Reclaiming Development

An Alternative Economic Policy Manual

Ha-Joon Chang, Ilene Grabel

• Publisher: Zed Books
• Year: 2014
• ISBN:
  9781780329734
• Edition: 2
• Topic: Economics
• Subtopic: Development Economics
• Index: Economics

There is no alternative to neoliberal economics - or so it appeared when Reclaiming Development was published in 2004. Many of the same driving assumptions - monetarism and globalization - remain within the international development policy establishment. Ha-Joon Chang and Ilene Grabel confront this neoliberal development model head-on by combining devastating economic critique with an array of innovative policies and an in-depth analysis of the experiences of leading Western and East Asian economies. Still, much has changed since 2004 - the relative success of some developing countries in weathering the global financial crisis has exposed the latent contradictions of the neoliberal model. The resulting situation of increasingly open policy innovation in the global South means that Reclaiming Development is even more relevant today than when it was first published. History is being made.

Part I

Myths and Realities about Development

The chapters in Part I examine six distinct, but related, ‘Development Myths’. These myths form the basis of today’s conventional wisdom regarding the types of economic policies and institutions that are both appropriate and feasible for developing countries. This discussion serves as the backdrop for our discussion of economic policy alternatives in Part II.

Each of these chapters begins with a brief statement of a development myth as it is generally articulated (‘The Myth’). This is followed by an explication of the arguments that advocates generally advance in support of the myth (‘The Myth Explored’). Finally, each chapter concludes with a detailed refutation of the myth (‘The Myth Rejected’).

1 Myth 1

‘Today’s wealthy countries achieved success through a steadfast commitment to the free market’

1.1 The Myth

Today’s industrialized countries have prospered because of their steadfast commitment to free-market economic policies. Unfortunately, many policymakers in developing countries today have failed to learn this lesson, and remain committed to state interventionism. But the laws of economics and history cannot be denied, and this approach is doomed to failure.

1.2 The Myth Explored

The rich countries prospered through free trade and free financial flows.

Many economists argue that countries like Britain and the USA became world economic leaders because of their vigorous commitment to free-market policies.¹ These policies promote market- rather than state-direction of trade and financial flows. This strategy minimizes the scope of government regulation while encouraging private ownership of resources, enterprises and even ideas.

In this view, nineteenth-century France lost ground to Britain as a dominant player on the world scene because of its notoriously meddlesome government. Similarly, the Japanese economy has suffered from slow growth over the last decade because its leaders failed to liberalize the country’s state-led economy.

The folly of state intervention is most dramatically illustrated by the failed interlude of trade protectionism in industrialized countries in the early twentieth century. Following Britain’s success with free trade during and since the eighteenth century, most of today’s industrialized countries had adopted free-trade policies by the 1870s. Free trade inaugurated an era of unprecedented economic growth that extended until 1913.

Sadly, this free trade era ended with World War I and the ensuing economic and political instability. In this context, governments ceded to pressures for protectionism. The Great Depression exacerbated this trend: during the 1930s, governments erected a variety of tariff barriers against one another and implemented other ‘beggar-thy-neighbour’ strategies in a vain effort to promote domestic growth and stability. The protectionist, nationalist direction of trade policy ultimately prolonged the Depression, undermined the world trading system, and fuelled the flames of fascism in Europe. These economic, social and political tensions – the consequence in part of the retreat from the market – contributed significantly to the outbreak of World War II.

Today’s industrialized countries returned to free-trade policies following the end of World War II. Since then they have pursued trade liberalization through the General Agreement on Trade and Tariffs (GATT) and more recently through the World Trade Organization (WTO). In parallel fashion, they also deregulated and privatized their domestic industries. These initiatives have promoted world prosperity, especially in developing countries.

A similar story applies to finance. Over the last two centuries or so, today’s industrialized countries gradually learned of the benefits of deregulated, market-mediated (domestic and international) capital flows. ‘Financial liberalization’ has many components, including market allocation of investment funds, protection of investor rights and freedoms, and the maintenance of transparency. The trend towards financial liberalization has been reversed from time to time, but today most industrialized countries are deeply committed to the market mediation of financial flows – domestically and internationally.

Developing countries have suffered because of policymakers’ proclivity to adopt interventionist economic policies.

With the attainment of independence, most developing countries adopted highly interventionist economic strategies. As a consequence, they have faced economic stagnation.

Interventionism had many components. Pursuing ‘infant industry protection’ and ‘import-substituting industrialization’ (ISI) policies, governments insulated domestic industries from foreign competition with steep tariffs, restrictive quotas and large subsidies. Governments also nationalized key industries, creating state-owned enterprises (SOEs), and heavily regulated private-sector firms. Moreover, governments manipulated investment by nationalizing banks, regulating domestic financial activities, and restricting cross-border capital flows.

Most developing countries maintained these interventionist policies until the early 1980s. By then, however, these policies were recognized to be a resounding failure. Infant industry protection had not achieved the objective of promoting internationally competitive mature industries. SOEs also fared poorly: state subsidies and insulation from market competition left them bloated, inefficient and dependent on the state. Financial markets were stunted, while financial institutions provided funds to otherwise nonviable firms. In addition, industrial and financial controls gave rise to widespread corruption, bureaucratic ‘red tape’, and a costly misallocation of entrepreneurial talents. Together, these policies induced huge budget deficits and international debts, rapid inflation and myriad economic dislocations.

The economic crisis that swept through the developing world in the 1980s was the direct result of these misguided policies. The crisis led policymakers to embrace free-market capitalism – and not a moment too soon.

1.3 The Myth Rejected

The ‘secret’ of their success: today’s industrialized countries did not become rich through free trade and free financial flows.

An honest reading of the historical record shows that today’s industrialized countries pioneered and relied upon myriad interventionist industrial, trade and financial policies in the early and often in the later stages of their own development (see Chapters 7–11 and Chang 2002). With respect to trade, Britain and the USA, the most strident free-trade missionaries in the world today, actively utilized protectionist policy during the early years of their development. Indeed, they exercised greater protection than even Germany and France, countries typically associated with trade protection and industrial regulation. In the eighteenth century, for instance, Britain introduced import protection and export promotion policies to challenge the industrial supremacy of the Netherlands and Belgium (see Chapter 7) – policies that Japan and others would utilize so effectively in the decades after World War II.

The prize for protectionism, however, goes to the USA! It had the most protected economy in the world between the mid-nineteenth century and World War II (only Russia, for a brief period in the early twentieth century, maintained a more protected economy). The USA was also the intellectual home of infant industry protection, a strategy later adopted so successfully by Germany and Japan (see Chapter 7).

Most of today’s industrialized countries also used aggressive industrial policy to rebuild and modernize their economies after the devastation of World War II, even while they liberalized trade. Industrial policy played an especially important role in the post-World War II economic transformation of Japan, France, Norway, Austria and Finland. State-owned enterprises were also important during this period in France, Austria and Norway. Indeed, even the USA relies upon industrial policy, though it is not identified as such. For example, massive state investment and support for research and development (R&D) in defence and pharmaceuticals and large agricultural subsidies are de facto industrial policies with significant private-sector spillovers.² The development of transistors, radar, computers, nuclear fission, laser technology and the Internet can be traced directly to defence-related subsidies by the federal government.

Industrialized countries also used a variety of interventionist financial policies during the post-World War II period, and to great effect. These countries suffered from incessant financial instability prior to World War II because many then had neither central banks nor effective financial regulations. The financial stability (and ensuing growth) of the post-World War II era was very much a product of the effective financial regulation that characterized this era.

During the post-World War II era, Japan and most continental European countries subordinated their financial sectors to the needs of industrial development and thereby achieved rapid industrial growth. For example, the French government (via the central bank which it controlled) ensured that industrial policy objectives were met by the financial system. The Japanese government (working through the central bank and the Ministry of Finance) ensured that strategic industrial sectors received sufficient finance at attractive prices.

As we shall see in Chapter 9, almost all industrialized nations maintained stringent controls on international capital movements from the end of World War II until about 1980. These policies, known as capital controls, were designed to promote economic development and to protect fragile economies from the instability caused by capital flight. The USA was nearly alone in its failure to maintain capital controls following World War II (except for a brief moment in the early 1960s). The absence of capital controls in the USA was largely the product of the country’s unique status as the world’s financial superpower.

Finally, even while proclaiming the virtues of the free market, policymakers in industrialized countries have been quite willing to intervene in and re-regulate markets to avert financial crisis and/or to protect national (or sectoral) interest. Indeed, the US government has acted to socialize financial and economic risk on many recent occasions. Examples include its rescue of the Chrysler Corporation in 1980, and the multi-billion-dollar, publicly funded bail-outs of the savings and loan banks in 1989, the hedge fund Long-Term Capital Management (LTCM) in 1998, and the airline industry in 2001. In each of these cases, the government was willing to sacrifice the discipline of free financial markets in order to promote financial stability and to restore investor confidence.

The truth about developing countries: well-designed programmes of intervention explain most success stories.

As discussed in Chapter 2, the vast majority of developing countries performed far better in the post-World War II era of interventionism than in the post-1980 era of free-market policies. Indeed, the performance of developing countries during the interventionist era was impressive not only in an absolute sense, but also relative to the performance of today’s industrialized countries at a comparable stage in their development.

The truly dismal period of developing country performance was prior to World War II. During this period, developing countries were often coerced into using extreme free-market policies by colonial powers or, when nominally independent, through treaties that deprived them of tariff autonomy and the right to have a central bank. The typical result was sluggish growth and even economic decline. Economic performance in developing countries only improved after World War II because independence in some countries and a supportive ideological climate enabled policymakers to pursue interventionist strategies.

This is not to say that state intervention always works. There are cases where state intervention failed spectacularly. But when we look at the most dramatic success stories, the record clearly shows that development success is strongly related to myriad types of interventionism. Indeed, except for the case of Hong Kong, the East Asian ‘miracle’ was engineered by activist ‘developmental states’ that aggressively promoted economic development and financial stability (see Woo-Cumings 1999). China and India have also developed successfully via strong state direction of economic affairs (see Chapters 5, 7–11).

Notes

1. This policy regime was then known as ‘liberalism’. In its modern form it is called ‘neoliberalism’. This concept is explored more carefully in Chapter 2.

2. Throughout the post-World War II period, between half and two-thirds of US R&D was supported by the federal government (Mowery and Rosenberg 1993: Table 2.3). In 1989, 46.4 per cent of US R&D was supported by the government, while only 16.4 per cent of Japanese R&D in the same year was government supported (Odagiri and Goto 1993: Table 3.3). This contrast is rather striking, especially given the widely held view of Japanese state interventionism.

2 Myth 2

‘Neoliberalism works’

2.1 The Myth

Over the past two decades, those developing countries that adopted the neoliberal agenda have prospered, while those that continued to pursue state-directed economic models have stagnated. The lesson is clear: neoliberalism represents the sole path to development and prosperity.

2.2 The Myth Explored

Neoliberalism has succeeded where other regimes have failed.

The term ‘neoliberalism’ refers to the contemporary adoption of the free-market doctrines associated with the classical ‘liberal’ economists of the eighteenth and nineteenth centuries (such as Adam Smith and David Ricardo). The term ‘Washington Consensus’ is often used synonymously with neolibe...

Table of contents

• Cover
• About the Author
• Title
• Dedication
• Copyright
• Contents
• Acknowledgements
• List of Abbreviations
• Foreword
• Preface to the critique influence change edition
• Introduction: Reclaiming Development
• Part I: Myths and Realities about Development
• Part II: Economic Policy Alternatives
• Conclusion Obstacles and Opportunities for Reclaiming Development
• References
• Recommended Further Reading
• Index