23 04 2024

To catch up with the developed countries, developing countries need to use common sense, not neoliberal recipes

Indonesia is trying to give a push to industrialisation by banning exports and requiring domestic processing of certain raw materials, starting with nickel. France, Germany, Italy, Canada, Japan, the United Kingdom, and the US complained to the World Trade Organisation, WTO, which ruled against Indonesia, but it has appealed the decision to the WTO Appellate Body. This body is presently non-functional as the election of judges has been blocked by the US (first Trump, then Biden). Indonesia now plans to ban exports of other raw materials such as tin, bauxite, and copper. https://thediplomat.com/2023/05/how-indonesias-president-joko-widodo-rejuvenated-dependency-theory/ Photo is of the Grasberg Copper and Gold mine in Indonesia. Indonesia is trying to give a push to industrialisation by banning exports and requiring domestic processing of certain raw materials, starting with nickel. France, Germany, Italy, Canada, Japan, the United Kingdom, and the US complained to the World Trade Organisation, WTO, which ruled against Indonesia, but it has appealed the decision to the WTO Appellate Body. This body is presently non-functional as the election of judges has been blocked by the US (first Trump, then Biden). Indonesia now plans to ban exports of other raw materials such as tin, bauxite, and copper. https://thediplomat.com/2023/05/how-indonesias-president-joko-widodo-rejuvenated-dependency-theory/ Photo is of the Grasberg Copper and Gold mine in Indonesia. Photo by Alfindra Primaldhi. https://commons.wikimedia.org/wiki/Category:Grasberg_Mine#/media/File:Grasberg_mine.jpg

When developing countries try to catch up with the developed countries, there are many challenges. Will they be allowed to protect the new industries, they are trying to set up? Can they get funding for the huge investments needed? Can they get their economic policy right? It is not easy, but history tells us that it is not impossible.

As is often the case, economic theory comes after economic policy practice, not the other way around. Developmentalism was to a high degree a result of the 1930 depression and the break-down of international trade, inducing countries to find ways to produce themselves the things they needed but couldn’t import any more (called import-substitution). This was the case both for many developing countries and also European countries and gave rise to a broader industrial development. This was simply driven by pragmatism and common sense, which also guided most of the East-Asian developmentalist states after World War 2. The same is the case for many other more recent initiatives in developing countries, often related to promoting increased value added to natural resource based exports (producing iron and steel products for home market and exports instead of just exporting iron ore, refining oil instead of exporting raw oil, producing plastics and fertilizers from fossil fuels, and so on). There is no generally accepted grand economic theory behind this (but a lot of neoclassical economic theory explaining, against all evidence, why it is a bad idea).

As we are talking about developing countries, there is a catch-up opportunity. Taking into account that these countries are poorer than the developed ones, it means by definition that their productivity is lower (as people generally don’t work less). There are two main reasons for this lower productivity: (i) in similar industries, the capital invested per worker is lower (less mechanised production) and the work force has less education and training, and (ii) the poorer countries are concentrated on low value products (think raw materials, unprocessed agricultural products, garments and so on), while the richer countries are concentrated on the production of higher value products, including productive services (think aircraft, machine tools, software, design of computer chips, and so on). So there are two elements in catching-up, and both require heavy investments: (i) increasing the productive capital per worker (mechanisation, updated machinery and so on), including education and training of workers to be able to manage more advanced processes, and (ii) shifting the industry structure to higher value products, investing in acquiring the needed knowledge and equipment. The reason that this is considered an opportunity is that "late-comers" have the opportunity to learn technology, they don’t have to invent it (or they can copy products and processes to the degree that the increasingly excessive Intellectual Property protections don’t prevent it). This is why some developing countries can have growth rates of 5-10 % annually for a prolonged period, as they are shifting people from low to high productivity sectors, something that is not an option for developed countries where most of this shift has already taken place. For this opportunity to be realised, the policy has to be right and the capital for investment has to be available at a reasonable cost. Sounds simple, but it isn’t. It is actually quite complicated.

It is estimated that around 60 percent of the world’s population works in the informal sector. It is often (but not always) low productive work which produces low incomes. Developing countries have a possibility for a prolonged period of high growth if part of this population can be moved to higher productivity work, for example industry. Photo: Fruit sellers at Avenida del Imán, Mexico City. Wikimedia Commons.

Most of the countries that have succeeded in catching up have recurred to what is called a Developmentalist State, which is understood here as a state taking the lead in planning the future development of a country, including creating and developing industries considered to be essential for the country’s future and ability to compete in the world market in higher value products. We looked at the political conditions in a former article. In this one we shall look at the content of the economic and industrial polity. There is no blue print for the design of economic and industrial policy, as it is highly dependent on local conditions, but some lessons can be drawn from history.

1. Developmental States normally elaborate development plans, often a 5-year plan with a longer term indicative plan, which includes prioritisation of sectors and goals for investment, production, infrastructure development and so on. Often a planning commission is established with a high degree of power, not only related to public investment decisions but also with power over private sector investments through investment and production permissions and subsidies and/or tax exemptions for priority investments. Sometimes sector consultative commissions are formed with participation of sector stakeholders and sometimes the Government is actively promoting mergers between existing private companies to reach the necessary scale.

2. Heavy investment is made in education, from primary to tertiary education, and in research and development, both through public research institutions and by subsidising companies investing in priority sectors, according to the national development plans.

3. The way of funding investments differs from country to country. In Asian countries, the population’s savings are generally high and there are different ways of channelling these savings into investments according to the development plans. In South Korea, the Government nationalised the private banks and took direct control of lending, while in Japan the control was partly direct through control of lending from the State Development Bank, partly indirect through control of private banks. The Cold War was also a factor as these countries were close US allies, and hence loans from the US and US-controlled institutions (IMF and Asian Development Bank) were readily available. In countries with a low level of savings, funding can become an insurmountable obstacle as relying on foreign funding can lead to expensive, unsustainable debt.

Bolivia hopes to be able to produce most of the iron and steel products it needs from its Mutún Iron Mining and Processing Project, located in Santa Cruz province. It was first concessioned to Jindahl Steel from India, but after several years of slow or no progress, the Bolivian Government rescinded the contract and decided to go it alone with a State Owned enterprise. It was funded with 546 million US Dollar from the Central Bank reserves and should start operating from September 2024. It is planned to produce 200,000 tons iron products annually and repay the investment in 5 years. Photo is from the daily ‘La Razón’.

4. Both Japan, South Korea and Taiwan were very restrictive regarding foreign direct investments, as they distrusted foreign companies. China, on the other hand, has been much more permissive, perhaps because it is so big that it feels that it can control the risk, while Brazil has mainly relied on foreign direct investment. This means that the Asian countries have preferred technology transfer through licensing, or, in the case of China, by forcing the foreign investors into partnership with local firms, often state-owned companies, while the technology transfer in the case of Brazil has been limited as an important part of the investments has been carried out by foreign companies so the technological knowledge stayed with these (which many consider is the reason for the limited results in Brazil).

5. Should the development be planned based mainly on exports, or mainly on supply to the domestic market? This has been an eternal debate, as one of the reasons for the limited results of developmentalism in Latin America has been identified as its excessive focus on the home market, often with foreign companies assembling or producing products locally. As traditional exports suffered during the seventies and eighties due to falling prices, the result was big trade deficits, a spiralling foreign debt and a currency crisis, ending in IMF bailouts, conditioned on a policy shift to neoliberalism. This is contrasted with the export oriented industrial policies of the Asian countries, which also were favoured by their status as US allies during the Cold War (including China).1 My take on this is that the domestic market should be taken as point of departure, particularly for lower income developing countries, ensuring supply to the home market of basic consumer goods (first of all food and processed food products) and some investment goods (cement, other construction materials and the like), but that the strategy should also support exports, and in particular export diversification, improvement of quality and an increase in the value added of traditional exports. Without exports there will not be sufficient capacity for imports to avoid a balance-of-payment crisis. The economic policy should secure a competitive exchange rate to facilitate exports.

Some have argued that a Developmentalist State is impossible today, as there in our globalised world is no place for policies that imply protection and subsidies for local production.

One factor is the World Trade Organisation (WTO), which does not permit protection of domestic industries (even if there is in WTO an “enabling clause”, which gives developing countries special rights). However, it is possible that WTO in practice is not an obstacle, taking into account the flouting of WTO rules by the US and its allies in their trade war against China and in their sanctions against Iran, Russia, Venezuela and so on, and the fact that the WTO dispute settlement system is not working, since former US President Trump blocked the appointment of judges (a policy continued by the present President Biden).

Another factor is the control that US has over the international financial institutions as IMF, the World Bank and the Regional Development Banks, which will make it difficult for developing countries to get access to loans, if they drop the neoliberal policies imposed by these institutions. On the other hand, the increasing economic weight of non-Western countries, first and foremost China, but also India and Russia, and the establishment of alternative funding mechanisms as the Eurasian Development Bank, the BRICS New Development Bank, and, of course, the substantial lending from Chinese banks to developing countries, the leverage of these US-led financial institutions is diminishing. If they put up too many political conditions, they will be out of business.

So my conclusion is that with the development towards a multipolar world, some sort of developmentalist economic policy is not only possible, but also likely in many developing countries.

Then some would say: yes, but what about Climate Change? Is it not bad that the developing countries are catching up with the unsustainable way of life of the developed countries? I think it is preposterous to say that the developing countries should stay poor, just because the developed countries have filled the atmosphere with carbon dioxide. They should not be forced to pay the bill for the developed countries’ historic (and present) sins. It is in principle possible for the developing countries to catch up without copying the worst practices of the developed countries, as they can build from scratch, for example by investing in cheap renewable energy, electrification of transport, cleaner processes and so on. A bit of free green technology transfer and low-interest funding from the developed countries would be helpful.

Despite all the talk on Green Economy, the developed countries continue to emit much more CO2 per capita (based on their consumption, which includes imported emissions) than the developing countries (except for Saudi Arabia, Oman and UAE). The leader is the US, followed closely by Canada, Australia, Belgium and Switzerland. This perhaps helps to understand why developing countries, while happy to implement green technologies, don’t think they should abstain from economic development to save the planet. Source: https://ourworldindata.org/grapher/consumption-co2-per-capita

A more serious question is that some developing countries seem to have lost their soul on their road to catching up, as witnessed by for example the extremely low fertility rate in most of East Asia (in South Korea and Singapore now below one, which means that each new generation is less than half the size of the preceding), and the high suicide rate in South Korea (the fourth highest in the world), both at least partly related to excessively competitive societies.

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 Notes:

1. At that time, my opinion was that China could not possibly follow the export oriented path of South Korea, Hong Kong and Taiwan because of the size of the country, as the world market would not be able to absorb all that production. I was obviously wrong. However, the impact of this excessive export orientation on the developed countries has been huge, forcing through painful processes of deindustrialisation. China’s exports as percentage of GDP topped in 2006 at 36% and was in 2022 down to 20% (for comparison, in 2022 the figures were: South Korea: 48%, Russia: 28%, European Union: 25%, India: 23%, and USA: 12%). As the huge trade surplus with the rest of the world has been reduced and the Balance of Payments surplus is now close to zero (1.5% of GDP in 2022), China is obviously in a process of reducing its excessive dependence on exports in favour of its home market. It was about time.

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This is the third article on developmentalism.

 To read the first and second articles, click on the links below:

1. It is time to dust off some old ideas about economic development.

2. The developmentalist state and crony-capitalism

In later articles we shall look into some of the other hurdles developing countries are confronting, courtesy of the developed countries, among these brain drain, capital flight and excessive intellectual property protection

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Thorbjorn Waagstein

Thorbjørn Waagstein, Economist, PhD, since 1999 working as international Development Consultant in Latin America, Africa and Asia.

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