Nafziger Economic Development (4th ed)

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petroleum, agriculture, health, education, and social welfare, as well as with regional and local government departments and planners.

Economists are ambivalent about integrating the central bank into the government’s monetary and fiscal planning. To be sure, most economists favor the integration of monetary policy with the government administration’s fiscal policies. Still, because many economists fear that political and administrative leaders will not be vigilant in fighting inflation, these economists recommend that the central bank operate independently of the head of state and government departments.

Takatoshi Ito (1992:89–95) contends that under presidential administration (similar to that of the United States), the incumbent party manipulates financial policy in its effort to be reelected, whereas a parliamentary state (such as that in Japan or India) does not manipulate policies in anticipation of approaching elections, but instead waits to call general elections until times of autonomous economic expansion. Thus, parliamentary governments manipulate the timing of elections, whereas presidential governments manipulate the timing of economic policies.

Do financial policies in democratic states differ from those under authoritarian regimes? Political scientists find no difference between the macroeconomic policies of established democratic and authoritarian governments, but countries undergoing transitions to democracy pursued more expansionary monetary and fiscal policies than before and after the transition and compared to established regimes (Sandbrook 1985; Diamond, Linz, and Lipset, 1988; Haggard and Kaufman 1989:57–77).

State Planning as Ideology for New States

Economic planning in LDCs was limited before their independence (often gained during the 1950s and 1960s). The British and French used development plans (worked out by territorial governments with help from London and Paris) as a basis for colonial aid after World War II. The plans, prepared by administrators with little or no planning background, were usually just lists of investment projects. And no attempt was made to integrate the various economic sectors. However, they did have the virtue of being carried out, in contrast to many postindependence plans.

Many intellectuals, nationalist leaders, and politicians believed that laissez-faire capitalism rigidly adhered to during the colonial period was responsible for slow LDC economic growth. So, once independence was granted, nationalists and anticolonialists pushed for systematic state economic planning to remove these deepseated, capitalistic obstacles. Such sentiments were expressed in a statist (usually called socialist) ideology that stressed government’s role in assuring minimum economic welfare for all citizens.

Many third-world leaders, even from mixed economies, such as Nigeria, Kenya, India, and Sri Lanka, agreed with Kwame Nkrumah (Ghana’s president, 1957–66) who wrote in 1965 that “the vicious circle of poverty, which keeps us in our rut of impoverishment, can only be broken by a massively planned industrial undertaking.” He was skeptical of the market mechanism’s effectiveness, argued for the “uncounted advantages of planning,” and contended that government interference

in the economic growth of developing countries is “universally accepted.” Vigorous state planning would remove the distorting effects of colonialism and free a LDC from dependence on primary exports.

And as in many LDCs, the business class was weak at independence, the argument for a major state role in spearheading economic development was strengthened. Yet decisions concerning government size were usually based less on economic reasoning than on ruling elites’ interests. Most third-world elites were politicians, professional administrators, and bureaucrats and wanted to protect their interests from businesspeople. Elites perceived anarchy in the market, which reinforced by their lack of control, produced a statist ideology.

Afro–Asian Socialism

African and Asian socialism did not coincide with the Western socialist concept of the ownership of most capital and land by the state (see Chapter 2). Instead, the Afro– Asian variety usually included the following: a high-level of state ownership of the commanding heights (major sectors of heavy industry, metallurgy, military industries, mining, fuel, transport, banking, and foreign trade), a penchant for public control of resource allocation in key sectors, a deemphasis on foreign trade and investment, a priority on inward-looking production, and a rapid indigenization of high-level jobs (Acharya 1981: 117–118).

Dirigiste Debate

From after World War II to the early 1980s, many development economists favored a major role for the LDC state in promoting macroeconomic stability, national planning, and a sizable public sector. In the early 1980s, a series of World Bank and IMF reports (for example, World Bank 1981i) emphasized reversing the LDC government sector’s overextension. Indeed, World Bank and IMF conditions for balance of payments lending to LDCs sometimes required privatization of LDC state-owned enterprises, a part of policy reforms that stressed state enterprise reform and competition policies in both private and public sectors (Mosley 1988:125–126).

The emphasis on privatization, discussed in Chapter 19, began with the 1981 to 1986 World Bank presidency of former New York bank president A. W. Clausen and continued under former U.S. Congressperson Barber B. Conable (1986–91), former New York bank president Lewis T. Preston (1991–95), and former New York investment banker James D. Wolfensohn (1995–2005). The emphasis was not just an extension of President Ronald Reagan’s and Prime Minister Margaret Thatcher’s domestic economics to U.S., British, and Western-dominated multilateral aid and lending programs, but also an LDC response to the failure of public enterprise to match expectations, especially when they operated under a soft budget constraint, an absence of financial penalties for enterprise failure. Frequently, LDC governments provided massive subsidies to public enterprises that had been expected to produce an investible surplus.

enterprise produced and how much it invested. Yet even Soviet planning, probably more comprehensive than any other country ever attained, was not so totally planned and rigidly controlled as you might think. Soviet planning began modestly. During the 1918 to 1921 civil war, enterprises ignored planning directives. Not until 1925 to 1926 did Gosplan, the State Planning Committee of the USSR, which consults with ministries, republics, and enterprises, have the personnel and authority to plan detailed input–output relationships.

In the centrally planned key sectors (heavy industry, much of light industry, and a small part of agriculture) in the quarter century after World War II, there was much local, extraplan discretion – government simply could not control all operations details. For example, bad weather or shortages sometimes prevented delivery of essential materials so that enterprise managers adjusted by hoarding, bartering, and other informal arrangements. In the late 1980s, over half of Soviet GNP remained out of the purview of planners and under the control of local officials, enterprises, and even private markets. These activities, however, generally depended on state policies for financial controls, purchasing, pricing, wage schedules, labor mobility, education and training, turnover taxes, foreign trade, and so forth (Gregory and Stuart 1994).

Leon Trotsky recognized the difficulties of comprehensive Soviet centralized planning early in its history. Trotsky (1931:29–30, 33), Communist party leader exiled by Joseph Stalin, criticized Soviet bureaucratic and centralized economic management:

If there existed the universal mind that projected itself into the scientific fancy of Laplace; a mind that would register simultaneously all the processes of nature and of society, that could measure the dynamics of their motion, that could forecast the results of their interreactions, such a mind, of course, could a priori draw up a faultless and exhaustive economic plan, beginning with the number of hectares of wheat and down to the last button for a vest. In truth, the bureaucracy often conceives that just such a mind is at its disposal; that is why it so easily frees itself from the control of the market and of Soviet democracy. . . . The innumerable living participants of the economy, state as well as private, collective as well as individual, must give notice of their needs and of their relative strength not only through the statistical determination of plan commissions but by direct pressure of supply and demand. The plan is checked, and, to a considerable measure, realized through the market. . . . Economic accounting is unthinkable without market relations.

Although Soviet leader Gorbachev (1985–91) believed that economic restructuring was essential in reversing slow U.S.S.R. growth after 1970, he decentralized without providing the enterprise freedom and market incentives that were essential.

Indian Planning

In 1950, India was the first major mixed LDC to have its own planning commission. English democratic socialism as well as Soviet industrial planning attracted Jawaharlal Nehru, prime minister at India’s independence in 1947. India’s economic policies for its first five-year plans (and several interim plans) through 1978 suffered from the paradox of inadequate attention to programs in the public sector and too much control over the private sector. Thus, we had Indian planners

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frequently choosing public sector investments on the basis of rough, sketchy, and incomplete reports, with little or no cost–benefit calculations for alternative project locations. And the government, having selected the project, often failed to do the necessary detailed technical preparation and work scheduling related to the project. The bureaucracy was slow and rigid, stifling quick and imaginative action by public sector managers. (Even public firms had to apply for materials and capital import licenses a year or so in advance.) Poorly stated criteria for awarding input licenses and production quotas led to charges of bribery, influence peddling, and ethnic or political prejudice. Key public sector products were often priced lower than scarcity prices, increasing waste and reducing savings. Furthermore, political involvement in public enterprises meant unskilled labor overstaffed many projects.

Jagdish N. Bhagwati and Padma Desai’s (1970) study shows that such planning problems led to profit rates for public enterprises that were lower than for indigenous, private operations even when adjusted for externalities. This inefficiency explains why the Indian public sector, despite its domination of large industry, made no net contribution to the country’s 1990 total capital formation; indeed dissavings from public sector losses, which the government budget covered, reduced capital formation (U.N. 1992; Nafziger 1997:385)!

Indian planners tried to influence private investment and production through licensing and other controls. These controls were intended to regulate production according to plan targets, encourage small industry, prevent concentrated ownership, and promote balanced regional economic development.

The Indian government’s award of materials and input quotas at below-market prices (before the 1991 reform) hampered private industrial efficiency.

1.It subsidized some firms and forced others to buy inputs on the black market or do without.

2.Favoring existing firms discouraged new-firm entry. And inefficient manufacturers sold controlled inputs on the free market for sizable profit.

3.Businesspeople were unproductive, because they were dealing with government agencies and buying and selling controlled materials.

4.Capital was often underutilized, because government encouraged building excess capacity by awarding more materials to firms with greater plant capacity.

5.Entrepreneurs inflated materials requests, expecting allotments to be reduced by a specific percentage.

6.Businesspeople used or sold all materials within the fiscal year to avoid quota cuts the following years.

7.A shortage of controlled inputs could halt production, because the application process took several months.

8.Large companies, which were better organized and informed than small enterprises, took advantage of economies of scale in dealing with the public bureaucracy.

9.Entrepreneurial planning was difficult because of quota delay and uncertainty (Bhagwati and Desai 1970; Nafziger 1978:114–119).

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commodities to maximize profits. If the resulting income distribution is acceptable, consumption and production are socially efficient. Third, production resources hire out to maximize income. Fourth, the market determines available labor and capital. Fifth, the market distributes income among production resources and, thus, among individuals.

The market provides incentives for economic growth. Consumers try to increase income to acquire more goods. Investors and innovators profit from the market. People invest in human capital and firms in material capital, because such capital earns an income.

The market stimulates growth and efficiency automatically, without a large administration on centralized decision making. Thus, it conserves on skilled personnel, a scarce resource in LDCs. The market needs little policing other than a legal system enforcing contracts. When government abandons the market and starts allocating scarce goods and concessions (for example, foreign currency, licenses, and materials), corruption, favoritism, bribery, and black markets are more likely to thrive.

Ronald Coase, an economist from the University of Chicago, argues that planning agencies and firms reach rapidly diminishing returns to management under centralized planning. Coase’s position is:

Firms exist because some transactions internal to firms are less costly than similar transactions carried out in markets. The limits of the firm depend on cost comparisons at these margins. . . . “Central planning” within firms is disciplined by competition among them, so long as resources are free to move to their highest valued uses. (Rosen 1991:76, including Coase 1937:386–405)

But under Soviet-type economy-wide central planning, most resources lack this freedom. Moreover, Oliver Williamson argues that the number of prices essential to decentralize a complex organization increases multiplicatively with size. The major cost explosion is that of monitoring labor and managers. When state socialism suppresses the market, the cost of monitoring people explodes, as reward and penalty systems no longer result in self-enforcing contracts (Williamson 1967:123–139; discussion of Williamson’s views by Rosen 1991:82; see also Malmgren 1961:399–421).

PROPLANNING ARGUMENTS

Market decisions do not produce the best results when the market fails, as with environmental degradation, HIV/AIDS prevention, measles vaccinations, and labor training. Social profitability exceeds private profitability when external economies (for example, vaccinations, sex education, and the training of labor) are rendered free by one economic unit to consumers or other producers. External diseconomies (pollution, let us say) mean private profitability exceeds social profitability (see Chapters 5, 11, and 13). National planners can choose investment projects for social profitability rather than for their internal market rates of return.

Social and private profitability also diverge in a market economy when there are monopolistic restraints and other market failures. A monopolist produces less and charges higher prices than does a competitive firm. National planners reduce a project’s monopoly profits but increase social profits by expanding output and

lowering prices to the competitive equilibrium. Industry and enterprise managers in a planned economy will however restrict output volume if they are rewarded on the basis of profits (Johnson 1962:152–163; Lange and Taylor 1965; Bergson 1967: 657–665).

Additionally, government needs to produce the public or collective goods, schools, defense, sewage disposal, and police and fire protection that the market fails to produce (see Chapter 19).

Moreover, the free market may not produce so high a saving rate as is socially desirable. A government generating surplus from its own production, setting low procurement prices for state trading monopsonies, and levying turnover taxes can usually save in excess of households and firms. Centrally planned economies have had higher rates of saving than market economies.

Furthermore, relying on the market assumes that people are well informed and want to maximize gains. Should not centralized planning replace the market in LDCs where this assumption is false? The answer is not clear-cut. If prospective private entrepreneurs lack information and motivation, the planner’s role may be enlarged. The planning agency can ease its task by disseminating information to make the market work more effectively. Although the peasant preoccupied with family survival may not be an income maximizer (Chapter 7), empirical studies demonstrate that the LDC industrialist, trader, and commercial farmer respond to income and price incentives, suggesting that the market works well.

MARKET SOCIALISM

The income distribution the market produces – partly dependent on the skills and property of the privileged and wealthy (Chapter 11) – may not be just or socially desirable. Yet the greater income inequality of capitalist economies may result less from the market than from unequal holdings of land and capital. The Polish economist Oskar Lange’s model of decentralized market socialism combined the advantages of market allocation with more uniform income distribution by dividing the returns from social ownership of nonhuman, productive resources among the whole population. Lange’s approach assumed that individuals allocated their limited income among consumer goods and services and provided labor services just as in capitalist economies. Socialist enterprises produced where product price equaled marginal cost (the competitive profit maximization rule), while combining factor inputs to minimize the average cost of production. Industrial authorities chose the rate of expansion or contraction of the industry as a whole. Central planners used trial and error to set prices at equilibrium (where shortages and surpluses disappeared), adjusted prices for externalities through taxes and subsidies, and allocated returns from property owned collectively by society.

Critics argued that pricing consistent with maximum profits would encourage monopolistic behavior by enterprise and industry managers in concentrated industries; planning decisions would not be compatible with political freedom; and central planners would have the impossible task of setting millions of prices for individual products and subproducts (Lange and Taylor 1965; Gregory and Stuart 1974:311–319). But decentralized enterprises could set prices rather than central

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planners, who need only intervene to prevent monopoly pricing. One example close to Lange’s model, the Soviet New Economic Policy, 1921 to 1927, which enabled the economy to recover rapidly from the chaos and disruption of revolution and civil war, was later replaced because the Communist party bureaucracy lacked control over the economy.

WORKER-MANAGED SOCIALISM: THE FORMER YUGOSLAVIA

Branko Horvat’sˆ historical review of the last two and one-half century indicates that, in large part, market or decentralized socialism has failed, resulting in a lapse to capitalism or statism. But the inference that market socialism is “an unrealisable utopia is clearly false.” The recurrent attempts despite bitter opposition from vested interests suggests to Horvatˆ that the few successes of market socialism result not from its unfeasibility but from its threat to established interests (Horvatˆ 1975b:39–40).

Economists in the former Yugoslavia, the nearest contemporary approximation of Lange’s model, argued that socialist planning must be managed by workers to be democratic and must use the market for resource allocation to be efficient. The Yugoslav experience with worker-managed socialism is instructive, despite the breakup of the country in the 1990s from ethnic conflict.

From 1948 to 1951, each firm elected a workers’ council, which hired a professional manager to carry out the council’s decision. Workers shared in income from the enterprise, after subtracting material and other costs, based on a democratically agreed-on income distribution determined by the intensity and quality of people’s labor. Individuals sought employment anywhere, and firms were free to hire a particular person. Generally, the labor-managed firm maximized net income per member (Horvat,ˆ Markovic, and Supek 1975, especially Horvatˆ 1975:Vol. 1, pp. 307–327; and Vanek 1975:Vol. 2, pp. 135–140.)

From 1959, a decade after worker management began, until 1979, Yugoslavia’s real GNP grew 6 percent annually, and the labor force was transformed from primarily peasant agriculture into modern sector employment. During the 1980s, however, real GNP per capita declined, the unemployment rate averaged 10–15 percent, strikes were widespread, annual inflation averaged more the 35 percent, and total external debt was the 10th largest in the world ($21 billion in 1988). Workers’ councils were limited by state regulations (including prices) and by political intervention of the League of Communists of Yugoslavia (LCY). Moreover, Yugoslavia’s 1976 reform established the basic organizations of associated labor (BOs), a separate autonomous planning unit for each department in the firm. The BOs, in addition to workers council, trade union, business managers, their administrative and technical staff, the LCY, and the local community, complicated enterprise decision making, introducing multiple checks and balances, so that the firm’s hierarchy was ill-defined. The need for consensus among so many units gave many people (for example, discontented, even striking, work units, such as janitors or carpenters) the capacity to impede and few people the power to implement policies. When coalitions broke down, the state (federation, province, or local community) or LCY bureaucracy could dissolve disruptive workers’ councils, recall business managers, or withhold infrastructure or funds.