Global Trends by Martin Khor

Monday 19 July 2010

Towards a new development strategy

Developing countries are moving from the failed “Washington Consensus” extreme liberal policies towards a rediscovery of the need for a strong role of the “developmental state” in a new economic strategy


The best strategy for developing countries to attain their development goals is for them to focus on a production plan for the various sectors, and to have the government play a key role in coordinating overall economic activities, including assisting and activating the domestic private sector.

This may not seem like breaking news.  It may even sound like common sense or even banal to most ordinary people being told this.

In reality, these simple ideas have had to make a come back.  They have re-emerged recently and stand a strong chance to become a core part of a new development paradigm.

In the past two to three decades the developing countries have been presented a vastly different view by the West and the international institutions (the IMF, World Bank and WTO).

The orthodox approach (often called “neo-liberal') is that governments should have as little to do with the economy as possible.  They should privatise public sector activities, withdraw assistance to local farmers and producers, and open the economy to the flow of foreign goods, services and funds and to the establishment of foreign companies.  This will lead to economic growth.

Countries that did not depend on the IMF and World Bank for loans escaped from having to follow these policies.

Thus many Asian countries were able to blend liberal policies with maintaining a strong role for the state.  Though the overwhelming state ownership of some activities and sectors was relaxed and the role of private companies became more prominent, the government has kept a strong guiding hand over investment, financial and trade policies.

The five-year plans and the national policies for certain sectors (industry, agriculture, finance) were  and still are instruments to give the government an over-riding management role over the economy.

Its role in nurturing the local private sector, through financing, public sector procurement and projects, incentives and public-private joint ventures, has also been critical. 

There is a general openness to foreign investors, but their role is regulated as to the sectors they are to take part in, their extent of ownership, and the partnerships they should enter into with local companies or the government.  This is to ensure local companies or farmers are not crowded out, and that the benefits are shared with the local economy, through taxes, value-added retained in the economy, and transfer of skills and technology.

There is also a general openness to trade, especially in using exports for growth.  However the liberalising of imports is calibrated to fit the needs of the economy, enabling cheaper inputs needed in production while preventing local products from being overwhelmed by cheap imports. 

In contrast, many other developing countries (especially in Africa and Latin America) followed the crude policy prescriptions of the neo-liberal approach.  They gave up industrial and agricultural policies and planning, withdraw the government's direct role in production but without being able to nurture the private sector to take over.

They also reduced their applied tariffs so drastically that cheap imports overwhelmed the local industries and farmers.  Most tragically, many African countries that once had a thriving food producing sector were told by the IMF and World Bank to withdraw government assistance to the farmers and to lower their tariffs, opening the way for highly subsidised food such as European poultry and American rice to take over the market from local farmers. 

The drop in economic growth in these countries and the lack of a thriving local market meant that foreign companies were also not keen to invest there, except to extract minerals and timber.

The lost development decades from following the Washington Consensus (so-called because the IMF, World Bank and US Treasury that preached these policies are located in that town) coupled with the financial crisis have discredited the “free market” or neo-liberal model.

The poorer developing countries are realising that the orthodox policies – having a minimalist role of the state and leaving everything to the market, when the local private sector is weak to start with and has been weakened further by the wrong trade policy – have not worked.

They are increasingly seeking lessons from the policy recipe of the more successful Asian countries.

The lessons include that there has to be a proper mix between the public and private sector, between exports and production for the local market, a careful planning and sequencing in opening up imports, and the importance of a strong coordinating role of the state in development,  including in building up and regulating the private sector. 

Meanwhile the Asian countries are themselves reviewing whether their model or rather models (since there is a diversity of approaches in Asia) need to be re-calibrated in light of the global economic slowdown. In particular, is their growth too dependent on exports to the developed countries, and have they become too open and vulnerable to the fluctuating flows of foreign funds?     

The move to a new development strategy was evident when the South African Trade and Industry Minister Rob Davies gave a couple of very interesting lectures in Geneva in June.

Mr. Davies unveiled South Africa's new industrial policy action plan. A new growth path is needed, he said, because the old model was not working, as shown by the 25% unemployment rate.

He stated that the new policy is focusing on expanding local industrial production with job creation.  Other policies (macro-economic, finance, trade, foreign exchange, competition, sectoral policies) have to be coherent with this main goal.

Davies said that the foreign exchange and interest rate regimes need to support the new industrial policy.  Also, the government will provide companies with industrial financing at concessional rates, linked to conditions such as the intensity of jobs.

The government's procurement policy will also be overhauled to provide more economic opportunities for domestic manufacturers, including improving the black empowerment policy.

There would also be a “developmental trade policy” where tariff setting will be in line with strategies for industrial sectors.  For example, there would be low tariffs for imported inputs to lower production costs of local industries, while increasing tariffs in some areas consistent with the sectoral plans.

Competition policy would curb monopolistic pricing.

Davies also revealed sectoral plans to boost production in existing industries (such as automobiles, plastics, pharmaceuticals, chemicals, textiles) and to build up new industries (such as metals fabrication, capital and transport equipment, green and energy saving industries and agro processing).

He stressed that trade and industrial policy has to make a positive contribution to development goals, such as rapid job creation.  And that a “strengthened developmental state” is essential to make the profound structural changes needed to the economy.

The South African example is a clear sign that developing countries are moving in the direction of an activist role for the state, in which expanded local production and job creation are the main priorities, and other policies are lined up to serve these goals.