Political Economy of Third World Development
Political Economy of Third World Development
 In recent years, scholarship on the Third World has
increasingly turned to political economy. Martin Staniland
defines this field as the study of “how politics determines
aspects of the economy, and how economic institutions
determine the political process as well as “the dynamic
interaction between the two forces”.
 This chapter focuses on several important economic issues:
What should the role of the state be in stimulating and
regulating economic growth and industrialization in the
LDCs?
 What are the major strategies for development? How
should countries deal with the deep economic inequalities
that persist or even increase, during the modernization
process?
The Role of the State
 During the sixteenth and seventeenth centuries, major
European powers were guided by the philosophy of
mercantilism, which viewed a nation’s economic
activity as a means of enhancing the political power of
the state and its monarch. Government was viewed as
“both source and beneficiary of economic growth”.
 That perspective was sharply challenged by the 18th cc
Scottish political economist Adam Smith, who
favoured a minimized state that allows market forces a
relatively free hand.
The Role of the State
 Today, the collapse of the Soviet “command economy” and
the poor economic performance of the remaining
communist nations (except China and Vietnam, which
have largely abandoned Marxist economics)have
discredited the advocates of state-dominated economies.
At the same time, however, no government embraces full
laissez faire (i.e allowing market forces a totally free reign,
with no government intervention). All countries, no matter
how capitalistic, have laws regulating banking, domestic
commerce and international trade. In the real world,
governments must decide where to position themselves
between the extreme poles of laissez faire and a command
economy.
The Role of the State
 In the less developed countries (LDCs), the fragile
nature of many Third World economies, their high
levels of poverty, their poor distribution of wealth and
income, their extreme dependence on international
market forces, and their endangered natural
environment have encouraged many governments to
assume an active economic role. As a consequence,
their governments have often built the steel mills,
railroads, or sugar refineries that the private sector
could not or would not.
The Role of the State
 More recently, governments have been called upon to
protect the environment against the ravages of
economic development. Not surprisingly, state
economic intervention traditionally has been more
pronounced in Africa, Latin America and South Asia
than in the West.
 In recent decades, however, a worldwide trend toward
“neoliberal” economic policies has sharply reduced
government economic intervention in both the
developing and developed world.
The Role of the State
 What follows is a discussion of a number of alternative
models prescribing the role of the state in Third World
economies, ranging from command economies such as
North Korea’s to very limited state intervention in
Hong Kong. Yet these are just ideal types, few
countries fit any of these models perfectly.
The Command Economy
 Marx argued that capitalism produces an
inequitable distribution of wealth and income
because those who control the means of
production (industrialists, landlords) exploit those
who work in them (the working class, peasants).
One of Marxism’s appeals to its supporters, then, is
its promise of great equality and social justice.
Command Economy
 The ideology has appealed to many Third World
leaders and aspiring leaders who are troubled by the
deep injustices in their own economic systems. That
argument is particularly persuasive in Latin America
and parts of Africa, which have the greates disparities
between rich and poor.
 A second assertion made by Third World Marxist
regimes is that only they can free their country from
the yoke of dependency.
The Command Economy
 Another of communism’s appeals has been its belief in
centralized state control over the economy. A command
economy, initially established in the Soviet Union, has two
central features:
 First, the means of production are primarily owned and
managed by the state. That includes factories, banks, major
trade and commercial institutions, retail establishments,
and frequently, farms. While all communist nations have
allowed some private economic activity, the private sector
has been quite limited, aside from communist nations such
as China, which have largely abandoned Marxist economics
in recent years. Second, decisions concerning production
are not set by market forces but rather by centralized state
plans.
The Command Economy
 Command Economy’s earlier achievements: by being able
to dictate the movement of people and resources from one
sector of the economy to another, communist countries
such as the Soviet Union and China were able to jump-start
their industrial takeoffs.
 During the 1920s and 1930s, “entire industries were created
[in the USSR], along with millions of jobs that drew
peasants away from the country-side and into higherpaying jobs and higher living standards”.
 During the early decades of its revolution, China also
moved quickly from a backward agrarian economy to a far
more industrialized society.
The Command Economy
 Finally, command economies have generally made
great strides toward reducing income inequalities. It is
here that communist LDCs most clearly outperform
their capitalist counterparts. In Cuba, the revolution
brought a substantial transfer of income from the
richest 20 percent of the population to the poorest 40
percent.
 The poor also benefited from an extensive land reform
program, subsidized rents, and free health care,
though some of these gains were undermined in the
1990s, following the loss of Soviet economic assistance.
The Command Economy
 Weaknesses: In the absence of signals of consumer
demand, state planners have little basis for deciding
what to produce and how much.
 All efficient, centralized command economy would
need a highly skilled and honest bureucracy equipped
with sophisticated technology such as computers and
accurate consumer surveys. Non of these qualities exist
in Third World bureaucracies.
 Moreover, factory and farm managers in centrally
controlled economies are rewarded for meeting their
output quotas, with little concern for product quality.
The Command Economy
 While the Soviet Union and China enjoyed impressive bursts of
growth in the early decades of their revolutions, each eventually
ran out of steam as their economies became more complex and,
hence harder to control to centrally.
 Moreover, command economies are more adept at building
heavy industries such as steel mills or contructing public work
projects-endeavors more typical of early industrialization- than
they are at developing sophisticated, high-tech production
techniques or producing quality consumer goods.
 By the late 1970s (in China) and in the 1980s (USSR), with both
economies deteriorating, their leaders (Deng Xiaoping and
Mikhail Gorbachev) recognized the need to decentralize their
economy and reduce state control.
Latin American Statism
 Even in capitalist Third World countries, the state has often
played a major economic role, seeking to be an engine of
economic growth.
 In the period between the two World Wars, many Latin
American nations first pursued state-led industrialization.
That process accelarated during the Great Depression,
when countries in the region had difficulty finding markets
for their food and raw material exports and consequently
lacked foreign exchange for industrial imports. Argentina,
Brazil, Chile, Uruguay and Mexico were among the early
leaders in the push towards industrialization.
Latin American Statism
 Unlike communist countries, Latin American nations,
with rare exceptions, have left most economic activity
in the hands of the private sector and have not
imposed centralized control over the economy. But
their government have generally owned strategically
important enterprises and have invested in industries
that failed to attract sufficient private capital.
Consequently, prior to the recent privatization of state
enterprises, many of the region’s railroads, airlines,
petroleum industries, mines, steel mills, electronic
power plants etc were state owned.
Latin American Statism
 Government takeovers frequently were not opposed by the
domestic private sectors. Many of the most important
nationalizations- incuding the petroleum industries in
Mexico and Venezuela, mining in Chile and Peru, and
railroads in Argentina- involved companies that had been
owned by multinational corporations, not local capitalists.
 Second, state-owned petroleum industries, railroads, and
utilities provided private sector industries with subsidized
transportation, power and other needed resources. In fact,
until the 1980s, conservative governments in the region
were as likely to expand as were left leaning or populist
regimes.
Latin American Statism
 The state also played a pivotal role in formenting private
sector-indutrial growth. In Latin America’s largest
economies, the government initiated import-substituting
industrialization (ISI) programs in the early to mid 20th cc.
 ISI sought to replace imported consumer goods with
products that were manufactured domestically. Although
import-substituting manufactures were almost always
privately owned, government economic policies such as
protective import tariffs, quotas, favourable exchange rates
were essential for stimulating industrial growth.
Latin American Statism
 In Argentina, Brazil, Colombia, Mexico and elsewhere
these state policies were quite succesful. From 1945 to
1970, rates of investment in Latin America were higher
than in the Western industrial powers.
 Virtually, every countyry in the region began to
manufacture basic consumer goods such as textiles,
apparel, packaged food and furniture. Larger nations
such as Argentina, Brazil and Mexico established
automotive industries, steel mills and other heavy
industries.
Latin American Statism
 But
state sponsored ISI also promoted economic
inefficiencies and inequalities. While its nurturing of
industrialization was helpful, perhaps necessary, in the
early stages of economic development, government
protection and stimuli were employed too broadly and too
long.
 Inefficient domestic industries received excessive
protection; trade and fiscal policies designed to promote
industrialization often harmed agricultural exports; and
the income gap widened both between urban and rural
populations and between skilled and unskilled workers.
Latin American Statism
 Two sources of inefficiency shall be noted:
 While it is quite possible to run state enterprises
efficiently, few Third World governments manage to
do so. In the face of high unemployment and
underemployment rates, governments are under great
political pressure to hire more personnel than the
enterprises need. Consequently, most state economic
enterprises are substantially overstaffed. At the same
time, these enterprises are also under political
pressure to sell the public consumer goods and
services at highly discounted prices.
Latin American Statism
 Ultimately, the combination of money-losing state economic
enterprises, consumer subsidies and subsidies to private-sector
producers helped bankrupt many Latin American governments.
By 1982 virtually every government in the region was deeply in
debt and experiencing severe fiscal problems.
 Another important weakness of Latin America’s development
model was the inefficiency it encouraged in the private sector. To
be sure, governments throughout the world have effectively used
protectionist measures to help infant industries get off the
ground during the early stages of industrialization. Yet over time
the level of protection needs to be scaled back down or domestic
firms will have little incentive to become more productive and
internationally competitive.
Latin American Statism
 Since the 1980s, most Latin American nations, moved
by the region’s severe debt crisis and economic
depression, have sharply reversed their earlier statist
policies. Privatizations.
 These reductions in public-sector activity were
implemented at great human cost. Throughout Latin
America, millions of workers lost their jobs.
East Asia’s Developmental State
 While Latin America have been struggling since the
early 1980s, a number of East and Southeast Asian
economies have grown at a phenomenal rate during
most of that period. South Korea, Taiwan, Hong Kong
and Singapore and China have received the most
attention.
 Their impact on world trade has been enormous.
China is now one of the US’s leading trading partners.
But other Southast Asian economies- Thailand,
Malaysia and Indonesia have also grown dramatically.
East Asia’s Developmental State
 With the partial exception of Communist China
(which has developed a mixed socialist and free
market economy), East and Southeast Asian
countries have largely tied their growth to the free
market. More so than in other Third World
regions, productive capacity has been largely
owned by private enterprise, with a relatively
smaller state sector.
East Asia’s Developmental State
 This has led conservative economists to hail East Asian
economic miracle as a triumph of unfettered
capitalism, a testimony to keeping government out of
the economy.
 But many scholars specializing in East Asian
economies argue that, to the contrary, governments in
that region have been key players in stimulating
economic growth.
East Asia’s Developmental State
 Chalmers Johnson’s notion of the developmental state:
 The early developing Western nations established
regulatory states in which government refrained from
interfering in the marketplace, except to insure certain
limited goals, while the East Asian developmental
states “intervene actively in the economy in order to
guide or promote particular substantive goals”.
East Asia’s Developmental State
 Japan’s powerful Ministry of International Trade and
Industry (MITI) directed that country’s postwar industrial
resurgence. Subsequently, South Korea, Taiwan, Singapore,
Indonesia, and other industrializing nations in East and
Southeast Asia adopted many aspects of Japan’s stateguided, capitalist development model.
 Under the developmental model, there is far more
extensive and direct goverment economic intervention
than in the West, targeting either whole economic sectors
(such as agriculture or industry), whole industries (such as
computers, automobiles, and electronics) or particular
companies.
East Asia’s Developmental State
 East Asian state intervention more indirect than Latin
America. Governments used tax policy, control over
credit, and influencing the price of raw materials to
encourage private sector activity.
 Example: South Korean and Taiwanese governments
electronics, computer software
East Asia’s Developmental State
 But can this model be applicable elsewhere?
 Developmental state’s requirements: Chalmer Johnson
notes that most developmental states have been
authoritarian or soft authoritarian during their major
industrialization push. Taiwan and South Korea
industrialized under authoritarian governments, though
both have subsequently become democracies. The
governments of Malaysia, Singapore and Indonesia have all
repressed democratic expression in varying degrees. Thus,
the question is how the developmental states would
perform under the democratic pressures now spreading
across the Third World.
East Asia’s Developmental State
 Another important question is the transferability of
East Asian political and economic practices to other
parts of the Third World. The developmental state
seems to require qualities that are in short supply
elsewhere in the developing world: a highly skilled
government bureucracy and close cooperation
between business, labor and agriculture.
The Neoclassical Model
 Unlike the preceding models, the neoclassical ideal
assigns government a very limited economic role. The
state, it argues, should provide certain fundamental
“public goods”, such as national defense, police
protection, a judicial system and an educational
system. It can also supply physical infrastructure,
including sewers and harbors, when it is not feasible
for private capital to do so and perhaps allocate
enough resources to the very poor to meet their basic
needs.
The Neoclassical Model
 Neoclassical economists insist that free-market forces
should determine production decisions and set prices
without government interference. Consequently, they
have criticized government policies designed to
stimulate industrial growth in the LDCs: protective
tariffs and import quotas that restrict free trade and
thereby drive up prices to the consumer, state
subsidies to producers and consumers.
 Only when these artificial constraints are removed will
the economy “get prices right” (i.e let them be
determined by free-market forces”.
The Neoclassical Model
 Since the 1980s, neoclassicalists (also known as
neoliberals) have largely won the debate against
advocates of extensive state intervention. As we have
observed, governments throughout Africa and Latin
America have liberalized their economies in recent
years, deregulating the private sector, removing trade
barriers, and freeing prices.
 Yet neoclassical model did not triumph completely.
East Asian miracle- far from following the market, it
was state “governing the market”.
The Neoclassical Model
 The only East Asian economy that has been conformed
to the neoclassical model has been Hong Kong. As the
least regulated economy in the area, it is often cited as
a success story for unrestricted capitalism. But Hong
Kong is such a unique case that it may not offer many
lessons for other countries. For one thing, it is rather
small and consists of a single city with no rural
population. Initially, its wealth was tied to its location
as a major port for Asian trade and an outpost of the
British Empire.
Industrialization Strategies
 Since the time of Britain’s industrial revolution, governments
have equated industrialization with economic development,
economic sovereignity and military strength.
 Neoclassical economists frequently criticized industrialization,
arguing that each country should specialize in economic
activities for which it has a “comparative advantage”. That is, it
should produce and export those goods it can provide most
efficiently and cheaply relative to other nations. Neoclaccisists
maintained that most Third World Nations should abandon
plans for industrialization and concentrate, instead, on the
production and export of raw materials or agricultural products.
(Sri Lanka producing tea rather than cars, washing machines).
Industrialization Strategies
 Industrializing
nations have generally pursued two
alternative strategies: import-substituting industrialization
(ISI) and export-oriented industrialization (EOI).
 In the first case, LDCs reduce their dependency on
manufactured imports by producing more of them at
home. While ISI has been most closely identified with
Latin America, it is a strategy that has been used, at least
initially, in most of the developing world. While ISI focuses
on producing consumer goods for the home market, EOI
stresses industrial development with East and Southeast
Asia, it is a strategy now widely embraced in Latin America
and other parts of the Third World.
Import Substituting Industrialization
 National economic policies are partly the product of
deliberate choice, partly the result of political and
socioeconomic opportunities and constraints.
 ISI has emerged as a development strategy in Latin
America during the 1930s as the worldwide depression
sharply reduced international trade.
Because the
industrialized nations of North America and Europe
curtailed their consumption of Third World primary goods,
Latin America was denied the foreign exchange needed to
import manufactured products. Then ISI became a long
term strategy for industrial development.
Import Substituting Industrialization
 In order to protect embryonic domestic industries
from foreign competition, consumer imports were
generally subjected to protective quotas and tariffs. At
the same time, planners also wanted to facilitate other
types of imports, namely capital equipment (primarily
machinery) and raw materials needed by domestic
manufacturers. To reduce the cost of those imports,
governments overvalued their own currencies.
Eventually, most Latin American countries established
multiple currency exchange rates, with differing rates
for transactions tied to either imports, exports or other
financial activities.
Import Substituting Industrialization
 Overvalued currencies and export taxes put traditional
primary goods exporters at a competitive disadvantage,
thereby depriving the country of needed foreign
exchange revenues. Because local consumer goods
manufacturers were allowed to import capital goods
cheaply, the region never developed its own capitalgoods industry and instead, imported manufacturing
technologies that were inappropriate to local needs.
Subsidized imports of machinery and heavy
equipment encouraged capital-intensive production
rather than the labour-intensive manufacturing
common to Asia.
Import Substituting Industrialization
 The ISI model of industrialization benefited a small,
relatively well-paid “labor elite”. But it failed to provide
enough jobs for the region’s unemployed and
underemployed.
 Although ISI was originally designed to make Latin
America more economically independent, in the end it
merely replaced dependence on consumer goods imports
with dependence on imported capital goods, foreign
technologies. Traditional primary exports were allowed to
languish, while little was done to develop new
manufactured exports. Increased balance of trade deficits
contributed to Latin America’s spiralling foreign debt,
leading eventually to a major debt crisis and an economic
depression in the 1980s.
Export Oriented Industrialization
 East Asia’s Newly Industrialized Countries initiated
their industrialization
drive through import
substitution, just as their Latin American counterparts
had done earlier. Soon, they diversified into
manufacturing for export.
 By 1980, manufactured products constituted more
than 90 percent of all South Korean and Taiwanese
exports but represented only 15 percent in Mexico and
39 percent in Brazil. Fueled by their dynamic
industrial exports, East Asia’s booming economies
became the envy of the developing world.
Export Oriented Industrialization
 The East Asian industrialization drive began in the 1960s, a
period of unprecedented expansion in world trade,
inspired by the GATT and the West’s economic boom. The
opportunities offered by outwardly oriented growth were
more obvious to government policy makers at that time.
 Another factor that distinguished East Asia from Latin
America were the influence of US advisers and the differing
training and economic orientation of government
technocrats. Until the 1980s, Latin American intellectuals
remained very committed to economic nationalism and the
need to limit US influence.
Export Oriented Industrialization
 On the other hand, because of Taiwanese and South
Korean military and political dependence on the
United States during the postwar decades, their
leaders were far more receptive to American policy
advisers advocating Export Oriented Industrialization.
East and Southeast Asia’s Economic Crisis
 The onset of the crisis: On July 2, 1997, the Thai
government announced that the exchange rate for
their national currency, the baht, which had been
previously fixed (i.e the Thai government had
guaranteed that its value relative to the dollar
remained constant) would be allowed to float (its
value would now fluctuate based on market forces).
East and Southeast Asia’s Economic Crisis
 As the value of the baht fell, investments in the Thai
stock exchange and bank accounst held in bahts also
lost value. For both the Thai government and private
companies that had secured extensive loans in dollars
from international banks, this meant that the cost of
bahts of repaying those loans climbed incredibly.
International banks, in return, curtailed further dollar
loans to Thailand, knowing that it would be difficult
for debtors to repay.
East and Southeast Asia’s Economic
Crisis
 Companies that imported consumer goods or
manufacturing inputs (machinery, raw materials,
technology) found the price of doing business
sharply increasing as the value of the baht
declined.
East and Southeast Asia’s Economic Crisis
 1997 crisis was not limited to Thailand. Foreign and
domestic investors in other Southeast and East Asian boom
economies began to fear that those countries might also be
overheated and plagued by the same fragilities (including
excessive external debts) that had undermined Thailand’s
economy. Indonesia, Malaysia and later South Korea all
forced to devaluate their currencies and were plunged into
deeeper recessions. During the following year, the
economic crisis threatened to spread to Hong Kong, Japan
and China. Countries with smaller foreign debts (Taiwan,
Singapore, the Philippines, Vietnam and China) were less
vulnerable to capital flight and have survived the crisis
relatively well.
Causes of the Asian Crisis
 Businesses in Thailand, Indonesia, Malaysia and South
Korea had borrowed and invested excessively. From
1992 to 1997 alone, Asian companies (excluding Japan)
had borrowed more than $700 billion from the rest of
the world. The result was questionable investments,
manufacturing overcapacity and excess construction of
new real estate.
 Another problem- credit in some countries often not
directed to firms or industries that could most
effectively invest it.
Causes of the Asian Crisis
 These underlying long-term weaknesses were then
aggravated by additional short-term problems. For a
period of time, several Southeast Asian countries had
pegged their currencies to the dollar, meaning that
their governments had guaranteed to keep the
currencies’ values fixed relative to the dollar. The
purpose of that arrangement was to assure foreign
investors that the value of their investments in the
region would not be undermined by devaluation, as it
had been in many Latin American countries.
Causes of the Asian Crisis
 But in the mid-1990s, when the dollar strengthened,
the region’s pegged currencies automatically gained
value as well (relative to currencies such as the
Japanese yen). As a consequence, the price of
Southeast Asia’s exports increased while the cost of its
imports declined, contributing to a growing trade
deficit.
Consequences of the 1997 Crash
 The crisis next spread to Malaysia and South Korea.
Ultimately, the implications were even broader, as
international financial institutions watched events in
Asia and became increasingly concerned about their
investments in other LDCs. Asia’s sharp currency and
stock market declines spread to Russia and caused
steep drops in the Argentine, Brazilian and Chilean
stock markets as well.
Consequences of the 1997 Crash
 As Asia’s financial crisis intensified, the region sank into a
deep economic recession, inflicting enormous pain on the
population. Unable to pay their debts, many companies
were forced into bankruptcy, throwing their employees out
of work.
 It shall be underlined that the key causal factor behind the
crisis have been external indebtedness. Countries such as
Thailand, Indonesia and South Korea which had borrowed
excessively, got into trouble. Those that had either
exercised restraint (Taiwan and China) or had been unable
to secure extensive foreign credit (the Philipines and
Vietnam) were not badly hurt.