The Last Development Crusade

J. Bradford DeLong

August 2001

William Easterly (2001), The Elusive Quest for Growth: Economists' Adventures and Misadventures in the Tropics (Cambridge: MIT Press: 026205065X).

Today the industrialized world as a whole is embarked--half-heartedly, I admit--on yet another crusade to try to make the poorer parts of the world rich. The ideology behind this crusade--an ideology that I believe in--is called "neoliberalism." It has two guiding principles. The first is that close economic contact between the industrial core and the developing periphery is the best way to accelerate the transfer of technology which is the sine qua non for making poor economies rich (hence all barriers to international trade should be eliminated as fast as possible). The second is that governments in general lack the capacity to run large industrial and commercial enterprises (hence save for core missions of income distribution, public-good infrastructure, administration of justice, and a few others, governments should shrink and privatize).

However, this neoliberal crusade is not the first such crusade for economic development. Since World War II there have been at least six such crusades: the "building socialism" crusade, the "financing gap" crusade, the "import substitution" crusade, the "aid for education" crusade, the "oil money recycling" crusade, and the "population boom" crusade. All of them failed to spark rapid economic development. Does what went wrong then have any lessons to tell us about the future of the crusade we are undertaking now? Yes--and now is a good time to take a look back at the history of crusades-for-development since World War II, for World Bank economist Bill Easterly has just written The Elusive Quest for Growth (published by MIT Press), his own take on the largely dismal history of government-led programs to spark development.

These different crusades in the past overlapped in time, so there is no clear chronological sequence among them. Among the first, however, was the "building socialism" crusade. Easterly does not cover this: his concern is with the quality of advice provided to developing countries by western economists. But for much of the post-World War II period, the idea that the Soviet Union's development strategy in the 1930s had been a success and was worth emulating was a very powerful one throughout much of the world. Decreeing that factories, dams, railroads, and power plants be built; squeezing down the standard of living of the people to free up resources for investment; making foreign trade an instrument for state-led development rather than for importing luxuries for the rich--all these coupled with a degree of terror rarely if ever seen in human society had by 1950 created one of the world's two superpowers out of what had thirty years before been a poor, backward, war-devastated empire.

People at the time grossly underestimated the human cost of Stalinist industrialization. People grossly overestimated the extent to which the Soviet Union was an industrial economy. And few recognized how quickly the Soviet system would degenerate into corruption and stagnation in the absence of mass terror and a small set of readily-measurable industrial goals. Outside of Eastern Europe, economies that followed the central-planning road saw little if any economic progress, and did significantly worse than neighboring countries that did not try to "build socialism."

The second was the "financing gap" crusade. Based on W.W. Rostow's belief that a sharp rise in the share of national product devoted to investment stood a good chance of triggering a take-off into self-sustained growth, the idea was that industrial nations and international organizations could provide countries with large-scale aid to finance such an investment boom. This would, Rostow and others thought, both do good and fight communism by demonstrating, as Easterly quotes Rostow, "that communism was not 'the only form of effective state organization that can... launch a take-off'."

But what was to make sure that the aid would boost rather than substitute for domestically-financed investment? And what was to ensure that aid-financed investment would be economically productive, as opposed to being designed with an eye toward attractive pictures for politicians and corruption opportunities for the husband of the niece of the Vice-Minister of Finance? In Easterly's judgment, this approach was and remains a dismal failure because it focuses on macroeconomic aggregates and prestige projects rather than on incentives. In a way, it combines the worst aspects of central planning and market-based development: the top-down unrealism of central planning coupled with the vulnerability to diversion and hold-up found in markets where there is substantial monopoly power.

Closely associated with this second was a third crusade: the idea that the right way to pursue growth was through import-substitution industrialization. According to economists like Raul Prebisch of the U.N.'s Economic Commission for Latin America, the terms of trade were stacked against primary product-exporting developing economies. Only if they moved quickly to replicate the economic structure of the industrial economies could they avoid getting caught in a trap where they grew more and more and sold it for less and less. And only if, in the meanwhile, they used controls to cut down on luxury imports could their undervalued exports provide enough foreign exchange to support the build-up of the industrial sector.

It is fair to say that this crusade for development might have worked had governments been up to the task, and had the focus been on building those parts of an industrial base in which developing countries could credibly think they might develop a comparative advantage. But policies aimed at controlling imports produced high black-market premiums. As Easterly says, this creates "a strong incentive to get access to U.S. dollars at the official rate and resell them at the black market rate... fierce competition for licenses to buy U.S. dollars." And "anytime the main profit opportunity in the economy is to get around government rules, not much good is going to happen in the real economy." And too much of import-substitution industrialization--Argentina's attempt to build an auto industry, Brazil's attempt to build a minicomputer industry--had its principal effect in reducing the real incomes of individuals and the efficiency of firms that had to buy from local producers.

The other three stories are as depressing. In the 1970s the tripling of world oil prices created a problem: how were developing countries to finance their imports of oil. The answer was that loans would be made by money-center banks out of oil-country assets deposited in money centers. The result was a tremendous debt overhang that, when real interest rates on the debt and the real value of the dollar in which the debt was denominated rose, led to the LDC debt crisis of the 1980s, and the "lost decade" of development. At the end of the 1960s Stanford's Paul Ehrlich wrote a book, The Population Bomb, in which he predicted Malthusian disaster: mass starvation in south Asia and elsewhere before the end of the 1980s. This triggered a major push to provide people with contraceptives--sometimes whether they wanted them or not--that had little effect on economic development.

The belief that not physical investment but investment in people--human capital--education--was the key to growth was not far wrong. But according to Easterly the way that development advisors and governments went about promoting it was backwards. As he puts it, governments can pass laws requiring that people go to school (and getting clients of government politicians foreign aid-funded jobs as schoolteachers), but will people learn? "The quality of education will be different in an economy with incentives to invest in the future versus an economy where they are none." Where other things in the economy are going right, there is indeed a powerful link between more education and faster economic growth. But hopes that education alone can turn around an economy where much is going wrong have proved futile.

The failure of these development crusades over the past century does not have to leave us without hope. Easterly tells the story of the Bangladeshi garment industry, that grew from nothing at all in 1979 to $2 billion of exports--more than half of Bangladesh's exports--today. Noorul Quader's Desh Garments Ltd. agreed in 1979 that Daewoo of Korea would trade 130 of its workers in modern technology and administration. By the early 1980s Desh Garments felt that it did not need the assistance of its Korean collaborators any more. By the end of the 1980s 115 out of those 130 Korean-trained workers had started their own garment firms. By the mid-1980s the rapid growth of Bangladesh's garment industry had come to the attention of that "ardent believer in free enterprise, Ronald Reagan." In 1985 he imposed quotas to restrict U.S. purchases of Bangladesh-made clothing.

So what does all this tell us about our current crusade for development? In Easterly's view, there are a few big lessons from the history: "Prosperity happens when all the players in the development game have the right incentives. It happens when government incentives induce technological adaptation, high-quality investment in machines, and high-quality schooling. It happens when donors face incentives that induce them to give aid to countries with good policies where aid will have high payoffs, not to countries with poor policies where aid is wasted. It happens when the poor get good opportunities and incentives... It happens when politics is not polarized between antagonistic interest groups, but there is a common consensus to invest in the future. Broad and deep development happens when a government that is held accountable for its actions energetically takes up the task of investing in collective goods like health, education, and the rule of law..."

It is clear that the neoliberal policy prescriptions--try to make government honest and smaller (so it doesn't have its fingers in as many economic decisions), try to keep the macroeconomy stable, and boost world trade and thus cross-border economic links as much as possible--affect only a small proportion of these requirements for successful economic development. Neoliberal policy prescriptions have little ability to create governments that energetically invest in collective goods, a political system that enforces accountability, a national consensus for growth, and a commitment by donors to reward success only.

Thus there is a sense in which neoliberalism as we know it is a counsel of despair. Most of what is needed is beyond its reach. The hope is that privatization and world economic integration will in the long run help create the rest of the preconditions for successful development. But we are playing this card not because we think it is a winner, but because it is the last one in our hand.

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