Glob - 06 ch01 PDF

Chapter 1
The Pros and Cons of Globalization for

Developing Countries
A Review of the Theoretical Issues and the Empirical Debate
David Bigman*
Introduction
Despite the highly favorable views that most researchers in the academic community
and in the international development organizations hold on the globalization process
and its impact on developing countries, and notwithstanding the strong support of the
empirical evidence of the benefits that many developing countries have derived from
their integration with the global economy, the backlash against globalization continues
unabated. An online debate on Globalization and Poverty organized by the World
Bank Development Forum in mid-2000 echoed the loud and often very aggressive
protests against globalization that erupted in Seattle, Washington, and Prague; nearly
all the participants in the debate emphasized the very negative impact of the
globalization process on the distribution of income and wealth between and within
countries:
Globalization may improve growth rates, increase productivity, enhance
technological capability, but it cannot redistribute created wealth and
income in favor of the poor. In fact, it does the reverseit redistributes
wealth and income in favor of the not so poor.
The participants underscored the harmful impact on the poor:
Money can be made by growing things for export on foreign-owned
commercial farms No money can be made by the villager working her own
land when she cannot afford the few bags of fertilizer, the seeds and the
insecticides, courtesy of the structural adjustments, the liberalization, the
removal of support systems and the massive devaluations.
Many participants also noted that the market is by no means the panacea for the central
problems that the majority of the population in developing countries is facing:
With the opening of our market, our country has become a supermarket of
foreign goods, which are cheaper, killing our local industries, rendering
* David Bigman: International Service for National Agricultural Research

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Chapter 1
many more jobless. The disparity between the rich and the poor has
widened, and although some may have benefited from the effect of
liberalized economy, the majority continue to languish in poverty.
The opposition against globalization unifies labor organizations that protest against
the flight of jobs South of the border, human-rights groups opposed to sweat shops
thriving on child labor, environmentalists concerned about the damage to the global
habitat, and radicals suspicious of the clout of multinational corporations that are
perceived as the all-powerful agents of capitalism. The IMF, the World Bank, and the
WTO, and, more generally, the high-income countries, are held responsible for
influencing and largely determining the course of the globalization process. They are
also seen as the driving forces behind the policy reforms that the developing countries
had to implement as part of their structural adjustment programs under the stewardship
of the IMF, the World Bank, and the WTO. However, while many passionate
opponents of globalization view these reforms as unacceptable dictates, the reforms
had actually quite positive effects on the economies of most developing countries. In
East Asia, most countries experienced unparalleled rates of economic growth during
the past two decades; as a consequence, a large portion of their poor population was
lifted out of poverty. Despite the crisis of 199798, which exposed serious weaknesses
in their financial, social, and political systems, as well as in their institutions of
governance, most East Asian countries embarked on a course of comprehensive
reforms to deal with the crisis, and they have entered the 21st century with renewed
drive.
In contrast, most countries of sub-Saharan Africa, and quite a few countries in
South Asia, Latin America, and the Caribbean, did not benefit from the globalization
process, and, despite a series of structural adjustments, these countries are burdened
with much the same structural problems that plagued their economies in the previous
century, but which now aggravated by heavy debts and the AIDS epidemic. It has been
generally agreed that the benefits brought about by the global trading system under
GATT and the WTO have so far been distributed very unevenly between and within
nations. The rich industrial countries have reaped large gains from increased trade and
faster growth, whereas most poor nations have actually become worse off and their
economies shrank during the past decade. As a result, the gap between the nations with
the poorest 20% of the worlds population (in terms of per capita income) and the
nations with the 20% most affluent population has nearly doubled in the past two
decades, and many developing countries have been marginalized and practically cut
off from the mainstream of the global economy.
These contrasting experiences and the growing global income inequality are
reflected in the heated debate and the diametrically opposed views on globalization.
On the one side of the debate are the various protest groups that underscore the failed
experience of many sub-Saharan African and South Asian countries and the
widespread perception that globalization is detrimental to the poor even in countries
where it has had a positive impact on the economy at large. On the opposite side of the
debate is the majority of the economists who, backed by the supporting empirical
evidence on the gains from free trade, adhere to the neoclassical maxim that highlights
The Pros and Cons of Globalization for Developing Countries
29
the potential gains from trade and trade liberalization. The theoretical tenets emphasize
that, with trade liberalization, resources are allocated more efficiently to productive
uses, and low-income countries with an abundance of unskilled labor and significantly
lower labor costs can expand output and employment in labor-intensive industries,
thus accelerating their growth.1 The poor also stand to benefit from this growth, and
trade liberalization is therefore also good for the poor. These benefits are highlighted
in several World Bank research papers that concluded that growth is good for the
poor (Dollar and Kraay 2000a) and that In general, the more rapid growth that
developing countries experience as they integrate with the global economy translates
into poverty reduction (Dollar 2001).
The positive effects of globalization on productivity are also thanks to the transfer
of advanced technologies and to the opportunities that developing countries can obtain
from the flow of FDI. Another World Bank paper that focused on the impact of the
rising tide of FDI during the 1990s concluded that the flow of FDI was central to the
more rapid growth that many developing countries achieved, and this growth also
contributed to financing many government-led distribution programs that provided
direct assistance to the poor and improved the social safety nets (Klein and
Hadjimichael 2000).
Even ardent proponents of globalization agree, however, that the benefits from
free trade and trade liberalization can be realized only after a transition period during
which the countrys institutions of governance and its legal system will have to be
restructured, many public enterprises be privatized or dismantled and the market
system be strengthened. Given the transformation that most segments of the economy
and most institution of governance will have to undergo, this transition may take much
longer than expected and the process may sometimes be reversed under political
pressures. In Indonesia and the Philippines, for example, it is not clear whether the
critical part of the transition was completed in the early 1990s with the expansion of
export-oriented production, or whether it still continues through the first decade of 21st
century, as the reforms reach the political institutions. Has China completed its
transition period with the economic reforms it implemented as it joined the WTO, or
has it just begun?
These questions are also echoed in what has become known as the debate over the
post-Washington consensus, which acknowledges the fragility of prescriptive
policy packages of the form liberalize trade and set the price right and the likelihood
that these prescriptions will fail in countries that lack proper institutions of
governance and have only a rudimentary market system. In the on-line debate on
Globalization and Poverty quoted earlier, many participants reflected these views
when they argued that the benefits from market deregulation and trade liberalization
are not likely to trickle down to the poor because, in the words of one of the
participants, the main cause of poverty is the market, not market failure, since
markets fail to address strategic interests like food security. Other participants noted
that often their countries own institutions prevent a flowering market-based
1. See, for example, the World Banks World Development Report 1999, p. 52, for a summary of these
benefits.
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Chapter 1
development. Others emphasized unequivocally that Decades of external influences

in different forms have undermined and destroyed the traditional institutional
mechanisms while creating islands of modern institutions that are inefficient and alien
to their society at large. Through this process, the North has imposed a money-based
economic system and such rules for participation upon the poorer nations of the world
[that] have destroyed the traditional and local ways of wealth distribution in favor of a
cash economy ruled by international forces. Indeed, suspicion and even hostility
toward the market, and strong opinions that unfettered market processes favor the rich
and powerful and their outcomes are inherently unjust are common.
Against the background of these opposing views and the resulting heated debate
over the merits of globalization for developing countries, the objective of this chapter
is to provide an overview of the main arguments raised by the two sides in the debate
and evaluate the pros and cons of globalization for different groups of developing
countries. Section I reviews the theoretical issues raised in this debate and the
empirical evidence on the impact of globalization on economic growth. The section
includes a survey of the development strategies that the international development
organizations, primarily the World Bank and the IMF, have promoted. In addition, the
section presents the main results of an empirical study on global income inequality
based on the data of the GDP per capita of 152 developed and developing countries
over the period 196098. The first objective of this study is to identify and compare
patterns in the economic reforms that countries that have gained from the globalization
process have implemented in order to be integrated into the global economy, and
patterns in the economic policies of countries that were left behind; the second
objective is to evaluate how inclusive the process of globalization has so far been.
Section II focuses on the different approaches to the trade policy of a developing
country in the current global trading system. The theoretical writings and empirical
evidence of the past two decades clearly support the basic tenets of the neo-classical
paradigm which hold that a labor-abundant developing country stands to reap
significant gains from trade liberalization and an outward looking economic policy.
But a number of issues require closer examination: One issue is the question whether
the global trading system that evolved under the Uruguay Round Agreement of the
General Agreement on Tariffs and Trade, the WTO and the regional trade agreements,
including the rules on food safety, the nontechnical barriers to trade, and IPR, is indeed
the system of free trade that the neoclassical economists envisaged. Other issues are
related to the lessons from the Asian economic model: First, even the East Asian
countries adopted at the early stages of their development active policies that protected
and subsidized their infant industries in order to promote their exports. Second, the
high and often unqualified praise that was heaped on the Asian model of capitalism
until the 199798 financial crisis ignored major weaknesses in their systems of
government and their legal and political institutions that were exposed during the crisis
and that, to a large extent, were responsible for this crisis.
Another issue is related to the failure of most countries in sub-Saharan Africa and
many countries in South Asia and Latin America to develop an industrial base,
particularly against the background of the Asia miracle. One factor that hampered
their growth performance is their focus on the production of import substitutes and the
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bias of their policies in favor of consumers and against producers; another factor is the
bias in their trade policies against agriculture and in favor of industrialization. These
issues are discussed in section III, which focuses on the agricultural sector and on the
trade and development policies that affected the rural population. The section
underscores the difficulties that the rural population had to face during and as an effect
of the structural adjustment programs (SAPs) and the reforms to liberalize trade. The
chapter concludes with remarks that discuss some central considerations for the
formulation of development policies.
Globalization and Economic Growth: Theory and

Empirical Evidence
The debates over development strategiesin retrospect
The debate over the structure of development strategies that would be most effective
and socially most desirable for promoting growth and alleviating poverty, and over the
balance between these potentially conflicting objectives, went through distinct phases
since the early 1960s. In part, these phases reflected the wide differences in the
experience of different countries during different time periods; in part, they reflected
marked disagreements over the ability to bring about a significant reduction in poverty
by promoting economic growth alone, and over the need and the potential advantages
and disadvantages of accompanying these growth strategies with active income
distribution measures.
The early economic growth literature that provided the intellectual foundation for
this debate emphasized the segmentation of the economy in developing countries into
a modern, mostly industrial sector in urban areas, and a traditional, mostly agricultural
sector in rural areas. Constraints on land availability and declining land quality,
together with the continued rise in the rural population, reduce the marginal product of
labor in the traditional sector to near-subsistence levels and drive the surplus of
unskilled labor to urban areas. In this model, the embryonic modern sector cannot
absorb all the surplus labor and, at the early stages of development, this migration
would lead to a rise in income inequality and poverty. However, abundance of cheap
and mostly unskilled labor and open unemployment in urban areas, and disguised
under-employment in rural areas, give incentives to increase production in the modern
sector in labor-intensive industries. The rising demand for labor in the labor-intensive
industries would gradually absorb the unemployed in urban areas and the
underemployed in rural areas, thus bringing about, over time, a reduction in poverty
and income inequality at later stages of development.
The actual realization of this stylized model varied widely between countries and
continents and between time periods. In the 1960swith the emergence of new nation
states throughout Asia and Africa and the rapid economic progress in all countries
across all continentsthe focus was on economic growth as the most effective
strategy for meeting the needs of the rapidly growing populations in the newly
independent countries. In the 1970s, poverty and income inequalities were on the rise.
In many countries in Latin America and the Caribbean, South Asia, and sub-Saharan
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Africa, the pace of industrialization was too slow to absorb the flow of rural migrants,
often because production in the modern sector, especially manufacturing of import
substitutes, was highly capital intensive and did not provide enough employment.
Despite the diminishing prospects of rural migrants to find employment in urban areas,
migration from rural areas continued due to rapid population growth and dwindling
land resources, thus leading to higher poverty also in the urban areas.
Disillusion with the trickle-down effects of growth shifted the emphasis to a
strategy that deals simultaneously with economic growth and poverty. The then World
Banks President, Robert McNamara, expressed this shift by stating that [g]rowth, as
such, can be considered a necessary but not sufficient target of development strategy.
In 1974, the Bank issued a document titled Redistribution with Growth that extended
the goals of its development strategy by seeking to influence both the rate and the
patterns of growth in order to reach the poor. The document advocated policy
packages consisting of a wide range of measures that included promoting
employment of unskilled labor, developing new technologies to make low-income
workers more productive, targeting investments on pockets of poverty, allocating
more resources to the education of the poor, and providing for the basic needs of the
poor, particularly food and health care, from public sources. Redistribution with
Growth insisted that poverty-focused planning does not imply abandonment of
growth as an objective. It implies, instead, a redistribution of the benefits of growth.
(p. xviii). The 1980 World Development Report echoed this theme and made the case
for a more concerted effort to secure the basic needs of the poor and argued for targeted
investments in human development and technologies suitable for the poor primarily in
rural areas.
During the almost three decades since the publication of Redistribution with
Growth, these strategies continued to evolve with the accumulation of more
experience and data from a growing number of countries, and with the deepening
understanding of the economic and political processes in developing countries. The
1980s brought two diametrically opposed experiences. At the one extreme was the
failed experience of many countries in Latin America and the Caribbean and
sub-Saharan Africa with highly interventionist policies and large public spending that
led to high public debts, massive macroeconomic imbalances, stagnation, and growing
poverty. The debt crisis propelled the IMF and the World Bank to enter stage and give
rise to policy-based lending: loans disbursed in exchange for policy reforms aimed at
correcting macroeconomic imbalances and boosting productivity through structural
reforms. At the other extreme was the very successful experience of the East Asian
countries with rapid industrialization, high growth rates and a steep reduction in
poverty. The accelerated growth of their modern sector, led by labor-intensive
production for exports, brought about a gradual reduction in their unemployment and a
rise in incomes in their urban and rural areas that led, in turn, to a steep reduction in
poverty. Moreover, improving skills of the labor force enabled these newly
industrialized countries to gradually move to higher, more advanced levels of
industrial production and to products and production technologies that are more
capital- and more skilled-labor intensive. Although growth was accompanied in some
countries by rising income inequalities, it lifted all boats and steeply reduced
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poverty. The sharp differences between these experiences underscored the limitations
and potentially undesirable effects of proactive redistribution policies. Against this
background, the debate over the pros and cons of alternative growth strategies acquired
another dimension with the renewal of old debates over the proper balance between
measures to promote growth and measures to reduce income inequality and poverty,
and over the desirability of government intervention in the economy even if this meant
curtailing the free market and reducing efficiency.
During the 1980s, the reforms focused on structural adjustment programs under
which governments had to make firm commitments to economic restructuring that
focused on trade liberalization, tax reform, realistic exchange rates, liberalization of
capital markets and privatization in exchange for support by the World Bank and the
IMF. In the early 1990s, the East Asia miracle highlighted the significance of
market-oriented structural adjustments. The World Banks 1990 World Development
Report advocated a new strategy to combat poverty based on more effective market
incentives and better social and political institutions, infrastructure, and technology on
the one hand, and on direct measures of governments to provide social services such as
primary health care and education on the other hand. This two-pronged approach was
based on more open markets and large-scale privatization accompanied by greater
government activism in the provision of public goods in health, education and
infrastructure. The 1990 World Development Report on Poverty concluded that [t]he
evidence in this report suggests that rapid and politically sustainable progress on
poverty has been achieved by pursuing a strategy that has two equally important
elements. The first element is to promote the productive use of the poors most
abundant assetlabor. It calls for policies that harness market incentives, social and
political institutions, infrastructure, and technology to that end. The second is to
provide basic social services to the poor (p. 3). Specifically, the poverty reduction
strategy recommended in the report had three main components:
1. Promoting broad-based growth that makes intensive use of labor in order to
increase the productivity of the poor and the economic opportunities available to
them.
2. Ensuring the access of the poor to good quality basic social services in order to
enable them to take advantage of economic opportunities.
3. Providing social safety nets for the most vulnerable members of society.
The 1990 World Development Report recommended a growth strategy that includes
investments in industries and production technologies that can absorb surplus labor as
well as investments in human capital to allow the poor to take advantage and reap the
benefits of new technologies. The World Banks Poverty Reduction Handbook of 1993
and Adjustment in Africa of 1994 echoed the message of the 1990 World Development
Report by emphasizing the importance of an outward-oriented strategy and export-led
growth. The Handbook emphasized the need to promote trade and exploit the
comparative advantage of developing countries in products and production processes
that are labor-intensive; in contrast, tariffs and other restrictions on trade are likely to
inhibit growth and increase unemployment and poverty by giving incentives to
capital-intensive production of import substitutes. A study conducted by the World
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Banks Office of Executive Directors in 1995 titled The Social Impact of Adjustment
Operations emphasized that growth is the most significant process affecting poverty
and that a consistent implementation of sound macroeconomic policies is essential for
promoting sustainable growth. A subsequent study titled Social Dimension of
Adjustment, conducted by the Banks independent Operations Evaluation Department
in 1996, concluded that good macro-economic policies and measures, combined with
relevant sectoral policies and appropriate public expenditure allocation, provide a
favorable environment for sustained growth and poverty reduction. The study
found, however, that in most countries, the actual reduction in poverty was quite small
and high levels of income inequality and poverty persisted.
Addressing the controversy over the seeming trade-off between growth and
equality, Bruno (1995) noted that, although direct action on health, education, and
nutrition can improve the quality of life for the poor, growth is the only strategy that
can secure a sustained reduction in poverty and provide the resources that are
necessary for any direct action to reach the poor. The 1995 World Development Report
reiterated the conclusion that open trading relations [and] domestic policies that
promote labor-demanding growth are central to equitable growth. The World Bank
and the IMF therefore relentlessly pushed developing countries in the direction of the
WTO system. However, the Banks 1995 report also noted that growth may augment
income inequalities and that
[s]ome groups of relatively poor workers have experienced large gains in the past
thirty yearsespecially in Asia. But there is no worldwide convergence between
rich and poor workers. Indeed, there are risks that workers in poorer countries will
fall further behind, as low investment and educational attainment widen
disparities. Some workers, especially in sub-Saharan Africa, could be increasingly
marginalized. And those left out of the general prosperity in countries that are
enjoying growth could suffer permanent losses, setting in motion intergenerational
cycles of neglect (p. 21).
These considerations led to the argument that in these countries the government must
take active measures to secure the livelihood of the poor, even if these measures may
restrict the free market and diminish the countrys growth prospects. The counterargument asserted that, by reducing the countrys rate of growth, the government
might in fact defeat the long-term goal of reducing poverty.
During the past decade, it has been increasingly recognized, however, that a
successful implementation of policy reforms depends on the countrys institutions of
governance, and that the weakness of the institutions in the majority of the developing
countries was the principal obstacle for the success of their structural adjustment
programs. In the East Asian countries, weak institutions contributed to the 199798
financial crisis; in many countries in Latin America and the Caribbean, the weakness
of institutions contributed to aggravate the impact of the global crisis on their
economies, and in nearly all the countries in sub-Saharan Africa, weak institutions
were not only the main obstacle to the implementation of the reforms, but also the main
reason for the continuous political and social unrest. It has been realized that, in all
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developing countries, the reforms were too narrowly focused on macroeconomic

policy and that the new agenda must stress also anticorruption efforts, effective
corporate governance, banking transparency and independence, strong capital
markets, and adequate social safety nets. The World Bank and the IMF made concerted
efforts to work with governments to implement codes of best practices in a variety of
technical areas such as banking regulation and supervision, corporate governance, and
accounting.
The World Development Report of the year 2000 adopted a much wider definition
of poverty, which includes not only income shortfalls and low levels of health and
education, but also powerlessness, voicelessness, vulnerability, and fear. This very
wide definition of poverty also calls for a much larger menu of policies to combat
poverty, ranging from fostering economic growth, strengthening the rule of law,
promoting community development and gender equity, to closing the digital and
knowledge divide. To be able to attack the wider dimensions of poverty, the World
Bank has continuously diversified its own operations by adopting new goals and new
work areas in order to assist countries in education, science, health, child nutrition,
population, industrial development, trade policy, and the environment. This expansion
reflected not only the Banks propensity to grow, but often also pressing needs that had
not been adequately addressed by the existing development institutions, primarily the
other agencies of the UN system; in addition, it also reflected the growing influence of
nongovernmental organizations (NGOs) that pushed for the incorporation of issues
such as the environment, the role of women in development, human rights and
democracy into the Banks agenda, although some critics claim that this expansion
reflects mostly the Banks inability to sort out its priorities.
In principle, each of the above actions is essential to tackle the wider dimensions of
poverty. However, given the limited resources that developing countries can
command, not all of these actions are feasible, and it is therefore necessary to establish
clear priorities and trade-offs. The Bretton Woods institutions have a clear
comparative advantage in advising on, and supporting the implementation of, actions
that affect a countrys economy, and even among these actions, it is necessary to
establish priorities. However, by widening the definition of poverty, spreading thin the
World Banks resources, and, without determining priorities, extending the menu of
actions beyond the scope of the Banks comparative advantagethus also diverting
governments (and the World Bank) from the task of promoting growth and economic
efficiencythe 2000 World Development Report may have reduced the Banks
effectiveness and its influence over the choice of a development strategy.
While the debates over development strategies have always reflected topical
concerns of the time, they often remained too abstract and generic in that they failed to
recognize the substantial differences between countries. These differences cast doubt
on the notion that a development strategy can be formulated in the abstract or that it can
yield a menu of actions and policy recommendations that apply to all countries.
Lumping all the developing countries together and advocating a one-size-fits-all
development strategy with a blueprint of actions can be oversimplifying and possibly
even misleading. For each country, it is necessary to recognize its unique geographic,
socio-economic and political conditions, to establish priorities that reflect these
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conditions, and to identify the critical areas on which its economic policy should focus.
Recommendations to promote labor-intensive growth and open trade (World
Development Report 1990), or to promote opportunity, facilitate empowerment, and
enhance security (World Development Report 2000), may fail to recognize
country-specific needs and differences in the underlying conditions.
Thus, while in most East Asian countries growth proved to be the most effective
strategy for reducing poverty, many Latin American and Caribbean countries
experienced a much smaller reduction in poverty with growth. Their greater sensitivity
to the needs of the poor made it necessary to accompany the pro-growth policies with
additional measures to ensure a more equal distribution of the growing national
income. The experience in a considerable number of sub-Saharan African countries
showed that for them, administrative restrictions on exchange and interest rates, or
even on the government budget, proved to be quite useless, since these countries lack
the necessary institutions and the rule of law to ensure the proper implementation of
these policies. In these countries, the main focus of policy reforms at the early stages of
development should therefore be on measures to strengthen the institutions of
government and the rule of law. Indeed, one lesson of the East Asian crisis is that even
in the relatively more advanced developing countries, economic policy must place
much greater emphasis on institution building, strengthening the rule of law, fighting
corruption, etc. The second lesson is that a countrys growth is function not only of its
endowments of labor, capital, and natural resources, but also of the strength of its
public and private institutions and its legal and political systems.
The neo-classical prescription for promoting growth in a
labor-abundant country
The present discussions on growth and employment in a labor-abundant developing
country take their origin in the neoclassical writings, particularly the labor-surplus
model of Lewis (1954), Fei and Ranis (1964), which dominated much of the economic
development literature in the 1960s and 1970s. In Lewis model of a dual (or
segmented) economy of a labor-abundant developing country with two distinct
sectors, the modern, mostly industrial sector in the urban areas operates along the
traditional, mostly agricultural sector in rural areas. The low living standards in rural
areas drive many to the urban centers and increase the supply of unskilled and low
wage workers (Table 1.1). In the early stages of development, the rural-urban migrants
join the ranks of the under- and unemployed in the urban areas due to the limited
employment available in the modern sector. Empirical studies estimated that in many
countries the rate of unemployment in urban areas exceeded 20% of the labor force
(Berry and Sabot 1978; Berry 1989). Nevertheless, rural-urban migration continued
unabated.
Harris and Thodaro (1970) explained the continued flow of migrants despite the
rising urban unemployment by the migrants (subjective) expectations for higher
wages that took into account not only the wage differential between urban and rural
areas, but also the probability of finding employment. Rural migrants were also
attracted by the better facilities for health and education and the better quality of water
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Table 1.1. Demographic Characteristics of Selected Developing Countries: 197395

Annual growth rate of the population
overall
LAC
Brazil
Chile
Peru
Africa
Ghana
Kenya
Tanzania
Asia
India
Indonesia
Pakistan
urban
rural
Share of urban population

mid-1970s
mid-1980s
mid-1990s
2.2
1.8
2.3
4.1
2.4
3.6
-2.45
-0.9
-0.3
59
77
59
71
82
67
87
87
76
3.9
4.3
3.4
5.3
8.0
8.6
3.0
3.5
2.5
33
12
9
38
17
14
43
24
23
2.1
2.1
2.7
4.2
4.8
4.3
1.2
1.2
2.0
19
18
25
24
24
29
30
31
34
Source: World Bank, various tables
supplies in urban areas that reflected the large bias in government expenditures (Lipton
1977; Larson and Mundlak 1997). In many developing countries, industrial growth
remained, however, quite slow and capital intensive despite the large supply of labor,
and the bulk of new jobs in urban areas were not created in the modern sector, but in the
informal, traditional urban sector that includes basic manufacturing and small-scale
commerce and services, where production is highly labor-intensive and earnings are
low (Berry 1989).
In many East Asian and some Latin American countries, in contrast, rapid growth
of labor-intensive and export-oriented industries led to a gradual reduction in
unemployment, a rise in real wages, and a reduction in poverty in both urban and rural
areas. In Korea, Adelman and Robinson (1978) concluded the strategy of
labor-intensive, export-led growth produced significantly higher incomes for the
poorer half of the population and a far more equal relative distribution (p. 127). In
Indonesia, Thailand, and Malaysia, the industrial growth led to an annual rise of over
2% in the real incomes of the rural population. Accumulation of both physical and
human capita enabled the East Asian countries to move to higher, more advanced
levels of industrial production, and to products and production technologies that are
more capital-intensive and require more skilled labor.
Table 1.2 demonstrates the large differences between the rates of growth of
different countries during the past four decades. The economies of the sub-Saharan
African countries generally stagnated; in Latin America and the Caribbean, growth
rates were higher, but they varied widely between countries. In these two groups of
countries, many of the poor remained in rural areas and did not benefit much from the
growth in the urban sector. In the East Asian countries, in contrast, the rates of growth
in labor-intensive export industries were high enough to absorb the surplus labor
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Table 1.2. Growth of GDP Per Capita in Selected Countries: 196097

Country
1960
1997
Average annual change (%)
South Korea
Taiwan
885
1355
10,500
13,250
6.9
6.4
Ghana
Senegal
Mozambique
875
1015
1125
850
1095
805
-0.1
0.2
-0.9
Brazil
Mexico
Argentina
1745
2800
3295
5500
6300
4750
3.2
2.2
1.0
GDP per capita in US$ in 1985 prices.

Source: World Bank, various tables.
despite the continued migration to urban areas; as a result, the rate of unemployment
declined, both urban wages and rural earnings increased and poverty declined.
Table 1.2 also highlights the reasons for the criticism of the labor surplus model,
because it fails to explain why in so many labor-abundant economies growth was very
slow and industrialization faltered, while in other countries growth was very rapid and
industrialization was highly successful. There is also criticism of the models failure to
explain the changes in income distribution that took place during the growth process:
many countries that experienced rather similar growth rates of the average per capita
GDP had wide differences in the changes in the level of poverty. In Mexico, the
Philippines, Nigeria, and few other countries, growth was accompanied by a rise in
income inequality to the extent that poverty actually increased.
A large number of empirical studies tested Kuznets hypothesis either in
cross-section studies of many developing countries or in time-series analysis of
individual countries. Many of these studies, particularly the ones that conducted a
cross-section analysis (Adelman and Morris 1973; Ahluwalia 1976; Chenery and
Syrquin 1975), tended to confirm Kuznets hypothesis, and thus strengthened the
inclination to adopt a development strategy that puts greater emphasis on
redistribution measures. Since the initial impact of growth is to increase income
inequalities, so the argument went, and since this effect can last for quite some time,
growth must be accompanied by active redistribution measures. Chenery (1971)
asserted that growth that does not change the resource allocation in favor of the poor
constitutes growth with little development, and recommended proactive
redistributive measures if economic growth does not bring about a significant
reduction in poverty.
During the 1990s, with the accumulation of more data on income distribution in a
large number of developing countries over a longer time period, several studies
examined again Kuznets hypothesis, but this time in a time series analysis (Bruno,
39
Ravallion, and Squire 1995; Ravallion 1995; Ravallion and Chen 1996). These studies
concluded that, while the trends in income inequality with growth differ significantly
across countries, there is no evidence that growth has any discernible systematic
impact on inequality. In a sample of household surveys from a large number of
countries, Ravallion and Chen found that in only half of the cases growth was
associated with an increase in inequality. Bruno et al. emphasized that although there
are exceptions, as a rule, sustainable economic growth benefits all layers of society
roughly in proportion to their initial standard of living.
Based on the evidence of the last decades, there seems to be no credible support for
Kuznets hypothesis. These studies also confirmed that positive economic growth was
significantly associated with a falling incidence of poverty, and that economic
contraction was associated with a rising incidence of poverty. Bruno et al. calculated
with data of 20 countries over the period 198493 that a 10% increase in mean per
capita consumption led to an average 20% decline in the proportion of the population
living on less than $1 per day. Lipton and Ravallion (1995) calculated with the data of
eight developing countries that a distribution neutral growth at an annual rate of 2% in
mean per capita consumption would lead to a decline in the poverty gap of 3 to 8%.
These findings motivated a change in the approach to development strategy in the
mid-1990s in favor of a strategy that gives much greater weight to growth and
advocates re-distributive measures only in countries where there is clear evidence that
the growth process is narrowly based and leaves out large segments of the population.
In most countries, though, this approach emphasized the potentially undesirable
effects of re-distributive measures on economic incentives and efficiency. The debate
on these issues is far from over, and the more recent chapters in this debate are
discussed later on.
Globalization and global income distribution 196098:
Has there been a convergence?
A large number of studies sought to estimate the changes in the global income
distribution between and within countries during the second half of the 20th century.
Blotho and Toniolo (1999), drawing on data for 49 countries, found that the measure of
global income inequality shows a modest trend toward convergence starting in 1980.
Melchio, Telle, and Wiig (2000) evaluated the changes in income inequality between
countries on the basis of a sample of 115 countries and they also found that, after a
relatively stable period during the 1950s through the 1970s, global incomes tended to
converge from the mid-1980s through the mid-1990s. Other studies used different
samples and slightly different time periods, but came essentially to the same
conclusion (Schultz 1988; Firebaugh 1999; Radetzki and Jonsson 2000). In a sample
of 100 countries, Clark, Kraay, and Dollar (see Dollar 2001) found that worldwide
inequality increased during 196075, but declined during 197595, largely due to the
accelerated growth in China and India. Using household survey data drawn from 91
countries for 1988 and 1993, Milanovic (1999) reached a different conclusion.
According to his estimates, income inequality, measured by the Gini index, rose
marginally from 63 to 66, primarily due to an increase in income inequality between
40
Chapter 1
countries, rather than rising inequalities within countries. These seemingly conflicting
conclusions reflect primarily differences in the sample of countries and time periods
on which they draw and the small changesup or downthat these analyses indicate.
The question examined in this section is whether the trends in global income inequality
indicated by these global measures indeed represent a tendency of global incomes to
converge, and whether they indicate that the globalization process has therefore been
inclusive, as several recent World Bank reports maintain (see e.g., Dollar 2001).
The analysis in this section is based on household survey data from a larger sample
of countries that includes also the ex-centrally planned countries, but it focuses only on
income inequalities between countries that represent only part, though a central part, of
the global income inequality. Nevertheless, the estimates of the trends in income
inequality between countries since 1960 are in agreement with the results of most of
the studies mentioned above. According to these estimates, the three main measures of
inequality indicated that there has been a decline in global income inequality during
the past two decades after a period of relative stability during the 1960s and 1970s.
This analysis also shows, however, that the global measures of inequality do not
provide an adequate representation of the widening gap between the richest and the
poorest countries.
During 196096, the worlds average GDP per capita increased by nearly 80% in
real terms, but growth rates varied widely between countries and regions: In SSA, the
annual average growth rate of GDP per capita was less than 1% during the past four
decades, and it actually declined in the past two decades, whereas in East Asia, the
average GDP per capita increased since 1980 at an annual rate of over 4.5% (Table 1.3
and Figure 1.1). This rapid economic growth of one group of developing countries and
the relative stagnation in the other group had two conflicting effects on the global
income distribution: On the one hand, the Asian miracle and the accelerated growth
of India and some Latin American countries during the 1990s closed the income gap
between these countries and the developed countries. On the other hand, the gap
between the average GDP per capita in the least developed countries, particularly in
Table 1.3. Trends in GDP Per Capita in Selected Regions 196096 (in PPP
Exchange Rates in 1985 Prices)
Region
South Asia
East Asia
SSA
LAC
Devped cts
World
Number of Population
1990
countries*
(millions)
6
18
45
32
28
164
* Including the CIS countries
1,105
1,671
478
421
858
5,064
GDP per capita (in USD$)
1960
1980
1996
781
630
761
2,447
6,205
2,250
935
1,242
1,130
4,537
11,347
3,806
1,333
2,251
1,036
4,480
14,259
4,000
Annual growth rate

196096
198096
1.5
3.5
0.9
1.6
2.4
1.6
2.2
3.8
-0.5
-0.1
1.4
0.3
41
8
6
4
1960-1980
1980-1996
ev
W
or
ld
el
op
ed
Pl
an
.
en
t.
LA
A
EN
SS
A
tA
-C
Ex
-4
si
a
si
a
A
So
ut
h
-2
1997-1998
Ea
s
Figure 1.1. Average annual growth rates of GDP per capita in main regional groups,
196098
Source: IMF
sub-Saharan Africa, and that in the developed countries has widened significantly. As
a consequence of these conflicting trends, global income inequality changed relatively
little during most of these years (depending on the measure) and the main impact was
on the relative position of countries on the global income ladder. What conclusions can
be drawn from these changes about the convergence of the global income distribution?
In 1960, the East Asian countries were at the bottom of the global income ladder
with an average GDP per capita that was some 20% lower than that of the sub-Saharan
African and South Asian countries; in 1998, the average GDP per capita in East Asia
was more than double the average GDP in sub-Saharan Africa. As a result, most East
Asian countries climbed to much higher levels on that ladder, while the sub-Saharan
countries fell to the bottom (Figure 1.2). In 1960, over 80% of the population in the
lower one-third of the global income distribution were in the East Asian countries; in
1998, 65% of the population in the lower one-third of the global income distribution
were in South Asia and 31% in sub-Saharan Africa. In 1960, less than 15% of the
population at the higher one-third of the global income distribution were from
developing countries; by 1998, their share had risen to 40% (Figure 1.3a and 1.3b).
Table 1.4 shows the changes in global income inequality during 196098, as
indicated by the three most common measures of income inequality: the Gini
coefficient, Theils measure, and the coefficient of variations (CV). All three measures
indicate that there were only minute changes in income inequality during the 1960s
and 1970s, but since 1980 and until 1998, the decline has been more noticeable. During
the 1990s, the decline in the measures of global income inequality was primarily due to
the rapid growth in China and India and the large share of these countries in the global
population. As a result, these two countries, along with most other East Asian
countries and some countries in Latin America and the Caribbean, moved to a higher
position on the global income ladder, whereas the countries in sub-Saharan Africa
dropped to the bottom. The relatively small changes in the three global measures do
not show, however, the changes in the relative position of countries on the global
income ladder, nor do they show the growing absolute gap between the richest and the
42
Chapter 1
350
1985 US Dollars
300
250
200
150
100
50
1960
1970
South Asia
SSA
LAC
Developed
1980
1990
1996
East Asia
MENA
Ex-centrally planned
Figure 1.2. Index of GDP per capita (PPP adjusted) by regions, 196096
poorest countries. The two other measures in Table 1.4 indicate that the gap between
the group of high-income developed countries and the group of sub-Saharan African
countries has increased by nearly 80% during these years, and the gap between the
most affluent country (the US) and the poorest country (indicated in the table by the
Max/Min Ratio) has increased by over 60%.
Several other observations are noteworthy:
1. During the 1980s and the 1990s, the share of the sub-Saharan African countries in
the lowest quintile of the global income distribution has nearly tripled from 11.8%
to 31.5%, while the share of the East Asian countries in the lowest quintile fell
sharply from 35.1 to 7.3% despite their growing population.
2. The share of the South Asian countries in the lowest one-third of the global income
distribution increased during the 1980s and 1990s despite the relatively more rapid
growth of India, and these countries now constitute more than two-thirds of the
lowest income group.
3. In the 1960s and 1970s, the share of the East Asian countries in the lowest income
group was more than three-quarters, but by 1996 this share had dropped to nearly
zero.
4. The share of the East Asian countries in the middle-income group rose from
around 10% in the 1960s and 1970s to around three-quarters by the end of the
1990s.
5. The share of the developed countries in the highest one-third of the global income
distribution declined from 64% in 1960 to 43% in 1996, but this was due to the
decline in their share in the global population.
43
0,9
0,8
0,7
0,6
Low
0,5
0,4
Medium
0,3
High
0,2
0,1
0
South Asia
East Asia
SSA
MENA
LAC
Ex-Centrally
Developed
Planned
Figure 1.3a. The Share of Regions in the Three Income Groups: 1960
0,9
0,8
0,7
0,6
0,5
0,4
0,3
0,2
0,1
0
Low
Medium
High
South Asia
East Asia
SSA
MENA
LAC
Ex-Centrally
Developed
Planned
Figure 1.3b. The Share of Regions in the Three Income Groups: 1996
Table 1.4. Measures of Inter-Country Income Inequality 196098

Indicator
Max/min ratio1
Developed/SSA
ratio 2
Gini Coefficient
Theils Measure
Coeff. of
Variations
1960
1970
1980
1990
1998
Change: 196098 (%)
38.55
8.15
43.67
9.18
47.26
10.04
61.93
12.26
62.97
14.53
+63.3
+78.3
0.63
0.60
1.58
0.63
0.61
1.55
0.62
0.60
1.52
0.60
0.56
1.52
0.58
0.49
1.48
- 8.1
-17.6
- 6.3
1. The ratio between the average GDP per capita in the US and in the poorest country.
2. The ratio between the average GDP in the developed countries and the average in the SSA countries.
44
Chapter 1
As a result of these changes, the gap between the average GDP per capita in the
developed countries and that in the sub-Saharan African countries has increased
sharply, while the gap between the developed countries and the East Asian countries
has narrowed by over 40%. During these years, the share of South Asia and
sub-Saharan Africa in the worlds population rose from 27% to 33.4%, while the share
of the developed countries dropped from 21% to 16%. As a result of all these changes,
the gap between the average GDP in the group of developing countries and the average
in the group of developed countries has changed by only 13%, and the measures of
income inequality within the group of developing countries have actually declined.
These changes do not reflect, however, a convergence of the global income
distribution, since the gap between the richest and the poorest countries, i.e., the height
of the income ladder, has increased significantly. Clearly, for the populations in the
countries in sub-Saharan Africa, in most of South Asia, and in Latin America and the
Caribbean, globalization was not inclusive, and the gap between their standard of
living and that of the developed countries is now wider than ever. For the population in
East Asia, India, and some Latin American countries, in contrast, globalization was
indeed inclusive, and they enjoyed a rapid increase in their standard of living both in
absolute and in relative terms. An attempt to draw a general conclusion from these
opposing trends and apply it for the average or the representative people in
developed and developing countries is a rather meaningless exercise in statistics.
Instead, the sharp difference between these opposing trends makes it necessary to draw
different conclusions for the group of countries that benefited from globalization and
for the group of countries that were left behind.
The critical question in this connection is whether the differences between these
two groups of countries reflect also the differences in their development strategies. In
other words, were the countries that reformed their economies able to gain from
globalization and managed to achieve unparalleled rates of economic growth and a
sharp reduction in poverty, and were the countries that failed to restructure their
economies unable to integrate themselves into the mainstream of the global economy
and, as a consequence, did they see their economies shrink and their number of poor
increase? A complete answer to this question would require a more thorough analysis,
but the reviews of the country experiences in this volume suggest that there is no such
clear correspondence. Quite a few countries, including several countries in
sub-Saharan Africa, made considerable efforts to reform their economies but were
unable to integrate into the global economy due to a host of other reasons.
Table 1.5 summarizes the trends in poverty in the main groups of developing
countries and in the world during the 1990s. These trends in the incidence of poverty
were reflected also in the changes in the rates of child mortality during the 1990s.
Whereas in most East Asian and South Asian countries there was a reduction in the rate
of child mortality during these years, in most sub-Saharan African countries this rate
increased. In nearly all Asian countries (Cambodia is one exception), child mortality
declined during the 1990. The steepest decline was in the East Asian countries: in
Indonesia the rate declined from 97 to 52, and in the Philippines it dropped from 68 to
47. In sub-Saharan Africa, in contrast, child mortality increased in most countries.
45
Table 1.5. Trends in World Poverty during the 1990s

Region
1990
No. (million)
EA
LAC
SA
SSA
World*
450
74
495
242
1276
1998
Poverty rate
No. (million)
Poverty rate
27.6
16.8
44.0
47.7
29.0
280
78
522
291
1200
15.6
15.6
40.0
46.3
24.0
Source: World Development Report 2000.

* Includes also MENA and the ex-centrally planned economies
The large differences between the patterns and rates of growth of different groups
of developing countries underscore the fact that lumping all the developing countries
together and conducting the analysis in terms of North vs South, or developed vs
developing countries is becoming increasingly misleading.
International Trade and Trade Policies in Developing Countries

The changing concept of comparative advantage
International trade economists have long maintained that a liberal and outwardoriented trade regime is the best strategy for a small economy to increase its welfare
and income by optimizing the allocation of its resources in production according to the
countrys comparative advantage, and by minimizing the incentives for unproductive
activities associated with protection, such as smuggling, lobbying, and tariff evasion.
Additional channels through which trade can precipitate growth include higher returns
to investments by increasing the market size with trade, higher productivity through
imports and diffusion of advanced technologies, and pressures to rationalize the
government trade and macroeconomic policies. Sachs and Warner (1995) estimated
that open economies grew about 2.5% faster than closed economies, with even greater
differences among developing countries. Tarr and Rutherford (1998) use a CGE model
to estimate that a 10% reduction in average tariff (from 20 to 10%) brings about a
welfare gain of 10 to 37% of the present value of consumption (depending on the type
of taxes that are being used to replace lost tariff revenues).
The neoclassical theory emphasizes the driving force of low wages, abundance of
unskilled labor and labor-intensive production technologies in promoting trade and
specialization in a labor-abundant country. This analysis is based on an aggregate
model in which production is a function of labor and capital, and technologies are
characterized by the proportions (or intensities) of labor and capital in production.
Different proportions of labor and capital in the production of different goods, and
different endowments of labor and capital in different countries provide the incentives
for specialization in production and for trade. This model is the basis of the widely
46
Chapter 1
employed Heckscher-Ohlin model that separates consumption and production, and

shows how the location of production is determined by differences in the technology
and by differences in factor endowments between regions and countries that
determine, in turn, their comparative advantage. The model predicts that, as trade
barriers are reduced, production will relocate according to comparative advantage
(with relatively unskilled labor-intensive activities moving to relatively unskilled
labor-abundant locations). As this occurs, the changes in demand for factors of
production will tend to equalize factor prices across countries.
In this model, the patterns of trade are determined by ranking goods according to
their factor intensities; the labor-abundant country has a comparative advantage in the
production of labor-intensive goods. Rybczynskis theorem strengthens this
conclusion by showing that, under fairly general conditions, an increase in labor
supplyor an increase in labor productivity (Corden)brings about an increase in the
production of labor-intensive goods. Specialization in production and movements of
goods between countries, in line with their comparative advantage, are substitutes for
the movement of factors of production, and trade therefore narrows the differences
between factor prices. However, the comparative advantage of a country need not be
fixed. It may change over time with the changes in its factor endowments and
productivity and with changes in its production technologies. The higher the rate of
growth of a countrys labor force, the larger the proportion of labor-intensive goods in
production and the larger the comparative advantage of the country in the production
of labor-intensive goods. The larger the flow of capital from the capital-abundant to
the labor-abundant country, the smaller the comparative advantage of the former in
capital-intensive goods.
Labor-intensive production. In the neo-classical Heckscher-Ohlin two-factor model,
labor intensity of a given production technology or a given product is determined by
the capital-labor ratio in production. One production technology is said to be more
labor-intensive than another if the capital-labor ratio in the first technology is lower
than in the second. Several production technologies can be ranked from the most
labor-intensive to the least, according to the corresponding capital-labor ratios, thus
emphasizing that labor intensity is a relative concept. Moreover, the same product can
be more labor intensive than another in one factor price ratio, but more capital
intensive than another in another factor price ratio. (This is known as factor
reversal). In empirical studies within a given country, the physical definition of
labor intensity is replaced by a cost definition that evaluates the shares of labor and
capital costs in the total costs.
For this comparison, it is necessary to remove first any price and cost distortions
due to subsidies or taxes targeted on some of the industries. A considerable number of
articles have examined various modifications and extensions of the neoclassical model
of comparative advantage in order to adjust the model to todays conditions in the
global economy. Most of these contributions still focus on production technologies,
factor requirements, and factor endowments as the driving forces for specialization
and international trade. Wood and Berge (1997) argued that the concept of
comparative advantage in the Heckscher-Ohlin model is no longer suitable for todays
47
conditions for two reasons. First, the high mobility of capital has led to major changes
in factor endowments across countries, thereby continuously changing their
comparative advantage. Second, since there is little difference between primary
products and simple manufactured products in the intensity of unskilled labor in
their production, the only factors that distinguish the modern sector from the
traditional one are land and skilled labor. On these grounds, they concluded that
[c]ountries that have a lot of land and low levels of education should concentrate on
opportunities for progress within the narrow primary category (p. 1468). This,
however, is a static strategy that ignores the dynamic aspects of comparative advantage
and the potential to raise the levels of education and thereby acquire new technologies
and change the countrys specialization.
The more recent writings on the dynamic nature of a countrys comparative
advantage highlighted the following additional factors:
< The effects of investment in R&D that can change a developing countrys
comparative advantage by allowing it to produce and export high quality products.
(Okamoto and Woodland 1998);
< The impact of change in a countrys technological capabilities, and thus also in its
comparative advantage, due to higher skills of its labor force with better education
and training. (Pietrobelli 1997);
< The impact of demand shifts in the more affluent North to higher-quality products
as an effect of the rise in income that shifts the production in the North to
higher-quality products, while production of an increasing number of relatively
lower quality products is shifted to the South, where labor costs are lower (Flam
and Helpman 1987).
In addition to these traditional gains from trade through the more efficient allocation
of resources that is achieved with trade, there will be the following additional gains
when the domestic market can be made more competitive and production better
organized:
1. Pro-competitive gains. These are the effects of increased imports on the
competitive behavior of firms in the domestic market by disciplining the
monopolistic or oligopolistic behavior of firms, forcing them to behave in more
competitive ways.
2. Gains from economies of scale. As the quantity produced by one firm increases,
its average cost decreases. This may be the result of economies of specialization
(firms operating on a larger scale can match inputs more closely to tasks), of
indivisibilities in production, or of the greater efficiency of large machines
compared to small ones. The decline in average costs leads, in turn, to lower prices.
3. Gains from the rationalization of production. Competitive imports force local
producers to increase efficiency or to exit the market. As a result, the number of
domestic firms declines and the level of production of each remaining firm
increases. Tthe remaining domestic firms are necessarily more efficient and can
reap the benefits of economies of scale.
48
Chapter 1
4. Gains from the increase in variety. The larger variety of products that become
available as the country opens up to trade give consumers higher levels of
satisfaction.
The globalization of trade and research, the growing weight of multinational
corporations in world trade, production, and investments, and the rapid technological
advancements all promoted greater specialization in production and introduced
considerable changes in the comparative advantage of both developed and developing
countries. These changes were precipitated by the large flows of investment capital to
developing countries, by the growing share of skilled labor in these countries that
enabled them to produce advanced manufacturing products, and by the rapid
advancements of information and communication technologies that changed the
concept of distance in all transactions. These changes help explain the significant
transformation of the structures of industrial production in the East Asian countries.
The initial industrialization process in these countries was led by the production of
textiles and simple industrial products. Gradually, the production base expanded to
include more sophisticated manufactured products such as machinery, steel,
automobiles, and later to still more advanced products such as computers and
electronics, which are more capital intensive and more skilled-labor intensive.
However, not even the production of textiles and clothing could take place at the initial
stages of the industrialization process without a considerable inflow of capital, since at
the time these countries were primarily agrarian and lacked the capital necessary for
the production of these simple and labor-intensive goods. Although the
industrialization process also brought a rise in wages, the rise in labor productivity was
more rapid and the comparative advantage of the East Asian countries against the
developed countries was therefore maintained. Nevertheless, the structure of their
production and trade gradually changed with the establishment of more advanced
industries that were attracted by the increasingly better trained and more skilled labor.
The multinational corporations were perhaps the most important vehicles that
brought about this change. In their search for the least costly forms of production, these
corporations established or expanded affiliates in the East Asian countries and
transferred to them, or to independent contractors, the production of labor-intensive
products. Labor costs were, however, not the only consideration of the multinational
corporations; their choices were also influenced by the relatively stable political
conditions in most countries and by the direct government support that these
corporations received. Although labor costs were equally low or even lower in South
Asia and sub-Saharan Africa, these countries were much less attractive to
multinational corporations and other investors. Despite striking similarities between
these groups of developing countries in their initial conditions in the 1960s, the huge
differences between them in the depth of the industrialization process and the pace of
the transition to the production of higher-quality and more sophisticated products are,
first and foremost, testimony to the fact that the concept of comparative advantage can
no longer be narrowly defined, as in the Heckscher-Ohlin model, only in terms of
production technology, the direct costs of labor and capital, and the relative intensities
49
of labor and capital. Other factors are also pivotal in determining the costs of
production and the countrys comparative advantage. They include:
< Access to markets. In this context, access refers not only to the geographical
distance, but to all the components that determine transport costs, including inland
and sea transport costs and the costs of insurance and financial services for trade.
Although the African countries are closer to the European markets than are the
East Asian countries, high inland costs due to the distance to the port and poor road
infrastructure considerably reduce their access to these markets. Access to markets
is also determined by tariff and/or quota protection and by other barriers to trade,
including those established by bilateral or regional trade agreements. In the global
economy, accessibility is also determined by access to supply chains that control
the trade and marketing of many commodities at the wholesale and retail levels.
< Access to advanced technologies. Low labor productivity, due to high levels of
illiteracy, prevents many developing countries from taking full advantage of their
labor abundance and low labor costs. In the agricultural sector, the use of
traditional technologies, traditional crop varieties, and low yielding crop
management practices in the indigenous agricultural systems constrain farmers to
producing only self-consumption or for the local market and prevent the
development of agricultural exports. The transfer of advanced production
technologies and methods from developed countries can accelerate growth and
raise labor productivity in the developing countries. The key question is, however,
what barriers prevent or slow down the transfer of these technologies and what
policy measures can accelerate their diffusion. On the one hand, access to
advanced technologies is limited by the lack of necessary skills, by low investment
in R&D, and, increasingly, by the costs and restrictions on the transfer of
technologies due to IPR and patent issues. On the other hand, modern information
and communication technologies, including the Internet, reduce communication
costs and break down geographical borders, thus speeding up the diffusion of
knowledge and advanced technologies.
< Economic and political stability. These are essential non-tangible conditions that
determine investment risks and costs. Until the 1998 crisis, investors in Asian
countries enjoyed very stable political conditions. This stability was often assured
by authoritarian rule, but opposition was significantly mitigated by the success in
raising the standard of living. When these standards fell sharply during the crisis,
political stability was severely shaken in many, if not most, of these countries. In
most sub-Saharan Africa, political stability is all but lacking. Continued wars,
frequent changes in policies and in the regimes themselves, weak institutions of
law enforcement, and widespread corruption significantly raise business risks,
discourage investment, increase insurance costs, and are highly detrimental to both
internal and external trade.
< (Relatively) stable labor market. The Asian countrieseach according to its
level of developmentadopted elements of the Japanese system of lifelong
employment, seniority-based wages, and enterprise labor unions that secured
workers loyalty to their employers. Government welfare programs are
rudimentary even in South Korea and Taiwan, and labor unions focus their
50
<
<
Chapter 1
demands mainly on job protection. In Latin America, labor unions are national and
they are very active in their countrys politics. The pressures exerted by the unions
and their political power triggered government intervention through minimumwage legislation and relatively high wages in the public sector. These interventions
distorted the price of labor and inhibited the absorption of surplus labor.
Functioning markets. The economies of many developing countries were, and
still are, plagued by massive price distortions and a host of restrictions that prevent
the development of functioning markets. The removal of these distortions and
restrictions is necessary not only to attract foreign investors, but also to create
profit incentives for domestic private enterprises, and thereby boost production
and streamline labor allocation. In sub-Saharan Africa, the haphazard and
incomplete market reforms were noted as one of the central reasons for slow
growth (World Bank 1994). However, even among the most successful East Asian
and Latin American countries, market reforms were limited in two ways. First, the
governments in these countries maintained and even expanded some price
distortions that were designed to support local enterprises and encourage industrial
production. Second, the removal of distortions and the development of functioning
markets were often confined to producer services and to what Radelet and Sachs
(1997) termed the export platform.
Government interventions. In all Asian countries, government investments in
infrastructure, health, and education, as well as direct investments in enterprises
were pivotal at the early stages of the industrialization process. These, together
with large-scale interventions in many other forms, gave strong incentives to
foreign and domestic entrepreneurs to invest in local industries. Indeed, even the
World Bank (1993) survey of the Asian miracle provided details on more
proactive tactics of direct intervention that the Asian government often adopted at
the early stages of their development. The report acknowledged that the
neo-classical, getting the basics right policies do not tell the entire story. In each
of these economies the government also intervened to foster development, often
systematically and through multiple channels. Policy interventions took many
forms: targeted and subsidized credit to selected industries, low deposit rates, and
ceilings on borrowing rates to increase profits and retain earnings, protection of
domestic import substitutes, subsidies to declining industries, the establishment
and financial support of government banks, public investment in applied research,
firm- and industry-specific export targets, development of export marketing
institutions, and wide sharing of information between public and private sectors.
Two additional factors that, from the public welfare point of view, must be considered
negative have an impact on the comparative advantage of a country:
< Absence of labor laws. In addition to minimum wages, companies in the
developed countries must provide high social benefits that include pension
contributions, vacation, paid sick leave, social security, and health benefits, etc.
They are also bound by occupational safety and health rules. In many developing
countries, there are no such laws, not even with respect to child labor.
<
51
Low environmental standards. Against the high and rising standards of

environmental protection and pollution control in the US and Western Europe, the
very low standards and lax enforcement in most developing countries give them an
advantage in highly polluting production processes (Bhagwati 1997).
On these grounds, producers in importing countries that maintain high environmental

and labor standards claim that the lax standards maintained in some exporting
countries give those countries an unfair competitive edge. Indeed, the pressures of
many groups and labor unions in the developed countries to enforce minimum
environmental standards and child labor laws under WTO agreements reflect not only
a genuine concern for these issues, but also efforts to lower the comparative advantage
that these exporting countries have on account of their low environmental standards
and the absence of labor laws.
Low labor costs, combined with all the other factors that determine the cost of
capital and the risk for foreign investors, created the conditions that changed the
comparative advantage of East Asian countries and enabled them to specialize in
manufacturing production and to attract foreign investors. Other developing countries,
particularly in Latin America, offered some of these components, but few could
compete with the conditions investors found in East Asia. Obviously, not all of these
components are positive or beneficial to the country in the long term, nor are they
equally tenable in all countries. However, the rapid growth of the East Asian
economies, their dramatic downfall in 1997 and 1998, and the equally dramatic
recovery of most of them since 1999 emphasize the need to take into account the entire
spectrum and all the components that determine the comparative advantage of a
country, not just the abundance and low cost of unskilled labor, in order to have a more
complete understanding of the East Asian miracle and in order to apply the lessons
from this miracle in the design of development policies for other countries.
Outward- vs inward-oriented growth strategy
While the debate about the most suitable growth strategy for a labor-abundant
economy has always been loaded with controversies, the dominating view was that, for
the majority of developing countries, the prospects of growth are closely linked to
industrialization. Even in the primarily agricultural countries of sub-Saharan Africa,
long-term growth was linked to increasing the domestic value added through
processing, and in practically all countries, per capita GDP grew with the rise in the
ratio of manufactured to primary products. During the past decade, discussions on the
most suitable industrial strategy were dominated by the rapid growth of the East Asian
economies that was achieved through an outward-oriented development process and a
rapid increase in exports. The discussions centered on the following key questions:
< How significant was the outward-oriented strategy?
< How significant was the focus on industrialization?
< What was the role of the other components of the growth strategy of the East Asian
countries, including government investment in infrastructure and education and
the large subsidies to foreign direct investment (FDI, see Box 1.1)?
52
Chapter 1
Box 1.1. Foreign Direct Investment (FDI)

Since the early 1980s, world FDI flows have grown faster than either the world
trade or the world output. The flows of FDI to East Asia and, to a lesser extent, to
the other developing countries, grew at an average annual rate of over 30% in the
first half of the 1990s, from less than $35bn per year to around $100bn by 1994, and
at an average annual rate of 15% in the second part of the 1990s to over $250 billion
in 2000, but their share of total investment flows declined from 43% in 1997 to
21% by the end of the decade as an effect of the financial crisis in East Asia. More
than half of these investments were made in East Asian countries, whereas the flow
to Latin America and the Caribbean (primarily Chile, Argentina, and Brazil) grew
at much lower rates, and only a trickle reached sub-Saharan Africa. The Asian
crisis had a significant and immediate impact on this flow. Indonesia, for example,
had an FDI inflow in excess of $4bn during 199497, but in 1998, with the
emergence of the crisis, this flow dried out, and in 1999 there was a net outflow of
over $2bn. China was the main beneficiary of this change of direction of FDI, and
in 1999, it had an inflow of nearly $50bn. Some Latin American countries also had
larger inflows in recent years due, in part, to the outflow of capital away from the
crisis countries in East Asia. In 1999, the FDI flow to Brazil exceeded $30bn, and
the FDI flow to Argentina reached nearly $25bn.
Notwithstanding the financial turmoil in East Asia in 1998, global FDI inflows
increased for the seventh consecutive year to reach $430-440 billion, becoming an
important source of private external finance for the developing countries.
According to the latest FDI data released by UNCTAD, world FDI flows increased
by 18% in 2000 to a record US$1.3 trillion, compared with only $203 billion in
1990. Much of this investment was driven by corporations buying or merging with
companies in other countries, contributing to increasingly global multinational
firms. Most FDI flows went to the industrialized world. FDI flows to the
developing countries overall grew by 8% to US$240 billion, and to the economies
in transition of Central and Eastern Europe by 9% to US$25 billion. However, FDI
flows to Latin America and the Caribbean declined in 2000 by 22% to US$86
billion, primarily as an effect of the evolving crisis in Argentina, and the flows to
Africa continued to decline.
The factors that determine the inflow of FDI into a country and make the
country a desirable destination for FDI include political and economic stability, the
market size, the availability of natural resources and human capital, the countrys
growth prospects, and the existence of favorable investment and tax regimes. A
recent UNCTAD report concludes, however, that such traditional features,
although still important, no longer constitute the most significant driving forces. In
a world increasingly characterized by a global and highly interconnected trading
system, companies look for places to invest that offer specific advantages, such as a
good communications infrastructure and intangibles such as political stability and
business culture. The direct effects of FDI on the host country are the product of the
FDIs effects on factor endowments and rewards. These investments improve
53
productivity, raise the marginal product of labor, and reduce the marginal product of
capital, thereby promoting economic growth and exports and raising incomes and
wages. There are also indirect effects (or externalities) of FDI that are due to the
impact of foreign multinational corporations on their host economies. These effects
may vary, however, between industries and countries, depending on the
characteristics of the host country and the policy environment.
The large flows of FDI to the EA countries and the growing integration and
globalization of the capital markets increased their capacity (that came to be
perceived as good risks) to access these markets directly in order to secure funding
for projects that in the past could only be financed through the World Bank.
<
What was the rise in total factor productivity in these countries, and what was its
contribution to their economic growth relative to the contribution of the large
resource mobilization? How effective was export promotion industrialization vs.
import substitution?
To answer these questions, this section surveys the discussions in the economic
literature and reviews the experience of selected countries.
In their highly influential research on trade and industrialization, Little, Scitovsky,
and Scott (1970) provided a thorough account of the connection between an
export-oriented growth strategy and the rate of economic growth. They emphasized
the effects of competitive conditions in the world markets on exporting enterprises that
force countries to eliminate distortions, thus leading to better macroeconomic
performance and more rapid growth. In contrast, efficiency considerations are
secondary behind the walls of protection, and (infant) industries (even construction)
have little incentive to select the more cost-effective and labor-intensive technologies.
The World Banks World Development Report of 1987 and 1990 noted that the high
walls of protection often reduced the use of labor in the formal sector, whereas more
open and outward-oriented trade regimes tend to support more labor-intensive patterns
of industrial expansion in both import-competing and export industries. Bhagwati
(1982) highlighted another distortion of an inward-oriented trade regime that is a result
of its heavy reliance on market restrictions and state intervention and is therefore more
likely to create an environment that is more congenial to directly unproductive profit
seeking. With open, outward-oriented strategies, in contrast, the state is less involved,
and profit seeking is more likely to be productive. Bhagwati noted the wide consensus
among economists that an outward-oriented trade strategy helps the process of
industrialization and economic growth. In his words: The question of the wisdom of
an outward-oriented (export-promotion) strategy may be considered to have been
settled (1987, p. 257).
There is, however, no conclusive empirical evidence that in all countries an
inward-oriented development strategy based on import substitution would indeed
reduce longer-term growth rates. In a comprehensive cross-country study, Chenery,
Robinson, and Syrquin (1986) showed that the average yearly GDP growth rate in
54
Chapter 1
semi-industrial economies that adopted import-substitution policies was only a few

tenths of a percent lower than the growth rate in countries that adopted exportpromotion strategies. McCarthy, Taylor, and Talati (1987) used a different grouping of
countries, based on per capita GNP, and showed that the fast-growing countries did not
have, on average, a higher (or increasing) share of exports in GDP. Easterly and Levine
(1994), however, established a clearer causal relationship between enhanced exports
performance and more rapid growth in extended cross-section studies.
Two factors may affect the straightforward calculus of the gains and relative merits
of an outward-oriented trade policy. The first is the importance of trade taxes in the
budgetary revenues of developing countries. An IMF survey of the 36 least developed
countries (LDCs, see Box 1.2) found that trade taxes account on average for 5% of
GDP, or about one-third of total tax revenues. The implementation of a broadly
defined trade reform that includes the overhaul of customs administration or
compliance with WTO obligations requires heavy budgetary outlays. The second
factor is the strategic trade policy, emphasized by the new trade theory, which
justifies protection in the presence of strategic interactions among firms in domestic
and international markets (i.e., when a change in the behavior of firm 1 leads to a
change in the optimal behavior and a strategic response of firm 2). By choosing an
optimal import tariff or subsidy, the government can affect the strategic game played
by firms in international markets to the advantage of domestic firms. Often, however,
the strategic trade policy literature gives rise to contradictory results depending on the
type of market structure and the form of competitive rivalry. As a result, this literature
has generally been considered of little use in the guidance of governments trade
policy. There are also doubts about its relevance for trade policy in developing
Box 1.2. The Least Developed Countries

Since 1971, countries with weak economies and deep poverty have been
categorized as Least Developed Countries (LDCs). By the end of the 1990s, 49
countries with a combined population of 610 million, equivalent to 10.5% of the
world population, were identified as LDCs. Most of these countries are in
sub-Saharan Africa. In 1981, the United Nations General Assembly held the first
UN Conference on the Least Developed Countries in Paris, in which it adopted the
Substantial New Programme of Action for the 1980s for the Least Developed
Countries. However, despite major policy reforms initiated by many LDCs to
carry out a structural transformation of their domestic economies, and supportive
measures taken by donors, the economic situation of these countries as a whole
worsened during the 1980s. The Second UN Conference on the Least Developed
Countries held in Paris in September 1990 formulated national and international
policies and measures for accelerating the development process in the LDCs,
drawing on the experience and lessons from the 1980s. A mid-term review of the
implementation of the program of action for the LDCs for the 1990s concluded,
however, that these countries continue to be marginalized.
55
countries, which tend to be primary product exporters, since the production of primary
products is rarely characterized by large economies of scale.
The success of East Asian countries in achieving high rates of economic growth
made export promotion, spurred by open trade and market liberalization, the strategy
of choice. The World Bank study titled The East Asian Miracle (1993) emphasized the
prominent role of export-oriented policies in the economic miracle of the East Asian
countries. The report paid close attention to the process of industrialization in these
countries that initially took advantage of the abundance of cheap labor by building up
industries with highly labor-intensive production that required mostly unskilled labor.
Perhaps the most obvious example is the clothing industry, which is highly laborintensive and in which developing countries have a clear comparative advantage.
Although higher productivity in the developed countries could offset part of their
higher labor costs, the very low labor costs in Indonesia, China, and Pakistan, which
were only 5 to 10% of those in the US, allowed these countries to produce much
cheaper clothing despite their less productive technologies. In East Asia, the clothing
industry was the quintessential foundation on which the industrial base was gradually
built as these countries accumulated more know-how, developed a better-skilled labor
force, and opened their economies to foreign investment. In other developing
countries, the agricultural sector can play this role, as we see in Part III.
The World Bank account of the East Asian miracle emphasized the importance
of market-oriented incentives that led to large gains in efficiency and factor
productivity. These incentives were created by setting the correct price signals through
the unification of the exchange rate, the measured devaluation, and the removal of
various distortions on the one hand, and the disciplining force of open trade and
export-promotion strategies on the other. The pressures of international competition
and the greater role of the market seem to have mitigated the worst kind of rent-seeking
behavior observed in those countries that rely on industrialization through
import-substitution. Other studies on the experience of East Asia gave, however, equal
weight to the influence of government intervention through subsidies, trade
restrictions, administrative guidance, and credit allocations (Rodrik 1992 and 1995;
Amsden 1990; Wade 1990). In their view, this government intervention was necessary
at the early stages in order to facilitate the transition from the production of primary
products for the domestic market to the production of manufacturing goods for the
home market and exports, and in order to make investments in the non-traditional
sector sufficiently attractive. The weakness of the market system in these countries at
the early stages of development, and the absence of the necessary financial and
economic institutions, made the state the only entity that could offer these incentives
and provide a measure of security. Rodrik argued that the main push for the economic
take-off in South Korea and Taiwan did not come from the increase in exports, but
from the sharp rise in investments that was largely engineered by the government
through direct credit at low or even negative interest rates, and through investment
subsidies, direct administrative subsidies, and the use of public enterprises. In both
countries, investments rose from 10% of GDP in the late 1950s to 20% in the
mid-1960s and 30% in the early 1970s. This large increase in investments was
matched by a roughly equivalent increase in savings that prevented inflationary
56
Chapter 1
pressures. Government coordination in the form of administrative guidelines as well as

direct investments in key industries were pivotal, since increasing returns to scale in
the production of the modern sector made it initially impossible for the private sector to
take full advantage of these investment opportunities despite the high subsidies
(through credit at negative real interest rates, tax incentives, etc.).
Another part of the debate on the forces behind the East Asian miracle focused
on the effect of export-led growth on total factor productivity (TFP) and the
contribution of the rise in TFP to growth. Several empirical studies found a high
correlation between a countrys overall growth performance and its export growth, and
between a countrys growth in TFP and its export growth, although this correlation
does not establish causality. Sarel (1995) estimated that in the four Asian tigers,
output per person rose during 197590 by an average of 6.5% annually, whereas the
annual TFP growth rate ranged between 2% in Singapore and over 3.5% in Taiwan and
Hong Kong. According to his estimates, TFP growth accounted for nearly half of the
total growth of output per person. In China, Hu and Khan (1996) estimated that TFP
rose at an annual rate of nearly 4% during 197994. The World Bank 1993 study
emphasized the contribution of the significant rise in productivity to economic growth,
and noted two factors that led to this rise. One was the removal of discriminative and
highly distorting prices in the domestic market and the elimination of trade barriers;
these measures exposed local enterprises to the disciplines of competition, which led to
better allocation of resources. The other factor was the adoption of new technologies
and the latest vintage capital formation by export industries that led to technology and
productivity spillovers from which the entire economy could benefit. To maintain their
international competitiveness, enterprises in East Asia also had to rely on a steady rise
in the productivity of their workers that was made possible by their improved skills and
better training. In Korea, this led to a virtuous cycle of growing exports that led to more
investment in the export industries that led, in turn, to further productivity gains.
In contrast, Young (1992, 1994, 1995), Rodrik (1995), and Krugman (1994)
argued that the remarkable growth of East Asian countries was not due to an unusual
rapid growth of TFP, but to the rapid accumulation of capital and the increase of the
labor force in manufacturing. According to Youngs (1994) estimates, the annual TFP
growth in South Korea and Taiwan during 196690 was 1.2% and 1.8% respectively.
These rates, however respectable, were of the same order of magnitude as the rates in
Argentina, Brazil, Chile, and Mexico. Kim and Lau (1994) found that in the four Asian
tigers, capital accumulation accounted for over half of their economic growth.
Krugman attributes this growth primarily to an astonishing mobilization of
resources rather than to gains in efficiency.
The debate over the merits of export promotion vs import substitution was at the
center of the discussion in the economic development literature as early as the 1950s.
The consensus among professionals at the time in favor of an outward-oriented,
export-led growth strategy did not rule out, however, an import substitution strategy in
the first stage of the industrialization process, and it has been recognized that virtually
all the successful exporters of manufacturing, with the exception of Hong Kong, began
their industrialization with an inward-oriented strategy that promoted import
substitution under significant protection. Moreover, in some countries, the gains from
57
export-led growth that are due to scale economies in production can also be reaped in
the production of import substitution if their domestic market is large enough. In small
countries, the industrial strategy must be based on specialization and niche-oriented
industries (Chenery et al. 1986). Brazil and Korea are good examples of these two
extremes: in Brazil, the share of commodity exports in the mid-1980s was less than
10%, whereas in Korea, the share was close to 40%. Brazil relied on the growth of its
domestic demand to generate scale economies and technical change, whereas Korea
pursued more aggressively outward-oriented policies aimed at transforming the
domestic industries from producing predominantly for the highly protected local
market to producing industrial goods for exports (Taylor 1989). Korea is poor in
natural resources and the shares of its industry in both exports and GDP are therefore
much higher than in resource-rich Brazil.
A series of country studies organized by the World Institute for Development
Economics Research in 1987 and 1988 demonstrated that Korea, Taiwan, Turkey, and
other countries where economic progress was led by the rapid growth of export
industries had an initial stage of industrialization based on import substitution. In
Turkey, for example, the export-led growth during the first part of the 1980s was built
on an industrial base that had been created at an earlier stage of import-substitution
industrialization as well as on heavy export subsidies and various administrative
measures to promote exports. The success of the export-oriented strategy in these
countries was attributed, in part, to the crowd in effect of public investments that
gave incentives to private investments via complementarities and allowed a greater
diversification of the industrial sector. On these grounds, Shapiro and Taylor (1990)
argued the following:
There is no reason why production for appropriate niches should not initially be
supported by import barriers and export subsidies; indeed, the opportunity costs
of not trading have to be ignored until learning and scale effects take hold. The
point is that full industrialization only occurs after infant firms grow up, and can
compete more or less effectively on international terms. (p. 873).
In Korea, infant industries were protected by high tariffs during the early stages of
industrialization alongside the export drive, and while exports were liberalized, the
domestic market remained protected. The monopolistic or oligopolistic conglomerates
that dominated many Korean industries were able to practice price discrimination that
was considerably augmented by export subsidies. Infant industries matured by
acquiring more advanced technologies, and gradually the effective protection rates
were reduced. These industries turned to international trade not due to market forces,
but largely because they were driven by government regulations to export their
products (Lee 1997). However, the concentration of manufacturing production in
Korea and in most other East Asian countries (except Taiwan) in large conglomerates,
together with the power exercised by transnational corporations over exports created
their own distortions, substantially reducing the efficiency gains of the export-led
growth and its advantage over industrialization via import substitution (Helleiner
1990).
58
Chapter 1
What are the prerequisites for and the impediments against the adoption of a
similar growth strategy in sub-Saharan Africa? What should the components of this
strategy be? The East Asian Miracle drew two main lessons from the strategy of East
Asian countries. First, the prerequisites for a successful growth policy are suitable
social and political environments. Appropriate infrastructurefrom electricity and
highways to schools and health clinicsmust be in place, and the government must
have a central role in building this infrastructure. Second, the price system must
provide proper incentives, and the institutions and mechanisms for competition must
be sufficiently robust to secure the efficient working of the market. The World Bank
report titled A Continent in Transition: Sub-Saharan Africa in the Mid-1990s (1995),
which focused on the lessons for sub-Saharan Africa, emphasized the need for more
market-oriented policies, more openness to trade, and sound macroeconomic policies.
Alesina (1997) emphasized the importance of institutions for growth and noted the
need for the protection of property rights and relative political stability. All these
components determined the comparative advantage of East Asia as much as, or even
more than, their factor endowments and relative costs in production. The role of
institutions and the idiosyncratic structure of institutions in the Asian model are
discussed in more detail in the next section.
The Asia way and the role of institutions
The high performance of the East Asian countries until the 1998 crisis was the main
reason for the near general praise of the policies that these countries implemented. The
East Asian Miracle noted the importance of market-oriented incentives that led to
large gains in efficiency and factor productivity. These incentives were created by
setting the correct price signals through the unification of the exchange rate, the
measured devaluation, and the removal of discriminatory and distorting prices on the
one hand, and the disciplining force of open trade and export-promotion strategies on
the other. Other studies on the East Asian miracle gave equal weight to the role and
effects of direct government intervention through continued subsidies, trade
restrictions, administrative guidance, and targeted credit allocations to selected
industries, on the grounds that, at the early stages of development, direct government
support was necessary to make the transition from the production of primary products
for the domestic market to the production of manufacturing goods for exports, and in
order to stimulate foreign direct investments in the nontraditional sector. The
weakness of the market system in these early stages, and the near absence of the
necessary financial and economic institutions, made the state the only entity that was
able to offer these incentives and provide a measure of security.
The focus on the economic aspects of the Asian miracle narrowed the Asian
model unduly and omitted key components that did not show up in the countries
statistics, but are essential for a more comprehensive understanding of the miracle. It
was recognized well before the 199798 crisis that the Asian way of doing business
is different from that of the West. The Asian model of capitalism, in which free market
competition was transformed to accommodate collusion between the government and
the business establishment, was, however, touted (until that crisis) as better suited to
59
Asian traditions than the Western model of free market capitalism. The crisis exposed
fundamental weaknesses of this model, which were also the main reasons for the crisis
itself. The organization of production for exports at the early stages of development
allowed Asian countries to make the transition despite the lack of an industrial base.
Radelet and Sachs (1997) noted that a unique and essential feature of the Asian model
was the creation of an export platforman enclave economy, hospitable to foreign
investors and integrated into the global economy, unfettered by problems of
infrastructure, security, rule of law, and trade policies that plagued the rest of the
economy. On this platform, Asian countries were able to concentrate their investment
and move up in technological development. Moreover, in the authors view, the
platform not only allowed these countries to move up on the production ladderfrom
primary products to textiles to electronics and machinerybut also created a much
broader modernization of the political and economic institutions.
The principal reason for the greater complexity and the inherent weakness of the
Asian economic model is that the export platform was not really an autonomous
economic enclave. Rather, it remained connected in some essential functions to the
rest of the economy. Plagued by problems of infrastructure, security, and the rule of
law, these countries had to find a strategy that would allow an efficient and unimpaired
management of production and the conduct of other business affairs on the export
platform, despite these connections. Asian countries found a strategy that proved
workable and effective for nearly three decades and was instrumental in promoting
their rapid growth. The most important channel through which the export platform was
connected to the rest of the economy was the financial sector. Since foreigners were
not allowed to own banks, corporations that produced for exports had to rely on and
adjust to the countrys financial institutions. The financial system was plagued,
however, by sloppy banking practices and ineffective and often corrupt supervision,
which allowed the provision of loans on the instruction of, or as a favor to, influential
politicians or cronies. Another channel was the work force and the increasingly
militant labor unions. With the rise in living conditions and the expansion of the
industrial sector, workers began to organize and demand wage increases and improved
working conditions. The third channel was the system of government, which was
highly centralized, highly authoritarian, and actively involved in all aspects of the
economy.
These channels exposed the export platform to the weaknesses of the local
economic, legal, and political systems and threatened to stall its take-off. To deal with
these stumbling blocks, it was necessary to have a strategy that would allow the export
platform to function despite these weaknesses. The strategies adopted by Asian
countries show remarkable similarities. In fact, these countries followed, with
surprisingly little variation, the patterns of the countries just ahead of them in the
development process, not only in their technological advancement, but also in the
evolution of their economic institutions. Indeed, the common denominator of these
patterns constitutes the Asia model. The principal components of this model were
the following:
60
<
<
<
<
Chapter 1
strong and authoritarian governments, assisted by an obedient and highly efficient

bureaucracy, secured peace and stability, and enabled corporations to work
without red tape in their investments and production decisions;
the financial system, which had very limited independence in making business
decisions and mainly functioned as a service agent to corporations;
large corporations that organized a significant portion of production and exercised
influence over the political system and controlled the financial institutions;
a social welfare system that was built on a social contract between the workers and
the corporations employing them. The role of the government was mainly to
support that contract by subsidizing companies in order to keep people employed.
Authoritarian governments had a clear and significant role in creating the necessary
conditions for establishing the export platform, in forging partnerships with foreign
capital (and meeting the whims of foreign investors), and in conducting conservative
fiscal and monetary policies, thus igniting the engines of growth and keeping them on
track. The management of the economy was often delegated to a team of efficient
technocrats that conducted a very responsible fiscal policy and maintained a stable
currency, helping to keep inflation low. Thus, for example, the relative peace and
social stability until the crisis, abundance of cheap labor, plentiful natural resources,
and a stable currency made Indonesia highly attractive to foreign investors. As the
economy developed, production became more sophisticated and capital intensive,
financial decisions grew more complex, and the scope for errors and corruption under
an authoritarian government rose sharply. Moreover, the Indonesian government, like
most other East Asion governments, did not permit any significant development of
institutions of governance and any significant move toward greater democracy. Hopes
and expectations that the export platform would provide an incentive to modernize the
political and economic institutions did not materialize. In the absence of these
institutions, cronyism and corruption became common. In Indonesia, the absence of
proper institutions of government was the reason why a financial crisis that initially
appeared rather benignprimarily a case of mismanagementand seemed not too
difficult to correct, rapidly deteriorated into a complete meltdown of the currency and
a crisis of leadership.
In the 1960s and 1970s, most East Asian countries were essentially political
tyrannies, either of political parties or of individuals. In that sense, they were not much
different from the political tyrannies that ruled in most of sub-Saharan Africa. Yet in
the 1980s, East Asia grew very rapidly and succeeded in developing rather advanced
economic institutions that managed the economy very efficiently, whereas
sub-Saharan Africa failed to reform its economies and entered into a spiral of slow or
even negative growth that was accompanied in many countries with a collapse of the
institutions of governance and outright chaos. An intriguing explanation of the marked
differences between the experiences of these two groups of countries can be found in
the (last) book that Mancur Olson published in 1998, entitled Power and Prosperity:
Communist and Capitalist Dictatorships. Olson distinguished between what he terms
political tyrants and political warriors, arguing that political tyrants have a stake in the
country they are ruling over and exploiting, because the more the country prospers, the
61
more they can extract for themselves in the form of legal or illegal taxes. The political
tyrant therefore keeps taxes relatively low and develops rather effective institutions to
manage the economy in order to assure the countrys long-term prosperity, thus
maximizing also his long-term profits. The political warrior, in contrast, does not have
the long-term perspective and seeks to maximize the profits he can extract from his
subjects as fast as possible, thus leading to the collapse of institutions and to anarchy.
The Asian financial model served the needs of the production systems in these
countries very well in the early years by raising funds, initially in the domestic market
and later also abroad, and making them available, on the instructions of government
officials and at highly subsidized rates, to strategic industries. The investment and
lending decisions were rather simple at that stage, since the choice of strategic
industries and the investment decisions in these industries were rather clear. Already
early on, however, banking practices were sloppy, in part due to the absence of a
proper regulatory system and lax government oversight, and in part because the
financial institutions were captive to high-level politicians, bureaucrats, and corporate
managers. Nonetheless, the banks remained profitable because they were able to raise
inexpensive funds from the public thanks to the very high saving rates and the rapid
growth in income. At a later stage, the banks were also flooded with funds as a result of
the larger inflow of foreign capital that grew six-fold between 1991 and 1996.
Unconstrained by the lax government oversight, the banks went out of their way to
give loans, in the process exposing themselves to higher risks and becoming leveraged
with short-term debts. Corporations expanded well beyond their needs, and
profitability of new investments was not the guiding principle for corporations or
banks. Deference, trust and tightly knit relationshipsthose Asian values that in the
early stages were instrumental in providing a substitute for the lack of practice and
experience with risk managementgradually gave rise to cronyism, nepotism,
corruption, and reckless risk-taking whenever rising profit opportunities presented
themselves. Large investments in real estate and office construction continued
unabated despite the slow-down in exports.
The Asian crisis brought the deficiencies of the Asian model to the forefront and
revealed the weaknesses of the economic and political institutions in these countries.
When the crisis unfolded, some hastened to conclude that the model was
fundamentally flawed. The crisis should not obliterate, however, the fact that the
Asian way had many advantages in the early years of the regions development. It
failed, however, to keep up with its own success by hindering the evolution of the
institutions that are essential for longer-term development. The focus on economic
growth gave precedence to the short-term. The longer-term price that Asian countries
paid for this narrow focus was not, however, confined to the lack of institutional
development and improper governance; it also included environmental degradation,
crowded cities, and the decay of the rural sector. The Asian crisis thus highlights the
need to make the development of institutions an integral part of development strategy.
The relatively rapid recovery of some of the countries in the regionparticularly
South Korea, Singapore, and Malaysiain 1999 and, even more so, in 2000, and the
slow recovery of Indonesia, Thailand, and the Philippines, also emphasize the political
dimension of the crisis and the fundamental weaknesses of the political and social
62
Chapter 1
systems that were aggravated in the crisis and slowed down the recovery. Indonesia is
clearly the most notable example of the impact of political instability on the economy.
The country experienced a 14% fall in GDP in 1998 and zero growth in 1999. The
economic decline exacerbated the political problems, and in mid-2000 the economy
entered a new slump. The Philippines were initially less affected by the regional crisis,
but the political turmoil in 2000 very markedly slowed down economic growth. The
entire region benefited from the continued rapid growth in the US and the EU during
1999 and 2000, which generated high demand for East Asian export products, most
notably electronics. However, the high share of electronics in their exports and the
high share of exports in their GNP make these countries very vulnerable to any
slowdown in the economy of developed countries, particularly the US.
Globalization and Strategies of Sectoral Development

The role and structure of agricultural development strategy
The slow pace of industrialization and the rapid population growth in many developing
countries, particularly in sub-Saharan Africa and South Asia, severely compromise the
potential of the modern/industrial sector to absorb surplus labor. As a result, the
continued flow of rural migrants has led to growing unemployment and poverty in the
urban areas. An effective growth strategy in these countries must have a balance
between industrialization and rural development and explore the potential
employment opportunities in rural areas. So far, however, the pace of development is
not very encouraging. During the past two decades, the per capita agricultural
production in all the developing countries grew at an annual rate of less than 1%, and in
many of the LDCs, agricultural growth was outpaced by population growth. The pace
of agricultural growth is considerably slower than during the 1970s, at the time of the
Green Revolution, when per capita agricultural production in the developing countries
grew at an annual rate of 1.1%, after declining at an annual rate of 0.3% during the
preceding decade (Table 1.6).
The evidence of the last two decades, primarily in sub-Saharan Africa and South
Asia, makes clear that in these countries the agricultural sector will not be able to
Table 1.6. Growth of Food and Agricultural Production in Developing Countries
(%)
Country
group
Food
Total
All agriculture
Per capita
Total
Per capita
196170 197184 196170 197184 196170 197184 196170 197184
Developing
Low-income
Asia
Africa
2.2
1.3
1.2
2.6
Source: World Bank (1986)
3.2
3.2
3.4
2.0
-0.3
-1.3
-1.3
-0.2
1.1
1.2
1.5
-0.9
2.4
1.9
1.8
3.0
3.0
3.3
3.6
1.2
-0.1
-0.7
-0.7
0.2
0.9
1.3
1.7
-1.7
63
sustain per capita growth rates in excess of 2% per annum without a significant
increase in yields. Despite the early hopes during the Green Revolution, growth rates
in agriculture seldom exceeded 4% per annum, and sub-Saharan Africa benefited very
little from the new crop varieties that were developed at that time. Several factors may
inhibit the growth prospects of the agricultural sector in many developing countries:
< large direct and indirect subsidies to agricultural producers in the EU and the US
and a rise in their production efficiency and yields. This led to a continuous and
often sharp decline in many commodity prices in the international markets and
reduced the capacity of farmers in the developing countries to produce these
commodities at competitive prices. In many developing countries that opened up
their economies to international trade, cheap imports of wheat, rice, corn,
soybeans, and other raw crops from the developed countries made it difficult for
local farmers to sell their products at competitive prices even in the local markets.
< constraints on the transfer of advanced technologies and crop varieties from the
developed countries due to IPR regulations and constraints on the development
and adaptation of local technologies and varieties due to shrinking budgets for
public agricultural research;
< slow diffusion of new technologies due to the ineffective and resource-stretched
extension services and slow adoption of high-yielding varieties due to the skills
required for successful adoption.
< poor infrastructure limits access to markets, both domestic and abroad, thus
preventing greater specialization and adoption of high-value crops that can
generate higher income, and forcing many farmers to grow primarily for
self-consumption;
< limited access of small landholders to credit and lack of financial institutions,
arrangements and instruments for savings and investments in rural areas;
< continuous erosion in the quality and quantity of agricultural lands;
< decline in the world prices of traditional export crops such as coffee, cocoa, and
bananasthe main cash crops in sub-Saharan Africa and in Latin America and the
Caribbean.
As a result, the growth of agricultural production was much slower in quite a few
countries, particularly in sub-Saharan Africa, and employment opportunities for the
rural population declined in practically all developing countries. In the developing
countries as a whole, the share of the agricultural sector in total employment fell from
an average of over 30% in the mid-1960s to an average of less than 20% in the
mid-1980s, primarily due to the decline in the share of agriculture in the total GDP and
the rapid urbanization. There were, however, wide variations between countries:
during 195090, the share of agricultural employment in total employment declined by
30% in Thailand and Indonesia, by nearly 80% in South Korea, by 5060% in Latin
America, and by 1025% in sub-Saharan Africa.
In sub-Saharan Africa, the growth rate of agriculture was highly correlated with
the growth rate of the other sectors, primarily because of the dominant role of the
agricultural sector in the economy, and the share of agriculture in the GDP therefore
changed relatively little (Rao and Caballero 1990). Since the growth rate of their
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Chapter 1
industrial sector was also very slow, these countries could not rely on the industrial
sector as a source of employment, and the pace of urbanization was much slower than
in other continents. The relatively slow decline in the share of agriculture in total
employment also accentuates the low and declining productivity in agriculture that
was due, in part, to the migration to the urban areas, which left behind the very young,
the old, the handicapped, and single mothers (Table 1.7).
For countries that are predominantly rural and where industrialization is still at an
early stage, rural-based development strategies have been advocated (Mellor 1976).
The time that these countries would need to build an industrial base able to absorb the
surplus labor from rural areas is bound to be long, and a strategy based on rural
development therefore promises a faster increase in employment and reduction in
poverty. Restructuring and expansion of agricultural production can also contribute to
the development of the other sectors through forward linkages with processing
industries. A study in India, Pakistan, Malaysia, and the Philippines found that, as an
effect of this linkage, a 1% addition to the growth rate of agriculture would add 0.5% to
the growth rate of industrial output, and 0.7% to that of the national income
(Haggblade, Hazell, and Brown 1989). A rural-based strategy will also be more
effective in reaching the poor because the majority of the poor still live in rural areas,
and most of them depend on earnings from agriculture or from non-farm work that is
partly linked to agriculture (WDR 1990). Over two-thirds of the rural poor are small
farmers and landless laborers; many of them live in countries and regions where
growth in agricultural production is lagging behind the population growth, turning
many regions into pockets of poverty.
Even in these countries and regions, however, the potential for agricultural growth
is far from being exhausted, since their crop yields are very low and increased only
very slowly in the past decade. In many countries in sub-Saharan Afriaca and South
Asia, the single most important factor that inhibits agricultural growth and limits
farmers income from agriculture is the lack of passable roads to the urban center.
Mellor and Johnston (1984) estimated that this was the major reason why in India the
potential growth of the agricultural sector during 196984 (calculated on the basis of
the available inputs) was 50% higher than the actual growth. By realizing the potential
of their agricultural sector, these countries could increase their food supply and the
Table 1.7. The Share of Agriculture in the Economy of Selected SSA Countries (%)
Country
Ghana
Madagascar
Malawi
Niger
Tanzania
Zaire
Share of agriculture
in GDP
197577
198082
198991
50.7
32.3
39.5
35.1
56.1
27.3
Source: World Tables, World Bank, various years
56.8
32.3
36.9
30.8
53.4
29.0
47.7
36.5
34.4
37.0
55.7
34.8
Share of agriculture in
employment
198087
65
81
83
91
80
72
65
earnings of the rural population. That, however, would require massive investments in
irrigation, roads, and extension services. In addition, the adoption of high yield crop
varieties and the use of fertilizers would have to be increased, and access to rural credit
would have to be improved.
Despite their potential, most developing countries refrained from building on their
traditional strength in agriculture, citing a long list of reasons for their strategy to
promote industrialization, the most common one being the following:
< The demand for primary products is both price- and income-inelastic, and
therefore cannot be a reliable base for export-led growth or a stable source of
foreign exchange.
< Export earnings from primary products are subject to wide fluctuations.
< The traditional sector is often backward and unresponsive to economic
incentives.
< Agricultural exports from developing countries are depressed by the high
protection rates on agricultural products in most developed countries, particularly
in the EU (Bautista and Valdez 1993).
On these grounds, many developing countries implemented policies that were highly
biased against the agricultural sector, including:
< overvalued exchange rates and/or direct export levies that reduced real returns on
agricultural exports;
< high protection rates on import-competing manufacturing goods that lowered the
relative price of agricultural goods in the domestic market;
< ill-functioning state marketing boards that used their monopoly power to raise the
margins between the border price of exports and the farm-gate price and lowered
the returns to farmers;
< suppressed prices of food produce paid to farmers in order to secure low prices to
urban consumers.
These policies, implemented as part of the industrialization process, inhibited the
development of the agricultural sector and trapped the entire economy in low
productivity and low growth (Krugman 1991; Lucas 1988). They also reflect the
political bias in favor of the politically and economically more influential urban
population. To capitalize on their potential for agricultural growth, countries in
sub-Saharan Africa, where a large portion of agricultural production is based on slash
and burn or shifting cultivation, will have to encourage the transition to settled
cultivation and to invest in rural infrastructure in order to increase agricultural
production and employment. In South Asian countries, where the rural areas are
already densely populated, agricultural development will have to be based on
high-value products and highly intensive cultivation. To exploit the countries
comparative advantage, the industrialization process will have to be built on two-way
linkages with the traditional sector that allow both agriculture and industry to realize
their growth potential.
The key to future agricultural growth, however, lies in significant increases in
yields. After an increase of 3% in yields during the Green Revolution in the 1970s, the
66
Chapter 1
rate of increases in yields dropped to 1% in the 1990s. In all the developing countries,
there are still heavy losses of crops to pests, disease, salinity, and drought, but efforts to
compensate for these losses by increasing the area under cultivation may aggravate the
pressure on the environment and natural resources. Small-scale farmers may, however,
not be able to increase production by using modern technologies or more fertilizers and
pesticides due to their high costs. Further increases in yields at affordable costs and
without depleting the countrys nonrenewable resources or damaging the environment, therefore present a daunting challenge to agricultural research. The recent
developments in biotechnology and research in transgenic crops may offer a way to
meet this challenge. Transgenic plants with traits such as pest and herbicide resistance,
and tolerance to salinity and drought, can increase yields and reduce crop losses
without the heavy use of fertilizers and chemicals. To take advantage of this potential,
the challenge of public agricultural research is to develop or adapt suitable plant
varieties and technologies, and to expand and improve their extension services so that
they can bring these new technologies to farmers and encourage their adoption.
The impact of multinational trade agreements on agricultural trade
Another obstacle to the development of the agricultural sector in developing countries
is posed by the constraints on the access to the markets of the developed countries,
primarily the EU and the US. These constraints are due, in part, to the various tariffs
these countries impose on imports of agricultural products and the subsidies they give
to their own agricultural producers, and, in part, to the myriad regulations and
administrative restrictions. The agricultural chapter is high on the agenda of the
WTO since Seattle, but despite the general agreement on the need to open up the
markets of the developed countries to agricultural products from the developing
countries, actual progress has been very slow.
The GATT agreement that was signed initially by 23 mostly developed countries
was a provisional agreement without any institutional setup. At the time, it was
envisaged that the next step would be the establishment of an international trade
organization, but the World Trade Organization was founded only in 1995, 47 years
later. Until that time, GATT was expanded in both scope and global coverage, and a
series of interim agreements brought about a reduction of tariffs and other barriers to
trade, contributed to a vast expansion of international trade, and precipitated the
globalization process. The GATT rules applied, however, primarily to merchandise
trade, and in the Uruguay Round in 1992, the need to expand the agreement to
agricultural products became apparent. The WTO provided a framework of rules for
the conduct of world trade in goods and services, but nearly a decade after the Uruguay
Round, it does not yet include an agreement on agricultural trade.
The agreements on a wide variety of trade issues and the establishment of the WTO
represent the widening recognition that open tradelargely free of government
intervention and based on legally binding rulesis to the benefit of all nations and
helps to secure global growth. The liberalization of trade met with opposition from
various interest groups within countries that stood to lose, at least in the short run, from
more liberalized trade. The legal obligations that bind member countries when they
67
join the WTO were designed, in part, to help reduce these pressures by presenting the
wider benefits. An important principle governing the WTO is the nondiscriminatory
treatment of all member countries; the legal term for that principle is the most favored
nation (MFN) treatment. The GATT agreement states that any advantage, favor,
privilege, or immunity granted by one WTO member to another has to be granted
immediately and unconditionally to all other members. Another important principle is
the need to establish a consensus as the basis for any resolution. Decision-making by
consensus is bound to be slow and tedious in an organization of more than 140
members, but it was hoped that this would reduce conflict and secure wide acceptance
of the rules. A third important principle of the WTO is the stability, transparency, and
predictability of trading conditions, and this has been achieved by establishing upper
bounds on tariff levels and a schedule of tariff concessions, and by determining the
conditions of market access for services.
Agriculture was the most contentious area in the negotiations and, as of 2002, very
little progress has been made. The main reason was the impasse between the EU and
the US that also delayed the conclusion of the entire Uruguay Round by four years and
contributed to the failure of the 1999 Seattle meeting. Although agriculture was finally
incorporated into the GATT in 1994, the more difficult negotiations were delayed to
early 2000, but then these negotiations broke down and were delayed again.
Nevertheless, a major achievement of the 1994 agreement was the conversion of all the
nontariff barriers to tradequantitative restrictions, import bans, etc.into tariffs.
The Uruguay Round Agreement on Agriculture took the first step to subject
agricultural trade to the same rules that apply to merchandise trade, and to
progressively reduce interventionist policies. The agreement stipulated the elimination
of all quantitative and other nontariff restrictions, converting them into explicit tariffs,
and it determined bounds on and a gradual reduction of domestic support and export
subsidies for agriculture. Complete import bans on specific agricultural products were
also replaced by tariffs, though these tariffs were initially set at a sufficiently high level
so that they effectively prevented any imports of these products. Import quotas were
replaced by equivalent tariffs (tariff rate quota or TRQ) that established the same
restrictions. These tariffs brought agriculture into conformity with other trade areas,
provided a more transparent regime and facilitated any liberalization agreements in the
future through a gradual reduction of these tariffs over time. The Uruguay Round
Agreement stipulated that the developed countries had to lower the aggregate tariffs by
36% over a six-year period, and the developing countries had to lower the tariffs by
24% over a 10-year period.
In addition, the agreement imposed limits on production and export subsidies for
agricultural products by requiring that the budgetary outlays on export subsidies, the
overall volume of the subsidized exports, and the domestic subsidies be gradually
reduced by predetermined ratesin the developed countries over six years and in the
developing countries over 10 years. The LDCs (with a GNP per capita below $1000)
were not subject to these restrictions. The agreement to restrict export subsidies was a
major achievement of the Uruguay Round Agreement, since it came against the
background of the trade war in agricultural products between the US and the EU in the
1980s, when their prices faltered and the price support programs in both the US and the
68
Chapter 1
EU generated large commodity surpluses. Both the EU and the US provided massive
export subsidies to sell these surpluses in third markets. With these sales, they inflicted
considerable damage to agricultural export earnings and farmers incomes in many
developing countries.
With all the exemptions and concessions, however, the main accomplishment of
the Uruguay Round Agreement with respect to agriculture was primarily symbolic and
only little immediate progress was made. Nevertheless, the changes in the ground rules
in the Agreement paved the way to more substantive achievements. In particular, the
agreements on TBT and SPS measures permit governments to use technical
regulations, standards, and sanitary measures for health and safety reasonsprovided
they are transparentwhile the SPS measures have to be scientifically justified and
not create unnecessary obstacles to trade. These new rules and agreements reduced the
likelihood of a renewed trade war of the type that was waged between the US and the
EU in the 1980s (as the peaceful resolution of the 2001 banana war illustrates), but it
left in place many of the policies and practices that are damaging to agricultural
producers and exporters in the developing countries.
The failure in Seattle to negotiate a new trade agreement on agricultural and textile
goods delayed the removal of the walls of high tariffs that agricultural exporters from
the LDCs are facing for some of their key products. A recent World Bank study
(Hoekman, Ng, Olarreaga 2000) estimates that reducing the tariffs on imports of these
products from the LDCs will raise exports of the affected products by 3060%; an
agreement in the next round of trade negotiations can therefore make a significant
contribution to enable LDCs to increase their exports.
The promise and challenge of new technologies
In the second half of the 1990s, many developing countries benefited from large gains
in productivity due to major technological improvements. Information and
communication technology (ICT) and the Internet were key to these productivity
gains, but many other technologies also offered innovations that contributed to
increasing the productivity. In the developed countries, the huge investments in R&D
that were required for these technological advancements were provided by the private
sector. In the developing countries, most of these investmentsparticularly in
education, training, and R&Dmust be made by the public sector. While the need to
invest heavily in the physical and human infrastructure presents obstacles to the
adoption of many new technologies by poor countries, there are some major
technologies that offer significant improvements without requiring large investments.
An obvious example is ICT, particularly the Internet and the mobile phone. By giving
even the less affluent individuals and entrepreneurs access to a huge amount of
information and expert advice, these technologies have a leveling capacity, and they
help reduce the barriers to competition along the supply chain. The Internet and the
World Wide Web are not just symbols of globalization, as Thomas Friedman
suggested in his book The Lexus and the Olive Tree. They are also among the main
factors that made the process of globalization possible and profitable.
69
Yet, whether the benefits from the new technologies will trickle down to all
segments of society, or whether the primary beneficiaries will be the more educated
and more affluent, remains open to question. In India, the main beneficiaries of the
rapid growth brought about in recent years by ICT have been the professional workers.
The majority of the Indian population, which lacks basic education and training, has
benefited very little from the new economy, and spillovers to other sectors have been
minimal. Moreover, the penetration of ICT into poor countries and poor regions has
been very slow. The Organization for Economic Co-operation and Development
(OECD) estimates that 95.6% of the worlds Internet hosts in 2000 were located in its
member countries. On these grounds, UNDPs 1999 Human Development Report
warns that
[t]hose with income and literallyconnections have cheap and instantaneous
access to information. The rest are left with uncertain, slow and costly access.
When people in these new worlds live and compete side by side, the advantage of
being connected will overpower the marginal and impoverished, cutting off their
voices and concerns from the global conversation (UNDP 1999).
The gap between the rich and the poor thus threatens to widen the knowledge gap, and
the widening gap between the knows and know-nots will further deepen the
income and wealth gap.
While the breathtaking pace of technological innovation in recent years,
particularly in ICT, may indeed threaten to increase the gap between the rich and the
poor, there is also a promising potential that technological innovation will make it
easier to fill the gap. An instructive example is the fate of the public telephone services.
In most developing countries, particularly in sub-Saharan Africa, telephone service is
dismal, due to the poor state of the local infrastructure, the inefficiency of the mostly
public telephone companies, and the very high prices, which are primarily due to the
monopolistic power of these companies. Privatization of public telephone companies
is therefore high on the agenda of most economic reforms. However, the process of
privatizing these companies is quite complex and has proceeded rather slowly even in
many of the more developed countries. In developing countries, the monopolistic
public telephone company is often replaced by a monopolistic private company that
increases profits by extorting its captive customers rather than reducing costs and
increasing efficiency. In recent years, however, with the spread of the new mobile
phone technology, customers found an effective way of bypassing the existing services
and overcoming the constraints imposed by the poor infrastructure. By doing away
with the requirement of setting up a cumbersome physical infrastructure, the new
technology facilitates the entry of new providers that compete by improving efficiency
and reducing prices. Similarly, with this technology, access to the Internet no longer
depends on an expensive desktop computer connected to a telephone line, thus making
it cheaper and easier to get connected. While technological innovation created the
gap between those with connections and those without, it is also creating
possibilities for developing countries to leapfrog outdated technologies.
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Chapter 1
Concluding Remarks
Development strategy has two central components. The first determines the policy
guidelines for the countrys economic development: the balance between industry and
agriculture, between rural and urban development, between exports and import
substitution, etc. The second defines the role of the public sector in the implementation
of this strategy. The large differences between the experience of the East Asian
countries and most countries in sub-Saharan Africa and South Asia during the past two
decades should therefore be explained not only by the differences in the policies that
these countries implemented, but also, and perhaps much more so, by the differences
in the role and effectiveness of their public sector, i.e., their public institutions and their
systems of governance, law, and order, in the implementation of these policies. A brief
comparison of the development strategies of these two groups of countries can offer a
number of instructive lessons.
In the 1960s, the standards of living in Africa were, on average, considerably
higher than in the Far East, and the growth prospects of most African countries seemed
to be much brighter. The picture changed dramatically in the 1980s, as an increasing
number of East Asian countries embarked on an export-oriented, industry-led course
of development that ushered in a period of rapid growth and a remarkable reduction in
poverty. Sub-Saharan Africa and many countries in Latin America and the Caribbean
and South Asia entered into a deep debt crisis and saw their growth rates and growth
prospects plummeting. These sharply diverging experiences raise several questions:
< What lessons can be drawn from these experiences with respect to the structure of
and the balance between industrial, agricultural and trade policies in a developing
country?
< What economic, social, institutional, and political conditions made the Asian
miracle,and the subsequent Asian crisis, possible, and what lessons can their
experience offer for the design of growth strategies in the countries of sub-Saharan
Africa?
< What lessons can, for example, Bangladesh or Ghana draw from the experience of
Thailand, Malaysia, and Uganda, as they design their development and trade
strategies and structure their institutions of governance?
< What lessons can be drawn from the large differences in the pace of development
between these groups of countries with respect to the rather generic policy
prescriptions of the form liberalize thy trade, deregulate, privatize and set thy
prices right that were advocated by the World Bank and the IMF (and became
known as the Washington Consensus)?
The successful experience of the East Asian countries during most of the 1980s and
1990s underscores the merits of an outward looking development strategy and greater
integration with the world economy. Indeed, this lesson remains valid despite the
Asian crisis of 199798 and despite some periodic setbacks to the process of
globalization. The key to the rapid industrialization and the swift rises in income and
employment in East Asia were the effective use of the large supply of a cheap but
disciplined labor force for the development of an internationally competitive and
71
export-oriented industrial base. The outward-oriented development of these countries

avoided the constraints that an inward-looking, import-substitution industrialization
encountered in many other countries due to the limited size of their local markets. The
export-led growth of the East Asian countries contributed to accelerating their growth
also by attracting foreign investments and advanced technologies. The adoption of
labor-intensive industries and technologies at their early stage of development enabled
these countries to absorb rather rapidly the waves of migrants from rural areas and
thereby raised employment and income in both rural and urban areas. In contrast, many
of the countries that relied more heavily on inward-looking industrialization led by
capital-intensive manufacturing were much more constrained by the limited size of
their market that restricted, in turn, their capacity to absorb surplus labor and reduce
unemployment.
Despite the wide validity of these lessons, the diverging experiences of these
countries also suggest caution in translating them into commandments and applying
them too schematically in other countries. An equally important lesson is that a
development strategy cannot be formulated as a menu of rules and policy
recommendations that can be applied with relatively minor modifications to most
countries. Indeed, the menu of policies that became known as the Washington
Consensus achieved highly inconsistent results mainly because these policies did not
take adequately into account the importance of each countrys unique social, cultural,
and political conditions, the constraints imposed by the countrys past on its present
course of development, and the impact of these conditions and constraints on the
countrys capacity to build up the institutions and the system of governance and law
necessary for an effective implementation of these policies. Instead, the underlying
logic of these policies appears to have been their apparent technical and thus also, it
seems, a-political nature (remove this tariff, cut that subsidy), and the apparent
assumption that these policies, by being so highly beneficial for the vast majority of the
population, would enable the government to easily mobilize the wide public support
and the political coalition necessary to guarantee their successful implementation.
However, this logic seems to ignore the social and economic quake that each
policy reform unavoidably triggers by shattering the existing balance between sectors,
regions, and social groups. Policy reforms that involve a change in import tariffs or
export subsidies inadvertently affect a large number of consumers and producers.
Eeven if, in the long run, most of them will benefit from the more rapid economic
growth thanks to the greater efficiency in production and in the allocation of resources,
in the short run, some people and sectors will gain, while others will lose. Those who
lose are likely to coalesce in order to demand different policy reforms or at least
compensations that will minimize their losses; those who gain may coalesce to oppose
any policy reversal (see also Alesina et al. 1999). These conflicts prolong the transition
period and make the implementation of the reforms far more difficult and
controversial. Although the initial step in the reform may look technical, the
subsequent steps are likely to be highly political. Strong institutions of governance are
therefore necessary throughout this process to ensure that the reform will remain on
course and that the promised Pareto improvement, when progress takes place and
economic growth is accelerated, will indeed materialize.
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Chapter 1
These conflicts and their impact on the economy may not be captured, however, in
the standard analysis that focuses on technical indicators. A symptomatic illustration is
provided by Esterly (2001) in his discussion of an apparent puzzle: During 198098,
the growth of median per capita income in developing countries was 0.0%, compared
with 2.5% in 196079, even though variables that are standard in growth regressions
(policies like financial depth and real overvaluation, and initial conditions like health,
education, fertility, and infrastructure) generally improved during these years, and
theory suggests that, therefore, these countries growth should have increased. In most
of sub-Saharan Africa and South Asia, the puzzle is even more perplexing because
their median per capita income actually declined rather sharply during these years,
even though, in the majority of these countries, the variables that represent the
determinants of growth in the standard growth regression generally improved. Esterly
commented that this stagnation represented a disappointing outcome of the standard
menu of policy reforms of the Washington Consensus. In fact, the puzzle was
created by the analysts themselves as they focused exclusively on technical variables
in the standard growth equation. These variables fail to take into account other
dimensions of the growth process, particularly the rather dramatic changes in the social
and political setting that occurred in the majority of the African countries during the
past two decades. These changes had a very strong impact on the explanatory power of
the technical variables, and if they are not taken account, a puzzle is likely to emerge.
Even more important, these changes in the social and political conditions affect not
only the retroactive explanatory power of these variables, but also the power of
economic reforms that focus on the more technical rules of the economic policies that
these variables determine to generate growth. A failure to take into account the
changes in the social and political conditions and in the institutional setting in the
country may doom the reforms themselves to fail.
Consider, as an illustration, the reasons for the mixed performance of privatization,
one of the principal policy reforms that were aimed at improving the notoriously
malfunctioning public services. Among these public services, the public marketing
boards are at the top of the list in most developing countries. Their dismal
performance, particularly in the African countries, and the widespread corruption that
cripples their operation make their total elimination via privatization the only logical
solution. Privatization is expected to usher in healthy competition between the newly
privatized enterprises, and this competition, in turn, is expected to become the driving
force for the elimination of the distortions that were introduced by the heavily
regulated public agencies. In practice, however, the transition from a marketing system
based on public marketing boards to a system based on private trading companies was
by no means beneficial to all producers and consumers. In many countries, the
privatized marketing boards were essentially taken over by trading companies that
established their monopolistic power either in the country at large or in the local
market, often with a little help from the retired managers of the existing public board,
from other government officials, or from family members of the president. These
monopolistic private enterprises often created much larger distortions to the
disadvantage of larger segments of the population, particularly the politically and
economically weak. With few constraints on their monopolistic power, these trading
73
companies were under no pressure to improve their service or reduce prices to their
customers. In developed countries, these distortions are reduced to a minimum, thanks
to the watchful eye of various public legal institutions charged with preventing such
abuses. In most developing countries, these institutions are too weak or nonexistent,
and the supervision over private companies is either highly inefficient or entirely
lacking.
Consider, for example, the potential obstacles that may hinder the process of trade
liberalization, another example of a policy reform that developing countries are often
pressured to implement. The existing tariffs and/or subsidies are clearly damaging to
the country as they distort its resource allocation and reduce economic efficiency. Prior
to the reforms, producers, consumers, and traders have to organize their entire
operations on the basis of the distorted prices. The trade liberalization reforms then
force them to make considerable changes, particularly in their production system, and
these changes may also require large investments that are bound to prolong the
transition period. During the transition period, some producers and traders will suffer
losses due to the decline in the relative price of their products, while others will gain as
the relative price of their products is rising. Even though most people will be better off
in the long run, those who suffer losses during the transition period are likely to oppose
liberalization, while those who gain already in the short run are likely to have
higher-than-normal profits until all producers and traders make the necessary
adjustments. The losses of one group of producers and traders as an effect of the
reforms, and the higher-than-normal profits of the other group are bound to sharpen the
discord and possibly lead to an open conflict that can embroil all the countrys social
and political institutions.
The possibility of such a conflict inadvertently introduces social and political
dimensions to the process of implementing the reforms, no matter how technical or
a-political the reforms may appear at the outset. The possibility that the reforms will
produce rival coalitions or deepen already simmering conflicts between social or
ethnic groups must be taken into account in advance, i.e., the reforms have to be
designed with full consideration of the specific social, economic, and political
conditions in the country and with the participation of the potentially affected groups.
Trade liberalization reforms may then have to be accompanied by targeted measures
aimed at assisting those producers who may be outcompeted by a wave of cheap
imports of the products they produce. This can be achieved by offering assistance for
their transition to new products or to other sectors. Obvious examples for the failure to
avoid unintended consequences can be found in the situation resulting from the
measures that many countries implemented in order to reduce trade barriers on
agricultural products when they joined the WTO. The flood of cheap imports of maize,
wheat, and other field crops from developed countries forced many small farmers in
developing countries either to retreat into production for their own consumption or to
abandon agriculture altogether, because their own resourcesfinancial and
otherwisedid not enable them to make the transition to other crops and a different
farming system quickly enough. Indeed, many of these farmers joined the ranks of
those who oppose globalization.
74
Chapter 1
To smooth the transition and reduce the intensity of potential conflicts, it may also
be necessary to put in place a proper legal system and establish or strengthen the
institutions that can prevent one group or sector from taking undue advantage of the
distorted prices that are likely to emerge during the transition period. In some cases, it
may also be necessary to provide some form of compensation to those who may
become worse off as an initial result of the reforms. However, the provision of
measures and mechanisms to ease the transition period takes time, and when the
institutions that are supposed to provide them do not even exist, the preparatory
process is likely to be even longer. Without careful preparation, however, the conflicts
and inequities that may emerge during the transition period can pose a risk not only to
the success of the reforms, but also to the countrys entire social infrastructure. This is
why a countrys institutional and legal systems and its specific social, economic and
political conditions are critical to the success of trade liberalization. Even when the
need for reform and the gains that it promises in the long run are obvious, the
seemingly technical reforms will still have to be implemented in a specific context, and
this is why the Letters of Agreement of different countries cannot be mere
duplicates.
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Chapter 1

The Pros and Cons of Globalization for

* David Bigman: International Service for National Agricultural Research

The Pros and Cons of Globalization for Developing Countries

development. Others emphasized unequivocally that Decades of external influences

The Pros and Cons of Globalization for Developing Countries

Globalization and Economic Growth: Theory and

The Pros and Cons of Globalization for Developing Countries

The Pros and Cons of Globalization for Developing Countries

developing countries, the reforms were too narrowly focused on macroeconomic

The Pros and Cons of Globalization for Developing Countries

Table 1.1. Demographic Characteristics of Selected Developing Countries: 197395

Share of urban population

Source: World Bank, various tables

Table 1.2. Growth of GDP Per Capita in Selected Countries: 196097

Average annual change (%)

GDP per capita in US$ in 1985 prices.

The Pros and Cons of Globalization for Developing Countries

* Including the CIS countries

GDP per capita (in USD$)

Annual growth rate

The Pros and Cons of Globalization for Developing Countries

The Pros and Cons of Globalization for Developing Countries

Table 1.4. Measures of Inter-Country Income Inequality 196098

Change: 196098 (%)

The Pros and Cons of Globalization for Developing Countries

Table 1.5. Trends in World Poverty during the 1990s

Source: World Development Report 2000.

International Trade and Trade Policies in Developing Countries

employed Heckscher-Ohlin model that separates consumption and production, and

The Pros and Cons of Globalization for Developing Countries

The Pros and Cons of Globalization for Developing Countries

The Pros and Cons of Globalization for Developing Countries

Low environmental standards. Against the high and rising standards of

On these grounds, producers in importing countries that maintain high environmental

Box 1.1. Foreign Direct Investment (FDI)

The Pros and Cons of Globalization for Developing Countries

semi-industrial economies that adopted import-substitution policies was only a few

Box 1.2. The Least Developed Countries

The Pros and Cons of Globalization for Developing Countries

pressures. Government coordination in the form of administrative guidelines as well as

The Pros and Cons of Globalization for Developing Countries

The Pros and Cons of Globalization for Developing Countries

strong and authoritarian governments, assisted by an obedient and highly efficient

The Pros and Cons of Globalization for Developing Countries

Globalization and Strategies of Sectoral Development

196170 197184 196170 197184 196170 197184 196170 197184

Source: World Bank (1986)

The Pros and Cons of Globalization for Developing Countries

Source: World Tables, World Bank, various years

The Pros and Cons of Globalization for Developing Countries

The Pros and Cons of Globalization for Developing Countries

The Pros and Cons of Globalization for Developing Countries

The Pros and Cons of Globalization for Developing Countries

export-oriented industrial base. The outward-oriented development of these countries

The Pros and Cons of Globalization for Developing Countries

The Pros and Cons of Globalization for Developing Countries

The Pros and Cons of Globalization for Developing Countries

The Pros and Cons of Globalization for Developing Countries

World Bank. 1995. A Continent in Transition: Sub-Saharan Africa in the Mid-1990s.

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