challenges of development in lagging regions.docx
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challengesofdevelopmentinlaggingregions
DevelopmentStrategy,TransitionandChallengesofDevelopmentinLaggingRegions
JustinYifuLin
PekingUniversityandHongKongUniversityofScienceandTechnology
MingxingLiu
ChinaCenterforEconomicResearch,PekingUniversity
FirstDraft:
May2003
Revision:
October2003
DevelopmentStrategy,TransitionandChallengesofDevelopmentinLaggingRegions
JustinYifuLinandMingxingLiu
Abstract
AftertheWorldWarII,manyLDCsadoptedvariousmeasurestoindustrializetheireconomies,hopingtoacceleratetheirprocessesofcatchingupwiththeDCs.However,exceptforasmallnumberofeconomiesinEastAsia,thegapsbetweentheLDCsandtheDCshaveenlarged.HowtocatchupwiththeDCsisstilladauntingchallengeformanyLDCs.RecentstudiesfindthatthepoordevelopmentperformanceintheLDCsislargelyattributabletotheirproblemsininstitutions,includingallkindsofmarketdistortionsandgovernmentinterventions.Followingthepolicyadvice,capsulatedintheWashingtonConsensus,LDCsbothinthesocialistandnon-socialistgroupsstartedtoreformtheirinstitutionsintheearly1980s.However,thegrowthperformanceofmostLDCshasdeterioratedfurther.TheLDCsfaceanotherchallengeofhowtoachievedynamicdevelopmentbysuccessfullyreformingtheireconomies.
Inthispaper,wearguethatthepoorgrowthperformanceoftheLDCsaftertheWorldWarIIcanbelargelyexplainedbytheiradoptionofaninappropriatedevelopmentstrategy.Motivatedbynationbuilding,mostLDCs,includingthesocialistcountries,adoptedacomparativeadvantagedefying(CAD)strategytoacceleratethegrowthincapital-intensive,advancedsectors.Manyfirmsinthoseprioritizedsectorswerenonviableinopen,competitivemarketsbecauseoftheviolationoftheireconomies’comparativeadvantages.ForimplementingtheCADstrategy,thegovernmentsintheLDCsadoptedaseriesofdistortionsininputandoutputmarketstosubsidize/protectthenonviablefirms,resultinginrentseeking,soft-budgetconstraint,macroeconomicinstability,andincomedisparities.Economicstagnationorevensuddencollapsebecomesunavoidable,promptingtheLDCs,voluntarilyorinvoluntarily,tostartreformingtheireconomies.TheWashingtonconsensusfromtheinternationaldevelopmentagenciesadvisedtheLDCstocarryoutapackageofreforms,includingpriceliberalization,privatization,andeliminationofotherdistortions.Withoutaddressingthefirms’viabilityissue,theimplementationofthosepolicyrecommendationswouldresultinwidespreadbankruptcies,unemployment,andsocial/politicalinstability.Forfearoftheabovedreadfulconsequences,manygovernmentsfoundotherdisguisedwaystoprotect/subsidizethosenonviablefirmsafterimplementingthereform.Ineithercase,notonlythereformstowardawell-functioningmarketeconomycouldnotbecompletedbutalsotheeconomicperformancebecamepoorerthanthatbeforethereform.
Inthepaper,wearguethatLDCsshouldfollowacomparativeadvantage-following(CAF)strategysothattheirfirmswouldbeviable,theireconomiescompetitive,andasustainedupgradingoftheirendowmentstructuresaswellasindustrialstructurespossible.Wealsodiscussthegovernment’sappropriateroleintheCAFstrategyandthewaytocompletethetransitionsmoothlyfromaneconomythatadoptedaCADstrategytoaneconomythatfollowsaCAFstrategy.
I.Introduction
AftertheWorldWarII,manygovernmentsinthelessdevelopedcountries(LDCs)adoptedvariouspolicymeasurestoindustrializetheireconomies.ThepercapitaGDP,measuredincomparableprices,hasincreasedinalmostallnations.However,asshowninfigure1,thegapsofpercapitaincomebetweenthedevelopedregionsandlaggingbehindregionswidenedsubstantially.OnlyasmallnumberofeconomiesinEastAsiahaveactuallynarrowedthegapandconvergedtothelevelofpercapitaincomeinthedevelopedcountries(DCs).HowtocatchupwiththeDCsisstilladauntingchallengeformanyLDCsaftertheirdevelopmentpursuitofseveraldecadesinthelasthalfof20thcentury.
Figure1:
GDPperCapita,1950-1992(56countries)
(In1900Geary-KhamisDollars)
Source:
AngusMaddison,MonitoringtheWorldEconomy,1820-1992,DevelopmentCenterofOECD,pp。
212.
TherapidincreaseinwealthandnationalpowerintheDCsaftertheindustrialrevolutioninthe18thcenturywasrootedintheirspeedyupgradingofindustriesandtechnologies.Therefore,theearlydevelopmentattemptintheLDCsprimarilyfocusedonhowtoacceleratethedevelopment/adoptionofthedominantindustries/technologiesoftheDCs.RecentstudiesfindthatthepoordevelopmentperformanceintheLDCsislargelyattributabletotheirproblemsininstitutions,includingallkindsofmarketdistortions,governmentinterventions,macroinstability,inequalityinincomedistributions,colonialheritage,andsoforth(Shleiferetal.,1998;Rodrick,1998,2003;Acemogluetal.,2001a,2001b,2002a,2002b;Djankovetal.,2003).Toimprovetheeconomicperformance,institutionalreformsinfacthavestartedinmanyLDCs,includingthe(former)socialistcountries,sincethelate1970s.Manyofthosereformshavefollowedapackageofpolicy-advicebasedonneoclassicaleconomicsandarecapsulatedintheWashingtonConsensus(Williamson1990).Nevertheless,withthevariousreformattemptsandtheimprovementsinmanyfactorsthatareconsidereddeterminantsofgrowth(Barro1997),thegrowthperformanceofmanyLDCshasdeterioratedfurther.Easterly(2001,p.2)showsthat“in1980-98,medianpercapitaincomegrowthindevelopingcountrieswas0.0percent,ascomparedto2.5percentin1960-79”.Thecontrastofgrowthperformancesinthesetwoperiodsrepresentsadisappointingoutcomeofthemovementtowardsthe“WashingtonConsensus”bydevelopingcountries(Krugman,1995).TheLDCsfaceanotherchallengeofhowtoachievedynamicdevelopmentbysuccessfullyreformingtheireconomies.
Inthispaper,weattempttoanswerthefollowingquestions:
WhydidmostLDCswiththeirindustrializationdrivesofseveraldecadesfailtonarrowtheirincomegapstotheDCs?
Whydidtheinstitutionalreformsbasedonthe“WashingtonConsensus”failtostimulateeconomicgrowthinmostLDCsandsometimeevencauseseriouscrises?
WhatarethelessonsforLDCsfromthefewsuccessfulcasesofconvergenceintheEastAsianeconomies?
HowcantheLDCscompleteinstitutionalreformssuccessfullyandachievesimultaneouslydynamiceconomicgrowthintheirreformprocesses?
Thecoreofourargumentsovertheabovequestionsisasfollows:
Theoptimalindustrial/technologicalstructureofaneconomyisendogenouslydeterminedbyitsendowmentstructure.Disregardingthenatureofitsownendowmentstructureandhopingtoclosethegapofitsindustrial/technologicalstructuretothatoftheDCsasquicklyaspossible,thegovernmentinanLDCoftenpursuedacapital-intensiveheavyindustriesorienteddevelopmentstrategyoncegainingpoliticalindependenceaftertheWorldWarII.ThisdevelopmentstrategycausedmanyfirmsintheLDCgovernment’sprioritysectorstobenonviableinopen,competitivemarkets.Consequently,theLDCgovernmentintroducedaseriesofdistortionsinitsinternationaltrade,financialsector,labormarket,andsoontosupport/protectthenon-viablefirms.Throughthosedistortionsitwaspossibletomobilizeresourcesadministrativelytoestablishcapital-intensiveindustriesinthecapital-scarceLDCandhadaninvestment-ledgrowthinitially.However,theeconomybecameveryinefficientduetomisallocationofresources,distortionofincentives,rampantrentseeking,suppressionofprivateinitiativesandsoforth.Whendomesticresourcesdepletedandafurtherresourcemobilizationfrominternationalsourcestosupportthenonviablefirmsexhausted,theeconomystagnated.Consequently,convergencefailedtooccur.Moreover,thevariousdistortionsandinterventionsenlargedincomedisparitydomesticallyanddebtburdensinternationally,andoftenledtotheeruptionsofsocialconflictandfinancialcrisis.
Sincethelate1970s,manypoor-performing,crisis-hitLDCs,followingthepolicyadviceofWashingtonConsensus,havestartedtheireconomicreforms.TheWashingtonconsensus,basedontheneoclassicaleconomics,whichimplicitlyassumedthatfirmsexistinginthemarketsareviable,advisedtheLDCstoeliminatetheexistingdistortionsandinterventionsimmediatelysoastocreatewell-functioningopen,competitivemarkets.However,asthefirms’viabilityproblemwasnotsolvedfirst,eitherthenonviablefirmscollapsedimmediately,resultinginwidespreadunemploymentandsocial/economicdisruptions,orthegovernmentneededtoprotect/subsidizethosenonviablefirmsthroughvariousdisguisedmeansofdistortionsandprotections.Therefore,notonlythereformstowardafull-fledgedmarketeconomycouldnotbecompletedbutalsoeconomicperformancemightbecomepoorerthanitwasbeforethereformstarted.ThepapersuggeststhattheviabilityissuebeaddressedformerlyindesigningtheLDCs’economicreforms.
Thepaperisorganizedasfollows:
Followingtheintroduction,SectionIIdiscussestheimpactsofanLDCgovernment’sdevelopmentstrategyontheviabilityoffirms,theeconomicinstitutions,andtheeconomicandsocialconsequences.SectionIIIexploresthedifferentexperiencesofeconomicreformandtransitioninLDCsandshowswhypolicyadvicecapsulatedintheWashingtonConsensusmaynotbeappropriate.SectionIVtestsempiricallysomehypothesesderivedfromSectionsIIandIII.SomeconcludingremarksareprovidedinSectionV.
II.DevelopmentStrategy,Viability,andInstitutionsinLDCs
WhytheLDCs
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