Chapter 2 the Previous Studies and the Shift of the Main Questions
The early days of development studies of post war period have held the idea of "Structuralism" as a conviction in common. According to the idea, the essential economic structure of LDC is different from that of developed country (DC), and the economic gap, industrial gap and life level gap seemed to increase. Thus, they found the main question of development study in exploring the reason of poverty and the method to escape from it.
Since 1960’s, development studies have been divided into three schools: neoclassical approach, human basic needs and neo-Marxism dependency approach. Owing them, neoclassical approach occupied the main stream of the study. The neoclassical view has been composed based on the strong criticisms for structuralism. The neoclassical view insisted that the market function even in LDC worked as well as that of DC and the reason of the development failure of LDC should be located on the inappropriate or too much government intervention.
However, since the latter half of 1980s, various criticisms have emerged against neoclassical view, and it has been compelled to review the paradigm again. Then, there appears new development political economy, new institutonist, new growth model approach and new market-government relationship approach. The argument on this line has its origin in the criticism for the presupposition of neoclassical view that market functions even in LDC. New approaches assume that imperfect market or market failure are dominant in LDC. Then, they insist on the necessity to reconsider the relation between market and government and the effective combination.
This chapter would like to examine what question has been discussed, in what framework, and how industrialisation has been understood. 2.2 introduces the main arguments of structuralism, neoclassical view and development state view, and those understanding of industrial strategy. 2.3 return to the new approach resulted from past studies. It suggests that there are coordination problems represented by multiple equilibrium. In 2.4, the current and new understanding of industrial policy, as well as the main subject in the next paradigm will be summarised.
Structuralism dominated the early days development study from the 1940’s till the beginning of the 1960s. The study insisted that obstruction against development in LDC was due to the stiffness of supply side and that the structural difference from DC in economy system was the source of poverty. The structuralism has been composed by various hypotheses; supply constraint, export pessimism, camouflaged unemployment, market failure, the latter industrialisation and so on.
Supply constraint is the idea that the various indispensable goods for industrialisation, especially the supply and import of capital goods are considerable burden for the lack of enough foreign currency. Additionally, the lack of sufficient number of entrepreneur, the lack of sufficient infrastructures, the lack of the modern law system are dominant. The deficiency of essence of industrialisation not only disturbs the supply of concrete goods but also seriously impedes supplying prerequisite. Nurkse's (1952) words "vicious circle of poverty" is a good illustration of this idea. Namely, the purchase ability is quite small for the low income in LDCs, which leads to low incentive for investment. Accordingly capital formation remains stranded, low productivity, provokes difficulty in improving income level. On the supply side, low real income level restricts savings, thus, low capital form possibility to be low productivity. Nurkse called it "the trap of low equilibrium"
The second hypothesis is disguised unemployment. It means the situation in which labour marginal productivity is zero. One has a job in agriculture sector, but somebody else can also hold the post without productivity decrease. In other words, the lack of available demand for labour market causes much latent unemployment.
The third hypothesis is export pessimism. According to Nurkse (1952, 1953), the rapid economic development in England spread among its colonies through the increasing demand for raw material, and it hauled economic development in the colonies in the 19c. However, after the war, the change in the manufacture production structure and the increased service sector altered the conditions to develop. He concluded that LDCs could not develop by raw material export.
The last important hypothesis is the idea of market failure, which structuralism inherited from Keynesians. The Keynesians view is characterised by their negative perspective towards: market function: they regard that market function cannot work sufficiently even in DC, so, the government even in DC needs to intervene in order to make equilibrium between gross demand and gross supply. In LDCs, markets work no more than that of DC do. Therefore the government function which substitute market function is required to be larger than that of DC government.
Those hypothesises have given rise to a concrete strategy. Structuralism proposed a industrialisation strategy in a closed economy, reflecting export pessimism. Then, it was thought to be short cut to develop domestic economy through foreign currency acquisition. The industrialisation process in which the domestic enterprises substitute the imported goods was called import substitute industrialisation (ISI). Inevitably, the government was expected to be panacea, which manages trade and substitutes immature domestic market function. In other words, the government is required to hold the whole market information, perfect planning, and not to be selfish. However, these prerequisites had a fatal problem, i.e., they were too idealistic, which has provoked the strong criticisms by neoclassical approach.
It has been neoclassical approach that dominated the main stream of development study since the middle of 1960s. Their idea is marked by their basic thought: "market functions even in LDCs." They refuted the hypothesises of structural deference, export pessimism and market failure, as well as confuted "perfect government" by "government failure".
Firstly, they examined both theoretically and empirically, which ISI based on export pessimism caused distorted resource allocation and obstruction of development. The resource allocation without market function was to be arbitrary and far from ideal allocation. The arbitrary settlement of high currency rate in order to import goods favourably causes weaned export sector, and trade protection declines domestic market competition, as well as it caused higher price than international market.
Next, they insisted on the serious problem caused by government failure. From the point of view focusing on economic welfare, the market failure makes less serious damage than the government failure does. They asserted that the stranded development in LDCs have been resulted by government intervention.
Neoclassical approach offered an industrial strategy based on their free trade theory, instead of ISI. Firstly, they recommended "market liberalisation" involved with deregulation and privatisation. They tended to avoid forced control to the market because the market has been regarded as sole system achieving the Pareto optimum. They announced the strategy called export-oriented industrialisation (EOI), which involved a removal of import protection to induce international competition into domestic market and right currency rate to accomplish welfare maximum. At the same time, industrial production of comparative advantage is believed to be essential for foreign currency in order to import low price material from abroad. Concerning to the lack of capital and technology, foreign direct investment (FDI) by transnational companies (TNCs) should be attractive to the cheap labour force of LDCs, then, they would transfer those necessary source for industrialisation into LDCs. Most importantly, the systematic industrialisation process is thought to be damaged by the government intervention. Accordingly, the government is required to be small government allowed not running public enterprise or controlling market, but its function is restricted to correct obvious market failures.
However, in practice, only East Asian economies, which embrace "strong government", have achieved conspicuous development ironically, on the contrary to their argument. A different school based on the fact asserts neoclassical view.
The Japanese study by Johnson (1982), the study of Korean rapid economic development by Amsden (1989) and also the report of Taiwan market by Wade (1990) have emphasised the significant role of government in industrialisation period.
Each of them is targeting separate regions, but has a common message, i.e., each government substitutes the infant market function and it is thought to be the element of successful development. This, at the same time, denies the argument of government failure by neoclassical view, and development state view demonstrates evident case in which government can push development actively. Moreover, the discussion by Amsden (1989) that government intervention distorting immature market function itself has been the significant, criticised sharply to the myth of free trade market. She insists that Korean government intervened by getting price wrong to stimulate export industry, then, it succeeded to economic development through accelerated export. This argument is completely opposed to the conclusion of Balassa (1990) that focused on the policy change from ISI to EOI with "getting price right ".
Surely any other regions than the East Asian economies demonstrate such high development performance and the greater part of countries holds government with strong leadership. The study of development state view pressed the World Bank, which is a branch of neoclassical view, to reconstruct its posture.
The World Bank Report in 1991 and "the East Asian Miracle"(EAM) has to be presented as the watershed the neoclassical view and development state view. It means epoch making paradigm change of the World Bank. In both of the reports, the staff of World Bank touched the role of government and recognised that active government involvement effectively worked in the East Asian miracle.
According to the report in 1991, following four factors have to be satisfied by government: (1) the investment to elementary education, public hygiene or family planning to improve human capital, (2) deregulation and maintenance of infrastructure to promote the competition in private sector, (3) the open policy by import protection abolishment or mitigation of FDI, and (4) macro economic stability. These policies are named as fundamental policy. The market friendly approach implies that the government involvement should not make any special treatment to individual enterprise or industry, but improve the framework of whole market. Hence, this approach has avoided that government runs enterprises or promotes specific industry by protections and regulations.
EAM is also based on the same idea of the report in 1991, as well as influenced by neoclassical view, but it shows a new comprehension and an approach called a functional approach. The first notable point is that it admits active government involvement as some government intervention caused better and impartiality results than that without the intervention in Northeast Asia (Japan, Korea and Taiwan). However, it declines government involvement generally because it requires quite high institutional capability to avoid government failure.
In addition to this, a new approach has been introduced, called a functional approach. It consists of two methods; one is fundamental policy to reinforce market function being same as that in the report in 1991, and the other is competition principle, which is based on contest with a high institutional capability to intervene selectively in the market. The government promoted the performance index rewards accompanying with the competition aiming a desirable remuneration among enterprises based on fair and clear rule with bureaucrats as referee promoted by the government. Concretely, the compensation contains low interest financial quota based on export past records, branch office licensing based on business record or preferential tax treatment given by the achievement of remarkable cost reduction. This system accompanies with more difficulty than free trade policy, but if it succeeds to carry, it may result in more desirably than that by free trade market.
Thus, it is a great paradigm change that EAM recognised the significance of government activity to development, to distinguish itself from current neoclassical approach. It seems to fill up the gap between development state view. However, there is room for argument on this view. The paradigm change turns to be different image of government from that of current "small is beautiful", and what is the next? Moreover, it described some individual elements in which the government could be in charge, but what is the common and general role for the government? Unfortunately, EAM leaves those questions unanswered
2.3 New Approach and the Central Subject
The current studies can be abridged into the question: "which is better market failure or government failure, or, immature market function or imperfect government ability?" As demonstrated above, the criticism by neoclassical approach toward structuralism was the point of government failure, and the criticism by development state view against neoclassical approach was the point of effectiveness of government function.
Then, the subject of the discussion has shifted to another point since the World Bank Report in 1991. It brings about new subject how to combining the immature market function and the imperfect government functions, instead of the subject where market or government is regarded as of no worth. In other words, the main subject is how to search for the principle defining the role to both market and government.
The market enhancing approach representing new paradigm has been held by Aoki, Murdock and Okuno-Fujiwara (1996). They account for the principle that the government policy can be valuable if it works only to complement the private ability to coordinate problems (1996: 22). Adding that," This boundary, however, may depend on the level of development of the economy. When the economy is in a low state of development, the availability of intermediaries is limited, the capabilities of firms are modest, and even the efficiency of markets is hampered by poor integration and under development of property-rights arrangements in the economy. Under these circumstances, the ability of the private sector to solve challenging coordination problem is suspect, and there may be significant scope for government policy to facilitate development." The standpoint indicates that the relation of the market and the government is not substitutive in the executive ability but complementary in the coordination capability. However, they have noted that the ability of the private sector improves and the scope for policy becomes more limited, as the economy matures. It implies that the volume of government involvement depends on the degree of coordination capability in the private sector.
However, in fact, coordination problem universally holds true, and all of the problems cannot be cited here. Here we will show a typical coordination problem for industrialisation as an example. What would obstruct industrialisation? For this question, neo-Keynesians give a good model. It is the multiple equilibrium model in which the plural entrepreneurship exist inside, which corresponds to the consensus in advance. The model argues that there exist enterprises capable of realising the economy of scale and technology ability, and that they are given a strategic complementary at attributing its investment strategy on other enterprises' strategies. Under this strong mutual dependency, if there is not a meeting or information exchange among investors in advance, or if there is not sufficient reliance on information in spite of the existence of the information exchange, there must be a coordination failure to make consensus. It turns to be the failure of achieving economy of scale and high economic performance of each enterprise. Meanwhile, if there is a commitment to investment by offering its strategy in advance and if there is a reliance on information exchange, a different result would come. The commitment and reliable information exchange will coordinate with the investment behaviour, which also provides the realisation of favourable externalities among enterprises and sectors. The former is called as low equilibrium opposing to high equilibrium of the latter.
Thus, according to the conditions, the desirable strategy of each subject may cause undesirable result in the whole. This is called a multiple equilibrium model.
Adapting to industrialisation, the heavy chemical industry requires forward and backward involvement. That is, the investment decision of forward sector (= supply) and the investment decision of backward sector (= demand) control the investment planning of itself (= product planning). If there is no information exchange or if the information does not have enough reliance, the product strategy tends not to be aggressive but to be rather small, with low equilibrium.
2.4 Summary
Currently, the main subject has been the weight comparison between market function (failure) and government function (failure) since the age of structuralism up to development state view. In other words, the question whether the government should substitute infant market function or not has lied at background.
The paradigm, however, has been renewed. The new approach focuses on how combines market function and government function effectively and reasonably, which provokes another question: what element decide the distribution of the role to the market and the government.
Then, the multiple equilibrium model is given as a good example of coordination failure which obstructs industrialisation process. The model provides counterevidence to neoclassical school which insists that favourable strategy of each enterprise would lead welfare maximum under perfectly free trade market. This model also has shown a serious problem to LDCs, because LDCs are aiming to develop not individual improvement but whole industrial improvement. Consequently, in this respect a plain reason for active government intervention to complement can be justified at the point.
Chapter 3 we will turn to native coordination failures through the industrialisation process.
