Volume 2, No. 7, July 2020
Editor: Rashed Rahman
In the January and February 2020 issues of Pakistan Monthly Review, Professor S M Naseem wrote an excellent article (Whither Development Economics? – I and II) commenting on the rise and fall of development economics. This is of course not surprising; ideas never remain constant, but change and merge with other ideas that happen to be dominant at the time. Such has been the case with the evolution of economics too. For instance, development economics as a separate discipline branched off from mainstream economics at the end of WWII. And before the advent of neoclassical economics, all of economics was in a way development economics. Classical economists such as Smith, Ricardo and Marx were all concerned with issues of economic development, namely, what is the nature of production and its distribution? How is value created? Why are wages so low compared with the profits of capitalists? What taxes can we raise? Neoclassical economists, on the other hand, paid no attention to problems of growth or development in poor countries, though they started to change after WWII.
Similar inflexions and deviations could be observed in the treatment of development issues at the Pakistan Institute of Development Economics (PIDE) in Islamabad. From the 1950s to the 1970s, PIDE was considered a premier institution for generating new ideas and research on development policy. This gave way to heavier concentration on planning and forecasting models at a time when planning was going out of fashion. After some experimentation, PIDE has now embraced the idea of ‘free-market fundamentalism’ emanating from the Chicago school of institutional economics.
The subject of development is vast, so we will focus on just a few points. First, we will analyse the main arguments of development theory and examine the impact of policy choices. Second, we will look at the question of unequal development and efforts made to reform the global economic system. Finally, we will review the phenomenal record of development in the past five decades and draw policy conclusions for future reference.
It is sometimes claimed that when economic growth became the goal of development in the 1950s and 1960s, the question of promoting individual well being receded. By the 1960s it was clear from many developing countries that income growth had not tackled the problem of income distribution and mass poverty.
Such criticism is, however, not supported by an analysis of the facts. This is not to say that at times development and growth of income per head have not been treated as synonymous. This confusion was clarified as early as 1958 by the eminent Dutch economist Jan Tinbergen in his famous book, The Design of Development, in which he stated explicitly that the main purpose of development was to maximise the contribution of an investment programme that promoted the country’s well being and distribution of income over social groups and regions. Like Tinbergen, other early economists and more importantly, policy makers in developing countries were clear that income growth and better distribution of income were important instruments for achieving a better quality of life for all. They were aware that any development plan that lacked a definite aim and social objective would not win the support of parliaments or donor agencies. The aim of development was generally accepted to be to ensure an adequate standard of living for the masses, i.e. to get rid of appalling poverty, and to promote a more equitable distribution of wealth.
There was optimism at the time that the ‘trickle down effect’ of growth would lead to poverty reduction and better distribution of income. Regrettably, many countries failed to achieve either of these two goals to a significant extent. To examine this we have to look at the development strategies and policies they chose and the assumptions that turned out to be flawed.
The ideas of development came to be influenced by the experience of the global depression of the 1930s. The clearest exposition of issues in development economics is contained in a short book by Kurt Mandelbaum (1945), who taught me economics at The Hague Institute of Social Studies. He brought together the works of some of the leading development economists of our time that included Arthur Lewis, Gunnar Myrdal, Ragner Nurkse, Rosestein-Rodan and Raul Prebisch. He succeeded in elaborating and filling in the details of what came to be regarded as the dominant theory of development. Much of it continues to be relevant today, although with modifications.
The main points of development theory can be summarized as follows:
It was assumed that developing countries had a large surplus of rural labour with low marginal productivity. Industrialisation was the only way to absorb this surplus in more productive activities. However, the process of industrialisation was constrained on the demand side by lack of domestic demand, and on the supply side by shortage of physical capital. It was also assumed that investment possibilities were limited. Spontaneous industrialisation via private initiatives was not likely to happen, so the state had to play a major role in this process. At the same time, prospects for foreign trade were seen to be limited, for two reasons. First, traditional exports of primary products  could be expanded only by lowering their prices, i.e. the terms of trade were believed to move against exporters of primary products. Second, non-traditional exports of simple manufacture were precluded on the demand side by the trade barriers operating in the industrial countries, and on the supply side by a lack of industrial base and infrastructure.
Only industrialisation based on a policy of import-substitution could remove the constraints of domestic demand and foreign exchange.
Thus, development through import-substituting industrialisation became the widely accepted paradigm. This view was accepted by international organisations such as the UN, World Bank and IMF. It was also accepted by developing country policy makers who saw industrialisation and import-substitution as an essential prerequisite for the survival of their nation. They recognized that the state would have to play a lead role in the economy, which would require comprehensive planning. So, a five-year plan became the norm.
Drawing up a plan that was internally consistent required some analytical framework or models. Two growth models gained prominence. The Harrod-Domar model was used to derive the income growth implications of a given inflow of foreign aid with other variables (savings rate and capital output ratio) remaining constant. Or conversely, to calculate the amount of foreign aid required to achieve a certain predetermined growth target. The Chenery and Bruno two-gap model was also used for similar purposes. And even today World Bank country officers apply the two-gap model for projecting financing needs. It is interesting to note that both Harrod-Domar and the two-gap model were used quite successfully to lobby for foreign aid from both bilateral and multilateral donors.
 See paper by Jagdish Bhagwati (1968) on immiserising growth, which stipulated that when growth is heavily export based, it might lead to a fall in terms of trade of the exporting country. Fall in terms of trade may be so large as to outweigh any gain from growth.
In contrast, there were others like Nehru of India and followers of the ‘dependency’ school who took a different path. Their view was that greater reliance on imports and foreign capital would undermine their nation’s independence and sovereignty. So they opted to work with closed economy models. In the Indian case, prominence was given to the Soviet-style planning model that gave priority to development of the capital goods sector (heavy industry) over the consumer goods sector (such single minded pursuit of capital goods production prompted Nikita Khrushchev to chastise his Soviet planners as ‘machine eaters’). The Two-Sector Model of Mahalanobis became the basis for India’s five-year plans and guided development for over four decades.
A backward look at the Indian planning experience suggests that while it did build up an industrial base, it was at the cost of an unbeaten record of low two percent growth rate over an extended period of time (two percent came to be known as the Hindu growth rate). It was not until the liberalisation reforms of Manmomohan Singh that India’s economy started to gain momentum.
Given that the strategy of import substitution was embraced by many developing countries in the 1960s and 1970s, and its elements are still present in the economic policies being pursued, a brief assessment would be useful. In particular: were the underlying assumptions supported by experience on the ground? Did the countries that changed their development strategy perform better than those that did not?
To begin with, trade pessimism on which the strategy of import-substitution was based turned out to be flawed. World trade grew at a historically unprecedented rate of 8.5 percent per year during 1960-70, and at slower but still respectable rates of five and four percent respectively in 1970-80 and 1980-89. It continued to grow fairly robustly in the decades that followed, five percent between 2000-10, and seven percent in 2011. Developing countries’ trade in manufactures grew even faster and their share in global trade rose. Terms of trade of primary commodities also improved in favour of commodity exporting countries. Interestingly, those developing countries that moved away from inward-oriented import substitution to outward-oriented policies did noticeably better in export growth as well as in easing their foreign exchange constraint. Ironically, countries with inward oriented policies ended up even more import dependent in spite of their efforts at import substitution.
Similarly, countries pursuing import-substituting industrialisation were less successful in absorbing surplus agricultural labour because of lower growth in employment opportunities outside the agricultural sector. This was despite massive increase in domestic savings and investment rates, which did not raise growth rates because of the choice of production methods – high capital intensity of production and inefficiencies in utilisation of capital (see Amartya Sen 1968).
In many countries a major role was assigned to the state. It was assumed that the state would have certain benevolent characteristics and behave like a platonic guardian rather than a predator. But this turned out to not be the case. In fact, we find that in the name of planning, a system of regulations was established to control allocation of resources – credit, foreign exchange, and private investment. The result was a chaotic incentive structure and the unleashing of rapacious rent seeking and diversion.
Finally, the few countries that deviated from inward-oriented strategies, such as Korea and Taiwan and later Indonesia and Thailand, tended to perform better in most aspects of development. But it would be simplistic to assume that their outward orientation was the only reason. Their success was also attributed to an important extent to the role of an ‘efficient’ state that implemented ‘industrial’ policies and increased domestic savings to enable higher growth.
There were a number of other problems of omission and commission, one of which was that the theory completely ignored the role of technical change, investment in human capital and productivity improvements in the development process. Robert Solow (1957) in his ‘Sources of Growth Accounting’ highlighted these factors and showed that technical change and productivity improvements accounted for as much as 70 pc of output increase (known as the Solow residual).
Finally, it was a mistake to explain development exclusively in terms of country characteristics. Not enough attention was paid to the role of the global economic system and its pervasive impact on development. We turn to this aspect in the next section.
 Amartya Sen’s book on choice of techniques contains an excellent discussion on the relative merits of capital-intensive versus labour-intensive methods of production and their respective impacts on the rate of capital accumulation and alternative growth paths.
The idea of development and unequal exchange emerged out of the work done by the ‘dependencia’ school at the UN Economic Commission for Latin America (UN ECLA), notably by Raul Prebisch. He argued that the processes that generated high income in Western Europe and the US were the very same ones that maintained the rest of the world in a state of dependence via wealth extraction. Prebisch worked with Hans Singer and formalised one of the primary tenets of dependency theory. The Prebisch-Singer conclusion was that the imbalance inherent in the exchange between centre and periphery resulted in a consistent flow of capital from the periphery to the centre. From this Prebisch concluded that development could only be enhanced through targeted intervention, which involved reform of the global economic system.
The international economic system set up after the war consisted of the General Agreement on Tariffs and Trade (GATT), later the World Trade Organisation (WTO), for handling trade, and the World Bank and International Monetary Fund (IMF) for managing international finance to ensure stability and growth in the world economy. In the 1960s, several attempts were made by non-aligned and other developing countries to reform the global economic system on the ground that it did not serve their interests well, but without much success due to headwinds from Pax Americana.
In 1962 the situation changed when economic ministers from a small group of non-aligned countries, some African and a few Latin American countries, met at a Cairo conference and adopted a declaration calling for the establishment of a new institution on trade and development within the UN framework. Raul Prebisch attended the conference as personal representative of the UN Secretary General and played a key role in steering the Cairo Declaration. The declaration was endorsed by the UN General Assembly, along with an agreement to set up a new organisation called the United Nations Conference on Trade and Development (UNCTAD). Initially, the US opposed the proposal for UNCTAD, but this was reversed when Adlai Stevenson took over as the new US Ambassador to the UN under the Kennedy administration.
Raul Prebisch was appointed as the first Secretary-General of UNCTAD. He began by strengthening the inter-regional solidarity forged by developing countries in Cairo. In this regard, he made a fundamental point that developing countries should be ‘compensated’ for past and future losses resulting from deteriorating terms of trade, either through commodity agreements or through ‘compensatory finance’. The second main incentive for unity was to call for a system of trade preferences for developing-country exports of manufactures to industrial countries.
In order to placate the Soviet bloc, Prebisch proposed the idea of long-term trade agreements between Soviet state trading enterprises and developing country governments.
Finally, it was felt that achieving reforms in all three areas, commodities, trade and compensatory financing, would take time, so it would be necessary to set up a supplementary financing mechanism that could fill the projected trade gap during the interim period. Surprisingly, the idea of supplementary financing was supported by the President of the World Bank, George D Woods, who agreed to look into the possibility of setting up a special window for this purpose in the World Bank . However, the idea failed to gain support and was dropped when aid donors decided to replenish the International Development Association (IDA), a soft-loan window of the Bank, with additional funds.
Despite high expectations, the results of the first UNCTAD conference (Geneva, 1964) were disappointing. On this, see Nicolas Kaldor’s perceptive observation . In subsequent UNCTAD conferences, the results were, at best, modest, though it did make tangible progress in a few areas of importance.
 In his meeting with Prebisch, George D Wood is reported to have said, “Something is wrong when gross external lending by our Bank can be wiped out by commodity price reductions.”
 In the aftermath of the conference, Nicholas Kaldor wrote, “Though in terms of concrete results its achievements were meagre, this conference seems to have succeeded in promoting a new consciousness among the underdeveloped nations of their community of interest, and in creating a forum through which their needs and requirements will receive more continuous and systematic attention in the future.”
UNCTAD succeeded in persuading the IMF to create a compensatory financing facility (CFF) that could provide balance of payments support to countries that were facing unexpected decline in their export earnings. CFF was set up as a short-term financing facility and did not address the longer-term problem of secular declines in commodity prices, which was left to commodity agreements.
Success was also achieved in securing agreement on a Generalized System of Trade Preferences (GSP) in 1970, when nearly 18 preference-giving industrial countries, including the US, agreed to implement the scheme. GSP provided access to industrial country markets on low or zero tariffs. Initially limited in scope, GSP was later expanded to include more countries and more products. Its impact on trade has been significant for many countries including Bangladesh, Pakistan, India and Sri Lanka.
There were also substantial external benefits from UNCTAD’s de facto role as a secretariat for developing countries. For instance, it played a major role in providing support to developing countries during the Uruguay Round negotiations, which led to agreement on new trade rules and establishment of the WTO. Its work on international monetary reforms, particularly on conditionality and growth-oriented adjustment was highly regarded in discussions of the G24 at Bank-Fund meetings. UNCTAD was also a focal point in the UN system for Least Developed Countries and in that capacity it was able to secure not only debt relief for them, but also GSP status.
Unfortunately, despite several attempts, UNCTAD was unable to make headway on its core objective, which was to create a system for dealing with large swings in commodity prices and long-term decline in commodity terms of trade. In 1974, Gamani Corea (new Secretary General of UNCTAD), made a bold move to revive the stalled dialogue by launching an ‘Integrated Programme for Commodities’. The programme called for the setting up of a new financing mechanism, the Common Fund, to be used actively to manage commodity stocks and thereby influence prices. This was a revolutionary proposal and could have transformed the commodity markets in favour of the developing countries. The proposal was discussed at UNCTAD 4 in Nairobi in 1976; the discussions proved to be difficult and no agreement could be reached. In his comments after Nairobi, Gamani Corea summed up the situation well when he said that the international community had passed a great milestone that could have set a new policy towards commodities.
The failure of developing countries to bring about radical change in international trade and finance led to a gradual decline in UNCTAD’s influence in the North-South dialogue. The establishment of WTO was also a setback, and further diminished UNCTAD’s role as a negotiating forum on trade matters.
The decline in developing countries’ influence corresponded with a period that represented a policy shift when a number of countries decided to adopt liberal market economy policies in reaction to past policies. These included countries such as India (Manmohan Singh reforms), Pakistan (Sharif deregulation), Peronist Argentina, Brazil, Mexico, several Sub-Saharan African countries and the transition economies of Eastern Europe and Central Asia after the break-up of the Soviet Union.
In 1989 a neo-liberal policy agenda came to the fore in the form of the Washington Consensus. It was not a consensus in the broad sense but referred to an agreement between Washington-based financial institutions: the World Bank, IMF and the US treasury – the aim being to use policy based lending by the Bank and the Fund to enforce neo-liberal economic policy reforms in borrowing countries, irrespective of their level of development and internal structures (Williamson, 1990). These policies, containing 10 key policy prescriptions , were pursued vigorously during the period of the 1980s and the 1990s, before they became a subject of debate and contention.
In countries that followed the consensus policies, economic growth was limited at best and disproportionately benefitted those at the top. In Latin America for example, seven years of strong growth was followed by seven years of recession and stagnation. Similarly, in many Sub-Saharan African countries, the economies failed to take off in the 1990s despite efforts at reform (Uganda, Tanzania and Mozambique were countries that showed some success). In the case of the transition economies of Eastern Europe and Central Asia, there was a prolonged and deep collapse of their economies. The handling of the East Asian financial crisis in 1997 was equally controversial.
It was no surprise that the Washington Consensus failed to work as promised. Internal review of Bank-Fund policies showed that in many cases the programme design had been flawed. The one-size-fits-all approach had proved to be disastrous. It was clear that the reforms listed under the Consensus were no longer working, and a set of changes were needed (Williamson, 2002). The kind of changes required were discussed at the Barcelona Conference on ‘Washington Consensus Reconsidered’ by a group of leading economists, which included several former chief economists of the Bank and the Fund. This resulted in a reformulation of policy prescriptions with the aim of improving outcomes in borrowing countries.
The Barcelona principles underscored the importance of a balanced role for the state and markets; experimentation as a tool for development; greater attention to income distribution and poverty reduction, as well as the importance of tailoring policies to country-specific situations.
On the question of macro-economic policy, it was suggested that a broader view of macro-stability could be considered, i.e. to include not only price stability and sound fiscal policies but also growth and a stable ‘real’ economy.
Several of these recommendations have been taken on board by the International Financial Institutions (IFIs), but there still remain serious reservations on some, which include a strong resistance to using ‘industrial policy’ as an instrument of development.
In taking stock of development, we should not lose sight of the enormous progress that has been made and continues to be made in the developing world. In the process a number of valuable lessons have been learnt for future reference. We will try to look at the broad trends on the basis of available data at this time.
Average income in developing countries has more than doubled (2.5 times) over the past four decades – faster than in the UK during the industrial revolution, in the US during its spurt to industrial maturity in the 19th century, or Japan during its pre-war growth spurt. Economic progress in some developing countries has been dramatic; Turkey doubled its average income in 20 years (1957-77); Brazil in 18 years (1961-79); South Korea in 11 years (1966-77) and China in 10 years (1977-87). As a result, income levels of developing countries have tended to converge to the level in industrialized countries as predicted by the ‘conditional convergence’ concept of the Solow-Swan model of long-term growth .
Tremendous social progress has also been achieved in developing countries. Social progress has been even more striking in East Asia. It is estimated that the incidence of absolute poverty (that is, the
 These include: (1) trade liberalisation, (2) privatisation, (3) de-regulation, (4) fiscal reforms, (5) market determined interest rates, (6) competitive exchange rates, (7) elimination of subsidies, (8) fiscal discipline, (9) safety nets for the poor, and (10) security of property rights.
 The Solow-Swan model predicts that the income levels will tend to catch up with or converge towards the income levels of rich countries if the poor countries have a similar savings rate for both physical capital and human capital as a share of output.
percentage of the population that subsists below the poverty line) has fallen consistently in the past three decades from a third of the population in 1970 to a tenth in 1990. Some people think that the 1980s was the ‘lost decade’ for development. Indeed, for the economies of Latin America, the Middle East, North Africa and Sub-Saharan Africa, average income declined in real terms during the decade. For all developing countries taken as a group, growth of income per capita was above the historic average during this period. This reflects the acceleration of growth in China, East Asia and India.
Of course this relatively favourable record conceals enormous variations in economic growth rates across countries. Per capita income in some countries has doubled twice over since the 1960s and is on its way to a third doubling. But 36 nations with a combined population of nearly 500 million people have seen low or declining average incomes over the past three decades. Poverty remains a formidable problem and substantial economic progress has yet to reach people.
We can draw certain lessons and conclusions in summing up the development story.
First, countries that have succeeded economically have also been successful in enjoying socio-political stability. By contrast most of the 36 countries that have lost ground over the past two decades or more were involved in a substantial military conflict (World Development Report 1991).
Second, a stable macro-economic framework and structural reforms that aim to remove distortions where they arise are essential for effectiveness of development.
Third, the incentive system matters. Competition, both domestic and international, is the most reliable way of ensuring that appropriate policies for efficient resource allocations are present. Weak competition policies lead to monopolistic control of resources, higher prices and misallocation of scarce resources.
Fourth, an outward-oriented trade strategy that is ‘neutral’ between export promotion and import substitution is good for promoting growth in total factor productivity. However, outward oriented strategies have not invariably been the most effective. Looking at the recent period of increasing protectionism, it is not difficult to see the appeal of import substitution.
Fifth, the state has a vital role to play in intervening where there are market failures and where the private sector cannot enter. Intervention should be transparent, rules-based rather than discretionary. Discretionary interventions are often closely co-related with rent seeking.
Sixth, the development of human capital through encouraging investments in education, health and nutrition is essential, not only for enhancing productivity of physical capital but also for the strength and vitality of the political system.
Seventh, a safety net is needed to protect the welfare of the poor, those falling below the poverty line or who are marginalised or weakly connected to the economic system.
Finally, countries that have managed their economies well and achieved high growth rates (over seven percent), sustained for at least ten years, have reduced poverty levels sharply. In such cases, ‘trickle down’ has worked. However, in most countries, income distribution among social groups has worsened sharply. When the rate of return on capital exceeds the rate of economic growth, it automatically generates arbitrary and unsustainable inequalities that run the risk of undermining the values on which democracies are based (see Piketty, 2014). Seeds of this are already evident in the rise of extreme right movements in the US, Western Europe and even in our own Subcontinent.
The writer studied economics at the London School of Economics and Cambridge University and worked in UNCTAD (Geneva) and the World Bank (Washington DC).
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