Thursday, April 21, 2011

Development studies - essay exercise

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Essay Exercise

. “With the point of departure in the distinction between market failure and government failure, discuss the appropriate level of state intervention in different categories of developing countries.”

The particular roles of the state and the market in the development process have been debated continuously since the end of the Second World War.

In most part of developing countries the argument about market failure had led to adopt state-managed development strategies from 150s until end 170s. The “invisible hand”, the main focus of Adam Smith, did not seem capable to help market forces to reach the perfect equilibrium.

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Many are the ways by which the market fails. All the so-called “externalities” are not regulated by the supply and demand laws. The positive externalities are benefits which cannot be fully “internalized” in the market as extra profits (i.e. education, research). Again, the negative externalities cannot be fully internalized as extra costs (i.e. pollution). The state should intervene with subsidies and taxes to avoid losses, to promote the right amount of production, and to protect the environment.

Another example of market failure is represented by the “public goods”. These are goods characterized by being non-rivalrous and non-excludable, so that they cause the “free-rider” problem which makes the private sector non willing to supply that kind of goods. Imperfect information is also a manifestation of market failing, in the two ways of “moral hazard” and “adverse selection”. Referred to financial markets the gravity of this problem is emphasised, the access to saving and credit limited, and the investment opportunities lowered. Finally, tendency to monopoly and monopsony can be broken down only by the state’s enforcement of competition.

It is note worthy that in Third World countries market failures are amplified by structural deficiencies in the economy, such as lack of rules, inadequate property rights system, few infrastructures, low skills, and little capital. And the absence of a strong entrepreneurial class is a cause of aggravation, as well.

Third World countries are not capable of initiating a sustainable and self reinforcing growth process unless the state intervened and coordinated the development efforts. But an extensive state intervention can also miss the developmental goal.

The neoclassical view became generally accepted by the World Bank, IMF and the OECD countries around 180. Neoclassical economists such as Balassa, Bhagwati, Lal, stated that free competition and market mechanisms would bring a more optimal allocation of resources than a regulated economy with administrative control and central planning. They recognized that market failures existed and were more in developing countries, but rejected that special strategies were required. They saw government failure as the most serious problem facing economic progress in developing countries.

The most important cause of state failure in his role as engine of growth is constituted by the general deficiencies of the government apparatus in developing countries. Myrdal, in his socio-economic analysis of the state, came to the definition of “Soft State” as the better description of post-colonial countries’ governments. This kind of state was created only to secure the interests of the colonial powers in terms of law and order and taxes, thus reflects incapability of implementing policies that go against the interests of the bureaucracies or powerful groups in society. Self-seeking and corruption are natural consequences of the soft state.

The weakness of the state in Third World countries comes also from lacks of competence and knowledge within the administrators regarding economic and business operations. These insufficiencies could, through wrong economic policies, generate distortions into the already segmented markets. For instance, labour market distortions, including minimum wage laws, union negotiated wages, hiring and firing restrictions, and legally mandated benefits, if effective, they could increase the price of labour and induce a shift toward capital use which is lacking in developing countries. Furthermore, regulations always run the risk of stifling enterprises, inducing illegal activities in order to avoid them and providing a source of control and financial gain for government officials.

Commonly, in low income countries the inefficiency of the state is aggravate by the strong influence of cultural values on bureaucratic behaviour. Hyd�n, in his study about relations between state and society in most African countries, elaborated his most central concept the “economy of affection”. The term denotes a network of support, communication and interaction among structurally defined groups connected by blood, kin, community or religion. The mutual obligations characterizing this kind of relationship easily lead to “nepotism” and favouritism. In many African societies not even the basic democratic principle of respecting majority decisions is widely accepted. And this may in some measure be explained by the continued existence of separate identities that make citizens view themselves as belonging primarily to ethnic, religious or other socio-cultural groups within the political community.

Tribalism and linguistic multiplicity, in particular, have provided fertile ground for ethnic problems and political unrest in most Sub Saharan African countries. Many national and ethnic conflicts have been caused or exacerbated in the colonial era, mainly because the boundaries of the colonies were drawn without considering national or ethnic lines of division in the population. In post-colonial regime the situation has not changed and represents one of the most important reasons of government instability which takes away foreign direct investment possibilities.

The role of the state in SSA should be creating the right environment to attract FDI and thus promote a sustainable private sector growth. At present there is a consensus that the private sector is the main engine of economic growth and of poverty reduction. And in order to make it possible for the private sector to flourish and to ensure that growth indeed contributes to poverty reduction, the government has a major role to play as the architect of a positive enabling environment.

In low-income countries where markets are fundamentally inefficient, the state should first of all provide the basic infrastructure by investing in communications’ construction, from railway to telephone connection.

Another field of intervention must be the law and judiciary system. A legal and regulatory framework (mainly with regard to the financial market) and strengthened property rights are needed.

Macroeconomic stability is also required. Such as low inflation, stable exchange rate, low level of unemployment, interest rate stability.

Savings should be channelled from the informal to the formal sector in order to broaden credit availability and investment opportunities.

Something should also be done with regard to the high transaction costs of linking into international markets faced by local enterprises. Transaction costs are high because most SSA exporters either lack of reputation or, worse yet, have negative reputations in the world markets. The state can intervene to reduce this handicap by creating national promotion agencies, business associations programs, etc.

In short Sub Saharan African countries need more capitalism. In the past political leaders have clearly preferred the state and the bureaucracy to the market as the most important mechanisms for allocating resources, investments and incomes. The choice is understandable when it is remembered that the political leaders after independence had the control over the state, while the market was controlled mainly by foreign capital. But the choice has led to waste of resources, because of nepotisme and tribalism prevailing in bureaucratic decisions. Reliance on capitalism and free-market forces will contribute to break down the worse aspects of the economy of affection and the system of patronage. More capitalism is also the key to bring into existence a national bourgeoisie strong enough to compete in the world economy. Thus the government should interact with the market, but only in a particular mode by helping the national economy to operate by itself in a successful way.

In the literature on the causes of East Asian countries’ flourishing economic development, it is no longer claimed that the key of their success is simply the absence of state regulations and interventions. Rather, it is proposed that the secret is the specific nature of these regulations and interventions.

Based on Anne Krueger’s study of the East Asian Tigers, the role of the government has been substantially neutral. It has just created the right conditions for the “take-off” to happen. Two categories of conditions were successful for the export promotion general economic environment (stable macroeconomic and business climate) and trade policies (clearly export oriented).

The economic environment had been ingeniously created by the state also through investment in education among with a particular openness to foreign technology. Several Asian NIEs relied on importing or copying transnational corporations’ technologies, and their own R&D became increasingly important only when buying new technologies became more difficult for them. Their exports depended heavily on original equipment arrangements with TNCs, making electronics and other products to TNCs which then sold the products under their own brand names.

But it is note worthy that the “East Asian miracle” is primarily the result of a good combination of Import-Substitution (ISI) and Export-Oriented industrialisation (EOI), supporting the thesis according to which the national industry should grow before entering the world market. During the 150s the governments played a decisive role in promoting and protecting the infant national industry (basic consumer goods). In 160s the strategy adopted was a primary export-oriented industrialization based on exports of manufactures, especially labour-intensive products. Finally, from 170s to the present they combined a secondary ISI (heavy and chemical industrialization) with a secondary EOI focused on higher value-added and skill-intensive products.

In this way, an extraordinary process of improvement of the labour force, as well as sustainable capital accumulation, was created, leading the countries to grow in the most old-fashioned way.

But the East Asian miracle has had a huge break with the 17-8 financial crises which affected Thailand, Malaysia, Indonesia, the Philippines, and South Korea. These developing economies shift dramatically from a path of high growth to a sharp decline in economic activity.

Without analysing in depth what happened, it can be said that the principal causes were in the tardy corporate governance and the risky financial structures. The IMF post-crisis programme is directed to eliminate both these causes, on one hand by reforming the internal structure of the corporations and on the other hand by strengthening the financial markets. The latter aim should be pursued by the state.

Hence the appropriate level of the state at the present should be characterized mainly by an implementation of the IMF recommending policies regarding the investment protection. The governments should ensure the financial market by means of security laws, bankruptcy laws, takeover laws, competition laws, exchange regulations and accounting standards.

Every country is different from another, and every country is characterized by its specific historical, political, sociological and economic features. It appears difficult to try to analyse what kind of role should the state play in the developing process without ignoring those differences and classifying developing countries in broad categories such as low-income (SSA) and middle- or upper-middle income countries (East Asia), as done along this discussion.

In conclusion, it can be said that in the latter cluster (East Asia) the already well-developed market should be let functioning independently, except sporadic government interventions against market failures or possible deficiencies. The most active role played by the state is actually in countries in which markets are only in embryonic shape (SSA).

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