazil, and Chile, for example,
governments decided to promote domestic automobile production as a
central component of secondary ISI. Each country imported cars in pieces,
called complete knockdowns, and assembled the pieces into a car for sale
in the domestic market. Domestic auto firms were required to gradually
increase the percentage of locally produced parts used in the cars they
assembled. In Chile, for example, 27 percent of a locally produced car’s
components had to be manufactured domestically in 1964. The percentage
rose to 32 percent in 1965 and then to 45 percent in 1966 (Johnson 1967).
By increasing the percentage of local components of cars and other
goods in this manner, governments hoped to promote the development of
backward linkages throughout the economy (Hirschman 1958). Backward
linkages arise when the production of one good, such as a car, increases
demand in industries that supply components for that good. Thus,
increasing the percentage of locally produced components of cars, by
increasing the demand for individual car parts, would increase domestic
part production. The latter would in turn increase demand for inputs into
part production: steel, glass, and rubber, for example. Industrialization,
therefore, would spread backwards from final goods to intermediate inputs
to capital goods as backward linkages multiplied.
Governments promoted secondary ISI with three policy instruments:
government planning, investment policy, and trade barriers. Most
governments structured their efforts around 5-year plans (Little 1982, 35).
Planning was used to determine which industries would be targeted for
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development and which would not, to figure out how much should be
invested in a particular industry, and to evaluate how investment in one
industry would influence the rest of the economy. India’s second Five
Year Plan (1957–1962), for example, sought to generate ambitious growth
in manufacturing by targeting the development of capital goods production
(Srinivasan and Tendulkar 2003, 8). The plan thus served as the
coordination device that governments thought necessary, given their belief
that the market itself could not coordinate investment decisions.
With a plan in place, governments used investment policies to promote
targeted industries. Most governments either nationalized or heavily
controlled the financial sector in order to direct financial resources to
targeted industries. Governments also invested directly in those economic
activities in which they thought the private sector would not invest. Much
of the infrastructure necessary for industrialization—things such as roads
and other transportation networks, electricity, and telecommunications
systems—it was argued, would not be created by the private sector. In
addition, the private sector lacked access to the large sums of financial
support needed to make huge investments in a steel or auto plant.
Moreover, it was claimed that private-sector actors lacked the technical
sophistication required for the large-scale industrial activity involved in
secondary ISI.
Governments invested in these industries by creating state-owned and
mixed-ownership enterprises. In Brazil, for example, state-owned
enterprises controlled more than 50 percent of total productive assets in the
chemical, telecommunications, electricity, and railways industries and
slightly more than one-third of all productive assets in metal fabrication
(Trebat 1983). Indian state-owned enterprises provided 27 percent of total
employment and 62 percent of all productive capital (Krueger 1993a, 24–
5). In Africa, governments in Ghana, Mozambique, Nigeria, and Tanzania
each created more than 300 state-owned enterprises, and in many African
countries, state-owned enterprises accounted for 20 percent of total wagebased
employment (World Bank 1994b, 101). Throughout developing
societies, therefore, the shift to secondary ISI was accompanied by the
emergence of the state as a principal, and in many instances the largest,
owner of productive capacity.
Finally, governments used trade barriers to control foreign exchange and
protect infant industries. Because export earnings were limited,
governments controlled foreign trade to ensure that foreign exchange
supported their development objectives (Bhagwati 1978, 20–33). After all,
many elements critical to industrialization, including intermediate inputs
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and capital goods, had to be imported. Protection also allowed infant
industries to gain the experience needed to compete against established
producers. In Brazil and India, for instance, the state prohibited imports of
any good for which there was a domestic substitute, regardless of price and
quality differences.
The scale and the structure of protection that governments used to
promote industrialization are illustrated in Table 6.4, which focuses on
Latin America in 1960. In all but two of the listed countries, nominal
protection on nondurable consumer goods was well over 100 percent, and
for all but three countries, tariffs on consumer durables also were over 100
percent. Mexico and Uruguay stand out as clear exceptions to this pattern,
which has more to do with those countries’ extensive use of import quotas
in place of tariffs than with an unwillingness to protect domestic producers
(Bulmer-Thomas 1994, 279). It is also clear that tariffs were lower for
semi-manufactured goods, industrial raw materials, and capital goods (all
of which were items that developing countries needed to import in
connection with industrialization) than they were for consumer goods. This
pattern of tariff escalation was common in much of the developing world
(Balassa and Associates 1971).
The costs of ISI were borne by agriculture (see Krueger 1993a; Krueger,
Schiff and Valdes 1992; Binswanger and Deininger 1997). Governments
taxed agricultural exports through marketing boards that controlled the
purchase and export of agricultural commodities (Krueger et al. 1992, 16).
Often established as the sole entity with the legal right to purchase,
transport, and export agricultural products, marketing boards set the price
that farmers received for their crops. In the typical arrangement, the
marketing board would purchase crops from domestic farmers at prices
well below the world price and then would sell the commodities in the
world market at the world price. The difference between the price paid to
domestic farmers and the world price represented a tax on agricultural
incomes that the state could use to finance industrial projects (Amsden
1979; Bates 1988; Krueger 1993a). The trade barriers that protected
domestic manufacturing firms from foreign competition also taxed
agriculture. Tariffs and quantitative restrictions raised the domestic price
of manufactured goods well above the world price. People employed in the
agricultural sector, who consumed these manufactured goods, therefore
paid more for them than they would have in the absence of tariffs and
quantitative restrictions (Krueger 1993a, 9).
TABLE 6.4
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Nominal Protection in Latin America, circa 1960
(percent)
Source: Bulmer-Thomas 1994, 280, Table 9.1.
Such government policies transferred income from rural agriculture to
the urban manufacturing and nontraded-goods sectors. The size of the
income transfers was substantial. As a World Bank study summarized,
the total impact of interventions … on relative prices [between agriculture and
manufacturing] was in some countries very large. In Ghana … farmers
received only about 40 percent of what they would have received under free
trade. Stated in another way, the real incomes of farmers would have
increased by 2.5 times had farmers been able to buy and sell under free trade
prices given the commodities they in fact produced. While Ghanaian total
discrimination against agriculture was huge, Argentina, Cote d’Ivoire, the
Dominican Republic, Egypt, Pakistan, Sri Lanka, Thailand, and Zambia also
had total discrimination against agriculture in excess of 33 percent, implying
that in all those cases, farm incomes in real terms could have been increased
by more than 50 percent by removal of these interventions.
(Krueger 1993a, 63)
Thus, ISI redistributed income. The incomes of export-oriented
producers fell while those of import-competing producers rose.
A Closer Look
Import Substitution Industrialization in Brazil
In the late nineteenth and early twentieth centuries, Brazil was the
classic case of a country that exported primary commodities. Its
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principal crop, coffee, accounted for a large share of its production and
the overwhelming majority of its export earnings. This economic
structure was supported by a political system dominated by the
interests of coffee producers and other agricultural exporters (Bates
1997). Political authority in Brazil was decentralized, and the states
used their power in the country’s federal system to influence
government policy. As a result, Brazil pursued a liberal trade policy
throughout the late nineteeth and early twentieth centuries. World War
I and the Great Depression disrupted these arrangements. The world
price for coffee fell sharply in the late 1920s and early 1930s,
generating declining terms of trade and rising trade deficits. The
government responded to this crisis by adopting protectionist measures
to limit imports. The initial turn to protectionism was accompanied by
political change. A military coup in 1930 handed power to Getúlio
Vargas, who centralized power by shifting political authority from the
states to the federal government. Even though Vargas did not adopt an
ISI strategy, this period represented in many respects the easy stage of
ISI (Haggard 1990, 165–6). Protectionism promoted the growth of
light manufacturing industries at a rate of 6 percent per year between
1929 and 1945 (Thorp 1999, 322). Concurrently, the centralization of
power created a state that could intervene effectively in the Brazilian
economy. Although the export-oriented interests did not lose all
political influence in this new political climate, the balance of power
had clearly shifted toward new groups emerging in urban centers: the
professionals, managers, and bureaucrats who constituted the
emerging middle class and the nascent manufacturing interests. As
Brazil moved into the post-World War II period, therefore, the stage
was set for the transition to secondary ISI.
A full-blown ISI strategy emerged in the 1950s. The government
restricted imports tightly with the so-called law of similars, which
effectively prohibited the import of goods similar to those produced in
Brazil. In 1952, the Brazilian government created the National
Economic Development Bank (BNDE), an important instrument for
industrial policy through which the Brazilian state could finance
industrial projects. In the late 1950s, the government created a new
agency, the National Development Council, to coordinate and plan its
industrialization strategy. In taking up its task, the council was heavily
influenced by structuralist ideas (Haggard 1990, 174). Studies
conducted within these agencies—and, in some instances, in
collaboration with international agencies such as the United Nations
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(UN) Economic Commission on Latin America—focused on how best
to promote industrialization (Leff 1969, 46). Most of these studies
came to similar conclusions: industrialization in Brazil would quickly
run into constraints caused by inadequate transportation networks
(road, rail, and sea), shortages of electric power, and the
underdevelopment of basic heavy industries such as steel, petroleum,
chemicals, and nonferrous metals. Building up those industries thus
became the focus of the government’s development policies. The
Brazilian government had little faith that the private sector would
create and expand these critically important industries. Instead,
policymakers determined that the state would have to play a leading
role. In the early 1950s, the state nationalized the oil and electricity
industries and began investing heavily in the expansion of capacity in
both. A similar approach was adopted in the transportation sector (in
which the government owned the railways and other infrastructure), in
the steel industry, and in telecommunications. By the end of the 1950s,
the state accounted for 37 percent of all investment made in the
Brazilian economy. As a result, the number of state-owned enterprises
grew rapidly, from fewer than 35 in 1950 to more than 600 by 1980.
Beyond creating these basic industries, the Brazilian government
also sought to create domestic capacity to produce complex consumer
goods. To achieve this objective, Brazil, in contrast to many other
developing countries, drew heavily upon foreign investment to
promote the development of certain industries. The auto industry is an
excellent example. In 1956, the Brazilian government prohibited all
imports of cars. Any foreign producer that wanted to sell cars in the
Brazilian market would have to set up production facilities in the
country. To ensure that such foreign investments were not simple
assembly operations in which the foreign company imported all parts
from its suppliers at home, the Brazilian government instituted local
rules that required the foreign automakers operating in the country to
purchase 90 percent of their parts from Brazilian firms. In order to
induce foreign automakers to invest in Brazil under these conditions,
the government offered subsidies; by one account, the subsidies offset
about 87 percent of the total investment between 1956 and 1969.
Relying on this strategy, Brazilian auto production rose from close to
zero in 1950 to almost 200,000 cars in 1962.
Brazil’s ISI strategy helped transform the country’s economy in a
remarkably short time. Imported consumer nondurable goods (the
products targeted during easy ISI) had been almost completely
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replaced with domestic production by the early 1950s (Bergsman and
Candal 1969, 37). Imported consumer durables, the final goods
targeted in secondary ISI, fell from 60 percent of total consumption to
less than 10 percent of total consumption by 1959. Imports of capital
goods also fell, from 60 percent of total domestic consumption in
1949, to about 35 percent of consumption in 1959, and then to only 10
percent by 1964. Finally, imports of intermediate goods, the inputs
used in producing final goods, also fell continually throughout the
decade, to less than 10 percent of total consumption by 1964. Thus, as
imports were barred and domestic industries created, Brazilian
consumers and producers purchased a much larger percentage of the
goods they used from domestic producers and a much smaller
percentage from foreign producers. As a consequence, the importance
of manufacturing in the Brazilian economy increased sharply: whereas
manufacturing accounted for only 26 percent of total Brazilian
production in 1949, by 1964 it accounted for 34 percent.
The strategy of ISI promoted rapid economic growth in the 1960s and
1970s: developing countries’ economies grew at annual average rates of
between 6 percent and 7.6 percent during this period. In many countries, it
was the manufacturing sector that drove economic growth. Argentina,
Brazil, Chile, Mexico, Mozambique, Nigeria, Pakistan, and India, to select
only a few examples, all enjoyed average annual rates of manufacturing
growth between 5 percent and 10 percent during the 1960s. A glimpse
back at Table 6.1 indicates that, in Latin America, manufacturing’s share
of the total economy increased substantially between 1960 and 1980. Thus,
although the policies that governments adopted had important effects on
the distribution of income, they also appeared to be transforming
developing societies into industrialized economies.
Reforming the International Trade System
Developing countries also tried to alter the rules governing international
trade. For many developing-country governments, these efforts reflected
their experience with colonialism. India’s perspective was not unique:
international trade was “a whirlpool of economic imperialism rather than a
positive instrument for achieving economic growth” (Srinivasan and
Tendulkar 2003, 13). Consequently, as early as 1947, India, Brazil, and
Chile were arguing that the multilateral rules the United States and Great
Britain were writing failed to address the economic problems that
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developing countries faced (Kock 1969, 38–42). Advancing the infantindustry
justification for protection, many developing countries argued that
their firms could not compete with established producers in the United
States and Europe. Yet, GATT rules not only made no provision for the
infant-industry justification for protection but indeed, explicitly prohibited
the use of quantitative restrictions and tightly restricted the use of tariffs.
Developing countries insisted that they be given a relatively free hand in
the use of trade restrictions to promote economic development, because
the GATT failed to do so.
Developing countries continued to press for GATT reforms throughout
the 1950s (see Kock 1969, 238; Finger 1991). By the early 1960s, a
coalition of developing countries dedicated to far-reaching reform had
emerged. Its first important success was achieved with the formation of the
United Nations Conference on Trade and Development (UNCTAD) in
March of 1964. The UNCTAD was established as a body dedicated to
promoting the interests of developing countries in the world trade system.
At the conclusion of this first UNCTAD conference, 77 developingcountry
governments signed a joint declaration calling for reform of the
international trade system. Thus was born the Group of 77, the leading
force in the campaign for systemic reform. During the next 20 years, trade
relations between the developing world and the advanced industrialized
countries revolved almost wholly around competing conceptions of
international trade rules embodied in the GATT and UNCTAD.
During the 1960s, the Group of 77 used UNCTAD to pursue three
international mechanisms that would increase their share of the gains from
trade (Kock 1969; UNCTAD 1964; Williams 1991). First, the Group of 77
sought commodity price stabilization schemes. Commodity price
stabilization was to be achieved by setting a floor below which commodity
prices would not be allowed to fall and by creating a finance mechanism,
funded largely by the advanced industrialized countries, to purchase
commodities when prices fell below the floor. Stabilizing commodity
prices would be an important step toward stabilizing developing countries’
terms of trade (recall the Singer-Prebisch hypothesis). The Group of 77
also sought direct financial transfers from the advanced industrialized
countries to compensate them for the purchasing power they were losing
from declining terms of trade (UNCTAD 1964, 80). Developing countries
also sought greater access to core-country markets, pressuring the
advanced industrialized countries to eliminate trade barriers on primary
commodities and to provide manufactured exports from developing
countries with preferential access to the core-countries’ markets.
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These reform efforts yielded few concrete results. Core countries agreed
to incorporate concerns specific to developing countries into the GATT
charter. In 1964, three articles focusing on developing countries were
included in the GATT Part IV. Part IV called upon core countries to
improve market access for commodity exporters, to refrain from raising
barriers to the import of products of special interest to the developing
world, and to engage in “joint action to promote trade and development”
(Kock 1969, 242). In the absence of meaningful changes in the trade
policies pursued by the advanced industrialized countries, however, Part
IV provided few concrete gains. The advanced industrialized countries
also allowed the developing countries to opt out of strict reciprocity during
GATT tariff negotiations. The developing countries that belonged to the
GATT were therefore able to benefit from tariff reductions without having
to offer concessions in return. Benefits from this concession were more
apparent than real, however: GATT negotiations focused primarily on
manufactured goods produced by the advanced industrialized countries
and excluded agriculture, textiles, and many other labor-intensive goods.
Developing countries were therefore exporting few of the goods on which
the advanced industrialized countries were actually reducing tariffs. In the
late 1960s, the advanced industrialized countries agreed to the
Generalized System of Preferences (GSP), under which manufactured
exports from developing countries gained preferential access to advanced
industrialized countries’ markets. This concession, too, was of limited
importance, because advanced industrialized countries often limited the
quantity of goods that could enter under preferential tariff rates and
excluded some manufacturing sectors from the arrangement entirely.
Even though their efforts during the 1960s had achieved few concrete
gains, the Group of 77 escalated its demands in the early 1970s. Escalated
demands were sparked by the 1973 oil shock. The oil shock was a clear
illustration of the potential for commodity power. The world’s major oilproducing
countries, working together in the Organization of Petroleum
Exporting Countries (OPEC), used their control of oil to improve their
terms of trade. OPEC’s ability to use commodity power to extract income
from the core countries strengthened the belief within the Group of 77 that
commodity power could be exploited to force fundamental systemic
change.
Greater confidence in the possibilities that their control of commodities
offered led the Group of 77 to develop a set of radical demands dubbed the
New International Economic Order (NIEO). The NIEO represented an
attempt to create an international trade system whose operation would
186
promote development (see Krasner 1985). The NIEO, which the UN
General Assembly adopted in December 1974, embodied a set of reforms
that would have radically altered the operation of the international
economy. In addition to the three mechanisms that developing countries
had demanded during the 1960s, the NIEO included rules that would grant
developing countries greater control over multinational corporations
operating in their countries, easier and cheaper access to northern
technology, a reduction in foreign debt, increased foreign aid flows, and a
larger role in the decision-making processes of the World Bank and
International Monetary Fund (IMF).
Governments in the advanced industrialized countries refused to make
significant concessions, and by the mid-1980s the NIEO had disappeared
from the international agenda. The failure of the NIEO has been attributed
to a number of factors. First, developing countries were unable to establish
and maintain a cohesive coalition. The heterogeneity of developing
countries’ interests made it relatively easy for the advanced industrialized
countries to divide the Group of 77 by offering limited concessions to a
small number of governments in exchange for defection from the broader
group. In addition, the Group of 77 had hoped that OPEC would assist it
by linking access to oil to acceptance of the NIEO. But OPEC
governments were unwilling to use their oil power to help other
developing countries achieve broader trade and development objectives.
Most importantly, however, by the early 1980s, many developing
countries were facing serious balance-of-payments problems and turned to
the IMF and the World Bank for financial support. The need to obtain IMF
and World Bank assistance altered the balance of power in favor of the
advanced industrialized countries. This power shift sparked a reform
process that changed fundamentally development strategies throughout the
developing world.
CONCLUSION
Throughout much of the postwar period, developing countries insulated
themselves from the world trade system. The interaction between domestic
politics on the one hand, and economic shocks and decolonization on the
other, generated governments that were highly responsive to the interests
of import-competing manufacturing industries and a growing class of
urban workers. Influenced greatly by structuralism, most governments
transformed the political incentive to protect these domestic industries into
ambitious state-led development strategies. Structuralism’s critique of the
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ability of domestic and international markets to promote industrialization
led governments to intervene in domestic markets to overcome the market
imperfections that reduced private incentives to invest in manufacturing
activities.
Policy Analysis and Debate
The Sustainable Development Goals
Question
Can the Sustainable Development Goals eradicate extreme poverty?
Overview
Members of the UN agreed in 2015 that for the next 15 years they
would focus their development policies on 17 Sustainable
Development Goals (SDGs). The SDGs constitute an ambitious
attempt to build on the gains realized through the Millenium
Development Goals, and include (among other things) end extreme
poverty everywhere (measured as living on less than $1.25 per day)
and cut the numbers living in poverty in half by 2030. In addition, the
SDGs place greater emphasis on sustainable development—and thus
have a variety of environmental goals—and they attach greater
importance to protection of human rights. Governments are to achieve
these goals through extensive planning at the domestic and
international levels. Policies based on these plans will in turn be
supported by foreign aid offered by the international community. For
that purpose, the UN has called upon rich countries to provide aid
equal to 0.7 percent of GDP to developing countries and provide
technical assistance and technology transfers where it is useful to do
so.
The logic upon which SDGs rest is similar to the thinking that at the
broad level shaped the government’s role in ISI. The SDGs rest on a
diagnosis of poverty that emphasizes structural factors. Rather than
emphasize market failure, however, contemporary thinking
emphasizes a “poverty trap”:
When poverty is extreme, the poor do not have the ability—by
themselves—to get out of the mess … When [people] are utterly
destitute, they need their entire income, or more, to survive … There is no
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 ■
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 ■
 ■
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margin of income above survival that can be invested for the future.
(Sachs 2005, 56)
People can escape the poverty trap with help from the contemporary
analogue of the “big push.” The international community must provide
“a leg up” through well-funded and well-conceived government policy
initiatives. Given the logic upon which they are based, do you think
the SDGs will be successful?
Policy Options
An SDG-like strategy is necessary if the world is to eradicate
extreme poverty. Governments must embrace these goals.
The SDGs rest on faulty logic and thus cannot reduce extreme
poverty. Governments should re-evaluate their approach to the
problem of global poverty.
Policy Analysis
Do developing-country governments have incentives to
implement the policies called for by the SDG strategy? Why or
why not?
Do advanced industrialized countries have incentives to provide
the foreign aid that is required to support SDG policies? Why or
why not?
Take a Position
Which option do you prefer? Justify your choice.
What criticisms of your position should you anticipate? How
would you defend your recommendation against these criticisms?
Resources
Online: To learn more about the SDGs and current progress toward
achieving them, conduct an online search for the keywords UN and
MDGs. Look especially for the UN’s annual progress reports.
In Print: Read the alternative perspectives embodied in Jeffrey Sachs’
Ending Poverty: Economic Possibilities of Our Time (New York:
Penguin Press, 2005), and William Easterly’s The White Man’s
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Burden: Why the West’s Efforts to Aid the Rest Have Done So Much
Ill and So Little Good (New York: Penguin Publishers, 2006).
To the extent that developing countries participated in the global trade
system, they sought to achieve far-reaching reform of the rules governing
the system. Again, the structuralist critique served an important role in this
effort, as it suggested that developing countries could not expect to gain
from trade with the advanced industrialized countries until they themselves
had industrialized. Moreover, structuralism claimed that trade based on
GATT rules would only make industrialization harder to achieve. Rather
than accept participation in the global economy on what they viewed as
vastly unequal terms, developing countries battled to change the rules
governing international trade in order to capture a larger share of the
available gains. Thus, an international struggle over the distribution of the
gains from trade arose as an important counterpart of the domestic strategy
of redistributing resources from agriculture to industry embodied in ISI.
KEY TERMS
Backward Linkages
Big Push
Complementary Demand
Easy ISI
Enclave Agriculture
Export Substitution Strategy
GATT Part IV
Generalized System of Preferences
Group of 77
Import Substitution Industrialization
Monoexporters
New International Economic Order
Pecuniary External Economies
Secondary ISI
Singer-Prebisch Theory
Structuralism
Sustainable Development Goals
Terms of Trade
United Nations Conference on Trade and Development
SUGGESTIONS FOR FURTHER READING
For a readable introduction to structuralism and development strategies more
190
generally, see Ian Little, Economic Development (New York: Basic Books,
1982). For an in-depth look at Latin America, see Victor Bulmer-Thomas, The
Economic History of Latin American since Independence, 3rd edition
(Cambridge: Cambridge University Press, 2014).
For a comparative study of the role of the state in development, see Atul Kohli,
State-Directed Development: Political Power and Industrialization in the
Global Periphery (Cambridge: Cambridge University Press, 2004).
For a detailed examination of the New International Economic Order, see the
recent special issue of Humanity (2015 6 (1), http://humanityjournal.org/issue-
6-1/), Paul Adler, 2017. “‘The Basis of a New Internationalism?’ The Institute
for Policy Studies and North-South Politics from the NIEO to Neoliberalism.”
Diplomatic History 41(4): 665–93, and the now classic, Stephen Krasner,
Structural Conflict: The Third World against Global Liberalism (Berkeley:
University of California Press, 1985).
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W
CHAPTER 7
Trade and Development II:
Neoliberalism and Institutionalism
hereas structuralism and import substitution industrialization (ISI)
shaped development strategies during the first 35 years of the
postwar period, the last 30 years have been dominated by neoliberalism
and export-oriented industrialization. In contrast to structuralism, with its
skepticism about the market and faith in the state, neoliberalism is highly
skeptical of the state’s ability to allocate resources efficiently and places
great faith in the market’s ability to do so. And in contrast to
structuralism’s advocacy of protectionism and state intervention,
neoliberalism advocates the state’s withdrawal from the economy, the
reduction (ideally, elimination) of trade barriers, and reliance on the
market to generate industries that produce for the world market. In
addition, the current consensus within the development community
stresses the critical importance for development outcomes of high-quality
political and economic institutions.
Like structuralism, neoliberalism has dramatically affected policy.
Across the developing world, governments have reduced tariffs and
removed other trade barriers, thereby opening their economies to imports.
They have sold state-owned enterprises to private groups. They have
deregulated their economies to allow prices to reflect the underlying
scarcity of resources. They have shifted their emphasis from producing for
the domestic market to producing for the global market. Countries that had
never joined the General Agreement on Tariffs and Trade (GATT) sought
membership in the World Trade Organization (WTO). Thus, the last 30
years have brought a complete reversal of the development strategies that
most governments had adopted. Belief in the power of states has been
replaced by belief in the efficacy of the market; skepticism about trade has
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been replaced by concerted efforts to integrate deeply into the world trade
system. Neoliberalism has replaced structuralism as the guiding
philosophy of economic development. And as the state retreated from the
economy, the development community began to place new emphasis on
how important it was to development to have good political and economic
institutions.
The shift from structuralism to neoliberalism emerged from the
interplay between three developments in the global economy. First, by the
early 1970s, ISI was generating economic imbalances. The emergence of
these imbalances suggested that economic reform of some type was
required, although it did not point to a specific solution. Second, at about
the same time, it was becoming apparent that a small group of East Asian
economies were outperforming all other developing countries based on
what many viewed as a neoliberal strategy. Third, a severe economic crisis
in the early 1980s forced governments to embark on reform, and as they
did, the International Monetary Fund (IMF) and World Bank strongly
encouraged them to base reform on the neoliberal model.
We examine each of these three developments. We look first at the
factors that caused ISI to generate economic imbalances. This examination
allows us to understand the problems ISI created and the reasons that
reform of some type was necessary. We then turn our attention to the East
Asian countries. We briefly compare their performance with that of the
rest of the developing world. We next examine two contrasting
explanations for this remarkable performance, one that emphasizes the
neoliberal elements of those countries’ strategies and one that emphasizes
the role East Asian states played in the development process. We then turn
to the economic crisis and reform. We look at how the crisis pushed
developing countries to the World Bank and the IMF, and at how these
two institutions shaped the content of the reforms governments adopted. In
the final section, the chapter explores the relationship between domestic
political institutions and economic development.
EMERGING PROBLEMS WITH IMPORT
SUBSTITUTION INDUSTRIALIZATION
By the late 1960s, ISI was generating two important economic imbalances,
which together suggested that it had reached the limits of its utility as a
development strategy. The first imbalance lay in government budgets. ISI
tended to generate persistent budget deficits because it prescribed heavy
government involvement in the economy. Since governments believed that
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the private sector would not invest in industries that were important for the
success of secondary ISI, governments themselves often made the
investments, either in partnership with private-sector groups or alone by
creating state-owned enterprises.
Yet, many of these state-owned enterprises never became profitable. By
the late 1970s, state-owned enterprises in developing countries were
running combined operating deficits that averaged 4 percent of gross
domestic product (GDP) (Waterbury 1992, 190). Governments kept these
enterprises afloat by using funds from the state budget. Government
investment and the subsequent need to cover the losses of state-owned
enterprises combined to generate large and persistent budget deficits
throughout the developing world.
Domestic politics aggravated the budget deficits generated by ISI. For
many governments, urban residents provided critical political support.
Governments maintained this support by subsidizing essential items.
Electricity, water and sewers, transportation, telephone service, and food
were all made available to urban residents at below-market prices. This
was possible only by using government revenues to cover the difference
between the true cost and the price charged. In addition, many
governments expanded the civil service to employ urban dwellers. In
Benin, for example, the civil service tripled in size between 1960 and
1980, not because the government needed so many civil servants, but
because the government used it to employ urban residents in order to
maintain support. Such practices added to government expenditures and
added nothing to government revenues, thereby worsening the budget
deficit.
ISI also generated a second important imbalance: persistent currentaccount
deficits. The current account registers a country’s imports and
exports of both goods and services. A current-account deficit means that a
country is importing more than it is exporting. Import substitution gave
rise to current-account deficits because it generated a considerable demand
for imports while simultaneously reducing the economy’s ability to export.
Somewhat ironically, ISI depended on imports. Industrialization required
countries to import the necessary machines, and once these machines were
in place, production required continued import of parts that were not
produced in the domestic economy.
Exports declined for two reasons. First, the manufacturing industries
created through import substitution were not competitive in international
markets. Production in many of the heavy industries that governments
targeted in secondary ISI was characterized by economies of scale. The
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domestic market in most developing countries, however, was too small to
allow domestic producers to realize economies of scale. These
inefficiencies were compounded by excess capacity—the creation of more
production capacity than the domestic market could absorb (see Little,
Scitovsky, and Scott 1970, 98). Consequently, the newly created
manufacturing industries could not export to the world market.
Second, the policies that governments used to promote industrialization
weakened agriculture. The decline in agricultural production was most
severe in sub-Saharan African countries, which, as a region, taxed farmers
heavily (Schiff and Valdés 1992). Heavy tax burdens reduced farmers’
incentives to produce, hence the rate of growth of agriculture declined. In
Ghana, for example, the real value of the payments that cocoa farmers
received from the government marketing board fell by about two-thirds
between 1960 and 1965. Falling prices gave cocoa farmers little incentive
to invest in order to maintain, let alone increase, cocoa output (Killick
1978, 119). In addition, cocoa farmers smuggled much of what they did
produce into the Ivory Coast, where they could sell cocoa at world prices
(Herbst 1993, 40).
These microeconomic inefficiencies were reinforced by the tendency of
most governments to maintain overvalued exchange rates. Ideally, a
government should maintain an exchange rate that equalizes the prices of
goods in the domestic and foreign markets. However, under ISI, many
governments set the exchange rate higher than that, and as a result, foreign
goods were cheaper in the home market than they should have been and
domestic goods were more expensive in foreign markets than they should
have been. Because foreign goods were underpriced in the domestic
market, capital goods and intermediate inputs could be acquired from
abroad at a lower cost than they could be produced at home. This
difference in price created a strong incentive to import, rather than creating
the capacity to produce the goods locally. The result was rising imports.
Because domestic goods were overpriced in foreign markets, domestic
producers, even when efficient, found it difficult to export.
The emergence of budget deficits and current-account deficits indicated
that ISI was creating an economic structure that couldn’t pay for itself.
Many of the manufacturing industries created during secondary ISI could
not sell their products at prices that covered their costs of production.
Many developing countries could not export enough to pay for the imports
demanded by the manufacturing industries they were creating. Such
imbalances could not persist forever; some reform was clearly necessary.
Yet, the domestic politics of ISI greatly constrained the ability of
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governments to implement reforms. The balance of power among domestic
interest groups created multiple veto players that limited the ability of
governments to alter policies. Because governments depended so heavily
on urban residents for political support, they could not easily reduce
benefits provided to that group (Waterbury 1992, 192). In 1971, for
example, the Ghanaian prime minister devalued the exchange rate in an
attempt to correct Ghana’s current-account deficit. Concern that
devaluation would raise the prices of many imported goods consumed by
urban residents contributed to a coup against the government a few days
later. Once in power, the new regime quickly restored the currency to its
previous rate (Herbst 1993, 22–23). What message did that send to
politicians who might be contemplating measures to address the economic
imbalances they were facing?
In addition, the administration of ISI had created opportunities for rent
seeking and other corrupt practices. Those who engaged in these activities
had a vested interest in the continuation of the system. On the one hand,
government intervention had established an environment conducive to
rent seeking (Krueger 1974; Bhagwati 1982)—efforts by private actors to
use the political system to achieve a higher-than-market return on an
economic activity. Consider, for example, the consequences of
government controls on imports. Governments controlled imports by
requiring all residents who wanted to import something to first gain the
permission of government authorities. Such restrictions meant that
imported goods were scarce, thus imports purchased at the world price
could be sold at a much higher price in the domestic market. The
difference between the world price and the domestic price provided a rent
to the person who imported the good. A government license to import,
therefore, was valuable. Consequently, people had incentives to pay
government civil servants to acquire licenses, and government civil
servants had incentives to sell them.
Such behavior was extraordinarily costly. It has been estimated, for
example, that rent seeking cost India about 7 percent and Turkey about 15
percent of their national incomes during the 1960s (Krueger 1974, 294).
Because so many people inside the government and in the economy were
benefiting from the opportunities for rent seeking, they had a very strong
incentive to resist any efforts by the government to dismantle the system.
Finally, even if governments could overcome these obstacles, it was
unclear what model they should shift to. Far-reaching reforms would
require them to re-evaluate the underlying strategy they were using to
industrialize. The only available alternative to ISI was a market-oriented
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 ■
 ■
 ■
development strategy (one we will look at in detail in the next section). In
the 1970s, however, it was precisely this strategy that the Group of 77 was
fighting against in the UNCTAD and with the NIEO. Even moderate
reforms held little appeal. Most governments were unwilling to scale back
their industrialization strategies. Instead, they looked for a way to cover
the twin deficits without having to scale back their ambitious plans.
Facing economic imbalances, unable and unwilling to change policy,
many governments sustained ISI by borrowing from abroad. Yet foreign
loans could provide only a temporary solution; foreign lenders would
eventually question whether loans could be repaid. When they concluded
that they couldn’t, they would be unwilling to lend more, and governments
would be forced to correct budget and current-account deficits. This point
arrived in the early 1980s and ushered in a period of crisis and reform.
Before we examine this period, however, we must look at economic
developments in East Asia as these developments played a critical role in
shaping the content of the reforms adopted throughout the developing
world after 1985.
THE EAST ASIAN MODEL
Whereas ISI was generating imbalances in Latin America and sub-Saharan
Africa, four East Asian economies—Hong Kong, Singapore, South Korea,
and Taiwan—were realizing dramatic gains on the basis of a very different
development strategy. The dramatic performance gap is evident in three
economic indicators (see Table 7.1).
Per capita income in East Asia grew almost three times faster than
in Latin America and South Asia and more than 26 times higher
than in sub-Saharan Africa.
Manufacturing output grew by 10.3 percent per year between 1965
and 1990. No other developing country came close to this growth
for the period as a whole.
Exports from East Asia grew 8.5 percent per year between 1965
and 1990 while exports from Latin America shrank by 1 percent
per year.
TABLE 7.1
Comparative Economic Performance, Selected
Developing Countries (Average Annual Rates of
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Change)*
1965–1990 1985–1995
Growth of per Capita GNP
East Asia and the Pacific  5.3  7.2
Sub-Saharan Africa  0.2  1.1
South Asia  1.9  2.9
Latin America and the Caribbean  1.8  0.3
Growth of Manufacturing
East Asia and the Pacific 10.3 15.0
Sub-Saharan Africa  n.a.  0.2
South Asia  4.5  5.3
Latin America and the Caribbean  8.3  2.5
Growth of Exports
East Asia and the Pacific  8.5  9.3
Sub-Saharan Africa  6.1  0.9
South Asia  1.8  6.6
Latin America and the Caribbean  2.1  5.2
Notes: n.a. = not available.
GNP = gross national product.
Source: World Bank, World Development Report, various issues.
As a consequence, manufacturing grew in importance in East Asia,
while the importance of agriculture diminished. This differed substantially
from ISI countries, where agriculture’s importance fell but manufacturing
failed to grow (see Table 6.1). The growing manufacturing sector
transformed the composition of East Asia’s exports (see Table 6.2). By the
mid-1990s, manufactured goods accounted for more than 80 percent of
East Asian exports. By contrast, only in Brazil, Mexico, India, and
Pakistan did manufactured goods account for more than 50 percent of total
exports by the 1990s, and most of these gains were realized after 1980.
Finally, per capita incomes in East Asia soared above those in other
developing countries (Table 7.2). In 1960, per capita incomes in East Asia
were lower than per capita incomes in Latin America; by 1990, East Asian
incomes were higher than—in some cases twice as large as—per capita
incomes in Latin America.
Why did East Asian countries outperform other developing countries by
such a large margin? Most people who study East Asian development
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agree that the countries in the region distinguished themselves from other
developing countries by pursuing export-oriented development. In an
export-oriented strategy, emphasis is placed on producing manufactured
goods that can be sold in international markets. Scholars disagree about the
relative importance of the market and the state in creating export-oriented
industries. One position, the neoliberal interpretation, is articulated most
forcefully by the IMF and the World Bank. This thesis argues that East
Asia’s success was a consequence of market-friendly development
strategies. In contrast, the state-oriented interpretation, advanced by many
specialists in East Asian political economy argues that East Asia’s success
is due in large part to state-led industrial policies.
TABLE 7.2
Gross National Product per Capita, Selected
Developing Countries (1996 U.S. Dollars)
1960 1990 2000 Percent Change 1960–2000
Hong Kong 3,090 20,827 26,699  764
Singapore 2,161 17,933 24,939 1,054
Taiwan 1,430 10,981 17,056 1,093
South Korea 1,495 9,952 15,876  962
Mexico 3,980 7,334 8,762  120
Malaysia 2,119 6,525 9,919  368
Argentina 7,371 7,219 11,006  49
Chile 3,853 6,148 9,926  158
Brazil 2,371 6,218 7,190  203
Thailand 1,091 4,833 6,857  528
Zaire/Congo  980  572  281  −71
Indonesia  936 2,851 3,642  289
Pakistan  633 1,747 2,008  217
India  847 1,675 2,479  193
Nigeria 1,033 1,095  707  −32
Kenya  796 1,336 1,244  56
Zambia 1,207 1,021  892  −26
Tanzania  382  494  482  26
Sources: Penn World Tables; Data for 1996, Data for 1997; Data for 1998.
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The IMF and the World Bank contend that East Asia’s economic
success derived from the adoption of a neoliberal approach to
development. This interpretation places particular emphasis on the
willingness of East Asian governments to embrace international markets,
and their ability to maintain stable macroeconomic environments (see
World Bank 1989, 1991, 1993; Little 1982; Lal 1983; for critiques, see
Toye 1994 and Rodrik 1999). Most East Asian governments adopted ISI
strategies in the immediate postwar period. Unlike governments in Latin
America and Africa, however, East Asian governments shifted to exportoriented
substitution once they had exhausted the gains from easy ISI. In
Taiwan, for example, the government shifted in 1958 from production for
the domestic market to a strategy that emphasized production for export
markets. South Korea adopted similar reforms in the early 1960s. A
second wave of newly industrializing countries (NICs)—a group that
includes Indonesia, Malaysia, and Thailand—followed the same path
starting in the late 1960s (World Bank 1993). The emphasis on exports
forced Asian manufacturing firms to worry about international
competitiveness. As a result, the World Bank and the IMF argue, Asian
societies invested their resources in domestic industries profitable in world
markets.
The shift to export-oriented strategies was followed by selective import
liberalization. Asian governments did not engage in wholesale import
liberalization. The Taiwanese and South Korean governments continued to
rely heavily on tariff and non-tariff barriers to protect domestic markets. In
Taiwan, for example, approximately two-thirds of imports were subject to
some form of tariff or non-tariff barrier greater than 30 percent, and as late
as 1980 more than 40 percent of imports faced protection greater than 30
percent (World Bank 1993, 297). A similar pattern appeared in South
Korea, where, as late as 1983, “most sectors were still protected by some
combination of tariffs and nontariff barriers” (World Bank 1993, 297).
However, selective liberalization helped promote exports by reducing the
cost of critical inputs. Reducing tariffs on key intermediate goods, such as
looms and yarn in the textile industry, enabled domestic producers to
acquire inputs at world prices. This kept exports competitive in
international markets.
East Asian governments also maintained stable macroeconomic
environments. Three elements of the macroeconomic environment were
particularly important. First, inflation was much lower in East Asia than in
other developing countries. Between 1961 and 1991, inflation averaged
only 7.5 percent in the East Asian economies. By contrast, annual inflation
200
rates in the rest of the developing world averaged 62 percent (World Bank
1993, 110). Second, because governments kept inflation under control,
they could maintain appropriately valued exchange rates. In many
developing countries, high inflation caused the domestic currency to rise in
value against foreign currencies, making exporting difficult. In the East
Asian countries, by contrast, governments were able to maintain exchange
rates that allowed domestic firms to remain competitive in foreign
markets. Third, East Asian governments pursued relatively conservative
fiscal policies. They borrowed little, and when they did borrow, they
tapped domestic savings rather than turning to international financial
markets. This approach was in stark contrast to Latin American
governments, which accumulated large public-sector deficits financed with
foreign capital.
This stable macroeconomic environment had beneficial consequences
for Asian economic performance. Low inflation promoted high savings
rates and investment (World Bank 1993, 12). Savings rates in the Asian
NICs averaged more than 20 percent of GDP per year, almost twice the
level attained in other developing countries, whereas investment rates were
7 percentage points of GDP higher, on average, than in other developing
countries (World Bank 1993, 16, 221). A stable macroeconomic
environment also made it easier to open the economy to international
trade. Because inflation was low and exchange rates were maintained at
appropriate levels, trade liberalization did not generate large currentaccount
deficits. Finally, the ability to maintain relatively stable and
appropriately valued real exchange rates encouraged private actors to
invest in export-oriented industries.
The interaction between the export orientation, the relatively liberal
import policy, and the stable macroeconomic environment promoted
economic development. As Doner and Hawes (1995, 150) summarize the
World Bank perspective, the
pattern of limited government intervention in the market, coupled with cheap
labor and an open economy, [has] guaranteed the private sector stability and
predictability, the means to achieve competitiveness on a global scale, and
access to the international market so that entrepreneurs could actually
discover areas where they have comparative advantage. In shorthand, the
model is often reduced to “getting the prices right” and letting market-based
prices determine resource allocation. Doing so results in export growth that is
in turn positively correlated with broader economic growth.
According to the World Bank and the IMF, East Asia succeeded because
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markets played a large role, and states played a small role, in allocating
resources.
Other scholars have argued that East Asia’s success had less to do with
allowing markets to work and much more to do with well-designed
government industrial policies (see Wade 1990; Amsden 1989; Haggard
1990). In what has come to be called the East Asian model of
development, economic development is conceptualized as a series of
distinct stages. Government intervention in each stage identifies and
promotes specific industries likely to be profitable in the face of
international competition. In the first stage, industrial policy promotes
labor-intensive light industry, such as textiles and other consumer
durables. In the second stage, industrial policy emphasizes heavy
industries such as steel, shipbuilding, petrochemicals, and synthetic fibers.
In the third stage, governments target skill- and research and development
(R&D)-intensive consumer durables and industrial machinery, such as
machine tools, semiconductors, computers, telecommunications
equipment, robotics, and biotechnology. Governments design policies and
organizations to promote the transition from one stage to the other (Wade
1994, 70).
These three stages of industrialization are evident in the paths traced by
Taiwan and South Korea (see Table 7.3). In Taiwan, industrialization
focused initially on light manufacturing, textiles in particular. By the mid-
1950s, textiles were Taiwan’s most important export. The government also
encouraged production of simple consumer durable goods such as
television sets. In the late 1950s, the Taiwanese government began to
emphasize heavy industries. A joint venture between several Taiwanese
firms and an American firm was formed in 1954 to produce synthetic
fibers (Wade 1990, 80). In 1957, a plant to produce polyvinyl chloride was
constructed under government supervision and then was handed to a
private entrepreneur, Y. C. Wang (Wade 1990, 79). The government
created state-owned enterprises in the steel, shipbuilding, and
petrochemical industries. During the 1970s, attention shifted to skillintensive
industries, with particular emphasis on machine tools,
semiconductors, computers, telecommunications, robotics, and
biotechnology (Wade 1990, 94). By the mid-1980s, electrical and
electronic goods had replaced textiles as Taiwan’s largest export (Wade
1990, 93).
TABLE 7.3
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Stages of Industrialization in Taiwan and South Korea,
1880–1968
Commodity
Exports
1880–1930
Primary ISI*
1930–1955
Primary ExportOriented
Industries
1955–1968
Main
Industries
Taiwan:
Sugar, rice
South
Korea:
Rice, beans
Taiwan and South
Korea: Food,
beverages,
tobacco, textiles,
clothing, cement,
light manufactures
(wood, leather,
rubber, and paper
products)
Taiwan and South
Korea; Textiles and
apparel, electronics,
plywood, plastics
(Taiwan), wigs (South
Korea), intermediate
goods (chemicals,
petroleum, paper, and
steel products)
Major
Economic
Actors
Taiwan and
South
Korea:
Local
producers
(colonial
Japan)
Taiwan and South
Korea: Private
national firms
Taiwan and South
Korea: National private
firms, multinational
corporations, stateowned
enterprises
Orientation
of the
Economy
External
markets
Internal market External markets
* ISI, import substitution industrialization.
Source: Gereffi 1990, 19.
The South Korean government adopted similar policies (Amsden 1989).
In the 1950s, the government emphasized textile production, and textiles
became South Korea’s first important manufacturing export. During the
late 1960s, the South Korean state initiated the development of the
chemical and heavy-machinery industries. It created the Pohang Iron and
Steel Company, known as POSCO, which subsequently became one of the
world’s leading steel producers. The government also provided extensive
support to Hyundai Heavy Industry, a shipbuilder that subsequently
became a world leader in this industry. Then in the late 1970s, the South
Korean government began to give priority to skill- and R&D-intensive
203
sectors, and it is during this period that the South Korean electronics and
automobile industries began to emerge (Amsden 1989).
In the East Asian model of development therefore, government policy
drives industrialization from low-skilled, labor-intensive production to
capital-intensive forms of production and from there to industries that rely
on high-skilled labor and technology-intensive production. Each stage is
associated with particular types of government policies, and as each stage
reaches the limits of rapid growth, emphasis shifts to the next stage in the
sequence (Wade 1994, 71). Moreover, at each stage, governments stress
the need to develop internationally competitive industries.
East Asian governments relied heavily on industrial policies. They used
industrial policy to achieve four policy goals: reduce the cost of
investment funds in targeted industries, create incentives to export, protect
infant industries, and promote the acquisition and application of skills.
Taiwan and South Korea created incentives to invest in industries that state
officials identified as critical to development. To do so, governments in
both countries provided firms investing in these industries with
preferential access to low-cost credit. In South Korea, the government
nationalized the banks in the early 1960s and in the ensuing years fully
controlled investment capital. Control of the banks allowed the
government to provide targeted sectors with access to long-term
investment capital at below-market rates of interest (Haggard 1990, 132).
Although the banking sector was not nationalized in Taiwan, the
government did influence banks’ lending decisions. During the 1960s,
banks were provided with government-formulated lists of industries that
were to receive preferential access to bank loans. During the 1970s, the
banks themselves were required to select five or six industries to target in
the coming year. As a result, about 75 percent of investment capital was
channeled to the government’s targeted industries (Wade 1990, 166).
Asian governments also implemented policies that encouraged exports.
One method linked access to investment funds at low interest rates to
export performance. In Taiwan, for example, firms that exported paid
interest rates of only 6–12 percent, whereas other borrowers paid 20–22
percent (Haggard 1990, 94). In South Korea, short-term loans were
extended “without limit” to firms with confirmed export orders (Haggard
1990, 65). Credit was also made available to exporters’ input suppliers and
to these suppliers’ suppliers (Haggard 1990, 65–66). In addition,
“deliberately undervalued exchange rates” improved the competitiveness
of exports in international markets (World Bank 1993, 125). Finally, a
variety of measures ensured that domestic firms could purchase their
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intermediate inputs at world prices. These measures often entailed the
creation of free-trade zones and export-processing zones—areas of the
country into which intermediate goods could be imported duty free as long
as the finished goods were exported. Export-processing zones allowed
domestic producers to avoid paying tariff duties that would raise the final
cost of the goods they produced.
The Taiwanese and South Korean governments also protected infant
industries at each stage. In some instances, the measures they used were
straightforward forms of protection. The South Korean government, for
example, enacted legislation in 1983 that “prohibited the import of most
microcomputers, some minicomputers, and selected models of disk
drives,” in order to protect domestic producers in the computer industry
(Amsden 1989, 82). POSCO initially produced steel behind high import
barriers. In other instances, protection was less transparent. Hyundai
Heavy Industry, for instance, was protected in part through a government
policy that required Korean oil imports to be carried in ships operated by a
merchant marine that Hyundai Heavy Industry had itself created (Amsden
1989, 273). Taiwan adopted similar policies.
Finally, the Taiwanese and South Korean governments put in place
policies that raised skill levels. Investments in education were made to
improve labor skills. In Taiwan, enrollment in secondary schools had
reached 75 percent of the eligible age group by 1980. Enrollment increases
were accompanied by rising expenditures on education; per pupil
expenditures increased eightfold in primary schools, threefold in
secondary schools, and twofold at the university level between the early
1960s and 1980s (Liu 1992, 369). Similar patterns are evident in South
Korea, where enrollment in secondary schools increased from 35 percent
in 1965 to 88 percent in 1987 and “real expenditures per pupil at the
primary level rose by 355 percent” (World Bank 1993, 43, 45).
Governments also invested in scientific infrastructure to facilitate the
application of skills to R&D activities. In Taiwan, the Industrial
Technology Research Institute was formed in 1973, and nonprofit
organizations were created during the 1970s to perform research and
disseminate the results to firms in the private sector. A science-based
industrial park designed to realize agglomeration effects was created in
1980 (Haggard 1990, 142). In South Korea, tax incentives were used to
induce chaebols, the large South Korean firms, to create laboratories for
R&D purposes. An industrial estate for computer and semiconductor
production was created, and the Electronics and Telecommunications
Research Institute, a government-funded institute oriented toward product
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development was established there (Amsden 1989, 82). These policies
raised skill levels and created an infrastructure that allowed the more
highly skilled labor force to work to its full potential. This skill upgrading
was critical to the transition to the third stage of the industrialization
process.
The two explanations discussed thus present different arguments for
East Asia’s success. One suggests that East Asia succeeded because
governments allowed markets to work. The other suggests that East Asia
succeeded because governments used industrial policy to promote
economic outcomes that the market could not produce. Which argument is
correct? Although we lack definitive answers, we may conclude that both
explanations have value. By “getting prices right,” the export orientation
and the stable macroeconomic environment encouraged investments in
industries in which East Asian countries had, or could develop,
comparative advantage. By targeting sectors where comparative advantage
could be created, by reducing the costs of firms operating in those sectors,
by encouraging firms to export, and by upgrading skills, industrial policy
encouraged investments in areas that could yield high returns. As Stephan
Haggard (1990, 67) has summarized, macroeconomic “and trade policies
established a permissive framework for the realization of comparative
advantage, and more targeted policies pushed firms to exploit it.”
Although the relative importance of the state and the market in
accounting for East Asia’s success remains in dispute, what is clear is that
the experience of the East Asian NICs was vastly different from the
experience of Latin America and sub-Saharan Africa. East Asian
governments adopted development strategies that emphasized exports
rather than the domestic market, and they realized substantial
improvements in per capita income. The development strategies adopted
by governments in other developing countries emphasized the domestic
market over exports and generated economic imbalances and modest
improvements in per capita incomes. Consequently, when economic crises
forced governments to adopt reforms, the East Asian example provided a
powerful guide for the kind of reforms that would be implemented.
A Closer Look
Economic Reform in China
China’s emergence as a global economic power has also been driven
by dramatic market reforms. China has followed a distinct path to the
global market, however, because it embarked on the journey as a
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centrally planned economy: all economic activity was conducted by
state-owned enterprises in line with targets established by the
Communist Party’s central plan. China’s move to a market economy
has followed a strategy of “gradualism” in which it sought to “grow
out of the planned economy” (Naughton 1995). Rather than quickly
replacing the centrally planned economy with a market economy.
China maintained the planned economy while simultaneously
encouraging market-based activities. As China’s market economy
grew, the relative importance of the planned economy shrank. During
the last 25 years, therefore, a market economy gradually emerged in
place of the previous state-centered economy.
China based reform on three pillars. The first pillar, implemented in
the late 1970s, brought market incentives to agricultural production.
This Household Responsibility System encouraged farmers to lease
land from their agricultural commune. The government required
farmers that took advantage of this opportunity to sell some of their
crop to the state at state-set prices. They could sell the remainder at
market prices and retain the resulting profits. The Chinese government
also changed state-set prices to more accurately reflect the supply of
and demand for agricultural commodities. In doing so they encouraged
farmers to respond to market prices rather than state production
targets. By most accounts, the reform was a dramatic success, raising
agricultural productivity and farm incomes sharply during the 1980s
(Pyle 1997, 10). Agricultural reform also released labor from the
Chinese countryside. Consequently, China has experienced substantial
rural-to-urban migration of about 10 million people each year.
The second reform pillar, introduced in 1984, brought market
incentives to manufacturing. This Enterprise Responsibility System
encouraged enterprises to manage themselves like profit-oriented
firms. Enterprises were increasingly required to acquire their inputs
from and to sell their output in markets at market-determined prices
rather than through state agencies at state-set prices. The government
reduced production subsidies and required enterprises to turn to banks
for working capital. This withdrawal of state financial support forced
enterprises to care about profitability. Over time, private contracts
based on market prices replaced state-determined targets as the basis
for production (Jefferson and Rawski 2001, 247). By 1996, about 9.4
million non-state enterprises were operating in the Chinese economy,
accounting for about 75 percent of total industrial output (Shen 2000,
148). Here we clearly see China growing out of the planned economy
207
—each year a larger share of total output is produced by non-state
enterprises and a smaller share by the state-owned sector.
The third pillar of reform, the open-door policy, opened China to the
global economy by liberalizing foreign direct investment and trade.
The government attracted foreign investment by creating Special
Economic Zones along China’s southern coast. Special Economic
Zones (SEZs) allowed more market-based activity than was permitted
in the rest of the economy. Tariffs were reduced, labor market
restrictions were relaxed, private ownership was allowed, and taxes
were reduced in the SEZs. The SEZs thus provided useful “reform
laboratories” in which officials could experiment before implementing
reforms throughout the country (Shen 2000; Grub and Lin 1991). The
decision to locate the SEZs along the southern coast reflected the
desire to attract investment by Chinese nationals living abroad. The
SEZs in Guangdong province bordered Hong Kong, for example,
whereas the SEZ established in Fujian Province faced Taiwan. The
policy was extended to the entire coastal region and selectively
extended into the interior in 1988. The government also liberalized
trade. It expanded the number of companies allowed to conduct
foreign trade from 12 to more than 35,000 (Lardy 2002, 41). The
government also reduced trade barriers, first shifting from a quotabased
to a tariff-based system and then reducing tariffs sharply to the
current average rate of 15 percent. In December 2002, China joined
the WTO after almost 15 years of negotiations.
These reforms have transformed China from a sleeping dragon into
a powerful force in the global economy. China has grown more rapidly
than almost all other economies since the early 1980s, with the best
estimates suggesting annual growth rates of 6 to 10 percent since the
early 1980s. Such rapid growth has raised per capita incomes, which
doubled between 1979 and 1990 and then doubled again during the
1990s. Rising incomes have in turn reduced poverty. According to the
World Bank, the share of China’s population living in extreme poverty
fell from 53 percent in 1981 to just 1.9 percent by 2017 (World Bank
2006, 2017c). China has also emerged as an important player in the
global economy. It is currently the leading recipient of foreign direct
investment in the developing world, and now hosts one-third of all FDI
based in the developing world. China’s share of world trade has grown
from less than 1 percent in the 1970s to 17 percent today (Lardy 2002,
55; WTO 2017). As a consequence, China is now the world’s largest
exporter of merchandise (WTO 2017).
208
China’s transformation is not yet complete. The state-owned sector
remains an important component of China’s economy that requires
reform. The state-owned sector is composed of a relatively small
number (only 106) of very large firms (47 of these firms are among
Fortune Magazine’s 500 largest firms in the world). But together these
enterprises account for between one-quarter and one-third of China’s
total output (Leutert 2016). These very large enterprises are (on
average) inefficient and require substantial reform. It remains to be
seen whether the Chinese government can effectively consolidate these
enterprises, or encourage them to operate more efficiently. In late
2015, the Chinese government launched a new reform initiative In
addition, rapid growth has widened the income gap between urban and
rural regions, as industrial incomes rise more rapidly than agricultural
incomes. In fact, farm incomes have even fallen a bit over the last 5
years. Rising inequality has sparked rural protests, which have been
met with rather brutal government responses. Thus, China’s
government continues to face substantial challenges as it transforms its
economy.
STRUCTURAL ADJUSTMENT AND THE
POLITICS OF REFORM
By the early 1980s, governments in many developing countries were
recognizing the need for reform. The imbalances generated by ISI created
pressure for reform, and East Asia’s success provided an attractive
alternative model. It took a massive economic crisis, however, for
governments to implement reform. We will examine this crisis in detail in
Chapter 14; here, we say a few words about it in order to understand how
it produced the wave of reform that swept the developing world during the
1980s.
Economic crises struck developing countries during the early 1980s in
large part as a consequence of governments’ decision to borrow to finance
their budget and current-account deficits. Using foreign loans to finance
budget and current-account deficits is not an inherently poor choice. But
two factors made this decision a particularly bad one for developing
countries in the 1970s. First, many of the funds that governments
borrowed were used to pay for large infrastructure projects or domestic
consumption, neither of which generated the export revenues needed to
repay the loans. As a result, the amount that developing countries owed to
209
foreign lenders rose, but the countries’ ability to repay the debt did not.
Second, between 1973 and 1982, developing countries were buffeted by
three international shocks: an increase in the price of oil, a reduction in the
terms of trade between primary commodities and manufactured goods, and
higher interest rates on the foreign debt those countries had accumulated.
These shocks increased the amount of foreign debt that developing
countries owed to foreign banks, raised the cost of paying that debt, and
greatly reduced export earnings. By the early 1980s, a number of
developing countries were unable to make the scheduled payments on their
foreign debt.
As crisis hit, governments turned to the IMF and the World Bank for
financial assistance. The international institutions linked financial
assistance to economic reform. The World Bank and the IMF encouraged
governments to adopt such reforms under the banner of structural
adjustment programs—policy reforms designed to reduce the role of the
state and to increase the role of the market in the economy. The specific
content of the reforms that the IMF and the World Bank advocated were
shaped by their belief that East Asia’s success had resulted from exportoriented
and market-based development strategies (see World Bank 1991,
1993). In the World Bank’s own words,
the approach to development that seems to have worked most reliably, and
which seems to offer most promise, suggests a reappraisal of the respective
roles for the market and the state. Put simply, governments need to do less in
those areas where markets work, or can be made to work, reasonably well.
(World Bank 1991, 9)
To this end, structural adjustment emphasized changing those aspects of
developing economies that were most unlike conditions in Asia.
Governments were encouraged to create a stable macroeconomic
environment, to liberalize trade, and to privatize state-owned enterprises
(Williamson 1990, 1994). Macroeconomic stability was to be achieved by
transforming government budget deficits into budget surpluses.
Governments were encouraged to liberalize imports by dismantling
import-licensing systems, shifting from quota-based forms of protection to
tariffs, simplifying complex tariff structures, and reducing tariffs and
opening their economies to imports.
The IMF and the World Bank also encouraged privatization of stateowned
enterprises—that is, selling such enterprises to private individuals
and groups. The IMF and the World Bank argued that reducing
government involvement in the economy would foster competition and
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that greater competition would in turn help create a more efficient private
sector that could drive economic development. Through structural
adjustment, therefore, governments were encouraged to scale back the role
of the state in economic development and to enhance the role played by
the market.
Many governments implemented structural adjustment programs
between 1983 and 1995 (see Table 7.4). They began to liberalize trade in
the mid-1980s. In Latin America, average tariffs fell from 41.6 percent
prior to the crisis to 13.7 percent by 1990 (Inter-American Development
Bank 1997, 42). They began to privatize state-owned enterprises in the late
1980s. In Latin America, “more than 2,000 publicly owned firms,
including public utilities, banks, and insurance companies, highways,
ports, airlines, and retail shops, were privatized” between 1985 and 1992
(Edwards 1995, 170; see also Corbo 2000). They liberalized investment
regimes, thus opening to multinational corporations. They deregulated
industries and reduced government intervention in the financial system.
Structural adjustment programs had a dramatic impact on average
incomes in the short run and the distribution of income in the long run.
The crisis and the reforms brought about a sharp contraction of economic
activity. Income fell sharply as a result. In Latin America, income fell by
about 8 percent between 1981 and 1984. In sub-Saharan Africa, incomes
fell, on average, by about 1.2 percent per year throughout the 1980s
(Thorp 1999, 220; World Bank 1993). The dismantling of ISI also
redistributed income from urban import-competing sectors to agriculture
and emerging export-oriented manufacturing industries. In The Gambia,
for instance, structural adjustment tripled the prices farmers received for
groundnuts and significantly increased prices that urban residents paid for
petroleum products, public transportation, water, electricity, and
telecommunications (Jabara 1994, 309). Privatization and civil-service
reform resulted in large job losses. In Guinea, for example, the civil
service was reduced in size from 104,000 in 1985 to 71,000 in 1989
(Arulpragasam and Sahn 1994, 91). In pursuing structural adjustment,
therefore, governments redistributed income: export-oriented producers
benefited these policies, whereas people employed in the importcompeting
and nontraded-goods sectors saw their incomes fall.
TABLE 7.4
Countries Adopting Trade and Domestic Policy
Reforms, 1980–1996
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Africa Latin America
Benin Malawi Argentina Honduras
Burkina Faso Mali Bahamas Mexico
Burundi Mauritania Barbados Nicaragua
Cameroon Mauritius Belize Panama
Central African
Republic
Mozambique Bolivia Paraguay
Chad Niger Brazil Peru
Congo Nigeria Chile Suriname
Cote d’Ivoire Rwanda Colombia Trinidad
Ethiopia Senegal Costa Rica Uruguay
Gabon Sierra Leone Dominican
Republic
Venezuela
The Gambia Tanzania Ecuador
Ghana Togo El Salvador
Guinea Uganda Guatemala
Guinea-Bissau Zambia Guyana
Kenya Zimbabwe Haiti
Madagascar
Sources: World Bank 1994a; Thorp 1999.
The economic consequences of structural adjustment drove the domestic
politics of reform (see Nelson 1990; Remmer 1986; Haggard and Kaufman
1992; Oatley 2004). Groups that would lose from structural adjustment
attempted to block the reforms, whereas those who stood to gain attempted
to promote reform. Governments were forced to mediate between them,
and in many countries governments were heavily dependent upon political
support from the import-competing and nontraded-goods sectors. Thus,
reforms were hard to implement. Over time, however, the economic crisis
triggered a realignment of interests, discrediting groups associated with the
old policies and giving greater influence to groups that proposed an
alternative approach (Krueger 1993a). By weakening key interest groups
and by forcing many to redefine their interests, the crisis gradually eroded
many of the political obstacles to far-reaching reform. Yet, this process
took time, as reforms could be implemented only after new governments
responsive to new interests had replaced the governments that presided
over ISI.
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GETTING INSTITUTIONS RIGHT
As the 1990s progressed, members of the development community began
to argue that “getting prices right” by using SAPs to liberalize and
marketize developing economies, while perhaps a necessary step toward
sustained development, was not sufficient to deliver sustained growth. As
a consequence, policymakers and academics began to focus greater
attention on the broader context within which states made policy. As
attention shifted away from the rather exclusive focus on policy reform,
the characteristics and quality of political and economic institutions moved
to the center. By the turn of the century there was “widespread agreement
among economists studying economic growth that institutional quality
holds the key to prevailing patterns of prosperity around the world”
(Rodrik 2004, 1).
Thinking about institutions led to the articulation of two broad
institutional configurations—inclusive institutions and extractive
institutions—that have very different consequences for economic
performance (Acemoglu and Robinson 2012). Inclusive institutions have
political and economic characteristics that encourage individual initiative
and sustained economic growth. The most important political
characteristics of inclusive institutions include the broad extension of the
right to select and constrain governments, adherence to the rule of law and
a strong but (by virtue of the rule of law) constrained state. Among the
relevant economic characteristics, inclusive institutions have strong
property rights and market structures that reward individual talent.
Inclusive institutions are likely to provide high-quality public services that
are important to growth, such as public education that is available to all
and infrastructure investments that facilitate market development. The
elaboration of property rights and their defense in the rule of law system
encourages investment in productivity-improving activities. The fact that
the opportunities for economic activity are open to the broad public rather
than restricted to the chosen few creates incentives for individual initiative.
Inclusive institutions are thus likely to generate economic growth that is
sustained over time.
Extractive institutions, by contrast, lack most of these redeeming
qualities. In terms of politics, extractive institutions allocate power very
narrowly to a small ruling elite and systematically exclude other segments
of society from access to power. In addition, the elite’s power is relatively
unconstrained by electoral institutions or by a clear rule-of-law-based
judicial system. Economic institutions also do little to reward the initiative
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of individuals. Property rights are often lacking, or where present are
unevenly enforced. In such systems, the elite use their power to extract
income from those who are excluded from politics and use it to provide
benefits to the narrow group that rules or to the subset of society that keeps
the government in power. Such systems become characterized by
corruption within the state and among the ruling elite, and by rent seeking
at the level of the society as a whole. As a consequence, the balance
between productive and unproductive activity tips in a direction
unfavorable to sustained economic growth.
One might illustrate the importance to economic performance of these
institutional differences relative to other possible factors by comparing
societies that share common cultures and geographies but have very
different institutional characteristics. Consider North Korea and South
Korea as one such comparison. South Korea has experienced sustained
growth rates and dramatic improvements in the standard of living. North
Korea, in contrast, has experienced exceptionally poor economic
performance, even to the point of suffering widespread food scarcity.
Acemoglu and Robinson’s institutional perspective attributes these
different economic trajectories to different institutions. They argue that the
two countries occupy basically the same geographic space (the Korean
peninsula), and thus confront the same climate and geographical
constraints and opportunities. The two Koreas share a common language
and culture, and (at least through 1940) they had a common history. The
two differ primarily in their institutional characteristics, with South Korea
benefiting from inclusive institutions and North Korean performance
undermined by its extractive institutions. Acemoglu and Robinson offer
other comparisons that are similar in nature, such as East and West
Germany during and after the Cold War. Perhaps you can think of other
comparative cases that either support or confound their institutional
hypothesis.
Although the Acemoglu and Robinson institutional hypothesis holds
considerable appeal, at least two important questions about the approach
have been posed by its critics. The first critique points to potential issues
of reverse causality. What we mean by reverse causality is the possibility
that economic development outcomes are the underlying cause of
institutional configurations rather than the Acemoglu and Robinson
hypothesis that institutions cause development outcomes. Concerns about
reverse causality arise from a large body of research that had been
conducted prior to the more recent work by Acemoglu and Robinson.
Indeed, almost 60 years ago Seymour Marin Lipset hypothesized that
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economic development causes democratization: “the more well-to-do a
nation, the greater the chances that it will sustain democracy” (Lipset
1959, 75). Subsequent empirical scholarship has found substantial support
for the Lipset hypothesis (Boix 2011; Barro 1996; Przeworski et al. 2000).
Indeed, as one highly influential recent study concluded, “the level of
economic development, as measured by per capita income, is by far the
best predictor of [democratization]” (Przeworski et al. 2000, 88).
The second critique concerns the origins of political institutions. If, as
Acemoglu and Robinson claim, different institutional configurations
generate different development outcomes, it becomes important to
understand what accounts for cross-national variation in institutions. That
is, why are some societies fortunate enough to have been endowed with
inclusive institutions that promote development while other societies have
had the misfortune to be burdened with extractive institutions that do not
promote development? Acemoglu and Robinson (2001) have argued that
institutions reflected colonial settlement patterns. Where colonial mortality
was high, due to climate and disease, colonists did not expect to establish
permanent residence. They thus created extractive institutions that
maximized their short-run take. Where colonial mortality rates were low,
colonists were more likely to establish permanent settlements and thus
were more likely to create inclusive institutions that promoted economic
development. And these distinct institutions persisted after colonialism
ended. For A&R, therefore, contemporary institutions—and thus
development outcomes—are reflect developments that occurred hundreds
of years ago and continue to exert influence through the social processes
that make it very difficult to change institutions. One potential problem
with this argument is that it is difficult to isolate the causal significance of
institutions from the impact of climate and geography (see Diamond
2012).
Other scholars also have explained institutions by focusing on the
interaction between colonialism and resource endowments. Engerman and
Sokoloff (2000) focus their attention on explaining divergent development
outcomes in South and North America and the Caribbean. They argue that
low-quality institutions—essentially the equivalent of extractive
institutions—emerged in colonies in which land, climate, and labor
endowments encouraged colonists to engage in plantation-based
agriculture. On Caribbean islands, for instance, the climate and land were
conducive to sugar production, while small indigenous populations forced
the colonial powers to rely upon imported slave labor. Colonists built
political institutions that enabled them to control sugar production and
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income and to exclude slaves from participation in politics. The result was
high inequality and low political inclusiveness. In contrast, in the northern
parts of North America, climatic conditions and land endowments
encouraged grain farming organized as small-holdings that relied on
family labor rather than slaves. This small holding model generated less
economic inequality which carried over into the design of political
institutions which were more inclusive. In short, the interaction between
geography and colonialism led to the establishment of particular
institutional arrangements 250 and more years ago, and these institutions
have exerted a powerful influence on development trajectories ever since.
The continued uncertainty about the origins or causes of institutions has
important implications. Because different institutions are associated with
different development outcomes, a central determinant of success lies in
getting institutions right. Yet, this implies that societies stuck with
extractive institutions can escape only if they can create more inclusive
institutions. But if societies can change from extractive to inclusive
institutions at will, then institutions aren’t exogenous to state policy—they
haven’t really been inherited from 200 years ago—and cannot have the
substantial independent impact on economic development that
institutionalists claim.
Policy Analysis and Debate
Shifting from the Washington to the Beijing Consenus?
Question
Should the “Washington Consensus” be replaced by the “Beijing
Consensus” as a development model?
Overview
The 1980s were turbulent for the developing world. The decade began
with sovereign debt crises in several Latin American countries, and
ended with the collapse of the Berlin Wall and political and market
reforms in Eastern Europe. Responding to these events, economist
John Williamson identified the “Washington Consensus” on the
policies that developing countries must implement to ensure a return to
growth. Williamson called this package the Washington Consensus
because the World Bank, IMF, and U.S. Treasury Department—all
based in Washington D.C.—concurred with these policy
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recommendations. Key to the Consensus was eliminating government
involvement in the economy: “stabilize, privatize, and liberalize.”
The recent success of China and other East Asian countries as well
as what some characterize as disappointing achievements from the
Washington Consensus, have led some to suggest that a so-called
“Beijing Consensus” is replacing or should replace the Washington
Consensus. If the “Washington Consensus” espoused decentralized
market fundamentalism, then the “Beijing Consensus” advocates a
return to a state-led development strategy. This new development path
appeals to many governments for two reasons: first, it promises rapid
results without a loss of sovereignty to Western governments that
many developing country governments saw as a major part of the
Washington Consensus. Second, it increases the government’s power
within the country by creating a justification for state intervention and
allocation. Advocates for the Beijing Consensus emphasize its
potential for delivering rapid development. Critics ask why
governments would be expected to have better success with a state-led
strategy now than they experienced under ISI.
Policy Options
Washington-based institutions should continue to promote
neoliberal politics. If governments do not comply, Washingtonbased
institutions should withhold aid and consider trade
sanctions.
Governments should be allowed to pursue development as they
see fit, and development aid and trade relations should not be
contingent upon the adoption of any particular policy orientation.
Policy Analysis
What differences do you see between the Washington Consensus
and the Beijing Consensus? What about between the Beijing
Consensus and the ISI strategy?
What interest, if any, does the United States have in promoting
neoliberal reforms like those of the “Washington Consensus”?
Why might the United States oppose diffusion of a state-led
strategy?
Why might developing countries resist neoliberal development
programs and favor a more state-centric model?
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Take A Position
Should the United States pressure developing countries to pursue
neoliberal policies? Should developing countries resist? Justify
your answer.
What criticisms of your position should you anticipate? How
would you defend your recommendations against these
criticisms?
Resources
Online: Do online searches for “Washington Consensus” and “Beijing
Consensus.” You might begin with a speech given by John
Williamson titled “Did the Washington Consensus Fail?” (located at
www.iie.com/publications/papers/paper.cfm?ResearchID=488).
Kenneth Rogoff, former head of the IMF, wrote an open letter to
Joseph Stiglitz in response to criticisms of IMF neoliberal policies
(located at www.imf.org/external/np/vc/2002/070202.HTM). One
influential criticism of the “Washington Consensus” is Dani Rodrik,
“Goodbye Washington Consensus, Hello Washington Confusion?”
(located at
www.hks.harvard.edu/fs/drodrik/Research%20papers/Lessons%20of%20the%2019
In Print: There are many lengthy criticisms of the “Washington
Consensus”, the best-known of which may be Joseph Stiglitz,
Globalization and Its Discontents (New York, NY: W.W. Norton &
Co., 2002), which prompted Rogoff’s reply (linked above).
CONCLUSION
Neoliberalism supplanted structuralism as the guiding philosophy of
economic development as a result of the interplay among three factors in
the global economy. Import substitution generated severe economic
imbalances that created pressure for reform of some type. The success of
East Asian countries that adopted an export-oriented development strategy
provided an alternative model for development. Finally, the emergence of
a severe economic crisis in the early 1980s, a crisis that resulted in part
from the imbalances generated by ISI and in part from developments in the
global economy, pushed governments to launch reforms under the
supervision of the IMF and the World Bank. By the mid-1980s, most
governments were implementing reforms that reduced the role of the state
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and increased the role of the market in economic development.
The implementation of these reforms has been neither quick nor
painless. The depth of the reforms brought substantial short-run costs as
average incomes fell and as this smaller income was redistributed among
groups. The proponents of neoliberal reforms argue that the short-run costs
are worth paying, however, for they establish the framework for strong and
sustainable growth far into the future. Achieving that outcome will require
developing societies to consolidate and build upon the reforms already
implemented. In addition, it will require the advanced industrialized
countries to accept short-run adjustment costs of their own in order to meet
the legitimate demands that developing countries now make about market
access.
The adoption of neoliberal reforms in the developing world is also
transforming the global economy. For the first time since the early
twentieth century, the developing world has integrated itself into that
economy. In doing so, developing countries have altered the dynamics of
global economic exchange. Standard trade theory tells us to expect trade
between capital-abundant and labor-abundant societies. Yet, trade barriers
have greatly limited such trade for most of the postwar era. As these
barriers have fallen during the last 20 years, trade between countries with
different factor endowments has become increasingly important.
Businesses are increasingly locating their activities in those parts of the
world where they can be performed most efficiently. Labor-intensive
aspects of production are being shifted to developing societies, whereas
the capital-intensive aspects of production remain in the advanced
industrialized countries. The expansion of North–South trade is thus
creating a new global division of labor.
KEY TERMS
Current Account
East Asian Model of Development
Export-Oriented Strategy
Extractive Institutions
Inclusive Institutions
Rent Seeking
Structural Adjustment Program
SUGGESTIONS FOR FURTHER READING
On the East Asian Model of Development, see Robert Wade, Governing the
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Market: Economic Theory and the Role of Government in East Asian
Industrialization (Princeton: Princeton University Press, 2003), Yin-wah Chu
(editor) The Asian Developmental State: Reexaminations and New Departures
(London: Palgrave MacMillan, 2016), and Dani Rodrik, One Economics, Many
Recipes: Globalization, Institutions, and Economic Growth (Princeton:
Princeton University Press, 2008).
The single best account of China’s trajectory is Barry Naughton, The Chinese
Economy: Adaptation and Growth (Cambridge: MIT Press, 2018).
For a detailed examination of the relationship between institutions and
development, see Daron Acemoglu and James Robinson, Why Nations Fail:
The Origins of Power, Prosperity and Poverty (New York: Crown Business,
2013).
For an application of the institutionalist perspective to contemporary sub-Saharan
Africa, see Robert H Bates and Steven Block, 2017. “Political Institutions and
Economic Growth in Africa’s ‘Renaissance.’” Oxford Economic Papers, 1–26.
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