Trade & Development II:
Economic Reform
International Political Economy
Prof. Tyson Roberts
Brief history globalization &
development
• Mercantilism (1500s-1700s)
• Classical liberalism (1800s– early 1900s )
• World Wars & interwar period (1914-1945)
– Breakdown of free trade system, nationalist,
fascist & communist movements
– Structuralism, ISI policies
• Embedded Liberalism (1945 – 1970s)
– Bretton Woods institutions: WTO, IMF, GATT
– “Big Push”
• Neoliberalism (1980s-2000s)
Causes of Shift from Structuralism to
Neoliberalism
• Economic imbalances from ISI
• East Asian countries with export-oriented
policies outperforming other developing
countries
• Financial crisis in late 1970s/early 1980s forces
developing countries to reform – World Bank
& IMF push neoliberal reforms
$2
$1
$1
Assume the world equilibrium price for cocoa is $2. How much
would Ghana cocoa farmers be willing to produce?
Price of
cocoa
3
SC
2
DC
1
2
4
6
Quantity of
Ghanaian Cocoa
Assume the world equilibrium price for cocoa is $2. How much
would Ghana cocoa farmers be willing to produce?
Price of
cocoa
3
SC
2
DC
1
2
4
6
Quantity of
Ghanaian Cocoa
How would cocoa farmers respond if the
government sets the producer price at $1?
Price of
cocoa
3
SC
2
DC
1
2
4
6
Quantity of Cocoa
How would cocoa farmers respond if the
government sets the producer price at $1?
Price of
cocoa
3
SC
2
DC
1
2
4
6
Quantity of Cocoa
Ghana’s producer price was consistently below the
international price from the mid-1950s – 1980s
Cocoa production held up ‘til ~1970 (trees), then fell for 15 years
Cocoa production dominance switched hands from Ghana to
Cote d’Ivoire (where producer prices were higher)
Overvalued exchange rates and
industrialization
1. Why would an overvalued exchange rate
facilitate industrialization?
2. How would the market-based response of
manufacturers, farmers, international
traders, or bureaucrats undermine
development?
– Use supply and demand diagram
Overvalued exchange rates (which makes foreign currency
cheaper) lowers costs of imported capital good and inputs
Cedis per
$
S$
Fewer dollars needed to buy foreign goods
D$
Number of Dollars
12
But overvalued exchange rates (which makes foreign
currency cheaper) makes domestic goods more expensive
Cedis per
$
S$
Fewer foreign buyers want to buy
more expensive exports
D$
Number of Dollars
13
Demand for foreign currency exceeds supply of foreign
currency => shortage of foreign currency, opportunity for
rent seeking
Cedis per
$
S$
D$
Number of Dollars
14
What policies need to accompany
overvalued exchange rates for ISI to work?
• Trade barriers on manufactured goods
– Tarriffs, import quotas, etc.
• But…
– If the state is weak, government officials corrupt,
exceptions will be made for the politically
connected
– As global trade increases, increasingly difficult to
target trade barriers
Results of State Intervention Policies
• 1960s-70:
– High government spending, commodity prices
enabled growth
– Debt build-up
– State intervention + weak state => Poor
governance, corruption, inefficient firms, etc.
• 1979:
– Increase in interest rates & oil prices, global
recession, fall in commodity prices => crisis
1970s & 1980s:
Latin America & Africa: Good to Flat
East Asia Booms
GDP/capita growth
1960s & 70s
1980s
Latin America
2.3%
-0.3%
Sub-Saharan Africa
1.4%
0.2%
Middle East & N. Africa
3.7%
-1.3%
East Asia
5.2 %
5.0%
South Asia
1.2%
2.0%
Southeast Asia
3.1%
3.3%
Source: pwt_grgdpch for countries with pwt_pop>1000
Some lessons from “Asian miracle”
• Macroeconomic stability promotes investment
in capital & education
– Low inflation encourages savings & investment
– Competitive exchange rates promote investment
in manufacturing
– High domestic savings enables little foreign
borrowing
– Low budget deficits enable private borrowing &
signal stable tax rates
Some lessons from “Asian miracle”
• Export orientation enables sustainable
economic growth
– World market enables economies of scale
– World competition force improvements in
efficiency
– Foreign currency earnings reduce risk from global
financial crisis
Why would governments continue to pursue ISI
policies when they result in trade & budget
deficits & stagnant growth?
• Winners from ISI policies oppose economic
reform
• ISI policy supporters can solve collective action
problems more easily than reform supporters
– Urban vs. rural
– Private goods vs. public goods
– Government vs. private citizens
• Reform becomes possible when benefits from ISI
are exhausted
Shift in economic development
paradigm
• Post-independence:
– Problem: Lack of capital, market failures (poverty
trap, etc.)
– Solution: Aid and state intervention
• Post-debt crisis:
– Problem: State intervention created inefficiencies
– Solution: Conditional aid to encourage withdrawal
from state intervention to allow market forces to
work
Washington Consensus
1. Fiscal discipline
2. Shift public spending
from subsidies &
bureaucracy to health,
education, infrastructure
3. Tax reform
4. Liberalize interest rates
5. Competitive exchange
rate
6. Trade liberalization
7. Liberalization of inward
investment (e.g., FDI)
8. Privatization
9. Deregulation
10. Property rights
Neoliberalism success?
• Many studies find structural adjustment policies
did not increase growth
• Pro-neoliberal argument
– Short term downturn followed by growth
– Strict application of SAPs did lead to success
• Anti-neoliberal argument
– Macroeconomic stability & trade helps, but…
– The state still plays an important role
– “Keep the windows open, but don’t forget the
mosquito screen”
Post-Washington Consensus ?
• Underinvestment in education & healthcare has
human & economic costs
– IMF/WB response: PRSPs
• Neoliberal policies don’t necessarily => growth
– “Good” policies with weak institutions => poor results
– Order of reforms matters
• The state plays an important role in development
– State is necessary to create efficient markets, etc.
– Developmental industrial policies can work if there is
sufficient state capacity & good governance
An example of state-facilitated markets:
Singapore’s healthcare system
• Universal healthcare coverage
• Spends 4% of GDP on healthcare (vs. 17% in US)
• 1/3 of healthcare expenses paid by individuals (vs. 1/10
in US) => encourages price competition
• Ministry of Health publishes hospital price information
• Healthcare savings accounts mandated by government
(20% of wages by employees, 13% by employers)
• Gov’t-provided safety net for the poor
• Gov’t subsidizes 80% of costs in acute care hospitals
• Public sector provides 80% of acute care; private sector
provides 80% of primary care
Conclusions
• ISI did enable industrialization
• Some argue that this laid the groundwork for
future growth for some successful economies
• For many others, ISI created imbalances that
undermined later growth, especially if…
– Secondary ISI instead of export substitution
– Weak state (captured by uncompetitive interests)
– Low state capacity (bureaucratic quality, etc.)
Conclusions
• Long-term growth appears to be facilitated by
– Integration in the world trade market (but not too
open?)
– Pro-export policies in agriculture and/or
replacement of ISI with export orientation
– Stable macroeconomic policies (inflation,
exchange rate, budget deficit)
– State capacity, investment in education, public
health, infrastructure, R&D, etc.
Midterm Prep
• Review readings & lecture slides
• Self-test using reading quizzes
• Self-test using class exercises (in slides) &
problem sets
• Cheat sheet: index card, double sided,
handwritten
• Get lots of sleep, bring a drink
Questions?