New Directions in Development Economics

Growth, Environmental Concerns and Government in the 1990s

Mats Lundahl, Benno Ndulu, Mats Lundahl, Benno Ndulu

• Publisher: Taylor & Francis
• Year: 2005
• Print ISBN:
  9781138866089
• Edition: 1
• eBook ISBN:
  9781134808816
• Topic: Business
• Subtopic: Business General
• Index: Business

New Directions in Development Economics is divided into two parts. The first half considers the dilemna of growth with special reference to its environmental cost. The second half focuses on the role of the state in the context of the growing dominance of the free market argument. The contributors include Paul Collier, Partha Dasgupta, Ronald Findlay and Deepak Lal.

1
INTRODUCTION

Mats Lundahl and Benno J.Ndulu

Economic development usually encompasses issues of growth and distribution. Development takes place when the gross national product (or income) per capita grows at a sustained pace over a long period without simultaneously worsening the distribution of income and increasing the number of absolute poor. Given that economic growth implies using resources, some of which are not renewable, to these requirements should also be added a condition with respect to sustainability. That is, growth should take place in a way that takes the true costs of resource depletion and environmental degradation into account. Growth should not be hampered, but resources must be left to future generations as well.

The essays contained in this volume all attempt to reflect the above definition of economic development. At the same time, they focus on some of the most important issues facing development economics as the present century draws to a close. The first of these issues is economic growth and its costs. Growth—the overriding development concern during the 1950s—has been brought back to the forefront in the 1990s. The socalled New Growth Theory has endogenized technological change, focusing not only on capital formation (as was the case in the 1950s) but also on such determinants as the development of human capital, research and international trade. In order to bring out the complexity of the growth process the economy has been disaggregated into more than one sector. On the empirical side, interest is shifting from short-run stabilization of economies that were in acute crisis in the 1980s to more long-run issues, including structural reforms and institutional requirements, creating a growth-inducing economic environment.

The concern with growth is reflected in the first six essays. The three following ones all discuss the costs of growth in terms of the environment. Environmental issues as such have been dealt with for a long time in economics, notably in the theory of exhaustible resources and in the discussion of externalities in welfare economics and public-choiceoriented literature. The problems of deforestation and soil erosion and more generally the protection of biodiversity remain among the most serious issues facing developing countries today. However, until relatively recently few systematic attempts had been made to bring environmental considerations into the development context.

The second half of the book concentrates on problems related to the role of the state. Hand in hand with the emphasis on growth in the 1950s went a belief that the state would be able to promote growth by means of an active, highly interventionist, development policy that substituted an orderly planning procedure for the capricious swings of the market. As is well known, the pudding of central planning has not stood the test of eating. The trend during the past twenty years has been one away from dirigisme towards a more market-and incentive-oriented view of how development can be brought about. Still, laissez-faire has not carried the day. The notable success of the East Asian economies during recent years and the many incomplete answers to questions about the exact degree and nature of government intervention in these economies has revived the state versus market debate, as reflected in the last seven essays of this volume.

GROWTH, INNOVATION AND THE ENVIRONMENT

Economic growth has occupied a central place in the development literature throughout the past four decades. Growth has led to the prosperity and welfare gains of nation states. Indeed the differentiation of the well-being of economies over time rests mainly on the level of achievements in growth performance. Development strategies have thus invariably focused on the means to achieve high rates of growth as a basis for reducing poverty and improving living standards.

These strategies have experienced major changes over time. The changes have been influenced by developments in the theory of growth and by experience from the actual implementation of growth strategies. The early theories emphasized capital formation as the engine of growth and savings mobilization as the main means for achieving high investment. Productivity growth was considered to be driven largely by exogenous technological progress. Incomes of the world economies were expected to converge unconditionally over time as the poorer nations caught up, given the anticipated higher productivity of capital in these countries. Macroeconomic policy stances were expected to have no influence on the long-term rates of growth as these were driven by exogenously determined rates of technological progress and population growth. Since the 1980s, however, the New Growth Theory has shown that technical change is endogenous to the growth process and that human capital and policy stances do matter for long-term growth. Technological progress benefits from human capital formation, scale economies and access to foreign technologies. This contention is supported by growing disparities in incomes between the developed and the least developed world and the empirical evidence that convergence of incomes is conditional on the improvement of other growth fundamentals.

The 1980s also saw a major swing towards concerns with macroeconomic stability in the developing world as a condition for long-term growth. In addition, this shift emphasized market-oriented incentive structures to promote efficiency in resource use and productivity growth. Little attention was paid to other fundamentals. The continued sluggish growth performance in the least developed countries, however, points to the need for addressing the problems related to such issues as well. Moreover, since these countries depend to a large extent on environmental resources for sustaining growth, the increasing loss in biodiversity has raised serious concerns about the protection of environmental resources for future generations.

The six essays that focus on long-term growth highlight the importance of the recent emphasis on macroeconomic stability as a condition for achieving sustained growth. At the same time, these chapters draw attention to several other conditions for growth. They emphasize the need to coordinate stabilization and development policies in order to ensure that short-run corrective measures are consistent with the broader aims of promoting employment, investment and innovation. The essays also point to the importance of appropriate institutional environments that will facilitate resource accumulation and efficient allocation. The main concerns here relate to uncertainty and lack of credible policies which discourage investment and distort resource use.

Also addressed is the need to create a productive structure in developing economies that is capable of responding flexibly to external reversible shocks so as to ensure a continued stable development environment. The essays consider regional integration as a strategy to reach threshold scales of activities, attract investment into marginal regions and coordinate security and resource management in order to reduce risks and uncertainties as well as conserve scarce resources. The role of innovation is considered in the context of long-run cyclical patterns of technological change and with a view to meeting the necessary conditions for keeping up with a rapidly innovating world.

The focus of the three essays on the environment concerns the over-exploitation of environmental resources, as well as approaches to resolve the tension in the appropriate utilization of these resources to ensure the well-being of generations over time. All three use the viewpoint of inter-generational equity as their point of departure and emphasize the need to respect resource constraints when pursuing economic development. The essays also consider specific policy instruments to address the distortions arising from the failure of markets and governments so as to ameliorate the rising loss in biodiversity. These initiatives and their potential impacts are reviewed in relation to local market failures, government intervention failures and global appropriation failures.

Chapter 2

‘Macropolicies for the Transition from Stabilization to Growth’, by José María Fanelli and Roberto Frenkel, focuses on coordination of macroeconomic and development policies. Using the Latin American experience of the 1980s and 1990s, the chapter shows how a lack of coordination between macroeconomic and structural policies in situations of undeveloped markets and pervasive market and government failures can lead to persistent macroeconomic instability and uncertainty. This, in turn, discourages investment and innovation, which hinders both growth and productivity gains. The chapter singles out four key factors as the fundamental causes of coordination failures. These are the extremely thin and rationed capital markets, the public sector’s tendency to generate unsustainable deficits because of rudimentary systems of taxes and expenditure, a productive structure incapable of responding flexibly to external shocks, and a lack of access to timely financing of resource gaps caused by reversible shocks.

In contrast to the situation in the developed economies where the task of macroeconomic policies is largely that of fine tuning to smooth out cyclical fluctuations in investment and employment rates, macroeconomic policy in developing countries has primarily aimed at correcting short-run current account disequilibria and fiscal imbalances. The preoccupation with restoring equilibrium has led to a dichotomization between stabilization and development policies. The authors emphasize the need to coordinate policies so as to achieve macrostability on a sustained basis while at the same time promoting employment, investment and innovation. They highlight the need for taking into account the longer-run consequences of stabilization policies on economic structure and the effects of structural reforms on short-run stability.

Fanelli and Frenkel review the coordination failures of the 1980s in Latin America during which uncertainty and instability prompted domestic savers to prefer liquid international assets—capital flight. Owing to the limited availability of international credit to governments and domestic private investors, effective investment was lower than its potential. During the 1990s, macroeconomic stabilization policies have reversed the capital flight and expanded short-term inflows. This has generated significant real appreciation of currencies and an allocation of resources that is inconsistent with longterm sustainability of the external equilibrium. In both cases, these undesirable effects are attributed to the fundamental coordination failures.

Fanelli and Frenkel point to four main challenges in the 1990s which are related to the links between macroeconomic policies and development. First, there is the need to raise the rate of investment and savings through a combination of the classical tradition of ‘thriftiness’, the Keynesian tradition of appealing to the investor’s ‘animal spirits’, the neoclassical tradition of ‘allocative efficiency’ and the Schumpeterian tradition of ‘incentives for innovation’. The second challenge is that of addressing the problem of disarticulation of the financial system in the light of the thinness of financial markets and the lack of robustness of the domestic demand for financial assets. Third is the need for strengthening the fiscal structures in order to close unsustainable fiscal gaps. In this regard, particular attention needs to be paid to the harmonization of the multiple objectives of fiscal policy, particularly between fostering macroeconomic stability and nurturing productive investment. A primary task singled out here is that of improving the revenue productivity of the tax system while minimizing the distortionary allocative effects. Fanelli and Frenkel encourage the reduced use of tax handles in order to avoid ‘fiscal rebellion’ by instilling a sense of fairness. Expenditure restructuring towards public investment and anti-poverty programmes is encouraged. The fourth and final challenge is to avoid interruption of the growth process through the creation of a productive structure that can flexibly respond to external shocks and through improved access to contingent finance. All together, the Fanelli and Frenkel chapter characterizes the ideal macroeconomic framework for growth as that which ensures a lower degree of uncertainty regarding inflation, an appropriate and stable rate of exchange and an improved fiscal balance in support of higher savings and investment, as well as the sound instrumentation of strategic interventions to compensate for market failures.

Chapter 3

In ‘Constraints on African Growth’, Arne Bigsten raises research questions with respect to the persistently very poor growth performance of African economies in contrast to other developing regions, which have shown a remarkable ability to catch up with the developed world. The chapter first reviews the results of various studies that explain growth performance. The review singles out three factors—the rate of resource accumulation, technological innovation and efficiency in resource allocation—as being fundamental for sustained growth. It is further argued on the basis of these studies that technological progress benefits from human capital accumulation, the existence of scale economies and access to foreign technologies. The advantage of late-starters is partly related to the opportunity to adopt up-to-date foreign technologies at significantly lower costs than the inventors. Against this background, the African economies are seen to be sliding back in relative terms as a result of low rates of resource accumulation, the absence of scale economies, negative productivity growth and an increasing gap between the technologies applied in Africa and those on the international frontier.

Bigsten then delineates the important areas for further investigation, focusing on the appropriate economic and institutional environment for facilitating the accumulation of resources, their efficient allocation and the introduction of better technologies. In acknowledging the considerable effort and progress in macroeconomic policy reforms, three key areas are singled out for further research. The first task is to determine the extent to which instability and unsustainability of policies discourage investment. The role of a large debt overhang is also highlighted in relation to the pressures for policy change and increased vulnerability to shocks. Uncertainty and lack of credibility are thus pinpointed as important constraints to investment that need further study.

The second issue is the extent to which selective market interventions can be adopted from the East Asian experience to promote export growth. Transparency in the selection of target agents for support and the development of appropriate supportive institutions are emphasized. Also important, in order to reduce transaction costs, is a clear delineation of exchange rules and enforcement of contracts. Finally, Bigsten stresses the importance of research on the political processes that promote policy interventions based on rules rather than discretion. What mechanisms can be adopted to insulate a competent bureaucracy from undue political pressure and interference?

Chapter 4

‘Long-Term Development and Sustainable Growth in Sub-Saharan Africa’, by Ibrahim Elbadawi and Benno Ndulu, focuses on the constraints and prospects for long-term growth in Sub-Saharan Africa. The analysis is motivated by widely supported empirical evidence that a significant proportion of Africa’s poor growth performance is unexplained even after taking into account basic growth fundamentals and policy stances. The chapter identifies three broad categories of constraints to long-term growth in Sub-Saharan Africa. The first set is what is referred to as the growth fundamentals. The economies are characterized by vastly underdeveloped infrastructure, weak institutions, rudimentary technology and relatively low human capital development, as well as unstable macroeconomic and political environments that discourage saving and investment. Elbadawi and Ndulu review empirical studies on the relationship between long-term growth and these fundamentals and in addition use their own empirical analysis to confirm the significance of all these factors in explaining the poor growth of Africa and the failure to ‘catch up’ with the rest of the world.

The second constraint is the structural disarticulation of African economies, which makes them more susceptible to external shocks and limits their capacity to respond to those shocks. The chapter assesses the income effects of external shocks resulting from changes in the external terms of trade, interest rates and net transfers of external resources for a median African country. In contrast to the conventional wisdom, the results show a significantly higher loss of income from external shocks in Sub-Saharan Africa than in other developing regions. At best, net transfers of foreign resources only partially offset the negative effects of the sustained decline in the external terms of trade. The chapter also looks at the indirect effects of these shocks in the light of the weak response capacity and relatively poor access to timely liquidity to help ride out temporary shocks. These indirect effects include irreversible resource allocation decisions by producers attempting to cope with persistent unpredictable shocks and the stimulation of bad policy response to shocks, Finally, Elbadawi and Ndulu point to the close link between external and fiscal pressures in the African economies and the high debt overhang as crucial factors constraining a prudent response to external shocks.

The third set of constraints relates to the small size of African markets and their poor strategic location υis-à-υis the main economic growth poles of the world. The chapter points to the failure to generate the threshold scales necessary for creating strategic complementarities and attracting adequate levels of investment for badly needed modernization and technological progress. It also raises the issue of regional spillover effects from investment in human and physical capital and from civil instability. Finally, it urges policy coordination at the regional level to buttress reforms as well as other forms of regional integration to achieve threshold scales of activities and attract investment.

The Southeast Asian experience is referred to in the context of rethinking industrial strategies as African countries move away from the previous disastrous experience with import substitution and selectively build on past investment. The urge for selectivity and transparency in intervention, the need to exploit comparative advantage in unskilled labour and the necessity of building on human competence and technological capabilities are emphasized as important lessons from this successful experience.

Chapter 5

‘How Painful is the Transition? Reflections on Patterns of Economic Growth, Long Waves and the ICT Revolution’, by Claes Brundenius, focuses on the role of innovation in the growth process in the context of long-run cyclical patterns of technological change. Such cyclical patterns are characterized by transitions from one ‘techno-economic paradigm’ (TEP) with a dominant form of technology to another. These transitions involve significant costs.

Brundenius’ central thesis is that countries that move rapidly to higher development stages need to adopt new technology relatively early in a Kondratiev cycle or position themselves with foresight on what the new underlying technology of the future will turn on. The empirical evidence presented in the chapter suggests that as technology changes, developing countries that have positioned themselves to benefit from the ‘underlying technology’ of the next long wave can catch up with the rich countries, while those that lock themselves in dinosaur technologies fall behind. According to Brundenius, the catching-up process crucially depends on the ability to adapt to the rapidly changing conditions of entry into the world market during the transition from one techno-economic paradigm to another. This adaptation requires changes in the institutional, social and response capacity of firms to exploit emerging opportunities.

The author illustrates his contention with a comparison of long-term growth performance among ‘pioneers’, ‘late-comers’ and ‘late late-comers’. Those now developed countries that were successful in making the painful transition between phases got ahead, while those that did not stagnated in relative terms or even fell back. Through the first four waves, ‘late-comers’ such as the United States, Germany and Sweden were able to catch up with pioneers (e.g. Britain) and surpass them by engaging in revolutionary technological breakthroughs. These countries are now well positioned to exploit the opportunities of the next techno-economic paradigm (fifth cycle), which will be driven by the information and communication revolution.

Countries in Latin America such as Argentina and Brazil, which posted reasonably fast growth during the first cycle, as well as the former Soviet Union, which posted rapid growth during the fourth cycle, have stumbled, owing to their inability to make the painful transition to new dominant technologies. Other countries, such as India, have stayed behind for the same reason. The only ‘late-comers’ singled out by Brundenius as having been able to position themselves well for the transition to the fifth cycle recently are those of Southeast Asia.

The evidence presented in Brundenius’ chapter poses two key questions for development as the world moves from the fourth Kondratiev cycle, driven by mechanization, to the fifth, which will be spearheaded by information technology. The first issue is that this transition provides an opportunity for developing countries to ‘leapfrog’ in terms of growth, as shown by the Southeast Asian experience. This opportunity arises from the fact that microelectronics and informatics, which enhance human mental effort, are based on a cheap and undepletable resource—silicon—and the skills for using such technology can be more easily acquired.

The second issue relates to the conditions for successful exploitation of this opportunity. These go beyond the current focus on trade liberalization/ competitive environment as the quickest route to learning. The chapter underscores the need to adopt policies that support the learning...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• FIGURES
• TABLES
• NOTES ON THE CONTRIBUTORS
• PREFACE
• OPENING REMARKS
• WELCOME ADDRESS
• 1: INTRODUCTION
• Part I: GROWTH, INNOVATION AND THE ENVIRONMENT
• Part II: THE ROLE OF THE STATE