Globalization
Chapter 1
The Pros and Cons of Globalization for
Developing Countries
A Review of the Theoretical Issues and the Empirical Debate
David Bigman*
Introduction
Despite the highly favorable views that most researchers in the academic community and in the international development organizations hold on the globalization process and its impact on developing countries, and notwithstanding the strong support of the empirical evidence of the benefits that many developing countries have derived from their integration with the global economy, the backlash against globalization continues unabated. An online debate on “Globalization and Poverty” organized by the World
Bank Development Forum in mid-2000 echoed the loud and often very aggressive protests against globalization that erupted in Seattle, Washington, and Prague; nearly all the participants in the debate emphasized the very negative impact of the globalization process on the distribution of income and wealth between and within countries: “Globalization may improve growth rates, increase productivity, enhance technological capability, but it cannot redistribute created wealth and income in favor of the poor. In fact, it does the reverse—it redistributes wealth and income in favor of the not so poor.”
The participants underscored the harmful impact on the poor:
“Money can be made by growing things for export on foreign-owned commercial farms… No money can be made by the villager working her own land when she cannot afford the few bags of fertilizer, the seeds and the insecticides, courtesy of the structural adjustments, the liberalization, the removal of support systems and the massive devaluations.”
Many participants also noted that the market is by no means the panacea for the central problems that the majority of the population in developing countries is facing:
“With the opening of our market, our country has become a supermarket of foreign goods, which are cheaper, killing our local industries, rendering
* David Bigman: International Service for National Agricultural Research
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many more jobless. The disparity between the rich and the poor has widened, and although some may have benefited from the effect of liberalized economy, the majority continue to languish in poverty.”
The opposition against globalization unifies labor organizations that protest against the flight of jobs “South of the border,” human-rights groups opposed to sweat shops thriving on child labor, environmentalists concerned about the damage to the global habitat, and radicals suspicious of the clout of multinational corporations that are perceived as the all-powerful agents of capitalism. The IMF, the World Bank, and the
WTO, and, more generally, the high-income countries, are held responsible for influencing and largely determining the course of the globalization process. They are also seen as the driving forces behind the policy reforms that the developing countries had to implement as part of their structural adjustment programs under the stewardship of the IMF, the World Bank, and the WTO. However, while many passionate opponents of globalization view these reforms as unacceptable dictates, the reforms had actually quite positive effects on the economies of most developing countries. In
East Asia, most countries experienced unparalleled rates of economic growth during the past two decades; as a consequence, a large portion of their poor population was lifted out of poverty. Despite the crisis of 1997–98, which exposed serious weaknesses in their financial, social, and political systems, as well as in their institutions of governance, most East Asian countries embarked on a course of comprehensive reforms to deal with the crisis, and they have entered the 21st century with renewed drive. In contrast, most countries of sub-Saharan Africa, and quite a few countries in
South Asia, Latin America, and the Caribbean, did not benefit from the globalization process, and, despite a series of structural adjustments, these countries are burdened with much the same structural problems that plagued their economies in the previous century, but which now aggravated by heavy debts and the AIDS epidemic. It has been generally agreed that the benefits brought about by the global trading system under
GATT and the WTO have so far been distributed very unevenly between and within nations. The rich industrial countries have reaped large gains from increased trade and faster growth, whereas most poor nations have actually become worse off and their economies shrank during the past decade. As a result, the gap between the nations with the poorest 20% of the world’s population (in terms of per capita income) and the nations with the 20% most affluent population has nearly doubled in the past two decades, and many developing countries have been marginalized and practically cut off from the mainstream of the global economy.
These contrasting experiences and the growing global income inequality are reflected in the heated debate and the diametrically opposed views on globalization.
On the one side of the debate are the various protest groups that underscore the failed experience of many sub-Saharan African and South Asian countries and the widespread perception that globalization is detrimental to the poor even in countries where it has had a positive impact on the economy at large. On the opposite side of the debate is the majority of the economists who, backed by the supporting empirical evidence on the gains from free trade, adhere to the neoclassical maxim that highlights
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the potential gains from trade and trade liberalization. The theoretical tenets emphasize that, with trade liberalization, resources are allocated more efficiently to productive uses, and low-income countries with an abundance of unskilled labor and significantly lower labor costs can expand output and employment in labor-intensive industries, thus accelerating their growth.1 The poor also stand to benefit from this growth, and trade liberalization is therefore also good for the poor. These benefits are highlighted in several World Bank research papers that concluded that “growth is good for the poor” (Dollar and Kraay 2000a) and that “In general, the more rapid growth that developing countries experience as they integrate with the global economy translates into poverty reduction” (Dollar 2001).
The positive effects of globalization on productivity are also thanks to the transfer of advanced technologies and to the opportunities that developing countries can obtain from the flow of FDI. Another World Bank paper that focused on the impact of the rising tide of FDI during the 1990s concluded that the flow of FDI was central to the more rapid growth that many developing countries achieved, and this growth also contributed to financing many government-led distribution programs that provided direct assistance to the poor and improved the social safety nets (Klein and
Hadjimichael 2000).
Even ardent proponents of globalization agree, however, that the benefits from free trade and trade liberalization can be realized only after a transition period during which the country’s institutions of governance and its legal system will have to be restructured, many public enterprises be privatized or dismantled and the market system be strengthened. Given the transformation that most segments of the economy and most institution of governance will have to undergo, this transition may take much longer than expected and the process may sometimes be reversed under political pressures. In Indonesia and the Philippines, for example, it is not clear whether the critical part of the transition was completed in the early 1990s with the expansion of export-oriented production, or whether it still continues through the first decade of 21st century, as the reforms reach the political institutions. Has China completed its transition period with the economic reforms it implemented as it joined the WTO, or has it just begun?
These questions are also echoed in what has become known as the debate over the
“post-Washington consensus,” which acknowledges the fragility of prescriptive policy packages of the form “liberalize trade and set the price right” and the likelihood that these “prescriptions” will fail in countries that lack proper institutions of governance and have only a rudimentary market system. In the on-line debate on
“Globalization and Poverty” quoted earlier, many participants reflected these views when they argued that the benefits from market deregulation and trade liberalization are not likely to trickle down to the poor because, in the words of one of the participants, “the main cause of poverty is the market, not market failure,” since
“markets fail to address strategic interests like food security.” Other participants noted that often their countries’ own institutions “prevent a flowering market-based
1. See, for example, the World Bank’s World Development Report 1999, p. 52, for a summary of these benefits. 30
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development.” Others emphasized unequivocally that “Decades of external influences in different forms have undermined and destroyed the traditional institutional mechanisms while creating islands of modern institutions that are inefficient and alien to their society at large”. Through this process, “the North has imposed a money-based economic system and such rules for participation upon the poorer nations of the world
[that] have destroyed the traditional and local ways of wealth distribution in favor of a cash economy ruled by international forces.” Indeed, suspicion and even hostility toward the market, and strong opinions that “unfettered market processes favor the rich and powerful and their outcomes are inherently unjust” are common.
Against the background of these opposing views and the resulting heated debate over the merits of globalization for developing countries, the objective of this chapter is to provide an overview of the main arguments raised by the two sides in the debate and evaluate the pros and cons of globalization for different groups of developing countries. Section I reviews the theoretical issues raised in this debate and the empirical evidence on the impact of globalization on economic growth. The section includes a survey of the development strategies that the international development organizations, primarily the World Bank and the IMF, have promoted. In addition, the section presents the main results of an empirical study on global income inequality based on the data of the GDP per capita of 152 developed and developing countries over the period 1960–98. The first objective of this study is to identify and compare patterns in the economic reforms that countries that have gained from the globalization process have implemented in order to be integrated into the global economy, and patterns in the economic policies of countries that were left behind; the second objective is to evaluate how inclusive the process of globalization has so far been.
Section II focuses on the different approaches to the trade policy of a developing country in the current global trading system. The theoretical writings and empirical evidence of the past two decades clearly support the basic tenets of the neo-classical paradigm which hold that a labor-abundant developing country stands to reap significant gains from trade liberalization and an outward looking economic policy.
But a number of issues require closer examination: One issue is the question whether the global trading system that evolved under the Uruguay Round Agreement of the
General Agreement on Tariffs and Trade, the WTO and the regional trade agreements, including the rules on food safety, the nontechnical barriers to trade, and IPR, is indeed the system of free trade that the neoclassical economists envisaged. Other issues are related to the lessons from the “Asian economic model:” First, even the East Asian countries adopted at the early stages of their development active policies that protected and subsidized their infant industries in order to promote their exports. Second, the high and often unqualified praise that was heaped on the “Asian model of capitalism” until the 1997–98 financial crisis ignored major weaknesses in their systems of government and their legal and political institutions that were exposed during the crisis and that, to a large extent, were responsible for this crisis.
Another issue is related to the failure of most countries in sub-Saharan Africa and many countries in South Asia and Latin America to develop an industrial base, particularly against the background of the “Asia miracle.” One factor that hampered their growth performance is their focus on the production of import substitutes and the
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bias of their policies in favor of consumers and against producers; another factor is the bias in their trade policies against agriculture and in favor of industrialization. These issues are discussed in section III, which focuses on the agricultural sector and on the trade and development policies that affected the rural population. The section underscores the difficulties that the rural population had to face during and as an effect of the structural adjustment programs (SAPs) and the reforms to liberalize trade. The chapter concludes with remarks that discuss some central considerations for the formulation of development policies.
Globalization and Economic Growth: Theory and
Empirical Evidence
The debates over development strategies—in retrospect
The debate over the structure of development strategies that would be most effective and socially most desirable for promoting growth and alleviating poverty, and over the balance between these potentially conflicting objectives, went through distinct phases since the early 1960s. In part, these phases reflected the wide differences in the experience of different countries during different time periods; in part, they reflected marked disagreements over the ability to bring about a significant reduction in poverty by promoting economic growth alone, and over the need and the potential advantages and disadvantages of accompanying these growth strategies with active income distribution measures.
The early economic growth literature that provided the intellectual foundation for this debate emphasized the segmentation of the economy in developing countries into a modern, mostly industrial sector in urban areas, and a traditional, mostly agricultural sector in rural areas. Constraints on land availability and declining land quality, together with the continued rise in the rural population, reduce the marginal product of labor in the traditional sector to near-subsistence levels and drive the surplus of unskilled labor to urban areas. In this model, the embryonic modern sector cannot absorb all the surplus labor and, at the early stages of development, this migration would lead to a rise in income inequality and poverty. However, abundance of cheap and mostly unskilled labor and open unemployment in urban areas, and disguised under-employment in rural areas, give incentives to increase production in the modern sector in labor-intensive industries. The rising demand for labor in the labor-intensive industries would gradually absorb the unemployed in urban areas and the underemployed in rural areas, thus bringing about, over time, a reduction in poverty and income inequality at later stages of development.
The actual realization of this stylized model varied widely between countries and continents and between time periods. In the 1960s—with the emergence of new nation states throughout Asia and Africa and the rapid economic progress in all countries across all continents—the focus was on economic growth as the most effective strategy for meeting the needs of the rapidly growing populations in the newly independent countries. In the 1970s, poverty and income inequalities were on the rise.
In many countries in Latin America and the Caribbean, South Asia, and sub-Saharan
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Africa, the pace of industrialization was too slow to absorb the flow of rural migrants, often because production in the modern sector, especially manufacturing of import substitutes, was highly capital intensive and did not provide enough employment.
Despite the diminishing prospects of rural migrants to find employment in urban areas, migration from rural areas continued due to rapid population growth and dwindling land resources, thus leading to higher poverty also in the urban areas.
Disillusion with the trickle-down effects of growth shifted the emphasis to a strategy that deals simultaneously with economic growth and poverty. The then World
Bank’s President, Robert McNamara, expressed this shift by stating that “[g]rowth, as such, can be considered a necessary but not sufficient target of development strategy.”
In 1974, the Bank issued a document titled Redistribution with Growth that extended the goals of its development strategy by seeking to influence both the rate and the patterns of growth in order to reach the poor. The document advocated “policy packages” consisting of a wide range of measures that included promoting employment of unskilled labor, developing new technologies to make low-income workers more productive, targeting investments on “pockets of poverty,” allocating more resources to the education of the poor, and providing for the basic needs of the poor, particularly food and health care, from public sources. Redistribution with
Growth insisted that “poverty-focused planning does not imply abandonment of growth as an objective. It implies, instead, a redistribution of the benefits of growth.”
(p. xviii). The 1980 World Development Report echoed this theme and made the case for a more concerted effort to secure the basic needs of the poor and argued for targeted investments in human development and technologies suitable for the poor primarily in rural areas.
During the almost three decades since the publication of Redistribution with
Growth, these strategies continued to evolve with the accumulation of more experience and data from a growing number of countries, and with the deepening understanding of the economic and political processes in developing countries. The
1980s brought two diametrically opposed experiences. At the one extreme was the failed experience of many countries in Latin America and the Caribbean and sub-Saharan Africa with highly interventionist policies and large public spending that led to high public debts, massive macroeconomic imbalances, stagnation, and growing poverty. The debt crisis propelled the IMF and the World Bank to enter stage and give rise to policy-based lending: loans disbursed in exchange for policy reforms aimed at correcting macroeconomic imbalances and boosting productivity through structural reforms. At the other extreme was the very successful experience of the East Asian countries with rapid industrialization, high growth rates and a steep reduction in poverty. The accelerated growth of their modern sector, led by labor-intensive production for exports, brought about a gradual reduction in their unemployment and a rise in incomes in their urban and rural areas that led, in turn, to a steep reduction in poverty. Moreover, improving skills of the labor force enabled these newly industrialized countries to gradually move to higher, more advanced levels of industrial production and to products and production technologies that are more capital- and more skilled-labor intensive. Although growth was accompanied in some countries by rising income inequalities, it “lifted all boats” and steeply reduced
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poverty. The sharp differences between these experiences underscored the limitations and potentially undesirable effects of proactive redistribution policies. Against this background, the debate over the pros and cons of alternative growth strategies acquired another dimension with the renewal of old debates over the proper balance between measures to promote growth and measures to reduce income inequality and poverty, and over the desirability of government intervention in the economy even if this meant curtailing the free market and reducing efficiency.
During the 1980s, the reforms focused on “structural adjustment programs” under which governments had to make firm commitments to economic restructuring that focused on trade liberalization, tax reform, realistic exchange rates, liberalization of capital markets and privatization in exchange for support by the World Bank and the
IMF. In the early 1990s, the East Asia “miracle” highlighted the significance of market-oriented structural adjustments. The World Bank’s 1990 World Development
Report advocated a new strategy to combat poverty based on more effective market incentives and better social and political institutions, infrastructure, and technology on the one hand, and on direct measures of governments to provide social services such as primary health care and education on the other hand. This two-pronged approach was based on more open markets and large-scale privatization accompanied by greater government activism in the provision of public goods in health, education and infrastructure. The 1990 World Development Report on Poverty concluded that “[t]he evidence in this report suggests that rapid and politically sustainable progress on poverty has been achieved by pursuing a strategy that has two equally important elements. The first element is to promote the productive use of the poor’s most abundant asset—labor. It calls for policies that harness market incentives, social and political institutions, infrastructure, and technology to that end. The second is to provide basic social services to the poor” (p. 3). Specifically, the poverty reduction strategy recommended in the report had three main components:
1. Promoting broad-based growth that makes intensive use of labor in order to increase the productivity of the poor and the economic opportunities available to them. 2. Ensuring the access of the poor to good quality basic social services in order to enable them to take advantage of economic opportunities.
3. Providing social safety nets for the most vulnerable members of society.
The 1990 World Development Report recommended a growth strategy that includes investments in industries and production technologies that can absorb surplus labor as well as investments in human capital to allow the poor to take advantage and reap the benefits of new technologies. The World Bank’s Poverty Reduction Handbook of 1993 and Adjustment in Africa of 1994 echoed the message of the 1990 World Development
Report by emphasizing the importance of an outward-oriented strategy and export-led growth. The Handbook emphasized the need to promote trade and exploit the comparative advantage of developing countries in products and production processes that are labor-intensive; in contrast, tariffs and other restrictions on trade are likely to inhibit growth and increase unemployment and poverty by giving incentives to capital-intensive production of import substitutes. A study conducted by the World
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Bank’s Office of Executive Directors in 1995 titled The Social Impact of Adjustment
Operations emphasized that growth is the most significant process affecting poverty and that a consistent implementation of sound macroeconomic policies is essential for promoting sustainable growth. A subsequent study titled Social Dimension of
Adjustment, conducted by the Bank’s independent Operations Evaluation Department in 1996, concluded that “good macro-economic policies and measures, combined with relevant sectoral policies and appropriate public expenditure allocation, provide a favorable environment for … sustained growth and poverty reduction.” The study found, however, that in most countries, the actual reduction in poverty was quite small and high levels of income inequality and poverty persisted.
Addressing the controversy over the seeming “trade-off” between growth and equality, Bruno (1995) noted that, although direct action on health, education, and nutrition can improve the quality of life for the poor, growth is the only strategy that can secure a sustained reduction in poverty and provide the resources that are necessary for any direct action to reach the poor. The 1995 World Development Report reiterated the conclusion that “open trading relations [and] domestic policies that promote labor-demanding growth” are central to equitable growth. The World Bank and the IMF therefore relentlessly pushed developing countries in the direction of the
WTO “system.” However, the Bank’s 1995 report also noted that growth may augment income inequalities and that
“[s]ome groups of relatively poor workers have experienced large gains in the past thirty years—especially in Asia. But there is no worldwide convergence between rich and poor workers. Indeed, there are risks that workers in poorer countries will fall further behind, as low investment and educational attainment widen disparities. Some workers, especially in sub-Saharan Africa, could be increasingly marginalized. And those left out of the general prosperity in countries that are enjoying growth could suffer permanent losses, setting in motion intergenerational cycles of neglect” (p. 21).
These considerations led to the argument that in these countries the government must take active measures to secure the livelihood of the poor, even if these measures may restrict the free market and diminish the country’s growth prospects. The counterargument asserted that, by reducing the country’s rate of growth, the government might in fact defeat the long-term goal of reducing poverty.
During the past decade, it has been increasingly recognized, however, that a successful implementation of policy reforms depends on the country’s institutions of governance, and that the weakness of the institutions in the majority of the developing countries was the principal obstacle for the success of their structural adjustment programs. In the East Asian countries, weak institutions contributed to the 1997–98 financial crisis; in many countries in Latin America and the Caribbean, the weakness of institutions contributed to aggravate the impact of the global crisis on their economies, and in nearly all the countries in sub-Saharan Africa, weak institutions were not only the main obstacle to the implementation of the reforms, but also the main reason for the continuous political and social unrest. It has been realized that, in all
The Pros and Cons of Globalization for Developing Countries
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developing countries, the reforms were too narrowly focused on macroeconomic policy and that the new agenda must stress also anticorruption efforts, effective corporate governance, banking transparency and independence, strong capital markets, and adequate social safety nets. The World Bank and the IMF made concerted efforts to work with governments to implement codes of “best practices” in a variety of technical areas such as banking regulation and supervision, corporate governance, and accounting. The World Development Report of the year 2000 adopted a much wider definition of poverty, which includes not only income shortfalls and low levels of health and education, but also powerlessness, voicelessness, vulnerability, and fear. This very wide definition of poverty also calls for a much larger “menu” of policies to combat poverty, ranging from fostering economic growth, strengthening the rule of law, promoting community development and gender equity, to closing the digital and knowledge divide. To be able to attack the wider dimensions of poverty, the World
Bank has continuously diversified its own operations by adopting new goals and new work areas in order to assist countries in education, science, health, child nutrition, population, industrial development, trade policy, and the environment. This expansion reflected not only the Bank’s propensity to grow, but often also pressing needs that had not been adequately addressed by the existing development institutions, primarily the other agencies of the UN system; in addition, it also reflected the growing influence of nongovernmental organizations (NGOs) that pushed for the incorporation of issues such as the environment, the role of women in development, human rights and democracy into the Bank’s agenda, although some critics claim that this expansion reflects mostly the Bank’s inability to sort out its priorities.
In principle, each of the above actions is essential to tackle the wider dimensions of poverty. However, given the limited resources that developing countries can command, not all of these actions are feasible, and it is therefore necessary to establish clear priorities and trade-offs. The Bretton Woods institutions have a clear comparative advantage in advising on, and supporting the implementation of, actions that affect a country’s economy, and even among these actions, it is necessary to establish priorities. However, by widening the definition of poverty, spreading thin the
World Bank’s resources, and, without determining priorities, extending the menu of actions beyond the scope of the Bank’s comparative advantage—thus also diverting governments (and the World Bank) from the task of promoting growth and economic efficiency—the 2000 World Development Report may have reduced the Bank’s effectiveness and its influence over the choice of a development strategy.
While the debates over development strategies have always reflected topical concerns of the time, they often remained too abstract and generic in that they failed to recognize the substantial differences between countries. These differences cast doubt on the notion that a development strategy can be formulated in the abstract or that it can yield a menu of actions and policy recommendations that apply to all countries.
Lumping all the “developing countries” together and advocating a “one-size-fits-all” development strategy with a blueprint of actions can be oversimplifying and possibly even misleading. For each country, it is necessary to recognize its unique geographic, socio-economic and political conditions, to establish priorities that reflect these
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conditions, and to identify the critical areas on which its economic policy should focus.
Recommendations to “promote labor-intensive growth and open trade” (World
Development Report 1990), or to “promote opportunity, facilitate empowerment, and enhance security” (World Development Report 2000), may fail to recognize country-specific needs and differences in the underlying conditions.
Thus, while in most East Asian countries growth proved to be the most effective strategy for reducing poverty, many Latin American and Caribbean countries experienced a much smaller reduction in poverty with growth. Their greater sensitivity to the needs of the poor made it necessary to accompany the pro-growth policies with additional measures to ensure a more equal distribution of the growing national income. The experience in a considerable number of sub-Saharan African countries showed that for them, administrative restrictions on exchange and interest rates, or even on the government budget, proved to be quite useless, since these countries lack the necessary institutions and the rule of law to ensure the proper implementation of these policies. In these countries, the main focus of policy reforms at the early stages of development should therefore be on measures to strengthen the institutions of government and the rule of law. Indeed, one lesson of the East Asian crisis is that even in the relatively more advanced developing countries, economic policy must place much greater emphasis on institution building, strengthening the rule of law, fighting corruption, etc. The second lesson is that a country’s growth is function not only of its endowments of labor, capital, and natural resources, but also of the strength of its public and private institutions and its legal and political systems.
The neo-classical prescription for promoting growth in a labor-abundant country
The present discussions on growth and employment in a labor-abundant developing country take their origin in the neoclassical writings, particularly the labor-surplus model of Lewis (1954), Fei and Ranis (1964), which dominated much of the economic development literature in the 1960s and 1970s. In Lewis’ model of a dual (or segmented) economy of a labor-abundant developing country with two distinct sectors, the modern, mostly industrial sector in the urban areas operates along the traditional, mostly agricultural sector in rural areas. The low living standards in rural areas drive many to the urban centers and increase the supply of unskilled and low wage workers (Table 1.1). In the early stages of development, the rural-urban migrants join the ranks of the under- and unemployed in the urban areas due to the limited employment available in the modern sector. Empirical studies estimated that in many countries the rate of unemployment in urban areas exceeded 20% of the labor force
(Berry and Sabot 1978; Berry 1989). Nevertheless, rural-urban migration continued unabated. Harris and Thodaro (1970) explained the continued flow of migrants despite the rising urban unemployment by the migrants’ (subjective) expectations for higher wages that took into account not only the wage differential between urban and rural areas, but also the probability of finding employment. Rural migrants were also attracted by the better facilities for health and education and the better quality of water
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Table 1.1. Demographic Characteristics of Selected Developing Countries: 1973–95
Annual growth rate of the population overall LAC
Brazil
Chile
Peru
Africa
Ghana
Kenya
Tanzania
Asia
India
Indonesia
Pakistan
urban
rural
Share of urban population mid-1970s mid-1980s
mid-1990s
2.2
1.8
2.3
4.1
2.4
3.6
-2.45
-0.9
-0.3
59
77
59
71
82
67
87
87
76
3.9
4.3
3.4
5.3
8.0
8.6
3.0
3.5
2.5
33
12
9
38
17
14
43
24
23
2.1
2.1
2.7
4.2
4.8
4.3
1.2
1.2
2.0
19
18
25
24
24
29
30
31
34
Source: World Bank, various tables
supplies in urban areas that reflected the large bias in government expenditures (Lipton
1977; Larson and Mundlak 1997). In many developing countries, industrial growth remained, however, quite slow and capital intensive despite the large supply of labor, and the bulk of new jobs in urban areas were not created in the modern sector, but in the informal, traditional urban sector that includes basic manufacturing and small-scale commerce and services, where production is highly labor-intensive and earnings are low (Berry 1989).
In many East Asian and some Latin American countries, in contrast, rapid growth of labor-intensive and export-oriented industries led to a gradual reduction in unemployment, a rise in real wages, and a reduction in poverty in both urban and rural areas. In Korea, Adelman and Robinson (1978) concluded “the strategy of labor-intensive, export-led growth … produced significantly higher incomes for the poorer half of the population and a far more equal relative distribution” (p. 127). In
Indonesia, Thailand, and Malaysia, the industrial growth led to an annual rise of over
2% in the real incomes of the rural population. Accumulation of both physical and human capita enabled the East Asian countries to move to higher, more advanced levels of industrial production, and to products and production technologies that are more capital-intensive and require more skilled labor.
Table 1.2 demonstrates the large differences between the rates of growth of different countries during the past four decades. The economies of the sub-Saharan
African countries generally stagnated; in Latin America and the Caribbean, growth rates were higher, but they varied widely between countries. In these two groups of countries, many of the poor remained in rural areas and did not benefit much from the growth in the urban sector. In the East Asian countries, in contrast, the rates of growth in labor-intensive export industries were high enough to absorb the surplus labor
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Table 1.2. Growth of GDP Per Capita in Selected Countries: 1960–97
Country
1960
1997
Average annual change (%)
South Korea
Taiwan
885
1355
10,500
13,250
6.9
6.4
Ghana
Senegal
Mozambique
875
1015
1125
850
1095
805
-0.1
0.2
-0.9
Brazil
Mexico
Argentina
1745
2800
3295
5500
6300
4750
3.2
2.2
1.0
GDP per capita in US$ in 1985 prices.
Source: World Bank, various tables.
despite the continued migration to urban areas; as a result, the rate of unemployment declined, both urban wages and rural earnings increased and poverty declined.
Table 1.2 also highlights the reasons for the criticism of the labor surplus model, because it fails to explain why in so many labor-abundant economies growth was very slow and industrialization faltered, while in other countries growth was very rapid and industrialization was highly successful. There is also criticism of the model’s failure to explain the changes in income distribution that took place during the growth process: many countries that experienced rather similar growth rates of the average per capita
GDP had wide differences in the changes in the level of poverty. In Mexico, the
Philippines, Nigeria, and few other countries, growth was accompanied by a rise in income inequality to the extent that poverty actually increased.
A large number of empirical studies tested Kuznets’ hypothesis either in cross-section studies of many developing countries or in time-series analysis of individual countries. Many of these studies, particularly the ones that conducted a cross-section analysis (Adelman and Morris 1973; Ahluwalia 1976; Chenery and
Syrquin 1975), tended to confirm Kuznets’ hypothesis, and thus strengthened the inclination to adopt a development strategy that puts greater emphasis on redistribution measures. Since the initial impact of growth is to increase income inequalities, so the argument went, and since this effect can last for quite some time, growth must be accompanied by active redistribution measures. Chenery (1971) asserted that “growth that does not change the resource allocation in favor of the poor constitutes growth with little development,” and recommended proactive redistributive measures if economic growth does not bring about a significant reduction in poverty.
During the 1990s, with the accumulation of more data on income distribution in a large number of developing countries over a longer time period, several studies examined again Kuznets’ hypothesis, but this time in a time series analysis (Bruno,
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Ravallion, and Squire 1995; Ravallion 1995; Ravallion and Chen 1996). These studies concluded that, while the trends in income inequality with growth differ significantly across countries, there is no evidence that growth has any discernible systematic impact on inequality. In a sample of household surveys from a large number of countries, Ravallion and Chen found that in only half of the cases growth was associated with an increase in inequality. Bruno et al. emphasized that although there are exceptions, as a rule, sustainable economic growth benefits all layers of society roughly in proportion to their initial standard of living.
Based on the evidence of the last decades, there seems to be no credible support for
Kuznets’ hypothesis. These studies also confirmed that positive economic growth was significantly associated with a falling incidence of poverty, and that economic contraction was associated with a rising incidence of poverty. Bruno et al. calculated with data of 20 countries over the period 1984–93 that a 10% increase in mean per capita consumption led to an average 20% decline in the proportion of the population living on less than $1 per day. Lipton and Ravallion (1995) calculated with the data of eight developing countries that a distribution neutral growth at an annual rate of 2% in mean per capita consumption would lead to a decline in the poverty gap of 3 to 8%.
These findings motivated a change in the approach to development strategy in the mid-1990s in favor of a strategy that gives much greater weight to growth and advocates re-distributive measures only in countries where there is clear evidence that the growth process is narrowly based and leaves out large segments of the population.
In most countries, though, this approach emphasized the potentially undesirable effects of re-distributive measures on economic incentives and efficiency. The debate on these issues is far from over, and the more recent chapters in this debate are discussed later on.
Globalization and global income distribution 1960–98:
Has there been a convergence?
A large number of studies sought to estimate the changes in the global income distribution between and within countries during the second half of the 20th century.
Blotho and Toniolo (1999), drawing on data for 49 countries, found that the measure of global income inequality shows a modest trend toward convergence starting in 1980.
Melchio, Telle, and Wiig (2000) evaluated the changes in income inequality between countries on the basis of a sample of 115 countries and they also found that, after a relatively stable period during the 1950s through the 1970s, global incomes tended to converge from the mid-1980s through the mid-1990s. Other studies used different samples and slightly different time periods, but came essentially to the same conclusion (Schultz 1988; Firebaugh 1999; Radetzki and Jonsson 2000). In a sample of 100 countries, Clark, Kraay, and Dollar (see Dollar 2001) found that worldwide inequality increased during 1960–75, but declined during 1975–95, largely due to the accelerated growth in China and India. Using household survey data drawn from 91 countries for 1988 and 1993, Milanovic (1999) reached a different conclusion.
According to his estimates, income inequality, measured by the Gini index, rose marginally from 63 to 66, primarily due to an increase in income inequality between
40
Chapter 1
countries, rather than rising inequalities within countries. These seemingly conflicting conclusions reflect primarily differences in the sample of countries and time periods on which they draw and the small changes—up or down—that these analyses indicate.
The question examined in this section is whether the trends in global income inequality indicated by these global measures indeed represent a tendency of global incomes to converge, and whether they indicate that the globalization process has therefore been inclusive, as several recent World Bank reports maintain (see e.g., Dollar 2001).
The analysis in this section is based on household survey data from a larger sample of countries that includes also the ex-centrally planned countries, but it focuses only on income inequalities between countries that represent only part, though a central part, of the global income inequality. Nevertheless, the estimates of the trends in income inequality between countries since 1960 are in agreement with the results of most of the studies mentioned above. According to these estimates, the three main measures of inequality indicated that there has been a decline in global income inequality during the past two decades after a period of relative stability during the 1960s and 1970s.
This analysis also shows, however, that the global measures of inequality do not provide an adequate representation of the widening gap between the richest and the poorest countries.
During 1960–96, the world’s average GDP per capita increased by nearly 80% in real terms, but growth rates varied widely between countries and regions: In SSA, the annual average growth rate of GDP per capita was less than 1% during the past four decades, and it actually declined in the past two decades, whereas in East Asia, the average GDP per capita increased since 1980 at an annual rate of over 4.5% (Table 1.3 and Figure 1.1). This rapid economic growth of one group of developing countries and the relative stagnation in the other group had two conflicting effects on the global income distribution: On the one hand, the “Asian miracle” and the accelerated growth of India and some Latin American countries during the 1990s closed the income gap between these countries and the developed countries. On the other hand, the gap between the average GDP per capita in the least developed countries, particularly in
Table 1.3. Trends in GDP Per Capita in Selected Regions 1960–96 (in PPP
Exchange Rates in 1985 Prices)
Region
Number of Population
1990
countries*
(millions)
GDP per capita (in USD$)
1960
South Asia
East Asia
SSA
LAC
Dev’ped cts
World
6
18
45
32
28
164
* Including the CIS countries
1,105
1,671
478
421
858
5,064
1980
1996
781
630
761
2,447
6,205
2,250
935
1,242
1,130
4,537
11,347
3,806
1,333
2,251
1,036
4,480
14,259
4,000
Annual growth rate
1960–96
1980–96
1.5
3.5
0.9
1.6
2.4
1.6
2.2
3.8
-0.5
-0.1
1.4
0.3
The Pros and Cons of Globalization for Developing Countries
41
8
6
4
1960-1980
2
1980-1996
D
ev
W or ld
el op ed
Pl an .
C
en
t.
LA
A
EN
SS
A
tA
M
-C
Ex
-4
si a si a A
So ut h
-2
1997-1998
Ea s 0
Figure 1.1. Average annual growth rates of GDP per capita in main regional groups,
1960–98
Source: IMF
sub-Saharan Africa, and that in the developed countries has widened significantly. As a consequence of these conflicting trends, global income inequality changed relatively little during most of these years (depending on the measure) and the main impact was on the relative position of countries on the global income ladder. What conclusions can be drawn from these changes about the convergence of the global income distribution?
In 1960, the East Asian countries were at the bottom of the global income ladder with an average GDP per capita that was some 20% lower than that of the sub-Saharan
African and South Asian countries; in 1998, the average GDP per capita in East Asia was more than double the average GDP in sub-Saharan Africa. As a result, most East
Asian countries climbed to much higher levels on that ladder, while the sub-Saharan countries fell to the bottom (Figure 1.2). In 1960, over 80% of the population in the lower one-third of the global income distribution were in the East Asian countries; in
1998, 65% of the population in the lower one-third of the global income distribution were in South Asia and 31% in sub-Saharan Africa. In 1960, less than 15% of the population at the higher one-third of the global income distribution were from developing countries; by 1998, their share had risen to 40% (Figure 1.3a and 1.3b).
Table 1.4 shows the changes in global income inequality during 1960–98, as indicated by the three most common measures of income inequality: the Gini coefficient, Theil’s measure, and the coefficient of variations (CV). All three measures indicate that there were only minute changes in income inequality during the 1960s and 1970s, but since 1980 and until 1998, the decline has been more noticeable. During the 1990s, the decline in the measures of global income inequality was primarily due to the rapid growth in China and India and the large share of these countries in the global population. As a result, these two countries, along with most other East Asian countries and some countries in Latin America and the Caribbean, moved to a higher position on the global income ladder, whereas the countries in sub-Saharan Africa dropped to the bottom. The relatively small changes in the three global measures do not show, however, the changes in the relative position of countries on the global income ladder, nor do they show the growing absolute gap between the richest and the
42
Chapter 1
350
1985 US Dollars
300
250
200
150
100
50
1960
1970
South Asia
SSA
LAC
Developed
1980
1990
1996
East Asia
MENA
Ex-centrally planned
Figure 1.2. Index of GDP per capita (PPP adjusted) by regions, 1960–96
poorest countries. The two other measures in Table 1.4 indicate that the gap between the group of high-income developed countries and the group of sub-Saharan African countries has increased by nearly 80% during these years, and the gap between the most affluent country (the US) and the poorest country (indicated in the table by the
Max/Min Ratio) has increased by over 60%.
Several other observations are noteworthy:
1. During the 1980s and the 1990s, the share of the sub-Saharan African countries in the lowest quintile of the global income distribution has nearly tripled from 11.8% to 31.5%, while the share of the East Asian countries in the lowest quintile fell sharply from 35.1 to 7.3% despite their growing population.
2. The share of the South Asian countries in the lowest one-third of the global income distribution increased during the 1980s and 1990s despite the relatively more rapid growth of India, and these countries now constitute more than two-thirds of the lowest income group.
3. In the 1960s and 1970s, the share of the East Asian countries in the lowest income group was more than three-quarters, but by 1996 this share had dropped to nearly zero. 4. The share of the East Asian countries in the middle-income group rose from around 10% in the 1960s and 1970s to around three-quarters by the end of the
1990s.
5. The share of the developed countries in the highest one-third of the global income distribution declined from 64% in 1960 to 43% in 1996, but this was due to the decline in their share in the global population.
The Pros and Cons of Globalization for Developing Countries
43
0,9
0,8
0,7
0,6
Low
0,5
0,4
Medium
0,3
High
0,2
0,1
0
South Asia
East Asia
SSA
MENA
LAC
Ex-Centrally
Developed
Planned
Figure 1.3a. The Share of Regions in the Three Income Groups: 1960
0,9
0,8
0,7
0,6
0,5
0,4
0,3
0,2
0,1
0
Low
Medium
High
South Asia
East Asia
SSA
MENA
LAC
Ex-Centrally
Developed
Planned
Figure 1.3b. The Share of Regions in the Three Income Groups: 1996
Table 1.4. Measures of Inter-Country Income Inequality 1960–98
Indicator
Max/min ratio1
Developed/SSA
ratio 2
Gini Coefficient
Theil’s Measure
Coeff. of
Variations
1960
1970
1980
1990
1998
Change: 1960–98 (%)
38.55
8.15
43.67
9.18
47.26
10.04
61.93
12.26
62.97
14.53
+63.3
+78.3
0.63
0.60
1.58
0.63
0.61
1.55
0.62
0.60
1.52
0.60
0.56
1.52
0.58
0.49
1.48
- 8.1
-17.6
- 6.3
1. The ratio between the average GDP per capita in the US and in the poorest country.
2. The ratio between the average GDP in the developed countries and the average in the SSA countries.
44
Chapter 1
As a result of these changes, the gap between the average GDP per capita in the developed countries and that in the sub-Saharan African countries has increased sharply, while the gap between the developed countries and the East Asian countries has narrowed by over 40%. During these years, the share of South Asia and sub-Saharan Africa in the world’s population rose from 27% to 33.4%, while the share of the developed countries dropped from 21% to 16%. As a result of all these changes, the gap between the average GDP in the group of developing countries and the average in the group of developed countries has changed by only 13%, and the measures of income inequality within the group of developing countries have actually declined.
These changes do not reflect, however, a convergence of the global income distribution, since the gap between the richest and the poorest countries, i.e., the height of the income ladder, has increased significantly. Clearly, for the populations in the countries in sub-Saharan Africa, in most of South Asia, and in Latin America and the
Caribbean, globalization was not inclusive, and the gap between their standard of living and that of the developed countries is now wider than ever. For the population in
East Asia, India, and some Latin American countries, in contrast, globalization was indeed inclusive, and they enjoyed a rapid increase in their standard of living both in absolute and in relative terms. An attempt to draw a general conclusion from these opposing trends and apply it for the “average” or the “representative” people in developed and developing countries is a rather meaningless exercise in statistics.
Instead, the sharp difference between these opposing trends makes it necessary to draw different conclusions for the group of countries that benefited from globalization and for the group of countries that were left behind.
The critical question in this connection is whether the differences between these two groups of countries reflect also the differences in their development strategies. In other words, were the countries that reformed their economies able to gain from globalization and managed to achieve unparalleled rates of economic growth and a sharp reduction in poverty, and were the countries that failed to restructure their economies unable to integrate themselves into the mainstream of the global economy and, as a consequence, did they see their economies shrink and their number of poor increase? A complete answer to this question would require a more thorough analysis, but the reviews of the country experiences in this volume suggest that there is no such clear correspondence. Quite a few countries, including several countries in sub-Saharan Africa, made considerable efforts to reform their economies but were unable to integrate into the global economy due to a host of other reasons.
Table 1.5 summarizes the trends in poverty in the main groups of developing countries and in the world during the 1990s. These trends in the incidence of poverty were reflected also in the changes in the rates of child mortality during the 1990s.
Whereas in most East Asian and South Asian countries there was a reduction in the rate of child mortality during these years, in most sub-Saharan African countries this rate increased. In nearly all Asian countries (Cambodia is one exception), child mortality declined during the 1990. The steepest decline was in the East Asian countries: in
Indonesia the rate declined from 97 to 52, and in the Philippines it dropped from 68 to
47. In sub-Saharan Africa, in contrast, child mortality increased in most countries.
The Pros and Cons of Globalization for Developing Countries
45
Table 1.5. Trends in World Poverty during the 1990s
Region
1990
No. (million)
EA
LAC
SA
SSA
World*
450
74
495
242
1276
1998
Poverty rate
No. (million)
Poverty rate
27.6
16.8
44.0
47.7
29.0
280
78
522
291
1200
15.6
15.6
40.0
46.3
24.0
Source: World Development Report 2000.
* Includes also MENA and the ex-centrally planned economies
The large differences between the patterns and rates of growth of different groups of developing countries underscore the fact that lumping all the developing countries together and conducting the analysis in terms of North vs South, or developed vs developing countries is becoming increasingly misleading.
International Trade and Trade Policies in Developing Countries
The changing concept of comparative advantage
International trade economists have long maintained that a liberal and outwardoriented trade regime is the best strategy for a small economy to increase its welfare and income by optimizing the allocation of its resources in production according to the country’s comparative advantage, and by minimizing the incentives for unproductive activities associated with protection, such as smuggling, lobbying, and tariff evasion.
Additional channels through which trade can precipitate growth include higher returns to investments by increasing the market size with trade, higher productivity through imports and diffusion of advanced technologies, and pressures to rationalize the government trade and macroeconomic policies. Sachs and Warner (1995) estimated that open economies grew about 2.5% faster than closed economies, with even greater differences among developing countries. Tarr and Rutherford (1998) use a CGE model to estimate that a 10% reduction in average tariff (from 20 to 10%) brings about a welfare gain of 10 to 37% of the present value of consumption (depending on the type of taxes that are being used to replace lost tariff revenues).
The neoclassical theory emphasizes the driving force of low wages, abundance of unskilled labor and labor-intensive production technologies in promoting trade and specialization in a labor-abundant country. This analysis is based on an aggregate model in which production is a function of labor and capital, and technologies are characterized by the proportions (or intensities) of labor and capital in production.
Different proportions of labor and capital in the production of different goods, and different endowments of labor and capital in different countries provide the incentives for specialization in production and for trade. This model is the basis of the widely
46
Chapter 1
employed Heckscher-Ohlin model that separates consumption and production, and shows how the location of production is determined by differences in the technology and by differences in factor endowments between regions and countries that determine, in turn, their comparative advantage. The model predicts that, as trade barriers are reduced, production will relocate according to comparative advantage
(with relatively unskilled labor-intensive activities moving to relatively unskilled labor-abundant locations). As this occurs, the changes in demand for factors of production will tend to equalize factor prices across countries.
In this model, the patterns of trade are determined by ranking goods according to their factor intensities; the labor-abundant country has a comparative advantage in the production of labor-intensive goods. Rybczynski’s theorem strengthens this conclusion by showing that, under fairly general conditions, an increase in labor supply—or an increase in labor productivity (Corden)—brings about an increase in the production of labor-intensive goods. Specialization in production and movements of goods between countries, in line with their comparative advantage, are substitutes for the movement of factors of production, and trade therefore narrows the differences between factor prices. However, the comparative advantage of a country need not be fixed. It may change over time with the changes in its factor endowments and productivity and with changes in its production technologies. The higher the rate of growth of a country’s labor force, the larger the proportion of labor-intensive goods in production and the larger the comparative advantage of the country in the production of labor-intensive goods. The larger the flow of capital from the capital-abundant to the labor-abundant country, the smaller the comparative advantage of the former in capital-intensive goods.
Labor-intensive production. In the neo-classical Heckscher-Ohlin two-factor model, labor intensity of a given production technology or a given product is determined by the capital-labor ratio in production. One production technology is said to be more labor-intensive than another if the capital-labor ratio in the first technology is lower than in the second. Several production technologies can be ranked from the most labor-intensive to the least, according to the corresponding capital-labor ratios, thus emphasizing that labor intensity is a relative concept. Moreover, the same product can be more labor intensive than another in one factor price ratio, but more capital intensive than another in another factor price ratio. (This is known as “factor reversal”). In empirical studies within a given country, the “physical” definition of labor intensity is replaced by a cost definition that evaluates the shares of labor and capital costs in the total costs.
For this comparison, it is necessary to remove first any price and cost distortions due to subsidies or taxes targeted on some of the industries. A considerable number of articles have examined various modifications and extensions of the neoclassical model of comparative advantage in order to adjust the model to today’s conditions in the global economy. Most of these contributions still focus on production technologies, factor requirements, and factor endowments as the driving forces for specialization and international trade. Wood and Berge (1997) argued that the concept of comparative advantage in the Heckscher-Ohlin model is no longer suitable for today’s
The Pros and Cons of Globalization for Developing Countries
47
conditions for two reasons. First, the high mobility of capital has led to major changes in factor endowments across countries, thereby continuously changing their comparative advantage. Second, since there is little difference between primary products and simple manufactured products in the intensity of “‘unskilled labor” in their production, the only factors that distinguish the modern sector from the traditional one are land and skilled labor. On these grounds, they concluded that
“[c]ountries that have a lot of land and low levels of education should concentrate on opportunities for progress within the narrow primary category” (p. 1468). This, however, is a static strategy that ignores the dynamic aspects of comparative advantage and the potential to raise the levels of education and thereby acquire new technologies and change the country’s specialization.
The more recent writings on the dynamic nature of a country’s comparative advantage highlighted the following additional factors:
< The effects of investment in R&D that can change a developing country’s comparative advantage by allowing it to produce and export high quality products.
(Okamoto and Woodland 1998);
< The impact of change in a country’s technological capabilities, and thus also in its comparative advantage, due to higher skills of its labor force with better education and training. (Pietrobelli 1997);
< The impact of demand shifts in the more affluent North to higher-quality products as an effect of the rise in income that shifts the production in the North to higher-quality products, while production of an increasing number of relatively lower quality products is shifted to the South, where labor costs are lower (Flam and Helpman 1987).
In addition to these “traditional” gains from trade through the more efficient allocation of resources that is achieved with trade, there will be the following additional gains when the domestic market can be made more competitive and production better organized: 1. Pro-competitive gains. These are the effects of increased imports on the competitive behavior of firms in the domestic market by disciplining the monopolistic or oligopolistic behavior of firms, forcing them to behave in more competitive ways.
2. Gains from economies of scale. As the quantity produced by one firm increases, its average cost decreases. This may be the result of economies of specialization
(firms operating on a larger scale can match inputs more closely to tasks), of indivisibilities in production, or of the greater efficiency of large machines compared to small ones. The decline in average costs leads, in turn, to lower prices.
3. Gains from the rationalization of production. Competitive imports force local producers to increase efficiency or to exit the market. As a result, the number of domestic firms declines and the level of production of each remaining firm increases. Tthe remaining domestic firms are necessarily more efficient and can reap the benefits of economies of scale.
48
Chapter 1
4. Gains from the increase in variety. The larger variety of products that become available as the country opens up to trade give consumers higher levels of satisfaction. The globalization of trade and research, the growing weight of multinational corporations in world trade, production, and investments, and the rapid technological advancements all promoted greater specialization in production and introduced considerable changes in the comparative advantage of both developed and developing countries. These changes were precipitated by the large flows of investment capital to developing countries, by the growing share of skilled labor in these countries that enabled them to produce advanced manufacturing products, and by the rapid advancements of information and communication technologies that changed the concept of distance in all transactions. These changes help explain the significant transformation of the structures of industrial production in the East Asian countries.
The initial industrialization process in these countries was led by the production of textiles and simple industrial products. Gradually, the production base expanded to include more sophisticated manufactured products such as machinery, steel, automobiles, and later to still more advanced products such as computers and electronics, which are more capital intensive and more skilled-labor intensive.
However, not even the production of textiles and clothing could take place at the initial stages of the industrialization process without a considerable inflow of capital, since at the time these countries were primarily agrarian and lacked the capital necessary for the production of these simple and labor-intensive goods. Although the industrialization process also brought a rise in wages, the rise in labor productivity was more rapid and the comparative advantage of the East Asian countries against the developed countries was therefore maintained. Nevertheless, the structure of their production and trade gradually changed with the establishment of more advanced industries that were attracted by the increasingly better trained and more skilled labor.
The multinational corporations were perhaps the most important vehicles that brought about this change. In their search for the least costly forms of production, these corporations established or expanded affiliates in the East Asian countries and transferred to them, or to independent contractors, the production of labor-intensive products. Labor costs were, however, not the only consideration of the multinational corporations; their choices were also influenced by the relatively stable political conditions in most countries and by the direct government support that these corporations received. Although labor costs were equally low or even lower in South
Asia and sub-Saharan Africa, these countries were much less attractive to multinational corporations and other investors. Despite striking similarities between these groups of developing countries in their initial conditions in the 1960s, the huge differences between them in the depth of the industrialization process and the pace of the transition to the production of higher-quality and more sophisticated products are, first and foremost, testimony to the fact that the concept of comparative advantage can no longer be narrowly defined, as in the Heckscher-Ohlin model, only in terms of production technology, the direct costs of labor and capital, and the relative intensities
The Pros and Cons of Globalization for Developing Countries
49
of labor and capital. Other factors are also pivotal in determining the costs of production and the country’s comparative advantage. They include:
< Access to markets. In this context, access refers not only to the geographical distance, but to all the components that determine transport costs, including inland and sea transport costs and the costs of insurance and financial services for trade.
Although the African countries are closer to the European markets than are the
East Asian countries, high inland costs due to the distance to the port and poor road infrastructure considerably reduce their access to these markets. Access to markets is also determined by tariff and/or quota protection and by other barriers to trade, including those established by bilateral or regional trade agreements. In the global economy, accessibility is also determined by access to supply chains that control the trade and marketing of many commodities at the wholesale and retail levels.
< Access to advanced technologies. Low labor productivity, due to high levels of illiteracy, prevents many developing countries from taking full advantage of their labor abundance and low labor costs. In the agricultural sector, the use of traditional technologies, traditional crop varieties, and low yielding crop management practices in the indigenous agricultural systems constrain farmers to producing only self-consumption or for the local market and prevent the development of agricultural exports. The transfer of advanced production technologies and methods from developed countries can accelerate growth and raise labor productivity in the developing countries. The key question is, however, what barriers prevent or slow down the transfer of these technologies and what policy measures can accelerate their diffusion. On the one hand, access to advanced technologies is limited by the lack of necessary skills, by low investment in R&D, and, increasingly, by the costs and restrictions on the transfer of technologies due to IPR and patent issues. On the other hand, modern information and communication technologies, including the Internet, reduce communication costs and break down geographical borders, thus speeding up the diffusion of knowledge and advanced technologies.
< Economic and political stability. These are essential non-tangible conditions that determine investment risks and costs. Until the 1998 crisis, investors in Asian countries enjoyed very stable political conditions. This stability was often assured by authoritarian rule, but opposition was significantly mitigated by the success in raising the standard of living. When these standards fell sharply during the crisis, political stability was severely shaken in many, if not most, of these countries. In most sub-Saharan Africa, political stability is all but lacking. Continued wars, frequent changes in policies and in the regimes themselves, weak institutions of law enforcement, and widespread corruption significantly raise business risks, discourage investment, increase insurance costs, and are highly detrimental to both internal and external trade.
< (Relatively) stable labor market. The Asian countries—each according to its level of development—adopted elements of the Japanese system of lifelong employment, seniority-based wages, and enterprise labor unions that secured workers’ loyalty to their employers. Government welfare programs are rudimentary even in South Korea and Taiwan, and labor unions focus their
50
<
<
Chapter 1
demands mainly on job protection. In Latin America, labor unions are national and they are very active in their country’s politics. The pressures exerted by the unions and their political power triggered government intervention through minimumwage legislation and relatively high wages in the public sector. These interventions distorted the price of labor and inhibited the absorption of surplus labor.
Functioning markets. The economies of many developing countries were, and still are, plagued by massive price distortions and a host of restrictions that prevent the development of functioning markets. The removal of these distortions and restrictions is necessary not only to attract foreign investors, but also to create profit incentives for domestic private enterprises, and thereby boost production and streamline labor allocation. In sub-Saharan Africa, the haphazard and incomplete market reforms were noted as one of the central reasons for slow growth (World Bank 1994). However, even among the most successful East Asian and Latin American countries, market reforms were limited in two ways. First, the governments in these countries maintained and even expanded some price distortions that were designed to support local enterprises and encourage industrial production. Second, the removal of distortions and the development of functioning markets were often confined to producer services and to what Radelet and Sachs
(1997) termed the export platform.
Government interventions. In all Asian countries, government investments in infrastructure, health, and education, as well as direct investments in enterprises were pivotal at the early stages of the industrialization process. These, together with large-scale interventions in many other forms, gave strong incentives to foreign and domestic entrepreneurs to invest in local industries. Indeed, even the
World Bank (1993) survey of the “Asian miracle”’ provided details on more proactive tactics of direct intervention that the Asian government often adopted at the early stages of their development. The report acknowledged that the neo-classical, “getting the basics right” policies do not tell the entire story. In each of these economies the government also intervened to foster development, often systematically and through multiple channels. Policy interventions took many forms: targeted and subsidized credit to selected industries, low deposit rates, and ceilings on borrowing rates to increase profits and retain earnings, protection of domestic import substitutes, subsidies to declining industries, the establishment and financial support of government banks, public investment in applied research, firm- and industry-specific export targets, development of export marketing institutions, and wide sharing of information between public and private sectors.
Two additional factors that, from the public welfare point of view, must be considered negative have an impact on the comparative advantage of a country:
< Absence of labor laws. In addition to minimum wages, companies in the developed countries must provide high social benefits that include pension contributions, vacation, paid sick leave, social security, and health benefits, etc.
They are also bound by occupational safety and health rules. In many developing countries, there are no such laws, not even with respect to child labor.
The Pros and Cons of Globalization for Developing Countries
<
51
Low environmental standards. Against the high and rising standards of environmental protection and pollution control in the US and Western Europe, the very low standards and lax enforcement in most developing countries give them an
“advantage” in highly polluting production processes (Bhagwati 1997).
On these grounds, producers in importing countries that maintain high environmental and labor standards claim that the lax standards maintained in some exporting countries give those countries an unfair competitive edge. Indeed, the pressures of many groups and labor unions in the developed countries to enforce minimum environmental standards and child labor laws under WTO agreements reflect not only a genuine concern for these issues, but also efforts to lower the comparative advantage that these exporting countries have on account of their low environmental standards and the absence of labor laws.
Low labor costs, combined with all the other factors that determine the cost of capital and the risk for foreign investors, created the conditions that changed the comparative advantage of East Asian countries and enabled them to specialize in manufacturing production and to attract foreign investors. Other developing countries, particularly in Latin America, offered some of these components, but few could compete with the conditions investors found in East Asia. Obviously, not all of these components are positive or beneficial to the country in the long term, nor are they equally tenable in all countries. However, the rapid growth of the East Asian economies, their dramatic downfall in 1997 and 1998, and the equally dramatic recovery of most of them since 1999 emphasize the need to take into account the entire spectrum and all the components that determine the comparative advantage of a country, not just the abundance and low cost of unskilled labor, in order to have a more complete understanding of the “East Asian miracle” and in order to apply the lessons from this “miracle” in the design of development policies for other countries.
Outward- vs inward-oriented growth strategy
While the debate about the most suitable growth strategy for a labor-abundant economy has always been loaded with controversies, the dominating view was that, for the majority of developing countries, the prospects of growth are closely linked to industrialization. Even in the primarily agricultural countries of sub-Saharan Africa, long-term growth was linked to increasing the domestic value added through processing, and in practically all countries, per capita GDP grew with the rise in the ratio of manufactured to primary products. During the past decade, discussions on the most suitable industrial strategy were dominated by the rapid growth of the East Asian economies that was achieved through an outward-oriented development process and a rapid increase in exports. The discussions centered on the following key questions:
< How significant was the outward-oriented strategy?
< How significant was the focus on industrialization?
< What was the role of the other components of the growth strategy of the East Asian countries, including government investment in infrastructure and education and the large subsidies to foreign direct investment (FDI, see Box 1.1)?
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Chapter 1
Box 1.1. Foreign Direct Investment (FDI)
Since the early 1980s, world FDI flows have grown faster than either the world trade or the world output. The flows of FDI to East Asia and, to a lesser extent, to the other developing countries, grew at an average annual rate of over 30% in the first half of the 1990s, from less than $35bn per year to around $100bn by 1994, and at an average annual rate of 15% in the second part of the 1990s to over $250 billion in 2000, but their share of total investment flows declined from 43% in 1997 to
21% by the end of the decade as an effect of the financial crisis in East Asia. More than half of these investments were made in East Asian countries, whereas the flow to Latin America and the Caribbean (primarily Chile, Argentina, and Brazil) grew at much lower rates, and only a trickle reached sub-Saharan Africa. The Asian crisis had a significant and immediate impact on this flow. Indonesia, for example, had an FDI inflow in excess of $4bn during 1994–97, but in 1998, with the emergence of the crisis, this flow dried out, and in 1999 there was a net outflow of over $2bn. China was the main beneficiary of this change of direction of FDI, and in 1999, it had an inflow of nearly $50bn. Some Latin American countries also had larger inflows in recent years due, in part, to the outflow of capital away from the crisis countries in East Asia. In 1999, the FDI flow to Brazil exceeded $30bn, and the FDI flow to Argentina reached nearly $25bn.
Notwithstanding the financial turmoil in East Asia in 1998, global FDI inflows increased for the seventh consecutive year to reach $430-440 billion, becoming an important source of private external finance for the developing countries.
According to the latest FDI data released by UNCTAD, world FDI flows increased by 18% in 2000 to a record US$1.3 trillion, compared with only $203 billion in
1990. Much of this investment was driven by corporations buying or merging with companies in other countries, contributing to increasingly global multinational firms. Most FDI flows went to the industrialized world. FDI flows to the developing countries overall grew by 8% to US$240 billion, and to the economies in transition of Central and Eastern Europe by 9% to US$25 billion. However, FDI flows to Latin America and the Caribbean declined in 2000 by 22% to US$86 billion, primarily as an effect of the evolving crisis in Argentina, and the flows to
Africa continued to decline.
The factors that determine the inflow of FDI into a country and make the country a desirable destination for FDI include political and economic stability, the market size, the availability of natural resources and human capital, the country’s growth prospects, and the existence of favorable investment and tax regimes. A recent UNCTAD report concludes, however, that such traditional features, although still important, no longer constitute the most significant driving forces. In a world increasingly characterized by a global and highly interconnected trading system, companies look for places to invest that offer specific advantages, such as a good communications infrastructure and intangibles such as political stability and business culture. The direct effects of FDI on the host country are the product of the
FDI’s effects on factor endowments and rewards. These investments improve
The Pros and Cons of Globalization for Developing Countries
53
productivity, raise the marginal product of labor, and reduce the marginal product of capital, thereby promoting economic growth and exports and raising incomes and wages. There are also indirect effects (or externalities) of FDI that are due to the impact of foreign multinational corporations on their host economies. These effects may vary, however, between industries and countries, depending on the characteristics of the host country and the policy environment.
The large flows of FDI to the EA countries and the growing integration and globalization of the capital markets increased their capacity (that came to be perceived as good risks) to access these markets directly in order to secure funding for projects that in the past could only be financed through the World Bank.
<
What was the rise in total factor productivity in these countries, and what was its contribution to their economic growth relative to the contribution of the large resource mobilization? How effective was export promotion industrialization vs. import substitution?
To answer these questions, this section surveys the discussions in the economic literature and reviews the experience of selected countries.
In their highly influential research on trade and industrialization, Little, Scitovsky, and Scott (1970) provided a thorough account of the connection between an export-oriented growth strategy and the rate of economic growth. They emphasized the effects of competitive conditions in the world markets on exporting enterprises that force countries to eliminate distortions, thus leading to better macroeconomic performance and more rapid growth. In contrast, efficiency considerations are secondary behind the walls of protection, and (infant) industries (even construction) have little incentive to select the more cost-effective and labor-intensive technologies.
The World Bank’s World Development Report of 1987 and 1990 noted that the high walls of protection often reduced the use of labor in the formal sector, whereas more open and outward-oriented trade regimes tend to support more labor-intensive patterns of industrial expansion in both import-competing and export industries. Bhagwati
(1982) highlighted another distortion of an inward-oriented trade regime that is a result of its heavy reliance on market restrictions and state intervention and is therefore more likely to create an environment that is more congenial to directly unproductive profit seeking. With open, outward-oriented strategies, in contrast, the state is less involved, and profit seeking is more likely to be productive. Bhagwati noted the wide consensus among economists that an outward-oriented trade strategy helps the process of industrialization and economic growth. In his words: “The question of the wisdom of an outward-oriented (export-promotion) strategy may be considered to have been settled” (1987, p. 257).
There is, however, no conclusive empirical evidence that in all countries an inward-oriented development strategy based on import substitution would indeed reduce longer-term growth rates. In a comprehensive cross-country study, Chenery,
Robinson, and Syrquin (1986) showed that the average yearly GDP growth rate in
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semi-industrial economies that adopted import-substitution policies was only a few tenths of a percent lower than the growth rate in countries that adopted exportpromotion strategies. McCarthy, Taylor, and Talati (1987) used a different grouping of countries, based on per capita GNP, and showed that the fast-growing countries did not have, on average, a higher (or increasing) share of exports in GDP. Easterly and Levine
(1994), however, established a clearer causal relationship between enhanced exports performance and more rapid growth in extended cross-section studies.
Two factors may affect the straightforward calculus of the gains and relative merits of an outward-oriented trade policy. The first is the importance of trade taxes in the budgetary revenues of developing countries. An IMF survey of the 36 least developed countries (LDCs, see Box 1.2) found that trade taxes account on average for 5% of
GDP, or about one-third of total tax revenues. The implementation of a broadly defined trade reform that includes the overhaul of customs administration or compliance with WTO obligations requires heavy budgetary outlays. The second factor is the strategic trade policy, emphasized by the “new trade theory,” which justifies protection in the presence of “strategic” interactions among firms in domestic and international markets (i.e., when a change in the behavior of firm 1 leads to a change in the optimal behavior and a strategic response of firm 2). By choosing an optimal import tariff or subsidy, the government can affect the strategic game played by firms in international markets to the advantage of domestic firms. Often, however, the strategic trade policy literature gives rise to contradictory results depending on the type of market structure and the form of competitive rivalry. As a result, this literature has generally been considered of little use in the guidance of governments’ trade policy. There are also doubts about its relevance for trade policy in developing
Box 1.2. The Least Developed Countries
Since 1971, countries with weak economies and deep poverty have been categorized as Least Developed Countries (LDCs). By the end of the 1990s, 49 countries with a combined population of 610 million, equivalent to 10.5% of the world population, were identified as LDCs. Most of these countries are in sub-Saharan Africa. In 1981, the United Nations General Assembly held the first
UN Conference on the Least Developed Countries in Paris, in which it adopted the
“Substantial New Programme of Action for the 1980s for the Least Developed
Countries.” However, despite major policy reforms initiated by many LDCs to carry out a structural transformation of their domestic economies, and supportive measures taken by donors, the economic situation of these countries as a whole worsened during the 1980s. The Second UN Conference on the Least Developed
Countries held in Paris in September 1990 formulated national and international policies and measures for accelerating the development process in the LDCs, drawing on the experience and lessons from the 1980s. A mid-term review of the implementation of the program of action for the LDCs for the 1990s concluded, however, that these countries continue to be marginalized.
The Pros and Cons of Globalization for Developing Countries
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countries, which tend to be primary product exporters, since the production of primary products is rarely characterized by large economies of scale.
The success of East Asian countries in achieving high rates of economic growth made export promotion, spurred by open trade and market liberalization, the strategy of choice. The World Bank study titled The East Asian Miracle (1993) emphasized the prominent role of export-oriented policies in the economic “miracle” of the East Asian countries. The report paid close attention to the process of industrialization in these countries that initially took advantage of the abundance of cheap labor by building up industries with highly labor-intensive production that required mostly unskilled labor.
Perhaps the most obvious example is the clothing industry, which is highly laborintensive and in which developing countries have a clear comparative advantage.
Although higher productivity in the developed countries could offset part of their higher labor costs, the very low labor costs in Indonesia, China, and Pakistan, which were only 5 to 10% of those in the US, allowed these countries to produce much cheaper clothing despite their less productive technologies. In East Asia, the clothing industry was the quintessential foundation on which the industrial base was gradually built as these countries accumulated more know-how, developed a better-skilled labor force, and opened their economies to foreign investment. In other developing countries, the agricultural sector can play this role, as we see in Part III.
The World Bank account of the East Asian “miracle” emphasized the importance of market-oriented incentives that led to large gains in efficiency and factor productivity. These incentives were created by setting the correct price signals through the unification of the exchange rate, the measured devaluation, and the removal of various distortions on the one hand, and the disciplining force of open trade and export-promotion strategies on the other. The pressures of international competition and the greater role of the market seem to have mitigated the worst kind of rent-seeking behavior observed in those countries that rely on industrialization through import-substitution. Other studies on the experience of East Asia gave, however, equal weight to the influence of government intervention through subsidies, trade restrictions, administrative guidance, and credit allocations (Rodrik 1992 and 1995;
Amsden 1990; Wade 1990). In their view, this government intervention was necessary at the early stages in order to facilitate the transition from the production of primary products for the domestic market to the production of manufacturing goods for the home market and exports, and in order to make investments in the non-traditional sector sufficiently attractive. The weakness of the market system in these countries at the early stages of development, and the absence of the necessary financial and economic institutions, made the state the only entity that could offer these incentives and provide a measure of security. Rodrik argued that the main push for the economic take-off in South Korea and Taiwan did not come from the increase in exports, but from the sharp rise in investments that was largely engineered by the government through direct credit at low or even negative interest rates, and through investment subsidies, direct administrative subsidies, and the use of public enterprises. In both countries, investments rose from 10% of GDP in the late 1950s to 20% in the mid-1960s and 30% in the early 1970s. This large increase in investments was matched by a roughly equivalent increase in savings that prevented inflationary
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pressures. Government coordination in the form of administrative guidelines as well as direct investments in key industries were pivotal, since increasing returns to scale in the production of the modern sector made it initially impossible for the private sector to take full advantage of these investment opportunities despite the high subsidies
(through credit at negative real interest rates, tax incentives, etc.).
Another part of the debate on the forces behind the East Asian “miracle” focused on the effect of export-led growth on total factor productivity (TFP) and the contribution of the rise in TFP to growth. Several empirical studies found a high correlation between a country’s overall growth performance and its export growth, and between a country’s growth in TFP and its export growth, although this correlation does not establish causality. Sarel (1995) estimated that in the four Asian ‘”tigers,” output per person rose during 1975–90 by an average of 6.5% annually, whereas the annual TFP growth rate ranged between 2% in Singapore and over 3.5% in Taiwan and
Hong Kong. According to his estimates, TFP growth accounted for nearly half of the total growth of output per person. In China, Hu and Khan (1996) estimated that TFP rose at an annual rate of nearly 4% during 1979–94. The World Bank 1993 study emphasized the contribution of the significant rise in productivity to economic growth, and noted two factors that led to this rise. One was the removal of discriminative and highly distorting prices in the domestic market and the elimination of trade barriers; these measures exposed local enterprises to the disciplines of competition, which led to better allocation of resources. The other factor was the adoption of new technologies and the latest vintage capital formation by export industries that led to technology and productivity spillovers from which the entire economy could benefit. To maintain their international competitiveness, enterprises in East Asia also had to rely on a steady rise in the productivity of their workers that was made possible by their improved skills and better training. In Korea, this led to a virtuous cycle of growing exports that led to more investment in the export industries that led, in turn, to further productivity gains.
In contrast, Young (1992, 1994, 1995), Rodrik (1995), and Krugman (1994) argued that the remarkable growth of East Asian countries was not due to an unusual rapid growth of TFP, but to the rapid accumulation of capital and the increase of the labor force in manufacturing. According to Young’s (1994) estimates, the annual TFP growth in South Korea and Taiwan during 1966–90 was 1.2% and 1.8% respectively.
These rates, however respectable, were of the same order of magnitude as the rates in
Argentina, Brazil, Chile, and Mexico. Kim and Lau (1994) found that in the four Asian
“tigers,” capital accumulation accounted for over half of their economic growth.
Krugman attributes this growth primarily to an “astonishing mobilization of resources” rather than to gains in efficiency.
The debate over the merits of export promotion vs import substitution was at the center of the discussion in the economic development literature as early as the 1950s.
The consensus among professionals at the time in favor of an outward-oriented, export-led growth strategy did not rule out, however, an import substitution strategy in the first stage of the industrialization process, and it has been recognized that virtually all the successful exporters of manufacturing, with the exception of Hong Kong, began their industrialization with an inward-oriented strategy that promoted import substitution under significant protection. Moreover, in some countries, the gains from
The Pros and Cons of Globalization for Developing Countries
57
export-led growth that are due to scale economies in production can also be reaped in the production of import substitution if their domestic market is large enough. In small countries, the industrial strategy must be based on specialization and “niche-oriented” industries (Chenery et al. 1986). Brazil and Korea are good examples of these two extremes: in Brazil, the share of commodity exports in the mid-1980s was less than
10%, whereas in Korea, the share was close to 40%. Brazil relied on the growth of its domestic demand to generate scale economies and technical change, whereas Korea pursued more aggressively outward-oriented policies aimed at transforming the domestic industries from producing predominantly for the highly protected local market to producing industrial goods for exports (Taylor 1989). Korea is poor in natural resources and the shares of its industry in both exports and GDP are therefore much higher than in resource-rich Brazil.
A series of country studies organized by the World Institute for Development
Economics Research in 1987 and 1988 demonstrated that Korea, Taiwan, Turkey, and other countries where economic progress was led by the rapid growth of export industries had an initial stage of industrialization based on import substitution. In
Turkey, for example, the export-led growth during the first part of the 1980s was built on an industrial base that had been created at an earlier stage of import-substitution industrialization as well as on heavy export subsidies and various administrative measures to promote exports. The success of the export-oriented strategy in these countries was attributed, in part, to the “crowd in” effect of public investments that gave incentives to private investments via complementarities and allowed a greater diversification of the industrial sector. On these grounds, Shapiro and Taylor (1990) argued the following:
“There is no reason why production for appropriate niches should not initially be supported by import barriers and export subsidies; indeed, the ‘opportunity costs’ of not trading have to be ignored until learning and scale effects take hold. The point is that full industrialization only occurs after infant firms grow up, and can compete more or less effectively on international terms.” (p. 873).
In Korea, infant industries were protected by high tariffs during the early stages of industrialization alongside the export drive, and while exports were liberalized, the domestic market remained protected. The monopolistic or oligopolistic conglomerates that dominated many Korean industries were able to practice price discrimination that was considerably augmented by export subsidies. Infant industries matured by acquiring more advanced technologies, and gradually the effective protection rates were reduced. These industries turned to international trade not due to market forces, but largely because they were driven by government regulations to export their products (Lee 1997). However, the concentration of manufacturing production in
Korea and in most other East Asian countries (except Taiwan) in large conglomerates, together with the power exercised by transnational corporations over exports created their own distortions, substantially reducing the efficiency gains of the export-led growth and its advantage over industrialization via import substitution (Helleiner
1990).
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What are the prerequisites for and the impediments against the adoption of a similar growth strategy in sub-Saharan Africa? What should the components of this strategy be? The East Asian Miracle drew two main lessons from the strategy of East
Asian countries. First, the prerequisites for a successful growth policy are suitable social and political environments. Appropriate infrastructure—from electricity and highways to schools and health clinics—must be in place, and the government must have a central role in building this infrastructure. Second, the price system must provide proper incentives, and the institutions and mechanisms for competition must be sufficiently robust to secure the efficient working of the market. The World Bank report titled A Continent in Transition: Sub-Saharan Africa in the Mid-1990s (1995), which focused on the lessons for sub-Saharan Africa, emphasized the need for more market-oriented policies, more openness to trade, and sound macroeconomic policies.
Alesina (1997) emphasized the importance of institutions for growth and noted the need for the protection of property rights and relative political stability. All these components determined the comparative advantage of East Asia as much as, or even more than, their factor endowments and relative costs in production. The role of institutions and the idiosyncratic structure of institutions in the “‘Asian model” are discussed in more detail in the next section.
The “Asia way” and the role of institutions
The high performance of the East Asian countries until the 1998 crisis was the main reason for the near general praise of the policies that these countries implemented. The
East Asian Miracle noted the importance of market-oriented incentives that led to large gains in efficiency and factor productivity. These incentives were created by setting the correct price signals through the unification of the exchange rate, the measured devaluation, and the removal of discriminatory and distorting prices on the one hand, and the disciplining force of open trade and export-promotion strategies on the other. Other studies on the East Asian “miracle” gave equal weight to the role and effects of direct government intervention through continued subsidies, trade restrictions, administrative guidance, and targeted credit allocations to selected industries, on the grounds that, at the early stages of development, direct government support was necessary to make the transition from the production of primary products for the domestic market to the production of manufacturing goods for exports, and in order to stimulate foreign direct investments in the nontraditional sector. The weakness of the market system in these early stages, and the near absence of the necessary financial and economic institutions, made the state the only entity that was able to offer these incentives and provide a measure of security.
The focus on the economic aspects of the “Asian miracle” narrowed the “Asian model” unduly and omitted key components that did not show up in the countries’ statistics, but are essential for a more comprehensive understanding of the “miracle.” It was recognized well before the 1997–98 crisis that the “Asian way” of doing business is different from that of the West. The Asian model of capitalism, in which free market competition was transformed to accommodate collusion between the government and the business establishment, was, however, touted (until that crisis) as better suited to
The Pros and Cons of Globalization for Developing Countries
59
Asian traditions than the Western model of free market capitalism. The crisis exposed fundamental weaknesses of this model, which were also the main reasons for the crisis itself. The organization of production for exports at the early stages of development allowed Asian countries to make the transition despite the lack of an industrial base.
Radelet and Sachs (1997) noted that a unique and essential feature of the Asian model was the creation of an export platform—an enclave economy, hospitable to foreign investors and integrated into the global economy, unfettered by problems of infrastructure, security, rule of law, and trade policies that plagued the rest of the economy. On this platform, Asian countries were able to concentrate their investment and move up in technological development. Moreover, in the authors’ view, the platform not only allowed these countries to move up on the production ladder—from primary products to textiles to electronics and machinery—but also created a much broader modernization of the political and economic institutions.
The principal reason for the greater complexity and the inherent weakness of the
Asian economic model is that the export platform was not really an autonomous economic enclave. Rather, it remained connected in some essential functions to the rest of the economy. Plagued by problems of infrastructure, security, and the rule of law, these countries had to find a strategy that would allow an efficient and unimpaired management of production and the conduct of other business affairs on the export platform, despite these connections. Asian countries found a strategy that proved workable and effective for nearly three decades and was instrumental in promoting their rapid growth. The most important channel through which the export platform was connected to the rest of the economy was the financial sector. Since foreigners were not allowed to own banks, corporations that produced for exports had to rely on and adjust to the country’s financial institutions. The financial system was plagued, however, by sloppy banking practices and ineffective and often corrupt supervision, which allowed the provision of loans on the instruction of, or as a favor to, influential politicians or cronies. Another channel was the work force and the increasingly militant labor unions. With the rise in living conditions and the expansion of the industrial sector, workers began to organize and demand wage increases and improved working conditions. The third channel was the system of government, which was highly centralized, highly authoritarian, and actively involved in all aspects of the economy. These channels exposed the export platform to the weaknesses of the local economic, legal, and political systems and threatened to stall its take-off. To deal with these stumbling blocks, it was necessary to have a strategy that would allow the export platform to function despite these weaknesses. The strategies adopted by Asian countries show remarkable similarities. In fact, these countries followed, with surprisingly little variation, the patterns of the countries just ahead of them in the development process, not only in their technological advancement, but also in the evolution of their economic institutions. Indeed, the common denominator of these patterns constitutes the “Asia model.” The principal components of this model were the following:
60
<
<
<
<
Chapter 1
strong and authoritarian governments, assisted by an obedient and highly efficient bureaucracy, secured peace and stability, and enabled corporations to work without red tape in their investments and production decisions; the financial system, which had very limited independence in making business decisions and mainly functioned as a service agent to corporations; large corporations that organized a significant portion of production and exercised influence over the political system and controlled the financial institutions; a social welfare system that was built on a social contract between the workers and the corporations employing them. The role of the government was mainly to support that contract by subsidizing companies in order to keep people employed.
Authoritarian governments had a clear and significant role in creating the necessary conditions for establishing the export platform, in forging partnerships with foreign capital (and meeting the whims of foreign investors), and in conducting conservative fiscal and monetary policies, thus igniting the engines of growth and keeping them on track. The management of the economy was often delegated to a team of efficient technocrats that conducted a very responsible fiscal policy and maintained a stable currency, helping to keep inflation low. Thus, for example, the relative peace and social stability until the crisis, abundance of cheap labor, plentiful natural resources, and a stable currency made Indonesia highly attractive to foreign investors. As the economy developed, production became more sophisticated and capital intensive, financial decisions grew more complex, and the scope for errors and corruption under an authoritarian government rose sharply. Moreover, the Indonesian government, like most other East Asion governments, did not permit any significant development of institutions of governance and any significant move toward greater democracy. Hopes and expectations that the export platform would provide an incentive to modernize the political and economic institutions did not materialize. In the absence of these institutions, cronyism and corruption became common. In Indonesia, the absence of proper institutions of government was the reason why a financial crisis that initially appeared rather benign—primarily a case of mismanagement—and seemed not too difficult to correct, rapidly deteriorated into a complete meltdown of the currency and a crisis of leadership.
In the 1960s and 1970s, most East Asian countries were essentially political tyrannies, either of political parties or of individuals. In that sense, they were not much different from the political tyrannies that ruled in most of sub-Saharan Africa. Yet in the 1980s, East Asia grew very rapidly and succeeded in developing rather advanced economic institutions that managed the economy very efficiently, whereas sub-Saharan Africa failed to reform its economies and entered into a spiral of slow or even negative growth that was accompanied in many countries with a collapse of the institutions of governance and outright chaos. An intriguing explanation of the marked differences between the experiences of these two groups of countries can be found in the (last) book that Mancur Olson published in 1998, entitled Power and Prosperity:
Communist and Capitalist Dictatorships. Olson distinguished between what he terms political tyrants and political warriors, arguing that political tyrants have a stake in the country they are ruling over and exploiting, because the more the country prospers, the
The Pros and Cons of Globalization for Developing Countries
61
more they can extract for themselves in the form of legal or illegal taxes. The political tyrant therefore keeps taxes relatively low and develops rather effective institutions to manage the economy in order to assure the country’s long-term prosperity, thus maximizing also his long-term profits. The political warrior, in contrast, does not have the long-term perspective and seeks to maximize the profits he can extract from his subjects as fast as possible, thus leading to the collapse of institutions and to anarchy.
The Asian financial “model” served the needs of the production systems in these countries very well in the early years by raising funds, initially in the domestic market and later also abroad, and making them available, on the instructions of government officials and at highly subsidized rates, to “strategic” industries. The investment and lending decisions were rather simple at that stage, since the choice of strategic industries and the investment decisions in these industries were rather clear. Already early on, however, banking practices were sloppy, in part due to the absence of a proper regulatory system and lax government oversight, and in part because the financial institutions were captive to high-level politicians, bureaucrats, and corporate managers. Nonetheless, the banks remained profitable because they were able to raise inexpensive funds from the public thanks to the very high saving rates and the rapid growth in income. At a later stage, the banks were also flooded with funds as a result of the larger inflow of foreign capital that grew six-fold between 1991 and 1996.
Unconstrained by the lax government oversight, the banks went out of their way to give loans, in the process exposing themselves to higher risks and becoming leveraged with short-term debts. Corporations expanded well beyond their needs, and profitability of new investments was not the guiding principle for corporations or banks. Deference, trust and tightly knit relationships—those Asian values that in the early stages were instrumental in providing a substitute for the lack of practice and experience with risk management—gradually gave rise to cronyism, nepotism, corruption, and reckless risk-taking whenever rising profit opportunities presented themselves. Large investments in real estate and office construction continued unabated despite the slow-down in exports.
The Asian crisis brought the deficiencies of the Asian “model to the forefront and revealed the weaknesses of the economic and political institutions in these countries.
When the crisis unfolded, some hastened to conclude that the model was fundamentally flawed. The crisis should not obliterate, however, the fact that the
“Asian way” had many advantages in the early years of the region’s development. It failed, however, to keep up with its own success by hindering the evolution of the institutions that are essential for longer-term development. The focus on economic growth gave precedence to the short-term. The longer-term price that Asian countries paid for this narrow focus was not, however, confined to the lack of institutional development and improper governance; it also included environmental degradation, crowded cities, and the decay of the rural sector. The Asian crisis thus highlights the need to make the development of institutions an integral part of development strategy.
The relatively rapid recovery of some of the countries in the region—particularly
South Korea, Singapore, and Malaysia—in 1999 and, even more so, in 2000, and the slow recovery of Indonesia, Thailand, and the Philippines, also emphasize the political dimension of the crisis and the fundamental weaknesses of the political and social
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systems that were aggravated in the crisis and slowed down the recovery. Indonesia is clearly the most notable example of the impact of political instability on the economy.
The country experienced a 14% fall in GDP in 1998 and zero growth in 1999. The economic decline exacerbated the political problems, and in mid-2000 the economy entered a new slump. The Philippines were initially less affected by the regional crisis, but the political turmoil in 2000 very markedly slowed down economic growth. The entire region benefited from the continued rapid growth in the US and the EU during
1999 and 2000, which generated high demand for East Asian export products, most notably electronics. However, the high share of electronics in their exports and the high share of exports in their GNP make these countries very vulnerable to any slowdown in the economy of developed countries, particularly the US.
Globalization and Strategies of Sectoral Development
The role and structure of agricultural development strategy
The slow pace of industrialization and the rapid population growth in many developing countries, particularly in sub-Saharan Africa and South Asia, severely compromise the potential of the modern/industrial sector to absorb surplus labor. As a result, the continued flow of rural migrants has led to growing unemployment and poverty in the urban areas. An effective growth strategy in these countries must have a balance between industrialization and rural development and explore the potential employment opportunities in rural areas. So far, however, the pace of development is not very encouraging. During the past two decades, the per capita agricultural production in all the developing countries grew at an annual rate of less than 1%, and in many of the LDCs, agricultural growth was outpaced by population growth. The pace of agricultural growth is considerably slower than during the 1970s, at the time of the
Green Revolution, when per capita agricultural production in the developing countries grew at an annual rate of 1.1%, after declining at an annual rate of 0.3% during the preceding decade (Table 1.6).
The evidence of the last two decades, primarily in sub-Saharan Africa and South
Asia, makes clear that in these countries the agricultural sector will not be able to
Table 1.6. Growth of Food and Agricultural Production in Developing Countries
(%)
Country group Food
Total
All agriculture
Per capita
Total
Per capita
1961–70 1971–84 1961–70 1971–84 1961–70 1971–84 1961–70 1971–84
Developing
Low-income
Asia
Africa
2.2
1.3
1.2
2.6
Source: World Bank (1986)
3.2
3.2
3.4
2.0
-0.3
-1.3
-1.3
-0.2
1.1
1.2
1.5
-0.9
2.4
1.9
1.8
3.0
3.0
3.3
3.6
1.2
-0.1
-0.7
-0.7
0.2
0.9
1.3
1.7
-1.7
The Pros and Cons of Globalization for Developing Countries
63
sustain per capita growth rates in excess of 2% per annum without a significant increase in yields. Despite the early hopes during the Green Revolution, growth rates in agriculture seldom exceeded 4% per annum, and sub-Saharan Africa benefited very little from the new crop varieties that were developed at that time. Several factors may inhibit the growth prospects of the agricultural sector in many developing countries:
< large direct and indirect subsidies to agricultural producers in the EU and the US and a rise in their production efficiency and yields. This led to a continuous and often sharp decline in many commodity prices in the international markets and reduced the capacity of farmers in the developing countries to produce these commodities at competitive prices. In many developing countries that opened up their economies to international trade, cheap imports of wheat, rice, corn, soybeans, and other raw crops from the developed countries made it difficult for local farmers to sell their products at competitive prices even in the local markets.
< constraints on the transfer of advanced technologies and crop varieties from the developed countries due to IPR regulations and constraints on the development and adaptation of local technologies and varieties due to shrinking budgets for public agricultural research;
< slow diffusion of new technologies due to the ineffective and resource-stretched extension services and slow adoption of high-yielding varieties due to the skills required for successful adoption.
< poor infrastructure limits access to markets, both domestic and abroad, thus preventing greater specialization and adoption of high-value crops that can generate higher income, and forcing many farmers to grow primarily for self-consumption; < limited access of small landholders to credit and lack of financial institutions, arrangements and instruments for savings and investments in rural areas;
< continuous erosion in the quality and quantity of agricultural lands;
< decline in the world prices of traditional export crops such as coffee, cocoa, and bananas—the main cash crops in sub-Saharan Africa and in Latin America and the
Caribbean.
As a result, the growth of agricultural production was much slower in quite a few countries, particularly in sub-Saharan Africa, and employment opportunities for the rural population declined in practically all developing countries. In the developing countries as a whole, the share of the agricultural sector in total employment fell from an average of over 30% in the mid-1960s to an average of less than 20% in the mid-1980s, primarily due to the decline in the share of agriculture in the total GDP and the rapid urbanization. There were, however, wide variations between countries: during 1950–90, the share of agricultural employment in total employment declined by
30% in Thailand and Indonesia, by nearly 80% in South Korea, by 50–60% in Latin
America, and by 10–25% in sub-Saharan Africa.
In sub-Saharan Africa, the growth rate of agriculture was highly correlated with the growth rate of the other sectors, primarily because of the dominant role of the agricultural sector in the economy, and the share of agriculture in the GDP therefore changed relatively little (Rao and Caballero 1990). Since the growth rate of their
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industrial sector was also very slow, these countries could not rely on the industrial sector as a source of employment, and the pace of urbanization was much slower than in other continents. The relatively slow decline in the share of agriculture in total employment also accentuates the low and declining productivity in agriculture that was due, in part, to the migration to the urban areas, which left behind the very young, the old, the handicapped, and single mothers (Table 1.7).
For countries that are predominantly rural and where industrialization is still at an early stage, rural-based development strategies have been advocated (Mellor 1976).
The time that these countries would need to build an industrial base able to absorb the surplus labor from rural areas is bound to be long, and a strategy based on rural development therefore promises a faster increase in employment and reduction in poverty. Restructuring and expansion of agricultural production can also contribute to the development of the other sectors through forward linkages with processing industries. A study in India, Pakistan, Malaysia, and the Philippines found that, as an effect of this linkage, a 1% addition to the growth rate of agriculture would add 0.5% to the growth rate of industrial output, and 0.7% to that of the national income
(Haggblade, Hazell, and Brown 1989). A rural-based strategy will also be more effective in reaching the poor because the majority of the poor still live in rural areas, and most of them depend on earnings from agriculture or from non-farm work that is partly linked to agriculture (WDR 1990). Over two-thirds of the rural poor are small farmers and landless laborers; many of them live in countries and regions where growth in agricultural production is lagging behind the population growth, turning many regions into “pockets of poverty.”
Even in these countries and regions, however, the potential for agricultural growth is far from being exhausted, since their crop yields are very low and increased only very slowly in the past decade. In many countries in sub-Saharan Afriaca and South
Asia, the single most important factor that inhibits agricultural growth and limits farmers’ income from agriculture is the lack of passable roads to the urban center.
Mellor and Johnston (1984) estimated that this was the major reason why in India the potential growth of the agricultural sector during 1969–84 (calculated on the basis of the available inputs) was 50% higher than the actual growth. By realizing the potential of their agricultural sector, these countries could increase their food supply and the
Table 1.7. The Share of Agriculture in the Economy of Selected SSA Countries (%)
Country
Ghana
Madagascar
Malawi
Niger
Tanzania
Zaire
Share of agriculture in GDP
1975–77
1980–82
1989–91
50.7
32.3
39.5
35.1
56.1
27.3
Source: World Tables, World Bank, various years
56.8
32.3
36.9
30.8
53.4
29.0
47.7
36.5
34.4
37.0
55.7
34.8
Share of agriculture in employment 1980–87
65
81
83
91
80
72
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earnings of the rural population. That, however, would require massive investments in irrigation, roads, and extension services. In addition, the adoption of high yield crop varieties and the use of fertilizers would have to be increased, and access to rural credit would have to be improved.
Despite their potential, most developing countries refrained from building on their traditional strength in agriculture, citing a long list of reasons for their strategy to promote industrialization, the most common one being the following:
< The demand for primary products is both price- and income-inelastic, and therefore cannot be a reliable base for export-led growth or a stable source of foreign exchange.
< Export earnings from primary products are subject to wide fluctuations.
< The traditional sector is often “backward” and unresponsive to economic incentives. < Agricultural exports from developing countries are depressed by the high protection rates on agricultural products in most developed countries, particularly in the EU (Bautista and Valdez 1993).
On these grounds, many developing countries implemented policies that were highly biased against the agricultural sector, including:
< overvalued exchange rates and/or direct export levies that reduced real returns on agricultural exports;
< high protection rates on import-competing manufacturing goods that lowered the relative price of agricultural goods in the domestic market;
< ill-functioning state marketing boards that used their monopoly power to raise the margins between the border price of exports and the farm-gate price and lowered the returns to farmers;
< suppressed prices of food produce paid to farmers in order to secure low prices to urban consumers.
These policies, implemented as part of the industrialization process, inhibited the development of the agricultural sector and trapped the entire economy in low productivity and low growth (Krugman 1991; Lucas 1988). They also reflect the political bias in favor of the politically and economically more influential urban population. To capitalize on their potential for agricultural growth, countries in sub-Saharan Africa, where a large portion of agricultural production is based on “slash and burn” or “shifting cultivation,” will have to encourage the transition to settled cultivation and to invest in rural infrastructure in order to increase agricultural production and employment. In South Asian countries, where the rural areas are already densely populated, agricultural development will have to be based on high-value products and highly intensive cultivation. To exploit the countries’ comparative advantage, the industrialization process will have to be built on two-way linkages with the traditional sector that allow both agriculture and industry to realize their growth potential.
The key to future agricultural growth, however, lies in significant increases in yields. After an increase of 3% in yields during the Green Revolution in the 1970s, the
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rate of increases in yields dropped to 1% in the 1990s. In all the developing countries, there are still heavy losses of crops to pests, disease, salinity, and drought, but efforts to compensate for these losses by increasing the area under cultivation may aggravate the pressure on the environment and natural resources. Small-scale farmers may, however, not be able to increase production by using modern technologies or more fertilizers and pesticides due to their high costs. Further increases in yields at affordable costs and without depleting the country’s nonrenewable resources or damaging the environment, therefore present a daunting challenge to agricultural research. The recent developments in biotechnology and research in transgenic crops may offer a way to meet this challenge. Transgenic plants with traits such as pest and herbicide resistance, and tolerance to salinity and drought, can increase yields and reduce crop losses without the heavy use of fertilizers and chemicals. To take advantage of this potential, the challenge of public agricultural research is to develop or adapt suitable plant varieties and technologies, and to expand and improve their extension services so that they can bring these new technologies to farmers and encourage their adoption.
The impact of multinational trade agreements on agricultural trade
Another obstacle to the development of the agricultural sector in developing countries is posed by the constraints on the access to the markets of the developed countries, primarily the EU and the US. These constraints are due, in part, to the various tariffs these countries impose on imports of agricultural products and the subsidies they give to their own agricultural producers, and, in part, to the myriad regulations and administrative restrictions. The agricultural “chapter” is high on the agenda of the
WTO since Seattle, but despite the general agreement on the need to open up the markets of the developed countries to agricultural products from the developing countries, actual progress has been very slow.
The GATT agreement that was signed initially by 23 mostly developed countries was a provisional agreement without any institutional setup. At the time, it was envisaged that the next step would be the establishment of an international trade organization, but the World Trade Organization was founded only in 1995, 47 years later. Until that time, GATT was expanded in both scope and global coverage, and a series of interim agreements brought about a reduction of tariffs and other barriers to trade, contributed to a vast expansion of international trade, and precipitated the globalization process. The GATT rules applied, however, primarily to merchandise trade, and in the Uruguay Round in 1992, the need to expand the agreement to agricultural products became apparent. The WTO provided a framework of rules for the conduct of world trade in goods and services, but nearly a decade after the Uruguay
Round, it does not yet include an agreement on agricultural trade.
The agreements on a wide variety of trade issues and the establishment of the WTO represent the widening recognition that open trade—largely free of government intervention and based on legally binding rules—is to the benefit of all nations and helps to secure global growth. The liberalization of trade met with opposition from various interest groups within countries that stood to lose, at least in the short run, from more liberalized trade. The legal obligations that bind member countries when they
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join the WTO were designed, in part, to help reduce these pressures by presenting the wider benefits. An important principle governing the WTO is the nondiscriminatory treatment of all member countries; the legal term for that principle is the “most favored nation” (MFN) treatment. The GATT agreement states that any advantage, favor, privilege, or immunity granted by one WTO member to another has to be granted immediately and unconditionally to all other members. Another important principle is the need to establish a consensus as the basis for any resolution. Decision-making by consensus is bound to be slow and tedious in an organization of more than 140 members, but it was hoped that this would reduce conflict and secure wide acceptance of the rules. A third important principle of the WTO is the stability, transparency, and predictability of trading conditions, and this has been achieved by establishing upper bounds on tariff levels and a schedule of tariff concessions, and by determining the conditions of market access for services.
Agriculture was the most contentious area in the negotiations and, as of 2002, very little progress has been made. The main reason was the impasse between the EU and the US that also delayed the conclusion of the entire Uruguay Round by four years and contributed to the failure of the 1999 Seattle meeting. Although agriculture was finally incorporated into the GATT in 1994, the more difficult negotiations were delayed to early 2000, but then these negotiations broke down and were delayed again.
Nevertheless, a major achievement of the 1994 agreement was the conversion of all the nontariff barriers to trade—quantitative restrictions, import bans, etc.—into tariffs.
The Uruguay Round Agreement on Agriculture took the first step to subject agricultural trade to the same rules that apply to merchandise trade, and to progressively reduce interventionist policies. The agreement stipulated the elimination of all quantitative and other nontariff restrictions, converting them into explicit tariffs, and it determined bounds on and a gradual reduction of domestic support and export subsidies for agriculture. Complete import bans on specific agricultural products were also replaced by tariffs, though these tariffs were initially set at a sufficiently high level so that they effectively prevented any imports of these products. Import quotas were replaced by “equivalent tariffs” (tariff rate quota or TRQ) that established the same restrictions. These tariffs brought agriculture into conformity with other trade areas, provided a more transparent regime and facilitated any liberalization agreements in the future through a gradual reduction of these tariffs over time. The Uruguay Round
Agreement stipulated that the developed countries had to lower the aggregate tariffs by
36% over a six-year period, and the developing countries had to lower the tariffs by
24% over a 10-year period.
In addition, the agreement imposed limits on production and export subsidies for agricultural products by requiring that the budgetary outlays on export subsidies, the overall volume of the subsidized exports, and the domestic subsidies be gradually reduced by predetermined rates—in the developed countries over six years and in the developing countries over 10 years. The LDCs (with a GNP per capita below $1000) were not subject to these restrictions. The agreement to restrict export subsidies was a major achievement of the Uruguay Round Agreement, since it came against the background of the trade war in agricultural products between the US and the EU in the
1980s, when their prices faltered and the price support programs in both the US and the
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EU generated large commodity surpluses. Both the EU and the US provided massive export subsidies to sell these surpluses in third markets. With these sales, they inflicted considerable damage to agricultural export earnings and farmers’ incomes in many developing countries.
With all the exemptions and concessions, however, the main accomplishment of the Uruguay Round Agreement with respect to agriculture was primarily symbolic and only little immediate progress was made. Nevertheless, the changes in the ground rules in the Agreement paved the way to more substantive achievements. In particular, the agreements on TBT and SPS measures permit governments to use technical regulations, standards, and sanitary measures for health and safety reasons—provided they are transparent—while the SPS measures have to be scientifically justified and not create unnecessary obstacles to trade. These new rules and agreements reduced the likelihood of a renewed trade war of the type that was waged between the US and the
EU in the 1980s (as the peaceful resolution of the 2001 banana war illustrates), but it left in place many of the policies and practices that are damaging to agricultural producers and exporters in the developing countries.
The failure in Seattle to negotiate a new trade agreement on agricultural and textile goods delayed the removal of the walls of high tariffs that agricultural exporters from the LDCs are facing for some of their key products. A recent World Bank study
(Hoekman, Ng, Olarreaga 2000) estimates that reducing the tariffs on imports of these products from the LDCs will raise exports of the affected products by 30–60%; an agreement in the next round of trade negotiations can therefore make a significant contribution to enable LDCs to increase their exports.
The promise and challenge of new technologies
In the second half of the 1990s, many developing countries benefited from large gains in productivity due to major technological improvements. Information and communication technology (ICT) and the Internet were key to these productivity gains, but many other technologies also offered innovations that contributed to increasing the productivity. In the developed countries, the huge investments in R&D that were required for these technological advancements were provided by the private sector. In the developing countries, most of these investments—particularly in education, training, and R&D—must be made by the public sector. While the need to invest heavily in the physical and human infrastructure presents obstacles to the adoption of many new technologies by poor countries, there are some major technologies that offer significant improvements without requiring large investments.
An obvious example is ICT, particularly the Internet and the mobile phone. By giving even the less affluent individuals and entrepreneurs access to a huge amount of information and expert advice, these technologies have a “leveling” capacity, and they help reduce the barriers to competition along the supply chain. The Internet and the
World Wide Web are not just symbols of globalization, as Thomas Friedman suggested in his book The Lexus and the Olive Tree. They are also among the main factors that made the process of globalization possible and profitable.
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Yet, whether the benefits from the new technologies will trickle down to all segments of society, or whether the primary beneficiaries will be the more educated and more affluent, remains open to question. In India, the main beneficiaries of the rapid growth brought about in recent years by ICT have been the professional workers.
The majority of the Indian population, which lacks basic education and training, has benefited very little from the “new economy,” and spillovers to other sectors have been minimal. Moreover, the penetration of ICT into poor countries and poor regions has been very slow. The Organization for Economic Co-operation and Development
(OECD) estimates that 95.6% of the world’s Internet hosts in 2000 were located in its member countries. On these grounds, UNDP’s 1999 Human Development Report warns that
“[t]hose with income and— literally—connections have cheap and instantaneous access to information. The rest are left with uncertain, slow and costly access.
When people in these new worlds live and compete side by side, the advantage of being connected will overpower the marginal and impoverished, cutting off their voices and concerns from the global conversation” (UNDP 1999).
The gap between the rich and the poor thus threatens to widen the knowledge gap, and the widening gap between the “knows” and “know-nots” will further deepen the income and wealth gap.
While the breathtaking pace of technological innovation in recent years, particularly in ICT, may indeed threaten to increase the gap between the rich and the poor, there is also a promising potential that technological innovation will make it easier to fill the gap. An instructive example is the fate of the public telephone services.
In most developing countries, particularly in sub-Saharan Africa, telephone service is dismal, due to the poor state of the local infrastructure, the inefficiency of the mostly public telephone companies, and the very high prices, which are primarily due to the monopolistic power of these companies. Privatization of public telephone companies is therefore high on the agenda of most economic reforms. However, the process of privatizing these companies is quite complex and has proceeded rather slowly even in many of the more developed countries. In developing countries, the monopolistic public telephone company is often replaced by a monopolistic private company that increases profits by extorting its captive customers rather than reducing costs and increasing efficiency. In recent years, however, with the spread of the new mobile phone technology, customers found an effective way of bypassing the existing services and overcoming the constraints imposed by the poor infrastructure. By doing away with the requirement of setting up a cumbersome physical infrastructure, the new technology facilitates the entry of new providers that compete by improving efficiency and reducing prices. Similarly, with this technology, access to the Internet no longer depends on an expensive desktop computer connected to a telephone line, thus making it cheaper and easier to get “connected.” While technological innovation created the gap between those with “connections” and those without, it is also creating possibilities for developing countries to leapfrog outdated technologies.
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Concluding Remarks
Development strategy has two central components. The first determines the policy guidelines for the country’s economic development: the balance between industry and agriculture, between rural and urban development, between exports and import substitution, etc. The second defines the role of the public sector in the implementation of this strategy. The large differences between the experience of the East Asian countries and most countries in sub-Saharan Africa and South Asia during the past two decades should therefore be explained not only by the differences in the policies that these countries implemented, but also, and perhaps much more so, by the differences in the role and effectiveness of their public sector, i.e., their public institutions and their systems of governance, law, and order, in the implementation of these policies. A brief comparison of the development strategies of these two groups of countries can offer a number of instructive lessons.
In the 1960s, the standards of living in Africa were, on average, considerably higher than in the Far East, and the growth prospects of most African countries seemed to be much brighter. The picture changed dramatically in the 1980s, as an increasing number of East Asian countries embarked on an export-oriented, industry-led course of development that ushered in a period of rapid growth and a remarkable reduction in poverty. Sub-Saharan Africa and many countries in Latin America and the Caribbean and South Asia entered into a deep debt crisis and saw their growth rates and growth prospects plummeting. These sharply diverging experiences raise several questions:
< What lessons can be drawn from these experiences with respect to the structure of and the balance between industrial, agricultural and trade policies in a developing country? < What economic, social, institutional, and political conditions made the “Asian miracle,”and the subsequent Asian crisis, possible, and what lessons can their experience offer for the design of growth strategies in the countries of sub-Saharan
Africa?
< What lessons can, for example, Bangladesh or Ghana draw from the experience of
Thailand, Malaysia, and Uganda, as they design their development and trade strategies and structure their institutions of governance?
< What lessons can be drawn from the large differences in the pace of development between these groups of countries with respect to the rather generic policy prescriptions of the form “liberalize thy trade, deregulate, privatize and set thy prices right” that were advocated by the World Bank and the IMF (and became known as the “Washington Consensus”)?
The successful experience of the East Asian countries during most of the 1980s and
1990s underscores the merits of an outward looking development strategy and greater integration with the world economy. Indeed, this lesson remains valid despite the
Asian crisis of 1997–98 and despite some periodic setbacks to the process of globalization. The key to the rapid industrialization and the swift rises in income and employment in East Asia were the effective use of the large supply of a cheap but disciplined labor force for the development of an internationally competitive and
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export-oriented industrial base. The outward-oriented development of these countries avoided the constraints that an inward-looking, import-substitution industrialization encountered in many other countries due to the limited size of their local markets. The export-led growth of the East Asian countries contributed to accelerating their growth also by attracting foreign investments and advanced technologies. The adoption of labor-intensive industries and technologies at their early stage of development enabled these countries to absorb rather rapidly the waves of migrants from rural areas and thereby raised employment and income in both rural and urban areas. In contrast, many of the countries that relied more heavily on inward-looking industrialization led by capital-intensive manufacturing were much more constrained by the limited size of their market that restricted, in turn, their capacity to absorb surplus labor and reduce unemployment. Despite the wide validity of these lessons, the diverging experiences of these countries also suggest caution in translating them into “commandments” and applying them too schematically in other countries. An equally important lesson is that a development strategy cannot be formulated as a menu of rules and policy recommendations that can be applied with relatively minor modifications to most countries. Indeed, the menu of policies that became known as the Washington
Consensus achieved highly inconsistent results mainly because these policies did not take adequately into account the importance of each country’s unique social, cultural, and political conditions, the constraints imposed by the country’s past on its present course of development, and the impact of these conditions and constraints on the country’s capacity to build up the institutions and the system of governance and law necessary for an effective implementation of these policies. Instead, the underlying logic of these policies appears to have been their apparent “technical” and thus also, it seems, a-political nature (”remove this tariff,” “cut that subsidy”), and the apparent assumption that these policies, by being so highly beneficial for the vast majority of the population, would enable the government to easily mobilize the wide public support and the political coalition necessary to guarantee their successful implementation.
However, this logic seems to ignore the social and economic quake that each policy reform unavoidably triggers by shattering the existing balance between sectors, regions, and social groups. Policy reforms that involve a change in import tariffs or export subsidies inadvertently affect a large number of consumers and producers.
Eeven if, in the long run, most of them will benefit from the more rapid economic growth thanks to the greater efficiency in production and in the allocation of resources, in the short run, some people and sectors will gain, while others will lose. Those who lose are likely to coalesce in order to demand different policy reforms or at least compensations that will minimize their losses; those who gain may coalesce to oppose any policy reversal (see also Alesina et al. 1999). These conflicts prolong the transition period and make the implementation of the reforms far more difficult and controversial. Although the initial step in the reform may look “technical,” the subsequent steps are likely to be highly political. Strong institutions of governance are therefore necessary throughout this process to ensure that the reform will remain on course and that the promised “Pareto improvement,” when progress takes place and economic growth is accelerated, will indeed materialize.
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These conflicts and their impact on the economy may not be captured, however, in the standard analysis that focuses on technical indicators. A symptomatic illustration is provided by Esterly (2001) in his discussion of an apparent puzzle: During 1980–98, the growth of median per capita income in developing countries was 0.0%, compared with 2.5% in 1960–79, even though variables that are standard in growth regressions
(policies like financial depth and real overvaluation, and initial conditions like health, education, fertility, and infrastructure) generally improved during these years, and theory suggests that, therefore, these countries’ growth should have increased. In most of sub-Saharan Africa and South Asia, the puzzle is even more perplexing because their median per capita income actually declined rather sharply during these years, even though, in the majority of these countries, the variables that represent the determinants of growth in the standard growth regression generally improved. Esterly commented that this stagnation represented a disappointing outcome of the standard menu of policy reforms of the “Washington Consensus”. In fact, the puzzle was created by the analysts themselves as they focused exclusively on technical variables in the standard growth equation. These variables fail to take into account other dimensions of the growth process, particularly the rather dramatic changes in the social and political setting that occurred in the majority of the African countries during the past two decades. These changes had a very strong impact on the explanatory power of the technical variables, and if they are not taken account, a puzzle is likely to emerge.
Even more important, these changes in the social and political conditions affect not only the retroactive explanatory power of these variables, but also the power of economic reforms that focus on the more technical rules of the economic policies that these variables determine to generate growth. A failure to take into account the changes in the social and political conditions and in the institutional setting in the country may doom the reforms themselves to fail.
Consider, as an illustration, the reasons for the mixed performance of privatization, one of the principal policy reforms that were aimed at improving the notoriously malfunctioning public services. Among these public services, the public marketing boards are at the top of the list in most developing countries. Their dismal performance, particularly in the African countries, and the widespread corruption that cripples their operation make their total elimination via privatization the only logical solution. Privatization is expected to usher in healthy competition between the newly privatized enterprises, and this competition, in turn, is expected to become the driving force for the elimination of the distortions that were introduced by the heavily regulated public agencies. In practice, however, the transition from a marketing system based on public marketing boards to a system based on private trading companies was by no means beneficial to all producers and consumers. In many countries, the privatized marketing boards were essentially taken over by trading companies that established their monopolistic power either in the country at large or in the local market, often with a little help from the retired managers of the existing public board, from other government officials, or from family members of the president. These monopolistic private enterprises often created much larger distortions to the disadvantage of larger segments of the population, particularly the politically and economically weak. With few constraints on their monopolistic power, these trading
The Pros and Cons of Globalization for Developing Countries
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companies were under no pressure to improve their service or reduce prices to their customers. In developed countries, these distortions are reduced to a minimum, thanks to the watchful eye of various public legal institutions charged with preventing such abuses. In most developing countries, these institutions are too weak or nonexistent, and the supervision over private companies is either highly inefficient or entirely lacking. Consider, for example, the potential obstacles that may hinder the process of trade liberalization, another example of a policy reform that developing countries are often pressured to implement. The existing tariffs and/or subsidies are clearly damaging to the country as they distort its resource allocation and reduce economic efficiency. Prior to the reforms, producers, consumers, and traders have to organize their entire operations on the basis of the distorted prices. The trade liberalization reforms then force them to make considerable changes, particularly in their production system, and these changes may also require large investments that are bound to prolong the transition period. During the transition period, some producers and traders will suffer losses due to the decline in the relative price of their products, while others will gain as the relative price of their products is rising. Even though most people will be better off in the long run, those who suffer losses during the transition period are likely to oppose liberalization, while those who gain already in the short run are likely to have higher-than-normal profits until all producers and traders make the necessary adjustments. The losses of one group of producers and traders as an effect of the reforms, and the higher-than-normal profits of the other group are bound to sharpen the discord and possibly lead to an open conflict that can embroil all the country’s social and political institutions.
The possibility of such a conflict inadvertently introduces social and political dimensions to the process of implementing the reforms, no matter how “technical” or
“a-political” the reforms may appear at the outset. The possibility that the reforms will produce rival coalitions or deepen already simmering conflicts between social or ethnic groups must be taken into account in advance, i.e., the reforms have to be designed with full consideration of the specific social, economic, and political conditions in the country and with the participation of the potentially affected groups.
Trade liberalization reforms may then have to be accompanied by targeted measures aimed at assisting those producers who may be outcompeted by a wave of cheap imports of the products they produce. This can be achieved by offering assistance for their transition to new products or to other sectors. Obvious examples for the failure to avoid unintended consequences can be found in the situation resulting from the measures that many countries implemented in order to reduce trade barriers on agricultural products when they joined the WTO. The flood of cheap imports of maize, wheat, and other field crops from developed countries forced many small farmers in developing countries either to retreat into production for their own consumption or to abandon agriculture altogether, because their own resources—financial and otherwise—did not enable them to make the transition to other crops and a different farming system quickly enough. Indeed, many of these farmers joined the ranks of those who oppose globalization.
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To smooth the transition and reduce the intensity of potential conflicts, it may also be necessary to put in place a proper legal system and establish or strengthen the institutions that can prevent one group or sector from taking undue advantage of the distorted prices that are likely to emerge during the transition period. In some cases, it may also be necessary to provide some form of compensation to those who may become worse off as an initial result of the reforms. However, the provision of measures and mechanisms to ease the transition period takes time, and when the institutions that are supposed to provide them do not even exist, the preparatory process is likely to be even longer. Without careful preparation, however, the conflicts and inequities that may emerge during the transition period can pose a risk not only to the success of the reforms, but also to the country’s entire social infrastructure. This is why a country’s institutional and legal systems and its specific social, economic and political conditions are critical to the success of trade liberalization. Even when the need for reform and the gains that it promises in the long run are obvious, the seemingly technical reforms will still have to be implemented in a specific context, and this is why the “Letters of Agreement” of different countries cannot be mere duplicates. Bibliography
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The Pros and Cons of Globalization for
Developing Countries
A Review of the Theoretical Issues and the Empirical Debate
David Bigman*
Introduction
Despite the highly favorable views that most researchers in the academic community and in the international development organizations hold on the globalization process and its impact on developing countries, and notwithstanding the strong support of the empirical evidence of the benefits that many developing countries have derived from their integration with the global economy, the backlash against globalization continues unabated. An online debate on “Globalization and Poverty” organized by the World
Bank Development Forum in mid-2000 echoed the loud and often very aggressive protests against globalization that erupted in Seattle, Washington, and Prague; nearly all the participants in the debate emphasized the very negative impact of the globalization process on the distribution of income and wealth between and within countries: “Globalization may improve growth rates, increase productivity, enhance technological capability, but it cannot redistribute created wealth and income in favor of the poor. In fact, it does the reverse—it redistributes wealth and income in favor of the not so poor.”
The participants underscored the harmful impact on the poor:
“Money can be made by growing things for export on foreign-owned commercial farms… No money can be made by the villager working her own land when she cannot afford the few bags of fertilizer, the seeds and the insecticides, courtesy of the structural adjustments, the liberalization, the removal of support systems and the massive devaluations.”
Many participants also noted that the market is by no means the panacea for the central problems that the majority of the population in developing countries is facing:
“With the opening of our market, our country has become a supermarket of foreign goods, which are cheaper, killing our local industries, rendering
* David Bigman: International Service for National Agricultural Research
27
28
Chapter 1
many more jobless. The disparity between the rich and the poor has widened, and although some may have benefited from the effect of liberalized economy, the majority continue to languish in poverty.”
The opposition against globalization unifies labor organizations that protest against the flight of jobs “South of the border,” human-rights groups opposed to sweat shops thriving on child labor, environmentalists concerned about the damage to the global habitat, and radicals suspicious of the clout of multinational corporations that are perceived as the all-powerful agents of capitalism. The IMF, the World Bank, and the
WTO, and, more generally, the high-income countries, are held responsible for influencing and largely determining the course of the globalization process. They are also seen as the driving forces behind the policy reforms that the developing countries had to implement as part of their structural adjustment programs under the stewardship of the IMF, the World Bank, and the WTO. However, while many passionate opponents of globalization view these reforms as unacceptable dictates, the reforms had actually quite positive effects on the economies of most developing countries. In
East Asia, most countries experienced unparalleled rates of economic growth during the past two decades; as a consequence, a large portion of their poor population was lifted out of poverty. Despite the crisis of 1997–98, which exposed serious weaknesses in their financial, social, and political systems, as well as in their institutions of governance, most East Asian countries embarked on a course of comprehensive reforms to deal with the crisis, and they have entered the 21st century with renewed drive. In contrast, most countries of sub-Saharan Africa, and quite a few countries in
South Asia, Latin America, and the Caribbean, did not benefit from the globalization process, and, despite a series of structural adjustments, these countries are burdened with much the same structural problems that plagued their economies in the previous century, but which now aggravated by heavy debts and the AIDS epidemic. It has been generally agreed that the benefits brought about by the global trading system under
GATT and the WTO have so far been distributed very unevenly between and within nations. The rich industrial countries have reaped large gains from increased trade and faster growth, whereas most poor nations have actually become worse off and their economies shrank during the past decade. As a result, the gap between the nations with the poorest 20% of the world’s population (in terms of per capita income) and the nations with the 20% most affluent population has nearly doubled in the past two decades, and many developing countries have been marginalized and practically cut off from the mainstream of the global economy.
These contrasting experiences and the growing global income inequality are reflected in the heated debate and the diametrically opposed views on globalization.
On the one side of the debate are the various protest groups that underscore the failed experience of many sub-Saharan African and South Asian countries and the widespread perception that globalization is detrimental to the poor even in countries where it has had a positive impact on the economy at large. On the opposite side of the debate is the majority of the economists who, backed by the supporting empirical evidence on the gains from free trade, adhere to the neoclassical maxim that highlights
The Pros and Cons of Globalization for Developing Countries
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the potential gains from trade and trade liberalization. The theoretical tenets emphasize that, with trade liberalization, resources are allocated more efficiently to productive uses, and low-income countries with an abundance of unskilled labor and significantly lower labor costs can expand output and employment in labor-intensive industries, thus accelerating their growth.1 The poor also stand to benefit from this growth, and trade liberalization is therefore also good for the poor. These benefits are highlighted in several World Bank research papers that concluded that “growth is good for the poor” (Dollar and Kraay 2000a) and that “In general, the more rapid growth that developing countries experience as they integrate with the global economy translates into poverty reduction” (Dollar 2001).
The positive effects of globalization on productivity are also thanks to the transfer of advanced technologies and to the opportunities that developing countries can obtain from the flow of FDI. Another World Bank paper that focused on the impact of the rising tide of FDI during the 1990s concluded that the flow of FDI was central to the more rapid growth that many developing countries achieved, and this growth also contributed to financing many government-led distribution programs that provided direct assistance to the poor and improved the social safety nets (Klein and
Hadjimichael 2000).
Even ardent proponents of globalization agree, however, that the benefits from free trade and trade liberalization can be realized only after a transition period during which the country’s institutions of governance and its legal system will have to be restructured, many public enterprises be privatized or dismantled and the market system be strengthened. Given the transformation that most segments of the economy and most institution of governance will have to undergo, this transition may take much longer than expected and the process may sometimes be reversed under political pressures. In Indonesia and the Philippines, for example, it is not clear whether the critical part of the transition was completed in the early 1990s with the expansion of export-oriented production, or whether it still continues through the first decade of 21st century, as the reforms reach the political institutions. Has China completed its transition period with the economic reforms it implemented as it joined the WTO, or has it just begun?
These questions are also echoed in what has become known as the debate over the
“post-Washington consensus,” which acknowledges the fragility of prescriptive policy packages of the form “liberalize trade and set the price right” and the likelihood that these “prescriptions” will fail in countries that lack proper institutions of governance and have only a rudimentary market system. In the on-line debate on
“Globalization and Poverty” quoted earlier, many participants reflected these views when they argued that the benefits from market deregulation and trade liberalization are not likely to trickle down to the poor because, in the words of one of the participants, “the main cause of poverty is the market, not market failure,” since
“markets fail to address strategic interests like food security.” Other participants noted that often their countries’ own institutions “prevent a flowering market-based
1. See, for example, the World Bank’s World Development Report 1999, p. 52, for a summary of these benefits. 30
Chapter 1
development.” Others emphasized unequivocally that “Decades of external influences in different forms have undermined and destroyed the traditional institutional mechanisms while creating islands of modern institutions that are inefficient and alien to their society at large”. Through this process, “the North has imposed a money-based economic system and such rules for participation upon the poorer nations of the world
[that] have destroyed the traditional and local ways of wealth distribution in favor of a cash economy ruled by international forces.” Indeed, suspicion and even hostility toward the market, and strong opinions that “unfettered market processes favor the rich and powerful and their outcomes are inherently unjust” are common.
Against the background of these opposing views and the resulting heated debate over the merits of globalization for developing countries, the objective of this chapter is to provide an overview of the main arguments raised by the two sides in the debate and evaluate the pros and cons of globalization for different groups of developing countries. Section I reviews the theoretical issues raised in this debate and the empirical evidence on the impact of globalization on economic growth. The section includes a survey of the development strategies that the international development organizations, primarily the World Bank and the IMF, have promoted. In addition, the section presents the main results of an empirical study on global income inequality based on the data of the GDP per capita of 152 developed and developing countries over the period 1960–98. The first objective of this study is to identify and compare patterns in the economic reforms that countries that have gained from the globalization process have implemented in order to be integrated into the global economy, and patterns in the economic policies of countries that were left behind; the second objective is to evaluate how inclusive the process of globalization has so far been.
Section II focuses on the different approaches to the trade policy of a developing country in the current global trading system. The theoretical writings and empirical evidence of the past two decades clearly support the basic tenets of the neo-classical paradigm which hold that a labor-abundant developing country stands to reap significant gains from trade liberalization and an outward looking economic policy.
But a number of issues require closer examination: One issue is the question whether the global trading system that evolved under the Uruguay Round Agreement of the
General Agreement on Tariffs and Trade, the WTO and the regional trade agreements, including the rules on food safety, the nontechnical barriers to trade, and IPR, is indeed the system of free trade that the neoclassical economists envisaged. Other issues are related to the lessons from the “Asian economic model:” First, even the East Asian countries adopted at the early stages of their development active policies that protected and subsidized their infant industries in order to promote their exports. Second, the high and often unqualified praise that was heaped on the “Asian model of capitalism” until the 1997–98 financial crisis ignored major weaknesses in their systems of government and their legal and political institutions that were exposed during the crisis and that, to a large extent, were responsible for this crisis.
Another issue is related to the failure of most countries in sub-Saharan Africa and many countries in South Asia and Latin America to develop an industrial base, particularly against the background of the “Asia miracle.” One factor that hampered their growth performance is their focus on the production of import substitutes and the
The Pros and Cons of Globalization for Developing Countries
31
bias of their policies in favor of consumers and against producers; another factor is the bias in their trade policies against agriculture and in favor of industrialization. These issues are discussed in section III, which focuses on the agricultural sector and on the trade and development policies that affected the rural population. The section underscores the difficulties that the rural population had to face during and as an effect of the structural adjustment programs (SAPs) and the reforms to liberalize trade. The chapter concludes with remarks that discuss some central considerations for the formulation of development policies.
Globalization and Economic Growth: Theory and
Empirical Evidence
The debates over development strategies—in retrospect
The debate over the structure of development strategies that would be most effective and socially most desirable for promoting growth and alleviating poverty, and over the balance between these potentially conflicting objectives, went through distinct phases since the early 1960s. In part, these phases reflected the wide differences in the experience of different countries during different time periods; in part, they reflected marked disagreements over the ability to bring about a significant reduction in poverty by promoting economic growth alone, and over the need and the potential advantages and disadvantages of accompanying these growth strategies with active income distribution measures.
The early economic growth literature that provided the intellectual foundation for this debate emphasized the segmentation of the economy in developing countries into a modern, mostly industrial sector in urban areas, and a traditional, mostly agricultural sector in rural areas. Constraints on land availability and declining land quality, together with the continued rise in the rural population, reduce the marginal product of labor in the traditional sector to near-subsistence levels and drive the surplus of unskilled labor to urban areas. In this model, the embryonic modern sector cannot absorb all the surplus labor and, at the early stages of development, this migration would lead to a rise in income inequality and poverty. However, abundance of cheap and mostly unskilled labor and open unemployment in urban areas, and disguised under-employment in rural areas, give incentives to increase production in the modern sector in labor-intensive industries. The rising demand for labor in the labor-intensive industries would gradually absorb the unemployed in urban areas and the underemployed in rural areas, thus bringing about, over time, a reduction in poverty and income inequality at later stages of development.
The actual realization of this stylized model varied widely between countries and continents and between time periods. In the 1960s—with the emergence of new nation states throughout Asia and Africa and the rapid economic progress in all countries across all continents—the focus was on economic growth as the most effective strategy for meeting the needs of the rapidly growing populations in the newly independent countries. In the 1970s, poverty and income inequalities were on the rise.
In many countries in Latin America and the Caribbean, South Asia, and sub-Saharan
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Africa, the pace of industrialization was too slow to absorb the flow of rural migrants, often because production in the modern sector, especially manufacturing of import substitutes, was highly capital intensive and did not provide enough employment.
Despite the diminishing prospects of rural migrants to find employment in urban areas, migration from rural areas continued due to rapid population growth and dwindling land resources, thus leading to higher poverty also in the urban areas.
Disillusion with the trickle-down effects of growth shifted the emphasis to a strategy that deals simultaneously with economic growth and poverty. The then World
Bank’s President, Robert McNamara, expressed this shift by stating that “[g]rowth, as such, can be considered a necessary but not sufficient target of development strategy.”
In 1974, the Bank issued a document titled Redistribution with Growth that extended the goals of its development strategy by seeking to influence both the rate and the patterns of growth in order to reach the poor. The document advocated “policy packages” consisting of a wide range of measures that included promoting employment of unskilled labor, developing new technologies to make low-income workers more productive, targeting investments on “pockets of poverty,” allocating more resources to the education of the poor, and providing for the basic needs of the poor, particularly food and health care, from public sources. Redistribution with
Growth insisted that “poverty-focused planning does not imply abandonment of growth as an objective. It implies, instead, a redistribution of the benefits of growth.”
(p. xviii). The 1980 World Development Report echoed this theme and made the case for a more concerted effort to secure the basic needs of the poor and argued for targeted investments in human development and technologies suitable for the poor primarily in rural areas.
During the almost three decades since the publication of Redistribution with
Growth, these strategies continued to evolve with the accumulation of more experience and data from a growing number of countries, and with the deepening understanding of the economic and political processes in developing countries. The
1980s brought two diametrically opposed experiences. At the one extreme was the failed experience of many countries in Latin America and the Caribbean and sub-Saharan Africa with highly interventionist policies and large public spending that led to high public debts, massive macroeconomic imbalances, stagnation, and growing poverty. The debt crisis propelled the IMF and the World Bank to enter stage and give rise to policy-based lending: loans disbursed in exchange for policy reforms aimed at correcting macroeconomic imbalances and boosting productivity through structural reforms. At the other extreme was the very successful experience of the East Asian countries with rapid industrialization, high growth rates and a steep reduction in poverty. The accelerated growth of their modern sector, led by labor-intensive production for exports, brought about a gradual reduction in their unemployment and a rise in incomes in their urban and rural areas that led, in turn, to a steep reduction in poverty. Moreover, improving skills of the labor force enabled these newly industrialized countries to gradually move to higher, more advanced levels of industrial production and to products and production technologies that are more capital- and more skilled-labor intensive. Although growth was accompanied in some countries by rising income inequalities, it “lifted all boats” and steeply reduced
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33
poverty. The sharp differences between these experiences underscored the limitations and potentially undesirable effects of proactive redistribution policies. Against this background, the debate over the pros and cons of alternative growth strategies acquired another dimension with the renewal of old debates over the proper balance between measures to promote growth and measures to reduce income inequality and poverty, and over the desirability of government intervention in the economy even if this meant curtailing the free market and reducing efficiency.
During the 1980s, the reforms focused on “structural adjustment programs” under which governments had to make firm commitments to economic restructuring that focused on trade liberalization, tax reform, realistic exchange rates, liberalization of capital markets and privatization in exchange for support by the World Bank and the
IMF. In the early 1990s, the East Asia “miracle” highlighted the significance of market-oriented structural adjustments. The World Bank’s 1990 World Development
Report advocated a new strategy to combat poverty based on more effective market incentives and better social and political institutions, infrastructure, and technology on the one hand, and on direct measures of governments to provide social services such as primary health care and education on the other hand. This two-pronged approach was based on more open markets and large-scale privatization accompanied by greater government activism in the provision of public goods in health, education and infrastructure. The 1990 World Development Report on Poverty concluded that “[t]he evidence in this report suggests that rapid and politically sustainable progress on poverty has been achieved by pursuing a strategy that has two equally important elements. The first element is to promote the productive use of the poor’s most abundant asset—labor. It calls for policies that harness market incentives, social and political institutions, infrastructure, and technology to that end. The second is to provide basic social services to the poor” (p. 3). Specifically, the poverty reduction strategy recommended in the report had three main components:
1. Promoting broad-based growth that makes intensive use of labor in order to increase the productivity of the poor and the economic opportunities available to them. 2. Ensuring the access of the poor to good quality basic social services in order to enable them to take advantage of economic opportunities.
3. Providing social safety nets for the most vulnerable members of society.
The 1990 World Development Report recommended a growth strategy that includes investments in industries and production technologies that can absorb surplus labor as well as investments in human capital to allow the poor to take advantage and reap the benefits of new technologies. The World Bank’s Poverty Reduction Handbook of 1993 and Adjustment in Africa of 1994 echoed the message of the 1990 World Development
Report by emphasizing the importance of an outward-oriented strategy and export-led growth. The Handbook emphasized the need to promote trade and exploit the comparative advantage of developing countries in products and production processes that are labor-intensive; in contrast, tariffs and other restrictions on trade are likely to inhibit growth and increase unemployment and poverty by giving incentives to capital-intensive production of import substitutes. A study conducted by the World
34
Chapter 1
Bank’s Office of Executive Directors in 1995 titled The Social Impact of Adjustment
Operations emphasized that growth is the most significant process affecting poverty and that a consistent implementation of sound macroeconomic policies is essential for promoting sustainable growth. A subsequent study titled Social Dimension of
Adjustment, conducted by the Bank’s independent Operations Evaluation Department in 1996, concluded that “good macro-economic policies and measures, combined with relevant sectoral policies and appropriate public expenditure allocation, provide a favorable environment for … sustained growth and poverty reduction.” The study found, however, that in most countries, the actual reduction in poverty was quite small and high levels of income inequality and poverty persisted.
Addressing the controversy over the seeming “trade-off” between growth and equality, Bruno (1995) noted that, although direct action on health, education, and nutrition can improve the quality of life for the poor, growth is the only strategy that can secure a sustained reduction in poverty and provide the resources that are necessary for any direct action to reach the poor. The 1995 World Development Report reiterated the conclusion that “open trading relations [and] domestic policies that promote labor-demanding growth” are central to equitable growth. The World Bank and the IMF therefore relentlessly pushed developing countries in the direction of the
WTO “system.” However, the Bank’s 1995 report also noted that growth may augment income inequalities and that
“[s]ome groups of relatively poor workers have experienced large gains in the past thirty years—especially in Asia. But there is no worldwide convergence between rich and poor workers. Indeed, there are risks that workers in poorer countries will fall further behind, as low investment and educational attainment widen disparities. Some workers, especially in sub-Saharan Africa, could be increasingly marginalized. And those left out of the general prosperity in countries that are enjoying growth could suffer permanent losses, setting in motion intergenerational cycles of neglect” (p. 21).
These considerations led to the argument that in these countries the government must take active measures to secure the livelihood of the poor, even if these measures may restrict the free market and diminish the country’s growth prospects. The counterargument asserted that, by reducing the country’s rate of growth, the government might in fact defeat the long-term goal of reducing poverty.
During the past decade, it has been increasingly recognized, however, that a successful implementation of policy reforms depends on the country’s institutions of governance, and that the weakness of the institutions in the majority of the developing countries was the principal obstacle for the success of their structural adjustment programs. In the East Asian countries, weak institutions contributed to the 1997–98 financial crisis; in many countries in Latin America and the Caribbean, the weakness of institutions contributed to aggravate the impact of the global crisis on their economies, and in nearly all the countries in sub-Saharan Africa, weak institutions were not only the main obstacle to the implementation of the reforms, but also the main reason for the continuous political and social unrest. It has been realized that, in all
The Pros and Cons of Globalization for Developing Countries
35
developing countries, the reforms were too narrowly focused on macroeconomic policy and that the new agenda must stress also anticorruption efforts, effective corporate governance, banking transparency and independence, strong capital markets, and adequate social safety nets. The World Bank and the IMF made concerted efforts to work with governments to implement codes of “best practices” in a variety of technical areas such as banking regulation and supervision, corporate governance, and accounting. The World Development Report of the year 2000 adopted a much wider definition of poverty, which includes not only income shortfalls and low levels of health and education, but also powerlessness, voicelessness, vulnerability, and fear. This very wide definition of poverty also calls for a much larger “menu” of policies to combat poverty, ranging from fostering economic growth, strengthening the rule of law, promoting community development and gender equity, to closing the digital and knowledge divide. To be able to attack the wider dimensions of poverty, the World
Bank has continuously diversified its own operations by adopting new goals and new work areas in order to assist countries in education, science, health, child nutrition, population, industrial development, trade policy, and the environment. This expansion reflected not only the Bank’s propensity to grow, but often also pressing needs that had not been adequately addressed by the existing development institutions, primarily the other agencies of the UN system; in addition, it also reflected the growing influence of nongovernmental organizations (NGOs) that pushed for the incorporation of issues such as the environment, the role of women in development, human rights and democracy into the Bank’s agenda, although some critics claim that this expansion reflects mostly the Bank’s inability to sort out its priorities.
In principle, each of the above actions is essential to tackle the wider dimensions of poverty. However, given the limited resources that developing countries can command, not all of these actions are feasible, and it is therefore necessary to establish clear priorities and trade-offs. The Bretton Woods institutions have a clear comparative advantage in advising on, and supporting the implementation of, actions that affect a country’s economy, and even among these actions, it is necessary to establish priorities. However, by widening the definition of poverty, spreading thin the
World Bank’s resources, and, without determining priorities, extending the menu of actions beyond the scope of the Bank’s comparative advantage—thus also diverting governments (and the World Bank) from the task of promoting growth and economic efficiency—the 2000 World Development Report may have reduced the Bank’s effectiveness and its influence over the choice of a development strategy.
While the debates over development strategies have always reflected topical concerns of the time, they often remained too abstract and generic in that they failed to recognize the substantial differences between countries. These differences cast doubt on the notion that a development strategy can be formulated in the abstract or that it can yield a menu of actions and policy recommendations that apply to all countries.
Lumping all the “developing countries” together and advocating a “one-size-fits-all” development strategy with a blueprint of actions can be oversimplifying and possibly even misleading. For each country, it is necessary to recognize its unique geographic, socio-economic and political conditions, to establish priorities that reflect these
36
Chapter
conditions, and to identify the critical areas on which its economic policy should focus.
Recommendations to “promote labor-intensive growth and open trade” (World
Development Report 1990), or to “promote opportunity, facilitate empowerment, and enhance security” (World Development Report 2000), may fail to recognize country-specific needs and differences in the underlying conditions.
Thus, while in most East Asian countries growth proved to be the most effective strategy for reducing poverty, many Latin American and Caribbean countries experienced a much smaller reduction in poverty with growth. Their greater sensitivity to the needs of the poor made it necessary to accompany the pro-growth policies with additional measures to ensure a more equal distribution of the growing national income. The experience in a considerable number of sub-Saharan African countries showed that for them, administrative restrictions on exchange and interest rates, or even on the government budget, proved to be quite useless, since these countries lack the necessary institutions and the rule of law to ensure the proper implementation of these policies. In these countries, the main focus of policy reforms at the early stages of development should therefore be on measures to strengthen the institutions of government and the rule of law. Indeed, one lesson of the East Asian crisis is that even in the relatively more advanced developing countries, economic policy must place much greater emphasis on institution building, strengthening the rule of law, fighting corruption, etc. The second lesson is that a country’s growth is function not only of its endowments of labor, capital, and natural resources, but also of the strength of its public and private institutions and its legal and political systems.
The neo-classical prescription for promoting growth in a labor-abundant country
The present discussions on growth and employment in a labor-abundant developing country take their origin in the neoclassical writings, particularly the labor-surplus model of Lewis (1954), Fei and Ranis (1964), which dominated much of the economic development literature in the 1960s and 1970s. In Lewis’ model of a dual (or segmented) economy of a labor-abundant developing country with two distinct sectors, the modern, mostly industrial sector in the urban areas operates along the traditional, mostly agricultural sector in rural areas. The low living standards in rural areas drive many to the urban centers and increase the supply of unskilled and low wage workers (Table 1.1). In the early stages of development, the rural-urban migrants join the ranks of the under- and unemployed in the urban areas due to the limited employment available in the modern sector. Empirical studies estimated that in many countries the rate of unemployment in urban areas exceeded 20% of the labor force
(Berry and Sabot 1978; Berry 1989). Nevertheless, rural-urban migration continued unabated. Harris and Thodaro (1970) explained the continued flow of migrants despite the rising urban unemployment by the migrants’ (subjective) expectations for higher wages that took into account not only the wage differential between urban and rural areas, but also the probability of finding employment. Rural migrants were also attracted by the better facilities for health and education and the better quality of water
The Pros and Cons of Globalization for Developing Countries
37
Table 1.1. Demographic Characteristics of Selected Developing Countries: 1973–95
Annual growth rate of the population overall LAC
Brazil
Chile
Peru
Africa
Ghana
Kenya
Tanzania
Asia
India
Indonesia
Pakistan
urban
rural
Share of urban population mid-1970s mid-1980s
mid-1990s
2.2
1.8
2.3
4.1
2.4
3.6
-2.45
-0.9
-0.3
59
77
59
71
82
67
87
87
76
3.9
4.3
3.4
5.3
8.0
8.6
3.0
3.5
2.5
33
12
9
38
17
14
43
24
23
2.1
2.1
2.7
4.2
4.8
4.3
1.2
1.2
2.0
19
18
25
24
24
29
30
31
34
Source: World Bank, various tables
supplies in urban areas that reflected the large bias in government expenditures (Lipton
1977; Larson and Mundlak 1997). In many developing countries, industrial growth remained, however, quite slow and capital intensive despite the large supply of labor, and the bulk of new jobs in urban areas were not created in the modern sector, but in the informal, traditional urban sector that includes basic manufacturing and small-scale commerce and services, where production is highly labor-intensive and earnings are low (Berry 1989).
In many East Asian and some Latin American countries, in contrast, rapid growth of labor-intensive and export-oriented industries led to a gradual reduction in unemployment, a rise in real wages, and a reduction in poverty in both urban and rural areas. In Korea, Adelman and Robinson (1978) concluded “the strategy of labor-intensive, export-led growth … produced significantly higher incomes for the poorer half of the population and a far more equal relative distribution” (p. 127). In
Indonesia, Thailand, and Malaysia, the industrial growth led to an annual rise of over
2% in the real incomes of the rural population. Accumulation of both physical and human capita enabled the East Asian countries to move to higher, more advanced levels of industrial production, and to products and production technologies that are more capital-intensive and require more skilled labor.
Table 1.2 demonstrates the large differences between the rates of growth of different countries during the past four decades. The economies of the sub-Saharan
African countries generally stagnated; in Latin America and the Caribbean, growth rates were higher, but they varied widely between countries. In these two groups of countries, many of the poor remained in rural areas and did not benefit much from the growth in the urban sector. In the East Asian countries, in contrast, the rates of growth in labor-intensive export industries were high enough to absorb the surplus labor
38
Chapter 1
Table 1.2. Growth of GDP Per Capita in Selected Countries: 1960–97
Country
1960
1997
Average annual change (%)
South Korea
Taiwan
885
1355
10,500
13,250
6.9
6.4
Ghana
Senegal
Mozambique
875
1015
1125
850
1095
805
-0.1
0.2
-0.9
Brazil
Mexico
Argentina
1745
2800
3295
5500
6300
4750
3.2
2.2
1.0
GDP per capita in US$ in 1985 prices.
Source: World Bank, various tables.
despite the continued migration to urban areas; as a result, the rate of unemployment declined, both urban wages and rural earnings increased and poverty declined.
Table 1.2 also highlights the reasons for the criticism of the labor surplus model, because it fails to explain why in so many labor-abundant economies growth was very slow and industrialization faltered, while in other countries growth was very rapid and industrialization was highly successful. There is also criticism of the model’s failure to explain the changes in income distribution that took place during the growth process: many countries that experienced rather similar growth rates of the average per capita
GDP had wide differences in the changes in the level of poverty. In Mexico, the
Philippines, Nigeria, and few other countries, growth was accompanied by a rise in income inequality to the extent that poverty actually increased.
A large number of empirical studies tested Kuznets’ hypothesis either in cross-section studies of many developing countries or in time-series analysis of individual countries. Many of these studies, particularly the ones that conducted a cross-section analysis (Adelman and Morris 1973; Ahluwalia 1976; Chenery and
Syrquin 1975), tended to confirm Kuznets’ hypothesis, and thus strengthened the inclination to adopt a development strategy that puts greater emphasis on redistribution measures. Since the initial impact of growth is to increase income inequalities, so the argument went, and since this effect can last for quite some time, growth must be accompanied by active redistribution measures. Chenery (1971) asserted that “growth that does not change the resource allocation in favor of the poor constitutes growth with little development,” and recommended proactive redistributive measures if economic growth does not bring about a significant reduction in poverty.
During the 1990s, with the accumulation of more data on income distribution in a large number of developing countries over a longer time period, several studies examined again Kuznets’ hypothesis, but this time in a time series analysis (Bruno,
The Pros and Cons of Globalization for Developing Countries
39
Ravallion, and Squire 1995; Ravallion 1995; Ravallion and Chen 1996). These studies concluded that, while the trends in income inequality with growth differ significantly across countries, there is no evidence that growth has any discernible systematic impact on inequality. In a sample of household surveys from a large number of countries, Ravallion and Chen found that in only half of the cases growth was associated with an increase in inequality. Bruno et al. emphasized that although there are exceptions, as a rule, sustainable economic growth benefits all layers of society roughly in proportion to their initial standard of living.
Based on the evidence of the last decades, there seems to be no credible support for
Kuznets’ hypothesis. These studies also confirmed that positive economic growth was significantly associated with a falling incidence of poverty, and that economic contraction was associated with a rising incidence of poverty. Bruno et al. calculated with data of 20 countries over the period 1984–93 that a 10% increase in mean per capita consumption led to an average 20% decline in the proportion of the population living on less than $1 per day. Lipton and Ravallion (1995) calculated with the data of eight developing countries that a distribution neutral growth at an annual rate of 2% in mean per capita consumption would lead to a decline in the poverty gap of 3 to 8%.
These findings motivated a change in the approach to development strategy in the mid-1990s in favor of a strategy that gives much greater weight to growth and advocates re-distributive measures only in countries where there is clear evidence that the growth process is narrowly based and leaves out large segments of the population.
In most countries, though, this approach emphasized the potentially undesirable effects of re-distributive measures on economic incentives and efficiency. The debate on these issues is far from over, and the more recent chapters in this debate are discussed later on.
Globalization and global income distribution 1960–98:
Has there been a convergence?
A large number of studies sought to estimate the changes in the global income distribution between and within countries during the second half of the 20th century.
Blotho and Toniolo (1999), drawing on data for 49 countries, found that the measure of global income inequality shows a modest trend toward convergence starting in 1980.
Melchio, Telle, and Wiig (2000) evaluated the changes in income inequality between countries on the basis of a sample of 115 countries and they also found that, after a relatively stable period during the 1950s through the 1970s, global incomes tended to converge from the mid-1980s through the mid-1990s. Other studies used different samples and slightly different time periods, but came essentially to the same conclusion (Schultz 1988; Firebaugh 1999; Radetzki and Jonsson 2000). In a sample of 100 countries, Clark, Kraay, and Dollar (see Dollar 2001) found that worldwide inequality increased during 1960–75, but declined during 1975–95, largely due to the accelerated growth in China and India. Using household survey data drawn from 91 countries for 1988 and 1993, Milanovic (1999) reached a different conclusion.
According to his estimates, income inequality, measured by the Gini index, rose marginally from 63 to 66, primarily due to an increase in income inequality between
40
Chapter 1
countries, rather than rising inequalities within countries. These seemingly conflicting conclusions reflect primarily differences in the sample of countries and time periods on which they draw and the small changes—up or down—that these analyses indicate.
The question examined in this section is whether the trends in global income inequality indicated by these global measures indeed represent a tendency of global incomes to converge, and whether they indicate that the globalization process has therefore been inclusive, as several recent World Bank reports maintain (see e.g., Dollar 2001).
The analysis in this section is based on household survey data from a larger sample of countries that includes also the ex-centrally planned countries, but it focuses only on income inequalities between countries that represent only part, though a central part, of the global income inequality. Nevertheless, the estimates of the trends in income inequality between countries since 1960 are in agreement with the results of most of the studies mentioned above. According to these estimates, the three main measures of inequality indicated that there has been a decline in global income inequality during the past two decades after a period of relative stability during the 1960s and 1970s.
This analysis also shows, however, that the global measures of inequality do not provide an adequate representation of the widening gap between the richest and the poorest countries.
During 1960–96, the world’s average GDP per capita increased by nearly 80% in real terms, but growth rates varied widely between countries and regions: In SSA, the annual average growth rate of GDP per capita was less than 1% during the past four decades, and it actually declined in the past two decades, whereas in East Asia, the average GDP per capita increased since 1980 at an annual rate of over 4.5% (Table 1.3 and Figure 1.1). This rapid economic growth of one group of developing countries and the relative stagnation in the other group had two conflicting effects on the global income distribution: On the one hand, the “Asian miracle” and the accelerated growth of India and some Latin American countries during the 1990s closed the income gap between these countries and the developed countries. On the other hand, the gap between the average GDP per capita in the least developed countries, particularly in
Table 1.3. Trends in GDP Per Capita in Selected Regions 1960–96 (in PPP
Exchange Rates in 1985 Prices)
Region
Number of Population
1990
countries*
(millions)
GDP per capita (in USD$)
1960
South Asia
East Asia
SSA
LAC
Dev’ped cts
World
6
18
45
32
28
164
* Including the CIS countries
1,105
1,671
478
421
858
5,064
1980
1996
781
630
761
2,447
6,205
2,250
935
1,242
1,130
4,537
11,347
3,806
1,333
2,251
1,036
4,480
14,259
4,000
Annual growth rate
1960–96
1980–96
1.5
3.5
0.9
1.6
2.4
1.6
2.2
3.8
-0.5
-0.1
1.4
0.3
The Pros and Cons of Globalization for Developing Countries
41
8
6
4
1960-1980
2
1980-1996
D
ev
W or ld
el op ed
Pl an .
C
en
t.
LA
A
EN
SS
A
tA
M
-C
Ex
-4
si a si a A
So ut h
-2
1997-1998
Ea s 0
Figure 1.1. Average annual growth rates of GDP per capita in main regional groups,
1960–98
Source: IMF
sub-Saharan Africa, and that in the developed countries has widened significantly. As a consequence of these conflicting trends, global income inequality changed relatively little during most of these years (depending on the measure) and the main impact was on the relative position of countries on the global income ladder. What conclusions can be drawn from these changes about the convergence of the global income distribution?
In 1960, the East Asian countries were at the bottom of the global income ladder with an average GDP per capita that was some 20% lower than that of the sub-Saharan
African and South Asian countries; in 1998, the average GDP per capita in East Asia was more than double the average GDP in sub-Saharan Africa. As a result, most East
Asian countries climbed to much higher levels on that ladder, while the sub-Saharan countries fell to the bottom (Figure 1.2). In 1960, over 80% of the population in the lower one-third of the global income distribution were in the East Asian countries; in
1998, 65% of the population in the lower one-third of the global income distribution were in South Asia and 31% in sub-Saharan Africa. In 1960, less than 15% of the population at the higher one-third of the global income distribution were from developing countries; by 1998, their share had risen to 40% (Figure 1.3a and 1.3b).
Table 1.4 shows the changes in global income inequality during 1960–98, as indicated by the three most common measures of income inequality: the Gini coefficient, Theil’s measure, and the coefficient of variations (CV). All three measures indicate that there were only minute changes in income inequality during the 1960s and 1970s, but since 1980 and until 1998, the decline has been more noticeable. During the 1990s, the decline in the measures of global income inequality was primarily due to the rapid growth in China and India and the large share of these countries in the global population. As a result, these two countries, along with most other East Asian countries and some countries in Latin America and the Caribbean, moved to a higher position on the global income ladder, whereas the countries in sub-Saharan Africa dropped to the bottom. The relatively small changes in the three global measures do not show, however, the changes in the relative position of countries on the global income ladder, nor do they show the growing absolute gap between the richest and the
42
Chapter 1
350
1985 US Dollars
300
250
200
150
100
50
1960
1970
South Asia
SSA
LAC
Developed
1980
1990
1996
East Asia
MENA
Ex-centrally planned
Figure 1.2. Index of GDP per capita (PPP adjusted) by regions, 1960–96
poorest countries. The two other measures in Table 1.4 indicate that the gap between the group of high-income developed countries and the group of sub-Saharan African countries has increased by nearly 80% during these years, and the gap between the most affluent country (the US) and the poorest country (indicated in the table by the
Max/Min Ratio) has increased by over 60%.
Several other observations are noteworthy:
1. During the 1980s and the 1990s, the share of the sub-Saharan African countries in the lowest quintile of the global income distribution has nearly tripled from 11.8% to 31.5%, while the share of the East Asian countries in the lowest quintile fell sharply from 35.1 to 7.3% despite their growing population.
2. The share of the South Asian countries in the lowest one-third of the global income distribution increased during the 1980s and 1990s despite the relatively more rapid growth of India, and these countries now constitute more than two-thirds of the lowest income group.
3. In the 1960s and 1970s, the share of the East Asian countries in the lowest income group was more than three-quarters, but by 1996 this share had dropped to nearly zero. 4. The share of the East Asian countries in the middle-income group rose from around 10% in the 1960s and 1970s to around three-quarters by the end of the
1990s.
5. The share of the developed countries in the highest one-third of the global income distribution declined from 64% in 1960 to 43% in 1996, but this was due to the decline in their share in the global population.
The Pros and Cons of Globalization for Developing Countries
43
0,9
0,8
0,7
0,6
Low
0,5
0,4
Medium
0,3
High
0,2
0,1
0
South Asia
East Asia
SSA
MENA
LAC
Ex-Centrally
Developed
Planned
Figure 1.3a. The Share of Regions in the Three Income Groups: 1960
0,9
0,8
0,7
0,6
0,5
0,4
0,3
0,2
0,1
0
Low
Medium
High
South Asia
East Asia
SSA
MENA
LAC
Ex-Centrally
Developed
Planned
Figure 1.3b. The Share of Regions in the Three Income Groups: 1996
Table 1.4. Measures of Inter-Country Income Inequality 1960–98
Indicator
Max/min ratio1
Developed/SSA
ratio 2
Gini Coefficient
Theil’s Measure
Coeff. of
Variations
1960
1970
1980
1990
1998
Change: 1960–98 (%)
38.55
8.15
43.67
9.18
47.26
10.04
61.93
12.26
62.97
14.53
+63.3
+78.3
0.63
0.60
1.58
0.63
0.61
1.55
0.62
0.60
1.52
0.60
0.56
1.52
0.58
0.49
1.48
- 8.1
-17.6
- 6.3
1. The ratio between the average GDP per capita in the US and in the poorest country.
2. The ratio between the average GDP in the developed countries and the average in the SSA countries.
44
Chapter 1
As a result of these changes, the gap between the average GDP per capita in the developed countries and that in the sub-Saharan African countries has increased sharply, while the gap between the developed countries and the East Asian countries has narrowed by over 40%. During these years, the share of South Asia and sub-Saharan Africa in the world’s population rose from 27% to 33.4%, while the share of the developed countries dropped from 21% to 16%. As a result of all these changes, the gap between the average GDP in the group of developing countries and the average in the group of developed countries has changed by only 13%, and the measures of income inequality within the group of developing countries have actually declined.
These changes do not reflect, however, a convergence of the global income distribution, since the gap between the richest and the poorest countries, i.e., the height of the income ladder, has increased significantly. Clearly, for the populations in the countries in sub-Saharan Africa, in most of South Asia, and in Latin America and the
Caribbean, globalization was not inclusive, and the gap between their standard of living and that of the developed countries is now wider than ever. For the population in
East Asia, India, and some Latin American countries, in contrast, globalization was indeed inclusive, and they enjoyed a rapid increase in their standard of living both in absolute and in relative terms. An attempt to draw a general conclusion from these opposing trends and apply it for the “average” or the “representative” people in developed and developing countries is a rather meaningless exercise in statistics.
Instead, the sharp difference between these opposing trends makes it necessary to draw different conclusions for the group of countries that benefited from globalization and for the group of countries that were left behind.
The critical question in this connection is whether the differences between these two groups of countries reflect also the differences in their development strategies. In other words, were the countries that reformed their economies able to gain from globalization and managed to achieve unparalleled rates of economic growth and a sharp reduction in poverty, and were the countries that failed to restructure their economies unable to integrate themselves into the mainstream of the global economy and, as a consequence, did they see their economies shrink and their number of poor increase? A complete answer to this question would require a more thorough analysis, but the reviews of the country experiences in this volume suggest that there is no such clear correspondence. Quite a few countries, including several countries in sub-Saharan Africa, made considerable efforts to reform their economies but were unable to integrate into the global economy due to a host of other reasons.
Table 1.5 summarizes the trends in poverty in the main groups of developing countries and in the world during the 1990s. These trends in the incidence of poverty were reflected also in the changes in the rates of child mortality during the 1990s.
Whereas in most East Asian and South Asian countries there was a reduction in the rate of child mortality during these years, in most sub-Saharan African countries this rate increased. In nearly all Asian countries (Cambodia is one exception), child mortality declined during the 1990. The steepest decline was in the East Asian countries: in
Indonesia the rate declined from 97 to 52, and in the Philippines it dropped from 68 to
47. In sub-Saharan Africa, in contrast, child mortality increased in most countries.
The Pros and Cons of Globalization for Developing Countries
45
Table 1.5. Trends in World Poverty during the 1990s
Region
1990
No. (million)
EA
LAC
SA
SSA
World*
450
74
495
242
1276
1998
Poverty rate
No. (million)
Poverty rate
27.6
16.8
44.0
47.7
29.0
280
78
522
291
1200
15.6
15.6
40.0
46.3
24.0
Source: World Development Report 2000.
* Includes also MENA and the ex-centrally planned economies
The large differences between the patterns and rates of growth of different groups of developing countries underscore the fact that lumping all the developing countries together and conducting the analysis in terms of North vs South, or developed vs developing countries is becoming increasingly misleading.
International Trade and Trade Policies in Developing Countries
The changing concept of comparative advantage
International trade economists have long maintained that a liberal and outwardoriented trade regime is the best strategy for a small economy to increase its welfare and income by optimizing the allocation of its resources in production according to the country’s comparative advantage, and by minimizing the incentives for unproductive activities associated with protection, such as smuggling, lobbying, and tariff evasion.
Additional channels through which trade can precipitate growth include higher returns to investments by increasing the market size with trade, higher productivity through imports and diffusion of advanced technologies, and pressures to rationalize the government trade and macroeconomic policies. Sachs and Warner (1995) estimated that open economies grew about 2.5% faster than closed economies, with even greater differences among developing countries. Tarr and Rutherford (1998) use a CGE model to estimate that a 10% reduction in average tariff (from 20 to 10%) brings about a welfare gain of 10 to 37% of the present value of consumption (depending on the type of taxes that are being used to replace lost tariff revenues).
The neoclassical theory emphasizes the driving force of low wages, abundance of unskilled labor and labor-intensive production technologies in promoting trade and specialization in a labor-abundant country. This analysis is based on an aggregate model in which production is a function of labor and capital, and technologies are characterized by the proportions (or intensities) of labor and capital in production.
Different proportions of labor and capital in the production of different goods, and different endowments of labor and capital in different countries provide the incentives for specialization in production and for trade. This model is the basis of the widely
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employed Heckscher-Ohlin model that separates consumption and production, and shows how the location of production is determined by differences in the technology and by differences in factor endowments between regions and countries that determine, in turn, their comparative advantage. The model predicts that, as trade barriers are reduced, production will relocate according to comparative advantage
(with relatively unskilled labor-intensive activities moving to relatively unskilled labor-abundant locations). As this occurs, the changes in demand for factors of production will tend to equalize factor prices across countries.
In this model, the patterns of trade are determined by ranking goods according to their factor intensities; the labor-abundant country has a comparative advantage in the production of labor-intensive goods. Rybczynski’s theorem strengthens this conclusion by showing that, under fairly general conditions, an increase in labor supply—or an increase in labor productivity (Corden)—brings about an increase in the production of labor-intensive goods. Specialization in production and movements of goods between countries, in line with their comparative advantage, are substitutes for the movement of factors of production, and trade therefore narrows the differences between factor prices. However, the comparative advantage of a country need not be fixed. It may change over time with the changes in its factor endowments and productivity and with changes in its production technologies. The higher the rate of growth of a country’s labor force, the larger the proportion of labor-intensive goods in production and the larger the comparative advantage of the country in the production of labor-intensive goods. The larger the flow of capital from the capital-abundant to the labor-abundant country, the smaller the comparative advantage of the former in capital-intensive goods.
Labor-intensive production. In the neo-classical Heckscher-Ohlin two-factor model, labor intensity of a given production technology or a given product is determined by the capital-labor ratio in production. One production technology is said to be more labor-intensive than another if the capital-labor ratio in the first technology is lower than in the second. Several production technologies can be ranked from the most labor-intensive to the least, according to the corresponding capital-labor ratios, thus emphasizing that labor intensity is a relative concept. Moreover, the same product can be more labor intensive than another in one factor price ratio, but more capital intensive than another in another factor price ratio. (This is known as “factor reversal”). In empirical studies within a given country, the “physical” definition of labor intensity is replaced by a cost definition that evaluates the shares of labor and capital costs in the total costs.
For this comparison, it is necessary to remove first any price and cost distortions due to subsidies or taxes targeted on some of the industries. A considerable number of articles have examined various modifications and extensions of the neoclassical model of comparative advantage in order to adjust the model to today’s conditions in the global economy. Most of these contributions still focus on production technologies, factor requirements, and factor endowments as the driving forces for specialization and international trade. Wood and Berge (1997) argued that the concept of comparative advantage in the Heckscher-Ohlin model is no longer suitable for today’s
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conditions for two reasons. First, the high mobility of capital has led to major changes in factor endowments across countries, thereby continuously changing their comparative advantage. Second, since there is little difference between primary products and simple manufactured products in the intensity of “‘unskilled labor” in their production, the only factors that distinguish the modern sector from the traditional one are land and skilled labor. On these grounds, they concluded that
“[c]ountries that have a lot of land and low levels of education should concentrate on opportunities for progress within the narrow primary category” (p. 1468). This, however, is a static strategy that ignores the dynamic aspects of comparative advantage and the potential to raise the levels of education and thereby acquire new technologies and change the country’s specialization.
The more recent writings on the dynamic nature of a country’s comparative advantage highlighted the following additional factors:
< The effects of investment in R&D that can change a developing country’s comparative advantage by allowing it to produce and export high quality products.
(Okamoto and Woodland 1998);
< The impact of change in a country’s technological capabilities, and thus also in its comparative advantage, due to higher skills of its labor force with better education and training. (Pietrobelli 1997);
< The impact of demand shifts in the more affluent North to higher-quality products as an effect of the rise in income that shifts the production in the North to higher-quality products, while production of an increasing number of relatively lower quality products is shifted to the South, where labor costs are lower (Flam and Helpman 1987).
In addition to these “traditional” gains from trade through the more efficient allocation of resources that is achieved with trade, there will be the following additional gains when the domestic market can be made more competitive and production better organized: 1. Pro-competitive gains. These are the effects of increased imports on the competitive behavior of firms in the domestic market by disciplining the monopolistic or oligopolistic behavior of firms, forcing them to behave in more competitive ways.
2. Gains from economies of scale. As the quantity produced by one firm increases, its average cost decreases. This may be the result of economies of specialization
(firms operating on a larger scale can match inputs more closely to tasks), of indivisibilities in production, or of the greater efficiency of large machines compared to small ones. The decline in average costs leads, in turn, to lower prices.
3. Gains from the rationalization of production. Competitive imports force local producers to increase efficiency or to exit the market. As a result, the number of domestic firms declines and the level of production of each remaining firm increases. Tthe remaining domestic firms are necessarily more efficient and can reap the benefits of economies of scale.
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4. Gains from the increase in variety. The larger variety of products that become available as the country opens up to trade give consumers higher levels of satisfaction. The globalization of trade and research, the growing weight of multinational corporations in world trade, production, and investments, and the rapid technological advancements all promoted greater specialization in production and introduced considerable changes in the comparative advantage of both developed and developing countries. These changes were precipitated by the large flows of investment capital to developing countries, by the growing share of skilled labor in these countries that enabled them to produce advanced manufacturing products, and by the rapid advancements of information and communication technologies that changed the concept of distance in all transactions. These changes help explain the significant transformation of the structures of industrial production in the East Asian countries.
The initial industrialization process in these countries was led by the production of textiles and simple industrial products. Gradually, the production base expanded to include more sophisticated manufactured products such as machinery, steel, automobiles, and later to still more advanced products such as computers and electronics, which are more capital intensive and more skilled-labor intensive.
However, not even the production of textiles and clothing could take place at the initial stages of the industrialization process without a considerable inflow of capital, since at the time these countries were primarily agrarian and lacked the capital necessary for the production of these simple and labor-intensive goods. Although the industrialization process also brought a rise in wages, the rise in labor productivity was more rapid and the comparative advantage of the East Asian countries against the developed countries was therefore maintained. Nevertheless, the structure of their production and trade gradually changed with the establishment of more advanced industries that were attracted by the increasingly better trained and more skilled labor.
The multinational corporations were perhaps the most important vehicles that brought about this change. In their search for the least costly forms of production, these corporations established or expanded affiliates in the East Asian countries and transferred to them, or to independent contractors, the production of labor-intensive products. Labor costs were, however, not the only consideration of the multinational corporations; their choices were also influenced by the relatively stable political conditions in most countries and by the direct government support that these corporations received. Although labor costs were equally low or even lower in South
Asia and sub-Saharan Africa, these countries were much less attractive to multinational corporations and other investors. Despite striking similarities between these groups of developing countries in their initial conditions in the 1960s, the huge differences between them in the depth of the industrialization process and the pace of the transition to the production of higher-quality and more sophisticated products are, first and foremost, testimony to the fact that the concept of comparative advantage can no longer be narrowly defined, as in the Heckscher-Ohlin model, only in terms of production technology, the direct costs of labor and capital, and the relative intensities
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of labor and capital. Other factors are also pivotal in determining the costs of production and the country’s comparative advantage. They include:
< Access to markets. In this context, access refers not only to the geographical distance, but to all the components that determine transport costs, including inland and sea transport costs and the costs of insurance and financial services for trade.
Although the African countries are closer to the European markets than are the
East Asian countries, high inland costs due to the distance to the port and poor road infrastructure considerably reduce their access to these markets. Access to markets is also determined by tariff and/or quota protection and by other barriers to trade, including those established by bilateral or regional trade agreements. In the global economy, accessibility is also determined by access to supply chains that control the trade and marketing of many commodities at the wholesale and retail levels.
< Access to advanced technologies. Low labor productivity, due to high levels of illiteracy, prevents many developing countries from taking full advantage of their labor abundance and low labor costs. In the agricultural sector, the use of traditional technologies, traditional crop varieties, and low yielding crop management practices in the indigenous agricultural systems constrain farmers to producing only self-consumption or for the local market and prevent the development of agricultural exports. The transfer of advanced production technologies and methods from developed countries can accelerate growth and raise labor productivity in the developing countries. The key question is, however, what barriers prevent or slow down the transfer of these technologies and what policy measures can accelerate their diffusion. On the one hand, access to advanced technologies is limited by the lack of necessary skills, by low investment in R&D, and, increasingly, by the costs and restrictions on the transfer of technologies due to IPR and patent issues. On the other hand, modern information and communication technologies, including the Internet, reduce communication costs and break down geographical borders, thus speeding up the diffusion of knowledge and advanced technologies.
< Economic and political stability. These are essential non-tangible conditions that determine investment risks and costs. Until the 1998 crisis, investors in Asian countries enjoyed very stable political conditions. This stability was often assured by authoritarian rule, but opposition was significantly mitigated by the success in raising the standard of living. When these standards fell sharply during the crisis, political stability was severely shaken in many, if not most, of these countries. In most sub-Saharan Africa, political stability is all but lacking. Continued wars, frequent changes in policies and in the regimes themselves, weak institutions of law enforcement, and widespread corruption significantly raise business risks, discourage investment, increase insurance costs, and are highly detrimental to both internal and external trade.
< (Relatively) stable labor market. The Asian countries—each according to its level of development—adopted elements of the Japanese system of lifelong employment, seniority-based wages, and enterprise labor unions that secured workers’ loyalty to their employers. Government welfare programs are rudimentary even in South Korea and Taiwan, and labor unions focus their
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demands mainly on job protection. In Latin America, labor unions are national and they are very active in their country’s politics. The pressures exerted by the unions and their political power triggered government intervention through minimumwage legislation and relatively high wages in the public sector. These interventions distorted the price of labor and inhibited the absorption of surplus labor.
Functioning markets. The economies of many developing countries were, and still are, plagued by massive price distortions and a host of restrictions that prevent the development of functioning markets. The removal of these distortions and restrictions is necessary not only to attract foreign investors, but also to create profit incentives for domestic private enterprises, and thereby boost production and streamline labor allocation. In sub-Saharan Africa, the haphazard and incomplete market reforms were noted as one of the central reasons for slow growth (World Bank 1994). However, even among the most successful East Asian and Latin American countries, market reforms were limited in two ways. First, the governments in these countries maintained and even expanded some price distortions that were designed to support local enterprises and encourage industrial production. Second, the removal of distortions and the development of functioning markets were often confined to producer services and to what Radelet and Sachs
(1997) termed the export platform.
Government interventions. In all Asian countries, government investments in infrastructure, health, and education, as well as direct investments in enterprises were pivotal at the early stages of the industrialization process. These, together with large-scale interventions in many other forms, gave strong incentives to foreign and domestic entrepreneurs to invest in local industries. Indeed, even the
World Bank (1993) survey of the “Asian miracle”’ provided details on more proactive tactics of direct intervention that the Asian government often adopted at the early stages of their development. The report acknowledged that the neo-classical, “getting the basics right” policies do not tell the entire story. In each of these economies the government also intervened to foster development, often systematically and through multiple channels. Policy interventions took many forms: targeted and subsidized credit to selected industries, low deposit rates, and ceilings on borrowing rates to increase profits and retain earnings, protection of domestic import substitutes, subsidies to declining industries, the establishment and financial support of government banks, public investment in applied research, firm- and industry-specific export targets, development of export marketing institutions, and wide sharing of information between public and private sectors.
Two additional factors that, from the public welfare point of view, must be considered negative have an impact on the comparative advantage of a country:
< Absence of labor laws. In addition to minimum wages, companies in the developed countries must provide high social benefits that include pension contributions, vacation, paid sick leave, social security, and health benefits, etc.
They are also bound by occupational safety and health rules. In many developing countries, there are no such laws, not even with respect to child labor.
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Low environmental standards. Against the high and rising standards of environmental protection and pollution control in the US and Western Europe, the very low standards and lax enforcement in most developing countries give them an
“advantage” in highly polluting production processes (Bhagwati 1997).
On these grounds, producers in importing countries that maintain high environmental and labor standards claim that the lax standards maintained in some exporting countries give those countries an unfair competitive edge. Indeed, the pressures of many groups and labor unions in the developed countries to enforce minimum environmental standards and child labor laws under WTO agreements reflect not only a genuine concern for these issues, but also efforts to lower the comparative advantage that these exporting countries have on account of their low environmental standards and the absence of labor laws.
Low labor costs, combined with all the other factors that determine the cost of capital and the risk for foreign investors, created the conditions that changed the comparative advantage of East Asian countries and enabled them to specialize in manufacturing production and to attract foreign investors. Other developing countries, particularly in Latin America, offered some of these components, but few could compete with the conditions investors found in East Asia. Obviously, not all of these components are positive or beneficial to the country in the long term, nor are they equally tenable in all countries. However, the rapid growth of the East Asian economies, their dramatic downfall in 1997 and 1998, and the equally dramatic recovery of most of them since 1999 emphasize the need to take into account the entire spectrum and all the components that determine the comparative advantage of a country, not just the abundance and low cost of unskilled labor, in order to have a more complete understanding of the “East Asian miracle” and in order to apply the lessons from this “miracle” in the design of development policies for other countries.
Outward- vs inward-oriented growth strategy
While the debate about the most suitable growth strategy for a labor-abundant economy has always been loaded with controversies, the dominating view was that, for the majority of developing countries, the prospects of growth are closely linked to industrialization. Even in the primarily agricultural countries of sub-Saharan Africa, long-term growth was linked to increasing the domestic value added through processing, and in practically all countries, per capita GDP grew with the rise in the ratio of manufactured to primary products. During the past decade, discussions on the most suitable industrial strategy were dominated by the rapid growth of the East Asian economies that was achieved through an outward-oriented development process and a rapid increase in exports. The discussions centered on the following key questions:
< How significant was the outward-oriented strategy?
< How significant was the focus on industrialization?
< What was the role of the other components of the growth strategy of the East Asian countries, including government investment in infrastructure and education and the large subsidies to foreign direct investment (FDI, see Box 1.1)?
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Box 1.1. Foreign Direct Investment (FDI)
Since the early 1980s, world FDI flows have grown faster than either the world trade or the world output. The flows of FDI to East Asia and, to a lesser extent, to the other developing countries, grew at an average annual rate of over 30% in the first half of the 1990s, from less than $35bn per year to around $100bn by 1994, and at an average annual rate of 15% in the second part of the 1990s to over $250 billion in 2000, but their share of total investment flows declined from 43% in 1997 to
21% by the end of the decade as an effect of the financial crisis in East Asia. More than half of these investments were made in East Asian countries, whereas the flow to Latin America and the Caribbean (primarily Chile, Argentina, and Brazil) grew at much lower rates, and only a trickle reached sub-Saharan Africa. The Asian crisis had a significant and immediate impact on this flow. Indonesia, for example, had an FDI inflow in excess of $4bn during 1994–97, but in 1998, with the emergence of the crisis, this flow dried out, and in 1999 there was a net outflow of over $2bn. China was the main beneficiary of this change of direction of FDI, and in 1999, it had an inflow of nearly $50bn. Some Latin American countries also had larger inflows in recent years due, in part, to the outflow of capital away from the crisis countries in East Asia. In 1999, the FDI flow to Brazil exceeded $30bn, and the FDI flow to Argentina reached nearly $25bn.
Notwithstanding the financial turmoil in East Asia in 1998, global FDI inflows increased for the seventh consecutive year to reach $430-440 billion, becoming an important source of private external finance for the developing countries.
According to the latest FDI data released by UNCTAD, world FDI flows increased by 18% in 2000 to a record US$1.3 trillion, compared with only $203 billion in
1990. Much of this investment was driven by corporations buying or merging with companies in other countries, contributing to increasingly global multinational firms. Most FDI flows went to the industrialized world. FDI flows to the developing countries overall grew by 8% to US$240 billion, and to the economies in transition of Central and Eastern Europe by 9% to US$25 billion. However, FDI flows to Latin America and the Caribbean declined in 2000 by 22% to US$86 billion, primarily as an effect of the evolving crisis in Argentina, and the flows to
Africa continued to decline.
The factors that determine the inflow of FDI into a country and make the country a desirable destination for FDI include political and economic stability, the market size, the availability of natural resources and human capital, the country’s growth prospects, and the existence of favorable investment and tax regimes. A recent UNCTAD report concludes, however, that such traditional features, although still important, no longer constitute the most significant driving forces. In a world increasingly characterized by a global and highly interconnected trading system, companies look for places to invest that offer specific advantages, such as a good communications infrastructure and intangibles such as political stability and business culture. The direct effects of FDI on the host country are the product of the
FDI’s effects on factor endowments and rewards. These investments improve
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productivity, raise the marginal product of labor, and reduce the marginal product of capital, thereby promoting economic growth and exports and raising incomes and wages. There are also indirect effects (or externalities) of FDI that are due to the impact of foreign multinational corporations on their host economies. These effects may vary, however, between industries and countries, depending on the characteristics of the host country and the policy environment.
The large flows of FDI to the EA countries and the growing integration and globalization of the capital markets increased their capacity (that came to be perceived as good risks) to access these markets directly in order to secure funding for projects that in the past could only be financed through the World Bank.
<
What was the rise in total factor productivity in these countries, and what was its contribution to their economic growth relative to the contribution of the large resource mobilization? How effective was export promotion industrialization vs. import substitution?
To answer these questions, this section surveys the discussions in the economic literature and reviews the experience of selected countries.
In their highly influential research on trade and industrialization, Little, Scitovsky, and Scott (1970) provided a thorough account of the connection between an export-oriented growth strategy and the rate of economic growth. They emphasized the effects of competitive conditions in the world markets on exporting enterprises that force countries to eliminate distortions, thus leading to better macroeconomic performance and more rapid growth. In contrast, efficiency considerations are secondary behind the walls of protection, and (infant) industries (even construction) have little incentive to select the more cost-effective and labor-intensive technologies.
The World Bank’s World Development Report of 1987 and 1990 noted that the high walls of protection often reduced the use of labor in the formal sector, whereas more open and outward-oriented trade regimes tend to support more labor-intensive patterns of industrial expansion in both import-competing and export industries. Bhagwati
(1982) highlighted another distortion of an inward-oriented trade regime that is a result of its heavy reliance on market restrictions and state intervention and is therefore more likely to create an environment that is more congenial to directly unproductive profit seeking. With open, outward-oriented strategies, in contrast, the state is less involved, and profit seeking is more likely to be productive. Bhagwati noted the wide consensus among economists that an outward-oriented trade strategy helps the process of industrialization and economic growth. In his words: “The question of the wisdom of an outward-oriented (export-promotion) strategy may be considered to have been settled” (1987, p. 257).
There is, however, no conclusive empirical evidence that in all countries an inward-oriented development strategy based on import substitution would indeed reduce longer-term growth rates. In a comprehensive cross-country study, Chenery,
Robinson, and Syrquin (1986) showed that the average yearly GDP growth rate in
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semi-industrial economies that adopted import-substitution policies was only a few tenths of a percent lower than the growth rate in countries that adopted exportpromotion strategies. McCarthy, Taylor, and Talati (1987) used a different grouping of countries, based on per capita GNP, and showed that the fast-growing countries did not have, on average, a higher (or increasing) share of exports in GDP. Easterly and Levine
(1994), however, established a clearer causal relationship between enhanced exports performance and more rapid growth in extended cross-section studies.
Two factors may affect the straightforward calculus of the gains and relative merits of an outward-oriented trade policy. The first is the importance of trade taxes in the budgetary revenues of developing countries. An IMF survey of the 36 least developed countries (LDCs, see Box 1.2) found that trade taxes account on average for 5% of
GDP, or about one-third of total tax revenues. The implementation of a broadly defined trade reform that includes the overhaul of customs administration or compliance with WTO obligations requires heavy budgetary outlays. The second factor is the strategic trade policy, emphasized by the “new trade theory,” which justifies protection in the presence of “strategic” interactions among firms in domestic and international markets (i.e., when a change in the behavior of firm 1 leads to a change in the optimal behavior and a strategic response of firm 2). By choosing an optimal import tariff or subsidy, the government can affect the strategic game played by firms in international markets to the advantage of domestic firms. Often, however, the strategic trade policy literature gives rise to contradictory results depending on the type of market structure and the form of competitive rivalry. As a result, this literature has generally been considered of little use in the guidance of governments’ trade policy. There are also doubts about its relevance for trade policy in developing
Box 1.2. The Least Developed Countries
Since 1971, countries with weak economies and deep poverty have been categorized as Least Developed Countries (LDCs). By the end of the 1990s, 49 countries with a combined population of 610 million, equivalent to 10.5% of the world population, were identified as LDCs. Most of these countries are in sub-Saharan Africa. In 1981, the United Nations General Assembly held the first
UN Conference on the Least Developed Countries in Paris, in which it adopted the
“Substantial New Programme of Action for the 1980s for the Least Developed
Countries.” However, despite major policy reforms initiated by many LDCs to carry out a structural transformation of their domestic economies, and supportive measures taken by donors, the economic situation of these countries as a whole worsened during the 1980s. The Second UN Conference on the Least Developed
Countries held in Paris in September 1990 formulated national and international policies and measures for accelerating the development process in the LDCs, drawing on the experience and lessons from the 1980s. A mid-term review of the implementation of the program of action for the LDCs for the 1990s concluded, however, that these countries continue to be marginalized.
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countries, which tend to be primary product exporters, since the production of primary products is rarely characterized by large economies of scale.
The success of East Asian countries in achieving high rates of economic growth made export promotion, spurred by open trade and market liberalization, the strategy of choice. The World Bank study titled The East Asian Miracle (1993) emphasized the prominent role of export-oriented policies in the economic “miracle” of the East Asian countries. The report paid close attention to the process of industrialization in these countries that initially took advantage of the abundance of cheap labor by building up industries with highly labor-intensive production that required mostly unskilled labor.
Perhaps the most obvious example is the clothing industry, which is highly laborintensive and in which developing countries have a clear comparative advantage.
Although higher productivity in the developed countries could offset part of their higher labor costs, the very low labor costs in Indonesia, China, and Pakistan, which were only 5 to 10% of those in the US, allowed these countries to produce much cheaper clothing despite their less productive technologies. In East Asia, the clothing industry was the quintessential foundation on which the industrial base was gradually built as these countries accumulated more know-how, developed a better-skilled labor force, and opened their economies to foreign investment. In other developing countries, the agricultural sector can play this role, as we see in Part III.
The World Bank account of the East Asian “miracle” emphasized the importance of market-oriented incentives that led to large gains in efficiency and factor productivity. These incentives were created by setting the correct price signals through the unification of the exchange rate, the measured devaluation, and the removal of various distortions on the one hand, and the disciplining force of open trade and export-promotion strategies on the other. The pressures of international competition and the greater role of the market seem to have mitigated the worst kind of rent-seeking behavior observed in those countries that rely on industrialization through import-substitution. Other studies on the experience of East Asia gave, however, equal weight to the influence of government intervention through subsidies, trade restrictions, administrative guidance, and credit allocations (Rodrik 1992 and 1995;
Amsden 1990; Wade 1990). In their view, this government intervention was necessary at the early stages in order to facilitate the transition from the production of primary products for the domestic market to the production of manufacturing goods for the home market and exports, and in order to make investments in the non-traditional sector sufficiently attractive. The weakness of the market system in these countries at the early stages of development, and the absence of the necessary financial and economic institutions, made the state the only entity that could offer these incentives and provide a measure of security. Rodrik argued that the main push for the economic take-off in South Korea and Taiwan did not come from the increase in exports, but from the sharp rise in investments that was largely engineered by the government through direct credit at low or even negative interest rates, and through investment subsidies, direct administrative subsidies, and the use of public enterprises. In both countries, investments rose from 10% of GDP in the late 1950s to 20% in the mid-1960s and 30% in the early 1970s. This large increase in investments was matched by a roughly equivalent increase in savings that prevented inflationary
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pressures. Government coordination in the form of administrative guidelines as well as direct investments in key industries were pivotal, since increasing returns to scale in the production of the modern sector made it initially impossible for the private sector to take full advantage of these investment opportunities despite the high subsidies
(through credit at negative real interest rates, tax incentives, etc.).
Another part of the debate on the forces behind the East Asian “miracle” focused on the effect of export-led growth on total factor productivity (TFP) and the contribution of the rise in TFP to growth. Several empirical studies found a high correlation between a country’s overall growth performance and its export growth, and between a country’s growth in TFP and its export growth, although this correlation does not establish causality. Sarel (1995) estimated that in the four Asian ‘”tigers,” output per person rose during 1975–90 by an average of 6.5% annually, whereas the annual TFP growth rate ranged between 2% in Singapore and over 3.5% in Taiwan and
Hong Kong. According to his estimates, TFP growth accounted for nearly half of the total growth of output per person. In China, Hu and Khan (1996) estimated that TFP rose at an annual rate of nearly 4% during 1979–94. The World Bank 1993 study emphasized the contribution of the significant rise in productivity to economic growth, and noted two factors that led to this rise. One was the removal of discriminative and highly distorting prices in the domestic market and the elimination of trade barriers; these measures exposed local enterprises to the disciplines of competition, which led to better allocation of resources. The other factor was the adoption of new technologies and the latest vintage capital formation by export industries that led to technology and productivity spillovers from which the entire economy could benefit. To maintain their international competitiveness, enterprises in East Asia also had to rely on a steady rise in the productivity of their workers that was made possible by their improved skills and better training. In Korea, this led to a virtuous cycle of growing exports that led to more investment in the export industries that led, in turn, to further productivity gains.
In contrast, Young (1992, 1994, 1995), Rodrik (1995), and Krugman (1994) argued that the remarkable growth of East Asian countries was not due to an unusual rapid growth of TFP, but to the rapid accumulation of capital and the increase of the labor force in manufacturing. According to Young’s (1994) estimates, the annual TFP growth in South Korea and Taiwan during 1966–90 was 1.2% and 1.8% respectively.
These rates, however respectable, were of the same order of magnitude as the rates in
Argentina, Brazil, Chile, and Mexico. Kim and Lau (1994) found that in the four Asian
“tigers,” capital accumulation accounted for over half of their economic growth.
Krugman attributes this growth primarily to an “astonishing mobilization of resources” rather than to gains in efficiency.
The debate over the merits of export promotion vs import substitution was at the center of the discussion in the economic development literature as early as the 1950s.
The consensus among professionals at the time in favor of an outward-oriented, export-led growth strategy did not rule out, however, an import substitution strategy in the first stage of the industrialization process, and it has been recognized that virtually all the successful exporters of manufacturing, with the exception of Hong Kong, began their industrialization with an inward-oriented strategy that promoted import substitution under significant protection. Moreover, in some countries, the gains from
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export-led growth that are due to scale economies in production can also be reaped in the production of import substitution if their domestic market is large enough. In small countries, the industrial strategy must be based on specialization and “niche-oriented” industries (Chenery et al. 1986). Brazil and Korea are good examples of these two extremes: in Brazil, the share of commodity exports in the mid-1980s was less than
10%, whereas in Korea, the share was close to 40%. Brazil relied on the growth of its domestic demand to generate scale economies and technical change, whereas Korea pursued more aggressively outward-oriented policies aimed at transforming the domestic industries from producing predominantly for the highly protected local market to producing industrial goods for exports (Taylor 1989). Korea is poor in natural resources and the shares of its industry in both exports and GDP are therefore much higher than in resource-rich Brazil.
A series of country studies organized by the World Institute for Development
Economics Research in 1987 and 1988 demonstrated that Korea, Taiwan, Turkey, and other countries where economic progress was led by the rapid growth of export industries had an initial stage of industrialization based on import substitution. In
Turkey, for example, the export-led growth during the first part of the 1980s was built on an industrial base that had been created at an earlier stage of import-substitution industrialization as well as on heavy export subsidies and various administrative measures to promote exports. The success of the export-oriented strategy in these countries was attributed, in part, to the “crowd in” effect of public investments that gave incentives to private investments via complementarities and allowed a greater diversification of the industrial sector. On these grounds, Shapiro and Taylor (1990) argued the following:
“There is no reason why production for appropriate niches should not initially be supported by import barriers and export subsidies; indeed, the ‘opportunity costs’ of not trading have to be ignored until learning and scale effects take hold. The point is that full industrialization only occurs after infant firms grow up, and can compete more or less effectively on international terms.” (p. 873).
In Korea, infant industries were protected by high tariffs during the early stages of industrialization alongside the export drive, and while exports were liberalized, the domestic market remained protected. The monopolistic or oligopolistic conglomerates that dominated many Korean industries were able to practice price discrimination that was considerably augmented by export subsidies. Infant industries matured by acquiring more advanced technologies, and gradually the effective protection rates were reduced. These industries turned to international trade not due to market forces, but largely because they were driven by government regulations to export their products (Lee 1997). However, the concentration of manufacturing production in
Korea and in most other East Asian countries (except Taiwan) in large conglomerates, together with the power exercised by transnational corporations over exports created their own distortions, substantially reducing the efficiency gains of the export-led growth and its advantage over industrialization via import substitution (Helleiner
1990).
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What are the prerequisites for and the impediments against the adoption of a similar growth strategy in sub-Saharan Africa? What should the components of this strategy be? The East Asian Miracle drew two main lessons from the strategy of East
Asian countries. First, the prerequisites for a successful growth policy are suitable social and political environments. Appropriate infrastructure—from electricity and highways to schools and health clinics—must be in place, and the government must have a central role in building this infrastructure. Second, the price system must provide proper incentives, and the institutions and mechanisms for competition must be sufficiently robust to secure the efficient working of the market. The World Bank report titled A Continent in Transition: Sub-Saharan Africa in the Mid-1990s (1995), which focused on the lessons for sub-Saharan Africa, emphasized the need for more market-oriented policies, more openness to trade, and sound macroeconomic policies.
Alesina (1997) emphasized the importance of institutions for growth and noted the need for the protection of property rights and relative political stability. All these components determined the comparative advantage of East Asia as much as, or even more than, their factor endowments and relative costs in production. The role of institutions and the idiosyncratic structure of institutions in the “‘Asian model” are discussed in more detail in the next section.
The “Asia way” and the role of institutions
The high performance of the East Asian countries until the 1998 crisis was the main reason for the near general praise of the policies that these countries implemented. The
East Asian Miracle noted the importance of market-oriented incentives that led to large gains in efficiency and factor productivity. These incentives were created by setting the correct price signals through the unification of the exchange rate, the measured devaluation, and the removal of discriminatory and distorting prices on the one hand, and the disciplining force of open trade and export-promotion strategies on the other. Other studies on the East Asian “miracle” gave equal weight to the role and effects of direct government intervention through continued subsidies, trade restrictions, administrative guidance, and targeted credit allocations to selected industries, on the grounds that, at the early stages of development, direct government support was necessary to make the transition from the production of primary products for the domestic market to the production of manufacturing goods for exports, and in order to stimulate foreign direct investments in the nontraditional sector. The weakness of the market system in these early stages, and the near absence of the necessary financial and economic institutions, made the state the only entity that was able to offer these incentives and provide a measure of security.
The focus on the economic aspects of the “Asian miracle” narrowed the “Asian model” unduly and omitted key components that did not show up in the countries’ statistics, but are essential for a more comprehensive understanding of the “miracle.” It was recognized well before the 1997–98 crisis that the “Asian way” of doing business is different from that of the West. The Asian model of capitalism, in which free market competition was transformed to accommodate collusion between the government and the business establishment, was, however, touted (until that crisis) as better suited to
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Asian traditions than the Western model of free market capitalism. The crisis exposed fundamental weaknesses of this model, which were also the main reasons for the crisis itself. The organization of production for exports at the early stages of development allowed Asian countries to make the transition despite the lack of an industrial base.
Radelet and Sachs (1997) noted that a unique and essential feature of the Asian model was the creation of an export platform—an enclave economy, hospitable to foreign investors and integrated into the global economy, unfettered by problems of infrastructure, security, rule of law, and trade policies that plagued the rest of the economy. On this platform, Asian countries were able to concentrate their investment and move up in technological development. Moreover, in the authors’ view, the platform not only allowed these countries to move up on the production ladder—from primary products to textiles to electronics and machinery—but also created a much broader modernization of the political and economic institutions.
The principal reason for the greater complexity and the inherent weakness of the
Asian economic model is that the export platform was not really an autonomous economic enclave. Rather, it remained connected in some essential functions to the rest of the economy. Plagued by problems of infrastructure, security, and the rule of law, these countries had to find a strategy that would allow an efficient and unimpaired management of production and the conduct of other business affairs on the export platform, despite these connections. Asian countries found a strategy that proved workable and effective for nearly three decades and was instrumental in promoting their rapid growth. The most important channel through which the export platform was connected to the rest of the economy was the financial sector. Since foreigners were not allowed to own banks, corporations that produced for exports had to rely on and adjust to the country’s financial institutions. The financial system was plagued, however, by sloppy banking practices and ineffective and often corrupt supervision, which allowed the provision of loans on the instruction of, or as a favor to, influential politicians or cronies. Another channel was the work force and the increasingly militant labor unions. With the rise in living conditions and the expansion of the industrial sector, workers began to organize and demand wage increases and improved working conditions. The third channel was the system of government, which was highly centralized, highly authoritarian, and actively involved in all aspects of the economy. These channels exposed the export platform to the weaknesses of the local economic, legal, and political systems and threatened to stall its take-off. To deal with these stumbling blocks, it was necessary to have a strategy that would allow the export platform to function despite these weaknesses. The strategies adopted by Asian countries show remarkable similarities. In fact, these countries followed, with surprisingly little variation, the patterns of the countries just ahead of them in the development process, not only in their technological advancement, but also in the evolution of their economic institutions. Indeed, the common denominator of these patterns constitutes the “Asia model.” The principal components of this model were the following:
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<
<
<
<
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strong and authoritarian governments, assisted by an obedient and highly efficient bureaucracy, secured peace and stability, and enabled corporations to work without red tape in their investments and production decisions; the financial system, which had very limited independence in making business decisions and mainly functioned as a service agent to corporations; large corporations that organized a significant portion of production and exercised influence over the political system and controlled the financial institutions; a social welfare system that was built on a social contract between the workers and the corporations employing them. The role of the government was mainly to support that contract by subsidizing companies in order to keep people employed.
Authoritarian governments had a clear and significant role in creating the necessary conditions for establishing the export platform, in forging partnerships with foreign capital (and meeting the whims of foreign investors), and in conducting conservative fiscal and monetary policies, thus igniting the engines of growth and keeping them on track. The management of the economy was often delegated to a team of efficient technocrats that conducted a very responsible fiscal policy and maintained a stable currency, helping to keep inflation low. Thus, for example, the relative peace and social stability until the crisis, abundance of cheap labor, plentiful natural resources, and a stable currency made Indonesia highly attractive to foreign investors. As the economy developed, production became more sophisticated and capital intensive, financial decisions grew more complex, and the scope for errors and corruption under an authoritarian government rose sharply. Moreover, the Indonesian government, like most other East Asion governments, did not permit any significant development of institutions of governance and any significant move toward greater democracy. Hopes and expectations that the export platform would provide an incentive to modernize the political and economic institutions did not materialize. In the absence of these institutions, cronyism and corruption became common. In Indonesia, the absence of proper institutions of government was the reason why a financial crisis that initially appeared rather benign—primarily a case of mismanagement—and seemed not too difficult to correct, rapidly deteriorated into a complete meltdown of the currency and a crisis of leadership.
In the 1960s and 1970s, most East Asian countries were essentially political tyrannies, either of political parties or of individuals. In that sense, they were not much different from the political tyrannies that ruled in most of sub-Saharan Africa. Yet in the 1980s, East Asia grew very rapidly and succeeded in developing rather advanced economic institutions that managed the economy very efficiently, whereas sub-Saharan Africa failed to reform its economies and entered into a spiral of slow or even negative growth that was accompanied in many countries with a collapse of the institutions of governance and outright chaos. An intriguing explanation of the marked differences between the experiences of these two groups of countries can be found in the (last) book that Mancur Olson published in 1998, entitled Power and Prosperity:
Communist and Capitalist Dictatorships. Olson distinguished between what he terms political tyrants and political warriors, arguing that political tyrants have a stake in the country they are ruling over and exploiting, because the more the country prospers, the
The Pros and Cons of Globalization for Developing Countries
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more they can extract for themselves in the form of legal or illegal taxes. The political tyrant therefore keeps taxes relatively low and develops rather effective institutions to manage the economy in order to assure the country’s long-term prosperity, thus maximizing also his long-term profits. The political warrior, in contrast, does not have the long-term perspective and seeks to maximize the profits he can extract from his subjects as fast as possible, thus leading to the collapse of institutions and to anarchy.
The Asian financial “model” served the needs of the production systems in these countries very well in the early years by raising funds, initially in the domestic market and later also abroad, and making them available, on the instructions of government officials and at highly subsidized rates, to “strategic” industries. The investment and lending decisions were rather simple at that stage, since the choice of strategic industries and the investment decisions in these industries were rather clear. Already early on, however, banking practices were sloppy, in part due to the absence of a proper regulatory system and lax government oversight, and in part because the financial institutions were captive to high-level politicians, bureaucrats, and corporate managers. Nonetheless, the banks remained profitable because they were able to raise inexpensive funds from the public thanks to the very high saving rates and the rapid growth in income. At a later stage, the banks were also flooded with funds as a result of the larger inflow of foreign capital that grew six-fold between 1991 and 1996.
Unconstrained by the lax government oversight, the banks went out of their way to give loans, in the process exposing themselves to higher risks and becoming leveraged with short-term debts. Corporations expanded well beyond their needs, and profitability of new investments was not the guiding principle for corporations or banks. Deference, trust and tightly knit relationships—those Asian values that in the early stages were instrumental in providing a substitute for the lack of practice and experience with risk management—gradually gave rise to cronyism, nepotism, corruption, and reckless risk-taking whenever rising profit opportunities presented themselves. Large investments in real estate and office construction continued unabated despite the slow-down in exports.
The Asian crisis brought the deficiencies of the Asian “model to the forefront and revealed the weaknesses of the economic and political institutions in these countries.
When the crisis unfolded, some hastened to conclude that the model was fundamentally flawed. The crisis should not obliterate, however, the fact that the
“Asian way” had many advantages in the early years of the region’s development. It failed, however, to keep up with its own success by hindering the evolution of the institutions that are essential for longer-term development. The focus on economic growth gave precedence to the short-term. The longer-term price that Asian countries paid for this narrow focus was not, however, confined to the lack of institutional development and improper governance; it also included environmental degradation, crowded cities, and the decay of the rural sector. The Asian crisis thus highlights the need to make the development of institutions an integral part of development strategy.
The relatively rapid recovery of some of the countries in the region—particularly
South Korea, Singapore, and Malaysia—in 1999 and, even more so, in 2000, and the slow recovery of Indonesia, Thailand, and the Philippines, also emphasize the political dimension of the crisis and the fundamental weaknesses of the political and social
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systems that were aggravated in the crisis and slowed down the recovery. Indonesia is clearly the most notable example of the impact of political instability on the economy.
The country experienced a 14% fall in GDP in 1998 and zero growth in 1999. The economic decline exacerbated the political problems, and in mid-2000 the economy entered a new slump. The Philippines were initially less affected by the regional crisis, but the political turmoil in 2000 very markedly slowed down economic growth. The entire region benefited from the continued rapid growth in the US and the EU during
1999 and 2000, which generated high demand for East Asian export products, most notably electronics. However, the high share of electronics in their exports and the high share of exports in their GNP make these countries very vulnerable to any slowdown in the economy of developed countries, particularly the US.
Globalization and Strategies of Sectoral Development
The role and structure of agricultural development strategy
The slow pace of industrialization and the rapid population growth in many developing countries, particularly in sub-Saharan Africa and South Asia, severely compromise the potential of the modern/industrial sector to absorb surplus labor. As a result, the continued flow of rural migrants has led to growing unemployment and poverty in the urban areas. An effective growth strategy in these countries must have a balance between industrialization and rural development and explore the potential employment opportunities in rural areas. So far, however, the pace of development is not very encouraging. During the past two decades, the per capita agricultural production in all the developing countries grew at an annual rate of less than 1%, and in many of the LDCs, agricultural growth was outpaced by population growth. The pace of agricultural growth is considerably slower than during the 1970s, at the time of the
Green Revolution, when per capita agricultural production in the developing countries grew at an annual rate of 1.1%, after declining at an annual rate of 0.3% during the preceding decade (Table 1.6).
The evidence of the last two decades, primarily in sub-Saharan Africa and South
Asia, makes clear that in these countries the agricultural sector will not be able to
Table 1.6. Growth of Food and Agricultural Production in Developing Countries
(%)
Country group Food
Total
All agriculture
Per capita
Total
Per capita
1961–70 1971–84 1961–70 1971–84 1961–70 1971–84 1961–70 1971–84
Developing
Low-income
Asia
Africa
2.2
1.3
1.2
2.6
Source: World Bank (1986)
3.2
3.2
3.4
2.0
-0.3
-1.3
-1.3
-0.2
1.1
1.2
1.5
-0.9
2.4
1.9
1.8
3.0
3.0
3.3
3.6
1.2
-0.1
-0.7
-0.7
0.2
0.9
1.3
1.7
-1.7
The Pros and Cons of Globalization for Developing Countries
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sustain per capita growth rates in excess of 2% per annum without a significant increase in yields. Despite the early hopes during the Green Revolution, growth rates in agriculture seldom exceeded 4% per annum, and sub-Saharan Africa benefited very little from the new crop varieties that were developed at that time. Several factors may inhibit the growth prospects of the agricultural sector in many developing countries:
< large direct and indirect subsidies to agricultural producers in the EU and the US and a rise in their production efficiency and yields. This led to a continuous and often sharp decline in many commodity prices in the international markets and reduced the capacity of farmers in the developing countries to produce these commodities at competitive prices. In many developing countries that opened up their economies to international trade, cheap imports of wheat, rice, corn, soybeans, and other raw crops from the developed countries made it difficult for local farmers to sell their products at competitive prices even in the local markets.
< constraints on the transfer of advanced technologies and crop varieties from the developed countries due to IPR regulations and constraints on the development and adaptation of local technologies and varieties due to shrinking budgets for public agricultural research;
< slow diffusion of new technologies due to the ineffective and resource-stretched extension services and slow adoption of high-yielding varieties due to the skills required for successful adoption.
< poor infrastructure limits access to markets, both domestic and abroad, thus preventing greater specialization and adoption of high-value crops that can generate higher income, and forcing many farmers to grow primarily for self-consumption; < limited access of small landholders to credit and lack of financial institutions, arrangements and instruments for savings and investments in rural areas;
< continuous erosion in the quality and quantity of agricultural lands;
< decline in the world prices of traditional export crops such as coffee, cocoa, and bananas—the main cash crops in sub-Saharan Africa and in Latin America and the
Caribbean.
As a result, the growth of agricultural production was much slower in quite a few countries, particularly in sub-Saharan Africa, and employment opportunities for the rural population declined in practically all developing countries. In the developing countries as a whole, the share of the agricultural sector in total employment fell from an average of over 30% in the mid-1960s to an average of less than 20% in the mid-1980s, primarily due to the decline in the share of agriculture in the total GDP and the rapid urbanization. There were, however, wide variations between countries: during 1950–90, the share of agricultural employment in total employment declined by
30% in Thailand and Indonesia, by nearly 80% in South Korea, by 50–60% in Latin
America, and by 10–25% in sub-Saharan Africa.
In sub-Saharan Africa, the growth rate of agriculture was highly correlated with the growth rate of the other sectors, primarily because of the dominant role of the agricultural sector in the economy, and the share of agriculture in the GDP therefore changed relatively little (Rao and Caballero 1990). Since the growth rate of their
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industrial sector was also very slow, these countries could not rely on the industrial sector as a source of employment, and the pace of urbanization was much slower than in other continents. The relatively slow decline in the share of agriculture in total employment also accentuates the low and declining productivity in agriculture that was due, in part, to the migration to the urban areas, which left behind the very young, the old, the handicapped, and single mothers (Table 1.7).
For countries that are predominantly rural and where industrialization is still at an early stage, rural-based development strategies have been advocated (Mellor 1976).
The time that these countries would need to build an industrial base able to absorb the surplus labor from rural areas is bound to be long, and a strategy based on rural development therefore promises a faster increase in employment and reduction in poverty. Restructuring and expansion of agricultural production can also contribute to the development of the other sectors through forward linkages with processing industries. A study in India, Pakistan, Malaysia, and the Philippines found that, as an effect of this linkage, a 1% addition to the growth rate of agriculture would add 0.5% to the growth rate of industrial output, and 0.7% to that of the national income
(Haggblade, Hazell, and Brown 1989). A rural-based strategy will also be more effective in reaching the poor because the majority of the poor still live in rural areas, and most of them depend on earnings from agriculture or from non-farm work that is partly linked to agriculture (WDR 1990). Over two-thirds of the rural poor are small farmers and landless laborers; many of them live in countries and regions where growth in agricultural production is lagging behind the population growth, turning many regions into “pockets of poverty.”
Even in these countries and regions, however, the potential for agricultural growth is far from being exhausted, since their crop yields are very low and increased only very slowly in the past decade. In many countries in sub-Saharan Afriaca and South
Asia, the single most important factor that inhibits agricultural growth and limits farmers’ income from agriculture is the lack of passable roads to the urban center.
Mellor and Johnston (1984) estimated that this was the major reason why in India the potential growth of the agricultural sector during 1969–84 (calculated on the basis of the available inputs) was 50% higher than the actual growth. By realizing the potential of their agricultural sector, these countries could increase their food supply and the
Table 1.7. The Share of Agriculture in the Economy of Selected SSA Countries (%)
Country
Ghana
Madagascar
Malawi
Niger
Tanzania
Zaire
Share of agriculture in GDP
1975–77
1980–82
1989–91
50.7
32.3
39.5
35.1
56.1
27.3
Source: World Tables, World Bank, various years
56.8
32.3
36.9
30.8
53.4
29.0
47.7
36.5
34.4
37.0
55.7
34.8
Share of agriculture in employment 1980–87
65
81
83
91
80
72
The Pros and Cons of Globalization for Developing Countries
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earnings of the rural population. That, however, would require massive investments in irrigation, roads, and extension services. In addition, the adoption of high yield crop varieties and the use of fertilizers would have to be increased, and access to rural credit would have to be improved.
Despite their potential, most developing countries refrained from building on their traditional strength in agriculture, citing a long list of reasons for their strategy to promote industrialization, the most common one being the following:
< The demand for primary products is both price- and income-inelastic, and therefore cannot be a reliable base for export-led growth or a stable source of foreign exchange.
< Export earnings from primary products are subject to wide fluctuations.
< The traditional sector is often “backward” and unresponsive to economic incentives. < Agricultural exports from developing countries are depressed by the high protection rates on agricultural products in most developed countries, particularly in the EU (Bautista and Valdez 1993).
On these grounds, many developing countries implemented policies that were highly biased against the agricultural sector, including:
< overvalued exchange rates and/or direct export levies that reduced real returns on agricultural exports;
< high protection rates on import-competing manufacturing goods that lowered the relative price of agricultural goods in the domestic market;
< ill-functioning state marketing boards that used their monopoly power to raise the margins between the border price of exports and the farm-gate price and lowered the returns to farmers;
< suppressed prices of food produce paid to farmers in order to secure low prices to urban consumers.
These policies, implemented as part of the industrialization process, inhibited the development of the agricultural sector and trapped the entire economy in low productivity and low growth (Krugman 1991; Lucas 1988). They also reflect the political bias in favor of the politically and economically more influential urban population. To capitalize on their potential for agricultural growth, countries in sub-Saharan Africa, where a large portion of agricultural production is based on “slash and burn” or “shifting cultivation,” will have to encourage the transition to settled cultivation and to invest in rural infrastructure in order to increase agricultural production and employment. In South Asian countries, where the rural areas are already densely populated, agricultural development will have to be based on high-value products and highly intensive cultivation. To exploit the countries’ comparative advantage, the industrialization process will have to be built on two-way linkages with the traditional sector that allow both agriculture and industry to realize their growth potential.
The key to future agricultural growth, however, lies in significant increases in yields. After an increase of 3% in yields during the Green Revolution in the 1970s, the
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rate of increases in yields dropped to 1% in the 1990s. In all the developing countries, there are still heavy losses of crops to pests, disease, salinity, and drought, but efforts to compensate for these losses by increasing the area under cultivation may aggravate the pressure on the environment and natural resources. Small-scale farmers may, however, not be able to increase production by using modern technologies or more fertilizers and pesticides due to their high costs. Further increases in yields at affordable costs and without depleting the country’s nonrenewable resources or damaging the environment, therefore present a daunting challenge to agricultural research. The recent developments in biotechnology and research in transgenic crops may offer a way to meet this challenge. Transgenic plants with traits such as pest and herbicide resistance, and tolerance to salinity and drought, can increase yields and reduce crop losses without the heavy use of fertilizers and chemicals. To take advantage of this potential, the challenge of public agricultural research is to develop or adapt suitable plant varieties and technologies, and to expand and improve their extension services so that they can bring these new technologies to farmers and encourage their adoption.
The impact of multinational trade agreements on agricultural trade
Another obstacle to the development of the agricultural sector in developing countries is posed by the constraints on the access to the markets of the developed countries, primarily the EU and the US. These constraints are due, in part, to the various tariffs these countries impose on imports of agricultural products and the subsidies they give to their own agricultural producers, and, in part, to the myriad regulations and administrative restrictions. The agricultural “chapter” is high on the agenda of the
WTO since Seattle, but despite the general agreement on the need to open up the markets of the developed countries to agricultural products from the developing countries, actual progress has been very slow.
The GATT agreement that was signed initially by 23 mostly developed countries was a provisional agreement without any institutional setup. At the time, it was envisaged that the next step would be the establishment of an international trade organization, but the World Trade Organization was founded only in 1995, 47 years later. Until that time, GATT was expanded in both scope and global coverage, and a series of interim agreements brought about a reduction of tariffs and other barriers to trade, contributed to a vast expansion of international trade, and precipitated the globalization process. The GATT rules applied, however, primarily to merchandise trade, and in the Uruguay Round in 1992, the need to expand the agreement to agricultural products became apparent. The WTO provided a framework of rules for the conduct of world trade in goods and services, but nearly a decade after the Uruguay
Round, it does not yet include an agreement on agricultural trade.
The agreements on a wide variety of trade issues and the establishment of the WTO represent the widening recognition that open trade—largely free of government intervention and based on legally binding rules—is to the benefit of all nations and helps to secure global growth. The liberalization of trade met with opposition from various interest groups within countries that stood to lose, at least in the short run, from more liberalized trade. The legal obligations that bind member countries when they
The Pros and Cons of Globalization for Developing Countries
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join the WTO were designed, in part, to help reduce these pressures by presenting the wider benefits. An important principle governing the WTO is the nondiscriminatory treatment of all member countries; the legal term for that principle is the “most favored nation” (MFN) treatment. The GATT agreement states that any advantage, favor, privilege, or immunity granted by one WTO member to another has to be granted immediately and unconditionally to all other members. Another important principle is the need to establish a consensus as the basis for any resolution. Decision-making by consensus is bound to be slow and tedious in an organization of more than 140 members, but it was hoped that this would reduce conflict and secure wide acceptance of the rules. A third important principle of the WTO is the stability, transparency, and predictability of trading conditions, and this has been achieved by establishing upper bounds on tariff levels and a schedule of tariff concessions, and by determining the conditions of market access for services.
Agriculture was the most contentious area in the negotiations and, as of 2002, very little progress has been made. The main reason was the impasse between the EU and the US that also delayed the conclusion of the entire Uruguay Round by four years and contributed to the failure of the 1999 Seattle meeting. Although agriculture was finally incorporated into the GATT in 1994, the more difficult negotiations were delayed to early 2000, but then these negotiations broke down and were delayed again.
Nevertheless, a major achievement of the 1994 agreement was the conversion of all the nontariff barriers to trade—quantitative restrictions, import bans, etc.—into tariffs.
The Uruguay Round Agreement on Agriculture took the first step to subject agricultural trade to the same rules that apply to merchandise trade, and to progressively reduce interventionist policies. The agreement stipulated the elimination of all quantitative and other nontariff restrictions, converting them into explicit tariffs, and it determined bounds on and a gradual reduction of domestic support and export subsidies for agriculture. Complete import bans on specific agricultural products were also replaced by tariffs, though these tariffs were initially set at a sufficiently high level so that they effectively prevented any imports of these products. Import quotas were replaced by “equivalent tariffs” (tariff rate quota or TRQ) that established the same restrictions. These tariffs brought agriculture into conformity with other trade areas, provided a more transparent regime and facilitated any liberalization agreements in the future through a gradual reduction of these tariffs over time. The Uruguay Round
Agreement stipulated that the developed countries had to lower the aggregate tariffs by
36% over a six-year period, and the developing countries had to lower the tariffs by
24% over a 10-year period.
In addition, the agreement imposed limits on production and export subsidies for agricultural products by requiring that the budgetary outlays on export subsidies, the overall volume of the subsidized exports, and the domestic subsidies be gradually reduced by predetermined rates—in the developed countries over six years and in the developing countries over 10 years. The LDCs (with a GNP per capita below $1000) were not subject to these restrictions. The agreement to restrict export subsidies was a major achievement of the Uruguay Round Agreement, since it came against the background of the trade war in agricultural products between the US and the EU in the
1980s, when their prices faltered and the price support programs in both the US and the
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EU generated large commodity surpluses. Both the EU and the US provided massive export subsidies to sell these surpluses in third markets. With these sales, they inflicted considerable damage to agricultural export earnings and farmers’ incomes in many developing countries.
With all the exemptions and concessions, however, the main accomplishment of the Uruguay Round Agreement with respect to agriculture was primarily symbolic and only little immediate progress was made. Nevertheless, the changes in the ground rules in the Agreement paved the way to more substantive achievements. In particular, the agreements on TBT and SPS measures permit governments to use technical regulations, standards, and sanitary measures for health and safety reasons—provided they are transparent—while the SPS measures have to be scientifically justified and not create unnecessary obstacles to trade. These new rules and agreements reduced the likelihood of a renewed trade war of the type that was waged between the US and the
EU in the 1980s (as the peaceful resolution of the 2001 banana war illustrates), but it left in place many of the policies and practices that are damaging to agricultural producers and exporters in the developing countries.
The failure in Seattle to negotiate a new trade agreement on agricultural and textile goods delayed the removal of the walls of high tariffs that agricultural exporters from the LDCs are facing for some of their key products. A recent World Bank study
(Hoekman, Ng, Olarreaga 2000) estimates that reducing the tariffs on imports of these products from the LDCs will raise exports of the affected products by 30–60%; an agreement in the next round of trade negotiations can therefore make a significant contribution to enable LDCs to increase their exports.
The promise and challenge of new technologies
In the second half of the 1990s, many developing countries benefited from large gains in productivity due to major technological improvements. Information and communication technology (ICT) and the Internet were key to these productivity gains, but many other technologies also offered innovations that contributed to increasing the productivity. In the developed countries, the huge investments in R&D that were required for these technological advancements were provided by the private sector. In the developing countries, most of these investments—particularly in education, training, and R&D—must be made by the public sector. While the need to invest heavily in the physical and human infrastructure presents obstacles to the adoption of many new technologies by poor countries, there are some major technologies that offer significant improvements without requiring large investments.
An obvious example is ICT, particularly the Internet and the mobile phone. By giving even the less affluent individuals and entrepreneurs access to a huge amount of information and expert advice, these technologies have a “leveling” capacity, and they help reduce the barriers to competition along the supply chain. The Internet and the
World Wide Web are not just symbols of globalization, as Thomas Friedman suggested in his book The Lexus and the Olive Tree. They are also among the main factors that made the process of globalization possible and profitable.
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Yet, whether the benefits from the new technologies will trickle down to all segments of society, or whether the primary beneficiaries will be the more educated and more affluent, remains open to question. In India, the main beneficiaries of the rapid growth brought about in recent years by ICT have been the professional workers.
The majority of the Indian population, which lacks basic education and training, has benefited very little from the “new economy,” and spillovers to other sectors have been minimal. Moreover, the penetration of ICT into poor countries and poor regions has been very slow. The Organization for Economic Co-operation and Development
(OECD) estimates that 95.6% of the world’s Internet hosts in 2000 were located in its member countries. On these grounds, UNDP’s 1999 Human Development Report warns that
“[t]hose with income and— literally—connections have cheap and instantaneous access to information. The rest are left with uncertain, slow and costly access.
When people in these new worlds live and compete side by side, the advantage of being connected will overpower the marginal and impoverished, cutting off their voices and concerns from the global conversation” (UNDP 1999).
The gap between the rich and the poor thus threatens to widen the knowledge gap, and the widening gap between the “knows” and “know-nots” will further deepen the income and wealth gap.
While the breathtaking pace of technological innovation in recent years, particularly in ICT, may indeed threaten to increase the gap between the rich and the poor, there is also a promising potential that technological innovation will make it easier to fill the gap. An instructive example is the fate of the public telephone services.
In most developing countries, particularly in sub-Saharan Africa, telephone service is dismal, due to the poor state of the local infrastructure, the inefficiency of the mostly public telephone companies, and the very high prices, which are primarily due to the monopolistic power of these companies. Privatization of public telephone companies is therefore high on the agenda of most economic reforms. However, the process of privatizing these companies is quite complex and has proceeded rather slowly even in many of the more developed countries. In developing countries, the monopolistic public telephone company is often replaced by a monopolistic private company that increases profits by extorting its captive customers rather than reducing costs and increasing efficiency. In recent years, however, with the spread of the new mobile phone technology, customers found an effective way of bypassing the existing services and overcoming the constraints imposed by the poor infrastructure. By doing away with the requirement of setting up a cumbersome physical infrastructure, the new technology facilitates the entry of new providers that compete by improving efficiency and reducing prices. Similarly, with this technology, access to the Internet no longer depends on an expensive desktop computer connected to a telephone line, thus making it cheaper and easier to get “connected.” While technological innovation created the gap between those with “connections” and those without, it is also creating possibilities for developing countries to leapfrog outdated technologies.
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Concluding Remarks
Development strategy has two central components. The first determines the policy guidelines for the country’s economic development: the balance between industry and agriculture, between rural and urban development, between exports and import substitution, etc. The second defines the role of the public sector in the implementation of this strategy. The large differences between the experience of the East Asian countries and most countries in sub-Saharan Africa and South Asia during the past two decades should therefore be explained not only by the differences in the policies that these countries implemented, but also, and perhaps much more so, by the differences in the role and effectiveness of their public sector, i.e., their public institutions and their systems of governance, law, and order, in the implementation of these policies. A brief comparison of the development strategies of these two groups of countries can offer a number of instructive lessons.
In the 1960s, the standards of living in Africa were, on average, considerably higher than in the Far East, and the growth prospects of most African countries seemed to be much brighter. The picture changed dramatically in the 1980s, as an increasing number of East Asian countries embarked on an export-oriented, industry-led course of development that ushered in a period of rapid growth and a remarkable reduction in poverty. Sub-Saharan Africa and many countries in Latin America and the Caribbean and South Asia entered into a deep debt crisis and saw their growth rates and growth prospects plummeting. These sharply diverging experiences raise several questions:
< What lessons can be drawn from these experiences with respect to the structure of and the balance between industrial, agricultural and trade policies in a developing country? < What economic, social, institutional, and political conditions made the “Asian miracle,”and the subsequent Asian crisis, possible, and what lessons can their experience offer for the design of growth strategies in the countries of sub-Saharan
Africa?
< What lessons can, for example, Bangladesh or Ghana draw from the experience of
Thailand, Malaysia, and Uganda, as they design their development and trade strategies and structure their institutions of governance?
< What lessons can be drawn from the large differences in the pace of development between these groups of countries with respect to the rather generic policy prescriptions of the form “liberalize thy trade, deregulate, privatize and set thy prices right” that were advocated by the World Bank and the IMF (and became known as the “Washington Consensus”)?
The successful experience of the East Asian countries during most of the 1980s and
1990s underscores the merits of an outward looking development strategy and greater integration with the world economy. Indeed, this lesson remains valid despite the
Asian crisis of 1997–98 and despite some periodic setbacks to the process of globalization. The key to the rapid industrialization and the swift rises in income and employment in East Asia were the effective use of the large supply of a cheap but disciplined labor force for the development of an internationally competitive and
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export-oriented industrial base. The outward-oriented development of these countries avoided the constraints that an inward-looking, import-substitution industrialization encountered in many other countries due to the limited size of their local markets. The export-led growth of the East Asian countries contributed to accelerating their growth also by attracting foreign investments and advanced technologies. The adoption of labor-intensive industries and technologies at their early stage of development enabled these countries to absorb rather rapidly the waves of migrants from rural areas and thereby raised employment and income in both rural and urban areas. In contrast, many of the countries that relied more heavily on inward-looking industrialization led by capital-intensive manufacturing were much more constrained by the limited size of their market that restricted, in turn, their capacity to absorb surplus labor and reduce unemployment. Despite the wide validity of these lessons, the diverging experiences of these countries also suggest caution in translating them into “commandments” and applying them too schematically in other countries. An equally important lesson is that a development strategy cannot be formulated as a menu of rules and policy recommendations that can be applied with relatively minor modifications to most countries. Indeed, the menu of policies that became known as the Washington
Consensus achieved highly inconsistent results mainly because these policies did not take adequately into account the importance of each country’s unique social, cultural, and political conditions, the constraints imposed by the country’s past on its present course of development, and the impact of these conditions and constraints on the country’s capacity to build up the institutions and the system of governance and law necessary for an effective implementation of these policies. Instead, the underlying logic of these policies appears to have been their apparent “technical” and thus also, it seems, a-political nature (”remove this tariff,” “cut that subsidy”), and the apparent assumption that these policies, by being so highly beneficial for the vast majority of the population, would enable the government to easily mobilize the wide public support and the political coalition necessary to guarantee their successful implementation.
However, this logic seems to ignore the social and economic quake that each policy reform unavoidably triggers by shattering the existing balance between sectors, regions, and social groups. Policy reforms that involve a change in import tariffs or export subsidies inadvertently affect a large number of consumers and producers.
Eeven if, in the long run, most of them will benefit from the more rapid economic growth thanks to the greater efficiency in production and in the allocation of resources, in the short run, some people and sectors will gain, while others will lose. Those who lose are likely to coalesce in order to demand different policy reforms or at least compensations that will minimize their losses; those who gain may coalesce to oppose any policy reversal (see also Alesina et al. 1999). These conflicts prolong the transition period and make the implementation of the reforms far more difficult and controversial. Although the initial step in the reform may look “technical,” the subsequent steps are likely to be highly political. Strong institutions of governance are therefore necessary throughout this process to ensure that the reform will remain on course and that the promised “Pareto improvement,” when progress takes place and economic growth is accelerated, will indeed materialize.
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These conflicts and their impact on the economy may not be captured, however, in the standard analysis that focuses on technical indicators. A symptomatic illustration is provided by Esterly (2001) in his discussion of an apparent puzzle: During 1980–98, the growth of median per capita income in developing countries was 0.0%, compared with 2.5% in 1960–79, even though variables that are standard in growth regressions
(policies like financial depth and real overvaluation, and initial conditions like health, education, fertility, and infrastructure) generally improved during these years, and theory suggests that, therefore, these countries’ growth should have increased. In most of sub-Saharan Africa and South Asia, the puzzle is even more perplexing because their median per capita income actually declined rather sharply during these years, even though, in the majority of these countries, the variables that represent the determinants of growth in the standard growth regression generally improved. Esterly commented that this stagnation represented a disappointing outcome of the standard menu of policy reforms of the “Washington Consensus”. In fact, the puzzle was created by the analysts themselves as they focused exclusively on technical variables in the standard growth equation. These variables fail to take into account other dimensions of the growth process, particularly the rather dramatic changes in the social and political setting that occurred in the majority of the African countries during the past two decades. These changes had a very strong impact on the explanatory power of the technical variables, and if they are not taken account, a puzzle is likely to emerge.
Even more important, these changes in the social and political conditions affect not only the retroactive explanatory power of these variables, but also the power of economic reforms that focus on the more technical rules of the economic policies that these variables determine to generate growth. A failure to take into account the changes in the social and political conditions and in the institutional setting in the country may doom the reforms themselves to fail.
Consider, as an illustration, the reasons for the mixed performance of privatization, one of the principal policy reforms that were aimed at improving the notoriously malfunctioning public services. Among these public services, the public marketing boards are at the top of the list in most developing countries. Their dismal performance, particularly in the African countries, and the widespread corruption that cripples their operation make their total elimination via privatization the only logical solution. Privatization is expected to usher in healthy competition between the newly privatized enterprises, and this competition, in turn, is expected to become the driving force for the elimination of the distortions that were introduced by the heavily regulated public agencies. In practice, however, the transition from a marketing system based on public marketing boards to a system based on private trading companies was by no means beneficial to all producers and consumers. In many countries, the privatized marketing boards were essentially taken over by trading companies that established their monopolistic power either in the country at large or in the local market, often with a little help from the retired managers of the existing public board, from other government officials, or from family members of the president. These monopolistic private enterprises often created much larger distortions to the disadvantage of larger segments of the population, particularly the politically and economically weak. With few constraints on their monopolistic power, these trading
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companies were under no pressure to improve their service or reduce prices to their customers. In developed countries, these distortions are reduced to a minimum, thanks to the watchful eye of various public legal institutions charged with preventing such abuses. In most developing countries, these institutions are too weak or nonexistent, and the supervision over private companies is either highly inefficient or entirely lacking. Consider, for example, the potential obstacles that may hinder the process of trade liberalization, another example of a policy reform that developing countries are often pressured to implement. The existing tariffs and/or subsidies are clearly damaging to the country as they distort its resource allocation and reduce economic efficiency. Prior to the reforms, producers, consumers, and traders have to organize their entire operations on the basis of the distorted prices. The trade liberalization reforms then force them to make considerable changes, particularly in their production system, and these changes may also require large investments that are bound to prolong the transition period. During the transition period, some producers and traders will suffer losses due to the decline in the relative price of their products, while others will gain as the relative price of their products is rising. Even though most people will be better off in the long run, those who suffer losses during the transition period are likely to oppose liberalization, while those who gain already in the short run are likely to have higher-than-normal profits until all producers and traders make the necessary adjustments. The losses of one group of producers and traders as an effect of the reforms, and the higher-than-normal profits of the other group are bound to sharpen the discord and possibly lead to an open conflict that can embroil all the country’s social and political institutions.
The possibility of such a conflict inadvertently introduces social and political dimensions to the process of implementing the reforms, no matter how “technical” or
“a-political” the reforms may appear at the outset. The possibility that the reforms will produce rival coalitions or deepen already simmering conflicts between social or ethnic groups must be taken into account in advance, i.e., the reforms have to be designed with full consideration of the specific social, economic, and political conditions in the country and with the participation of the potentially affected groups.
Trade liberalization reforms may then have to be accompanied by targeted measures aimed at assisting those producers who may be outcompeted by a wave of cheap imports of the products they produce. This can be achieved by offering assistance for their transition to new products or to other sectors. Obvious examples for the failure to avoid unintended consequences can be found in the situation resulting from the measures that many countries implemented in order to reduce trade barriers on agricultural products when they joined the WTO. The flood of cheap imports of maize, wheat, and other field crops from developed countries forced many small farmers in developing countries either to retreat into production for their own consumption or to abandon agriculture altogether, because their own resources—financial and otherwise—did not enable them to make the transition to other crops and a different farming system quickly enough. Indeed, many of these farmers joined the ranks of those who oppose globalization.
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To smooth the transition and reduce the intensity of potential conflicts, it may also be necessary to put in place a proper legal system and establish or strengthen the institutions that can prevent one group or sector from taking undue advantage of the distorted prices that are likely to emerge during the transition period. In some cases, it may also be necessary to provide some form of compensation to those who may become worse off as an initial result of the reforms. However, the provision of measures and mechanisms to ease the transition period takes time, and when the institutions that are supposed to provide them do not even exist, the preparatory process is likely to be even longer. Without careful preparation, however, the conflicts and inequities that may emerge during the transition period can pose a risk not only to the success of the reforms, but also to the country’s entire social infrastructure. This is why a country’s institutional and legal systems and its specific social, economic and political conditions are critical to the success of trade liberalization. Even when the need for reform and the gains that it promises in the long run are obvious, the seemingly technical reforms will still have to be implemented in a specific context, and this is why the “Letters of Agreement” of different countries cannot be mere duplicates. Bibliography
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