Trade & Development II:Economic Reform

International Political EconomyProf. 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

2

1

2 64

SC

DC

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

2

1

2 64

SC

DC

Quantity of Ghanaian Cocoa

How would cocoa farmers respond if the government sets the producer price at $1?

Price of cocoa

3

2

1

2 64

SC

DC

Quantity of Cocoa

How would cocoa farmers respond if the government sets the producer price at $1?

Price of cocoa

3

2

1

2 64

SC

DC

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 yearsCocoa 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

12

Number of Dollars

S$

D$

Overvalued exchange rates (which makes foreign currency cheaper) lowers costs of imported capital good and inputs

Cedis per $

Fewer dollars needed to buy foreign goods

13

Number of Dollars

S$

D$

But overvalued exchange rates (which makes foreign currency cheaper) makes domestic goods more expensive

Cedis per $

Fewer foreign buyers want to buy more expensive exports

14

Number of Dollars

S$

D$

Demand for foreign currency exceeds supply of foreign currency => shortage of foreign currency, opportunity for rent seeking

Cedis per $

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 BoomsGDP/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 discipline2. Shift public spending

from subsidies & bureaucracy to health, education, infrastructure

3. Tax reform4. Liberalize interest rates5. Competitive exchange

rate

6. Trade liberalization7. Liberalization of

inward investment (e.g., FDI)

8. Privatization9. Deregulation10. 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?