State-led Development
Political Economy of the Global South
Prof. Tyson Roberts
Mobutu Surprise Pop Quiz!
1. What TV broadcast was Mobutu upset about?
2. What happened when Mobutu watched a
missile launch test?
3. True or False: Mobutu sometimes slept with the
wives of his top officials.
4. What are some of the economic policies of
Zairinization?
5. What would happen when Mobutu would ask
his officials to get him a million dollars?
Trivia Quiz
1. What does “ISI” stand for?
– Import-Substituting Industrialization
2. Name two policies that are part of ISI
3. What is “state capitalism”?
– The state controls the “commanding heights” of the
economy such as transportation and energy; other
parts of the economy can be private
4. Does the Washington Consensus favor or
oppose ISI policies?
– Oppose
How globalization helps developing countries
according to classical liberalism
• Free trade: poor countries specialize in comparative
advantage (e.g., agriculture) & import other products
(e.g., manufactures) => production 
• Free flow of labor: workers move from laborabundant to labor-scarce economies => wages 
• Free flow of capital: capital flows freely from capitalrich to capital scarce countries => investment,
development
Development philosophy 1950s-1970s:
“The Big Push”
• Marshall Plan big success in Europe; apply same
strategy to developing world
– “the tricks of growth are not that difficult” (Rostow
1960)
• Diagnosis: countries poor because agriculture
based, insufficient capital
– Private financial sector not sufficiently dev’ped;
wealthy class in poor countries consume rather than
invest
• Solution: capital transfers to poor country
governments to finance industrialization
Growth Model Review Part 1
• Harrod-Domar Model:
– y=f(k)
– Constant returns to capital
– Growth determined by savings rate
What might justify ignoring labor in a
growth model?
What might justify ignoring labor in a
growth model?
• Lewis: In developing countries, an increase in
capital attracts labor from subsistence farming
without reducing agricultural output
– In short run, no increase in wages
– In long run, profits from capital can be invested,
leading to self-sustaining economic development
– When subsistence labor is absorbed in modern
economy, wages begin to increase
What might justify ignoring technology
in a growth model?
• Sources of technological improvements:
– Adoption
– Innovation
• Developing countries can adopt technologies
from advanced countries as they increase
their capital stock
Growth Model Review Part 1
• Harrod-Domar Model:
– y=f(k)
– Constant returns to capital
– Growth determined by savings rate
Mathematical example
Harrod-Domar
•
•
•
•
If f(k) = 5k, and k =10, what is y?
y = 5 x 10 = 50
Now suppose k = 20. What is y?
y = 5 x 20 = 100
• Constant returns to capital
– if capital is doubled, output doubles
Savings and Harrod-Domar
• Poor countries can draw on savings from rich
countries (aid, loans, or investment) to
increase capital
• As income increases, more domestic savings
become available to invest in capital
The plan:
invested capital => industrialization =>
Take-off, following the West
Economic policy in post-independence Ghana
• Cocoa Marketing Board
– Originally answer to volatility
Marketing Boards (or Stabilization Boards) shielded
farmers from volatility in world markets
Economic policy in post-independence Ghana
• Cocoa Marketing Board
– Originally answer to volatility
– Became source of capital for
industrialization
• Other boards created
– Exports: timber, etc.
– Domestic markets: food, etc.
• Industrial projects included hydropower dam,
aluminum smelter plant, coconut oil mill, sugar
estates, tomato cannery, etc.
Structuralist Critique of Economic
Liberalism
• Market imperfections in developing countries
– Industrialization in modern era requires
coordination
• Complementary demand: need critical mass of wage
workers to buy manufactured products
• Pecuniary external demand: need related industries to
invest simultaneously
Solution to coordination problem:
“Big Push” by Government
Volta Dam, Ghana
Major electricity producer
Valco aluminum smelter
Major electricity user
Structuralist Critique of Economic
Liberalism
• Market imperfections in developing countries
– Industrialization in modern era requires
coordination
– Declining terms of trade
• Imported manufactures prices rise
• Export commodity prices fall
• Result: core country real incomes rise, periphery
country real incomes fall
Specialization in sugar enriched countries such as Haiti
in the short run but undermined long-run growth
Solution to Declining Terms of Trade
Problem: ISI
1. Easy ISI:
– Promote local production of consumer goods
• Sufficient local demand to enable economies of scale
• Sufficient local labor for labor intensive production
• Necessary technology available for import (in part in
form of foreign capital: machines, etc.)
• Benefits: wage-based employment, human capital
Solution to Declining Terms of Trade
Problem: ISI
1. Easy ISI
2. Second step options
– Secondary ISI
•
•
Move up to consumer durables (cars, etc.),
intermediate inputs (steel, etc.), and capital goods
(machines, etc.)
Common in Latin America, South Asia, etc.
– Export substitution
•
•
Expand consumer good production for export
Common in some East Asian countries
ISI Policies
• Government planning (5-year plans, etc.)
• Government investment
– Roads, rail, electricity, telecom, etc.
– State-owned & mixed-ownership enterprises
• Trade barriers
– Tariffs (on manufactured goods)
– Import quotas (on manufactured goods)
– Overvalued and/or multitiered exchange rates to
enable import of capital goods
Sources of funds for investment
• Foreign aid
• Foreign borrowing
• Taxes on agricultural exports (marketing
boards)
• Tariffs on imports
$2
$1
$1
Winners & Losers from ISI Policies
Winners
• Workers & firms in importcompeting industries
– Higher market share & prices
for produced goods
• Government
– Jobs, opportunities for rentseeking
• Urban residents
– Subsidized government
services
Losers
• Export-oriented farmers
– Lower producer prices =>
reduced production
• Consumers
– Higher prices for
manufactured goods
• Manufacturers in exportoriented industries (if any)
– Overvalued exchange rates
increase price of exports, etc.
Interest group politics
Urban bias
• Urban citizens tend to be more politically
active than rural citizens
– Lower transaction costs, collective action costs
• Nkrumah’s policies favored urban groups over
farmers, increasing the share of national
resources held by urban groups
• Urban groups use resources to push for more
pro-urban policies (including supporting
inefficient SOEs)
ISI policies successfully promoted
industrialization & GDP growth in 60s & 70s
GDP/capita growth
1960s & 70s
Latin America
2.3%
Sub-Saharan Africa
1.4%
Middle East & N. Africa
3.7%
East Asia
5.2 %
South Asia
1.2%
Southeast Asia
3.1%
But for most countries (all but East Asia), those growth rates would not prove sustainable…
Ghana’s producer price was consistently below the
international price from the mid-1950s – 1980s
Underpaid farmers reduced investment in cocoa plantations
When trees started to die ~1970, output fell for 15 years
Cocoa production dominance switched hands from Ghana to
Cote d’Ivoire, where producers were better paid
Real GDP per capita,
Ghana vs. Cote d’Ivoire, 1955-1979
The Ivoirien Miracle
Revenues from growth spent on ISI projects,
political support, and vanity projects
Revenues from growth spent on ISI project,
political support, and vanity projects
Other ISI policies:
Tariffs and import quotas
• Increases price of imports; enables local
producers to charge higher prices
• Government receives revenues from tariffs
• Producers sell more, but can remain inefficient
• Spending on lobbying for more protections
and benefits more lucrative than investment
in increased productivity
Other ISI policies
Overvaluation of currency
• Reduces cost of capital and inputs for
industrialization
• Reduces import costs for (urban) consumers
• Increases cost of exports on world markets
• Excessive demand for foreign currency drains
reserves
• Foreign currency then become scarce
– Encourages patronage and corruption
– Increases black market prices, which encourages
economic activity to move to the black market
Growth Model Review Part 2
• Solow Model (based on Cobb-Douglas)
– y = Akαlβ ; α + β = 1
– Diminishing returns to capital & labor
– Growth determined by technology
East Asian Miracles
• Government built and ran state-owned plants (higher
technology) – later privatized.
• Government subsidies for favored industries
– Included some agricultural sectors
• High tariffs on industrial products – later reduced.
• Infant industries grew under protection selling to local
consumers, then began to export
• Outward-orientation ensured high levels of
productivity
– But undervalued currencies reduced consumption levels of
citizens in short term – still the case (until recently?) in
China
African failures
• Government built and ran state-owned plants
• Government subsidies for favored industries
– Agriculture cash cows milked for investment in factories
• High tariffs on manufacture imports
• Infant industries were inefficient, generated losses
• Overvalued currencies enabled higher consumption
levels for citizens in short term
– But local firms uncompetitive relative to foreign firms
• Eventually, trade deficits & budget deficits forced
governments to accept structural adjustment
conditions – privatization, trade liberalization, etc.
Why did African countries pursue poor
policies?
Conclusions
• International and domestic developments and
new belief systems => ISI Policies
– World Wars & Depression strengthened relatively
scarce factor owners
– Political changes strengthened workers, domestic
industrialists, urban voters, etc.
– Marxism, Structuralist critique of economic
liberalism, etc.
Conclusions
• ISI policies increased industrialization & GDP growth,
but …
• Urban workers & industrialists benefitted to detriment
of export-oriented farmers
• Governments (esp. in “weak states”) took advantage of
rent-seeking opportunities to over-extend protection
of inefficient manufacturers
• Budget & trade deficits left countries exposed to global
economic crises
• Some Asian Miracle countries used ISI policies for “easy
ISI” then opened to trade for “export-led
industrialization”