Chapter 7: Trade and Development II Neoliberalism and Institutionalism §

(F) Day of the week: Wednesday Class: IS302 Created Time: December 16, 2020 4:05 PM Database: Class Notes Database Date: December 16, 2020 4:05 PM Days Till Date: Passed Last Edited Time: June 9, 2021 10:42 AM Type: Presentation Notes, Reading Notes

Introduction §

Neoliberalism Assumptions

• Have faith in market ability to allocated resources
• Wanted government less involved in economies
• Remove trade barrier

There were 3 reason from shifting structuralism to neoliberalism:

• Economic imbalance in the early 1970s

• East Asian countries outperformng other developing countries

• Economic crisis in the 1980s force governments to reform.

I. The emerging problem with import substitution industrialization §

By the late 1960s ISI have created 2 economics imbalance:

• ISI generate government budget deficit:

  1. Government spend money to invest in industry, but they never make enough to pay off the cost.
  2. Their biggest supporter are the urban residents, and they maintain this support by provide them with jobs and commodities.

• The economic imbalance was persistence current account deficit. The current account deficit meaning that it import more than it export. There are 2 reasons for the decrease of export:

  1. The manufacture industries weren’t competitive in global market.
  2. Promoting industries weaken agriculture.

• All these thing continue because the ISI government tend to overvalued their exchange rate. Lead to foreign product being cheaper, and domestic good that import more expensive.

• However the government cannot reform either because:

  1. Government depend so much on the urban residents, so they cannot change without addressing the benefit of those group.
  2. If government do reform what kind of model.

• Government most of the time would rather overlook all the problem, than dialing back their ambition plan.

• And when faced with the imbalance they would rather borrow loans.

• But in the early 1980s, when they cannot do that anymore the government are force to reform.

Latin America and sub-Saharan Africa: Import substitution industrialization

VS Asian Tiger Economies: Export oriented strategy

• Per capita income grew 3 time faster than in Latin America & south Asia, more than 26 time higher than in sub-Saharan Africa
• Manufacturing output grew by 10.3% per year between 1965 and 1990
• Exports grew 8.5% per year between 1965 and 1990

The important of the MARKET and STATE in

creating export-oriented industries

The Neoliberal Interpretation

By the IMF and The World Bank

Argues that East Asia’s success was a consequence of market-friendly development strategies.

The State-oriented Interpretation

By specialist in East Asian political economy

Argues that East Asia’s success is due in large part to state-led industrial policies.

The East Asian Model §

• Import Substitution Industrialization generate imbalances in Latin America and sub-Saharan Africa, however Asian Tiger Economies actually experienced gains because they developed a different development strategy, which is the Export-oriented strategy
• Their gains can be identified in 3 economic indicator
  • Per capita income: East Asia grew 3 times faster that Latin America and South Asia, 26 times higher than sub-Sahara
  • Manufacturing output grew by 10.3% (1965-1990)
  • Export grew 8.5% per year (1965-1990)
• There are two arguments argue on the important of the market and the state in creating export-oriented industries
  • 1st argument: Neoliberal Interpretation by the IMF and the World Bank argue “The East Asia’s success was a results of market-friendly development strategies”

Neoliberal interpretation §

Emphasis on the willingness of East Asian Governments to embrace international market, and their ability to maintain stable macroeconomic environments.

• Embrace international market/export

• Taiwan in 1958: Shift from production for domestic market to production for export

• South Korea in early 1960

• NICs: follow the same path starting in the late 1960s

  By focusing on the export, Asian firm worried about competition, resulted in profit

• Followed by selective import liberalization: government did not engage wholesale import but only selective import.

By doing so domestic producer can buy inputs at world price meaning lower price and this keep export competitive in international market

• Stable macroeconomic environment
  • Keep Inflation is low: 7.5% average (1961-1991): lead to higher saving and investment
  • Maintain valued exchange rates: the domestic currency low means easier to export, therefore keep domestic firm competitive in foreign market
  • Conservative fiscal policies: tapped domestic saving rather than international financial market, borrow less

By stabilizing macroeconomic environment, it is easier to open the economy to international trade since when inflation is low, and exchange rate is maintained, trade liberalization dis not generate large current account deficits

• 2nd argument: State-oriented interpretation by specialists in East Asian political economy argue “The East Asia’s success was results of state-led industrial policies.

State-led industrial policy: Argue that Well-designed government industrial policies is the reason of East Asia’s success. The East Asian Model of development is conceptualized as a series of 3 distinct stages and Each stage has particular type of policies

• First stage: labor-intensive light industry
• Second stage: heavy industries
• Third stage: skill-and research and development
  • Example:
    • Taiwan:
      • 1st: mid 1950s - light manufacturing and textile
      • 2nd: late 1950s - synthetic fiber
      • 3rd: during 1970 - skill-intensive industries
    • Korea:
      • 1st: in 1950s - textile production
      • 2nd: late 1960s - chemical and heavy machinery
      • 3rd: late 1970s - skill-and R&D
• The East Asian government used industrial policy to achieve 4 goals:
• Reduce cost of investment funds: achieved by lowering cost credit, providing long term investment capital at below-market rate of interest
  • South Korea: target sector - long term investment capital
  • Taiwan: influence bank lending decision to provide bank loans to target industrial
• Create incentive to export: achieved by providing investment funds at low interest rate, credit is available, input cost and creation of free trade zones and export-processing zone
  • Taiwan: Firm (exported) - pay interest rate of only 6-12%, borrower paid 20-22%
  • South Korea - short term loan were extended
• Protect infant industry: achieved by enforcing straightforward forms of protection
  • South Korea: prohibit of microcomputer, some minicomputer and disk drive
• Promote the acquisition and application of skill: achieved investment in education, invest in scientific infrastructure to facilitate the application of skills to R&D activities
  • Taiwan: reach 75% by 1980, The Industrial Technology Research Institution (1973)
  • Korea: increase from 35% 1965 to 88% 1986, The electronics and Telecommunications Research Institute
• There is no correct argument, lack of definitive answer on which argument is correct but both argument have value:
  • Neoliberal interpretation (getting price right): East Asian counties could have comparative advantage because there will be more investment resulting from export orientation and stable macroeconomic
  • State-oriented interpretation (targeting sector): East Asian counties could have comparative advantage because there will be more investment resulting from industrial policy which are reduction of costs for firm operating in targeted sector, encourage to export and skill upgrade.

III. Structural Adjustment and the Politics of Reform §

• Economic crisis struck developing countries during the early 1980s.

• The large large part of this consequences is due to the government’s’ decision to borrow to finance their budget an current-account deficits.

• Two contributions factors that involved in using foreign loan to fund the government’s budget became the bad idea:

  • Most of the fun that government borrowed was used for large infrastructure projects and domestic consumption.
  • During 1973 and 1982 developing were buffeted by three international stocks- an increase in price of oil, reduction in term of trade between primary commodities and manufactured goods, and higher interest rates on the foreign debts.

• Governments seek for financial assistance from IMF and World Bank

  • These two institutions encouraged governments to adopt structural adjustments programs.

• Structural adjustment program is a policy to reduce the role of the state and to increase the role of the market in the economy.

• How do the structural adjustments programs work ?

  • Encourage governments to liberalise imports by dismantling imports licensing system
  • Shifting from quota-based forms of protection to tariffs
  • Simplifying complex tariff structures
  • Reducing tariffs and opening their economics to imports
  • Encourage states to sell their state-owned enterprises to private individuals and groups.

• Structural adjustment program had a dramatic impact on average income in the short run and the distribution of income in the long run.

• The dismantling of ISI also redistributed income from urban import-competing sectors to agriculture and emerging export-oriented manufacturing industries.

• The economic consequences of structural adjustment drove the domestic political reform.

• Groups that would lose fm the structural adjustment attempted to block the reform while groups who stood to gain attempted to promote reform .

IV. Getting Institutions Right §

1990s, people doubted SAP’s ability in sustainably liberalizing and developing economies (Structural Adjustment Program)

SAP is necessary for sustained development

SAP is not sufficient for sustained growth.

Agreement that institutional quality holds the key to prosperity around the world.

Popularity of institutional approach rose with two configurations

Inclusive Institutions §

Encouraged individual initiative and sustained economic growth

Politically

• Individuals right to select and constrain governments
• Adherence to rule of law
• A strong but constrained state

Economically

• Strong property rights
• Market that rewards individual talent:
  • people are encouraged to be creative to be successful
  • economic opportunities are available to mass public, not only to elites
• Likely to provide high quality public services: education, health

This direction is good for sustained economic growth

Extractive Institutions §

Politically

• Power is exclusively given to small group of elites
• Elites are unconstrained from use of power: no institution power, or fair judicial system

Economically

• Little reward for individuals: property rights are lacking and is unfairly treated
• Elites extract income from non-political people and give to elites who keep the government in power
• Corruption within state and among elites

This direction is not good for sustained economic growth

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In historical context §

South Korea vs North Korea

• Both has the same culture, language, and history
• South Korea has inclusive institutions allowing rapid economic growth
• North Korea has extractive institutions causing poor economic performance

East Germany (Soviet Allied) vs West Germany (US Allied)

Problems With Theory §

Reverse Causality §

Possible that Economic Development is the cause of Institutional Configuration

• Economic development cause democratization: “the level of economic development, as measured by per capita income, is by far the best predictor of democratization”

Origins of Political Institutions §

Why do some countries have extractive institutions if it’s bad for economic development?

First Explanation: It’s from Colonial Settlement Patterns, Due to climate and disease

• if the colony has high colonial mortality rate ⇒ colonists will establish extractive institutions to maximize short run gain.
• if the colony has low colonial mortality rate ⇒ colonists will establish inclusive institutions for long term economic development.

The Second Explanation: The Interaction between resource endowment and colonialism led to the establishment of particular institutional arrangements.

• Caribbean: where land, climate, and labor fits for plantation-based agriculture (mass one crop production).
  • Colonists relied on imported slave labor
  • Slaves were excluded from politics
  • High inequality, low political inclusiveness
• North America: it’s land and climate encouraged family based grain farming
  • Less economic inequality
  • Political institutions more inclusive

Conclusion §

• Neoliberalism supplanted as the guiding philosophy of economic development as a result of the interplay among three factors in the global economy.
• The adoption of neoliberal reform in the developing world is also transforming the global economy
• Labor intensive aspects of production remain in the advance industrialised countries.