Sunday, 9 November 2008

BE MY GUEST! (VI. LUIS)

Luis is a regular contributor to this blog since the early days and has been a good friend of mine for a good decade now, since we met at the LSE where he was preparing his PhD and I my MSc.
Born in Mozambique of Portuguese and Chinese parentage, he lives in Portugal since his early childhood and is very much a citizen of the world.
The piece he presents here draws partly on his fieldwork in South Korea. He promised it here and now (finally!) delivered the goods.
Enjoy.

THE “REVENGE” OF THE STATE

For the best part of the past three decades, policymakers in the developed world followed Ronald Reagan and Margaret Thatcher in pursuing the idea of a “minimal state” as the best solution to economic growth. Privatisation, deregulation and liberalisation progressively became the all-mighty mantra of the market pundits to be exported to the developing world. Yet, as the current financial and subsequent economic crises have shown us all, the state is still a much needed actor.

This is even more relevant when we are talking about which policies should developing countries follow in their path to economic growth and development and as we begin to observe a shifting power from the West to East Asia. Why? Because most of us seem to be unaware of how in the first place did the East get into this position and the economic and financial lessons that maybe other developing countries can derive from it.

Several scholars sought to explain the successful economic performance of East Asia by looking at the interventionist and leading role played by the state. For example, analysing the Japanese case, Chalmers Johnson (1982) introduced the concept of the “developmental capitalist state” as one which seeks economic development through high rates of growth, productivity and competitiveness. Six main policy features are regarded as crucial to explain the performance of the East Asian developmental states: (1) redistributive land reform; (2) state-controlled financial system; (3) macroeconomic stability to nurture long-term investment; (4) industrial policy that favoured simultaneously import substitution and export-led production; (5) protection and investment in the agricultural sector as well as improvement of rural livelihoods; (6) and income policies that produced a more equitable income distribution and higher living standards. As a whole, all these policies are correlated with the East Asian successful economic performance. However, industrial policy and financial control, in particular, stand at the core of the East Asian developmental states’ peculiar way of organising the market.

According to developmental state literature, the economic performance of East Asia is strongly associated with a series of key mechanisms devised by the interventionist state to organise the financial system and define the blueprint for industrial development. These key features make up what is known as the system of “socialisation of private risk”: (1) in a closely regulated bank-based system as in Korea or Taiwan, enterprises were inclined to make better investment decisions, because they were offered the opportunity to develop long-term strategies. As this relationship strengthened over time, and as long as firms’ investments followed long-term plans, loans were rolled over even if the returns were not as immediate as thought; (2) the bank-based system allowed for a faster allocation of capital to strategic industrial sectors and granted the state the capacity to control the financial flows; (3) close relations between banks and firms improved collection and the processing of information, allowed the monitoring of management performance, and eased restructuring of firms undergoing difficulties and; (4) control over the financial system offered the state the political leverage to build up the coalitions necessary to implement the industrial and development strategies. In this sense, the public-private co-operation usually present in East Asia was far from being an outcome of voluntary compliance by the business groups as they were discouraged from opposing the state under threat of possible loss of access to credit (Wade 1990).

Additionally, this literature claims that this cooperative system between state, banks and firms succeeded because it obeyed certain “imperatives”: (1) the state sustained the risks involved in the investments. This socialised risk took the form of: deposit insurance, lender-of-last-resort, subsidies to banks dangerously exposed to loan losses and firms in financial difficulties, banks’ shareholding in firms, or state-owned banks; (2) the creditor was involved in the firm management, and did not pull out when the company was under distress showing instead commitment with the restructuring of its management; (3) the state and the banks were able to distinguish between ‘responsible’ and ‘irresponsible’ borrowings, and disciplined the latter. This capacity allowed the state to avoid bailing out firms and moral hazard. Simultaneously, the government was also careful to monitor the activities of the financial intermediaries to impede them, for example, from hiding non-performing loans (NPLs); (4) the existence of a ‘central guiding agency’ was crucial to complement market signals with its own signals as to which sectors would be most profitable; ((5) finally, the state regulated international capital flows which granted it the capacity to control money supply and the cost of capital to domestic firms as well as to set and manage the development of strategic industrial sectors.

Importantly, underneath the East Asian system of “socialisation of private risk” are “hard states”, i.e., states that are “able not only to resist private demands but actively shape the economy and society (Wade, 1990). A competent bureaucracy usually led by a pilot agency in charge of formulating and implementing economic policies is the leading actor in the process of economic change and development. It is this bureaucracy that in fact “guided” the market, and implemented the consistent, coherent, and rational system of “socialisation of private risk”. As Robert Wade puts it, “in this kind of political regime, the bureaucracy can more easily demonstrate competence and remain ‘clean’, because it is neither caught between and penetrated by struggling interest groups nor subverted from above by the politics of rulers’ survival”(Wade, 1990). In tandem, ongoing organisational and institutional linkages between the government and the private sector eased the stream of information exchange, facilitated co-operation, policy coordination, implementation and goal consensus (Okimoto, 1989).

Thus, the developmental state is basically one where the autonomy of the bureaucracy is complemented by an unusual degree of private-public co-operation. The difference between East Asia and other late industrialising economies did not rest in the invention of industrial policy and financial control mechanisms as “many other nations have at one time or another tried most of the policy tools used in East Asia” (Wade, 1990). For Alice Amsden (1992), what distinguished East Asia was the willingness of states to behave in relation to the private sector as “disciplinarian agents, imposing performance standards while allocating subsidies for industrial development.”

Of course this is not the whole story but is a big part of it……

[References]
Luis is a regular contributor to this blog since the early days and has been a good friend of mine for a good decade now, since we met at the LSE where he was preparing his PhD and I my MSc.
Born in Mozambique of Portuguese and Chinese parentage, he lives in Portugal since his early childhood and is very much a citizen of the world.
The piece he presents here draws partly on his fieldwork in South Korea. He promised it here and now (finally!) delivered the goods.
Enjoy.

THE “REVENGE” OF THE STATE

For the best part of the past three decades, policymakers in the developed world followed Ronald Reagan and Margaret Thatcher in pursuing the idea of a “minimal state” as the best solution to economic growth. Privatisation, deregulation and liberalisation progressively became the all-mighty mantra of the market pundits to be exported to the developing world. Yet, as the current financial and subsequent economic crises have shown us all, the state is still a much needed actor.

This is even more relevant when we are talking about which policies should developing countries follow in their path to economic growth and development and as we begin to observe a shifting power from the West to East Asia. Why? Because most of us seem to be unaware of how in the first place did the East get into this position and the economic and financial lessons that maybe other developing countries can derive from it.

Several scholars sought to explain the successful economic performance of East Asia by looking at the interventionist and leading role played by the state. For example, analysing the Japanese case, Chalmers Johnson (1982) introduced the concept of the “developmental capitalist state” as one which seeks economic development through high rates of growth, productivity and competitiveness. Six main policy features are regarded as crucial to explain the performance of the East Asian developmental states: (1) redistributive land reform; (2) state-controlled financial system; (3) macroeconomic stability to nurture long-term investment; (4) industrial policy that favoured simultaneously import substitution and export-led production; (5) protection and investment in the agricultural sector as well as improvement of rural livelihoods; (6) and income policies that produced a more equitable income distribution and higher living standards. As a whole, all these policies are correlated with the East Asian successful economic performance. However, industrial policy and financial control, in particular, stand at the core of the East Asian developmental states’ peculiar way of organising the market.

According to developmental state literature, the economic performance of East Asia is strongly associated with a series of key mechanisms devised by the interventionist state to organise the financial system and define the blueprint for industrial development. These key features make up what is known as the system of “socialisation of private risk”: (1) in a closely regulated bank-based system as in Korea or Taiwan, enterprises were inclined to make better investment decisions, because they were offered the opportunity to develop long-term strategies. As this relationship strengthened over time, and as long as firms’ investments followed long-term plans, loans were rolled over even if the returns were not as immediate as thought; (2) the bank-based system allowed for a faster allocation of capital to strategic industrial sectors and granted the state the capacity to control the financial flows; (3) close relations between banks and firms improved collection and the processing of information, allowed the monitoring of management performance, and eased restructuring of firms undergoing difficulties and; (4) control over the financial system offered the state the political leverage to build up the coalitions necessary to implement the industrial and development strategies. In this sense, the public-private co-operation usually present in East Asia was far from being an outcome of voluntary compliance by the business groups as they were discouraged from opposing the state under threat of possible loss of access to credit (Wade 1990).

Additionally, this literature claims that this cooperative system between state, banks and firms succeeded because it obeyed certain “imperatives”: (1) the state sustained the risks involved in the investments. This socialised risk took the form of: deposit insurance, lender-of-last-resort, subsidies to banks dangerously exposed to loan losses and firms in financial difficulties, banks’ shareholding in firms, or state-owned banks; (2) the creditor was involved in the firm management, and did not pull out when the company was under distress showing instead commitment with the restructuring of its management; (3) the state and the banks were able to distinguish between ‘responsible’ and ‘irresponsible’ borrowings, and disciplined the latter. This capacity allowed the state to avoid bailing out firms and moral hazard. Simultaneously, the government was also careful to monitor the activities of the financial intermediaries to impede them, for example, from hiding non-performing loans (NPLs); (4) the existence of a ‘central guiding agency’ was crucial to complement market signals with its own signals as to which sectors would be most profitable; ((5) finally, the state regulated international capital flows which granted it the capacity to control money supply and the cost of capital to domestic firms as well as to set and manage the development of strategic industrial sectors.

Importantly, underneath the East Asian system of “socialisation of private risk” are “hard states”, i.e., states that are “able not only to resist private demands but actively shape the economy and society (Wade, 1990). A competent bureaucracy usually led by a pilot agency in charge of formulating and implementing economic policies is the leading actor in the process of economic change and development. It is this bureaucracy that in fact “guided” the market, and implemented the consistent, coherent, and rational system of “socialisation of private risk”. As Robert Wade puts it, “in this kind of political regime, the bureaucracy can more easily demonstrate competence and remain ‘clean’, because it is neither caught between and penetrated by struggling interest groups nor subverted from above by the politics of rulers’ survival”(Wade, 1990). In tandem, ongoing organisational and institutional linkages between the government and the private sector eased the stream of information exchange, facilitated co-operation, policy coordination, implementation and goal consensus (Okimoto, 1989).

Thus, the developmental state is basically one where the autonomy of the bureaucracy is complemented by an unusual degree of private-public co-operation. The difference between East Asia and other late industrialising economies did not rest in the invention of industrial policy and financial control mechanisms as “many other nations have at one time or another tried most of the policy tools used in East Asia” (Wade, 1990). For Alice Amsden (1992), what distinguished East Asia was the willingness of states to behave in relation to the private sector as “disciplinarian agents, imposing performance standards while allocating subsidies for industrial development.”

Of course this is not the whole story but is a big part of it……

[References]

4 comments:

Nick said...

Very interesting article. I wonder, however, to what extent can the East Asian experience be replicated in Africa?
Or has it already been applied anywhere in Africa?
Congrats to Luis.

Koluki said...

Nick, I cannot find a clear cut example that can be comparable to the East Asian case, in Africa or elsewhere.
However, where it relates to the adoption of export-oriented strategies and their support by the state, one example that springs to mind is Mauritius. Botswana could arguably be mentioned too, except that it lacks a significant degree of economic diversification beyond the diamond and cattle industries.
In any case, both can be classified as outliers in the African context as far as the economic performance of institutions are concerned.

My congrats to Luis as well.

luis said...

Hi
Sorry for replying only now and thanks for the compliments.

I would like to say that we could replicate the East Asian experience in Africa but I cannot..

Simply because the role of the state has a lot to do with specific, historical and contextual features in East Asia.

Having said that, I do think that there is something to learn for the East Asian experience (and I would argue even American and European): that without states we cannot expect much development.

So..I am always surprised when people say that the only way for "Africa" to get out of her poverty is through more market and less state....

Granted...there are indeed major issues related to the work of many states in Africa...but does it mean we have to give up on them?

building capable states is not easy and it takes ages but it is in my view the only viable and sustainable way for economic growth and development.

For that you need national political will, a committed leadership, growth-oriented coalitions, and a friendly international trade scene.

For example, it will be interesting to see what might end up being the political, economic and social outcomes of the five free trade zones China has announced it intends to help create in Africa...

Cheerio,
L

Koluki said...

Once again, thanks Luis.
I just hope that the FTAs China, or any other non-African country for that matter, envisages to create in Africa don't end up creating even more overlapping with the already existing initiatives of that kind in the continent.
Above all, I hope that they will be aligned with the strategic development plans of the concerned African governments and the RECs they belong to.