UNCTAD stresses need to rethink development strategies

The UNCTAD paper also discusses possible ingredients of a development strategy that would foster a viable domestic capital accumulation process and channel investments to high-value-added areas with greater potential for innovation, productivity growth and export dynamism.

by Chakravarthi Raghavan

GENEVA: Over the past two decades, globalization has become a counterpoint to the policy issues surrounding late industrialization, and there is a need to rethink development strategies, to re-examine and remove potential constraints facing developing countries, particularly in terms of new obligations at the WTO that subject domestic policies on industrialization and technological development to stricter disciplines, according to UNCTAD.

The secretariat of UNCTAD has presented this view in an issues note  for the interactive debates during the mid-term review special session of the Trade and Development Board to be held in Bangkok from 29 April.

In the past two decades, “globalization has become the counterpoint to the policy issues surrounding late industrialization,” says the secretariat. Particularly since the debt crisis of the early 1980s, developing countries have been striving hard, and often at considerable cost, to integrate more closely into the global economy, hoping to end any stop-go growth and development through export expansion and inflows of private foreign capital.  This has required many developing countries to break with past policies and to pursue closer and faster integration into the world economy through rapid liberalization of trade, finance and investment.

However, there has been slow and erratic growth, increased instability, and rising income gaps between most developing countries and the industrial world. This has led to the question of  designing appropriate development strategies in a globalizing world.

“Good governance”

While policies initially focussed on “getting the prices right”, more recently, the question of appropriate institutions, epitomized under the rubric of “good governance”, has come to play a central role in the official policy advice to developing countries, notes the UNCTAD secretariat.

The basic principles espoused for good governance generally include political accountability, participation and ownership, effective rule of law, and transparency and information flows.  The pursuit of these principles is expected to result in good institutions such as democracy, an honest and efficient bureaucracy and judicial system, protection of property rights, good corporate governance and private and public finance systems, adequate social safety nets, protection of labour rights, etc. There is almost a universal agreement on the importance of most of these principles and institutions in economic, social and political development at a general level.

However, in assessing whether specific institutional arrangements are a prerequisite for rapid development in developing countries, it has to be borne in mind that historical experience showed that many of the institutions now regarded as prerequisites of successful economic development were the outcome rather than the cause of the economic development of today’s advanced countries.

In fact, many developing countries presently have much higher levels of institutional development compared to the levels attained by today’s industrialized countries when they were at similar levels of per capita income and economic development. (UNCTAD economists point out as examples that there was no adult franchise and parliamentary democracy or independent judiciary when the current industrial nations had a per capita income of about $2,000; neither was there gender equality.)

“Imposing a common institutional standard on all countries with different conditions is likely to be counterproductive: there is considerable institutional diversity even among industrial countries and recent experience shows that many of the institutions of the advanced countries superimposed on existing economic, social and political structures in developing countries have failed to function properly,” the secretariat note points out.

The efforts to adopt the institutions of developed countries (being pushed under the rubric of “governance”) may put considerable strain on financial and human resources in developing countries, and they may also conflict with social and cultural norms.

Moreover, a number of institutions which were once held as examples to be replicated (such as the bank-based financial system in East Asia or corporate governance in the United States) have subsequently been found to have serious weaknesses, the secretariat note says.

At the same time, the secretariat adds, exaggerating these difficulties could easily become an excuse for defending the institutional status quo in developing countries. The developing countries can still draw on the rich historical experience of today’s advanced economies in creating or adopting institutions that can help foster development.  Just as these countries have benefited immensely from technological advances in developed countries in areas such as medicine and industry to further human welfare without themselves having the need to innovate, they can equally learn and benefit from the institutional know-how and experience of developed countries.

“But levels of economic development and historical particularities set limits to what can be usefully replicated,” UNCTAD adds.

Policy challenges

On the policy front, it is generally agreed that fiscal and monetary discipline and macroeconomic stability are a necessary but not a sufficient condition for sustained growth and development.  Indeed, during the past decade, most developing countries have made considerable progress in attaining fiscal discipline and price stability. The fact that greater price stability has not resulted in more vigorous and sustained growth has now led many to argue that attention should be turned to micro-level, supply-side policies. While such policies should always be integral components of targeted industrial and technology policies in developing countries, it is far from  clear whether current difficulties have primarily microeconomic or macroeconomic origin, says UNCTAD.

Even though inflation has been brought under control, macroeconomic stability has not been attained since key variables such as wages, exchange rates and interest rates that exert strong influence on investment and resource allocation have been extremely unstable in most developing countries, “in large part because of increased financial instability associated with greater mobility of capital.”

A more stable and predictable macroeconomic environment is a prerequisite for a positive investment climate, and without it there is a risk that policies at a microeconomic level are much less likely to succeed.

So far, the forces unleashed by rapid liberalization have favoured certain income groups over others without stimulating investment and growth. Furthermore, income inequality has increased almost everywhere as capital has gained in comparison with labour, and the wage gap between skilled and unskilled workers has widened in many countries. Financial liberalization has also given rise to a rapid expansion of public and private debt, to the benefit of a new rentier class, while agricultural liberalization in developing countries has favoured in many of them an urban trading class rather than farmers. These factors making for greater inequality have at the same time deterred investment and slowed growth because the groups that have benefited from liberalization have not invested their wealth in productive activities.

“In particular, the advantages given to global finance in terms of the speedy entry into and exit from financial markets in search of quick gains have often undermined the ‘animal spirits’ needed to make longer-term commitments to investment in newly created productive assets.”

In the light of these trends, the success of the late industrializing developing countries, mainly from East Asia, stands out.  These experiences have provoked widespread interest and a good deal of controversy.  However, there is a broad agreement that success in these countries has been based on the “high animal spirits” of their business class, reflected in exceptionally high rates of savings and investment from profits, and that a disciplined developmental state was instrumental in organizing these ingredients.

From this perspective, effective development strategies may require accelerated investment and capital accumulation policies in most poor countries to initially be designed for a predominantly rural economy, with the basic aim of increasing agricultural productivity, particularly among smallholders, and generating a net agricultural surplus that can be used to nurture non-traditional activities.

“Predictable prices for inputs and final products, adequate rural credit, an appropriate exchange rate, public infrastructure investments, and specific supply-side policies to improve the technological capacities of farmers, to encourage market development and to minimize excessive risks are of crucial importance.”

As industrial activity begins to take off, a strategy to stimulate profitability and high levels of reinvestment of profits in productive activities will need to draw on fiscal measures as well as trade, financial and competition policies.

The early stages of rapid growth, particularly as industry takes off, are likely to involve a significant financing gap as investment surges ahead of domestic savings. This gap needs to be initially filled by means of capital inflows, but should be gradually closed as domestic savings rise with rising income levels. This process of reducing dependence on international capital inflows is a distinct feature of successful industrialization and development.  In many other countries, periods of rapid growth failed to stimulate domestic savings, with the result that when external trading and financial conditions deteriorated, growth could no longer be sustained.

An important challenge for a large majority of middle-income countries is how to reduce reliance on volatile international capital flows by encouraging savings and capital accumulation, particularly through reinvestment of a greater proportion of profits.

Concerns about excessive reliance on external financing also raise issues as to whether market forces should determine the forms these flows take and their destination and use. Recent financial crises in developing countries leave little doubt that it is essential for them to manage capital flows so as to avoid boom-bust cycles and serious disruptions to growth and development.

Most developing countries, says UNCTAD, also need to reorient the modalities of their participation in international trade.  Indeed, while developing countries as a whole appear to have become more active and dynamic participants in world trade over the past two decades, there has been a great deal of diversity in the channels of their participation in the international division of labour.

Many countries have not been able to move away from those primary commodities for which markets are relatively stagnant or declining.  However, some countries have become successful exporters of more dynamic commodities and enjoyed rising incomes.

Most developing countries that have been able to shift from primary commodities to manufactures have done so by focussing on resource-based, labour-intensive products, which generally lack dynamism in world markets.

The apparent jump by some countries into skill- and technology-intensive products is often less than it seems, the reality being involvement in labour-intensive, assembly-type activities in such products with relatively little value-added, UNCTAD notes.

Only a few countries, mainly from East Asia, have seen sharp increases in their shares in world manufacturing value-added and world manufacturing trade, reflecting their steady progress in industrialization which predates the recent export drive elsewhere in the developing world.

Most developing countries are still exporting resource- and labour-intensive products, effectively relying on their supplies of cheap labour to compete.  But even as policy-makers begin to see signs of success in terms of higher investment levels and rising market shares in labour-intensive manufactured exports, they need to anticipate future difficulties that these industries may face, including those due to rising wages, limits to productivity growth and deteriorating terms of trade.

Overcoming these constraints requires gradual and purposeful nurturing of a new generation of industries, particularly capital goods and intermediate products, with a greater potential for innovation, productivity growth and export dynamism; and measures to build and strengthen technological capacity at the national, industry and firm levels.

Tax and other incentives can be used to encourage enterprise training, along with a national programme at higher levels of education and on greater industry-level involvement in vocational training schemes.  Measures to facilitate local R&D, including financial subsidies, particularly for large and risky projects, the creation of science parks and special industrial estates offer potential ways of strengthening technological capacity.

On the issue of foreign direct investment (FDI), the secretariat says that although a successful development strategy must be firmly based on the establishment of strong local firms linked to a dynamic accumulation process, there is little doubt that foreign firms are likely to have an important role at all stages in the development process. A variety of techniques can be used to maximize the advantages from interactions with foreign firms, from reverse engineering and licensing to the hosting of foreign affiliates. In most cases, a combination of such techniques is likely to be desirable, tailored to specific sectoral demands.

“For poorer countries attempting to integrate at the low-cost end of the production chain, the very heavy import content of their activities poses one set of policy challenges,” says the secretariat.

“The potential technological and other spillovers, particularly for middle-income economies and in sectors where specific knowledge and capital equipment are closely knitted together, requires that host governments preserve a range of policy options to enable them to bargain effectively with TNCs [transnational corporations].

“Successful measures have in the past included regulation of FDI in areas where the aim is to nurture large domestic producers, domestic content agreements, and technology screening.  In general, a more liberal approach to FDI is likely to bring significant benefits after productivity levels and technological capacities cross certain thresholds.”

Policy constraints

The secretariat note however does not point directly to many of the new rules and disciplines sought to be forged in the WTO on the “new issues” (investment, competition policy, government procurement and trade facilitation), and the policy advice being given by other parts of the secretariat under ‘tailored’ technical assistance programmes that seem to be running counter to the note on rethinking development strategies.

On the question of whether the development strategies which have proved successful in the past are now feasible, given the constraints of the emerging international economic order, the secretariat notes that diminished sources of official financing and greater reliance on private capital flows are one source of potential constraint on policy options. Another source consists of the new obligations under the WTO, which subject domestic policies, particularly in the areas of industrial and technological development, to stricter disciplines than heretofore.  Also, conditionalities attached to multilateral loans have brought  a wider set of policy measures under the close surveillance and assessment of the multilateral financial institutions.

“All these potential constraints need to be reexamined to ensure that developing countries have sufficient policy space to create the sort of investment-export nexus that can support rapid and sustained growth.”

Many developing countries, the secretariat argues, are not using all the policy options open to them.  Many of the financial, fiscal and sectoral policies that can help create the basic conditions for faster and better directed capital accumulation and channel investments in a manner consistent with broader development objectives are not governed by multilateral agreements.  In particular, the scope for export promotion, though reduced, still allows for various forms of support, particularly in the poorest countries. (SUNS5103)                                                  

From Third World Economics No. 278 (1-15 April 2002)