Monday, October 28, 2013

How do developing countries catch up?

'Convergence' is a term that students of economics are familiar with. For several reasons, developing countries are poised to catch up with higher income countries over time, although this could be a long time. How to expedite this is an important policy issue. The conventional wisdom is that you allow markets to function freely and do the trick- produce high growth. Remove the dead hand of the state and- hey presto!- growth materialises. Most "reformers" would ascribe the high growth in India since the 1990s to precisely such a thing having happened.

Alas for them, the reality is rather different. Economist Deepak Nayyar has an article in the Hindu in which he points out that rapid growth flowed from meaningful state intervention rather than state retreat. (He has a book coming out on this theme):
Thus, industrialisation was not so much about getting-prices-right as it was about getting-state-intervention-right. Indeed, it is plausible to suggest that, for a time it might even have been about getting-prices-wrong. It may be argued that state intervention in the form of industrial policy should recognise and exploit potential comparative advantage, but it is just as plausible to argue that instead of climbing the ladder step by step it could be rewarding to jump some steps in defiance of what comparative advantage might be at the time. In either case, state intervention is critical.

Apart from an extensive role for governments, the use of borrowed technologies, an intense process of learning, the creation of managerial capabilities in individuals and technological capabilities in firms, and the nurturing of entrepreneurs and firms in different types of enterprises were important factors underlying the catch-up in industrialisation. The creation of initial conditions was followed by a period of learning to industrialise so that outcomes in industrialisation surfaced with a time lag. This accounts for the acceleration in growth of manufacturing output that became visible in the early 1970s.

Clearly, it was not the magic of markets that produced the sudden spurt in industrialisation. It came from the foundations that were laid in the preceding quarter century. In this context, it is important to note that much the same can be said about the now industrialised countries, where industrial protection and state intervention were just as important at earlier stages of their development when they were latecomers to industrialisation.

So, the acceleration since the 1990s didn't come out of thin air, it wasn't conjured up by markets or private sector firms. The foundations had been laid in terms of an industrial base, technological capability, investment in higher education, a growing middle class, etc. Liberalisation helped get the best out of this investment in capability that had been state-driven. It might have happened a little earlier; the License Raj excesses were clearly unwarranted. But this is different from saying that the private sector produced a magical transformation, starting in the 90s.


Anonymous said...

Good post!
Out here in the US a similar role was played by USDA starting early 20th c which made the country an agricultural superpower and created the basis for industrial growth....not to mention the state's role in development of ALL the general purpose technologies - space, IT, etc. People in India are not aware of some basic facts about the US economy - e.g close to 20% of labor force is in Public" sector, mostly education; not a single major airport is in pvt hands etc. etc. So much for free markets!

T T Ram Mohan said...

Anonoymous, Thanks. The role of the state in promoting growth has been well brought out economist Justin Lin in a recently published good; the hidden hand of the state has also been highlighted by Noam Chomsky.


Anonymous said...

Dear Sir,

Point accepted but also we cant not deny the fact that though IIM's and IIT's are present in our country since 1950 or 60 growth came from 1990 when LPG happened and private firms were allowed to flourish and in last two to three years government scared private firms and growth rate has come down to 4% to 5%. So probably the role of private firm is more important than government.

Anonymous said...

Dear Sir

could you please write one blog explaining the recent changes of banking industry and their impact in coming years or how banking industry is going to shape in near future.

Vishal Kale said...

State Intervention is and has been the mainstay of economic growth in the post-colonial world; be it arm-twisting developing countries in Farm Subsidies in bilateral and multilateral talks, or the creation of an uneven playing field in the name of protectionism - even by developed countries. You cant wish it away... examples are a dime a dozen.

As regards growth - or what I call the illusion of growth - since 1990, it was due to having the right set of strategies (yes, government enabled) at the right time: when the world was on the cusp of an unusual economic growth period of easy liquidity, heightened risk-taking in a overall cavalier world investment climate, culminating in the Lehmann tragedy.

The per capita income of the bottom 20% of India's population has not changed (as a percentage share) since 1978. That means, the bottom 20% of our population has not benefited at all from our economic boom. This is also confirmed by consumption patterns: with the consumption by the bottom 20% of the population being static @ between 0 - 1 growth%, in complete variance with the 3% growth registered by the top layers. While in the 1990s, India's Gini Coefficient was 0.32, it has now gone up to 0.38. The top 10% now make 12 time the bottom 10% - as opposed to 6 times in the 1990s.

What growth? I cant see any. That is why I call it the illusion of growth- which is in reality a deadly dangerous set of circumstances: unless everyone can partake in growth, we are creating big trouble for ourselves. Big, big trouble... we are postponing disaster. Dont see it any other way; every socio-economic indicator, every macro-economic indicator is inoy heightening this worry...

T T Ram Mohan said...

Vishal, your points are well taken. Perhaps the lack of inclusiveness is partly the result of growth being left to market forces.

Anonymous, could you take a look at the entries under Indian Banking in my blog?