Collapse of Development Planning 9780814723456

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The Collaps e o f Developmen t Plannin g

THE POLITICAL ECONOMY OF THE AUSTRIAN SCHOO L Serie s

General Editor: Mario Rizzo, New York University

Although lon g associated wit h a deep appreciation o f the free market , th e Austrian Schoo l ha s no t bee n full y recognize d a s a uniqu e approac h i n analyzing th e rol e o f governmen t i n th e economy . A major contributio n of the Austrian Schoo l wa s t o demonstrate, a s early a s 1920 , the impossi bility o f economi c calculatio n unde r socialism . Recen t event s i n th e for mer Sovie t Unio n an d Easter n Europ e hav e dramaticall y illustrate d th e cogency of this argument. In more recent times and in contrast t o conventional stati c analyses , Austria n researc h ha s bee n concerne d wit h th e impact o f governmen t contro l o n entrepreneuria l discovery . T o wha t extent doe s the impact o f such contro l g o beyond th e firm's stati c pricin g decision and reach into the very discovery of new opportunities and henc e the transmissio n o f knowledg e i n society ? Austrian s ar e als o concerne d with th e dynamic s o f stat e intervention—th e degre e t o whic h on e inter vention induce s furthe r intervention s and , conversely , th e degre e t o which one decontrol "necessitates " further step s in the process of deregulation. Finally , th e Austria n Schoo l i s firml y committe d t o th e value freedom o f economics , tha t is , th e separatio n o f th e analysi s o f polic y consequences fro m th e mora l an d politica l value s inheren t i n th e advocacy of particular economi c policies .

The Collaps e o f Development Plannin g Edited b y Peter J. Boettk e

NEW YORK UNIVERSITY PRES S New Yor k and Londo n

NEW YORK UNIVERSITY PRES S New York and Londo n Copyright © 199 4 by New York Universit y All rights reserve d Library of Congress Cataloging-in-Publication Dat a The Collapse of development plannin g / edited by Peter J. Boettke. p. cm . — (The Political economy of the Austrian school ) Includes bibliographical reference s an d index . ISBN 0-8147-1216-9. — ISBN 0-8147-1225-8 (pbk. ) 1. Economic development. 2 . Economic development—Case studies . I. Boettke, Peter J. II . Series. HD75.C645 199 4 338.9—dc20 93-5105 1 CIP New York University Press books are printed o n acid-free paper , an d their binding materials are chosen for strength an d durability . Manufactured i n the United State s of America 10

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This book has been sponsored i n part by the Austrian Economic s Program a t Ne w York University .

Contents

Acknowledgments vi i 1. Introductio n Peter

J. Boettke 1

1. Theor y 1 3 2. Mone y an d Capita l i n Economi c Developmen t ParthJ.Shah 1 5 3. Th e Theor y o f Economi c Developmen t an d th e "European Miracle' ' Ralph Raico 3 7 II. Cas e Studie s o f Planning 5 9 4. Th e Politica l Econom y o f Developmen t i n Communis t China: Chin a an d th e Marke t Jan S. Prybyla 6 1 5. Th e Failur e o f Developmen t Plannin g i n Indi a Shy am J. Kamath 9 0 6. Th e Failur e o f Developmen t Plannin g i n Afric a George B. N. Ayittey 14 6

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vi Content s III. Th e Record on Foreign Aid and Advice 18 3 7. Th e World Bank and th e IMF: Misbegotten Sister s David Osterfeld 18 5 8. Doe s Eastern Europ e Nee d a New (Marshall) Plan ? Steven Horwitz 21 0 IV. Th e Political Econom y o f the Asian Miracle 22 9 9. Industria l Polic y as the Engine of Economic Growth i n South Korea : Myth and Realit y Young Back Choi 23 1 10. Th e Political Econom y of Post-World Wa r II Japanese Development: A Rent-Seeking Perspectiv e Shigeto Naka, Wayne T. Brough, and Kiyokazu Tanaka 25 6 V. Marke t Solution s t o Economic Development 28 7 11. Privatizatio n an d Development : Th e Case of Sri Lank a Manisha H. Perera and Mark Thornton 28 9 12. Financia l Refor m an d Economi c Development : Th e Currency Board Syste m for Eastern Europ e Steve H. Hanke and KurtSchuler 31 0 Contributors 32 7 Index 33 1

Acknowledgments

First, I would lik e t o than k m y colleague s i n th e Austria n Econom ics Progra m a t Ne w Yor k University , Israe l Kirzne r an d Mari o Rizzo, fo r thei r critica l inpu t an d support . Financia l assistanc e from th e Sara h Scaif e Foundatio n fo r genera l suppor t o f th e Aus trian Progra m i s gratefully acknowledged . Second, i n thinkin g abou t developmen t economic s I benefite d greatly fro m m y sta y a t th e Institut e fo r th e Stud y o f Economi c Culture, Bosto n University , an d th e semina r ther e i n whic h I par ticipated. I woul d lik e t o than k Rober t Hefne r an d Pete r Berge r for includin g m e i n th e progra m a t ISEC . Also, I benefited greatl y from m y participatio n i n a Libert y Fun d Conferenc e o n Bankin g and Developmen t organize d b y Lawrenc e H . Whit e an d Georg e Selgin. Third, th e projec t wa s complete d whil e I wa s a 1992-9 3 Na tional Fello w a t th e Hoove r Institutio n o n War , Revolutio n an d Peace a t Stanfor d University . Dr . Thoma s Henriksen , th e directo r of th e Nationa l Fellow s Program , an d Ms . Wend y Minkin , th e administrator o f th e program , creat e a wonderfu l environmen t i n which th e fellow s ca n wor k an d learn . Ms . Jennife r Medvecki s provided helpfu l researc h assistance . Financia l suppor t fo r th e 1992-93 academi c yea r fro m Hoove r an d fro m th e E a r h a r t Foun dation i s gratefully acknowledged . Fourth, Mari o Rizzo , the genera l edito r o f the Ne w Yor k Univer vii

viii Acknowledgment s sity Pres s serie s o n th e politica l econom y o f th e Austria n School , was supportiv e o f the project fro m th e beginning. Niko Pfund, th e acquisitions edito r a t Ne w Yor k Universit y Press , wa s als o a source o f encouragemen t an d guidance . I n addition , I woul d lik e to than k Despin a Papazoglo u Gimbe l o f Ne w Yor k Universit y Press fo r he r wor k o n copyeditin g th e manuscrip t an d overseein g the publication process . Finally, I would lik e to than k m y wife , Rosemary , an d ou r tw o sons, Matthew an d Stephen , for their patience and lovin g support .

The Collaps e o f Developmen t Plannin g

1 Introduction Peter J. Boettk e

Prior t o th e twentiet h century , economi c developmen t wa s pri marily though t o f as a questio n o f th e institutiona l infrastructur e of a society . Adam Smith' s An Inquiry into the Nature and Causes of the Wealth of Nations ([1776 ] 1976 ) se t th e genera l ton e fo r economic discours e o n th e determinant s o f prosperit y fo r abou t one hundre d years. 1 Smit h argue d tha t economi c developmen t was th e resul t o f expandin g th e divisio n o f labo r withi n society . This expansion wa s du e t o the adoptio n o f certain political , legal , and economi c institution s an d practices . Privat e propert y rights , monetization, th e elimination o f trade restrictions , etc., sustaine d specialized productio n an d exchange , an d a s suc h le d t o th e in creased substitution o f market forces for centralized decisio n mak ing withi n th e economi c affair s o f society . Th e divisio n o f labor , Smith pointe d out , wa s limite d b y th e exten t o f th e market . Ex panding th e market allowe d individual s t o capture th e gains fro m specialized productio n an d exchange . I n short , th e sourc e o f eco nomic developmen t an d prosperit y wa s th e adoptio n o f institu tions an d policie s tha t approximate d th e syste m o f "natura l lib erty"—i.e., th e limite d government , night-watchma n stat e o f classical liberalism . As th e fat e o f classica l liberalis m a s a politica l an d economi c doctrine wane d i n th e twentiet h century , th e focu s o f attentio n 1

2 Pete r J.Boettk e with regar d t o economi c developmen t shifted . Question s o f insti tutional infrastructur e wer e replace d b y thos e dealin g wit h th e appropriate polic y mi x t o be implemented b y the stat e t o achiev e economic development . Discretionar y plannin g replace d th e con cern with rule s and institutions . Three development s i n though t an d histor y worke d t o under mine th e emphasi s o n institutiona l infrastructure : (1 ) the formal ist an d positivis t revolutio n i n economics, (2) the Bolshevik Revo lution an d th e ris e o f socialism, an d (3 ) the Keynesia n revolutio n in macroeconomics . Eac h o f thes e thre e shifte d attentio n awa y from governance to government activism . The marginalist revolutio n i n th e 1870 s was a great advanc e i n economic understanding . Unfortunately , th e forma l propertie s o f the logi c o f choic e tende d t o distrac t theoretica l attentio n fro m the institutiona l contex t o f choice . Th e grea t advanc e o f margin alism wa s th e developmen t o f a universal theor y o f human actio n to ai d ou r understandin g o f economi c behavior . But , despit e th e formal similarit y o f the choice problem acros s time and place, the fact remain s tha t th e institutiona l contex t o f choic e change s th e margins o n whic h economi c decision s ar e based . Unfortunately , the preoccupation wit h equilibrium state s that soo n came to dominate economics after th e 1930 s completely eliminated institution s from mainstrea m economics . Wha t emerge d wa s a theor y o f choice within a vacuum . Oskar Lange, for example, argued tha t economic s was a univer sal science , applyin g t o socialis t a s wel l a s capitalis t economies . One migh t no t disagre e wit h Lang e o n thi s point , bu t withi n Lange's comparativ e analysi s o f capitalism an d socialis m th e for mal similarity of the choice problem wa s transformed int o a stud y of the static allocatio n problem . In fact, Lang e explicitly assume d away th e importanc e o f institutions i n economic interaction , and , thus, in the comparison betwee n socialis m an d capitalis m ([1939 ] 1970,61-62). Lange wa s no t alon e i s thi s assessment . A s brillian t a s the y were, an d a s muc h a s thei r ow n wor k remaine d ric h i n institu tional analysis , Josep h Schumpete r (1942 ) an d Fran k Knigh t (1936) concurred wit h Lange . Leading thinker s wer e le d int o thi s error, a s F . A . Haye k pointe d out , becaus e o f th e preoccupatio n

Introduction 3 with equilibriu m state s tha t th e formalis t revolutio n engendere d (Hayek [1945 ] 1980,91) . Positivism als o contribute d t o th e shif t o f focu s awa y fro m institutional infrastructur e b y delegitimizin g th e stud y o f ideolog y as a n importan t componen t i n socia l theory . Political , legal , an d economic institution s ar e sustaine d o n th e basi s o f ideologica l systems o f thought . Ou t o f fea r o f ideologica l campaigns , positiv ism sough t t o eliminat e al l nontestabl e empirica l proposition s from science . Combine th e formalis t preoccupatio n wit h equilibriu m wit h the positivis t disregar d fo r ideas , an d th e kind s o f question s tha t Adam Smit h raise d abou t th e natur e an d cause s o f economi c de velopment an d lastin g prosperit y ar e eliminate d fro m th e field. The natura l tendenc y o f neoclassica l developmen t economic s wa s to ignor e political , legal , an d economi c institutions , an d instea d to search fo r measure s o f development. Th e questio n o f the institu tional infrastructur e o f sustainabl e developmen t wa s considere d to b e unscientific . Measuremen t alon e equal s science . The Bolshevi k Revolutio n an d th e ris e o f socialis m als o trans formed th e wa y scholar s approache d economi c development . Afte r the initia l failur e o f th e policie s o f Wa r Communis m (1918-1921) , the Bolshevik s introduce d a partia l liberalizatio n know n a s th e New Economi c Polic y (1921-28) . Thi s partia l liberalizatio n le d t o a relativ e recover y o f th e Russia n econom y fro m th e disaste r o f War Communism . Th e Ne w Economi c Policy , however , di d no t produce th e desire d result s i n term s o f industrializatio n an d ag ricultural development , a s i t suffere d fro m interna l contradiction s which m a d e officia l marke t exchang e a n insecur e outle t du e t o arbitrary interventio n (se e Boettk e 1990 , 113-46 ; Boettk e 1993 , 2 5 - 3 0 , 96-99) . Ne t officia l marketing s o f grain , fo r example , i n 1926-27 wer e onl y 5 0 an d 5 7 percen t o f thei r pre-Worl d Wa r I level, although grai n outpu t fo r tha t perio d wa s almos t equivalen t to pre-Worl d Wa r I level s o f output . Lenin's deat h i n 1924 , alon g wit h thes e uncomfortabl e result s of th e Ne w Economi c Policy , le d t o a protracte d debat e amon g Soviet economist s concernin g th e pat h t o be followe d i n industria l development. Th e debate s an d controversie s o f th e 1920 s contai n much tha t i s o f importanc e t o economi c an d intellectua l histori -

4 Pete r J. Boettke ans (se e Erlic h 196 0 and Boettk e 1990 , 147-91 , fo r a summar y o f the term s o f th e Sovie t debate) . A s Ale c Nov e ha s pointe d out , modern "developmen t economic s could b e said t o have been bor n here" ([1969] 1984 , 129). The Stalinis t mode l o f industrialization emerge d ou t th e 1920 s controversy, and th e Five-Year Planning Syste m was born. Forced industrialization an d collectivization , i t wa s argued , wer e neces sary t o transfor m a backwar d econom y int o a n advance d indus trial powe r whic h coul d simultaneousl y defen d itsel f agains t hos tile capitalis t encirclemen t an d serv e a s a beaco n t o th e moder n world. Th e earl y report s o f succes s fro m th e Sovie t governmen t (at the same time that th e Great Depressio n had destroyed faith i n the market syste m i n the West) were reinforced b y the outcome of World Wa r II . Tha t th e Stalinis t mode l ha d prepare d th e Sovie t Union t o defea t Nazis m becam e th e standar d justificator y expla nation fo r force d industrializatio n an d collectivizatio n o f agricul ture. Whateve r cos t th e Sovie t policie s o f th e 1930 s impose d o n the people, it was argued , th e avoidanc e o f economic crisi s as th e Great Depressio n an d th e victor y ove r Nazis m justifie d th e ex pense. A new path t o economic development ha d been discovered , a ne w worl d ha d bee n created . N o longe r wa s th e worl d divide d into develope d capitalis t countrie s an d underdevelope d noncapi talist countries , no w th e classificatio n include d th e Firs t Worl d (capitalist develope d economies) , th e Secon d Worl d (socialis t de veloped economies) , and th e Third Worl d (underdevelope d econo mies).2 Development wa s no longer synonymous with capitalism . The Keynesia n revolutio n als o contribute d significantl y t o th e shift o f focus i n development economics . First, the Keynesia n the ory reinforce d th e socialis t viewpoin t tha t capitalis m wa s inher ently unstable . Th e Grea t Depression , fo r example , wa s a conse quence o f aggregat e deman d failur e whic h periodicall y result s from chaoti c an d irrationa l investmen t decisions . Free-marke t competition coul d no t b e relie d upo n t o self-correc t fo r th e sys temic consequence s o f error s committe d b y privat e economi c actors, le t alon e promot e stabilit y an d security . Keyne s argue d that laissez-faire was dea d a s a legitimatin g ideology . In 1933 , he went a s fa r a s t o argu e tha t th e grea t socia l experiment s o f th e time i n Ital y (fascism) , German y (nationa l socialism ) an d Russi a

Introduction 5 (communism) coul d poin t th e wa y t o th e futur e o f economic pol icy. Country afte r countr y ha d abandone d th e old presupposition s of classical liberalism . Thinking me n an d wome n i n Great Britai n and i n the United State s would striv e to find a hybrid of their ow n which combine d th e successfu l aspect s o f these moder n economi c policies wit h th e successfu l component s o f thei r bourgeoi s politi cal system . Laissez-faire liberalis m wa s n o longe r a seriou s forc e in the world o f ideas (Keynes 1933) . Second, th e aggregat e technique s develope d i n th e Keynesia n revolution provide d economist s wit h a wa y t o measur e economi c development. Economi c developmen t becam e synonymous , a s H. W . Arnd t (1981 ) pointe d out , wit h measure d growt h i n pe r capita income . This equating o f economic developmen t wit h neo classical growt h theor y ha d sever e consequence s fo r th e theoreti cal foundation s o f developmen t economics . Th e preoccupatio n with "growth " an d "long-range " economi c plannin g wer e remi niscent o f th e debate s o f th e Sovie t economist s o f th e 1920s . This was no t a coincidence . Th e developmen t o f th e Harrod-Doma r model o f economi c growt h wa s directl y influence d b y th e Sovie t debates. Evsey Doma r remarke d tha t th e 1920 s Sovie t journal , The Planned Economy, wa s " a valuabl e sourc e o f ideas" for th e devel opment o f hi s ow n approach . Sovie t societ y represente d a sor t o f economic laboratory wher e the social scientist could examine "hi s whole intellectua l apparatu s i n ligh t o f a socia l an d economi c system sufficientl y differen t fro m our s t o mak e th e experimen t rewarding, an d ye t no t s o different t o mak e i t impossible " (1957 , 10). Domar' s mode l wa s a n elaboratio n o f th e theor y o f growt h worked ou t b y th e Sovie t economis t G . A. Fel'dman. In extendin g Fel'dman's model , however, Doma r replace d th e Marxis t concer n with capita l proportionalit y wit h Keynesia n aggregation . A s a result, moder n growt h theor y wa s completel y separate d fro m th e traditional concern s of capital theory . But capital theory, properly understood, provides the basis for the microeconomic foundation s for macroeconomi c analysis . Without thes e foundation s th e theo rist i s lef t wit h a worl d i n whic h ther e ar e eithe r n o marke t problems (th e Walrasian worl d of general equilibrium) or no mar ket solution s (th e Keynesia n worl d o f aggregat e deman d failure) .

6 Pete

r J.Boettk e

Neither theoretica l worl d doe s muc h t o advanc e ou r understand ing o f rea l existin g economie s an d th e precondition s fo r thei r economic developmen t (se e Garriso n 1984) . Modern developmen t economic s incorporate d al l thre e trends , each tendin g t o reinforc e th e others . Th e formalis t an d positivis t revolution demande d measurement , whil e Keynesia n technique s of aggregatio n supplie d th e neede d tool s fo r measurement . Th e socialist ide a o f th e chao s o f capitalis m receive d additiona l sup port fro m Keynesia n theory . Moreover , th e Sovie t experienc e seemed t o len d credenc e t o th e notio n o f comprehensiv e economi c planning, whil e th e Keynesia n theor y o f deman d managemen t provided a polic y techniqu e fo r noncomprehensiv e plannin g o f the economy . Economic though t i n bot h Eas t an d Wes t accepte d th e ide a tha t government managemen t o f th e econom y wa s th e wa y no t onl y t o run a moder n economy , bu t t o transfor m a backwar d econom y into a moder n one . Alternativ e model s o f governmen t manage ment o f economi c developmen t wer e exporte d fro m th e Firs t an d Second t o th e Thir d World . The hegemon y o f thi s paradig m fo r economi c developmen t ha s been seriousl y challenge d b y intellectua l development s an d politi cal event s i n th e pas t tw o decades . Th e Keynesia n mode l fel l ou t of vogu e i n th e 1970s ; then , i n th e mid - t o lat e 1980s , the commu nist mode l o f politica l econom y collapsed . Th e traditiona l Keyne sian mode l wa s prove n t o b e logicall y flawed an d empiricall y weak. Th e protracte d stagnatio n o f th e Britis h an d Unite d State s economies, combine d wit h hig h inflation , represente d a seriou s anomaly i n th e Keynesia n system . The rejectio n o f the Communis t Party throughou t Eas t an d Centra l Europ e i n 1989 , and th e aboli tion o f th e Sovie t Unio n i n 1991 , called int o questio n th e desirabil ity o f th e Leninis t politica l system . Th e terribl e economi c condi tions i n ever y on e o f th e communis t countrie s wa s witnes s t o th e folly o f economi c planning . Moreover , th e recor d o f th e exporte d models o f governmen t plannin g fo r economi c developmen t i n Af rica, Lati n America , India , etc. , i s conspicuousl y lackin g i n an y success story . The glasnos t revelation s fro m insid e th e forme r Sovie t Unio n during th e Gorbache v perio d ar e particularl y relevan t sinc e the y

Introduction 7 radically questio n al l previou s estimate s o f Sovie t economi c per formance throughou t it s histor y (se e Boettk e 1993 , 12-45) . Thes e revelations di d no t simpl y demonstrat e th e systemati c falsifica tion o f statistic s b y th e Sovie t government , bu t Sovie t economist s were criticall y assessin g th e accurac y o f eve n CI A statistic s o n Soviet economi c performance . Livin g standard s i n th e forme r USSR, a s Grigor y Khani n an d Vasil y Selyuni n (1987 ) pointe d out , had bee n fallin g fo r decades . Bu t thi s declin e wa s no t graspe d b y the CIA . I n 1986 , fo r example , th e CI A estimate d tha t Sovie t pe r capita GN P wa s abou t 4 9 percent o f tha t i n th e Unite d States . Th e revised estimate s no w pu t tha t figure a t abou t 2 5 percent. Ha d th e CIA figures bee n accurate , th e Sovie t econom y woul d hav e bee n a maturing industrialize d economy . Th e revise d estimates , how ever, no w revea l tha t th e Sovie t econom y provide d a standar d o f living t o it s citizen s equivalen t t o tha t o f a well-develope d Thir d World economy . Not onl y wer e th e growt h rate s challenged , bu t al l th e succes s claims o f th e Sovie t mode l wer e brough t int o questio n b y Sovie t scholars an d intellectuals . Wester n historians , suc h a s Rober t Conquest, ha d fo r a lon g tim e expose d th e exten t o f Stalin' s crime s against humanity . Conquest' s books , suc h a s The Great Terror an d The Harvest of Sorrow, wer e quit e wel l know n amon g intellectual s within th e Sovie t Unio n a s the y ha d circulate d samizdat fo r years . Moreover, literar y work s b y writer s o f th e statur e o f Aleksand r Solzhenitsyn, Vasil y Grossman , Anatol i Rybhakov , Arthu r Koest ler, an d Georg e Orwel l ha d expose d th e absurditie s an d tragedie s of th e Stalinis t system—an d thes e work s wer e als o wel l know n within th e Sovie t Union . Bu t thes e work s wer e no t par t o f th e official cultur e an d histor y o f th e Sovie t people . Ther e is , though , something vitall y importan t abou t th e transformatio n o f histori cal conscienc e fro m a sub rosa existenc e t o legitimat e inquiry . With th e adven t o f glasnost i n th e lat e 1980s , Sovie t intellectu als reclaime d thei r histor y an d thei r literar y culture . Samizdat periodicals cease d a s th e "thick " journals , suc h a s Novy Mir, car ried articl e afte r articl e whic h tor e asunde r on e ico n afte r anothe r of Sovie t histor y o r publishe d excerpt s fro m long-suppresse d nov els. Classi c book s whic h ha d onl y circulate d undergroun d wer e now publishe d i n ne w edition s abov e ground . Th e ful l extent , fo r

8 Pete r J.Boettk e example, of th e planne d los s of human live s fro m collectivizatio n and politica l persecutio n i n the 1930 s under Stalin' s direc t order s began t o be unearthed fro m unde r th e debri s o f state propagand a and censorship (see, for example, Medvedev 1989) . Even th e Grea t Patrioti c Wa r (Worl d Wa r II ) di d no t escap e scrutiny. The 193 9 Stalin-Hitler Pac t was officially acknowledged . The murde r o f Polis h officer s a t Katy n wa s debate d an d finally confessed. Sovie t official s admitte d tha t Stalin' s purg e o f the Re d Army's general s jus t befor e th e outbrea k o f wa r cos t th e Sovie t army dearly . Without th e assistanc e o f it s Wester n allies , the So viet Unio n migh t ver y wel l hav e falle n t o Hitler . Moreover , th e embarrassing fac t t o Sovie t leader s tha t man y peasan t communi ties, for example in the Ukraine, welcomed Hitler's troops as liberators fro m th e oppression o f Stalin's collectivizatio n becam e par t of th e legitimat e historica l record . I t wa s no t th e Stalinis t mode l that provide d th e resource s o r unity o f will t o defeat Nazism , bu t rather th e ultimate resolv e of the Soviet people and th e assistanc e of th e Wester n allies . Th e Stalinis t model , i n fact , ha d mad e th e Soviet Unio n highl y vulnerabl e t o Hitler's attac k b y crippling th e Soviet econom y an d breakin g th e spiri t o f millions o f Sovie t sub jects. The sacrifice s o f th e Sovie t peopl e wer e real , but wha t succes s story could thi s model clai m i n terms of enhanced consume r well being o r a n improve d wa y o f living? There i s a Sovie t qui p whic h captures th e failur e o f th e Stalinis t mode l fo r economi c develop ment. It goe s as follows. Th e problem wit h th e First World i s tha t you canno t breath e becaus e o f th e industria l ai r pollution . Th e problem wit h th e Thir d Worl d i s that yo u cannot drin k th e wate r because o f th e lac k o f sanitation . Unfortunately , i n th e Secon d World, a s a consequence o f the Sovie t mode l o f development, yo u can neither breathe no r drink . All of this demands a reevaluation of the economic developmen t literature. The Soviet mode l no longer represents a viable alterna tive. A new agend a fo r studyin g developmen t economic s mus t b e forged. A s the majo r opponen t o f th e origina l Keynesia n an d so cialist challenge , th e Austria n Schoo l seem s a natura l plac e t o look t o fo r a n alternativ e mode l o f economi c development . I n addition, th e Austrian Schoo l rejected th e formalistic an d positiv -

Introduction 9 ist revolution i n economic thought . In th e Austrian tradition , eco nomic developmen t wa s neve r confuse d wit h measure d rate s o f growth. T o understand economi c development , wha t i s needed i s not mor e elaborat e forma l model s o f growth o r bette r technique s for measurement , bu t mor e detaile d historica l studie s o f th e pat tern o f developmen t acros s countrie s an d periods . Thes e studies , however, mus t b e informe d b y a theor y o f economic an d politica l processes whic h i s ric h i n institutiona l analysis . I n othe r words , what i s required t o forge a new agenda i n development economic s is a retur n t o Ada m Smith' s concer n wit h institution s an d thei r impact o n economic behavior. Economic development ca n be seen as par t o f a genera l theor y o f economi c processe s an d socia l evo lution. The Collapse of Development Planning explore s th e theoretica l arguments an d historica l experienc e concernin g th e effectivenes s of economic developmen t policy , includin g foreig n ai d programs . The chapte r o n mone y an d capita l i n th e theor y o f economi c development provide s a n overvie w o f th e analytica l issue s in volved i n an y examinatio n o f th e patter n o f developmen t o f a n economic system. The historiography o f the rise of the West intro duces th e centra l political , legal , an d economi c institution s tha t contributed t o th e ris e o f capitalis m an d libera l democracy . Th e case studie s o f development plannin g i n China , India, an d Africa , and o f foreig n ai d program s (includin g th e Marshal l Plan ) illus trate th e importanc e o f th e insight s derive d fro m Austria n eco nomics fo r understandin g th e historica l recor d o f government ac tivism i n developmen t policy . Th e politica l econom y perspectiv e on th e Asia n model , an d th e discussio n o f marke t solution s t o economic developmen t question s explai n th e relativ e succes s o f an alternativ e nondeliberativ e plannin g pat h t o economi c devel opment. Not all of the authors in this volume would consider themselve s "Austrian/' bu t eac h o f th e contribution s focuse s o n political , legal, and economic institutions, their impact o n economic behav ior, and their role in the discovery and use of dispersed knowledge . In that sense, it is accurate to refer t o this collection as "Austrian/ ' It i s to o subtl e a distinctio n fo r presen t purpose s t o elaborat e o n the difference s betwee n Austria n economic s an d Neo-Institu -

10 Pete

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tionalism (see , e . g , Eggertsso n 1990) . Despit e thei r differences , Austrians an d Neo-Institutionalist s shar e a basi c perspectiv e o n the approac h t o th e stud y o f society. Dependin g o n ho w on e draw s the line , eithe r Austria n economic s coul d b e viewe d a s a subse t o f Neo-Institutionalism o r Neo-Institutionalis m coul d b e viewe d a s a subse t o f Austria n economic s (se e Langloi s 1986) . Wha t wa s important fo r th e presen t projec t wa s t o begi n t o forg e a ne w agenda fo r developmen t economic s tha t wil l focu s scholarl y atten tion onc e agai n o n th e institutiona l infrastructur e o f economi c development. While scholar s workin g explicitl y withi n th e Austria n traditio n have addresse d developmen t issue s befor e i n individua l article s o r in dissertation s (mos t notabl y Irigoi n 1990) , thi s volum e repre sents th e firs t collectio n an d book-lengt h treatmen t o f th e subjec t from a moder n marke t proces s perspective . I t i s offere d t o th e community i n th e spiri t o f critica l rationalism , an d wit h th e hop e that i t wil l stimulat e som e t o challeng e th e insight s offered , an d others t o min e th e Austria n paradig m fo r insight s int o th e press ing problem s o f th e politica l econom y o f economi c developmen t that confron t u s throughou t th e worl d today .

Notes 1. I hav e benefite d fro m usefu l conversation s o n th e topi c o f economi c development wit h Rober t Conquest , Thoma s Metzger , Ramo n Myers , and Hilto n Root . I n addition , I woul d lik e t o than k Ralp h Raic o fo r helpful comment s o n an earlier draft . Th e usual cavea t applies . 2. P . T. Bauer ha s argue d tha t th e ter m "Thir d World " emerge d merel y to represen t thos e countrie s receivin g foreig n ai d fro m th e develope d world. M y classificatio n doe s no t inten d t o challeng e Bauer' s etymo logical accuracy . Rather , I am jus t pointin g ou t tha t a ne w classifica tion schem e emerge d t o reflect th e perceive d fac t tha t capitalis m wa s no longer the only path t o industrial development .

References Arndt, H . W. 1981 . "Economic Development : A Semantic History. " Economic Development and Cultural Change 29 (April): 457-66.

Introduction 1

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Boettke, Pete r J . 1990 . The Political Economy of Soviet Socialism: The Formative Years, 1918-1928. Boston : Kluwer Publishing . 1993. Why Perestroika Failed: The Politics and Economics of Socialist Transformation. London : Routledge . Domar, Evsey. 1957 . Essays in the Theory of Economic Growth. New York: Oxford Universit y Press . Eggertsson, Thrainn . 1990 . Economic Behavior and Institutions. Ne w York: Cambridge Universit y Press . Erlich, Alexander . 1960 . The Soviet Industrialization Debate, 1924-1928. Cambridge: Harvard Universit y Press . Garrison, Roger . 1984 . "Time an d Money : Th e Universal s i n Macroeco nomic Theorizing." Journal of Macroeconomics 6 (2): 197-213. Hayek, F . A . [1945 ] 1980 . "Th e Us e o f Knowledg e i n Society. " I n hi s Individualism an d Economic Order, 77-91. Chicago: University of Chicago Press. Irigoin, Alfredo . 1990 . "Economi c Development : A Market Proces s Per spective." Ph.D. diss., Department o f Economics, New York University. Keynes, Joh n Maynard . 1933 . "Nationa l Self-Sufficiency. " Yale Review (Summer): 755-69. Khanin, Grigory , an d Vasil y Selyunin . 1987 . "The Elusiv e Figure. " Nov y Mir, 2 (February). Translated i n The Current Digest of the Soviet Press 39, no. 25 (1987): 10-12. Knight, Fran k 1936 . "The Plac e o f Marginal Economic s i n a Collectivis t System." American Economic Review 26, no. 1 (March) : 255-66. Lange, Oska r [1939 ] 1970 . On the Economic Theory of Socialism. Ne w York: Augustus M. Kelley. Langlois, Richard , ed . 1986 . Economics as a Process: Essays in the New Institutional Economics. Ne w York: Cambridge University Press . Medvedev, Roy. 1989 . Let History Judge. Revised ed. New York: Columbi a University Press . Nove, Alec. [1969] 1984 . An Economic History of the U.S.S.R. New York : Penguin Books. Schumpeter, Joseph . 1942 . Capitalism, Socialism, Democracy. Ne w York : Harper an d Row . Smith, Adam . [1776 ] 1976 . An Inquiry into the Nature and Causes of the Wealth of Nations. Chicago : University of Chicago Press.

2 Money an d Capita l i n Economic Developmen t Parth J. Sha h

A quick glanc e a t m y Austria n librar y ( a rathe r complet e collec tion i f I ma y sa y so ) fail s t o pic k u p an y wor k wit h "economi c development" o r "economi c growth " i n it s title . Despit e bein g part o f th e moder n economi c scienc e sinc e it s inception , a s a coinitiator o f th e marginalis t revolution , d o Austrians hav e noth ing t o say abou t ancien t problem s o f economic growt h an d devel opment? Fortunately , a sligh t reflectio n prove s th e impressio n o f the quick glance misleading . Austrians di d no t hav e t o create a special disciplin e o f development economic s fo r tw o reasons : first , thei r conceptio n o f th e nature of the economic problem facin g society ; second, their artic ulation o f th e natur e o f th e economi c theor y o f economy-wid e phenomena (th e domain o f macroeconomics). Following Lionel Robbins ([1932] 1984) , mainstream economic s still l see s th e economi c proble m facin g a n individua l o r a societ y as tha t o f allocatio n o f scarc e resource s amon g alternativ e an d competiting ends . In this view, the field of economics is a proble m or a se t o f problems o f rational choic e amon g scarc e resource s o f land, labor , an d capital ; an d economi c development , therefore , becomes a special typ e of problem o f allocation an d accumulatio n 15

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of resources, especially o f the produce d mean s o f production (capi tal), an d s o th e subjec t i s give n a specia l an d distinc t treatment . The ver y wor d " p r o b l e m " implie s th e existenc e o f som e "solu tion." 2 On e effec t o f thi s perspectiv e i s th e apparen t appea l o f government plannin g t o achiev e th e goal s o f development . Unde r Robbins's visio n o f economics , economi c developmen t i s see n a s a proble m tha t ca n bes t b e solve d b y methodica l an d detaile d rational planning. 3 At leas t sinc e Hayek' s "Economic s an d Knowledge " ([1937 ] 1980), Austrian s hav e define d th e scop e o f economic s a s tha t o f explaining creation , dissemination , an d us e o f knowledg e i n soci e t y — t h a t o f coordinatio n o f individuals ' articulat e an d inarticu late knowledge . Haye k i n hi s th e "Us e o f Knowledg e i n Society " ([1945] 1980 , 77-78) provide s a s u m m a r y statement : The economic proble m o f society i s thus no t merel y a problem o f how t o allocate "given " resources—if "given " i s taken t o mean give n t o a singl e mind whic h deliberatel y solve s th e proble m se t b y thes e "data. " I t i s rather a problem o f how t o secure th e best use of resources known t o an y of the member s o f society, for end s whose relativ e importanc e onl y thes e individuals know. Or, to put i t briefly, i t is a problem o f the utilization of knowledge which i s not give n to anyone in its totality . The proble m i s o f coordinatin g individua l plan s reflectin g de centralized decisio n makin g o n th e basi s o f disperse d knowledge . The pric e syste m provide s informatio n a s wel l a s incentive s t o ac t in way s s o a s t o brin g abou t meshin g o f individua l plans . Th e price syste m perform s it s functio n wel l withi n th e framewor k o f private propert y an d contrac t la w (Mise s 1981) . Legal , political , and economi c institution s an d policie s tha t allo w th e pric e syste m to operat e an d thereb y foste r coordinatio n woul d lea d t o develop ment: Developmen t i s simply a resul t o f successfu l coordination . Differences i n th e conceptualizatio n o f th e economi c proble m by Robbin s an d Haye k lea d t o divergen t view s o n th e natur e o f economic developmen t an d th e appropriat e mean s t o achiev e it . Robbins's visio n consider s developmen t a s a problem t o b e solve d by methodicall y planne d allocatio n o f resources . Hayek' s visio n contemplates developmen t a s a process t o b e fostere d b y th e insti tutional framewor k o f privat e property , th e pric e system , an d th e rule o f law .

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The secon d reaso n fo r Austrian s no t t o hav e a separat e disci pline o f developmen t economic s wa s thei r vie w o f th e domai n o f macroeconomics. Macr o theor y mus t tackl e bot h "th e marke t fo r money'7 and "the market for time," individually an d in their inter actions. 4 Austrians dea l not only with mone y (changes in its quan tity, origins of such changes, and thei r differentia l impac t o n various prices ) bu t als o wit h th e tim e elemen t a s expresse d an d embodied i n th e capital structur e o f the economy . Capital theory , therefore, i s very much a t th e heart o f Austrian macr o theory . The mainstream, on the other hand, has (arbitrarily) barred considera tions o f capita l an d it s structur e fro m it s macr o theor y an d thereby bee n compelle d t o dea l wit h th e topi c largel y a s par t o f growth o r developmen t economics. 5 Mainstrea m macr o theor y handles onl y liquidit y an d labor-leisur e preferences ; Austrian s in clude time preference also . Though Austrians di d no t se e any need for a separate disciplin e of development economics , the y hav e offere d an d ca n offe r usefu l analyses an d insight s o n th e issue s relate d t o economi c develop ment. I wil l first se t th e stag e b y briefl y outlinin g th e Austria n subjective vie w o f economi c developmen t an d the n tackl e th e main them e o f thi s chapter : th e rol e o f mone y an d capita l i n economic developmen t fro m th e Austria n an d mainstrea m per spectives. After discussin g th e differin g view s on mone y an d capi tal, th e questio n o f ho w mone y (o r rathe r credit ) get s converte d into capita l i s raised . Th e bankin g syste m play s a pivota l rol e i n this conversio n process—th e proces s o f financial intermediation . This i s especiall y tru e i n underdevelope d countrie s wher e othe r types o f capital market s ar e largel y absen t o r ar e i n rudimentar y form. Th e people i n th e bankin g syste m wh o evaluat e an d decid e on loa n request s b y firms—"bankers"—significantly determin e the exten t an d natur e o f economi c development . (Consumptio n loans ar e rathe r infrequen t i n underdevelope d countries. ) Cam eron (1967, 1972) and Goldsmit h (1969 ) provide detailed historica l accounts o f th e vita l rol e playe d b y th e financial system s i n gen eral and the banking systems in particular i n the growth processe s of no w develope d countries . McKinno n (1973 ) an d Sha w (1973 ) outline a theoretica l framewor k explainin g th e vita l rol e o f financial intermediation i n development .

18 ParthJ.Sha h The banking syste m an d bankers , especially i n underdevelope d countries, ar e majo r player s i n channelin g money , credit , an d capital. I n th e las t par t o f thi s chapter , variou s views—Austrian , Schumpeterian, an d mainstream—o n th e rol e o f banker s ar e ex amined an d a modified Austria n (Neo-Austrian? ) view is defended . The mainstrea m view s banker s a s bureaucrats , th e Austrian s a s tellers, Schumpeterian s a s surfers , an d Neo-Austrian s a s equi librists. Discussion o f these alternative conception s no t only clari fies th e rol e o f banker s an d financial intermediatio n i n develop ment bu t als o identifie s appropriat e institutiona l arrangement s within whic h banker s ca n perfor m tha t usefu l role . I t i s argue d that fre e an d competitiv e bankin g i s suc h a n institutiona l ar rangement.

A Subjective Vie w of Developmen t Standard textbook s o n developmen t economic s typicall y defin e development i n objective , quantifiabl e term s a s growt h i n pe r capita rea l incom e o r accumulatio n o f mean s t o produc e suc h income growth (Todar o 1989 , 83-86, for example). Realizing obvious pitfall s o f suc h a n aggregativ e vie w o f development , the y have moved on to defining developmen t a s elimination of absolut e poverty, income inequalities, urban migratio n an d congestion, unemployment, an d underemployment . A t times , achievin g huma n dignity, self-esteem, an d freedo m ar e included amon g th e goal s of economic development . Thi s proliferatio n o f developmen t objec tives ha s ha d tw o importan t effect s o n th e field. First , blurrin g o f the boundar y betwee n developmen t economic s an d traditiona l political econom y sinc e concern s abou t incom e inequalities , ur ban congestion, and underemployment ar e global, not limited jus t to les s develope d countrie s (LDCs) . Th e secon d an d mor e im portant effec t ha s been growin g confusion abou t appropriat e poli cies an d plannin g models . A given polic y ha s a differential , an d frequently opposite , impac t o n differen t developmen t objectives . This ha s le d t o unendin g debate s o n balance d o r unbalance d growth approaches , industrializatio n o r emphasi s o n th e agricul tural an d primar y commodities ' sector , impor t o f technolog y o r

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growth o f indigenous technology , expor t promotio n o r impor t sub stitution, an d s o on . In th e coordinatio n paradigm , Austrian s focu s o n individual s and thei r subjectivel y perceive d means-en d framework—purpo sive h u m a n actio n (Mise s 1966) . In thi s framework , economi c de velopment mean s expandin g th e rang e o f mean s availabl e t o indi viduals t o achiev e thei r desire d ends . Economi c development , Austrians argue , woul d b e a s natura l i n a societ y tha t facilitate s coordination a s it s individuals ' desir e t o bette r thei r lives . Ada m Smith ([1776 ] 1976 , 2: 49-50 ) ha s capture d th e spiri t o f thi s argu ment succinctly : The natural effor t o f every individual t o better his own condition . . . i s so powerful a principl e tha t i t i s alone , an d withou t assistance , no t onl y capable o f carryin g o n th e societ y t o wealt h an d prosperity , bu t o f sur mounting a hundre d impertinen t obstruction s wit h whic h th e foll y o f human law s too often incumber s its operations. Development, Austrian s conclude , i s a n unintende d conse quence o f successfu l coordination . Voluntar y exchang e withi n th e framework o f privat e propert y an d commo n law—catallaxy — guarantees th e bes t opportunitie s fo r individual s t o maximiz e their welfar e (Skouse n 1991) . Coordination occur s throug h norm s and practices , traditions , an d institutions ; throug h actors ' "insti tutional m a t r i x / ' Th e focu s o n coordinatio n naturall y draw s at tention t o a wid e variet y o f forma l an d informa l social , legal , an d economic institution s withi n whic h peopl e act . Instea d o f a de fined lis t o f goal s an d thei r targe t levels , wit h specifie d policie s t o achieve them , Austrian s favo r a broade r approac h t o develop m e n t — a "comparativ e institution s approach. " Thi s approac h (along wit h methodologica l individualis m an d subjectivis m tha t underlie it ) provides a uniqu e them e t o evaluat e th e rol e o f mone y and capita l i n economi c development . Money an d Developmen t The issue s discusse d i n thi s are a ar e standard : degre e o f monetiza tion o f a n economy , rol e an d optimu m rat e o f inflation , an d us e o f monetary polic y t o achiev e sustaine d development .

20 Part h J. Sha h Monetization: Why? And How? Most LDC s have a sizable barter sector . In India, for example , th e barter secto r i s estimate d t o hav e contribute d 3 1 percen t t o ne t national produc t i n 195 5 an d abou t 2 1 percen t i n 197 5 (Lauma s 1990, 377). Monetization o f the barter sector substantially reduce s search cost s by eliminating th e need fo r th e double coincidence of wants an d th e precise timing of transactions, and diminishe s stor age costs since money can act as a temporary abod e of purchasin g power instea d o f commodities. Us e of money save s rea l resource s and stimulate s th e developmen t o f bankin g an d credi t mech anisms. Thes e argument s fo r monetizatio n ar e standar d an d to increas e monetizatio n inflationar y policie s ar e typicall y sug gested. An Austria n understandin g o f th e rol e o f mone y an d mone y prices i n a market econom y argue s agains t suc h inflationar y poli cies. I n additio n t o minimizin g searc h an d storag e costs , us e o f money an d mone y price s enable s individual s t o accurately calcu late opportunit y cost s o f thei r actions , an d profit s an d losse s o f their enterprises . Mone y price s transmi t informatio n abou t rela tive scarcit y an d consume r preference s i n on e segmen t o f th e economy t o th e res t o f the econom y an d thereb y perfor m a n inte grating function . Th e price s simultaneousl y provid e approprat e incentives t o optimiz e th e us e o f scarc e resource s an d facilitat e efficient allocatio n o f resource s throughou t th e economy . (Se e Hayek [1945 ] 1980 ) o n th e significanc e o f th e pric e syste m a s a communication network. ) Inflationar y policie s an d unstabl e money distor t th e calculation , integration , an d allocatio n func tions of money prices and thereb y imped e monetization . Monetization increase s a s an econom y progresse s fro m produc tion fo r us e t o productio n fo r profit , a s i t move s awa y fro m self-sufficiency an d relie s mor e o n th e marke t fo r it s provisions . Production fo r profi t encourage s th e division o f labor an d special ization whic h reinforce s th e benefits o f monetization. Th e routin e attempts a t self-sufficienc y i n LDC s generally retar d th e divisio n of labo r an d specializatio n an d thereb y th e degre e o f moneti zation.

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Role of Inflation and Monetary Policy "[I]t i s th e teachin g o f thi s Treatise [on Money]," Keyne s intoned , " t h a t th e wealt h o f nation s i s enriched , no t durin g incom e infla tions bu t durin g profi t inflations—a t times , thi s i s t o say , whe n prices ar e runnin g awa y fro m costs " (1930 , 2: 154) . Keynes's inter pretation o f th e economi c growt h o f Europ e downplaye d th e rol e of thrif t an d endorse d inflationar y policies : "I t i s unthinkabl e that th e differenc e betwee n th e amoun t o f wealt h i n Franc e an d England i n 170 0 an d th e amoun t i n 150 0 coul d eve r hav e bee n built u p b y thrif t alone . Th e intervenin g profi t inflatio n whic h created th e moder n worl d wa s surel y wort h whil e i f w e tak e a long view " (1930 , 2 : 163) . Development economic s di d no t escap e the Keynesia n revolutio n tha t swep t th e professio n (Bartlet t 1992). Inflationary policie s ar e advocate d no t onl y t o kee p "price s running awa y fro m costs, " but als o t o monetize barte r LD C econo mies, direc t resource s towar d moder n emergin g industries , an d most importantl y t o rais e revenu e t o finance governmen t project s directly throug h printin g pres s an d indirectl y b y slo w repudiatio n of governmen t debt . The developmen t literatur e i s replet e wit h debate s abou t th e optimal rat e o f inflation . A s the cost s o f inflatio n wer e see n largel y as a ta x o n nomina l cas h balances , th e benefit s o f inflatio n see m to outweig h th e costs . Lik e an y tax , a s th e ta x rat e (inflatio n rate ) goes u p , th e ta x bas e (nomina l cas h balances ) woul d shrin k an d hence th e elaborat e estimation s abou t optima l inflatio n rate s fo r various LDC s (Todar o 1989 , chapter 17) . The Austria n understandin g o f th e rol e o f mone y price s i n cal culation, integration , an d allocatio n (a s discusse d above ) argue s for first-order cost s o f inflation . Errati c inflation s diminis h money's medium-of-exchang e functio n an d compe l peopl e t o spend mor e rea l resource s fo r exchang e activities , thereb y reduc ing resource s availabl e fo r th e productio n o f good s an d services . As that understandin g wa s elaborate d upo n (se e especiall y Leijon hufvud 198 1 an d Levi n 1982) , it wa s generall y recognize d tha t th e costs o f inflatio n wer e mor e tha n jus t "shoe-leathe r costs. " De bates switche d fro m optima l inflatio n rate s t o optima l monetar y

22 Part h J. Sha h policy rule s (unde r th e phras e "discretio n o r rule?" ) an d the n t o optimal monetar y constitution s (Dow d 1989 , chapter 3) . Proposals of fixed money suppl y growth , nomina l incom e o r pric e leve l tar geting, an d fre e bankin g base d o n gol d o r a commodit y baske t emerged.6 I t i s beyon d th e scop e o f thi s chapte r t o establis h th e proposition tha t a fre e bankin g syste m provide s th e mos t perma nent an d stabl e solutio n t o problem s o f errati c inflation s an d t o macro maladies induce d fro m th e side of money. 7 Before leavin g thi s topic , on e mor e rational e fo r inflationar y policies deserve s our attention . This rationale i s particularly rele vant t o th e issu e o f developmen t an d ha s bee n supporte d b y tw o otherwise riva l groups : Keynesian s (Tobi n an d Solow ) and Mone tarists (Patinkin an d Friedman) . Money and Capital: Complements or Substitutes? Monetary growt h theorist s (includin g Tobin , Solow, Patinkin, an d Friedman) hav e argue d tha t mone y balance s an d capita l ar e sub stitute assets , and s o by (moderately) increasin g th e inflatio n rat e and thereb y reducin g th e rea l rat e o f retur n o n cas h balances , government ca n induc e peopl e t o hol d mor e rea l capital. 8 Infla tion, therefore , help s diver t people' s fetis h fo r liquidit y towar d real capital formation . McKinnon (1973 ) contend s tha t i n developin g countrie s wher e capital market s ar e incomplete , mone y an d capita l serv e a s com plimentary assets . I n th e cas e o f incomplet e o r represse d capita l and credi t markets , a typica l situatio n i n LDCs , lumpines s o r indivisibilities o f investments make cash balances and real capita l complementary assets . Inflatio n tha t reduce s th e rea l retur n o n cash balance s als o retard s rea l capita l formation . Sha w (1973 ) reaches a similar conclusion through his debt-intermediation vie w of money. 9 Numerou s empirica l studie s o f LDC s suppor t a McKinnon-Shaw complementarit y hypothesi s (Kapu r 1986 ; Fr y 1988). Inflation doe s not promote real capital formation . Capital an d Developmen t The significanc e o f capita l an d it s growt h fo r economi c develop ment i s beyon d question . Th e issu e tha t separate s th e Austria n

Money and Capital in Economic Developmen t 2

3

and mainstrea m perspective s i s th e conceptualizatio n o f capita l and th e capital-usin g economy ; o r th e why an d ho w o f the rol e of capital i n development . Carl Menge r (1976 ) visualized th e econom y a s mad e o f variou s orders o f goods , lower-orde r good s bein g consume r good s an d higher-order good s bein g capita l goods ; an d economi c proces s as th e conversio n o f higher-orde r good s int o lower-orde r goods . Higher-order good s are valued fo r th e lower-order good s that the y help t o produce . A capital-using economy , therefore , i s a contin uum o f variou s order s o f goods ; suc h a n econom y ha s a specifi c structure o f capital. 10 Capital good s are characterized b y differen t degrees o f complementarit y an d substitutability , an d canno t b e viewed a s homogenous. Bohm-Bawerk (1959 ) identified th e principle o f the "productiv ity o f wisel y chose n roundabou t method s o f production " t o ex plain th e usefulnes s o f higher-orde r goods . Productio n o f higher order good s require s sacrific e o f consumptio n o f presen t goods , that is , i t require s savings , an d th e exten t o f saving s depend s on th e tim e preferenc e o f individuals . Th e rat e o f interes t i s th e manifestation o f thi s tim e preference ; i t i s the pric e o f a facto r o f production tha t ma y b e calle d "waiting, " a s onl y wit h a laps e o f time ca n higher-orde r good s ca n b e converte d int o lower-orde r goods. A competitively determine d marke t rat e o f interes t guide s entrepreneurs i n decidin g i n whic h stag e o f production (o r whic h order o f goods) it wil l be profitable t o invest. If people hav e lowe r time preference s an d s o ar e savin g mor e an d th e interes t rat e falls, entrepreneur s woul d exten d th e lengt h o f th e structur e o f production, tha t is , invest relatively mor e in higher-order goods. 11 This Austria n "time-structural " conceptio n o f capita l wa s at tacked earl y o n b y J . B . Clar k an d late r b y Fran k Knight . Th e Clark-Knight conceptio n o f capita l wa s tha t o f a "homogenou s blob" wit h a flexibilit y o f "putt y clay " (perfec t substitutabilit y and no complementarity). They likened capital stock to a reservoi r where wate r flows i n (production ) an d ou t (consumption) , but th e reservoir itsel f remain s a permanen t quantity . Knigh t contende d "all capita l i s inherentl y perpetual " (quote d i n Skouse n 1990 , 68). Clar k an d Knigh t viewe d productio n an d consumptio n a s synchronized an d simultaneous , an d denie d tha t an y waiting wa s

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involved i n th e productio n process . "Toda y w e work , an d toda y we eat ; an d th e eatin g i s th e effec t o f working " (Clar k quote d i n Skousen 1990 , 29) . The Clark-Knigh t "stock-flow' ' vie w o f capita l was i n direc t contras t wit h th e Austria n time-structura l view . The Clark-Knigh t concep t o f capita l wa s late r formalize d i n the Harrod-Doma r growt h model . Th e mode l treate d capita l a s perfectly homogenous , symbolize d b y th e lette r K, puttin g asid e the Austria n distinctio n o f variou s order s o f capita l goods , th e significance o f their relativ e prices , and variou s degree s o f comple mentarity an d substitutabilit y amon g capita l goods . All tha t mat tered fo r economi c growt h wa s th e stoc k an d productivit y o f capi tal, an d no t ho w th e heterogenou s capita l good s wer e create d an d employed t o for m a n orderl y structur e o f productio n i n a marke t economy i n congruenc e wit h people' s tim e preferences . Focus o n th e stoc k o f capita l an d explici t neglec t o f th e struc ture o f capital , couple d wit h Keynes' s parado x o f thrif t (popular ized b y th e famou s exampl e o f a thrif t campaig n o n a b a n a n a plantation) an d th e contention s tha t privat e investment s ar e driven b y "anima l spirits " an d engulfe d i n th e "dar k force s o f time an d ignorance, " an d tha t liquidit y preference s an d no t tim e preferences determin e interes t rates , pave d th e wa y fo r th e large r role o f governmen t i n savin g an d investmen t decisions . "Perhap s the ultimat e solutio n lie s i n th e rat e o f capita l developmen t be coming mor e largel y a n affai r o f state , determine d b y collectiv e wisdom an d lon g views " (Keyne s 1930 , 2: 163) . Austrians emphasiz e bot h th e stoc k a s wel l a s th e structur e o f capital. I t i s th e structur e o f capita l tha t determine s whethe r i t i s employed accordin g t o th e preference s o f individual s i n th e econ omy, tha t is , whethe r i t i s sociall y productiv e an d whethe r i t ca n be sustaine d ove r a perio d o f time .

Financial Intermediation : Th e Significanc e o f Banker s Financial intermediatio n i s typically achieve d throug h capita l (eq uity) an d credi t (debt ) markets . Developin g countries , whic h McKinnon aptl y describe s a s "fragmente d economies, " posses s incomplete an d imperfec t capita l markets ; generall y " t h i n " mar -

Money and Capital i n Economic Developmen t 2 5 kets lackin g i n a requisit e arra y o f financial instrument s t o mee t the varyin g need s o f customer s i n term s o f maturity , liquidity , denomination, an d ris k sharing . Economi c growt h i n developin g countries is , therefore , substantiall y finance d throug h credi t markets. One ca n eve n lin k th e natur e o f financial intermediatio n wit h the leve l o f economic development . I n primitiv e economies , firms rely o n self-financin g an d outsid e finance i s available onl y o n th e basis o f persona l relationships . Developin g economie s hav e well heeled forma l (o r informa l whe n forma l market s ar e repressed ) credit market s an d embryoni c capita l markets . Develope d econo mies hav e acces s t o almos t complet e an d rathe r well-performin g credit a s wel l a s capita l markets . In fact , i n develope d economie s financing o f productio n i s don e largel y o n capita l market s whil e that o f consumption i s on credit markets . Within credi t markets , th e bankin g syste m play s th e centra l role i n financial intermediatio n i n developin g economies . Mar shall, i n hi s Industry and Trade, praise s th e nineteenth-centur y German banking system and the bankers for courage and foresigh t in financing ne w products and technologies . Cameron (1967 , 1972) provides persuasiv e evidenc e o n th e crucia l rol e playe d b y bank ing systems in the early stage s of industrialization o f the West. He argues tha t wheneve r bank s hav e bee n lef t free , the y hav e gener ally performe d a growth-inducing rol e an d hav e hardly eve r bee n a hindranc e t o economi c growth . Recen t cas e studie s o f newl y developed countrie s als o indicate th e pivotal rol e played b y bank ing system s (an d monetar y policies ) i n economi c development . (See Lau 198 6 for th e analysis of South Kore a an d Taiwan. )

Pure Intermediation and Creative Intermediation Banks ar e uniqu e amon g financial intermediarie s becaus e onl y they perfor m tw o functions simultaneously—thos e o f providing a payments syste m an d financial intermediation . Th e monetar y na ture of banks' liabilities an d thei r powe r t o create payment medi a distinguish the m from nonban k financial intermediaries . Focusin g on th e abilit y t o creat e paymen t medi a o r purchasin g power , w e

26 P a r t h J . S h a

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can differentiat e financial intermediatio n int o tw o categories . One, pur e intermediatio n don e b y nonban k intermediarie s (mer chant banks , investmen t banks , insuranc e companies , mutua l funds); second , creativ e intermediatio n o f banking systems . It i s th e extensio n o f credi t b y bank s abov e th e actua l amoun t of saving s don e i n a n econom y whic h seem s t o symboliz e th e dynamic proces s o f economic growth . "Th e creatio n o f purchasin g power characterizes , i n principle/ ' Schumpete r argues , "th e method b y whic h developmen t i s carrie d ou t i n a syste m wit h private propert y an d divisio n o f labor " (1955 , 107) . H e furthe r states: The banker , therefore , i s no t s o muc h primaril y a middlema n i n th e commodity 'purchasin g power ' a s a producer of thi s commodit y . . . [H]e has himself become the capitalist par excellence. He stands between thos e who wis h t o for m ne w combination s an d th e possessor s o f productiv e means. H e i s essentiall y a phenomeno n o f developmen t . . . H e make s possible th e carryin g ou t o f new combinations , authorize s people , in th e name o f society a s it were, to form them . He is the ephor o f the exchang e economy. (1955, 74). Whether bank s abilit y t o creat e purchasin g powe r woul d b e used i n way s tha t ar e sociall y productiv e depend s o n th e institu tional structur e o f th e bankin g system : th e incentive s an d infor mation whic h guid e th e decision s o f th e peopl e operatin g th e banking system . Th e rol e o f banker s i n th e proces s o f creativ e intermediation deserve s mor e attentio n an d analysis . Th e ter m " b a n k e r " mus t b e understoo d i n a functiona l sens e an d no t so muc h i n th e sens e o f ownership ; banker s ar e th e peopl e eval uating an d decidin g o n th e financing o f projects , whic h coul d be thos e submitte d b y other s (loa n applications) , o r thei r ow n (in absenc e o f an y barrie r betwee n commercia l an d investmen t banking). One wa y t o begi n appraisin g th e significanc e o f banker s i n creative intermediatio n an d thereb y i n economi c developmen t i s to analyz e variou s existin g view s o n th e rol e an d functio n o f bank ers—views fro m (th e mainstream ) developmen t economics , fro m the Austria n School , an d fro m tha t pionee r o f developmental anal ysis, Schumpeter . Give n th e shortcoming s o f thes e thre e views , a modified Austria n (Neo-Austrian ) vie w i s outlined .

Money and Capital in Economic Developmen t 2 7 Bankers as Bureaucrats Much o f developmen t economic s suffer s fro m wha t Deepa k La i (1985) has called "dirigiste dogma/' Th e mainstream believe s tha t the pric e mechanis m o r th e marke t econom y mus t b e supersede d by direct governmen t controls ; that governmen t mus t formulat e a " development strategy " i n term s o f macro accountin g aggregate s such a s investment , savings , essentia l consume r goods , an d bal ance o f payments ; an d tha t fre e trad e i s no t onl y irrelevan t bu t detrimental t o development . I n thi s developmen t mode l domi nated b y central/indicative/informativ e planning , th e rol e o f financial intermediarie s i s simpl y tha t o f carryin g ou t th e dict a o f the planning boards . In mos t cases, banking systems are national ized o r subjecte d t o suc h detaile d regulation s an d control s tha t they are turned largel y int o plan-implementing agencies. 12 To control th e allocatio n o f resources t o sector s an d industrie s chosen i n th e "developmen t strategy/ ' LD C government s hav e established sector - o r industry-specifi c developmen t banks , hav e fixed credi t targets , an d hav e pu t ceiling s o n deposi t an d loa n rates of interest. Only imagination seem s to be the limi t fo r creat ing developmen t banks : Industria l Developmen t Bank , Agricul tural Developmen t Bank , Smal l Busines s Developmen t Bank , Handicraft Developmen t Bank , Rural Developmen t Bank , and th e list goes on. Under governmen t domination , price s i n th e credi t markets , especially interes t rates , d o not reflec t underlyin g economi c scar cities an d preferences . Government s routinel y kee p interes t rate s below market-clearin g level s an d the n ratio n credi t t o favore d sectors of the economy, creating a situation o f financial repressio n and dualism. Interest rate ceilings also cause disincentives to save, lower th e amount s o f deposit s availabl e t o bank s fo r intermedia tion, and driv e the growin g sector s of the economy no t favore d b y the governmen t t o informa l credi t market s (Chandavarka r 1987) . Government-mandated lo w interes t rate s creat e a bia s i n favo r of capital-intensiv e project s i n countrie s wit h a n abundanc e o f idle labor . Under th e mainstrea m mode l o f development , banker s d o no t play an y significan t independen t rol e i n financial intermediation .

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There i s very littl e room fo r individua l banker s t o exercise discre tion amon g project s t o b e financed. Banker s ar e nothin g bu t an other bunch o f bureaucrats.

Bankers as Tellers Within th e Austria n school , two rather differen t view s of bankin g dominate. One , le d b y Murra y Rothbar d ([1962 ] 1970 , 698-708) , advocates 10 0 percent reserv e bankin g an d consider s an y typ e o f fractional reserv e bankin g a s fraudulent. I t contend s tha t an y ol d quantity o f money i s sufficient t o lubricate transaction s a s long a s the pric e leve l i s fre e t o adjust . Th e othe r vie w o f free-bankin g theorists, le d b y Selgin , White , an d Yeager , contend s tha t wit h appropriate operational definitio n o f the monetary unit, fractiona l reserve bankin g coul d provid e a stabl e monetar y environment . After fixing the unit o f account, banks can be left fre e t o adjust th e supply o f money , o r rathe r medi a o f exchange , t o th e deman d for them . Both group s hav e largel y focuse d thei r analyse s onl y o n on e function o f th e bankin g system , tha t o f th e provisio n o f paymen t services. The questio n o f financial intermediatio n an d th e rol e of bankers i n tha t proces s hav e no t receive d muc h attentio n fro m either group. 13 I n term s o f ou r distinctio n o f pur e an d creativ e intermediation, the y implicitl y see m t o highlight onl y pure inter mediation an d dismis s or reject th e other . Though Austrians have always emphasized th e role of entrepreneurs i n economi c coordination , banker s ar e hardl y eve r use d a s models o f entrepreneurship . On e are a wher e banker s d o receiv e some attention i s the Austrian business cycle theory. In the theory , when a centra l ban k augment s th e poo l o f reserves o r lower s th e discount rat e (strictl y speakin g bring s th e marke t rat e belo w th e natural rat e o f interest) , banker s predictabl y respon d b y ex panding credi t an d obligin g th e econom y "t o bit e mor e tha n i t can chew. " Lowerin g o f th e interes t rat e make s investment s i n higher-order good s mor e profitabl e tha n thos e i n lower-orde r goods. Th e resultan t lengthenin g o f th e structur e o f productio n cannot actuall y b e sustaine d sinc e rea l saving s hav e no t change d

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("money i s masqueradin g a s savings 1 ')• Th e artificiall y induce d boom ultimatel y come s t o a n end . In th e Austria n busines s cycl e theory , give n th e suppl y o f credi t (as determine d b y th e centra l bank) , banker s respon d t o firms ' requests fo r loan s lik e teller s respon d t o customers ' request s fo r withdrawal o f funds . Banker s ar e nothin g bu t anothe r bunc h o f tellers. Bankers as Surfers In th e Schumpeteria n view , th e hear t o f th e capitalis t proces s i s the "perennia l gal e o f creativ e destruction/ ' Entrepreneur s ar e competing primaril y no t i n term s o f price s bu t i n generatin g ne w products, technologies , resources , an d mode s o f organization . Faced wit h suc h allurin g project s an d engulfe d i n spreadin g opti mism, banker s pu t asid e thei r natura l conservativ e an d cautiou s attitudes an d enabl e th e entrepreneur s t o materializ e thei r dreams. "Windfal l gains , risin g prices , an d s o o n produc e wave s of o p t i m i s m " (Schumpete r 1982 , 141) . Banker s d o exercis e thei r skills an d judgment s i n evaluatin g th e projec t proposals , bu t e x hypothesi, larg e enoug h project s mus t ge t funde d i f th e gal e (o f entrepreneurial discoveries ) i s t o creat e wave s instea d o f ripples . Bankers certainl y pla y a significan t rol e i n th e Schumpeteria n schema an d the y ar e accuratel y calle d ephor s o r overseer s o f capi talist economi c developmen t (1955 , 74) . Bu t fo r Schumpeter , th e theory o f economi c developmen t i s bu t a par t o f th e theor y o f (capitalist) busines s cycles ; economi c growt h i s th e resul t o f cycli cal fluctuations. 14 [I]t i s by no means farfetche d o r paradoxical t o say that 'progress ' unsta bilizes th e economi c world , o r tha t i t i s b y virtu e o f it s mechanis m a cyclical process . . . . [Pjublic opinio n [has ] persiste d i n tacitl y assumin g that "progress " is one thing (and naturally smooth ) while fluctuations ar e another thing , differing fro m it , perhaps inimica l t o it. It is, after all , only common sens e t o realiz e that , bu t fo r th e fac t tha t economi c lif e i s i n a process o f mcessan t internal change , th e busines s cycle , a s w e kno w it , would not exist. (Schumpeter 1982 , 138) Schumpeter's busines s cycl e theor y i s based o n som e composit e of variou s wave s o f differin g amplitude s an d frequencies . An d

30 Part h J. Sha h since hi s theor y o f economi c developmen t i s a n elemen t o f th e overarching theor y o f the business cycle , in th e ultimate analysis , Schumpeterian banker s ar e surfer s o n variou s Juglar , Kitchin , and Kondratief f waves . The y reall y canno t avoi d th e temptatio n of surfing o n the waves of discoveries or are unable t o hold firm i n sight o f their surfing comrades .

Bankers as Equilibrists The modifie d Austria n view 15 cast s banker s i n a genuinel y entre preneurial rol e i n bot h function s o f a bankin g system : i n equili brating th e suppl y o f an d deman d fo r medi a o f exchange , an d i n evaluating creative intermediation projects . (Austrians have so far focused largel y o n th e payment s function. ) I t accept s th e Schum peterian visio n o f banker s a s ephor s o r overseer s o f capitalis t development, especiall y durin g th e earl y stage s o f industrializa tion an d i n developin g economies . A t th e sam e time , i t doe s no t accept the other part of the Schumpeterian schema , that capitalis t economic developmen t occur s onl y throug h cyclica l busines s fluctuations. If Schumpeter had th e benefits o f recent historical an d theoreti cal researc h o n fre e bankin g (Selgi n 1988 ; White 1984 ; Greenfiel d and Yeage r 1983) , h e coul d easil y hav e separate d hi s theor y o f economic developmen t fro m tha t o f th e busines s cycle. 16 Instea d of relyin g o n banker s surfin g o n "wave s o f optimism " t o finance growth, Schumpete r coul d a s wel l hav e relie d o n th e profit-moti vated entrepreneuria l judgment s o f bankers . Jus t a s i t i s un profitable t o expan d suppl y o f medi a o f exchang e beyon d th e demand fo r them , i t woul d b e unprofitabl e t o expan d credi t be yond prudentia l margin s o f risk . Th e interes t rat e b y itsel f doe s not ratio n credit ; individua l bankers ' judgments abou t th e viabil ity o f project s ar e a t leas t a s important. 17 "Smoot h growth " i s possible i n a capitalist econom y wit h th e institutiona l framewor k of free banking . Bankers evaluat e project s no t onl y wit h thei r technica l financial expertise bu t als o with thei r knowledge an d understandin g o f local, regional , an d national/globa l markets . Activ e involvemen t

Money and Capital i n Economic Developmen t 3 1 by bankers results in democratization o f the investment process — the loa n applican t mus t convinc e a t leas t a fe w othe r individual s of the viability o f the project . Moreover, banker s perfor m a grea t balancin g act—balancin g the interests of their depositors , creditors, and loa n applicants . To create an d maintai n thei r reputatio n an d profits , the y lear n als o to balanc e genera l trend s i n th e econom y wit h thei r individua l judgments. Neo-Austrian banker s are equilibrists .

Policy Implication s I conclude with th e following brie f sketc h of the nature o f reform s that ar e necessar y i n orde r fo r bankin g system s an d banker s t o perform thei r appropriat e role s i n economic development—i n or der fo r the m t o ac t a s efficien t financial intermediarie s creatin g and converting credi t int o real capital . 1. Privatize the banking system. Nationalize d o r minutel y regu lated bankin g system s leav e n o room fo r th e equilibris t rol e of bankers. Bureaucrati c banker s ar e a drai n o n th e publi c trea sury, pron e t o corruption , an d ris k avers e i n fundin g indige nous discoveries , preferrin g th e saf e copyin g o f foreig n prod ucts an d technologies . Th e benefit s o f financial liberalizatio n and th e removal o f interest rat e ceiling s that g o with privatiza tion ar e b y no w wel l documente d (Fr y 1988 ; Kapur 1986 ; La u 1986). Privatization allow s prices to reflect tru e economic realities i n th e financial market s an d perfor m thei r allocative , cal culative, an d integratin g functions . I t woul d tur n informa l credit market s int o formal one s and thereb y reduc e inefficienc ies in the process of financial intermediation . 2. Reforms that encourage bankers to take long-run view and reward independence in judgment (as opposed to following the herd). Break artificia l barrier s betwee n commercia l an d investmen t banking; allow equity and managemen t participatio n b y bank s in th e companie s the y finance (Japa n an d Wes t German y hav e very successfully use d this route for their development an d als o in maintaining thei r lea d i n th e world); 18 eliminate o r severel y

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restrict government-provide d deposi t insurance ; allo w fre e en try an d exi t i n th e bankin g system . Notes 1. Despit e the fact tha t Robbins' s work was highly influence d b y Austrians, for th e Austrian s th e allocatio n proble m command s littl e atten tion as it is limited t o the realm o f "the Pure Logic of Choice" (Hayek [1937] 1980 , 47ff.). Th e mai n theoretica l focu s ha s bee n o n coordina tion an d spontaneousl y generate d orde r o f th e socia l system . I n th e preface t o th e first edition , Robbin s explicitl y recognize s Austria n influence: " I shoul d like , however , onc e mor e t o acknowledg e m y especial indebtedness to the works of Professor Ludwi g von Mises . . ." ([1932] 1984 , xliii). 2. Fo r furthe r elaboratio n o f thi s lin k an d it s ramifications , see Bu chanan (1979) , chapter 1 . 3. Eve n among th e Austrians, various interpretations o f Robbins's wor k exist (Buchana n 1979 ; Kirzne r 1988 ; Lavoi e 1985) . Th e interpreta tion take n her e i s mor e i n lin e with thos e o f Buchanan an d Kirzner . 4. Garriso n write s o n "Tim e an d Money : Th e Universal s o f Macroeco nomic Theorizing " (1984). 5. Recentl y Garriso n (1991 ) ha s urge d th e professio n t o "pu t capita l back int o macr o theory, " an d creat e a unifie d macroeconomics . H e provides a history o f how capital an d mone y were once main charac ters i n th e macr o dram a an d ho w bot h hav e bee n cas t asid e i n th e Keynesian revolution . Monetaris t counterrevolutio n ha s rehabili tated mone y an d th e rea l busines s cycl e theorist s ar e attemptin g t o bring bac k capital , albei t ver y crudely , throug h thei r "tim e t o build" hypothesis . 6. Fo r a discussion o f these various monetar y policies/constitution s an d their comparativ e evaluations , se e Dow d (1989) . Fo r elaboratio n o f the workin g o f a fre e bankin g syste m base d o n gold , se e Selgi n (1988); an d fo r a fre e bankin g base d o n a commodit y bundle , see Greenfield an d Yeage r (1983) . 7. Bu t see th e reference s i n not e 6 abov e fo r a might y effor t i n per suasion. 8. Kapu r (1986, chapter 1 ) supplies documentary evidenc e and a forma l model o f the proposition . He also details th e counterarguments fro m McKinnon an d Shaw . Se e also Fr y (1988). 9. I n thei r discussio n o n th e effect s o f inflation , Kesse l an d Alchia n (1962) earl y recognize d complementarit y betwee n mone y an d capi tal. However , the y mak e a distinctio n betwee n short-live d an d long lived capita l goods , and argu e tha t onl y th e short-lived capita l good s are complementar y t o cash balances .

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10. Du e t o spac e constraints , I coul d onl y provid e a rathe r simplifie d version o f Austria n capita l theor y an d th e debate s wit h Clark , Knight, an d others . Fo r a detaile d account , see Kirzne r (1966 ) an d Skousen (1990) . Th e semina l wor k o n complementarit y an d substi tutability o f capita l goods , an d thei r significanc e fo r capita l theor y and economi c policy , i s Lachmann (1978) . 11. Increase d investment s woul d generall y ad d t o th e siz e a s well a s th e length o f the structur e o f production. But a falling interes t rat e (o r a falling rat e of discount a t whic h futur e value s ar e discounted ) make s it mor e profitabl e t o invest i n higher-order goods . 12. Th e socialis t economie s o f Chin a an d forme r Sovie t Unio n provid e clear examples of banking systems functioning a s plan-implementin g agencies. Even i n countries lik e India whic h hav e nationalized bank ing systems , a substantia l par t o f credi t i s allocate d accordin g t o government directives . 13. Selgi n (1989) , who has touche d upo n th e issue , has stake d ou t a mid dle groun d betwee n th e "Old " an d "New " (Tobin's ) view s o f bank ing. But eve n here th e primary questio n i s regarding th e existence of limits t o credi t expansio n b y fre e banks . Bankers ' entrepreneuria l role i s limite d t o equilibratin g suppl y wit h th e deman d fo r medi a of exchange . 14. I n fact , th e subtitl e o f Schumpeter' s celebrate d boo k The Theory of Economic Development (1955 ) i s "A n Inquir y int o Profits , Capital , Credit, Interest , an d th e Busines s Cycle. " 15. Th e firs t choic e tha t cam e t o min d t o symboliz e th e modifie d Aus trian vie w wa s "banker s a s entrepreneurs. " Camero n (1963 ) wrot e an articl e wit h a simila r title . Eve n thoug h i t capture s th e spiri t o f the argument , entrepreneu r seem s t o be to o broad a term . I decide d to focu s o n th e specifi c natur e o f bankers ' entrepreneurship—tha t of balancin g payment s an d intermediatio n services , an d interest s o f depositors, creditors, an d loa n applicants . 16. Th e Scottis h free-bankin g episod e provide s convincin g evidenc e o f economic growt h withou t significan t busines s fluctuations (Whit e 1984). Adam Smit h als o noted: "Tha t th e trad e an d industr y o f Scot land . . . hav e increase d ver y considerabl y durin g thi s period , an d that th e bank s hav e contribute d a goo d dea l t o thi s increase , canno t be doubted " ([1776 ] 1976 , 281). 17. Yes , there i s credit rationin g a s claimed b y Stiglitz an d Weis s (1981), not becaus e o f adverse selectio n o r mora l hazar d bu t du e t o bankers' judgments abou t th e viabilit y o f projects . 18. Th e succes s o f Germa n "universal " o r "mixed " bank s i s wel l docu mented b y Cameron (1967) .

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References Bartlett, Bruc e R . 1992 . "Keynesia n Polic y an d Developmen t Econom ics/' I n Dissent on Keynes, ed . Mar k Skousen , 103-16 . Ne w York : Praeger. Bohm-Bawerk, Euge n von . 1959 . Capital and Interest. Sout h Holland , 111.: Libertarian Press . Buchanan, Jame s M . 1979 . What Should Economists Do? Indianapolis : Liberty Press . Cameron, Rondo . 1963 . "The Banke r a s Entrepreneur. " Explorations in Entrepreneurial History l(Fall) : 50-55. . 1967 . Banking in the Early Stages of Industrialization. Ne w York : Oxford Universit y Press . , ed. 1972 . Banking and Economic Development: Some Lessons from History. Ne w York: Oxford Universit y Press . Chandavarkar, Anan d G . 1987 . Informal Financial Sector in Developing Countries. Kuala Lumpur : SEACE N Centre. Dowd, Kevin . 1989 . The State and the monetary System. Ne w York : St . Martin's Press . Fry, Maxwell J . 1988 . Money, Interest, and Banking in Economic Development. Baltimore: Johns Hopkins University Press . Garrison, Roger W. 1984. "Time and Money: The Universals of Macroeconomic Theorizing." Journal of Macroeconomics 6(Spring) : 197-213. . 1991 . "Austrian Capita l Theor y an d th e Futur e o f Macroeconom ics." In Austrian Economics, ed . Richard M. Ebeling, 303-24. Hillsdale, Mich.: Hillsdale College Press. Goldsmith, Raymon d W . 1969 . Financial Structure and Development. New Haven: Yale University Press . Greenfield, R . L. , and Lelan d B . Yeager. 1983 . "A Laissez faire Approac h to Monetar y Stability. " Journal of Money, Credit and Banking 15 : 302-15. Hayek, F . A . [1937 ] 1980 . "Economic s an d Knowledge. " I n hi s Individualism and Economic Order, 33-56 . Chicago : Universit y o f Chicag o Press. . [1945] 1980 . "The Use of Knowledge in Society," in his Individualism and Economic Order, 77'-91. Kapur, Basant K . 1986 . Studies in Inflationary Dynamics. Singapore : Sin gapore University Press . Kessel, R . A. , an d A . A. Alchian. 1962 . "Effects o f Inflation. " Journal of Political Economy 70 : 521-37. Keynes, J. M. 1930. A Treatise on Money. London: Macmillan .

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Kirzner, Israe l M . 1966 . An Essay on Capital. Ne w York : Augustu s M . Kelley. 1988. "The Economic Calculation Debate : Lessons for Austrians. " Review of Austrian Economics, 2: 1-18 . Lachmann, Ludwig M. 1978. Capital and its Structure. Kansa s City: Shee d Andrews and McMeel . Lai, Deepak. 1985 . The Poverty of "Development Economics." Cambridge : Harvard Universit y Press . Lau, Lawrenc e J . 1986 . Models of Development. Sa n Francisco : Institut e for Contemporary Studie s Press. Laumas, Prem S . 1990 . "Monetization, Financial Liberalization , and Economic Development. " Economic Development and Cultural Change 38( January): 377-90. Lavoie, Don . 1985 . Rivalry and Central Planning. Cambridge : Cambridg e University Press . Leijonhufvud, Axel . 1981 . "Cost s an d Consequence s o f Inflation. " Re printed i n hi s Information and Coordination, 227-70 . Ne w York : Ox ford Universit y Press . Levin, Peter , 1982 . "Perspective s o n th e Cost s o f Inflation. " Southern Economic Journal 48( January): 627-41 . McKinnon, R. I. 1973. Money and Capital in Economic Development. Washington, D.C.: Brookings Institution . Menger, Carl. 1976. Principles of Economics. Ne w York: New York University Press. Mises, Ludwig von. 1976. Human Action. 3 d revised ed., Chicago: Contemporary Books. 1981. Socialism. 2 d enlarged ed., Indianapolis: Liberty Press . Robbins, Lionel . [1932 ] 1984 . An Essay on the Nature and Significance of Economic Science. 3 d ed., New York: New York University Press. Rothbard, Murray N . [1962] 1970 . Man, Economy, and State. Los Angeles: Nash Publishing . Schumpeter, Josep h A . 1955. The Theory of Economic Development. Cam bridge: Harvard Universit y Press . 1982. Business Cycles. Philadelphia: Porcupine Press . Selgin, Georg e A . 1988 . The Theory of Free Banking. Totowa , N.J. : Row man & Littlefield . 1989. "Commercial Bank s as Pure Intermediaries: Between "Old " and "New" Views." Southern Economic Journal (July): 80-92. Shaw, E . S . 1973 . Financial Deepening in Economic Development. Ne w York: Oxford Universit y Press . Skousen, Mark . 1990 . The Structure of Production. Ne w York : Ne w Yor k University Press .

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Skousen, Mark . 1991 . "Austrian Capita l Theor y an d Economi c Develop ment i n th e Thir d World. " I n Austrian Economics, ed . Richar d M . Ebeling, 355-78. Hillsdale, Mich.: Hillsdale College Press. Smith, Adam. [1776 ] 1976 . The Wealth of Nations. Chicago : Universit y o f Chicago Press. Stiglitz, Joseph E., and Andrew Weiss. 1981. "Credit Rationing in Markets with Imperfec t Information. " American Economic Review 71(June) : 393-410. Todaro, Michael. 1989 . Economic Development in the Third World. 4t h ed . New York: Longman . White, Lawrence H. 1984. Free Banking in Britain. Cambridge : Cambridg e University Press .

3 The Theor y o f Economi c Developmen t and th e " European Miracle " Ralph Raic o

Introduction Among writer s o n economi c development , P . T . Baue r i s note d both fo r th e dept h o f hi s historica l knowledge , an d fo r hi s insis tence o n th e indispensabilit y o f historica l studie s i n understand ing th e phenomeno n o f growt h (Walter s 1989 , 60 ; se e als o Dor n 1987). I n canvassin g th e wor k o f othe r theorists , Baue r ha s com plained o f thei r manifes t " a m p u t a t i o n o f th e tim e dimension" : The historica l backgroun d i s essentia l fo r a worthwhil e discussio n o f economic development , whic h i s a n integra l par t o f th e historica l prog ress o f society . Bu t man y o f th e mos t widel y publicize d writing s o n development effectivel y disregar d bot h th e historical backgroun d an d th e nature of development a s a process. (Bauer 1972 , 324-25) Too man y writer s i n th e field hav e succumbe d t o professiona l overspecialization combine d wit h a positivis t obsessio n wit h dat a that happe n t o b e amenabl e t o mathematica l techniques . Th e result ha s bee n model s o f developmen t wit h littl e connectio n t o reality: Abilities and attitudes , mores an d institutions , cannot generall y b e quan tified i n a n illuminatin g fashion . . . . Ye t the y ar e plainl y muc h mor e 37

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important an d relevan t t o development tha n suc h influence s a s the term s of trade , foreig n exchang e reserves , capita l outpu t ratios , o r externa l economies, topic s whic h fill th e page s o f th e consensu s literature , (ibid. , 326) Even whe n a write r appear s t o approac h th e subjec t histori cally, concentratio n o n quantifiabl e dat a t o th e neglec t o f underly ing institutiona l an d social-psychologica l factor s tend s t o fore shorten th e chronologica l perspectiv e an d thu s vitiat e th e result : It i s misleadin g t o refe r t o th e situatio n i n eighteenth-an d nineteenth century Europ e a s representin g initia l condition s i n development . B y then th e west wa s pervaded b y the attitudes an d institution s appropriat e to an exchang e econom y an d a technica l ag e t o a far greate r exten t tha n south Asia today. These attitudes an d institution s ha d emerged graduall y over a period of eight centuries. (Ibid., 219-20) 1 At th e roo t o f th e approac h criticize d b y Baue r ther e appear s t o be a methodologica l holis m tha t prefer s t o manipulat e aggregate s while ignorin g individua l h u m a n actor s an d th e institution s thei r actions generate . Yet , "difference s i n people' s capacitie s an d atti tudes an d i n thei r institution s ar e far-reachin g an d deepseate d and largely explain differences in economic performance and in levels and rates of material progress" (ibid. , 313-14 ; emphasi s added) . Bauer's critiqu e thu s draw s attentio n t o th e nee d t o stud y bot h the centurie s o f Europea n histor y antedatin g th e Industria l Revo lution an d "th e interrelationship s betwee n social , political , an d legal institutions " i n tha t perio d (ibid. , 211)? Her e hi s assessmen t links u p wit h a n impressiv e bod y o f scholarshi p tha t ha s emerge d in recen t year s emphasizin g precisel y thes e points . The "Europea n Miracle " While i t woul d b e wron g t o sugges t th e existenc e o f an y mono lithic analysis , a n u m b e r o f scholar s concerne d wit h th e histor y o f European growt h hav e tende d t o converg e o n a n interpretatio n highlighting certai n distinctiv e factors . Fo r th e sak e o f conve nience, w e shall , therefore , spea k o f them , despit e thei r differ ences, a s formin g a schoo l o f thought . Th e viewpoin t ma y b e referred t o a s th e "institutional"—or , t o us e th e titl e o f on e o f th e best-known work s i n th e field—th e "Europea n miracle " ap proach. 3

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The "miracle' ' i n questio n consist s i n a simpl e bu t momentou s fact: I t wa s i n E u r o p e — a n d th e extension s o f Europe , abov e all , America—that h u m a n being s first achieve d pe r capit a economi c growth ove r a lon g perio d o f time . I n thi s way , Europea n societ y eluded th e "Malthusia n t r a p , " enablin g ne w ten s o f million s t o survive an d th e populatio n a s a whol e t o escap e th e hopeles s misery tha t h a d bee n th e lo t o f th e grea t mas s o f th e h u m a n rac e in earlie r times . The questio n is : why Europe ? One possibl e answer , whic h ha s lon g enjoye d powerfu l suppor t in intellectua l circle s i n th e Wes t an d amon g official s i n underde veloped countries , wa s heavil y influence d b y socialis t an d eve n Marxist tenets. 4 I t accounte d fo r Europe' s extraordinar y growt h largely b y th e mor e o r les s spontaneou s advanc e o f science , com bined wit h a "primitiv e accumulation 1 ' o f capital—through impe rialism, slaver y an d th e slav e trade , th e expropriatio n o f smal l farmers, an d th e exploitatio n o f th e domesti c workin g class . Th e conclusion wa s clear . Th e extraordinar y growt h o f Europ e wa s a t the expens e o f untol d million s o f th e enslave d an d downtrodden , and th e Europea n experienc e shoul d serv e decisio n maker s i n underdeveloped countrie s mor e a s a cautionar y tal e tha n a n ex emplar. The contributor s t o th e newe r model , however , rejec t thi s ven erable legend . Concerne d a s the y ar e wit h comparativ e economi c history, the y hav e sough t fo r th e origin s o f Europea n developmen t in wha t ha s tende d t o se t Europ e apar t fro m othe r grea t civiliza tions, particularl y thos e o f China , India , an d Islam . T o on e degre e or another , thei r answe r t o th e question , wh y Europe ? ha s been : Because Europ e enjoye d a relativ e lac k o f politica l constraint . A s Jean Baechler , i n a pioneerin g work , pointedl y expresse d it : The first conditio n fo r th e maximizatio n o f economi c efficienc y i s th e liberation o f civi l societ y wit h respec t t o th e state . . . . The expansion of capitalism owes its origins and raison d'etre to political anarchy. (Baechle r 1975, 77, 113; emphasis i n original ) The Uniquenes s o f Europ e John Hick s partiall y a d u m b r a t e d thi s approac h i n th e lat e 1960 s (Hicks 1969). 5 I n A Theory of Economic History, Hick s lai d ou t th e

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"chief needs' ' o f th e expanding , mercantil e phas e o f economi c development—the protectio n o f propert y an d th e enforcemen t o f contracts—and stated : The Mercantile Economy , i n it s First Phase , was an escap e from politica l authority—except i n s o far a s i t mad e it s ow n politica l authority . Then , in th e Middl e Phase , whe n i t cam e formall y bac k unde r th e traditiona l political authority , tha t authorit y wa s no t stron g enoug h t o contro l it . (Ibid., 33, 100) Hicks's account , however , prove d t o b e muc h to o schematic , besides limitin g itsel f t o economic analysi s an d deliberatel y ignor ing political , religious , scientific , an d othe r factor s (se e Baue r 1971). Around th e sam e tim e a s Hicks , Davi d Lande s wa s sketchin g the essential s o f th e newe r outlook . I n seekin g t o answe r th e ques tion wh y th e industria l breakthroug h occurre d first i n wester n Europe, h e highlighte d tw o factor s " t h a t se t Europ e apar t . . . from th e res t o f th e worl d . . . the scop e an d effectivenes s o f privat e enterprise, an d th e hig h valu e placed o n th e rational manipulatio n of th e h u m a n an d materia l environment' ' (Lande s 1970 , 14—15) . "The rol e o f privat e enterpris e i n th e West, " i n Landes' s view , "i s perhaps unique : mor e tha n an y othe r factor , i t mad e th e moder n world" (ibid. , 15) . But wha t wa s i t tha t permitte d privat e enterpris e t o flourish? Landes pinpointe d th e circumstanc e tha t woul d b e vita l t o th e new interpretation—Europe' s radica l decentralization : Because o f thi s crucia l rol e a s midwif e an d instrumen t o f powe r in a context of multiple, competing polities (th e contras t i s with th e all-encom passing empires of the Orient or the Ancient World), private enterprise i n the Wes t possesse d a socia l an d politica l vitalit y withou t preceden t o r counterpart. (Ibid.; emphasis i n original) Damaging incursion s b y governmen t di d occur , an d th e situa tion i n som e part s o f Europ e conditione d a socia l preferenc e fo r military values ; "o n balance , however , th e plac e o f privat e enter prise wa s secur e an d improvin g wit h time ; an d thi s i s apparen t in th e institutiona l arrangement s tha t governe d th e gettin g an d spending o f w e a l t h" (ibid.) .

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1

A preconditio n o f economi c expansio n wa s th e definitio n an d defense o f propert y right s agains t th e politica l authority . Thi s occurred earl y o n i n Europe . Lande s contrast s th e Europea n method o f regula r taxatio n (supervise d b y assemblie s representa tive o f th e tax-bearin g classes ) wit h th e syste m o f "extortion " prevalent i n "th e grea t Asia n empire s an d th e Musli m state s o f th e Middle Eas t . . . where fines an d extortion s wer e no t onl y a sourc e of quic k revenu e b u t a mean s o f socia l control— a devic e fo r curb ing th e pretension s o f nouveaux riches an d foreigner s an d bluntin g their challeng e t o th e establishe d powe r structure " (ibid. , 16-17). 6 Landes's insights , briefl y sketche d i n a fe w page s o f introduc tion t o his Prometheus Unbound, hav e bee n vastl y elaborate d upo n by th e ne w school . Th e upsho t i s a n overal l interpretatio n o f Western histor y tha t ma y b e state d a s follows : Although geographica l factor s playe d a role , th e ke y t o wester n development i s t o b e foun d i n th e fac t that , whil e Europ e consti tuted a singl e civilization—Lati n Christendom—i t wa s a t th e same tim e radicall y decentralized. 7 I n contras t t o other cultures — especially China , India , an d th e Islami c world—Europ e com prised a syste m o f divide d and , hence , competin g power s an d jurisdictions. After th e fal l o f Rome , n o universa l empir e wa s abl e t o aris e o n the Continent . Thi s wa s o f th e greates t significance . Drawin g o n Montesquieu's dictum , Jea n Baechle r point s ou t tha t "ever y polit ical powe r tend s t o reduc e everythin g tha t i s externa l t o it , an d powerful objectiv e obstacle s ar e neede d t o preven t i t fro m suc ceeding" (Baechle r 1975 , 79). In Europe , th e "objectiv e obstacles " were provide d first o f al l b y th e competin g politica l authorities . Instead o f experiencin g th e hegemon y o f a universa l empire , Eu rope develope d int o a mosai c o f kingdoms , principalities , city states, ecclesiastica l domains , an d othe r politica l entities . Within thi s system , i t wa s highl y impruden t fo r an y princ e to attemp t t o infring e propert y right s i n th e m a n n e r customar y elsewhere i n th e world . I n constan t rivalr y wit h on e another , princes foun d tha t outrigh t expropriations , confiscator y taxation , and th e blockin g o f trad e di d no t g o unpunished. Th e punishmen t was t o b e compelle d t o witnes s th e relativ e economi c progres s o f one's rivals , ofte n throug h th e movemen t o f capital , an d capital -

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ists, t o neighborin g realms . Th e possibilit y o f "exit, " facilitate d by geographica l compactnes s and , especially , b y cultura l affinity , acted t o transfor m th e stat e int o a "constraine d p r e d a t o r " (Ander son 1991 , 58) Decentralization o f powe r als o cam e t o mar k th e domesti c ar rangements o f th e variou s Europea n polities . Her e feudalism — which produce d a nobilit y roote d i n feuda l righ t rathe r tha n i n state-service—is though t b y a n u m b e r o f scholar s t o hav e playe d an essentia l rol e (see , e.g. , Baechle r 1975 , 78) . Through th e strug gle fo r powe r withi n th e realms , representativ e bodie s cam e int o being, an d prince s ofte n foun d thei r hand s tie d b y th e charter s o f rights (Magn a Carta , fo r instance ) whic h the y wer e force d t o gran t their subjects . I n th e end , eve n withi n th e relativel y smal l state s of Europe , powe r wa s disperse d amon g estates , orders , chartere d towns, religiou s communities , corps , universities , etc. , eac h wit h its ow n guarantee d liberties . Th e rul e o f la w cam e t o b e estab lished throughou t muc h o f th e Continent . Thus, ther e i s general agreemen t tha t crucia l t o layin g th e foun dations fo r th e Europea n miracl e were , i n Jones' s words , th e "cur tailment o f predator y governmen t ta x behavior " an d "th e limit s to arbitrarines s se t b y a competitiv e politica l a r e n a " (Jone s 1987 , xix, xxi) . Ove r time , propert y rights—includin g right s i n one' s own person—cam e t o be mor e sharpl y defined , permittin g owner s to captur e mor e o f th e benefit s o f investmen t an d improvemen t (North 1981) . With th e free r dispositio n o f privat e propert y cam e the possibilit y o f ongoin g innovations , teste d i n th e market . Here , too, th e rivalrou s state-syste m wa s highl y favorable . Th e nation s of Europ e functione d "a s a se t o f joint-stoc k corporation s wit h implicit prospectuse s listin g resource s an d freedoms " i n suc h a way a s t o insur e "agains t th e suppressio n o f novelt y an d unortho doxy i n th e syste m a s a whole " (Jone s 1987 , 119) . A ne w socia l class arose , consistin g o f merchants , capitalists , an d manufactur ers "wit h immunit y fro m interferenc e b y th e formidabl e socia l forces oppose d t o change , growth , an d innovation " (Rosenber g andBirdzelll986,24). Eventually, th e econom y achieve d a degre e o f autonom y un known elsewher e i n th e worl d excep t fo r brie f periods . A s Jone s puts it :

The ' ' European Miracle' ' 4

3

Economic developmen t i n it s Europea n for m require d abov e al l freedo m from arbitrar y politica l act s concernin g privat e property . Goods and fac tors o f productio n ha d t o b e fre e t o b e traded . Price s ha d t o b e se t b y unconditional exchang e i f the y wer e t o b e undistorte d signal s o f wha t goods and service s really were i n demand , where and i n what quantities . (Jones 1987 , 85) The syste m protectin g th e ownershi p an d deploymen t o f pri vate propert y evolve d i n Europ e b y slo w degrees—ove r a t leas t "the eigh t centuries " mentione d b y Bauer . Quit e logically , there fore, th e economi c historian s concerne d wit h "ho w th e Wes t gre w rich" hav e directe d a grea t dea l o f thei r attentio n t o th e medieva l period.

The Importanc e o f th e Middl e Age s The stereotyp e o f th e Middl e Age s a s "th e Dar k Ages " fostere d by Renaissanc e humanist s an d Enlightenmen t philosophes has , o f course, lon g sinc e bee n abandone d b y scholars . Still , th e "consen sus" writer s o n economi c developmen t who m Baue r fault s hav e by an d larg e ignore d th e importanc e o f th e Middl e Age s fo r Euro pean growth—somethin g tha t make s a s muc h sens e a s beginnin g the explanatio n o f th e economi c an d cultura l successe s o f Euro pean Jewr y wit h th e eighteent h century . Economi c historians , however, followin g i n th e footstep s o f th e grea t Belgia n historia n Henri Pirenn e (Pirenn e 1937) , hav e ha d a quit e differen t estima tion o f th e medieva l period . Carl o M . Cipoll a assert s tha t "th e origins o f th e Industria l Revolutio n g o bac k t o tha t profoun d change i n ideas , socia l structures , an d valu e system s tha t accom panied th e ris e o f th e urba n commune s i n th e elevent h an d thir teenth centuries " (Cipoll a 1981 , 298). Of Europ e fro m th e lat e tent h t o th e fourteent h centuries , Rob ert S . Lopez states : Here, for the first time in history, an underdeveloped societ y succeeded i n developing itself, mostly by its own efforts . . . i t created the indispensabl e material an d mora l condition s fo r a thousan d year s o f virtually uninter rupted growth ; and , i n mor e tha n on e way , i t i s stil l wit h us . (Lope z 1971, vii)

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Lopez contrast s th e Europea n evolutio n wit h tha t o f a neighborin g civilization, Islam , wher e politica l pressure s smothere d th e poten tial fo r a n economi c upsurge : The early centuries of Islamic expansion opened large vistas to merchant s and tradesmen . But the y faile d t o bring t o towns th e freedo m an d powe r that wa s indispensabl e fo r thei r progress . Unde r th e tightenin g gri p o f military an d lande d aristocracie s th e revolution tha t i n the tenth centur y had bee n just aroun d th e corner lost momentum an d failed. (Ibid., 57) In Europe , a s trad e an d industr y expanded , peopl e discovere d that ''commerc e thrive s o n freedo m an d run s awa y fro m constric tion; normall y th e mos t prosperou s citie s wer e thos e tha t adopte d the mos t libera l policies " (ibid. , 90) . Th e "demonstratio n effect " that ha s bee n a constan t elemen t i n Europea n progress—an d which coul d exis t precisel y becaus e Europ e wa s a decentralize d system o f competing jurisdictions—helpe d sprea d th e libera l poli cies tha t brough t prosperit y t o th e town s tha t firs t venture d t o experiment wit h them . Scholars lik e Cipoll a an d Lopez , attemptin g t o understan d Eu ropean developmen t i n th e Middl e Ages , mak e constan t referenc e to ideas, value systems, moral conditions, an d simila r cultura l ele ments. 8 A s Baue r ha s emphasized , thi s i s a par t o f th e distinctiv e European evolutio n tha t canno t b e divorce d fro m it s institutiona l history. I n regar d t o th e Middl e Ages , prim e importance , i n th e view o f man y writers , attache s t o Christianity . Harol d J . Berma n (Berman 1974) 9 ha s stresse d tha t wit h th e fal l o f Rom e an d th e eventual conversio n o f th e Germans , Slavs , Magyars, an d s o forth , Christian idea s an d value s suffuse d th e whol e blossomin g cultur e of Europe . Christia n contribution s rang e fro m th e mitigatio n o f slavery an d a greate r equalit y withi n th e famil y t o th e concept s o f natural law , includin g th e legitimac y o f resistanc e t o unjus t rul ers. Th e Church' s cano n la w exercise d a decisiv e influenc e o n Western lega l systems : "i t wa s th e churc h tha t firs t taugh t West ern m a n wha t a moder n lega l syste m wa s like " (ibid., 59) . Berman, moreover , focuse s attentio n o n a critica l developmen t that bega n i n th e elevent h century : th e creatio n b y Pop e Gregor y VII an d hi s successor s o f a powerfu l "corporate , hierarchica l church . . . independent o f emperors , kings, an d feuda l lords, " an d

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thus capabl e o f foilin g th e power-seekin g o f tempora l authorit y (ibid., 56). 10 In thi s way , Berma n bolster s Lor d Acton' s analysi s o f the centra l rol e o f th e Catholi c churc h i n generatin g Wester n lib erty b y forestallin g an y concentratio n o f powe r suc h a s marke d the othe r grea t cultures , an d thu s creatin g th e Europ e o f divide d and conflictin g jurisdictions. 1 1 In a majo r synthesis , Law and Revolution, Berma n ha s high lighted th e lega l facet s o f the developmen t whos e economic , politi cal, an d ideologica l aspect s othe r scholar s hav e examine d (Ber m a n 1983) : "Perhap s th e mos t distinctiv e characteristi c o f th e Western lega l traditio n i s th e coexistenc e an d competitio n withi n the sam e communit y o f divers e lega l systems . I t i s thi s pluralit y of jurisdiction s an d lega l system s tha t make s th e supremac y o f law bot h necessar y an d possible " (ibid. , 10). 12 Berman's wor k i s i n th e traditio n o f th e grea t Englis h scholar , A. J . Carlyle , who , a t th e conclusio n o f hi s monumenta l stud y of politica l though t i n th e Middl e Ages , summarize d th e basi c principles o f medieva l politics : tha t all—includin g th e king—ar e bound b y law ; tha t a lawles s rule r i s no t a legitimat e king , bu t a tyrant; tha t wher e ther e i s n o justic e ther e i s n o commonwealth ; that a contrac t exist s betwee n th e rule r an d hi s subject s (Carlyl e and Carlyl e 1950 , 503-26) . Other recen t scholarshi p ha s supporte d thes e conclusions . I n his last , posthumou s work , th e distinguishe d historia n o f eco nomic thought , Jaco b Viner , note d tha t th e reference s t o taxatio n by St . Thoma s Aquina s "trea t i t a s a mor e o r les s extraordinar y act o f a rule r whic h i s a s likel y a s no t t o b e morall y illicit " (Vine r 1978, 68-69) . Vine r pointe d t o th e medieva l papa l bull , In Coena Domini—evidently republishe d eac h yea r int o th e lat e eighteent h century—which threatene d t o excommunicat e an y rule r "wh o levied ne w taxe s o r increase d ol d ones , except fo r case s supporte d by law , o r b y a n expres s permissio n fro m th e p o p e " (ibid. , 69) . Throughout th e Wester n world , th e Middl e Age s gav e ris e t o par liaments, diets , estates-generals, Cortes , etc., which serve d t o limi t the power s o f th e monarch. 1 3 A . R. Myer s notes : Almost everywher e i n Lati n Christendo m th e principl e was , at on e tim e or another , accepte d b y th e ruler s that , apar t fro m th e norma l revenue s of th e prince , n o taxe s coul d b e impose d withou t th e consen t o f parlia -

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ment. . . . B y using thei r powe r of the purse [th e parliaments] ofte n influ enced the ruler's policies, especially restraining him from militar y adven tures. (Myers 1975 , 29-30) In a recen t synthesi s o f moder n medievalis t scholarship , Nor m a n F . Cantor ha s summarize d th e heritag e o f th e Europea n Mid dle Age s i n term s strikingl y simila r t o thos e employe d b y th e current institutiona l historians : In th e mode l o f civil society , mos t goo d an d importan t thing s tak e plac e below th e universa l leve l o f th e state : th e family , th e arts , learning , an d science; busines s enterpris e an d technologica l process . Thes e ar e th e work o f individual s an d groups , an d th e involvemen t o f th e stat e i s re mote an d disengaged . I t i s th e rul e o f la w tha t screen s ou t th e state' s insatiable aggressivenes s an d corruptio n an d gives freedo m t o civil soci ety belo w th e leve l o f th e state . I t s o happen s tha t th e medieva l worl d was on e i n whic h me n an d wome n worke d ou t thei r destinie s wit h littl e or no involvement o f the state mos t of the time. (Cantor 1991 , 416) One highl y importan t facto r i n th e advanc e o f th e West , possi bly linke d t o Christianity , ha s not , however , bee n deal t wit h b y the newe r economi c historians . It i s the relativ e lac k o f institution alized env y i n Wester n culture . I n a wor k endorse d b y Bauer , th e sociologist Helmu t Schoec k ha s draw n attentio n t o th e omnipres ence o f env y i n h u m a n societie s (Schoec k [1969 ] 1987) . Perceive d as a grav e threa t b y thos e a t who m i t i s directed , i t typicall y results i n elaborat e envy-avoidanc e behavior : th e attemp t t o war d off th e danger s o f maliciou s env y b y denying , disguising , o r sup pressing whateve r trait s provoke d it . Th e antieconomi c conse quences o f sociall y p e r m i t t e d — o r eve n encouraged—env y an d reactive envy-avoidanc e scarcel y len d themselve s t o quantifica tion. Nonetheless , the y ma y clearl y b e highl y damaging . Drawin g on anthropologica l studies , Schoec k stresse s th e h a rm tha t institu tionalized env y ca n inflic t o n th e proces s o f economi c an d techni cal growt h (ibid. , 73) . Western culture , accordin g t o Schoeck , ha s somehow bee n abl e t o inhibi t env y t o a remarkabl e degree . Wh y this i s s o i s les s clear . Schoec k link s thi s fac t t o th e Christia n faith: "I t mus t hav e bee n on e o f Christianity' s mos t important , i f unintentional, achievement s i n preparin g me n for , an d renderin g them capabl e of , innovativ e action s whe n i t provide d m a n fo r th e first tim e wit h supernatura l being s who , h e knew , coul d neithe r

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envy no r ridicul e h i m " (ibid. , 79) . Ye t th e eviden t variatio n i n socially permitte d env y i n differen t Christia n societie s (e.g. , Rus sia a s agains t wester n Europe ) suggest s tha t th e presenc e o f Chris tian fait h alon e i s not a n adequat e explanation .

Case Studie s o f Developmen t Obviously, al l o f Europ e di d no t progres s a t th e sam e rate . I n particular, i n th e moder n perio d th e Netherland s an d the n En gland becam e th e pacesetter s o f economi c growth , whil e othe r countries declined . Thes e fact s ca n als o b e accounte d fo r b y th e model. The Lo w Countrie s h a d lon g benefite d fro m th e lega l syste m inherited fro m th e duke s o f Burgundy. Thes e rulers , who governe d in collaboratio n wit h a n activ e estates-general, 1 4 ha d promote d a n open commercia l an d industria l system , base d o n protectio n o f property rights . I n th e ris e o f th e "norther n Netherlands' 1 (th e United Provinces , o r "Holland" ) w e hav e a near-perfec t exampl e of th e Europea n miracl e i n operation . First , th e are a ha d bee n a major participan t i n Europea n economic , political , social , an d cultural development s fo r centuries . As Cipolla ha s observed , "Th e country tha t i n th e secon d hal f o f th e sixteent h centur y rebelle d against Spanis h imperialis m an d the n ros e t o th e rol e o f Europe' s economically mos t dynami c nation , wa s anythin g bu t a n underde veloped countr y fro m th e outset " (Cipoll a 1981 , 263) . Owin g it s independence t o th e decentralize d state-syste m o f Europe , i t emerged itsel f a s a decentralize d polity , withou t a kin g an d c o u r t — a "headles s c o m m o n w e a l t h " tha t combine d secur e prop erty rights , th e rul e o f law , religiou s toleration , an d intellectua l freedom wit h a degre e o f prosperit y tha t amounte d t o a n earl y modern Wirtschaftswunder. I t i s no t surprisin g tha t Hollan d ex erted a powerfu l demonstratio n effect . A s K. W. Swar t states : both foreigners an d Dutchme n wer e apt t o believe that th e Dutch Repub lic was uniqu e i n permittin g a n unprecedente d degre e o f freedom i n th e fields o f religion , trade , an d politics . . .. I n th e eye s o f contemporarie s it wa s thi s combinatio n o f freedo m an d economi c predominanc e tha t constituted th e true miracle of the Dutch Republic . (Swart 1969 , 20)

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The succes s o f th e Dutc h experimen t wa s note d wit h grea t interest, especiall y i n England , whos e soi l wa s alread y wel l pre pared t o accep t th e ide a tha t prosperit y i s a rewar d o f freedom . The dee p root s o f economi c individualism , an d henc e o f develop ment, i n Englis h medieva l histor y hav e bee n emphasize d b y Ala n Macfarlane (Macfarlan e 197 8 an d 1987). 15 I n th e earl y moder n period, th e commo n law , whic h h a d evolve d ove r man y centuries , acted a s a guaranto r o f th e sanctit y o f propert y an d fre e entr y t o industry an d trad e agains t th e policie s o f th e earl y Stuar t kings . In th e fac e o f authoritaria n usurpations , Si r Edwar d Cok e an d hi s fellow jurist s acted , i n th e word s o f Nort h an d Thomas , "t o plac e the creatio n o f propert y right s beyon d th e roya l whim ; t o embe d existing propert y right s i n a bod y o f impersona l la w guarde d b y the courts " (Nort h an d Thoma s 1973 , 148) . Crucia l i n th e cas e o f both th e Netherland s an d Englan d wa s th e preservation , agains t attempted roya l encroachments , o f traditiona l representativ e as semblies determine d t o deny th e rule r th e righ t t o tax a t will . Her e the antiauthoritaria n sid e exploited—an d furthe r developed—th e inherited discours e whos e ke y concept s include d "liberties, " "rights," "th e la w o f n a t u r e ," an d "constitution. " The declin e o f Spain , o n th e othe r hand , i s als o take n int o account i n th e model . Confiscatio n o f th e propert y o f Jew s an d Moors b y th e Spanis h crow n was , accordin g t o Nort h an d Thomas: only symptomati c o f th e insecurit y o f al l propert y right s . . . seizure , confiscation, o r th e unilateral alteratio n o f contracts wer e recurren t phe nomena whic h ultimatel y affecte d ever y grou p engage d i n commerc e o r industry a s wel l a s agriculture . . . . A s no property wa s secure , economi c retardation wa s the inevitable consequence. (Ibid., 131 ) The economi c deca y o f Spain , i n turn , provide d a negativ e demon stration effec t tha t playe d a poten t rol e i n th e polic y choice s o f other countries . The them e o f th e autonom y o f th e marke t an d th e inhibitio n o f the predator-stat e a s majo r factor s i n economi c growt h i s pursue d in th e examinatio n o f non-Europea n cultures . Baechler , fo r in stance, state s tha t "eac h tim e Chin a wa s politicall y divided , capi talism flourished," an d maintain s tha t Japanes e histor y manifest s

The '' European Miracle'' 4 9 conditions approximating thos e of Europe (Baechler 1975, 82-86). Anderson, after surveyin g economi c growt h i n the history o f Sun g China an d Tokugaw a Japan , a s wel l a s th e Netherland s an d En gland, conclude s tha t th e common elemen t i s that "the y occurre d when governmenta l constraint s o n economi c activit y wer e re laxed" (Anderson 1991 , 73-74).16 While, needless t o say, much mor e research require s t o be don e on economi c developmen t i n th e histor y non-Europea n civiliza tions, th e evidenc e s o fa r suggest s stron g suppor t fo r th e basi c thrust o f the institutional approach . Contrast o f Europ e with Russi a The meanin g o f th e Europea n miracl e ca n b e bette r see n i f Euro pean development s ar e contraste d wit h thos e i n Russia . Coli n White lists , a s th e determinin g factor s o f Russia n backwardnes s "a poor resource and hostile risk environment . . . a n unpropitiou s political traditio n an d institutiona l inheritance , ethni c diversity , and th e weaknes s o f suc h ke y group s limitin g stat e powe r a s the churc h an d lande d oligarchy/ ' (Whit e 1987 , 136 ) Afte r th e destruction o f Kieva n Ru s b y th e Tatar s an d th e ris e o f Muscovy , Russia wa s characterize d fo r centurie s b y th e virtua l absenc e o f the rule of law, including security fo r persons and property . The lawlessness—as wel l a s the poverty—of Muscovit e Russi a was notorious . When th e emissar y o f Elizabeth I inquired o f Iva n the Grea t th e statu s o f hi s subjects , h e wa s told : "Al l ar e slaves " (Besancon, i n Baechler , Hall , an d Man n 1988 , 161) . Ivan IV , th e Terrible, annihilate d th e flourishin g commercia l republic s o f Novgorod an d Pskov , and loose d his Oprichnina (Ivan' s praetoria n guard) on the kingdom fo r a frenzy o f butchery tha t cam e to stan d for wha t wa s permissibl e i n th e Muscovit e state . Alain Besango n remarks dryly , "O f th e thre e legend s (Romanian , German , an d Russian) tha t depict , in the guise of Dracula, th e reign o f Vlad th e Impaler, th e Russia n alon e sings the praises of the prince" (ibid.). The nobilit y i n Russi a wa s a state-servic e nobility , lackin g an y independent base . A s Whit e observes : "Russi a wa s neve r trul y feudal i n th e wes t Europea n sens e o f th e term " (Whit e 1987 , 10) . In contrast t o Europe an d America, the towns, as well, were "sim -

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ply anothe r a r m o f th e s t a t e " (ibid. , 137-38) . Th e difference s be tween Russi a an d th e Wes t ca n b e see n i n thei r respectiv e idea s o f "absolutism." Iva n IV' s concep t i s wel l known . I t ma y b e com pared wit h tha t o f a politica l write r i n th e Wes t wh o i s famou s a s a defende r o f roya l absolutism , Jea n Bodin . Alexande r Yano v ha s pointed ou t that , fo r al l hi s fait h i n absolutism : Bodin regarde d th e propert y o f th e citizen s a s thei r inalienabl e posses sion, in the dispositio n o f which the y were no less sovereign tha n wa s th e monarch i n ruling his people. To tax citizens of a part o f their inalienabl e property without their voluntary consent was, from Bodin' s point of view, ordinary robbery. (Yanov 1981 , 44-45) 17 In thi s connection , Yano v report s a tellin g anecdote . A Frenc h diplomat i n a conversatio n wit h a n Englis h colleagu e affirme d hi s belief i n th e principl e enunciate d b y Loui s XIV , tha t th e kin g wa s ultimate owne r o f al l th e propert y withi n hi s kingdo m ( a principl e which eve n th e Sun-Kin g neve r dare d t o ac t upon) . Th e En glishmen retorted : "Di d yo u stud y publi c la w i n Turkey? " (ibid. , 44 n . 17 ) The fac t tha t Russi a receive d Christianit y fro m Byzantiu m rather tha n Rom e shape d th e entir e cours e o f Russia' s histor y (Pipes 1974 , 221-43). I n th e word s o f Richar d Pipes , th e Orthodo x church i n Russi a became , lik e every othe r institution , "th e servan t of th e state. " Pipe s concludes , regardin g th e "relation s betwee n state an d societ y i n pre-190 0 Russia" : None o f th e economi c o r socia l group s o f th e ol d regim e wa s eithe r abl e or willing to stand up to the crown and challenge its monopoly of political power. They were not abl e to do so because, by enforcing th e patrimonia l principle, i.e. , b y effectivel y assertin g it s clai m t o al l th e territor y o f th e realm as property and all its inhabitants as servants, the crown prevente d the formation o f pockets of independent wealt h or power. (Ibid., 249) What idea s o f liberalis m cam e t o Russi a cam e perforc e fro m the West . I t wa s fro m listenin g t o th e lecture s o n natura l la w a t the Universit y o f Leipzi g tha t Alexande r Radishche v first learne d that limit s ma y b e pu t t o th e powe r o f th e tsa r (Clard y 1964 , 37-38). Th e beginning s o f th e shif t t o a mor e market-oriente d economic polic y befor e th e Firs t Worl d Wa r ar e trace d b y Besan gon t o th e fac t tha t th e Russia n minister s rea d th e libera l econo mists (Besangon , i n Baechler , Hall , an d Man n 1988 , 166) .

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The Downfal l o f Marxis t Historiograph y The Marxis t philosoph y o f histor y i s fille d wit h manifold , ofte n strategic, contradiction s an d ambiguities . Yet , i f "historica l mate rialism'' ha s an y significan t conten t a t al l i t i s a s a technological interpretation o f histor y (Mise s 1957 , 106-12 ; Bobe r 1962 , 3-28) . Although N a t h a n Rosenber g ha s denie d tha t Mar x hel d tha t "tech nological factor s are , s o t o speak , th e independen t variabl e i n generating socia l change , whic h constitute s th e dependen t vari able" (Rosenber g 1982 , 36 ; se e als o 34-51), 1 8 th e weigh t o f evi dence i s heavily agains t hi m (Cohe n 1978 , 134-50) . According t o Marx, Engels , and th e theoretician s o f the "Golde n Age" o f th e Secon d International , histor y proceed s basicall y vi a changes i n th e "materia l productiv e forces " (th e technologica l base), whic h rende r obsolet e th e existin g "mod e o f production " (the propert y system) . Because o f technologica l changes , th e mod e of productio n i s compelle d t o change ; wit h it , everythin g else — the whol e legal , political, an d ideologica l "superstructure " o f soci ety—is transformed , a s wel l (Mar x [1859 ] 1969b , 8-9) . A s Mar x put i t aphoristically : "Th e win d mil l yield s a societ y wit h feuda l lords, th e stea m mil l a societ y wit h industria l capitalists " (Mar x [1847] 1969a , 130) . Marxism has , o f course , bee n subjecte d fo r generation s t o with ering rebutta l o n man y differen t fronts , no t leas t i n regar d t o its philosoph y o f history . Th e newe r understandin g o f Europea n history i s particularly destructiv e o f it s fundamenta l claims , how ever, i n tha t i t direct s attentio n t o th e peculia r shallowness o f "historical materialism. " Thi s newe r understandin g insist s tha t the colossa l growt h o f technolog y i n th e Wester n worl d i n th e past millenniu m mus t itsel f b e explained , an d th e explanatio n i t provides i s i n term s o f the institutional and moral matrix tha t emerged i n Europ e ove r man y centuries. 1 9 Ne w an d mor e produc tive machine s di d no t sprin g fort h mysteriousl y an d spontane ously, no r wa s th e spectacula r expansio n o f technica l an d scien tific knowledg e someho w inevitable . A s Anderson ha s summe d u p the evidence , "th e scientifi c an d technica l stasi s tha t followe d th e remarkable achievement s o f th e Son g dynasty , o r o f th e flowerin g of earl y Islam , indicate s tha t scientifi c inquir y an d technolog y d o

52 Ralp h Raic o not necessaril y posses s i n themselve s th e dynamis m suggeste d b y the Europea n experience' ' (Anderso n 1991 , 46). On th e contrary , technology and science emerged out of an interrelated se t of political, legal , philosophical , religious , an d mora l element s i n wha t orthodox Marxis m ha s traditionall y disparage d a s th e "super structure" of society. Conclusion According t o th e India n developmen t economis t R . M . Sundrum , if we are t o understand ho w developmen t ca n b e promoted i n th e poorer countries today , we must understan d th e historical proces s which transforme d develope d countrie s i n th e past , an d wh y thi s process faile d t o tak e plac e elsewher e (cite d i n Arnd t 1987 , 177) . This i s th e positio n tha t P . T . Bauer , too , ha s insiste d upon . Re jecting th e "timeles s approach " t o economic development , Baue r has accentuated th e many centuries required fo r economic growt h in the Western world , and th e interplay o f various cultural factor s that wer e it s precondition . Mos t important , i n Bauer' s view , i s that i n th e Wester n worl d institution s an d value s evolve d tha t favored privat e propert y an d th e market , se t limit s t o stat e ar bitrariness an d predation , an d encourage d innovatio n an d th e sense tha t huma n being s ar e capabl e o f improvin g thei r lo t through thei r actions on the market . Recently, W. W. Rostow, in a summary of Bauer's career, chided him fo r failin g "t o tak e adequatel y int o accoun t th e extremel y large an d inescapabl e rol e o f the stat e i n earl y phase s o f develop ment" (Rosto w 1990 , 386). 20 Suc h a criticis m i s no t surprising , coming from on e of the leaders of what Bauer has for years assailed as the "spurious consensus. " Yet it finds little support i n the wor k of the historians dealt with here. (For some reason, Rostow ignore s this whol e body o f scholarship i n his very lengthy histor y o f theories o f economi c growth ; ibid. , passim) . Whil e som e o f thes e au thors woul d stipulat e a significan t rol e fo r th e stat e i n certai n ar eas—particularly i n definin g an d enforcin g propert y rights—thi s is consistent wit h Bauer' s viewpoint . Moreover, th e overal l thrus t of their work—which stresse s the importance of limits on state action in the development o f the West—tends t o corroborate Bauer' s

The ' ' European Miracl e " 5

3

position rathe r tha n Rostow's . Peter Burke, for instance , writing o n one o f th e earlies t example s o f Europea n development—th e merchant-states o f norther n Ital y an d th e Netherlands—describe s them a s "pro-enterpris e culture s i n whic h government s di d rela tively littl e t o frustrat e th e design s o f merchant s o r hinde r eco nomic growth , a negativ e characteristi c whic h al l th e sam e gav e those countrie s a n importan t advantag e ove r thei r competitors " (Burke i n Baechler, Hall , and Man n 1988 , 230). William H . McNeil l notes tha t "withi n Europ e itself , thos e state s tha t gav e th e mos t scope t o privat e capita l an d entrepreneurshi p prospere d th e most , whereas bette r governe d societie s i n which welfar e o n the one h a n d or warfar e o n th e othe r commande d a large r proportio n o f avail able resource s tende d t o la g b e h i n d / ' A s th e growt h leader s McNeill cite s "suc h conspicuousl y undergoverne d land s a s Hol land an d England " (McNeil l 1980 , 65) . And E . L . Jone s take s a s a guiding principl e i n th e explanatio n o f growt h a famou s passag e from Ada m Smith : "Littl e els e i s requisit e t o carr y a stat e t o th e highest degre e o f opulenc e fro m th e lowes t barbarism , bu t peace , easy taxes , and a tolerabl e administratio n o f justice; al l th e rest be ing brough t abou t b y th e natura l cours e o f things " (Jone s 1987 , 234-35, cite d i n Stewar t [1793 ] 1966 , 68). The ne w paradig m generate d b y th e wor k o f thes e an d othe r scholars ha s alread y helpe d produc e furthe r majo r work s o f re search an d synthesis. 2 1 I t goe s withou t sayin g tha t a grea t dea l more stud y i s required . Ye t i t i s likel y tha t furthe r researc h wil l provide additiona l substantiatio n o f th e viewpoin t steadfastl y rep resented b y Professo r Bauer . A s Anderso n observes : "Th e empha sis o n releas e fro m constraint s point s t o a fruitfu l directio n o f research int o wh y som e societie s experience d economi c develop ment an d other s d i d n ' t " (Anderso n 1991 , 73—74) I n an y case , th e subject wil l continu e t o b e o f ver y grea t theoretica l interes t t o scholars—and t o man y million s i n th e underdevelope d world , a m a t t e r o f lif e an d death . Notes 1. Cf . Robert s (1985 , 75) , wh o write s o f "th e genera l liberatio n o f th e economy," whic h "wa s wel l o n th e wa y t o autonom y everywher e i n

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western Europ e b y 1500 , i f autonom y mean s regulatio n b y price s providing undistorte d signal s o f deman d an d a substantia l degre e o f security fo r propert y agains t arbitrar y confiscatio n b y king , lord , or robber. " 2. Cf . Rosenber g (1976 , 286), who raise s th e questio n wh y Wester n Euro pean civilizatio n wa s abl e t o evolv e a uniquely powerfu l combinatio n of cultura l values , incentiv e systems , an d organizationa l capabilities , and remarks : "Interestin g answer s t o thi s questio n ar e unlikel y t o come fro m an y singl e socia l scienc e discipline. " 3. Majo r work s i n th e field includ e Nort h an d Thoma s (1973) ; Baechle r (1975); Nort h (1981) ; Rosenber g an d Birdzel l (1986) ; Jone s (1987) ; Baechler, Hall , an d Man n (1988) , especiall y th e essay s b y Michae l Mann, Joh n A . Hall , Alai n Besan^on , Kar l Ferdinan d Werner , an d Peter Burke ; an d Jone s (1988) . Summaries o f som e o f th e schola r shi p are provide d b y Anderso n (1991) ; an d Weed e (1988 ) an d (1990 , 40-59). Se e als o Osterfel d (1992 , 43-46). Th e essa y b y McNeil l (1980 ) makes creativ e us e o f th e fundamenta l concept s o f th e approach . 4. F . A . Haye k i n th e 1950 s referre d t o " a socialis t interpretatio n o f history whic h ha s governe d politica l thinkin g fo r th e las t tw o o r three generation s an d whic h consist s mainl y o f a particula r vie w o f economic history. " Se e Haye k (1954 , 7). 5. Th e ide a o f a stron g connectio n betwee n th e relativ e freedo m o f European societ y an d it s economi c succes s can , o f course , b e trace d back t o muc h earlie r authors , includin g thos e i n th e Whi g historica l tradition. Her e i t i s bein g considere d i n th e contex t o f recent , mainl y economic, historiography . 6. A secondary them e (Lande s 1970 , 21-22) i s th e characte r o f th e Euro pean Weltanschauung. Lande s point s t o th e emphasi s o n rationalit y in Europea n culture , relativ e t o others , fostered b y element s i n Chris tianity tha t ultimatel y ma y b e trace d t o Judaism' s disparagemen t o f magic an d superstition . 7. Cf . Baechle r (1975 , 74) : Europ e wa s " a societ y base d upo n th e sam e moral an d materia l civilizatio n tha t neve r ende d u p i n political unity , in short , i n a n Empire. " 8. Cf . Douglas s C . North , "Ideolog y an d th e Fre e Ride r Problem, " i n North (1981 , 45-58) . 9. I a m gratefu l t o Leonar d P . Liggi o fo r callin g m y attentio n t o thi s essay. 10. Cf . Robert s (1985 , 67-9) , o n th e Hildebrandin e reform , an d hi s com ment, 6 8 - 6 9 : "Th e preservatio n o f an ide a o f libert y an d it s transmis sion t o th e futur e thu s owe s a n incalculabl e amoun t t o th e quarrel s of churc h an d state. " 11. Se e Lor d Acton' s grea t essay , "Th e Histor y o f Freedo m i n Christian ity" (Acto n 1956) : "T o tha t conflic t o f fou r hundre d year s [betwee n the Churc h an d th e tempora l rulers ] w e ow e th e ris e o f civi l libert y

The "European Miracle " 5 5 . . . although libert y wa s no t th e en d fo r whic h the y strove , i t wa s th e means b y whic h th e tempora l an d th e spiritua l powe r calle d th e nations t o thei r aid . Th e town s o f Ital y an d German y wo n thei r franchises, Franc e go t he r States-General , an d Englan d he r Parlia ment ou t o f th e alternat e phase s o f th e contest ; an d a s lon g a s i t lasted i t prevente d th e ris e o f divin e right " (86-87) . 12. Cf . Chiro t (1986 , 23): "The mai n reaso n fo r th e lega l rationalizatio n o f the West , then , wa s th e long , indecisive , multiside d politica l struggl e between king , nobles , th e church , an d th e towns. " 13. Se e A . R. Myer s (1975 , 24), who state s o f thes e parliamentar y bodies : "they flourishe d a t on e tim e o r anothe r i n ever y real m o f Lati n Chris tendom. The y first emerg e clearl y toward s th e en d o f th e twelft h century i n th e Spanis h kingdo m o f Leon , i n th e thirteent h centur y i n Castile, Arago n (an d als o Cataloni a an d Valencia) , Portugal , Sicily , the Empir e an d som e o f th e constituen t state s suc h a s Brandenbur g and Austria , an d i n Englan d an d Ireland . I n th e fourteent h centur y . . . i n Franc e . . . the Netherlands , Scotland , mor e o f th e Germa n an d Italian states , an d Hungary ; i n th e fifteent h centur y . . . i n Denmark , Sweden, an d Poland. " 14. Cf . Chiro t (1986 , 18) : " a Burgundia n states-genera l me t 16 0 time s from 146 4 t o 1567 , exercisin g grea t fiscal power s an d defendin g th e rights o f town s an d merchants. " 15. Cf . Baechle r (1975 , 79): "I f th e genera l politica l structur e o f th e Wes t was favorabl e t o economi c expansion , i t woul d b e th e mos t marke d in tha t countr y wher e politica l powe r wa s mos t limite d an d tolerate d the greates t autonom y o f civi l society. " Tha t country , accordin g t o Baechler, wa s England . 16. Se e als o th e chapter s o n Sun g Chin a an d Japa n i n Jone s 1988 . 17. Compar e Carlyl e an d Carlyl e (1950 , 512) : "An d mos t remarkabl e i s i t that Bude , wh o se t ou t th e doctrin e o f th e absolut e monarch y i n France i n th e mos t extravagan t terms , shoul d hav e a t th e sam e tim e felt compelle d t o dra w attentio n t o th e fac t tha t th e Frenc h King s submitted t o th e judgmen t o f th e Parliamen t o f Paris ; an d tha t Bodi n should hav e contende d tha t th e judge s shoul d b e permanen t an d irremovable, excep t b y proces s o f law , becaus e th e kingdo m shoul d be governe d b y law s an d no t b y th e mer e wil l o f th e prince. " 18. Rosenber g state s tha t th e technologica l interpretatio n o f th e Marxis t philosophy o f histor y relie s upo n a fe w "aphoristi c assertions , ofte n tossed ou t i n th e hea t o f d e b a t e " (1982 , 36) . Nowher e i n hi s essay , however, doe s h e allud e t o th e locus classicus o f th e subject , Marx' s Preface t o A Contribution to a Critique of Political Economy (Mar x [1859] 1969b) . 19. Anderso n (1991 , 41 ) reject s technica l chang e a s a n independen t vari able explainin g economi c growth : "Technolog y i s more appropriatel y seen a s dependen t o n th e institutiona l structur e an d th e availabilit y

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of capital , includin g 'huma n capital ' expresse d a s a n educated , skilled, an d health y workforce . Th e availabilit y o f capita l i s i n tur n dependent o n a favorable se t of institutions. " 20. Rostow' s dismissiv e ton e i n hi s treatmen t o f Baue r ma y wel l hav e been affecte d b y Bauer' s devastatin g revie w o f Rostow' s magnum opus, The Stages of Economic Growth. See Bauer (1972: 477-89). 21. See , for instance , Robert s (1985) ; Chirot (1986) ; and Kenned y (1987 , 19-20), where the author of this celebrated boo k writes of the "decen tralized, largel y unsupervise d growt h o f commerc e an d merchant s and port s an d market s [i n Europe ] . . . there wa s n o wa y i n whic h such economi c development s coul d b e full y suppresse d . . . there ex isted n o unifor m authorit y i n Europ e whic h coul d effectivel y hal t this o r tha t commercia l development ; n o central governmen t whos e change i n priorities coul d caus e th e ris e or fal l o f a particular indus try; n o systemati c an d universa l plunderin g o f businessmen an d en trepreneurs b y ta x gatherers , whic h s o retarded th e econom y o f Moghul India. " References Acton, John Emeric h Edwar d Dalberg . 1956 . "The Histor y o f Freedom i n Christianity." I n Essays on Freedom and Power, ed. Gertrude Himmel farb, 82-112 . New York: Meridian. Anderson, J . L . 1991 . Explaining Long-Term Economic Change. London : Macmillan. Arndt, H . W . 1987 . Economic Development: The History of an Idea. Chi cago: University of Chicago Press. Baechler, Jean . 1975 . The Origins of Capitalism. Trans . Barr y Cooper . Oxford: Basi l Blackwell . Baechler, Jean , Joh n A . Hall, an d Michae l Mann , eds . 1988 . Europe and the Rise of Capitalism. Oxford : Basi l Blackwell . Bauer, P . T. 1971 . "Economic Histor y a s Theory." Economica, ne w serie s 38, no. 150 (May): 163-79. 1972. Dissent on Development. Studies and Debates on Development Economics. Cambridge : Harvard Universit y Press . Berman, Harol d J . 1974 . "The Influenc e o f Christianit y o n th e Develop ment o f Wester n Law. " I n idem , The Interaction of Law and Religion, 49-76. Nashville/New York : Abingdon Press. • 1983 . Law and Revolution: The Formation of the Western Legal Tradition. Cambridge: Harvard Universit y Press . Besancon, Alain. "The Russia n Case. " In Baechler, Hall , and Man n 1988 , 159-68. Bober, M. M. 1962. Karl Marx's Interpretation of History. Cambridge : Har vard Universit y Press .

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Burke, Peter. "Republics of Merchants i n Early Modern Europe, " 220-33. In Baechler, Hall, and Man n 1988 . Cantor, Norma n F . 1991 . Inventing the Middle Ages: The Lives, Works, and Ideas of the Great Medievalists of the Twentieth Century. Ne w York : William Morrow . Carlyle, R . W. , an d A . J . Carlyle . 1950 . A History of Medieval Political Theory in the West. Vol . 6 , Political Theory from 1300 to 1600. Edin burgh: Blackwood . Chirot, Daniel . 1986 . Social Change in the Modern Era. Sa n Diego : Har court, Brace, Jovanovich . Cipolla, Carlo M. 1981 . Before the Industrial Revolution: European Society and Economy, 1000-1700, 2 d ed. London: Methuen . Clardy, Jess e V . 1964 . The Philosophical Ideas of Alexander Radishchev. New York: Astra. Cohen, G . A . 1978 . Karl Marx's Theory of History: A Defence. Princeton : Princeton Universit y Press . Dorn, James A . 1987. "Introduction: Developmen t Economic s afte r Fort y Years." Cato Journal 7 , no. 1 (Spring/Summer) : 1-19 . Hayek, F. A. 1954. "History an d Politics. " In idem, ed., Capitalism and the Historians. Chicago : University o f Chicago Press. Hicks, John. 1969 . A Theory of Economic History. Oxford : Oxfor d Univer sity Press. Jones, E . L . 1987 . The European Miracle: Environments, Economies, and Geopolitics in the History of Europe and Asia. 2 d ed. Cambridge: Cam bridge Universit y Press . . 1988 . Growth Recurring. Economic Change in World History. Ox ford: Oxfor d Universit y Press . Kennedy, Paul . 1987 . The Rise and Fall of the Great Powers: Economic Change and Military Conflict, 1500-2000. Ne w York: Random House . Landes, David. 1970 . Unbound Prometheus: Technological Change and Industrial Development in Western Europe from 1750 to the Present. Cambridge: Cambridge Universit y Press . Lopez, Rober t S . 1971 . The Commercial Revolution of the Middle Ages 950-1350. Englewoo d Cliffs , N.J.: Prentice-Hall. Macfarlane, Alan . 1978 . The Origins of English Individualism: The Family, Property, and Social Transition. Oxford : Basi l Blackwell . 1987. The Culture of Capitalism. Oxford : Basi l Blackwell . McNeill, William H . 1980 . The Human Condition: An Ecological and Historical View. Princeton: Princeto n Universit y Press . Marx, Karl . [1847 ] 1969a . Das Elend der Philosophic I n Kar l Mar x an d Friedrich Engels , Werke, 4. Berlin: Dietz . [1859] 1969b . "Vorwort," Zur Kritik der Politischen Okonomie. I n Karl Marx and Friedric h Engels , Werke, 13. Berlin: Dietz . Mises, Ludwi g von . 1957 . Theory and History. Ne w Haven , Conn. : Yal e University Press .

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Myers, A . R . 1975 . Parliaments and Estates in Europe to 1789. Ne w York : Harcourt, Brace , Jovanovich . North, Douglas s C . 1981 . Structure and Change in Economic History. Ne w York: Norton . North, Douglas s C , an d Rober t Pau l Thomas . 1973 . The Rise of the Western World: A New Economic History. Cambridge : Cambridg e Univer sity Press . Osterfeld, David . 1992 . Prosperity versus Planning: How Government Stifles Economic Growth. Oxford : Oxfor d Universit y Press . Pipes, Richard . 1974 . Russia under the Old Regime. Ne w York : Scribner's . Pirenne, Henri . 1937 . Economic and Social History of Medieval Europe. Trans. I. E. Clegg. New York : Harcourt , Brace . Roberts, J. M. 1985 . The Triumph of the West: The Origins, Rise, and Legacy of Western Civilization. Boston : Little , Brown . Rosenberg, Nathan . 1976 . Perspectives on Development. Cambridge : Cam bridge Universit y Press . . 1982 . Inside the Black Box: Technology and Economics. Cam bridge: Cambridg e Universit y Press . Rosenberg, Nathan , an d L . E . Birdzell , Jr . 1986 . How the West Grew Rich: The Economic Transformation of the Industrial World. Ne w York : Basic Books . Rostow, W . W . 1990 . Theorists of Economic Growth from David Hume to the Present: With a Perspective on the Next Century. Ne w York : Oxfor d University Press . Schoeck, Helmut . [1969 ] 1987 . Envy: A Theory of Social Behaviour. Re print. Indianapolis : Libert y Press . Stewart, Dugald . [1793 ] 1966 . Biographical Memoir of Adam Smith. Re print. Ne w York : Augustu s M . Kelley . Swart, K . W . 1969 . The Miracle of the Dutch Republic as Seen in the Seventeenth Century. London : H . K . Lewis . Viner, Jacob . 1978 . Religious Thought and Economic Society. Ed . Jacque s Melitz an d Donal d Winch . Durham , N.C. : Duke Universit y Press . Walters, A. A. 1989. "Bauer, Pete r Tamas. " In The New Palgrave: Economic Development, ed . Joh n Eatwell , Murra y Milgate , an d Pete r Newman . New York : W . W. Norton . Weede, Erich . 1988 . "Der Sonderwe g de s Westens. " Zeitschrift fur Soziologie 17 , no. 3 (June): 172-86 . . 1990 . Wirtschaft, Staat, und Gesellschaft: Zur Soziologie der kapitalistischen Marktwirtschaft und der Demokratie. Tubingen : J . C . B . Moh r (Paul Siebeck) . White, Colin . 1987 . Russia and America: The Roots of Economic Divergence. London : Croo m Helm . Yanov, Alexander . 1981 . The Origins of Autocracy: Ivan the Terrible in Russian History. Trans . Stephe n Dunn . Berkeley : Universit y o f Califor nia Press .

4 The Politica l Econom y o f Developmen t in Communis t China : China an d the Marke t Jan S. Prybyl a

1. Argument an d Definition s Outline of Argument I wil l argu e tha t • i n orde r t o moderniz e an d prosper , th e economi c syste m Chin a adopted fro m th e Soviet s i n th e earl y 1950 s an d subsequentl y modified throug h spasmodic , ofte n spectacular , bu t structurall y minor polic y adjustments , ha s t o b e discarde d an d replace d b y the marke t system . Th e transformatio n mus t b e trul y intersys temic, tha t is , total ; • complet e transitio n t o th e marke t system , althoug h bese t b y enormous difficultie s an d alway s subjec t t o politica l hazards , i s not onl y conceivabl e bu t likel y t o happe n i n th e perhap s no t to o remote future ; • shoul d suc h transition , spreadin g a s i t doe s fro m th e south , b e prevented fro m materializin g i n th e whol e o f China , thos e part s of th e countr y wher e th e proces s o f marketizatio n i s presentl y the mos t dynami c an d advanced—th e souther n coasta l prov inces—may tr y t o find alternativ e way s o f bringing abou t transi 61

62 J a n S . P r y b y l

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tion by , fo r example , establishin g som e for m o f economic associ ation wit h Chines e marke t area s outsid e China , suc h a s Hon g Kong an d Taiwan . Wer e thi s t o occu r (an d th e attitud e o f th e People's Liberatio n Arm y wil l certainl y b e critica l i n thi s mat ter), i t woul d hav e t o happe n befor e th e takeove r o f Hon g Kon g by Chin a i n 1997 . Tha t i s s o becaus e withi n a n economicall y unreformed o r half-reforme d an d politicall y left-reactionar y China, Hon g Kon g wil l withe r away . Suc h a n even t woul d al most certainl y releas e laten t centrifuga l politica l an d economi c forces i n China , an d lea d t o change s i n th e politica l makeu p o f the countr y a s presentl y constituted ; • transitio n t o a marke t syste m i n th e whol e o r part s o f Chin a requires a t som e poin t th e remova l fro m monopol y powe r o f th e Communist party ; th e irreversibl e deca y o f th e plan , combine d with emergin g bu t a s o f no w unintegrate d o r partiall y linke d markets, wil l hav e a persuasiv e bu t no t determinin g influenc e on th e dissolutio n o f th e Chines e communis t regime ; • transitio n t o th e marke t syste m ha s t o fulfil l severa l conditions , which althoug h sociall y costl y i n th e shor t run , ca n b e me t in Chin a mor e easil y tha n i n som e othe r countries , notabl y i n the formerl y socialis t republic s tha t onc e m a d e u p th e Sovie t Union. Some Definitions The followin g ar e th e meaning s I attac h t o term s critica l t o th e understanding o f th e abov e argument .

Economic System. A n economi c syste m i s a mechanis m mad e u p of integrated , compatible , internall y consistent , interrelated , an d interacting institution s (agreed-o n an d legall y protecte d way s o f doing things ) an d ideas , bot h positiv e (analytica l theories ) an d normative (economi c ethics) . I t i s a livin g organism ; a n evolving , complex, extende d socia l order . To qualif y a s a n identifiabl e system , thi s organis m mus t con tain a critical minimum mass o f suc h integrated , compatible , an d

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so fort h institution s an d idea s tha t defin e i t an d clearl y indicat e what i s t o b e don e i n society , ho w tha t goa l i s t o b e accomplished , and fo r whom . The " t h i n g s " tha t th e institution s o f th e syste m ar e t o d o i s t o continuously apportio n th e relativel y scarc e resource s o f land , labor, capital , an d entrepreneurshi p t o th e attainmen t o f compet ing, alternative , changin g privat e an d publi c ends , an d t o d o thi s with reasonabl e efficiency , tha t is , with th e leas t possibl e resourc e waste a t a poin t i n tim e an d ove r time . All thi s i s fairly obvious . But ther e i s more , an d a s Ada m Smit h says, it , too , ought t o b e "s o perfectl y self-evident , tha t i t woul d b e absurd t o a t t e m p t t o prov e it. " Ye t i t ha s ofte n bee n ignored , consistently s o i n socialis t practice . Thi s fac t i s simpl y tha t a n economic syste m exist s t o serv e th e consumer . "Consumption, " says Smith , "i s th e sol e en d an d purpos e o f al l production ; an d the interes t o f th e produce r ough t t o b e attende d to , only s o fa r a s it ma y b e necessar y fo r promotin g tha t o f th e consumer . . . . Bu t in th e mercantil e [a s i n th e socialist ] system , th e interes t o f th e consumer i s almos t constantl y sacrifice d t o tha t o f th e producer ; and i t seem s t o conside r production , an d no t consumption , a s th e ultimate en d an d objec t o f al l industr y an d commerce." 1 I n sum , economizing, th e "economic " i n economi c systems , shoul d resul t in th e productio n o f increasin g quantitie s an d qualitie s o f good s and service s tha t consumer s actuall y wan t a t price s the y ar e abl e and willin g t o pay , thi s t o b e accomplishe d wit h a m i n i m u m expenditure o f resources . A system o f resource allocatio n tha t fail s t o fulfil l thi s conditio n is, strictl y speaking , noneconomic . I f i t fail s o n a grandios e scale , that is , i f a t grea t resourc e cos t i t produce s increasin g quantitie s of qualitativel y inferio r good s tha t consumer s d o no t wan t o r cannot us e (valu e subtraction , productio n fo r th e warehouse) , th e system i s antieconomic . Th e Soviet-typ e syste m o f centra l admin istrative c o m m a n d planning , lik e mercantilis m o f whic h i t i s th e highest left-autocrati c expression , i s normall y noneconomic : "i t produces mor e an d mor e o f th e mean s o f production , tha t is , machines, equipment , electricity , fuel , materials , an d metal s i n order t o agai n us e al l thi s i n th e nex t cycl e fo r stil l mor e produc -

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tion o f nonconsumabl e goods , tha t is , thing s tha t peopl e can' t e a t / ' 2 I n time s o f systemi c paroxysms , th e essentiall y noneco nomic natur e o f thi s syste m become s antieconomic . Thi s occurre d in Chin a i n 1958-6 0 an d agai n fro m th e mid-1960 s throug h th e late 1970 s unde r th e regim e o f th e so-calle d "Thir d Line " {sari xian) when , i n defianc e o f rationa l economi c calculatio n an d i n deference t o Mao' s idiosyncrati c militar y doctrine , 11 7 billio n yuan ou t o f a tota l o f 27 4 billion , o r 4 3 percen t o f China' s fixed capital investments , wer e pu t int o military-relate d factories , re search institutes , an d supportin g infrastructures , "disperse d t o the mountain s an d caves " i n th e mos t inaccessibl e an d retarde d regions, where muc h o f i t remain s t o thi s da y kep t aliv e b y subsid ies ou t o f th e publi c purse . I n Tibe t (1965-68) , th e hinterlan d crash industrializatio n progra m focusin g o n defense , investe d 72. 4 million yua n an d produce d losse s o f 2 3 million yua n i n thre e year s "on accoun t o f inferio r product s tha t ha d t o b e writte n off. " Ove r thirty years , 81 6 smal l hydroelectri c powe r station s wer e buil t i n Tibet. B y th e mid-1980s , two-fifth s o f the m ha d eithe r bee n scrapped o r wer e malfunctioning. 3 Notice tha t noneconomi c o r antieconomi c system s lik e bul lionism o r socialis m ca n b e judge d successfu l whe n measure d against interna l norm s o f performanc e tha t it s handler s se t fo r i t (e.g., accumulation o f specie , locatin g defens e industrie s wher e n o one, no t eve n one' s ow n military , ca n find them , developmen t o f the lates t technique s o f polic e control , etc.) . Al l w e ar e sayin g i s that suc h system s institutionall y suppres s individua l preference s and replac e the m wit h thos e o f th e politica l powe r elite , ofte n o f one suprem e paranoiac ; henc e tha t the y d o no t suppl y th e good s that consumer s reall y wan t ("thing s tha t peopl e ca n eat") , an d i n the wors t case s o f antieconomis m provid e almos t n o usefu l good s at all .

Socialism. B y socialis m i s meant th e syste m o f central administra tive c o m m a n d plannin g tha t ha s actuall y bee n applie d i n thi s century b y rulin g Communis t partie s al l ove r th e world : "real , existing socialism. " Exclude d fro m th e definitio n ar e academi c constructs o f socialism (Kathedersozialismus) distille d fro m Walra -

The Political Econom y i n Communist Chin a 6 5 sian pur e theory , a s wel l a s vision s o f abundant , equal , just , selfless, and communal phalansterie s (utopia n socialism) . Adjustment and Reform. Fro m it s inauspiciou s Wa r Communis m beginnings i n Lenin' s Russia , th e socialis t syste m wa s give n t o renovations, repairs, and orga n transplant s tha t di d not, however , in an y substantiv e wa y affec t it s philosophica l an d institutiona l foundations. I designat e suc h intrasystemi c change s a s revision i s t s adjustments, o r adjustment s fo r short . Example s o f marke t system adjustment s includ e th e Ne w Dea l and , a t th e theoretica l level, Keynesianism . Al l change s mad e i n th e socialis t comman d economies befor e 199 0 (i n Chin a befor e 1978)—includin g th e so called Kosygi n "reforms " o f th e 1960s , Gorbachev' s perestroika, and Mao' s Grea t Lea p Forward—qualif y a s intrasystemi c adjust ments. By reform I mea n fundamenta l change s i n th e institution s an d ideas of the system—a structura l intersystemi c transformation . Market System. A s a societa l phenomenon , th e marke t i s a syste m of communications throug h step-by-step , voluntary , autonomous , horizontal, competitive , bilatera l exchange s o f commoditie s (goods, services, an d factors ) base d o n th e utilitaria n principle , a constant searc h throug h compariso n an d evaluation , whic h dis covers ratio s an d rea l interdependencie s (scarcit y relations ) among commoditie s b y reference t o coded informatio n tha t take s the for m o f mone y prices . It i s a n unending , unobstructe d move ment: "lettin g people , companies , money , goods , services , an d ideas find thei r righ t rate s o f retur n throug h fre e movement." 4 I t is a means-connected rathe r tha n a n ends-oriented orde r of voluntary mutua l exchange s drive n b y prices. Money both compel s an d facilitates th e proces s o f searc h an d discovery : "th e mor e activ e the money , th e mor e unequivoca l th e signa l functio n o f prices." 5 Private property—lega l right s t o th e use , transfer , an d incom e from things , vested in individuals, and free association s of individuals create d i n respons e t o th e requirement s o f exchange—i s a necessary conditio n o f communication throug h mone y exchange. 6 As Adam Smit h puts it: "Give me that which I want, and you shal l have thi s which yo u want." I can giv e you thi s because i t i s mine ,

66 Ja n S . Prybyla and yo u ca n giv e m e tha t becaus e i t i s yours , an d w e shal l ex change ou r propert y right s accordin g t o th e regar d w e eac h hav e for ou r own interest synthesize d i n mone y prices. 7 This communi cation throug h monetar y exchang e o f privat e propertie s presup poses a condition o f legality; no t just th e presence of laws relatin g to property , tort , contract , an d bankruptcy , bu t o f th e rul e o f law, tha t is , of justice . Withi n th e rul e o f law , individua l choice , responsibility, an d persona l accountabilit y ar e give n broa d free dom o f expression. 8 Peopl e ar e lef t alon e a s a matte r o f genera l principle, no t i n ever y detail . Laissez-faire doe s no t connot e th e absence o f government . I t onl y require s tha t th e governmenta l urge to regulate an d control be kept in check . To ensur e tha t law s ar e no t mad e b y criminal s an d tha t lega l order obtains , th e political environmen t i n whic h th e marke t sys tem operate s ough t t o b e on e o f freedo m institutionalize d i n a secret ballot , unrigge d electora l contes t o f ope n alternative s o n the basi s o f universa l suffrage , an d i n representativ e (majority ) legislative an d executiv e organs of government a s well as an inde pendent judiciar y (constitutiona l democracy) . Tha t i s th e mos t congenial politica l environmen t fo r th e marke t system , eve n though th e syste m ca n accommodat e itsel f t o a wid e spectru m o f authoritarian regime s (bu t not , b y definition , t o totalitarianism ) and t o some quite advanced cultura l pathologies . I shal l no w argu e tha t marke t refor m i n Chin a i s necessar y (section 2) , an d feasibl e (sectio n 3) , particularly i n suc h coasta l provinces a s Guangdong an d Fujian . 2. Necessity o f Market Refor m Socialist Problems The problem s experience d b y China' s econom y durin g th e Ma o era include d th e following: (1 ) sluggish progres s of real pe r capit a consumption (1. 3 percent pe r year durin g 1955-77) ; (2) decline i n per capit a consumptio n o f a numbe r o f ke y food s durin g thi s period (e.g. , a 3 3 percen t fal l i n vegetabl e oi l an d 2 0 percen t fo r poultry an d aquati c products) ; (3 ) a pe r capit a annua l peasan t income i n 197 7 of 13 4 yuan, 8 9 yuan o f it fro m collectiv e wor k i n

The Political Econom y i n Communist Chin a 6 7 the socialis t sector , whe n th e subsistenc e leve l i n th e countrysid e at tha t tim e wa s officiall y pu t a t 12 0 yuan, wit h one-thir d o f th e production team s registering 6 0 yuan derived from socialis t work ; (4) a decline of total factor productivit y durin g 1957-7 8 estimate d at 1. 5 percent a year and 1. 1 percent a year during 1957-82 ; (5) an industrial labo r productivit y increas e o f abou t 2 percen t a yea r (1957-78); (6) a 33 percent declin e in industrial capita l productiv ity durin g thos e years ; (7 ) a 5 3 percen t fal l o f nationa l incom e (net materia l product ) obtaine d fro m a to n o f consume d energ y between th e Firs t Five-Yea r Pla n (1953-57 ) an d 1978 ; (8) a fal l o f one-third i n th e averag e profi t mad e b y industria l enterprise s from ever y on e hundre d yua n o f outpu t valu e betwee n 195 7 an d 1980; (9) a doublin g o f the lengt h o f building cycle s and construc tion cost s in the same tim e span; (10 ) the misemployment i n far m work (lat e 1970s ) of between one-thir d an d one-hal f o f tota l rura l labor—some 10 0 to 15 0 million people , whereas the y coul d hav e been mor e productivel y employe d elsewher e i f onl y th e syste m had had th e required sensor s to detect opportunity cost s and com parative advantages ; (11 ) lo w educationa l standards : i n Guizho u Province (1983) only 7 percent of primary schoo l teachers of mathematics an d 1 4 percen t o f junio r middl e schoo l mathematic s teachers passe d a n examinatio n i n thei r subject , an d th e result s were not muc h bette r fo r othe r subjects ; (12 ) budgetary deficit s a t all levels of government cause d i n large part b y a heavy and risin g burden o f retai l foo d pric e subsidie s an d bailout s o f inefficien t state-sector firms: i n th e earl y 1980 s food subsidie s alon e came t o one-third o f th e centra l government' s budgetar y expenditures ; i n 1978 total subsidie s average d 52 6 yuan pe r state-secto r worke r o r 82 percent o f the nominal wage and 1 3 percent of national income , whereas tota l subsidie s pe r peasan t wer e les s tha n 1 0 yuan; (13 ) egalitarian pronouncement s notwithstanding , th e long-term tren d (mid-1950s throug h lat e 1970s ) was fo r a progressiv e widenin g o f urban-rural incom e an d welfar e differentials , th e ga p b y th e lat e 1970s having probably reache d 5:1. These an d man y othe r qualitativ e problem s ma y b e trace d t o three sources : (1 ) objective cause s ("act s o f God" ) suc h a s a hig h rate o f populatio n increase , a skewe d population/lan d ratio , th e climate, availabilit y an d distributio n o f natura l resources , cul -

68 Ja n S . Prybyla tural heritage ; (2 ) error s o f policy , suc h a s errati c polic y swing s caused, fo r example , b y excessiv e politicizatio n an d factionalis m of economi c leadership , an d sectora l distortion s du e t o dogmati cally determine d investmen t priorities ; an d (3 ) the syste m o f economic organization. Of these, a defective syste m of economic organization ha s been, I think, the most importan t contributor . Error s of policy can be addressed withi n a basically unchanged economi c structure b y eithe r leftwar d adjustment s (increase d socializatio n and command) , o r rightwar d adjustment s (selectiv e introductio n of markets an d quasi-market s fo r individua l good s and restricted / truncated privat e o r quasi-privat e propert y rights ) withi n a basi cally unchange d an d dominan t structur e o f administrativ e com mand plannin g an d stat e ownership . This was , in fact , th e onl y wa y i n whic h economi c problem s i n China ha d bee n addresse d befor e Decembe r 1978 . Lef t adjust ments o f th e origina l neo-Stalinis t economi c mode l (installe d i n 1953-57) include d th e Grea t Lea p Forwar d (1958-60) , whic h re sulted i n famin e an d a n absolut e declin e o f populatio n i n 196 0 and 196 1 of 13. 5 million (officia l figures, possibl y to o low—at th e height o f the Leap there were only a dozen practicing statistician s in th e whol e of China, and unti l recentl y statistica l reportin g wa s regarded a s a Leninis t politica l art) . A second majo r left-radica l adjustment wen t b y th e nam e o f th e "Cultura l Revolution/ ' (1966-76, bu t mainl y 1966-69 ) an d it , too , claime d million s o f victims. Righ t adjustment s towar d th e marke t (loosenin g th e reins) wer e mad e principall y t o und o th e ravage s o f lef t adjust ments. The most importan t o f these took place i n 1961-6 5 follow ing th e Grea t Leap , an d i n 1976-7 8 i n th e wak e o f th e Cultura l Revolution. Ther e wa s als o a brie f rightwar d adjustmen t i n 195 7 (the perio d o f the "Hundre d Flowers" ) followin g Mao' s "littl e bi g leap" i n rura l collectivizatio n (1956) . Wha t bot h lef t an d righ t adjustments ha d i n commo n wa s tha t the y reste d o n th e premis e that th e socialist , centrall y planne d syste m wa s basicall y sound . It di d exhibi t som e failures an d imperfections , however , and thes e (most o f them du e t o willful distortion s b y individual lef t o r righ t deviationists) coul d b e take n car e o f b y polic y change s withi n a basically unchange d institutiona l structure . Th e procedur e wa s known a s "perfectin g socialism " by either radicalizin g i t or graft -

The Political Economy i n Communist Chin a 6 9 ing selectiv e an d circumscribe d borrowing s fro m th e marke t sys tem ont o it . Th e disagreemen t i n wha t cam e t o b e know n a s th e "two-line struggle" was about th e direction of policy, its pace, and instrumentalities, no t abou t principles . Th e operativ e phras e i n times o f rightwar d adjustment s ha s bee n "using capitalism " t o make socialism work better; no t replacing socialism with the mar ket system . The troubl e i s tha t th e mai n sourc e o f China' s economi c prob lems wa s (a s i t ha d bee n i n al l othe r socialis t economies ) th e system o f economi c organization , an d tha t suc h systemi c prob lems canno t b e solve d o r eve n significantl y mitigate d b y a d ho c policy adjustments . Wha t i s needed i s a change o f system, tha t is , structural reform . After a n initia l (1976-78 ) misdiagnosi s an d applicatio n o f largely ineffectiv e rightwar d remedie s durin g th e interregnu m o f Hua Guofeng , th e post Ma o leadership i n Decembe r 197 6 reache d a fragil e consensus , constantl y challenge d thereafter , regardin g the origin s o f th e economy' s manifes t qualitativ e failures . Th e operative cause s of the economy's difficulties , i t was now (circum spectly an d b y som e leader s quit e formalistically ) intimated , ha d to b e sough t i n th e foundation s an d structur e o f th e centrall y planned administrativ e comman d system : i n th e system's institu tions and i n its guiding positive and normative idea s ("emancipat ing one' s thought, " "darin g t o b e bold") . From scapegoatin g th e Gang of Four and exorcising ultraleftist wor k styles, the new dom inant leadershi p factio n unde r Den g Xiaopin g shifte d t o a mor e reasoned dissectio n o f systemi c arrangement s wit h respec t t o property, mandator y physica l allocation s (planning) , an d th e price mechanism. The need to find and put in place a new compre hensive theoretica l framewor k tha t woul d ligh t th e wa y fo r an d make sens e o f th e change s tha t wer e bein g empiricall y initiate d (e.g., the dismantlin g o f collectiv e agricultur e an d th e emergenc e of d e fact o famil y tenan t farming ; openin g th e doo r t o foreig n direct private investment) was not seen as compelling for a variet y of reasons , mos t o f the m havin g t o d o wit h Marxis t doctrina l taboos rathe r tha n wit h th e difficulty Wester n mainstrea m theor y has wit h elucidatin g problem s o f systemic transition . Fo r al l thi s dabbling i n formerl y forbidde n thoughts , i t i s importan t t o kee p

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in mind tha t fro m th e very onset and t o this day, the leadership i n general, an d Den g Xiaopin g i n person , insiste d repeatedly , em phatically, an d consistentl y tha t th e objectiv e o f theoretica l de bates an d institutiona l change s tha t wer e bein g implemented — cautiously, slowly, and in zigzag fashion ("crossin g th e river while groping fo r th e stones")—wa s no t t o abando n socialism , bu t t o revitalize it ; no t t o replace socialis m wit h capitalism , but t o "cor rectly" selec t th e mor e promisin g capitalis t method s an d proce dures, excis e fro m the m bourgeoi s cultura l carbuncle s an d politi cal accretions , an d graf t the m ont o th e socialis t system , t o creat e a "socialis t commodit y economy " o r "socialis m wit h Chines e characteristics." Whe n judge d necessary , suc h disjointe d trans plants coul d b e insulate d fro m th e res t o f th e economy , a s i n th e case of the four Specia l Economi c Zones in Guangdong and Fujia n Provinces tha t wer e designe d t o attrac t foreig n investmen t an d serve a s laboratorie s fo r innovativ e economi c experiment s with out contaminatin g th e surroundin g landscap e o f socialis t value s with capitalist spiritua l pollution . To reach such a consensus afte r the divisivenes s o f th e Cultura l Revolution , everyon e excep t th e ultraleftist radical s ha d t o b e pu t o n board , includin g th e princi pal architect of China's First Five-Year Plan, Chen Yun. "Stimulating th e economy, " Che n Yu n onc e said , "i s t o be don e withi n th e framework o f th e stat e plan . Th e relationshi p betwee n th e tw o i s like a bir d i n a cage . A bird shoul d b e allowe d t o fly, but withi n the framework o f the cage. Otherwise it will fly away." Chen raise s a n interestin g question , ver y pertinen t t o Chin a a t the presen t time . I t i s whethe r th e capitalis t bir d ca n b e use d t o stimulate th e socialis t econom y i f confine d i n th e pla n cage , o r whether it s stimulative power s come from it s natural conditio n of being free . Th e historical recor d o f real socialis m clearl y suggest s that s o long as the bars of the state plan ar e in place, the econom y will no t b e stimulated , o r wil l b e stimulate d i n rathe r bizarr e ways. Th e cag e ha s t o b e dismantled . Tha t ide a i s slowl y an d surreptitiously insinuatin g itsel f int o th e thinkin g processe s o f most scholars , "socialis t entrepreneurs, " an d som e officials , par ticularly i t woul d see m i n th e mor e prosperou s coasta l province s and th e more cosmopolitan cities . But it s presence i s not officiall y admitted, certainl y no t a t th e center . Despit e th e existenc e o f

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several conceptua l "forbidde n a r e a s / ' a livel y discussio n o f techni cal issue s concernin g prices , property, an d th e "commoditization " (i.e., marketization ) o f th e econom y di d tak e plac e i n Chin a afte r 1978, until i t wa s stoppe d b y th e politica l repressio n followin g th e Tienanmen event s o f Jun e 1989 . B y earl y 199 2 th e discussio n resumed, albei t hesitantl y an d wit h decorou s circumspection. 9 Systemic Errors What i s i t abou t th e cag e tha t make s i t deca y an d eventuall y crumble? Th e construc t o f socialis t centra l administrativ e com m a n d plannin g suffer s fro m thre e fundamenta l error s o f analysis , morality, an d psychology . Analytical Error. Th e syste m operate s o n th e mistake n ide a tha t the evolutionar y selectio n proces s o f th e marke t organis m work ing itsel f ou t throug h spontaneous , mone y price-informed , deper sonalized, competitive , utilitarian , search-and-discover , trial-and error, bilatera l exchange s o f privat e propert y rights , ca n no t onl y be replace d bu t vastl y improved-upo n b y largel y demonetized , central, administrativ e (hierarchical) , c o m m a n d plannin g de signed b y reason , an d supporte d b y quasi-tota l socializatio n o f th e means o f production an d distribution . Put anothe r way , th e erro r consist s i n th e assumptio n (1 ) tha t someone o r som e elit e grou p (th e nomenklatura) positione d a t th e top o r cente r o f a deliberatel y constructe d hierarchica l organiza tion ca n obtai n an d proces s divers e informatio n fro m numerou s dispersed source s concernin g degree s o f commodit y scarcity , i n advance o f exchang e communication ; (2 ) tha t thi s informatio n is superio r t o tha t obtaine d throug h th e marke t proces s o f fre e exchange; an d (3 ) tha t i t ca n b e use d t o determin e an d ran k end s that mandatoril y substitut e fo r an d ar e considere d superio r t o preferences an d productio n function s emergin g fro m individua l buyers' an d sellers ' utilitaria n exchang e transaction s (exogenou s determination o f th e structur e o f th e syste m b y th e politica l lead ership). It i s theoreticall y conceivable—o n th e basi s o f Wester n main stream, friction-fre e equilibriu m model s o f "substantia l rational -

72 Ja n S . Prybyla ity"—that, seen simply as computation, that is , central processin g of manifol d informatio n wit h th e hel p o f computer s an d mathe matical models , th e proble m i s manageabl e an d soluble. 10 How ever, th e communicatio n proble m i s intrinsically a socia l proces s of discovery and learning for which competitive market exchange s of privat e propert y right s embedde d i n commoditie s ar e indis pensable. 11 In thi s importan t sens e "the marke t i s the only know n method o f providin g informatio n enablin g individual s t o judg e comparative advantage s o f differen t use s o f resource s o f whic h they hav e immediat e knowledg e an d throug h whos e use, whethe r they inten d o r not , the y serv e th e need s o f distan t unknow n indi viduals. This dispersed knowledge is essentially dispersed an d can not b e gathere d togethe r an d conveye d t o a n authorit y charge d with th e tas k o f deliberatel y creatin g order . . . . We ar e abl e t o bring abou t a n orderin g o f th e know n only by causing it to order itself/'12 The erroneou s ide a o n whic h socialis t economi c analysi s an d hence it s institutiona l structur e rest , ha s ha d disastrou s effect s on th e qualit y o f informatio n an d coordinatio n i n th e centrall y planned system . Moral Error. Th e mora l erro r i s th e arrogan t assertio n tha t indi vidual huma n being s d o no t an d canno t reall y kno w wha t the y want an d that , therefore , the y hav e t o b e tol d wha t i t i s tha t they wan t b y historicall y chose n vanguards . B y virtu e o f thei r revolutionary anointment , thes e latter-day Part y high priests hav e access t o th e requisit e knowledg e an d superio r metaunderstand ing o f socia l necessit y acquire d fro m immutabl e law s o f histor y discovered b y Marx i n Germa n librarie s an d th e British Museum . Of course , thi s patronizing , self-servin g concei t predate s Marx' s discovery o f th e secre t o f history' s dialectica l progression . Mar x merely gav e th e ol d elitis t fair y tal e a purportedl y scientifi c cas t that thencefort h enable d an y autocrat , i f th e necessit y wa s upo n him, t o rationalize i n scientological , cryptomodern term s hi s nat ural propensit y t o keep grown-u p peopl e i n a perpetual conditio n of infantilism . Thi s insufferabl e condescensio n ha s ha d th e mos t adverse consequence s fo r socialis t incentive s t o planners, manag ers, workers , an d peopl e a s citizen s an d mora l being s and , mor e

The Political Economy in Communist Chin a 7 3 than th e system' s inabilit y t o delive r th e goods , ha s contribute d to th e delegitimatio n o f socialis m an d th e widesprea d popula r contempt i n which Communist partie s ar e held . The moral erro r is compounded b y the almost tota l suppressio n of privat e propert y an d it s nationalization , whereb y individual s are deprive d o f "sovereign spheres, " their firs t defens e agains t th e encroachment o n their liberty by self-appointed stat e bureaucrats . Psychological Error. Th e force d impositio n o n adul t peopl e o f someone else's allegedly mor e insightful preferences , provoke s opposition fro m thos e man y brande d a s intellectua l nullitie s an d moral midgets . There i s no mechanis m i n th e syste m t o reconcil e opposing end s o r settl e conflict s o f value s create d b y thi s high handedness, othe r tha n th e applicatio n o f forc e accompanie d b y fear (whenc e th e importanc e attache d b y socialis m t o military police good s an d eavesdroppin g services) . I n it s pur e for m th e system preclude s tension s fro m bein g resolve d b y concession , compromise, or retreat of the historically correctl y informed class . In fact , doctrinall y an d fro m practica l necessity , th e syste m re gards confrontation (th e dialectical clas h o f opposites, "struggle" ) as the engine of progress, a virtue that substitute s fo r what social ist theor y decrie s a s th e anarchy , greed , an d egoisti c cruelt y o f market competition. Unable to directly replace the planners' goal s foisted o n them , people—a s consumers , workers , collectiv e far m chairmen, an d manager s o f stat e firms—manipulat e th e mean s available t o the m fo r attainin g th e planners ' mandator y norms , by endless deceptions , prevarications, cynicisms, and imaginativ e bendings o f th e rules , t o th e poin t wher e th e syste m become s a sprawling li e and a bizarre distortio n o f the advertised intent , an d daily lif e turn s int o a successio n o f petty indignities . The exercis e of countervailin g value s b y individuals , whe n no t punishe d b y banishment o r worse as a counterrevolutionary crim e on th e line s of Sovie t hig h Stalinism , wa s see n i n Chin a a s a sympto m o f th e survival o f bourgeoi s idea s i n people' s minds , an d deal t wit h b y mass campaigns o f socialist rectificatio n an d intimidatin g "heart to-heart chats " conducted wit h individua l offender s b y Party cad res. Neither mas s movement s no r "intimate politica l solicitation " had th e anticipate d effec t o f fundamentall y transformin g th e na -

74 Ja n S . Prybyla tional psyche and liftin g i t to a level of superior selfless an d collective perfection. Th e procedure merel y debase d th e alread y debili tated information , coordination , an d incentiv e systems , an d further discredite d socialis t ethics . Additionally, th e almos t tota l nationalization/collectivizatio n of the means o f production an d distributio n ha s had a deleteriou s effect o n people's attitude s towar d th e conservation an d preserva tion o f objects tha t belon g t o everybody bu t t o no on e i n particu lar, resultin g i n a n extraordinar y decrepitud e o f publicl y owne d assets.

What's to Be Done? To excis e th e thre e error s a t th e leve l o f idea s an d institutions , several reformis t measure s hav e t o b e taken , i n Chin a a s else where. For several reasons there is, however, a divergence of views among economist s o n th e content , relativ e importance , pacing , and sequencin g of such measures. 13 One schoo l o f thought 14 argue s that , a t th e leve l o f ideas , it i s essential tha t th e objectiv e o f th e change s b e clearl y define d an d explained a s th e transformatio n o f th e socialis t syste m o f centra l administrative comman d plannin g an d it s associate d Marxist-Le ninist positiv e an d normativ e theorie s int o a ful l marke t syste m and int o marke t analyse s an d ethica l prescripts , an d tha t th e reform commitmen t b e credible , tha t is , not subjec t t o postpone ments, retreats , compromise s o f principle , an d surrender s t o re form-crippling structura l half-wa y settlement s whe n th e goin g gets tough . Thi s schoo l regard s i t a s perfectl y self-eviden t tha t such a commitmen t canno t b e mad e o r carrie d ou t b y an y rulin g Communist part y withou t tha t party' s denyin g it s philosophica l essence, political tempe r (th e wil l t o monopol y power) , and orga nizational structure , tha t is , withou t it s presidin g ove r it s ow n liquidation. The other school, 15 more given to pure economic speculation, has nothing explicit to say on the subject, but implie s tha t Communist partie s (th e Chinese, it would seem , in particular) ca n remold themselves , Zhao Ziyang-like, and gradually bring about a structural transformatio n o f socialis m explainabl e b y Lange - o r

The Political Economy i n Communist Chin a 7 5 Vanek-type theorie s o f marke t socialis m o r labor-manage d market. The first schoo l hold s that , a t th e leve l o f institutions , tw o critical measure s hav e t o b e taken , preferabl y concurrently : (1 ) property right s hav e t o b e trul y an d full y privatize d t o th e poin t where the y becom e th e dominan t ownershi p for m i n th e system ; and (2 ) physicall y oriente d administrativ e comman d plannin g must b e replace d b y voluntary , competitive , contractual , mone y exchange transaction s guide d b y marke t price s (Che n Yun' s cag e has t o b e take n apar t s o th e bir d ca n fly away) . Tru e an d ful l privatization mean s th e vestin g i n individual s an d fre e associa tions o f individual s (firms , partnerships , voluntar y cooperatives , households) o f th e broades t possibl e right s o f use , transfer , an d income. Workably competitiv e (horizontal ) mone y exchang e rela tions and private property rights must constitut e the critical mini mum mas s of the successor system's synchronous institutions . The second schoo l i s more accommodatin g o n bot h th e subjec t of marketization an d privatization . Pric e reform, th e core of mar ket ization, ca n b e piecemeal , carrie d ou t graduall y an d experi mentally, leaving room and time for multitier prices and exchang e rates. Privatization nee d not be either true or full; i t can be (in fac t it i s preferabl e tha t i t be ) multitie r an d ofte n simulate d (quasi private property right s [long-ter m leases] , as in post-1978 Chines e agriculture veste d i n peasan t families ; an d broade r autonom y over assets , investments , an d th e like , granted t o state-owne d en terprises unde r variou s "responsibilit y systems/ ' tha t i s n o ful l individualization o f propert y rights) . Th e schoo l doe s no t regar d private propert y eithe r a s central t o the marketization process , or urgent. Wha t matter s i s enterpris e profitability , th e manage ment's profit-orientatio n an d sensitivit y t o relative prices, not th e formal mod e o f ownership . Pric e reform , th e cor e o f marketiza tion, ca n o n thi s vie w b e piecemeal , carrie d ou t graduall y an d experimentally; price s nee d no t b e full y flexible i n th e shor t run , leaving room an d socially necessary (fro m th e standpoint o f social cost) time for transitiona l multitie r price s and exchange rates . East Europea n an d Sovie t experienc e sinc e 199 0 teache s that , contrary t o earlie r assumptions , capitalis m doe s no t jus t happe n when peopl e ar e lef t alone . True , a lo t o f crucia l marketizatio n

76 Ja n S . Prybyla and privatizatio n fro m belo w by people freel y enterin g uncoerce d exchange transaction s wil l occur , bu t fo r a variet y o f reason s a credible (preferabl y a democraticall y electe d an d democraticall y removable) governmen t seem s t o b e neede d t o ac t a s midwif e t o the birt h o r rebirt h o f th e marke t system . O n thi s issu e bot h schools ar e agreed , althoug h th e secon d i s inclined t o accept bot h the possibility an d probabilit y o f the democratizatio n o f Commu nist parties , an d no t jus t i n nam e only , whil e th e firs t schoo l does not . Some reason s fo r interventio n b y a credibl e governmen t i n th e economic refor m (marketization/privatization ) proces s include : (1) the nee d t o put i n place a system o f commercial la w favorabl e to a marke t econom y an d privat e property , an d t o enforc e th e laws predictably an d impartially ; (2 ) the need t o wean accountin g and statistica l system s awa y fro m Marxis t concept s an d Leninis t procedures; (3 ) difficulties experience d wit h privatizing ver y larg e (internationally uncompetitive ) stat e firms, necessitatin g th e cre ation b y th e stat e o f self-liquidatin g privatizatio n agencie s (per haps o n th e line s o f th e Germa n Treuhand) t o restructur e an d dispose o f state-owne d asset s t o privat e buyers ; (4 ) th e nee d fo r structural refor m o f th e monetar y an d fiscal systems , includin g the establishmen t o f financial intermediarie s (capita l markets ) and th e eliminatio n o f budgetar y subsidies ; (5 ) th e provisio n o f social safety net s (unemployment insurance , income supplements ) for thos e structure d ou t o f thei r job s and/o r inflate d ou t o f thei r incomes b y th e transition ; an d (6 ) the nee d t o reduce an d eventu ally abolis h barrier s t o internationa l commodit y an d mone y ex changes, thus importing competition . 3. Feasibility o f Market Refor m What Has Been Done since 1978 Let u s se e wha t ha s bee n don e i n Chin a sinc e Decembe r 197 8 when economi c change s combining for the first time policy adjustments and some structural reforms wer e initiated . I shal l focu s o n two areas , whic h appea r t o m e t o b e centra l t o systemi c transi tion: property an d prices .

The Political Econom y i n Communist Chin a 7 7 Property. Chinese privatization ha s been (1) partial (i.e., devolution of some bu t no t al l propert y right s t o individuals, families , work ers, managements , loca l governments , voluntaril y constitute d groups) an d largel y simulate d (d e facto , "a s if") ; (2 ) mos t ad vanced i n agriculture , retai l trade , consume r services , an d ligh t (consumer- an d export-oriented ) manufacturin g i n cooperativ e and village/townshi p enterprises ; an d (3 ) administratively decen tralized an d mos t forcefull y pursue d b y regional authoritie s i n th e coastal provinces , cities , specia l economi c zones , an d othe r "open" areas . In th e state-owne d industria l sector , comprise d fo r the most par t o f large, heavy industr y enterprises , "privatization " (if tha t i s th e appropriat e nam e fo r it ) ha s bee n ver y modest , limited t o governanc e adjustments , tha t is , to som e expansio n o f managerial prerogative s an d th e encouragemen t o f profit-orienta tion and responsiveness t o quasi-market signal s by managements . Take the question of partial d e facto privatization i n agricultur e where propert y right s change s have bee n th e mos t advanced . Th e property right s grante d t o peasan t household s ar e essentiall y those o f tenancy , limite d t o residua l right s o f use , tha t is , (mor e or less ) fre e us e o f th e produc t afte r fulfillmen t o f th e tenants ' contractual deliver y obligations to the state at "negotiated " price s (more o r less , becaus e loca l cadre s ofte n restric t tha t freedo m unless pai d a gratuity) . Th e contrac t i s i n essenc e compulsory — no contract, no land—and negotiatio n abou t prices is not betwee n equals, but betwee n atomisti c (bu t no t powerless) households an d representatives o f a bi g an d powerfu l stat e incline d t o graft . A birth quot a ride r i s usuall y attache d (o r i s suppose d t o b e attached) to the produce deliver y contract: one child per family o r no contract. Ther e i s no private righ t o f transfer becaus e th e scat tered lan d parcel s d o no t legall y belon g t o th e users , excep t fo r the availabilit y o f us e transfe r certificate s contingen t o n loca l government approval . Ther e ar e restriction s o n th e hirin g o f non family labo r an d o n th e siz e o f th e household' s "responsibility " land holdings, the original distributio n an d siz e of which had bee n determined b y socialis t criteri a o f fairnes s an d equality , no t b y reference t o economie s o f scale , whic h i n an y even t woul d hav e been very difficult t o arrive a t i n the absence of allocatively mean ingful prices . Th e stat e remain s a majo r supplie r o f ke y far m

78 JanS.Prybyl

a

inputs suc h a s chemica l fertilizers , pesticides , machinery , fuel , power, an d plastics , althoug h inroad s int o th e state' s forme r mo nopoly positio n i n thi s regar d hav e bee n mad e b y proliferatin g nonstate, cooperative/townshi p an d villag e firms a s wel l a s b y partially marketizin g o f stat e price s fo r som e o f th e input s (se e below). Th e stat e als o play s a rol e (albei t a declinin g one ) i n the distributio n o f far m produce : i t purchase s a portio n o f th e household's abov e contrac t outpu t an d police s urba n stree t mar kets (sometimes and in some places more thoroughly tha n at othe r times an d i n othe r places ) t o mak e sur e tha t price s ther e d o no t rise abov e "exploitative " levels . S o eve n wher e the y ar e numeri cally mos t commo n an d advanced—i n agriculture—partial , "a s if" privat e propert y right s remain encage d b y the state. How wel l encaged i s another, largel y political an d loca l matter . Nevertheless, i t ca n b e argued—an d th e argumen t i s mad e b y the secon d school—tha t eve n suc h partia l an d simulate d right s corrode th e cage , particularl y i n th e nonstate , villag e an d town ship, light , labor-intensive , consumer - an d export-oriente d indus trial sector, particularly whe n they spread mor e rapidly than stat e property, a s indee d the y hav e don e i n China , partl y unde r th e impulse o f private direc t foreig n investmen t (concentrate d i n cer tain part s o f the country) . Beginning i n th e fall o f 198 8 and accel erating afte r th e Tienanme n inciden t o f Jun e 1989 , ther e wer e attempts b y th e centra l leadershi p t o resocialize an d recentraliz e parts o f th e nonstat e economy , first o n technica l ground s a s par t of an austerit y driv e intende d t o check inflatio n an d ge t runawa y provincial an d loca l investment unde r control , later (afte r Tienan men) o n doctrina l grounds , tha t is , expansio n o f th e nonstat e sector wa s see n b y th e ne w hard-lin e leadershi p a s on e o f th e contributory cause s o f th e democrac y movement . Thes e attempt s were given expression i n th e so-called 3 9 Points of the Communis t Party's Centra l Committe e promulgate d i n Novembe r 1989 , bu t three year s late r hardl y an y o f the m ha d bee n implemented . O n the contrary , nonstate , cooperativel y owned , private , quasi-pri vate, an d foreig n join t venture , profit-oriente d firms, whic h bu y most o f thei r input s an d sel l mos t o f thei r outpu t o n market s (some real , som e simulated ) a t free , somewha t free , an d partl y controlled prices , an d obtai n a growin g shar e o f thei r capita l o n

The Political Econom y i n Communist Chin a 7 9 informal credi t markets , hav e expande d quickly , wherea s state owned firms stagnated , 4 0 percen t o f the m (bu t probabl y more ) suffering financial losse s an d survivin g o n subsidies , an d anothe r 30 percen t barel y breakin g even . I n 199 0 outpu t o f state-secto r firms gre w a t roughl y 3 percent, wherea s th e outpu t o f coopera tive, market-oriente d firms ros e a t thre e time s tha t rate , private sector outpu t wen t u p 2 2 percent , an d productio n o f foreign-in vested firms 5 6 percent. 16 I n 199 1 th e centrall y planne d state owned secto r contribute d roughl y one-thir d o f China' s gros s na tional product , employe d 1 8 percent o f th e tota l labo r force , an d produced 5 3 percent o f total industria l outpu t valu e compare d t o 80 percen t i n 197 8 an d a n averag e o f 7 0 percen t i n th e 1980s . I t was expecte d tha t i n 199 2 th e state-owne d firms' shar e o f indus trial outpu t woul d fo r th e first tim e fal l belo w 5 0 percent. 17 I n 1980 nonstate , smal l an d medium , market-oriented , rural/town ship, industrial consume r an d expor t good s enterprises numbere d 1,500; 300,00 0 te n year s later , contributin g hal f o f China' s tota l exports and three-quarter s o f garment exports . From 197 9 through 199 1 a total o f $48 billion i n foreign privat e investment had been approved by Beijing (41,30 0 enterprises), $20 billion of which had actuall y materialized . This was in addition t o seventy fou r join t offshor e oi l exploratio n an d developmen t proj ects wit h a contracte d valu e o f $3. 4 billion , o f which $2. 8 billio n had actuall y bee n used . Altogether , foreign-funde d firms ac counted i n 199 1 fo r 5 percent o f th e country' s industria l output , and 2 0 percen t o f expor t volume. 18 Hon g Kon g an d sinc e 198 7 (indirect) Taiwan private investment s ar e the leaders by far . The souther n coasta l province s o f Guangdon g an d Fujia n hav e been th e mai n recipient s o f direc t foreig n investmen t (DFI) . I n 1987, Guangdong Provinc e alon e accounte d fo r 5 8 percent o f DF I and Fujia n Provinc e fo r anothe r 6 percent. Th e Fujia n shar e ha s risen betwee n 198 7 an d th e earl y 1990s . I n 198 7 ther e wa s n o (legal) Taiwa n investmen t o n th e Chines e mainland . Th e 199 0 cumulative tota l wa s wel l i n exces s o f $ 2 billion , mos t o f i t i n Fujian, wit h som e thre e thousan d Taiwan-funde d firms operatin g in tha t province . Hon g Kon g investment s flow mainl y t o neigh boring Guangdong . Ther e ar e mor e tha n sixtee n thousan d Hon g Kong-owned factorie s i n th e province , employin g thre e millio n

80 Ja n S . Prybyla Chinese workers, processing material s an d producing good s (mos t of the m for export , particularl y t o th e Unite d States ) value d (i n 1991) a t $1 1 billion , an d contributin g t o Guangdong' s pe r capit a GDP o f $1,29 0 (1990) , nearl y thre e time s th e averag e pe r capit a GDP fo r Chin a a s a whole , an d t o sout h China' s phenomena l growth rat e o f aroun d 1 3 percent a year , abou t twic e th e rat e o f the res t o f the countr y i n recent years . Shanghai's shar e o f DFI in 1987 was 7 percent, bu t ha s rise n sinc e with th e establishmen t i n March 199 0 o f th e Pudon g investmen t zon e designe d principall y to attrac t Taiwa n DF I an d oversea s Chines e capital . Th e 198 7 share of of all the inland province s was a modest 1 1 percent, but if the hug e (an d unsuccessful ) Antaiba o coa l min e cooperativ e ven ture wit h Occidenta l Petroleu m i s subtracted , th e inlan d prov ince's share fall s t o about tha t o f Shanghai ( 7 percent). The south ern coasta l provinces , moreover , ar e no t nearl y a s burdene d a s the inlan d region s b y stagnant , value-subtracting , state-owne d enterprises. I n 199 1 state-owne d firms i n Guangdon g accounte d for 4 0 percen t o f th e gros s valu e o f industria l output , wherea s i n the res t o f th e countr y thei r shar e wa s 5 3 percent. Shangha i ha s the highest concentratio n o f state-owned larg e and mediu m enter prises i n th e country . On e Chines e autho r describe s thei r condi tion i n th e followin g terms : "The 'thre e irons ' (the iron ric e bowl , iron wages , an d iro n armchai r [guarantee d employment , wages , and manageria l positions] ) hav e no t bee n smashed . Neglec t o f duties an d la x disciplin e ar e accepte d behavior . Th e grea t ric e pot an d equalitarianis m ar e everywher e t o b e seen . Ther e ar e n o reward/punishment mechanism s for worker incentive and control , or for managing competitio n an d employment." 19 The second school' s argumen t i s that eve n thoug h th e propert y forms ar e varie d an d privat e propert y i s no t ful l an d true , bu t rather partia l an d often "a s if " (simulated) , the changes (1 ) oblige Chinese entrepreneur s i n charg e o f nonstate-owne d firms t o broadly confor m t o the rules of competitive marke t behavio r wit h respect t o mos t .of their sale s an d purchases , an d a rising shar e of their capita l needs ; (2 ) thi s partial , quasi-privat e propert y i s no t confined t o consumer good s and service s but exist s i n a variety of fields: consume r a s wel l a s produce r good s an d services , an d ex ports; an d (3 ) expanding muc h mor e rapidly tha n th e state-owne d

The Political Economy in Communist Chin a 8 1 segment o f th e economy. 20 Conformit y wit h th e rule s o f competi tive marke t behavio r ma y perhap s b e questioned . I n man y in stances the commercial succes s of nonstate ventures depends critically o n persona l politica l connection s (guanxi) an d th e greasin g of bureaucrats' palms. In fact, lik e the multitier prices (see below), the multitie r propert y arrangemen t wit h it s truncate d an d infor mal privat e properties , i s a majo r contributo r t o th e pervasiv e neomercantilistic corruptio n an d rampan t specia l privileg e tha t are characteristic o f contemporary China . Prices. As a result o f a combination o f administrative pric e adjust ments an d partia l reform s (pric e freeing) , Chin a toda y ha s a two track pric e arrangement . Som e price s ar e free . Sinc e th e mid 1980s thes e includ e price s o f industria l capita l good s produce d and trade d outsid e the plan as well as the prices of most consume r goods. Som e price s ar e loosel y controlle d b y below-provinc e au thorities; others are set and more strictly monitore d a t the provin cial level ; other s still , are fixed b y th e nationa l government , wit h a singl e nationwid e pric e fo r som e commoditie s an d regionall y differentiated price s for others. 21 The general tren d sinc e 197 9 has been towar d th e expansio n o f th e real m o f market-determine d prices. The World Bank estimates tha t a t th e end of the 1980 s onefourth o f al l commodit y price s i n Chin a wer e fixed b y th e state , another quarte r consiste d o f price s fluctuatin g betwee n state-se t limits ("floating" prices) , and th e remaining hal f were free. 22 The reason s fo r th e sprea d o f market an d quasi-marke t pricin g include th e following : (1 ) Th e mai n reaso n ha s bee n th e alread y mentioned rapi d growt h o f th e nonstat e (collectiv e an d private ) sector, which a s early a s 198 4 accounted fo r 9 5 percent o f Chinese industrial firms an d 3 0 percen t o f th e gros s valu e o f industria l output (4 7 percen t i n 1991). 23 Th e bul k o f transaction s amon g nonstate firms i s carrie d ou t a t almost-marke t price s (almos t be cause some prices are "negotiated " betwee n buye r an d seller , an d some, but no t all , of these negotiation s ar e no t amon g equal s an d are, therefore , ope n t o administrativ e pressure s an d interven tions). (2) A second reaso n fo r th e gradua l marketizatio n o f price s has bee n th e phased alignmen t o f many state-se t price s (e.g. , passenger an d freigh t transport , crud e oil , coal , foreig n exchange )

82 Ja n S . Prybyla with marke t prices , an d th e periodi c withdrawa l o f controls ove r the price s o f certai n commodit y groups . Fo r example , wholesal e markets replacin g i n par t centrall y planne d allocatio n hav e bee n opened fo r wheat , rice , corn, and timber , an d graduall y expande d for machinery, equipment, intermediate goods, and industrial ra w materials. Accordin g t o th e Worl d Bank , 7 5 percent o f al l metal cutting tool s wer e distribute d throug h market s a t th e en d o f th e 1980s.24 The marketization of coal, rubber, farm machinery , build ing materials , chemical products , and nonferrou s metal s price s i s under consideration. 25 (3 ) Th e sprea d o f marke t an d marketlik e pricing ha s als o bee n du e t o th e government' s allowin g it s firms to purchase an d sel l a risin g shar e o f thei r input s an d output s o n the market , tha t is , outsid e th e stat e allocatio n an d distributio n network. Al l thi s lead s som e observer s t o conclud e tha t i n Chin a "despite problems , marke t pricin g ha s becom e wel l establishe d and appear s t o be at leas t reasonabl y reflectiv e o f market equilib rium conditions/' 26 Considerable distortion s an d rigiditie s remai n i n th e pricing of labor i n th e stat e secto r (th e "thre e irons") , as wel l a s o f housin g space (ren t take s les s tha n 1 percent o f the average city-resident' s income), an d thi s ha s distortin g effect s o n marke t pricin g else where i n th e economy . However , i n th e nonstat e "entrepreneur ial" sector , a s Lard y call s it , wage s ar e largel y determine d b y labor productivit y an d firm profitability . Th e governmen t i s con sidering allowin g Chines e worker s t o bu y thei r ow n home s (i n part t o defuse widesprea d dissatisfactio n wit h urban housin g con ditions that th e state is financially unabl e to improve) but withou t creating a capitalis t housin g market. 27 I n th e absenc e o f suc h a market, labo r mobility , an d henc e a realistic pricin g o f labor, ar e severely hindered . Informal financial market s hav e mad e thei r appearance . Nonstate-sector firms acquir e a no t inconsiderabl e an d risin g share o f th e capita l the y nee d o n suc h informa l (i.e. , existin g outside th e stat e bankin g system ) credi t market s a t supply - an d demand- determine d interes t rates . Most of the capital fo r foreig n joint venture firms i s supplied a t market-determined interes t rate s by the foreign partner. 28 Two development s shoul d b e note d wit h respec t t o externa l

The Political Economy in Communist Chin a 8 3 sector marketization : (1 ) Th e numbe r o f relativel y autonomou s (but stil l state-owned ) foreig n trad e corporation s permitte d t o engage i n foreig n transaction s i n specifie d commodit y line s ros e from eigh t hundre d i n th e mid-1980 s t o five thousand i n th e lat e 1980s, consolidated t o around fou r thousan d i n the early 1990s . At the en d o f th e 1980s , roughl y hal f China' s export s consiste d o f goods outsid e th e trad e plans . Competitio n amon g th e tradin g corporations, accordin g t o Lardy , "mean t tha t b y th e en d o f th e decade mos t producer s wer e receivin g th e internationa l pric e fo r their products rather tha n th e state-fixed prices , as they had i n th e pre-reform foreig n trad e system/' 29 I n othe r words , th e competi tive influence o f the world marke t wa s brought t o bear o n China' s domestic econom y throug h bette r aligne d domesti c an d interna tional trad e prices . (2 ) Step s hav e bee n take n t o mov e fro m planned foreig n currenc y rationin g t o allocatio n throug h marke t forces. I n th e mid-1980 s foreig n exchang e market s wer e se t u p i n major citie s an d som e specia l economi c zone s t o enabl e foreig n invested-firms t o trad e foreig n currencie s amon g themselves . I n 1987-88 this right was extended t o domestic firms and the volum e of transaction s soared , reachin g $1 3 billio n i n 1990. 30 Becaus e external trad e ha s sinc e 197 9 com e t o represen t a n increasingl y significant shar e o f China' s (particularl y sout h China's ) nationa l product, th e progressiv e marketizatio n o f externa l trad e price s and foreig n exchang e allocation s an d pricin g canno t bu t strengthen th e drift towar d marke t reforms .

Prognosis The Chines e lik e t o sa y tha t thei r cas e i s differen t an d tha t th e lessons bein g learne d fro m th e collaps e o f th e centrall y planne d system an d totalitaria n politie s i n th e forme r Sovie t Unio n an d Eastern Europ e d o no t necessaril y appl y t o them . I n China , the y say, what yo u see is not always what yo u get; formal structure s d o not functio n th e wa y the y ar e described , an d ther e i s a n infinit e number o f subtl e way s i n whic h rule s ca n b e interpreted , s o tha t only native s steepe d i n ethno-specifi c millennia l cultura l tradi tions ca n kno w wha t thes e are . B e tha t a s i t may , ther e exis t

84 Ja n S . Prybyla certain systemi c regularities an d commonalities tha t equally , perhaps more powerfully, influenc e final outcomes . One o f the m i s tha t fo r a n economi c syste m t o functio n prop erly, tha t is , i n th e interes t o f th e materia l welfar e o f th e peopl e who liv e an d mak e thei r livin g withi n it , i t mus t compris e a minimum critica l mas s o f integrated , compatible , internall y con sistent, interrelated , an d interactin g idea s an d institution s tha t together constitut e a n identifiabl e organism . Th e integration , compatibility, an d s o on, need not (perhap s should not) be total — there can be borrowings and transplants from othe r systems—bu t there ha s t o b e a minimu m mas s o f clearl y dominant , relate d institutions an d idea s tha t giv e th e syste m structura l harmon y and interna l logic . Two-tier propert y right s an d two-trac k price s do not see m t o fulfill thi s condition , an d ar e clearl y a transitiona l phenomenon. Soone r o r later , one of the two tiers or tracks has t o become dominant . A t tha t poin t a n essentiall y politica l decisio n has t o b e mad e t o pas s fro m usin g truncate d privat e propert y i n and quasi-market s fo r individua l good s an d service s a s a supple ment t o th e socialis t die t t o a full y fledged marke t system . Th e question i n Chin a toda y i s whether th e process o f informal priva tization an d simulate d marketizatio n ha s reache d th e poin t a t which th e decisio n o n systemi c transitio n mus t b e made . Indica tions ar e tha t i t ha s don e s o institutionall y i n th e souther n prov inces, which ar e read y fo r th e marke t system . In muc h o f the res t of th e countr y thi s ha s no t ye t happened . Th e sam e seem s t o b e true a t th e leve l o f ideas . Th e sout h i s read y t o accep t th e ide a of th e marke t syste m analyticall y and , wit h som e reservations , ethically a s well. This i s not th e case in som e other inlan d places , notably i n th e sea t o f powe r a t Zhongnangha i i n Beijing . Th e market system, a s distinct fro m th e tactical use of markets t o keep people bus y improvin g thei r materia l conditio n an d thu s ensur e "social stability' ' (n o mor e Tienanmens ) fo r th e tim e bein g a t least, is rejected b y the central Part y leadership , and th e rejectio n is not just rhetorical . The politica l natur e o f economi c syste m transitio n consist s i n the fac t tha t howeve r spontaneou s th e d e fact o privatizatio n o f property right s an d marketizatio n o f price s ma y be , th e linking up o f scattere d an d incomplet e propert y right s an d individua l

The Political Economy in Communist Chin a 8 5 markets int o a marke t system—o f bod y part s int o a functionin g body—requires governmen t participation : th e establishmen t o f a framework o f law s tha t permi t th e marke t syste m t o operate , a n even-handed an d predictabl e enforcemen t o f thos e law s (rul e o f law), and th e removal o f the moral opprobrium attache d b y Marxist mora l code s t o marke t behavior . Th e lesson o f Eastern Europ e and th e forme r Sovie t Unio n applicable , I think , t o communis t China despit e importan t cultura l differences , i s tha t Communis t parties, n o matte r ho w revisionisticall y flexibl e (e.g. , Hungary , Yugoslavia) ar e philosophicall y an d constitutionall y incapabl e o f this crucia l ac t o f politica l will—without , tha t is , destroyin g themselves.31 I t i s not , a s i s ofte n asserted , a matte r o f changin g personnel withi n th e Part y (e.g. , replacin g a L i Pen g o r a Che n Yun wit h a "moderate " lik e Zha o Ziyang , o r th e ol d guar d wit h a younge r generatio n o f communists) , bu t on e o f replacin g th e Communist party , peacefully i f possible. The souther n coasta l province s o f Chin a contai n b y no w th e critical minimu m mas s o f propert y an d marke t arrangements , imperfectly integrate d an d incomplet e thoug h the y ma y be , t o make th e transitio n t o a marke t system . Th e sout h woul d benefi t from bot h th e sprea d o f it s idea s an d institution s t o th e res t o f China an d fro m th e forgin g o f linkage s wit h othe r dynami c an d more materiall y (a s wel l a s politically ) advance d Chines e marke t areas such as Taiwan an d Hong Kong. Both steps require th e prio r removal o f the Communis t part y fro m politica l powe r a t bot h th e regional an d centra l levels . I f th e transformatio n i s no t consum mated befor e Hon g Kon g returns t o the suffocating embrac e o f a n economically half-reforme d an d politicall y unreforme d mother land, Hon g Kong' s marke t econom y wil l suffe r possibl y irrepara ble damag e an d Chin a wil l hav e misse d a unique chanc e t o leav e behind centuries of underdevelopment, a n opportunity tha t is now within it s grasp . Notes 1. Ada m Smith , The Wealth of Nations, Edwi n Canna n editio n (1776 : reprint, New York: The Modern Library , 1937) , 625. 2. Russia n economist Vasily Selyunin cited by Bill Keller, "Soviet Econ -

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omy: A Shattere d Dream, " New York Times, 1 3 Ma y 1990 , A12 . "Fo r Mao a s fo r Stalin , th e rat e o f growt h o f national iro n an d stee l outpu t seemed a t time s th e sol e criterio n b y whic h socialis t advanc e shoul d be judged. " Richar d Kirb y an d Terr y Cannon , "Introduction, " i n China's Regional Development, ed . Davi d S . Goodma n (Londo n an d New York : Routledge , 1989) , 6 . "Ove r th e centur y th e Soviet s essen tially erase d th e ver y notio n o f economics. " "Chin a Globalized, " edi torial, Wall Street Journal, 2 2 Ma y 1989 , 8 . 3. Wan g Xiaoqian g an d Ba i Nanfeng , The Poverty of Plenty (Basingstoke , England: Macmillan , 1991) , 8 7 - 8 8 . 4. "Th e Stat e o f th e Natio n State, " Economist (London) , 2 2 Decembe r 22 1990 , 46. 5. Raimun d Dietz , The Reform of Soviet Socialism as a Search for Systemic Rationality: A Systems Theoretical View (Vienna : Th e Vienn a Institute fo r Comparativ e Economi c Studies , Reprin t Series , No . 130 , January 1991) , 428. Reprinted fro m Communist Economies 2 (1990) . 6. "Th e crucia l poin t i s tha t th e prio r developmen t o f severa l [private ] property i s indispensable fo r th e developmen t o f trading , an d thereb y for th e formatio n o f large r coheren t an d cooperativ e structures , an d for th e appearanc e o f thos e signal s w e cal l prices. " F . A . Hayek , The Fatal Conceit: The Errors of Socialism i n The Collected Works of F. A. Hayek, ed . W . W . Bartle y II I (Chicago : Universit y o f Chicag o Press , 1988), 1:31 . 7. "Th e ultimat e value s o f [ a multiplicit y o f differen t rank s o f differen t ends] com e t o b e reflecte d i n a singl e scal e o f value s o f [diverse , mutually substitutable ] means—i.e. , prices—tha t depend s o n thei r relative scarcit y an d th e possibilit y o f exchang e amon g owners. " Hayek, The Fatal Conceit, 96 . 8. "[T]h e justic e tha t politica l authorit y mus t enforce , i f i t want s t o secure th e peacefu l cooperatio n amon g individual s o n whic h prosper ity rests , canno t exis t withou t th e recognitio n o f privat e property : 'Where ther e i s n o propert y ther e i s n o justice / i s a propositio n a s certain a s an y demonstratio n i n Eucli d . . . (Joh n Locke : 1690). " Hayek, The Fatal Conceit, 34 . Haye k followin g F . C . Savign y (System des heutigen Roemischen Rechts [1840] ) define s privat e (o r a s h e pre fers t o cal l it , "several" ) propert y a s " a n invisibl e boundar y withi n which th e existenc e an d operatio n o f eac h individua l i s assure d a certain fre e space. " Hayek , The Fatal Conceit, 35 . 9. Rober t C . Hsu , Economic Theories in China, 1979-1988 (Cambridge : Cambridge Universit y Press , 1992) . 10. B y "substantia l rationality " i s mean t th e assumptio n o f a stat e o f rational affair s fro m whic h realit y alway s strays . O n thi s Harmonielehre view , th e rationalit y o f any syste m i s seen a s th e system' s abilit y through it s coordinatio n mechanis m t o brin g abou t th e posite d equi l i b r i u m — a problem , b y an d large , o f computationa l techniques .

The Politica l Econom y i n Communis t Chin a 8

7

Within thes e confinin g conceptua l parameters , i t ca n b e demon strated tha t bot h th e marke t an d centra l plannin g ar e equall y capa ble o f bringin g abou t substantia l rationa l equilibrium , indeed , an y mixture o f th e tw o ca n d o i t (Oska r Lange) . A technical equivalenc e of marke t an d pla n i s thu s theorized , whic h i s bu t a ste p fro m th e moral equivalenc e o f capitalis m an d socialis m wit h whic h libera l argument i s peppere d (o r use d t o be) . Dietz , The Reform of Soviet Socialism, 422 . In hi s essa y o n "Th e Compute r an d th e Market " (i n Socialism, Capitalism, and Economic Growth: Essays Presented to Maurice Dobb, ed. C. H. Feinstein [Cambridge : Cambridge Universit y Press, 1967] : 158), Lange writes: "Le t u s put simultaneou s equation s on a n electroni c compute r an d w e shal l obtai n th e solutio n i n les s than a second . Th e marke t proces s wit h it s cumbersom e tatonne ments appear s old-fashioned . Indeed , i t ma y b e considered a s a computing devic e of the pre-electronic age. " Janos Kornai , a practitione r of models o f substantial rationalit y i n th e 1950s , has thi s t o say afte r experiencing th e Hungaria n Ne w Economi c Mechanism' s attemp t t o mix market an d plan : "Th e Lange of the 1930s , although a convince d socialist, live d i n th e steril e worl d o f Walrasian pur e theor y an d di d not conside r th e socio-politica l underpinning s o f hi s basi c assump tions." Jano s Kornai , "Th e Hungaria n Refor m Process : Visions , Hopes, an d Reality, " i n ed . Remaking the Economic Institutions of Socialism, Victo r Nee and David Stark (Stanford: Stanfor d Universit y Press, 1989) , 85 . Kornai' s criticis m o f th e Lang e mode l i s o n pp . 83-86. 11. Do n Lavoie , "Computation, Incentives , and Discovery : The Cognitiv e Function o f Market s i n Marke t Socialism, " The Annals, America n Academy o f Political an d Socia l Science , 507 (January 1990) : 77-79; idem, Rivalry and Central Planning: The Socialist Calculation Debate Reconsidered (Cambridge : Cambridg e Universit y Press , 1985) ; idem , National Economic Planning: What Is Left? (Cambridge , Mass. : Bal linger, 1985) . 12. Hayek , The Fatal Conceit, 77, 83 (emphasis i n the original), and idem , "The Us e o f Knowledg e i n Society, " American Economic Review 3 5 (1945): 519-30. 13. I discuss thes e reasons a t lengt h i n my contribution t o Franz Michae l et al . See also Olivier Blanchard , Rudige r Dornbush , Pau l Krugman , Richard Layard , Lawrenc e Summers , Reform in Eastern Europe (Cambridge: MIT Press, 1991). 14. A s I read it , wit h som e shifting difference s o f emphasis amon g them , the first schoo l includes , Friedric h A . Hayek, Ludwi g vo n Mises , G . Warren Nutter , Janos Kornai , Jeffrey Sachs , the authors o f Reform in Eastern Europe mentione d i n not e 13 , Vaclav Klaus , Lesze k Balcero wicz, and Yego r Gaidar . 15. I n m y vie w th e school , agai n wit h som e changin g emphase s amon g

88 J a n S . P r y b y l

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its members , include s Willia m A . Byrd, Inderji t Sing h (bot h o f th e World Bank), Nicholas R. Lardy, and Valtr Komarek . 16. Nichola s R. Lardy, Redefining U.S.—China Economic Relations (Seat tle: Th e Nationa l Burea u o f Asian an d Sovie t Research , NB R Analy sis, June 1991 , No. 5), 7. 17. Paishing Semi-Monthly (Hon g Kong) , 1 March 1992 , 26-27', in Inside China Mainland (Taipei ) 1 4 (May 1992) : 15. 18. "Chin a Attracts Investment," Wall Street Journal, 1 0 March 1992 , A12. 19. Qi u Shi , "Getting th e Mos t Ou t o f State-Owne d Large - and Medium Sized Enterprises, " Finance and Economy Studies, Shanghai , 1 (1992): 3-7, in Inside China Mainland (Taipei ) 14 (May 1992): 44; Chuyuan Cheng, Trade and Investment across the Taiwan Strait: Economic Consequences and Prospects (Montclair , Calif. : Th e Claremon t Insti tute, Asia n Studie s Center , Strategi c Study , 1990) , Table s 1 and 4 . From 198 9 through 199 0 Fujian Provinc e receive d 4 5 percent o f Taiwan investment , Guangdon g Provinc e 2 1 percent , Jiangs u Provinc e 16 percent, an d Shangha i 7 percent (Tabl e 5) . Richard Pomfret , Investing in China: Ten Years of the Open Door Policy (Ames: Iowa Stat e University, 1991) , 75 , 95 ; "Independen t Stanc e Put s Guangdon g a t Forefront o f Renewed Commitment t o Economic Reform," Asian Wall Street Journal Weekly, 30 March 1992 , 16. 20. Willia m A . Byrd, The Market Mechanism and Economic Reforms in China (Armonk , N.Y . an d London , England : M . E . Sharpe , 1991) , 25-26, sums up th e secon d school' s position o n the subject: "Wha t i s important i s tha t agent s producin g fo r an d transactin g i n market s have a considerabl e degre e o f autonomy , whethe r o r no t the y ow n their enterprises . Thi s requiremen t i s consisten t wit h a variet y o f different ownershi p forms, possibly including public ownership." The first schoo l argue s tha t greate r autonom y fo r nomenklatura bureau crats is not enough . What is needed are clear titles of what belongs t o whom, s o tha t owner s pu t thei r mone y o n th e line , an d disciplin e those they put i n charge of managing tha t money . 21. Josep h C . H. Chai, and Chi-Keun g Leung , "Reform o f China's Indus trial Price s 1979-1985, " in ed . China s Economic Reforms, Josep h C . H. Chai, and Chi-Keun g Leun g (Hon g Kon g Centre o f Asian Studies , University of Hong Kong, 1987) , 584-698. 22. Worl d Bank , China between Plan and Market (Washington , D.C. : World Bank, 1990) , 59. 23. Byrd , The Market Mechanism and Economic Reforms in China, 201. 24. Worl d Bank, China between Plan and Market, 60. 25. "Chin a t o Ope n Som e Markets, " Wall Street Journal, 1 5 Januar y 1992: A16. 26. Byrd , The Market Mechanism and Economic Reforms in China, 200. 27. Nichola s R . Lardy , "I s Chin a Different? " Th e Fat e o f It s Economi c

The Political Economy in Communist Chin a 8 9 Reform," i n The Crisis of Leninism and the Decline of the Left: The Revolutions of 1989, ed . Danie l Chiro t (Seattle : Universit y o f Wash ington Press , 1991) , 147 ; Jame s McGregor , ''Chin a Want s Urba n Workers t o Purchas e Thei r Home s Abandonin g Mao' s Visio n o f Nearly Cost-Free Shelter, " Wall Street Journal, 23 January 1992 , A13. 28. Lardy , Redefining U.S.-China Relations, 10 ; idem , Foreign Trade and Economic Reform in China, 1970-1990 (Cambridge : Cambridg e Uni versity Press, 1991) , chapter 3 . 29. Lardy , Redefining U.S.-China Relations, 11 . 30. Ibid . 31. Ja n Prybyla , "China' s Revolutio n withou t Border s . . . Will Founde r Unless Part y Wall s Topple, " Asian Wall Street Journal, 1 6 Marc h 1992,6.

5 The Failur e o f Developmen t Planning i n Indi a Shyam J . Kamat h

1. Introduction Economic policy in India since it gained independenc e i n 194 7 has been conducted withi n a framework o f centrally directe d develop ment plannin g combine d wit h intensiv e governmen t regulatio n and contro l o f al l facet s o f economi c activity . Beginnin g i n 1951-52, a serie s o f Five-Yea r Plan s hav e provide d a comprehen sive an d comple x se t o f directive s an d target s fo r savings , invest ment, exports, imports, public ownershi p o f the mean s o f production an d fo r regulatin g privat e economi c activity . Privat e enterprise an d industr y hav e bee n allowe d t o functio n subjec t to numerou s physical , financial, an d noneconomi c constraints . A bewildering variet y o f interlinkin g control s an d polic y interven tions has constraine d marke t force s i n a manner quit e unlike tha t experienced i n Western develope d economies. 1 The plannin g an d contro l framewor k adopte d i n Indi a gre w out o f a convictio n o f th e India n elit e i n th e year s precedin g independence tha t economi c growth wa s not possible throug h th e reliance o n unfettere d marke t force s becaus e o f th e "objective " conditions of underdevelopment. According to this view, equitable growth coul d onl y be achieved b y systematic planning . The estab90

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lishment o f th e India n plannin g framewor k followe d th e recom mendations o f th e officiall y appointe d Advisor y Plannin g Boar d (1946) an d it s endorsemen t b y th e Economi c Programm e Commit tee o f th e Congres s part y (1948). 2 Th e direction s fo r establishin g the India n Plannin g Commissio n t o develo p an d coordinat e th e economy wide plannin g effor t wer e provide d b y thes e documents . The subsequen t Industria l Polic y Resolutio n o f Apri l 194 8 out lined th e comple x o f controls tha t woul d regulat e industria l activ ity. I t wa s th e first o f a serie s o f polic y resolution s an d regulator y interventions tha t followed . Th e plannin g syste m an d contro l framework, se t u p i n th e postindependenc e er a a s a resul t o f thes e initial polic y directions , produce d unintende d bu t disastrou s con sequences fo r th e subsequen t economi c developmen t o f th e country. Today, afte r forty-fiv e year s o f planne d economi c development , India's pe r capit a incom e remain s aroun d $300 . Almost 4 0 percen t of Indian s liv e belo w th e officia l povert y line , an d th e absolut e n u m b e r o f Indian s i n tha t categor y increase d sharpl y betwee n th e late 1950 s an d th e mid-1980s . Indi a lag s behin d th e majorit y o f nations o n mos t indicator s o f th e qualit y o f lif e suc h a s literacy , life expectancy , nourishment , acces s t o saf e drinkin g wate r an d sanitation, an d s o forth . Considerin g tha t almos t one-sixt h o f hu manity reside s i n India , th e failur e o f centrall y directe d develop ment plannin g ha s produce d a n economi c an d socia l debacl e o f much large r proportion s tha n wa s witnesse d b y th e collaps e o f socialism i n Easter n Europ e an d th e Sovie t Union . This chapte r examine s th e natur e an d structur e o f developmen t planning i n Indi a i n th e postindependenc e perio d an d analyze s the reason s fo r it s failure . I t provide s a comprehensiv e critiqu e o f the underlyin g vision , theoretica l basis , an d actua l experienc e with developmen t plannin g i n India . Th e lesson s tha t ca n b e drawn fro m th e India n developmen t plannin g experienc e ar e gen eral an d appl y t o al l th e developin g countrie s tha t adopte d suc h planning i n th e postwa r perio d wit h essentiall y simila r results . Section 2 outline s th e majo r characteristic s o f th e underlyin g "unconstrained" visio n o f developmen t plannin g an d detail s th e roots an d developmen t o f thi s visio n i n th e India n developmen t experience. Th e framewor k o f India n developmen t plannin g i s

92 Shya m J. Kamat h outlined i n sectio n 3 . Details o f th e plannin g an d contro l regim e are provided in section 4. The actual development recor d of Indian planning is detailed in section 5. A theoretical and epistemologica l critique o f th e India n developmen t plannin g experienc e i s pro vided i n section 6 . Section 7 contains some conclusions. 2. The Unconstrained Vision of Development Plannin g Development plannin g ha s bee n shape d an d influence d b y a n un derlying vision which is fundamental t o its spread an d subsequen t failure. The principal tenet s undergirding thi s vision ar e that eco nomic developmen t ca n b e engineere d throug h reaso n an d fore sight; tha t rationa l economi c plannin g an d effectiv e contro l o f a n entire economi c syste m ar e bot h feasibl e an d desirable ; an d tha t centralized knowledg e collectio n an d decisionmakin g ar e bot h feasible an d efficaciou s i n huma n society . Thi s visio n ma y b e called th e "unconstrained " visio n o f economi c development. 3 I t sees n o limi t t o huma n knowledg e o r it s applicatio n throug h hu man reason . It attempts t o reorganize and rearrange human socie ties by rationa l plannin g an d interventionis t socia l an d economi c policy s o as t o design th e "bes t o f all possible worlds/ ' I t believe s that centralize d governmenta l decisionmakin g an d coordinatio n can succee d rathe r tha n decentralized , voluntar y market-medi ated decision s and tha t quantitativ e criteri a an d decision s by "experts" can replace th e decentralized pric e signals of the market . The unconstraine d visio n see s th e orde r o f huma n civilizatio n and it s institution s a s th e product s o f deliberat e desig n b y th e application o f huma n reason , rathe r tha n th e spontaneou s prod ucts o f human actio n i n a long-ter m proces s o f cultural evolutio n as viewe d b y th e constraine d vision. 4 Th e forme r visio n see s n o limits t o huma n knowledg e an d reaso n an d concentrate s o n th e achievement o f hoped-for results. Th e latte r visio n see s huma n knowledge a s th e produc t o f socia l experienc e an d see s sever e limits t o th e applicatio n o f huma n reason , instea d focusin g o n evolved systemi c processe s an d thei r systematic effects an d unintended consequences. Since people' s view s ar e affecte d b y a variet y o f beliefs , theo ries, an d though t systems , a clear-cu t dichotom y int o th e tw o

The Failure of Development Plannin g in India 9 3 opposing visions cannot b e clearly identified i n every case. Rather, the tw o vision s ca n b e see n a s th e end s o f a continuu m wit h clearly definabl e characteristic s an d w e ca n spea k o f people wit h more or less constrained visions . What i s clea r i s tha t a n individ ual's o r a grou p o f individuals' positio n alon g thi s continuu m ha s a predictiv e powe r i n term s o f th e kin d o f economi c an d socia l policies tha t wil l b e espouse d an d practice d wit h a broad patter n of likely outcomes. Socialism an d communis m i n their man y guise s conform t o th e tenets o f th e unconstraine d vision , wit h a consequen t interven tionist ben t t o achiev e desire d result s throug h socia l engineerin g and control . Th e systemati c effect s o f suc h a visio n ar e neverthe less predictable an d differen t fro m th e intende d consequences , a s has bee n detaile d b y it s critic s suc h a s Bohm - Bawerk , Mises , Hayek an d Popper. 5 Th e choic e o f a particula r positio n alon g the continuum o f visions therefor e ha s predictable an d importan t consequences fo r th e typ e o f society tha t wil l evolv e as a result o f the application o f that visio n t o social and economi c policy . In th e cas e o f postindependenc e India , th e particula r polic y framework adopte d an d th e actua l result s tha t emerge d ca n b e seen as the product o f the less constrained or rather unconstraine d vision tha t wa s adopte d b y th e India n elite s wh o cam e t o power , especially th e visio n o f India' s first prim e ministe r an d architec t of modern India , Jawaharlal Nehr u an d hi s Congress party. While a number of contending factions existe d within the Congress part y both prio r t o and immediatel y afte r independence , i t wa s Nehru' s unconstrained visio n tha t wo n th e da y an d launche d Indi a o n it s own peculiar versio n of socialism. 6 Nehru, wh o wa s India' s prim e ministe r fo r th e first seventee n years afte r independenc e an d wh o wa s th e architec t o f postinde pendence India' s economi c an d socia l policies , wa s greatl y influ enced b y th e ideal s o f Fabia n socialis m durin g hi s studen t year s at Cambridg e an d after . Hi s participatio n i n th e Internationa l Conference Agains t Oppressio n an d Imperialis m i n February 192 7 left a dee p impressio n o n him . A subsequent visi t t o th e Sovie t Union i n Novembe r tha t yea r durin g th e tent h anniversar y cele brations o f th e Bolshevi k Revolutio n lef t hi m impresse d b y th e achievements o f th e revolution . O n hi s retur n t o Indi a h e i n ten-

94 Sh

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sively studie d Marxis t though t an d th e Bolshevi k Revolution , an d wrote a serie s o f article s o n socialis m an d relate d topics , whic h formed th e basi s o f hi s firs t book . A famou s pamphle t calle d "Whither India? " whic h h e wrot e i n th e thirties , sa w th e futur e o f India a s a n independen t socialis t stat e an d praise d Sovie t social ism muc h a s th e Britis h Fabia n socialists , Sidne y an d Beatric e Webb (1938 ) and Nehru' s ow n teache r Harol d Lask i (1935) , had . Nehru's fascinatio n wit h an d subsequen t conversio n t o th e un constrained socialis t visio n ca n b e see n fro m hi s addresse s an d writings followin g hi s retur n fro m th e Sovie t Union . O n Septem ber 22 , 1928 , he tol d th e Al l Bengal Students ' Conference : I wish t o tell yo u tha t thoug h personall y I do not agre e with man y o f th e methods o f th e communists , an d I a m b y n o mean s sur e t o wha t exten t communism ca n sui t presen t condition s i n India, I do believe i n commu nism a s an idea l fo r society . For essentially i t i s socialism, and socialism , I think, is the only way if the world i s to escape disaster. 7 Again, whe n Nehr u becam e presiden t o f th e India n Nationa l Con gress (th e Congres s party ) a t it s Lahor e sessio n i n 1929 , h e de clared hi s bon a fides: I mus t frankl y confes s tha t I a m a socialis t an d a republica n an d a m n o believer i n kings and princes , or i n th e order which produce s th e moder n kings o f industry , wh o hav e greate r powe r ove r th e live s an d fortune s o f men tha n eve n th e king s o f old , an d whos e method s ar e a s predator y a s those of the old feudal aristocracy. 8 In hi s presidentia l addres s t o th e Congres s part y i n 1936 , he spok e of th e achievement s o f th e Bolshevi k Revolutio n i n th e followin g terms: "Everywher e conflict s grew , an d a grea t depressio n over whelmed th e worl d an d ther e wa s a progressiv e deterioration , everywhere excep t i n th e wideflun g territorie s o f th e USSR , where, i n marke d contras t wit h th e res t o f th e world , astonishin g progress wa s m a d e i n ever y direction." 9 H e wen t o n t o defin e th e role tha t h e envisage d fo r socialis m i n th e followin g manner : [There is ] n o wa y o f endin g th e poverty , th e vas t unemployment , th e degradation, an d th e subjectio n o f th e India n peopl e excep t throug h So cialism. . . . Socialism mean s th e endin g o f privat e property , excep t i n a restricted sense , an d th e replacemen t o f th e privat e profi t syste m b y a higher idea l o f cooperativ e service . It mean s ultimatel y a chang e i n ou r

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instincts an d habit s an d desires . I n short , i t mean s a ne w civilization , radically differen t fro m th e present capitalis t order. 10 Nehru wa s instrumenta l i n th e settin g u p o f th e Nationa l Plan ning Committe e o f th e Congres s part y i n Decembe r 1938 , whic h adopted a n avowedl y socialis t an d interventionis t economi c phi losophy tha t h a d a grea t impac t o n th e economi c regim e estab lished afte r independence . Nehru , a s th e chairma n o f th e commit tee, preside d ove r seventy-on e meeting s betwee n Decembe r 193 8 and Septembe r 1940 , missin g onl y on e meeting . Th e committe e reaffirmed th e party' s earlie r commitmen t (i n th e for m o f th e Karachi Resolutio n o f 1931 , also drafte d mainl y b y Nehru ) t o stat e ownership o f key industrie s an d adde d services . As a resul t o f thes e step s take n b y th e Congres s part y spear headed b y Nehru , th e Nationa l Plannin g Commissio n wa s se t u p in 195 0 unde r th e chairmanshi p o f Nehr u an d th e final versio n o f the Firs t Five-Yea r Pla n i n Decembe r 195 2 contained th e followin g important assertion : Whether on e think s o f the problems o f capital formatio n o r th e introduc tion o f ne w technique s o r th e extensio n o f socia l services , or th e realign ment o f productiv e force s an d clas s relationship s withi n society , on e comes inevitably to the conclusion that a rapid expansion of the economic and socia l responsibilitie s o f th e Stat e alon e b e capabl e o f justifying th e legitimate expectation s o f th e people . . .. I t doe s . . . mean a progressiv e widening o f th e publi c secto r an d th e reorientatio n o f th e privat e secto r to the needs of a planned economy. 11 Thus, Nehru' s unconstraine d socialis t visio n bega n t o increasingl y dominate th e officia l document s o f th e newl y forme d government . This visio n wa s t o no w gro w t o becom e a mor e extrem e un constrained cred o fo r bot h th e Congres s part y an d th e govern ment. Fo r example , th e rulin g Congres s party' s conventio n i n 195 5 declared it s nationa l objectiv e t o be th e establishmen t o f "a social istic patter n o f societ y wher e th e principa l mean s o f productio n are unde r socia l ownershi p an d control." 1 2 Similarly , th e govern ment's 195 6 Industria l Polic y Resolutio n reiterate d that : The stat e wil l progressivel y assum e a predominan t an d direc t responsi bility for setting up new industrial undertakings and for developing transport facilities . I t wil l als o undertak e stat e tradin g o n a n increasin g scale. . . . The adoptio n o f th e socialis t patter n o f societ y a s th e nationa l

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objective, a s wel l a s th e nee d fo r planne d an d rapi d development , re quires tha t al l industrie s o f a basi c o r strategi c importance , o r i n th e nature of public utility services, be in the public sector. 13 This visio n wa s implemente d wit h th e Secon d Five-Yea r Plan , or th e "heav y industry " pla n whic h wa s modele d o n th e Sovie t five-year plan s an d place d a relativ e emphasi s o n th e developmen t of state-owned heav y industrie s an d envisage d a dominan t rol e fo r the publi c secto r i n th e economy . Th e reservatio n o f th e "com manding heights " o f th e India n econom y fo r th e publi c secto r involved th e exclusiv e o r dominan t investmen t o f th e stat e i n twenty-five ke y industria l sector s an d a 60:4 0 spli t betwee n th e public an d privat e sector s i n planne d investmen t outlays . A com plex an d extensiv e maz e o f quantitativ e an d pric e restriction s over ever y face t o f economic activity—suc h a s industria l licensin g controls, pric e an d distributio n controls , import-expor t controls , foreign exchang e controls , an d th e like—wa s introduce d t o con trol th e privat e secto r an d mak e i t confor m t o th e plannin g system. Nehru's socialis t visio n wa s explicitl y incorporate d int o th e Indian constitutio n b y hi s daughter , Indir a Gandhi , India' s thir d prime minister . I n 1976 , durin g th e "Emergency " period , whe n major provision s o f th e 195 0 Constitutio n o f Indi a an d th e India n Parliament wer e suspende d b y Mrs . Gandhi' s government , th e Congress part y effecte d th e infamou s 42n d Amendmen t t o th e Constitution an d change d th e politica l descriptio n o f th e countr y in th e country' s preambl e fro m a Sovereign Democratic Republic t o a Sovereign, Secular, Socialist Democratic Republic. The unconstraine d visio n o f Nehr u tha t ha s molde d India' s economic polic y sinc e independenc e ca n b e bes t illustrate d b y hi s comments durin g a n intervie w wit h a prominen t India n journalis t in 1960 : We hav e accepte d th e socialis t an d cooperativ e approach . . . . We hav e adopted als o th e planne d an d scientifi c approac h t o economi c develop ment i n preferenc e t o th e ol d laisse z fair e school . We ar e therefor e pro ceeding scientificall y an d methodicall y withou t leavin g thing s t o chanc e or fate . . . . But subject to these factors, planning and development have become a sort of mathematical problem which may be worked out scientifically}*

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That Nehru' s "scientistic " visio n wa s i n tun e wit h th e academi c ethos a t tha t tim e (a t leas t amon g eve n prominen t member s o f th e American academ y suc h a s Leontief , Samuelson , a n d others ) i s borne ou t b y thes e statement s i n th e sam e interview: 1 5 But, broadl y speaking , plannin g fo r industria l developmen t i s generall y accepted a s a matte r o f mathematica l formula . I t i s extraordinar y ho w both Sovie t an d America n expert s agre e o n this . I f a Russia n planne r comes here, studies our projects an d advise s us, it i s really extraordinar y how hi s conclusion s ar e i n agreemen t wit h thos e of—say,a n America n expert. . . the moment th e scientist o r technologist come s to the scene, be he Russia n o r American , th e conclusion s ar e th e sam e fo r th e simpl e reason tha t plannin g an d developmen t toda y ar e almos t a matte r o f mathematics. 16 In spit e o f thi s evidenc e o f th e dept h an d durabilit y o f Nehru' s unconstrained socialis t vision , h e wa s als o influence d b y th e lib eral value s o f the West. 17 Thes e libera l value s acte d a s a constrain t on hi s mor e extrem e Fabia n socialis t view s an d create d a curiou s ambivalence i n hi m abou t th e natur e o f politica l an d economi c good. This i n tur n le d t o th e developmen t o f India's peculia r bran d of socialism , wher e centrall y directe d plannin g o f th e publi c sec tor operate d i n a mixe d econom y wit h a substantia l privat e secto r and a democrati c polity . T o a larg e extent , thi s bran d o f "mixe d economy" socialis m wa s als o th e produc t o f th e previou s lon g period o f colonia l rul e whic h ha d mad e th e politica l leaders , intel ligentsia, an d commo n citize n suspiciou s an d distrustfu l o f mar ket-mediated institution s (thoug h thi s wa s no t a facto r i n othe r former colonie s suc h a s Singapor e afte r the y gaine d indepen dence). Th e intellectual s an d th e economi c idea s o f th e tim e wer e also greatl y influence d b y th e allege d "failure " o f capitalis m dur ing th e Grea t Depressio n an d th e allege d "success " o f th e Sovie t Union. But th e unconstraine d visio n o f Nehr u an d th e othe r socialis t Congress leader s wh o ultimatel y wo n th e battl e fo r leadershi p of th e part y wa s instrumenta l i n shapin g th e er a o f socialisti c development plannin g tha t dominate d economi c an d socia l polic y after independence . Whateve r th e ultimat e sourc e (o r sources ) o f this vision , it s limitation s wer e responsibl e fo r th e poo r economi c performance, fragmente d politics , an d socia l strif e tha t hav e de -

98 Sh y am J. Kamat h veloped an d dominate d dail y lif e i n th e forty-fiv e year s sinc e th e country gaine d independence . 3, The Framework o f India n Development Plannin g The plannin g framewor k tha t evolve d i n India , whil e heavil y in fluenced b y th e Sovie t plannin g system , differe d substantiall y from th e Soviet , Easter n European , o r Chines e models . I n thes e latter countries , plannin g operate d i n societie s unde r totalitaria n political contro l an d i n economie s wher e th e stat e owne d th e means o f productio n withou t an y significan t privat e ownership . Planning was centralized an d command-oriented . I n India, with a large privat e secto r an d a democrati c polity , plannin g coul d no t be only by command and/o r throug h stat e ownership o f the majo r means o f production. Consequently , a n elaborat e networ k o f controls an d regulation s ha d t o b e se t u p withi n th e contex t o f a centrally directe d plannin g framewor k fo r a n enlargin g publi c sector (and t o the extent possible for influencin g private-secto r de cisions). The plannin g framewor k tha t wa s develope d combine d suc h central directio n fo r th e publi c secto r wit h direct , discretionary , quantitative, nonmarket control s an d regulation s ove r the privat e sector, instea d o f indirect , rule-based , market-mediate d transac tions operatin g throug h th e pric e mechanis m a s wa s largel y th e case i n th e Western , develope d economie s a t tha t time . Suc h a planning framewor k ha d predictabl y disastrou s bu t unintende d consequences fo r efficiency , equity , an d politica l viability , a s pointed ou t b y a whol e generatio n o f classical economist s an d b y economists of the Austrian School . The Plannin g Commissio n (se t u p i n 1950 ) a t th e ape x o f th e planning an d contro l syste m wa s give n th e tas k o f directin g an d controlling th e process o f resource generatio n an d allocation . Th e basic decision s wit h whic h th e Plannin g Commissio n wa s en trusted wer e 1. Determin e th e size of the investment (an d savings) outlays. 2. Allocat e th e investmen t outlay s amon g alternativ e uses , dow n to the product level .

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3. Determin e th e choic e o f technology , extendin g t o scale , expan sion, direc t import-expor t content , an d th e term s o f foreig n collaboration an d know-ho w i n associatio n wit h othe r special ized governmen t department s an d agencies . These formidabl e task s wer e t o b e achieve d withi n th e framewor k of a mixe d econom y wit h a predominan t privat e secto r i n a coun try o f the n 35 7 millio n citizens , th e majorit y o f whom (8 5 percent ) lived i n rura l area s withou t adequat e communicatio n an d trans portation facilities . Th e mai n vehicl e fo r th e spellin g ou t an d transmission o f thes e decision s wa s five-year plan s develope d b y the Plannin g Commissio n an d it s associate d ministrie s an d agen cies; short-ter m target s an d implementatio n guideline s wer e t o b e detailed i n annua l plannin g document s an d budgets . There wer e ostensibl y thre e majo r polic y aim s o f postindepen dence governmen t economi c polic y whic h wer e achieve d throug h detailed polic y intervention s an d controls . Thes e wer e 1. T o achiev e th e bes t possibl e allocatio n o f investabl e resource s while a t th e sam e tim e reducin g th e concentratio n o f owner ship o f productive assets . 2. T o rais e th e m a x i m u m o f investabl e resource s b y wa y o f tax ation. 3. T o provide essentia l consume r good s a t lo w price s fo r th e bene fit o f th e poor , whil e keepin g th e price s o f intermediat e an d capital good s dow n i n orde r t o stimulat e investmen t an d achieve a "low-cost " economy . These contradictor y an d inadequatel y conceive d objective s wer e to b e achieve d throug h a poorl y pai d governmen t bureaucrac y i n a mixe d econom y wit h a dominan t privat e secto r an d a demo cratic polity , an d coul d onl y hav e le d t o poo r economi c perfor mance unde r condition s o f widespread corruptio n an d rentseekin g as ha d bee n warne d b y a prio r generatio n o f economists . The y were implemente d throug h a networ k o f physica l an d financial controls whic h ver y soo n becam e th e sourc e o f corruptio n an d rent-seeking activity . In orde r t o finance th e planne d developmenta l goals , increasin g government effort s wer e directe d a t raisin g th e proportio n o f sav -

100 Shya m J. Kamat h ings an d taxe s t o GNP . A multitude o f polic y instrument s wer e designed an d implemente d t o guid e economi c activit y i n direc tions congruen t wit h th e plannin g objective s an d targets . Th e policy instrument s wer e t o comprehensivel y cove r bot h th e do mestic an d foreig n sector s o f economi c activity . Th e domesti c policy instruments mainl y consisted o f the following : 1. A comprehensive industria l licensin g system . 2. Control s ove r th e financial syste m (th e culminatio n o f thes e controls wa s th e nationalizatio n o f th e majo r private-secto r banks and genera l insuranc e companies) . 3. Capita l marke t control s ove r monopol y house s an d restrictiv e trade practices . 4. Pric e an d distributio n control s o n agriculture , industry , an d tertiary-sector activity . 5. Activ e encouragement o f the public sector (particularly public sector enterprise s o r PSEs ) t o dominat e th e "commandin g heights" (critica l sectors ) o f th e econom y whil e providin g spe cial preferences fo r "cottage , village and small " industries . The successiv e Industria l Polic y Resolution s (IPRs ) provide d the strategi c framewor k fo r selectivel y applyin g thes e polic y in struments t o the industria l sector . Various ministrie s an d govern mental agencie s a t th e centra l an d stat e level s wer e entruste d with th e tas k o f refining , implementing , an d monitorin g th e net work of domestic controls . The foreign-sector polic y instrument s wer e designed t o suppor t the domestic efforts an d include d th e following : 1. Quantitativ e restriction s (QRs ) for shieldin g domesti c produc tion automaticall y fro m foreig n competition . 2. A n intensive an d extensiv e framework o f import licensin g poli cies and controls . 3. Foreig n exchang e restrictions an d rationing . 4. Expor t contro l and promotion policies . Thus, a wide variety of interlinking detaile d controls and polic y interventions wer e resorte d t o a s instrument s fo r implementin g the strategy o f planned development . These controls and interven tions ca n b e broadl y groupe d unde r domesti c an d foreign-secto r

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interventions. Whil e th e natur e o f thes e control s ha s undergon e considerable chang e i n recen t year s wit h th e program s o f liberal ization o f 198 5 an d 1991 , the majo r feature s o f th e control s an d policy intervention s tha t hav e existe d throug h mos t o f the postin dependence perio d ar e discussed below . 4. Policy Intervention s an d Controls—A Detaile d Discussio n Domestic control s an d intervention s i n postindependenc e Indi a have include d a variet y o f control s suc h a s industria l licensing , restrictions o n capacit y expansion , financial syste m an d interes t rate controls , pric e an d distributio n controls , labo r marke t an d employment controls , an d control s o n monopol y an d restrictiv e trade practices. 18 Controls on agriculture an d th e tertiary service s sectors constitute othe r major area s of regulation. Policy interven tions includ e centra l allocatio n o f majo r investments , encourage ment o f an d preferenc e fo r public-secto r enterprises , industria l location polic y an d public-secto r contro l ove r distributio n o f ma jor commodities . Whil e th e control s hav e bee n modifie d ove r th e years an d ther e ha s bee n a mov e towar d economi c liberalizatio n in recen t years , th e majorit y o f th e restriction s continu e t o appl y for majo r sector s of the economy . The mos t comprehensiv e se t o f capita l marke t control s wa s related t o the industrial licensin g system. 19 Under this system, any investment i n plan t an d machinery , structure s o r othe r capita l equipment abov e a certai n limi t ha d t o b e approve d b y th e gov ernment throug h variou s agencie s an d department s se t u p fo r this purpose . Th e polic y ai m o f thes e control s wa s t o regulat e investment an d th e allocatio n o f resource s an d provid e prefer ences fo r cottage , village , an d smal l industrie s whic h di d no t fal l within th e ambit o f the licensing procedures . The industria l licensin g procedur e a s originall y envisage d wa s found t o b e cumbersom e an d inefficient , sometime s takin g year s to deliver a decision. 20 Consequently, the government appointe d a number o f committees t o review an d streamlin e th e procedures. 21 A number o f industries wer e delicensed i n the seventies and eight ies (an d som e wer e subsequentl y relicensed ) an d expansion s an d diversifications u p t o 25 percent o f existing capacit y wer e permit -

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ted followin g th e 198 6 liberalizatio n til l th e mos t recen t liberal ization whe n al l excep t eigh t "core" ' industrie s hav e bee n entirel y exempted fro m licensing . Unlimite d expansio n o f capacit y wa s also permitte d onl y i n certai n industrie s til l th e mos t recen t liber alization di d awa y wit h thi s provisio n entirely , permittin g expan sion a s dictate d b y marke t consideration s fo r th e firs t tim e sinc e independence fo r th e majorit y o f industries . The industria l licensin g polic y an d syste m ha s bee n criticize d for stiflin g th e economi c growt h o f th e countr y an d fo r creatin g unemployment, imbalances , an d bottlenecks . O n th e othe r hand , academicians an d politician s o n th e lef t hav e criticize d th e polic y for favourin g bi g busines s an d increasin g th e degre e o f concentra tion o f economi c power . Th e majo r criticism s o n efficienc y an d distributive ground s ca n b e summarize d a s 1. Th e licensin g polic y ha s bee n criticize d fo r incorporatin g to o many, ofte n contradictory , objectives , fo r example , promotin g industrial growt h an d efficienc y bu t favorin g small-scal e an d cottage industries ; attemptin g t o chec k th e concentratio n o f economic powe r whil e allowin g th e preemptio n o f license d ca pacity b y larg e busines s houses ; demandin g expor t promotio n and growt h whil e progressivel y requirin g (high-cost ) impor t substitution, an d s o forth . 2. Multiplicit y o f overlappin g control s an d procedure s leadin g t o a proliferatio n o f licensin g agencie s an d inordinat e tim e delay s in clearances . 3. Absenc e o f explici t criteri a fo r evaluatin g licens e application s in term s o f "social/ ' a s distinc t fro m private , profitabilit y an d the consequen t a d ho c criteri a adopte d i n licensin g approval . Bhagwati an d Desa i (1970 , 255 ) fo r example , criticiz e "th e ab sence o f explici t economi c criteri a a s als o th e weightin g o f different objectives , i n th e gran t o r rejectio n o f industria l li censes [which ] wa s matched , throug h th e perio d b y th e gener ally poo r qualit y o f th e "techno-economic " examinatio n o f pro posed industria l investment s whic h th e DGT D wa s suppose d to carr y ou t i n eac h case. " Th e impossibilit y o f developin g "rational" criteri a wa s evidence d throughou t th e postindepen -

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dence perio d b y th e larg e numbe r o f committees tha t wer e se t up t o examine issues of industrial an d impor t licensing. 22 4. A n overemphasis o n "targeted" capacity an d th e sanctioning of such capacit y withou t regar d t o technoeconomi c o r marke t viability. Thi s had simultaneousl y resulte d i n th e settin g u p of noneconomic units, the preemption o r "foreclosure" of licensed capacity, an d th e nonrealizatio n o f larg e volume s o f license d capacities i n certain areas . According t o the Hazari Committe e (1967) and th e Dut t Committe e (1969 ) this le d t o the perpetua tion o f monopolies i n certain key sectors and th e chronic short age o f "essential " commoditie s lik e fertilizer , aluminum , ce ment, minera l oils , and s o forth. Th e deliberat e preemptio n o f capacity b y th e practic e o f makin g multipl e application s i n different name s fo r th e sam e ite m ha d bee n viewe d b y thes e committees as being helped an d abetted by the lending policie s of the public financial institutions , thus leveling the accusatio n of larg e busines s house s buildin g privat e empire s wit h publi c money. 5. Th e administrativ e exemption s an d restriction s wer e withou t economic rationale. For example, the arbitrary exemptio n lim its established (e.g. , units under Rs 30 million investment bein g exempt) ofte n interfere d wit h th e objective s an d efficienc y o f the planning process itself a s conceived by the authorities. This made th e whol e plannin g proces s self-contradictory . Wit h re gard t o restrictions , th e positio n wa s eve n worse . Th e sever e restrictions o n th e manufactur e o f "ne w articles " effectivel y prevented innovatio n an d efficienc y an d protecte d existin g products excessively . Th e emphasi s o n administrativ e rule s o f allocation ha d a built-in bia s against efficiency . Under th e rubri c o f capital marke t an d interes t rat e controls , a number o f specialize d governmenta l developmen t finance an d other institution s wer e se t u p t o provid e concessiona l loan s an d other kind s o f financial service s t o "priority " sectors . Th e mos t important institution s ar e th e Industria l Financ e Corporatio n o f India (IFCI ) se t u p i n 1948 , the Nationa l Industrie s Developmen t Corporation o f Indi a (NIDCI ) founde d i n 1954 , th e Industria l

104 Sh y am J. Kamat h Credit an d Investmen t Corporatio n o f India (ICICI ) set up in 1956 , and th e Industria l Developmen t Ban k o f Indi a (IDBI ) an d Uni t Trust o f Indi a (UTI) , bot h se t u p i n 1964 . In addition , ther e ar e corporations fo r financin g individua l industrie s (small-scal e in dustries, te a plantations , etc.) . Beginning i n 1951 , each stat e ha s also se t u p it s ow n industria l an d investmen t corporations . I n 1969, th e larges t twent y private-secto r bank s wer e nationalize d and hav e sinc e bee n regarde d a s a majo r instrumen t o f stat e financial developmen t effor t an d policy . Thes e financial syste m interventions an d control s hav e bee n use d t o targe t fund s t o chosen sectors. These interventions have made India's financial secto r grossly inefficien t an d antiquated , an d create d a bureaucrati c maze unresponsive t o market needs . Interest rat e controls were implemented throug h th e regulatio n of deposit an d lendin g rates of the commercial banks . In addition , the rates of cooperative banks, public-sector financial institutions , and other type s of financial institution s were also regulated. Inter est rate ceiling s applied selectivel y t o certain classe s of borrower s such a s agriculture , smal l secto r units , expor t units , an d s o on . Lending rate s o f commercia l bank s wer e controlle d t o certai n maximums throug h mos t o f th e period , whil e ceiling s o n deposi t rates wer e announce d fro m tim e t o time . Similarly, ceiling s wer e imposed o n compan y deposi t rate s dependin g o n th e perio d o f deposit an d publi c limite d companies ' rate s o f deposit . Beside s this ther e wer e lendin g rat e ceiling s o n export, small-scal e indus try, food procurement, an d interban k loans. 23 Price an d distributio n control s i n Indi a hav e bee n pervasiv e and ar e s o eve n toda y afte r tw o majo r period s o f liberalization . The Essential Commodities Act (1965) empowered th e central government t o control, regulate, or prohibit th e production, distribu tion, transport , trade , consumption , o r storag e o f a larg e numbe r of commodities . Al l foodstuffs , principa l ra w materials , iro n an d steel products , consume r good s lik e paper , sugar , vegetabl e an d mineral oils , textiles , an d s o forth , input s lik e fertilizer , cement , and s o on , an d th e impor t o f industria l component s hav e bee n under som e kin d o f distributio n control s throughou t mos t o f th e postindependence period . The Act also empowered (bu t not necessarily enabled ) th e governmen t t o se t price s an d t o tak e ove r

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stocks o n condition s se t b y itself . A total o f eighty-thre e contro l orders an d enactment s hav e bee n pu t o n th e statute-book s b y Parliament sinc e 1947 . Ther e i s a goo d dea l o f overla p betwee n the provisions o f the Essential Commoditie s Ac t and Sectio n 18(g ) of th e Industria l Developmen t an d Regulatio n (IDR ) Ac t (1951 ) which empower s th e centra l governmen t t o regulat e suppl y an d distribution o f trad e an d commerc e i n an y articl e relatin g t o a "scheduled" industry . Othe r good s suc h a s cars , trucks , scooters , drugs an d pharmaceuticals , hav e als o bee n pric e controlle d bu t have bee n distribute d throug h nongovernmenta l channels . Price s were se t b y th e India n Tarif f Commissio n s o as t o limi t profit s t o 8-12 percen t o f investe d capita l fo r th e representativ e firm fo r most of the period . Distribution control s fo r consume r good s hav e bee n primaril y applied b y th e establishmen t o f a publi c distributio n syste m fo r foodgrains an d "essential " commodities such as kerosene, cooking oil, sugar . Th e syste m consist s o f governmen t procuremen t agen cies, storage an d distributio n agencies , and a vast urba n networ k of Fair Pric e Shop s (FPRs ) operated b y th e private trad e bu t wit h government contro l an d monitoring . Th e distributio n control s vary fro m produc t t o produc t an d includ e restriction s o n interre gional movements , purchas e an d processin g restrictions , an d a ban o n certai n kind s o f tradin g suc h a s (til l recently ) forwar d markets i n a numbe r o f commodities . Th e distributio n control s have been mos t ofte n combine d wit h a system o f formal statutor y rationing fo r al l th e urba n centre s (i n th e latte r sixties , for exam ple) and a syste m o f informal rationin g i n rural areas . Unproduc tive rent-seeking activit y an d corruption hav e been th e rule rathe r than th e exception . Captur e o f th e regulator s b y th e regulate d and black-market activit y has been widely prevalent. 24 A common practice i s t o secur e allocation s o f th e controlle d commodit y o n some pretext an d t o resell th e ite m o n th e ope n (o r black) marke t at a substantial premium . No comprehensive forma l syste m o f controls exist s in th e labo r market. However , minimu m wag e law s hav e bee n enacte d i n ur ban area s thoug h thes e ar e largel y inoperativ e du e t o th e over abundant suppl y of labor and the impossibility of effectively polic ing th e larg e rura l an d informa l labo r market . Th e onl y majo r

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area o f labo r marke t interventio n i s i n th e publi c sector . Govern ment employee s o n th e averag e receiv e significantl y highe r wage s than thos e i n comparabl e job s i n th e privat e sector . Th e discrep ancy i n wage s i s th e sourc e o f considerabl e rent-seekin g behavio r aimed a t obtainin g governmen t job s throug h investmen t i n hu m a n capita l an d othe r unproductiv e means. 2 5 Anothe r are a o f policy interventio n i n labo r market s i s th e are a reservatio n o f a certain percentag e (often , a majority ) o f jobs fo r identifie d group s in India n society . In addition , India n labo r la w ha s bee n patterne d o n post depression er a Britis h labo r la w an d i s extremely pr o worker . I t i s virtually impossibl e t o clos e dow n a failin g busines s an d th e ma jority o f cour t decision s g o agains t th e employer . A s a result , industrywide union s i n banking , finance, an d th e industria l an d service sector s ca n paralyz e whol e sector s o f th e economy , wit h no recours e fo r employers . An importan t are a o f labo r marke t contro l i s i n regar d t o th e appointment an d remuneratio n o f manageria l personne l unde r the Companie s Ac t (1956 ) amende d fro m tim e t o time . Restric tions cove r th e natur e o f appointments tha t ca n b e m a d e an d thei r approval, th e n u m b e r o f directorship s a n individua l ma y hold , and limit s o n manageria l remuneration . Thes e provision s hav e le d to som e ver y creativ e way s o f remuneratin g an d appointin g to p company personnel . Th e provision s hav e als o bee n allege d t o hav e caused th e departur e o f qualit y manager s abroa d t o mor e remu nerative an d les s restrictiv e environments . Social policie s an d control s hav e include d th e activ e legislatio n and implementatio n o f preferentia l policie s fo r targete d loca l ma jorities an d nationa l "backward' ' minorities , muc h mor e compre hensive an d detaile d tha n simila r "affirmativ e action " policie s i n the Unite d State s Dirigist e labor-marke t an d employmen t poli cies, and governmen t contro l ove r th e broadcas t medi a an d educa tional an d socia l policy , hav e gon e hand-in-han d wit h th e unre strained growt h o f a bureaucratic , redistributiv e stat e an d a national polic y focuse d o n "th e uplif t an d socia l bettermen t o f th e weaker section s o f society. " Thes e policie s hav e bee n th e sourc e o f considerable socia l strife , communa l an d cast e unrest , an d politi cal protest s an d violence .

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Controls o n monopolies , larg e business , an d "restrictiv e trad e practices" ar e exercise d unde r th e Monopolie s an d Restrictiv e Trade Practice s (MRTP ) Act (1969), under th e aegi s o f the Monopo lies Commission. 2 6 Th e majo r thrus t o f thes e control s i s t o limi t the "concentratio n o f economi c power " an d preven t monopolisti c and restrictiv e practice s a s function s o f suc h concentration . Th e controls hav e bee n implemente d throug h th e regulatio n o f invest ment b y larg e industria l houses . Th e inten t o f thes e control s ha s been th e denia l o f ne w license s t o larg e firm s an d th e settin g u p o f public-sector capacit y o r uneconomi c smal l capacit y i n area s where economie s o f scal e an d larg e economi c siz e ar e technoeco nomic prerequisite s (e.g. , cement , fertilizers , paper , heav y engi neering). Th e provision s o f th e Ac t hav e paradoxicall y ofte n pro vided a preemptiv e barrie r fo r larg e industria l house s t o monopolize certai n industrie s b y settin g u p capacit y i n ke y area s while simultaneousl y bein g th e sourc e o f considerabl e rent-seek ing activity . (A s alread y mentioned , th e restriction s hav e bee n circumvented b y othe r means , lik e preemptio n o f capacit y b y "shell" corporations. ) On th e othe r hand , th e MRT P Ac t ha s bee n claime d t o hav e no t stood i n th e wa y o f investmen t an d industria l progres s becaus e it s provisions appl y t o onl y abou t 1 0 percent o f th e industria l licens e cases. 27 However , sinc e th e majorit y o f thes e case s ar e i n ke y sectors o f th e econom y an d involv e larg e investment s an d capacit ies, th e effec t ha s bee n considerabl y greate r tha n envisaged . Eve n though th e governmen t ha s i n recen t year s grante d license s t o large firms i n selectiv e area s an d ha s revise d th e lis t o f industrie s covered, th e deterrenc e an d inefficienc y effect s o f th e provision s o f the MRT P Ac t hav e bee n considerable . Controls o n th e externa l secto r o f th e econom y includ e quanti tative restriction s (QRs ) mainl y i n th e for m o f a n elaborat e im port-licensing syste m an d th e us e o f prohibitiv e tariffs. 28 A num ber o f restriction s o n foreig n investmen t hav e als o shielde d domestic productio n fo r a majo r par t o f th e postindependenc e period. Throughou t thi s perio d a n elaborat e exchang e polic y re gime ha s bee n i n plac e which , alon g wit h th e impor t controls , ha s been aime d a t comprehensive , direc t contro l ove r foreig n ex change utilization . Expor t policy , o n th e othe r hand , ha s grow n

108 Shya m J. Kamat h from a positio n o f almos t complet e neglec t i n th e earl y fiftie s t o one o f escalatin g subsidization , proliferatin g incentiv e schemes , and increasin g direc t governmen t promotio n an d involvement . The mos t importan t an d deleteriou s o f the external-secto r con trols i s th e syste m o f impor t licensing . Thes e control s ar e bot h comprehensive an d complex , and have the following harmfu l gen eral objectives : 1. T o allocate " scarce" foreign exchang e t o various users i n orde r to meet th e input requirement s o f priority sectors . 2. T o enabl e progressiv e impor t substitutio n i n orde r t o reduc e the deficits o n the balance of payments over a few years. 3. T o enable domestic industry t o grow to the exclusion of competition from foreig n industries . Items for which licenses were issued have been subject t o differ ent degree s o f restriction s an d differen t form s o f licensing . Th e variety of categories have included Ope n General Licenses (OGLs), Actual Use r (AU ) licences , Replenishmen t licence s (REPs) , re stricted items , banne d items , item s subjec t t o quot a fo r "estab lished importers " an d eve n "fre e licensed " items . Til l recently , there were sixteen mai n type s of licences, with various subcatego ries t o cater t o the specific requirement s o f each typ e of importer . Each typ e of licence was governed b y a different se t of procedure s and carrie d it s ow n lis t o f items , eac h subjec t t o differen t form s of restrictions. The for m an d degre e o f thes e quit e extraordinar y restriction s also changed frequentl y ove r time. Categories were changed with out an y clea r economi c rational e an d ofte n create d conflict s wit h other licens e categorie s an d items . Economists , administrators , and committee s appointe d b y th e governmen t hav e pointe d ou t the following advers e effects o f the import-licensing system: 29 1. Inordinat e procedural delays . 2. Multiplicit y o f agencies and lac k of coordination . 3. Hig h administrative an d other costs. 4. Inflexibilit y i n policies and procedures . 5. Discriminatio n agains t smal l entrepreneurs . 6. Inheren t bia s i n favo r o f industries base d o n importe d rathe r than domesti c inputs .

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7. Pervasiv e rent-seekin g activit y an d corruption . 8. Absenc e o f marke t competitio n fo r protecte d industries . 9. Anticipator y an d automati c protectio n give n t o certai n indus tries regardles s o f costs . 10. Discriminatio n agains t export s vis-a-vi s domesti c sale s an d consequent los s o f revenu e an d foreig n exchange . 11. Encouragemen t o f th e indiscriminat e growt h o f noneconomi c industries o n th e basi s o f impor t substitution . 12. Advers e distributiona l effect s o f administrativ e allocation . 13. Los s o f governmen t revenues . Two prominen t economists , Bhagwat i an d Srinivasa n (1975) , have pointe d ou t th e kind s o f economi c cost s an d inefficiencie s involved a s follows : The elaborate bureaucrati c machiner y fo r operating th e licensing mecha nisms involve d direc t cost s a s als o th e cost s resultin g fro m th e necessit y for actual and potential entrepreneurs t o maintain elaborate and frequen t "contacts" with th e licensin g authorities . Admittedly, alternativ e alloca tion mechanisms als o must necessitat e "administrative" and informatio n gathering costs. But th e specific typ e of "command" mechanis m involve d in the Indian Q R and industria l licensin g regimes added t o these costs by making necessar y expenditure s t o ensure "file-pushing " b y bribe-seekin g bureaucrats a t lowe r levels , for example . . . . And i f we could onl y disen tangle (a s w e cannot ) th e jo b expansio n i n th e bureaucrac y whic h ha s resulted fro m th e licensin g machinery , muc h o f the enormou s expansio n on curren t governmenta l expenditure s durin g 1956-7 1 ma y tur n ou t t o be a net cost of the regime. 30 A n u m b er o f stat e tradin g o r "canalization " agencie s hav e als o been se t u p a s a n importan t elemen t o f th e externa l tradin g sys tem. Ther e wer e unti l recentl y clos e t o twenty-fiv e canalizatio n agencies whic h togethe r handle d ove r tw o hundre d products . Th e products handle d b y thes e agencie s include d steel , petroleu m products, fertilizer , cement , metal s an d minerals , pharmaceuti cals, chemicals , electronics , film, newsprin t an d sil k an d cotton . The majo r canalizatio n agencie s include d th e Stat e Tradin g Cor poration, th e Mine s an d Mineral s Tradin g Corporatio n an d th e Handlooms an d Handicraft s Corporation . A considerable a m o u n t of rent-seekin g activit y i n th e are a o f externa l trad e involve d pri vate- an d public-secto r agencie s seekin g th e rent s allocate d b y other governmen t agencies .

110 Shya m J . Kamat h A protective tarif f syste m operate d concurrentl y wit h th e im port-licensing system . Tarif f rate s rang e u p t o 45 0 percent , wit h around 4 0 percen t o f import s havin g tariff s impose d o n the m o f between 7 5 an d 12 0 percent . Th e Alexande r Committe e (1978 ) analyzed 62 6 restricted item s and found tha t 25 2 of them receive d a "high " degre e o f protection , bot h throug h th e licensin g syste m and th e tarif f syste m assumin g tha t tarif f rate s abov e 10 0 percent implied a hig h degre e o f tariff protection ; 23 0 items wer e subjec t to les s rigorou s licensin g control s an d tarif f level s below 10 0 percent; while 39 items had eithe r rigorous import control s or "high " tariff level s above 10 0 percent. In recen t years , a numbe r o f relaxation s i n th e impor t contro l policies an d procedure s hav e bee n attempte d wit h th e improve ment i n India' s foreig n exchang e reserv e position . A number o f items hav e bee n delicense d u p t o a certai n limit , irrespectiv e o f indigenous availability . Export-oriente d industrie s hav e bee n given specia l impor t clearanc e exemption s an d incentives . Procedures hav e bee n simplifie d an d eve n eliminate d i n a fe w cases . However, a n extensiv e framewor k o f control s continue s t o exist , considerably hamperin g th e efficient operatio n o f economic activ ity an d providin g scop e fo r extensiv e rent-seekin g activit y an d corruption. Th e exten t o f rent-seekin g activit y i n th e are a o f im port policie s an d procedure s ha s been o n a massive scale . In spit e of th e hig h dutie s an d quantitativ e restrictions , i t i s mor e profit able t o impor t commoditie s an d marke t the m i n Indi a o n th e black marke t tha n t o produce an d sel l th e same goo d in the coun try. A numbe r o f governmenta l committee s hav e analyze d an d detailed th e types of malpractices resorte d t o in the import-expor t trade. 31 Thes e includ e smuggling , import s o f prohibite d items , imports throug h bogu s firms' licenses , underinvoicing an d overin voicing practices, and trafficking i n licenses. The most widesprea d illegal practic e ha s bee n th e profiteering o n impor t licenses . Dat a obtained by the author from trad e sources indicate that premium s on impor t license s varie d fro m 2 0 percen t t o 50 0 percen t o f th e value o f good s durin g th e perio d 195 8 to 1982. 32 It ha s bee n esti mated tha t i n th e sixtie s approximatel y R s 5,50 0 millio n ($55 0 million) wort h o f impor t license s wer e annuall y availabl e i n th e black market. 33 Kruege r (1974 ) estimate d th e valu e o f rent s fo r

The Failure of Development Plannin g in India 11

1

imports t o b e aroun d R s 10,27 1 millio n (abou t $1,00 0 million ) in 1964 . Till the recent polic y chang e makin g th e Indian rupe e partiall y convertible, th e exchang e rat e polic y regim e i n Indi a was , alon g with th e Q R and tarif f regimes , explicitly directe d a t contro l ove r the utilizatio n o f foreig n exchang e an d it s "conservation/ ' Th e Foreign Exchang e Regulatio n Ac t (FERA) of 194 7 stated tha t "i t i s expedient i n th e economi c an d financial interest s o f India t o pro vide fo r th e regulatio n o f certai n payments , dealing s i n foreig n exchange and th e import an d export of currency an d bullion." The Act empowered th e Reserv e Ban k o f India (RBI ) to secure foreig n exchange transaction s b y recording , controlling , an d channelin g all suc h transactions . The central governmen t wa s empowere d t o set and chang e the rules for th e RBI to act upon . The permissio n o f th e RB I wa s til l ver y recentl y require d fo r all investmen t mad e abroa d b y India n resident s a s wel l a s fo r investment i n Indi a b y nonresidents . Recen t regulation s wit h re gard t o Non-Resident Indian s (NRIs ) and relaxe d rule s for foreig n ownership o f stock s liste d o n th e stoc k exchang e hav e howeve r considerably relaxe d a number o f restrictions, resulting i n a floo d of suc h investmen t b y NRI s an d foreigners . Th e Foreig n Invest ment Boar d (FIB ) was th e single agency within th e government t o deal with all matters relating t o foreign investmen t an d collabora tion. Foreig n participatio n i n certai n consume r good s industrie s was completel y banne d til l recently . Ther e wer e policie s control ling th e lis t o f industries wher e foreig n collaboratio n wa s permit ted an d wher e n o foreign participatio n wa s permitted. Transfe r o f some kind s o f securitie s o r creatin g an y interes t i n a securit y i n favor o f a nonresident , a s wel l a s issuin g a n India n securit y t o a nonresident require d Reserv e Bank approval . Other general provisions of the Act include d 1. N o person residen t i n India, other tha n a n "authorized dealer/ ' can buy or otherwise acquir e any foreign exchang e excep t wit h the permissio n o f th e RBI . Thi s provisio n howeve r doe s no t apply t o NRIs and thei r foreign exchang e accounts . 2. A n Indian compan y cannot , excep t wit h th e permissio n o f th e RBI, open an account i n foreign countries .

112 Shya m J . Kamat h 3. A company residen t i n Indi a canno t mak e an y paymen t t o a nonresident ou t o f th e mone y hel d b y i t abroa d exceptin g i n a case where th e account wa s in existence prior t o 1947. 4. Al l busines s an d vacatio n trave l outsid e Indi a require s ap proval of the RBI on release of foreign exchang e for such travel . In addition, ther e are ceilings to the amounts tha t ca n be take n abroad. All thes e provision s o f FER A resulte d i n a thrivin g blac k marke t for foreig n exchange. 34 Foreig n exchang e coul d b e easil y pur chased o r sold on the black marke t i n any major cit y or town. The scale of illegal practices involvin g foreign exchang e can be judged by th e Financ e Ministry' s finding tha t durin g 1964-6 5 14,30 0 violations o f th e foreig n exchang e rule s wer e detected , a s agains t 5,192 i n 1959-60. 35 Considerin g tha t onl y a smal l percentag e o f the actua l violation s i s actuall y detected , th e practic e mus t hav e been rife . Policy interventio n o n th e expor t sid e o f th e externa l secto r involved control s an d ban s o n th e expor t o f certai n items , alon g with expor t incentive s fo r othe r products . Both type s o f interven tion generate d rent-seekin g activit y an d hav e bee n attribute d b y various economist s an d committee s a s bein g th e sourc e o f illega l activity.36 The executiv e authorit y fo r expor t contro l wa s veste d i n th e Office o f the Chief Controller of Imports and Exports (CCI&E). The list of items subject t o export control consisted of those considere d "essential" fo r domesti c consumption , man y o f whic h wer e i n short suppl y du e to price and othe r domesti c controls. Items com pletely banne d include d certai n oi l seeds , paraffi n wax , poultry , and sugarcane . However , th e restriction s o n othe r item s suc h a s gold, silver , minerals , hav e bee n quit e onerou s an d th e continua l changes can make export planning difficult . Starting fro m th e year s o f neglec t o f expor t promotio n i n th e First an d Secon d Pla n Period s (1951-61) , th e governmen t em barked o n a policy o f escalating subsidizatio n an d expor t encour agement an d participation. 37 Expor t subsidizatio n policie s essen tially too k tw o majo r forms , (1 ) fiscal measure s an d (2 ) impor t

The Failur e o f Developmen t Plannin g i n Indi a 11

3

entitlement scheme s whic h entitle d exporter s t o premium-car rying impor t licenses . Othe r promotiona l activitie s adopte d in cluded th e settin g u p o f variou s trad e developmen t agencie s an d bodies a s wel l a s budgetar y appropriation s fo r marke t develop ment, wit h th e inten t o f indirectl y raisin g th e profitabilit y o f for eign sale s t o domesti c trader s an d producers . Among th e majo r fiscal measure s adopte d fo r expor t promotio n were cas h subsidies , excis e an d custom s dut y drawback s o n in puts, sale s ta x exemption s o n final sales , direc t ta x concessions , other outrigh t subsidies , an d rai l freigh t concessions. 38 Othe r indi rect incentive s include d chea p export-credi t facilitie s throug h th e Export Credi t Guarante e Corporation , th e suppl y o f raw material s at internationa l prices , an d ta x holiday s an d investmen t rebate s to export-oriente d units . Th e scop e an d coverag e o f thes e expor t incentive scheme s continue d t o expand , an d i n 1982-8 3 an d 1983-84 ne w incentive s wer e awarde d t o bot h expor t house s an d to wha t wer e calle d "10 0 percen t export-oriented-units. " A fiveyear ta x holida y wa s als o grante d t o suc h units . Import replenishmen t scheme s throug h RE P license s wer e th e principal instrument s o f expor t promotion . Thes e license s at tracted hig h impor t p r e m i u m s pro-rat a t o th e valu e o f export s effected. 39 Th e impor t entitlemen t schemes , unlik e th e simple r exchange retentio n scheme s o f countrie s lik e Pakistan , wer e com plicated b y th e wid e variet y o f entitlement rates , the segmentatio n of th e marke t t o preven t th e transfe r o f RE P licenses , th e differ ences i n p r e m i u m s o n entitlement s an d thei r fluctuation s ove r time, th e widesprea d overinvoicin g o f exports , an d frequen t changes i n coverag e o f th e entitlemen t schemes . The governmen t ha s se t u p a n u m b e r o f agencie s an d entitie s for expor t promotio n suc h a s th e Marke t Developmen t Fun d (1963) for grants-in-ai d t o th e variou s Expor t Promotio n Councils ; the Marke t Developmen t Assistanc e Committee ; th e Expor t Credi t Guarantee Corporatio n (ECGC) ; th e RBI' s Standin g Committe e o n Export Financ e an d th e Expor t Credi t Cell ; th e Expor t House s Scheme fo r providin g incentive s t o registere d Expor t Houses ; th e Trade Developmen t Authorit y (TDA) ; an d variou s Commodit y Boards lik e th e Te a Board , th e Coffe e Board , an d th e Tobacc o

114 Shya

m J . Kamat h

Board. Th e public-secto r corporation s wer e als o directe d t o expor t a certai n percentag e o f thei r outpu t unde r variou s promotio n schemes. 5. Economi c Performanc e India's syste m o f centrall y directe d five-year plannin g an d regim e of comprehensiv e control s generate d a growt h rat e o f pe r capit a income o f onl y aroun d 1. 7 percen t ove r th e 1950-8 5 perio d whe n the plannin g an d contro l framewor k wa s operativ e (se e tabl e 1) . This "Hind u rat e o f growth " (a s th e well-know n India n economis t Raj Krishn a calle d it ) i s t o b e compare d wit h annua l pe r capit a real incom e growt h rate s o f 5.5-6. 5 percen t tha t wer e achieve d in th e market-oriente d economie s o f Hon g Kong , Sout h Korea , Singapore, an d Taiwa n ove r th e sam e period . Th e thre e Southeas t Asian nation s o f Indonesia , Malaysia , an d Thailan d als o average d per capit a annua l growt h rate s i n rea l incom e o f 3 - 4 percen t ove r this period . Thus , India' s economi c performanc e ove r mos t o f th e postindependence er a ha s bee n dismal , bot h relativel y an d abso lutely. With almos t 4 0 percen t o f Indian s livin g belo w th e officia l pov erty lin e an d pe r capit a incom e aroun d $30 0 afte r almos t forty five year s o f centrall y planne d economi c development , Indi a remains on e o f th e poores t nation s i n th e world . I n 1987 , lif e expectancy a t birt h wa s 5 9 years, th e literac y rat e wa s 4 3 percent , and i t wa s estimate d tha t les s tha n 6 0 percen t an d 1 0 percen t o f the populatio n ha d acces s t o saf e drinkin g wate r an d sanitatio n facilities, respectively. 40 Over twent y millio n Indian s ar e o n th e publi c payroll , wit h around 7 0 percen t o f al l organize d secto r employmen t i n th e pub lic sector . Th e government' s wag e bil l i n 199 0 wa s estimate d t o account fo r two-third s o f it s annua l revenu e budget . Ove r th e las t forty years , th e publi c secto r ha s accounte d fo r aroun d 6 0 percen t of tota l investment . India' s jungl e o f re d tap e i s sai d t o b e on e o f the larges t an d mos t comple x i n th e world . Fo r example , permis sion t o ope n a hote l involve s aroun d forty-fiv e application s whic h are reviewe d b y ove r twenty-fiv e differen t governmenta l agencies . Till ver y recently , i t too k anywher e fro m twenty-seve n t o sixty -

The Failur e o f Developmen t Plannin g i n Indi a 11 Table 1 . Annua l Growt h Rate s o f GN P an d Pe r Capit a NNP—India (1951-1990 ) Period First Pla n (1951-55) Second Pla n (1956-61) Third Pla n (1961-66) Annual Plan s (1966-69) Fourth Pla n (1969-74) Fifth Pla n (1974-79) 1974-75 1975-76 1976-77 1977-78 1978-79 Annual Pla n (1979-80) Sixth Pla n (1980-1985) 1980-81 1981-82 1982-83 1983-84 1984-85 Seventh Pla n (1985-1990) 1985-86 1986-87 1987-88 1988-89 1989-90

Real GNP (percentage)

Real NNP per capita (percentage )

3.6

(- -)1.7

4.0

1.9

2.5

0

4.1

1.8

3.5

1.1

5.2 1.2 9.6 0.9 8.7 5.9

2.9 (- -)0.7 7.3 (- -)1.5 6.5 3.2

(-)5.1

(- -)7.7

7.7 4.6 1.7 7.4 3.9

5.4 2.2 (- -)0.5 5.2 1.5

5.1 3.9 3.6 9.0 5.3

2.8 1.6 1.4 6.8 3.3

Source: Government o f India, Economic Survey (various years).

5

116 Sh y am J. Kamat h three month s t o obtain governmen t clearanc e for an y medium- o r large-sized private-secto r industria l project. 41 Confiscatory ta x rates , combine d wit h ever-escalatin g control s in th e 1960s , le d t o th e growt h o f on e o f th e larges t an d mos t thriving undergroun d economie s i n th e world , wit h aroun d 5 0 percent o f economi c activit y estimate d t o b e generate d i n thi s sector.42 Corruptio n an d rent-seekin g activit y pervad e ever y face t of daily life . The resul t o f India' s statis t developmen t policie s ha s bee n th e neglect an d systemati c suppressio n o f voluntar y exchang e an d market activity . Eve n thoug h th e la w formall y uphold s privat e property an d Indi a i s th e world' s larges t functionin g democracy , private propert y right s and private voluntary activit y ar e severel y attenuated an d circumscribed. 43 India's agricultura l sector , which i s the least regulated an d ha s been characterize d b y predominantly privat e propert y rights , ha s grown b y abou t 3 percen t pe r yea r i n th e 1950-8 5 period . Thi s represents a substantia l improvemen t ove r th e preindependenc e period an d i s largely responsibl e fo r th e improvement i n the over all growt h rat e a s compare d t o tha t perio d sinc e th e growt h rat e of industr y ha s remaine d unchange d ove r th e tw o periods . Eve n in agricultur e however , th e pe r capit a increas e ha s bee n a mer e 1 percent pe r yea r an d ma y b e attribute d t o th e one-side d force d focus o n planne d (mainl y public-sector ) industrializatio n an d th e regime o f price , procurement , an d distributio n control s impose d on agriculture b y the government . Yet, an d perhap s a s a consequence , agricultur e dominate s th e economy, accountin g fo r abou t one-thir d o f th e gros s domesti c product an d abou t 7 0 percen t o f th e tota l labo r force , wit h ove r half th e peopl e livin g i n th e rura l area s fallin g belo w th e officia l poverty line . However , improvement s i n agricultur e hav e mad e the countr y self-sufficien t i n food , thoug h th e distributio n o f thi s food suppl y has most often bee n quite unequal. 44 The syste m o f control s i n agricultur e ha s nevertheles s le d t o substantial distortion s an d th e coalescenc e o f powerfu l interes t groups. Price and distributio n control s have led to the widesprea d diversion o f controlle d supplie s t o th e blac k market , wit h th e consequent generatio n o f "black " income s an d corruption . Agen -

The Failure of Development Plannin g i n India 11

7

cies lik e th e Coffe e Board , th e Rubbe r Board , an d th e Te a Board , have bee n se t u p ostensibl y t o promot e export s an d th e develop ment o f thes e commodities , bu t instea d ac t a s productio n an d marketing board s t o control an d regulat e thei r activities . Regula tion ha s bee n capture d b y th e regulate d group s i n commoditie s like wheat, sugar , rice, and milk , and black-marke t activit y i s still widely prevalen t i n man y commodities . Veste d rura l interest s i n the for m o f "suga r baron " o r "mil k baron " politician s hav e gar nered politica l contro l an d economi c benefit s ou t o f proportio n with thei r participatio n i n th e rea l economi c activit y o f th e country. 45 The resul t o f India' s centrall y directe d industrializatio n polic y has bee n th e growt h o f a highl y protecte d an d inefficien t indus trial bas e whic h ha s mad e Indi a a high-cos t econom y unabl e t o grow fas t domesticall y an d i n th e internationa l economy . India n exports a s a percentage o f gross domestic product decrease d fro m around 8 percent i n 194 7 to 7 percent i n 1985, while India' s shar e of worl d export s fel l fro m aroun d 2. 5 percen t t o 0. 4 percen t ove r the sam e period . The y gre w a t a rate considerabl y belo w th e rat e of expansio n o f worl d trad e an d muc h belo w tha t o f othe r coun tries i n Asi a suc h a s Japan , Korea , Taiwan , Thailand , Indonesia , Singapore, and Hon g Kong . Centrally planne d industrializatio n als o le d t o th e growt h o f a large an d inefficien t publi c sector , whic h absorbe d th e majo r share o f capita l investmen t i n th e postindependenc e perio d bu t produced a n abysmall y lo w an d sometime s negativ e rat e o f re turn. B y 1979 , th e gros s fixed asset s o f th e centra l governmen t public secto r excludin g th e join t public-privat e sector—public sector companie s owne d b y th e individua l state s comprisin g th e union an d th e asset s o f th e centra l an d state-owne d railway s an d public utilities—exceeded tha t o f the private sector in industry b y over 1 6 percent. Th e inefficienc y o f thes e public-secto r industrie s can b e see n by th e fact tha t the y accounte d fo r 6 6 percent o f tota l capital an d 27 percent of total employment, but onl y 25 percent of industrial outpu t an d tota l value-added. 46 Thi s situatio n existe d despite th e fac t tha t th e publi c secto r ha d a nea r monopol y i n production i n industrie s lik e oi l productio n an d distribution , power generation, rail and air transport, coal mining, certain min -

118 Shya m J . Kamat h erals an d metals , lif e an d genera l insuranc e an d banking . I n 1980-81, th e to p 15 7 ou t o f India' s 21 5 public-secto r companie s (including th e alway s profitabl e oi l companies , bu t excludin g companies whic h b y virtu e o f larg e cumulativ e losse s ha d nega tive tota l capita l employed ) mad e a n overal l los s o f aroun d $16 0 million o n a tota l capita l employe d o f ove r $2 0 billion. 47 I n 1984-85, India' s publi c secto r (excep t fo r th e oi l companies ) stil l made a n overal l los s o f ove r $16 0 million , wit h th e mos t disas trously unprofitabl e area s bein g coa l an d textiles . Th e Nationa l Textile Corporatio n (wit h som e 14 5 'sick ' textil e mill s take n ove r from th e private sector ) had accumulate d losse s of $576 million i n 1985. Worse , i n man y area s suc h a s powe r generation , chroni c shortages coexis t wit h massiv e investmen t becaus e o f a woefu l underutilization o f capacity . Economic liberalization i n the mid-eighties under Prim e Minister Raji v Gandh i (Nehru' s grandson ) resulte d i n a spur t i n pe r capita economi c growt h t o aroun d 3.5- 5 percen t pe r annu m ove r the 1986-9 0 period . India's Sevent h Five-Yea r Plan , which ende d in Marc h 1990 , achieve d a n annua l averag e growt h rat e i n rea l GNP o f 5.2 5 percent , i n spit e o f farmin g suffering th e conse quences o f thre e consecutiv e year s o f drough t i n 1985-87 . Th e annual growt h o f industria l outpu t average d aroun d 8. 5 percen t during thi s period . This unprecedente d economi c performanc e wa s mad e possibl e by th e relaxation o f controls o n th e private secto r an d th e consid erable liberalization tha t too k place in industry, foreign trade , and the financial sector . Private investment flows were allowed largel y unimpeded int o previousl y tightl y controlle d consume r good s in dustries an d licensin g control s wer e significantl y altere d t o allo w greater competition i n these sectors. A large amount o f investmen t went int o automobiles , motorcycles , televisio n sets , othe r con sumer electronic s industries , home appliances , a n improve d tele phone system , processe d foods , an d a numbe r o f othe r consume r goods that wer e previously i n short supply , unavailable, or had t o be smuggled int o the country . But, i n spit e o f th e liberalizatio n b y th e Gandh i government , the majorit y o f control s an d th e centralize d framewor k o f plan ning were allowed t o remain. Intervention i n markets, the contin -

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ued growt h o f th e publi c sector , an d th e restrictio n o f privat e property right s an d voluntar y exchang e i n a n u m b e r o f area s continued t o limi t th e potentia l fo r economi c growth . The statis t economi c policie s o f th e previou s forty-fiv e year s finally cam e t o a hea d durin g th e Gul f War . Despit e th e 'Gandhi ' liberalization o f th e mid-eighties , th e mountin g budge t deficit s o f successive spendthrif t India n governments , th e maintenanc e o f the framewor k o f 'socialist ' plannin g an d onerou s controls , an d the continuin g abysma l performanc e o f th e dominan t publi c sec tor le d t o a situatio n wher e th e foreig n exchang e reserve s o f th e impoverished natio n h a d dwindle d t o les s tha n a coupl e o f months' requirement s b y mid-199 0 an d t o abou t on e billio n dol lars b y Ma y 1991 , just enoug h t o cove r abou t tw o weeks ' imports . The foreig n deb t o f th e natio n ros e t o ove r $7 5 billio n an d th e robust economi c growt h o f th e lat e eightie s seeme d t o ski d bac k to th e ol d 'Hind u rat e o f growth ' i n th e earl y nineties . The ne w governmen t tha t wa s electe d i n Jun e 1991 , after secur ing emergenc y internationa l assistance , se t i n motio n a rapi d an d hitherto unprecedente d packag e o f economi c reforms . Give n th e critical domesti c an d internationa l situatio n o f th e country' s finances, a stabilizatio n progra m wa s embarke d upo n t o reduc e th e central government' s balloonin g budge t defici t an d th e curren t account defici t whic h h a d reache d unfinanceabl e level s o f aroun d eight t o nin e billio n dollars . Wit h regar d t o th e domesti c fiscal crisis, polic y an d spendin g change s wer e mad e t o reduc e th e bud get deficit , a majo r facto r i n th e long-ter m worsenin g o f th e bal ance o f payments , fro m 8. 5 percen t o f GD P i n 1990-9 1 t o 6. 5 percent i n 1991-92 . With regar d t o th e externa l sector , th e adjust ment packag e consiste d o f a stee p devaluatio n o f th e rupe e an d the squeezin g o f import s throug h stringen t import-financin g re quirements (excep t fo r import s use d i n expor t production) . Thes e elements o f th e refor m progra m wer e conventiona l i n tha t the y did no t involv e an y chang e i n th e institutiona l structur e o f th e economy. The mor e importan t element s o f th e refor m packag e consiste d of a se t o f institutiona l change s whic h marke d a fundamenta l shift towar d a market-drive n an d ope n economy . Th e industria l licensing syste m tha t h a d lon g shackle d privat e India n industr y

120 Shya m J . Kamat h was al l bu t scrapped , excep t fo r eightee n "critical " industries , including absurdl y sugar , automobiles , an d drug s an d pharma ceuticals. Constraints o n capacity expansio n tha t wer e introduce d in th e sixtie s t o chec k concentratio n i n India n industr y an d t o slow the growth o f the "monopoly" larg e Indian industria l house s were also all but scrapped . I n addition , a s compared t o the score s of busines s area s tha t wer e previousl y reserve d exclusivel y fo r government-owned enterprises , onl y eigh t suc h sector s ar e re served fo r th e publi c secto r now . Eve n thi s amount s t o eigh t to o many, bu t constitute s som e progress . Also , pric e control s o n a number o f items such as steel have been removed . Most encouragin g o f all , th e governmen t ha s announce d it s intention t o mak e th e rupe e full y convertibl e withi n thre e t o five years (mos t observer s o f India n economi c affair s expec t thi s t o happen much sooner). As a first step, 60 percent of any deal involving foreign exchang e can be made a t a market rate , the remainin g 40 percen t bein g consummate d a t th e officia l fixed rate . In addi tion, rule s o n foreig n investment , hithert o som e o f th e mos t dis couraging anywhere , hav e bee n relaxed . Majorit y foreig n equit y participation i s no w permitted , albei t onl y fo r companie s whos e export growt h exceed s future profi t remittance s expected . Foreig n companies ar e also permitted t o purchase property, use their ow n brand names , open branc h offices , an d accep t deposit s wit h mini mal extradomesti c requirements—thing s hithert o no t possible . Even more recently, foreign institutiona l investor s were permitte d to purchase up to 25 percent of the shares of a company, as long as no single foreign investo r held more than 5 percent o f a company' s outstanding shares . With regard t o the foreign trad e sector, the quantitative impor t controls tha t exclude d mos t good s unles s larg e bribe s wer e paid , have bee n almos t completel y don e awa y with—excep t fo r con sumer goods . Bu t th e impor t tarif f syste m stil l exists , thoug h tariff rate s hav e been lowered . For example, the to p tarif f rat e fo r consumer good s ha s com e dow n fro m 15 0 percent t o 11 0 percent, while tha t fo r capita l good s ha s com e dow n fro m 8 0 percen t t o 60 percent. In addition , th e governmen t ha s i n principl e announce d it s intent t o sell 49 percent o f its share i n government-owned compa -

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nies t o the public , though th e implementatio n o f this inten t i s yet to materialize. Privatization o f the huge public sector, so essential if th e economi c reform s ar e t o succeed , i s likel y t o represen t th e biggest proble m i n th e economi c refor m progra m sinc e i t wil l pose a bi g threa t t o th e entrenche d special-interes t group s tha t dominate th e politico-economic arena . The limited economic reform progra m tha t has been acted upo n has ha d som e encouraging short-ter m results . The trade defici t i n 1991-92 shran k t o one-thir d it s 1990-9 1 level , mainl y du e t o a sharply reduce d impor t bill . Th e lowe r trad e deficit , combine d with quic k disbursin g loan s fro m th e IM F an d th e Worl d Ban k and a turnaroun d o n th e capita l accoun t du e t o th e retur n o f the privat e mone y deposit s o f overseas Indian s (estimate d a t $5 0 million ever y day ) which ha d draine d ou t o f the country i n 1990 91, hav e le d t o a larg e improvemen t i n foreig n exchang e reserve s to th e health y amoun t o f $6. 5 billio n b y th e en d o f April . Mos t importantly, th e fear o f a major deb t rescheduling , which seeme d inevitable i n 1991 , has faded . Encourage d b y th e improve d exter nal financial situation , th e impor t financing control s introduce d last year have been relaxed . The limited bu t radica l economi c reforms tha t have been intro duced have , however , create d som e short-ter m problem s an d ar e likely t o fac e som e majo r problem s i n th e longe r term . Th e slo w pace o f reforms , especiall y i n thei r implementation , ar e likel y t o create a situatio n simila r t o tha t face d b y Gorbachev' s Sovie t Union an d th e countries of Eastern Europe . The problem wit h th e current reform s i s that, even though the y are radical a s compared t o the policies of the las t forty-fiv e years , they ar e neithe r comprehensiv e no r complete . Whil e the y repre sent a significan t overthro w o f th e ideolog y o f centra l plannin g and Nehruvia n socialism , the y stil l fai l t o effect th e radica l insti tutional surger y tha t i s necessary for the m t o succeed . The reform s tha t hav e bee n implemente d til l no w hav e bee n politically eas y sinc e the y hav e no t pose d a rea l threa t t o th e special-interest group s tha t hav e bee n th e legac y o f th e statis t ethos tha t ha s dominate d th e countr y sinc e i t becam e indepen dent. Th e accumulate d rent s tha t hav e accrue d an d continu e t o accrue t o th e mos t powerfu l interes t group s hav e no t ye t bee n

122 Sh y am J . Kamat h seriously threatened . While major element s of the "permit-licenc e raj" hav e bee n jettisoned , th e privilege s an d protection s o f th e major interes t group s i n society—politicians , bureaucrats , unio n leaders an d members , public-secto r employees , selecte d busines s groups, farmers an d agriculturists , and so forth—remain intact . Most fundamentally , whil e variou s dimension s o f propert y rights have been taken out of the political common s because of the dimantling o f som e o f th e domesti c an d external-secto r control s mentioned above , private propert y right s ar e stil l no t guarantee d or protecte d fro m governmen t encroachment . Th e heav y han d o f government i s still presen t i n th e regulatio n o f th e sal e of privat e homes an d commercia l property ; purchas e an d sal e o f land ; th e ownership o f man y kind s o f private property ; pric e an d distribu tion control s fo r commoditie s suc h a s sugar , oil , kerosene , gaso line, certain categories of cereals; and the distribution of "critical" commodities lik e steel, fertilizers, an d foodgrains . A majo r are a wher e privat e propert y right s ar e stil l i n th e political (an d state ) domai n i s in th e massiv e an d inefficien t pub lic sector . Despit e th e tal k o f privatization , no t a singl e majo r public-sector o r state-secto r undertakin g ha s bee n privatized . Only "partia l privatization " o f selecte d public-secto r undertak ings i s envisaged , wit h n o fundamenta l privatizatio n i n term s o f complete sal e t o private-secto r companie s intereste d i n purchas ing th e companie s o r outrigh t purchas e o f al l th e share s b y th e public. Thi s i s s o despit e th e fac t tha t a recen t surve y o f 23 3 of the bette r ru n centra l public-secto r undertaking s foun d tha t thei r return o n equity i n 1989—9 0 averaged just 0.9 percent. 48 Although th e licensin g an d foreig n trad e control s a s wel l a s a whole ministr y hav e bee n abolished , no t a singl e bureaucra t o r public-sector employe e has lost his or her job. The most inefficien t government enterprise s an d department s continu e t o hold stead y or gro w i n employment . An d th e stronge r th e unio n i n a stat e industry, th e greate r th e governmen t subsid y t o pro p u p th e in dustry withou t an y attempt t o reduce its size. Another majo r are a i n whic h stat e ownershi p an d th e ol d con trols and regulation s continu e t o maintain thei r stranglehol d i s in the are a o f the country' s bankin g an d financial system . The state owned bank s an d insuranc e companies , whic h wer e nationalize d

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in th e lat e sixtie s an d earl y seventies , accoun t fo r ove r 9 0 percen t of th e deb t finance an d insuranc e coverag e i n th e organize d secto r and n o a t t e m p t ha s bee n m a d e t o retur n the m t o th e privat e sector. State-owne d bank s emplo y jus t unde r a millio n people , who ar e represente d b y militan t ban k union s whic h pus h u p wages an d resis t an y measure s t o improv e productivity . A gamu t of centra l governmen t an d stat e governmen t specialize d financial institutions ow n th e majo r shar e o f privat e companie s an d ac t t o retard th e entrepreneuria l policie s o f thes e companies . The government' s ta x policies , despit e a drasti c reductio n i n marginal ta x rate s unde r previou s Prim e Ministe r Raji v Gandhi , still remai n onerou s an d a dra g o n industria l efficienc y becaus e the excis e an d impor t ta x regim e an d machiner y stil l remai n i n place. Thes e taxe s accoun t fo r almos t 8 0 percen t o f th e govern ment's revenu e an d hav e bee n ver y resilien t t o attempt s t o reduc e or rationaliz e them , reflectin g politicians ' an d bureaucrats ' de sires fo r revenues . Last bu t no t least , th e onerou s an d nihilisti c Nehruvia n plan ning syste m an d th e five-year plan s remai n i n place . The Plannin g Commission i n Ne w Delh i continue s t o se t target s fo r publi c in vestment an d pla n allocation s fo r variou s sectors , base d o n a n impossible m a n d a t e . Thi s i s bein g don e despit e th e fac t tha t planned economi c developmen t ha s faile d i n ever y countr y wher e it ha s bee n trie d an d ha s prove n unabl e t o rais e th e standar d o f living o f Indian citizens . 6. A Theoretica l Critiqu e o f India n Developmen t Plannin g The discussio n abov e ha s detaile d th e failur e o f India n develop ment plannin g i n th e postindependenc e era . Yet , thi s disma l de velopment recor d ha s bee n defende d b y a n u m b e r o f wellknow n economists o n a variet y o f grounds. 4 9 Consequently , i t i s necessar y to sho w wh y India n developmen t plannin g wa s doome d t o fai l o n epistemological an d theoretica l grounds , an d th e experienc e o f forty-five year s wa s no t neede d t o manifes t it s failure . The majo r contentio n mad e b y bot h th e critic s an d supporter s of India n developmen t plannin g i s tha t it s failure s ca n b e attrib uted t o eithe r th e selectio n o f th e wron g instrument s an d policie s

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for plannin g an d contro l (suc h a s th e licensin g syste m o r th e foreign trad e polic y regime ) o r t o administrativ e o r politica l fail ure i n ensurin g prope r implementation. 5 0 Th e mor e enlightene d critics, suc h a s Sheno y (1971) , Roy (1984) , and La i (1988a , 1988b) , have focuse d o n th e rol e o f dirigism e an d statism , correctl y ar guing tha t i t wa s th e eschewa l o f marke t mechanism s i n favo r o f nonmarket policie s an d instruments , an d th e consequen t distor tions o f incentives , tha t le d t o th e failur e o f India n developmen t planning. The y hav e no t attempte d t o adequately detai l th e funda mental epistemologica l an d theoretica l consideration s tha t hav e resulted i n thi s failure . Thi s sectio n briefl y sketche s ou t thes e considerations. Indian developmen t plannin g ha s faile d fo r fundamenta l rea sons tha t hav e t o d o wit h wha t Haye k (1937 , 1945 ) ha s calle d th e knowledge problem , th e attemp t t o d o awa y wit h th e comple x o f legal an d economi c institution s (suc h a s th e institutio n o f privat e property an d th e pric e mechanism ) tha t enabl e th e achievemen t of a solutio n t o thi s fundamenta l proble m an d th e stiflin g o f th e role o f entrepreneurshi p i n th e contex t o f marke t processe s tha t i s the sourc e o f wealth an d prosperity . Onl y secondaril y i s the failur e due t o governmen t failur e an d publi c choic e considerations , which, thoug h important , ar e foun d t o cruciall y depen d o n th e first thre e considerations . An Information and

Knowledge Critique of Indian Planning

The fundamenta l economi c proble m o f an y societ y i s wha t Haye k (1945) ha s characterize d a s th e proble m o f knowledge . Th e majo r portion o f h u m a n knowledge , especiall y economi c knowledge , consists o f knowledg e o f a particula r tim e an d plac e know n t o th e myriad individua l economi c actor s i n society . Suc h knowledg e i s widely disperse d i n societ y an d unknowabl e t o a singl e min d o r group o f mind s (even , an d especiall y so , i n th e ag e o f high-spee d microcomputers). Consequently , an y attemp t t o comprehensivel y plan o r micro-manag e a complex , moder n econom y (o r fo r tha t m a t t e r a backward , as-yet-underdevelope d economy ) i s doome d to fai l sinc e th e coordinatio n o f plan s an d action s o f individua l economic actors , each possesse d wit h disperse d knowledg e o f tim e

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and plac e tha t canno t b e communicate d t o an y centralize d o r decentralized authority , b y suc h a centralize d o r decentralize d planning agenc y i s theoreticall y an d practicall y impossible . Th e knowledge proble m i s th e contentio n tha t a centra l o r decentral ized planning agency , even with th e best o f intentions, would lac k the knowledg e t o coordinat e an d combin e resource s i n a manne r economic enough t o sustain a functioning economy. 51 It i s onl y throug h th e pric e syste m i n a privat e property , free market econom y tha t informatio n relevan t t o their ow n decision s is communicated t o the individual s i n a large society. Only price s in freely functionin g market s ca n play th e role of coordinating th e plans an d action s o f individual s i n an y economy , sinc e price s provide a n adaptiv e mechanis m b y whic h changin g want s an d conditions are communicated t o these individuals i n an economiz ing manner . Thus , it i s th e marke t an d th e pric e mechanis m tha t provide th e discovery procedure whic h make s possible the utiliza tion o f th e disperse d knowledg e o f tim e an d plac e bette r tha n any othe r mechanis m o r syste m know n t o man . I t i s th e pric e mechanism i n a marke t econom y tha t provide s th e incentive s for individual s i n a societ y t o constantl y striv e t o discove r ne w information necessar y fo r adaptation , survival , and growt h i n th e face of ever-changing circumstance s facin g tha t society . Nehru and th e other architects of India's development plannin g system neve r care d t o educat e themselve s o r understan d th e knowledge problem. In actua l fact , mos t o f them wer e ignorant o f the literatur e o n th e problem , a s wer e mos t economist s i n th e developed marke t economie s at that time. 52 By opting for compre hensive developmen t planning , the y i n fac t attempte d t o over come th e proble m o f knowledg e throug h governmen t directio n and control , an d b y replacin g marke t price s an d incentive s wit h government-formulated plan s an d directives . Thi s wa s entirel y consistent wit h thei r unconstraine d visio n o f economic an d socia l processes. B y s o doing , the y eliminate d o r attenuate d th e ver y means o f communication an d coordinatio n whic h mad e th e func tioning an d growt h o f a n econom y possible . I n an y case , th e knowledge necessar y t o mak e th e million s o f economi c decision s that ar e mad e individuall y b y th e India n populatio n wa s impos sible t o collec t o r ac t upon , especiall y sinc e mos t o f thi s knowl -

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edge wa s taci t o r inarticulate. 5 3 Th e Plannin g Commissio n o f India embarke d o n a n impossibl e tas k an d it s plan s wer e doome d to fai l fro m th e start , jus t a s plannin g i n th e Sovie t Union , China, Easter n Europe , Africa , Lati n America , an d eve n i n osten sibly capitalis t countrie s suc h a s Sout h Korea , France , an d J a p a n did. The impossibilit y o f centralized economi c plannin g an d marke t socialism ha d earlie r als o bee n clearl y pointe d ou t b y it s oppo nents durin g th e celebrate d socialis t calculatio n debat e o f th e 1930s. 54 Th e majo r focu s o f thes e earlie r criticism s o f socialis t planning ha d bee n tha t b y doin g awa y wit h th e rivalrou s competi tive proces s fo r whic h privat e propert y an d free-marke t price s were essential , suc h plannin g woul d los e th e ver y ancho r whic h m a d e economi c lif e sustainabl e an d growing . Th e situatio n wa s analogous fo r developmen t plannin g eve n i n th e presenc e o f par tial privat e property , sinc e th e rivalrou s proces s woul d b e se verely attenuated . The conceptual , administrative , an d implementationa l failure s of Indian developmen t plannin g lamente d b y bot h proponent s an d opponents o f suc h plannin g identifie d abov e ca n b e trace d t o th e existence o f th e knowledg e problem . N o Indian planne r o r bureau crat coul d eithe r theoreticall y o r i n practic e eve r hav e bee n abl e to collect , collate , analyze , an d ac t upo n th e disperse d knowledg e of tim e an d plac e possesse d b y th e million s o f economi c actor s then livin g i n India n society . Eve n i f som e magica l mechanis m h a d bee n m a d e availabl e (clearl y a fiction) fo r suc h informatio n t o be m a d e available , th e taci t an d inarticulat e knowledg e possesse d by individual s coul d neve r hav e bee n s o conveyed . Further, b y settin g u p th e elaborat e plannin g an d contro l sys tem o f postindependenc e India , India n planner s di d awa y wit h any rivalrou s competitiv e proces s tha t migh t hav e flourished ha d an alternativ e market-base d voluntar y exchang e syste m bee n adopted. B y constrainin g an d severl y restrictin g voluntar y ex change, India n developmen t plannin g undermine d th e ver y mech anism tha t wa s th e basi s fo r wealth-generatio n an d doome d Indi a to th e "Hind u rat e o f g r o w t h / '

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A Property Rights Critique of Indian Planning By encouraging an d effectin g th e growt h o f government an d pub lic property ownership , Indian developmen t plannin g contribute d to th e erosio n o f private propert y right s s o indispensable fo r eco nomic development . A s has bee n show n b y legion s o f economist s since Ada m Smith , privat e propert y i s essential fo r a functionin g economy.55 Th e mos t importan t lin k i s with th e knowledg e prob lem outlined above . There can be no coordination o f the disperse d knowledge o f tim e an d plac e withou t th e existenc e o f a free-mar ket price system based on private property . Private propert y right s emerge d a s a consequenc e o f tryin g t o cope wit h th e ignoranc e an d uncertaint y cause d b y th e nee d t o constantly adap t t o changin g circumstance s an d thei r harmfu l and beneficia l effects . Specializatio n i n privat e propert y owner ship allow s peopl e t o specializ e i n knowledg e abou t th e bes t us e of th e propert y tha t the y ow n an d allow s the m t o expec t certai n kinds o f predictabl e behavio r wit h respec t t o theirs ' an d others ' property. Individual s specializ e thei r ownershi p i n area s wher e they hav e a comparativ e advantage , thu s leadin g t o greate r pro ductivity an d utilizatio n o f specialize d knowledge . I f thei r right s to propert y di d no t exis t o r wer e attenuated , individual s woul d not mak e th e necessar y investment s i n specialize d knowledg e which contribut e t o greate r productivity , sinc e the y woul d no t obtain th e fruits o f their activity . Private propert y right s als o permi t owner s t o measure , moni tor, control , an d reac t t o change s i n circumstance s an d knowl edge. Changes i n thei r price s signa l owner s abou t change s i n economic circumstances an d allo w owner s t o take advantag e o f thei r dispersed knowledg e o f tim e an d plac e b y changin g th e composi tion o f thei r bundl e o f property rights . Suc h change s i n propert y bundles facilitat e th e decentralize d coordinatio n o f disperse d knowledge an d henc e provid e a solution-mechanis m fo r th e knowledge problem . Unde r publi c ownership , o n th e othe r hand , even though employee specialization ca n still exist, the specializa tion of ownership inheren t i n private property an d hence the facil itation o f th e solutio n t o th e knowledg e proble m i s exclude d be cause of compulsory ownership .

128 Shya m J . Kamat h A major featur e o f publi c propert y i s tha t ownershi p i s veste d in al l member s o f th e publi c an d n o membe r ca n dives t him - o r herself o f that ownership . This lack of transferability o f ownership implies a lac k o f specializatio n i n ownershi p an d th e los s o f th e gains of specialized knowledge, specific riskbearing , foresight, an d judgment. Also lost are the concentration o f the rewards and cost s of decisions on the persons most directl y responsible for them an d the comparativ e advantag e effect s o f th e specialize d application s of knowledg e i n contro l an d risktaking . Th e los s o f thes e im portant dimension s o f privat e propert y ownershi p result s i n th e prevention o f a solution t o the knowledge problem . It i s a centra l propositio n o f propert y right s economic s tha t under public ownership, the costs of any decision or action are less fully thrus t upo n th e decisionmake r tha n unde r privat e propert y rights. Th e cost-benefi t calculu s i s change d towar d lowe r costs , even thoug h th e tru e cost s ar e mos t ofte n raised . Thi s lead s t o fraud, corruption , an d misus e o f publi c propert y b y managers . Since th e gain s t o an y owne r resultin g fro m an y cost-savin g ac tions ar e les s full y effective , costl y device s hav e t o b e use d t o prevent suc h fraud, corruption , and misuse. The development pro cess consequently become s prone to high costs, failure, and lack of accountability. The India n developmen t plannin g framework , wit h it s heav y emphasis o n publi c ownershi p an d control , systematicall y re duced th e scop e an d coverag e o f privat e propert y right s i n th e Indian econom y wit h predictabl e effects . Thi s had disastrou s con sequences fo r th e coordinatio n o f knowledge , entrepreneurship , and riskbearing, and th e fostering o f innovation. It gave rise to the fraud, corruption , an d misus e o f propert y tha t becam e s o preva lent i n th e seventie s an d eighties . It le d t o uncertainty, arbitrari ness, and capriciousness i n economic affairs. Th e problems identi fied i n th e conventiona l literatur e o n India n plannin g (discusse d above) originated i n the Indian planners'decision t o opt for publi c ownership leadin g t o the poo r economi c performanc e o f the post independence era . The consequences o f seriously attenuating th e regime of private property right s tha t existe d a t th e tim e o f independenc e wer e t o be seen in the decline i n private secto r agricultura l an d industria l

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growth ove r time , th e ris e o f widesprea d corruptio n an d rent seeking activity , an d th e politicizatio n o f everyda y life . Fo r exam ple, th e consequence s o f al l th e control s o n th e privat e sector , coupled wit h th e drasticall y increase d uncertaint y o f contro l ove r one's privat e property , cause d a large-scal e distortio n o f incen tives awa y fro m encouragin g firms t o improv e technolog y and/o r quality and/o r lowe r price s t o attrac t mor e customer s towar d encouraging the m t o concentrat e o n ren t seekin g an d othe r nonproductive activity . Similarly, th e polic y o f bannin g future s market s an d forwar d trading i n commodit y an d othe r market s force d bot h buyer s an d sellers t o carr y mor e ris k tha n the y woul d hav e normall y bee n prepared t o carr y an d cause d th e econom y t o los e ou t o n trade s that wer e beneficia l fo r it s growt h an d development . I t als o le d t o the us e o f quantitative a n d alternativ e undergroun d credi t marke t systems fo r financing an d conductin g business , wit h th e conse quent highe r cost s an d inefficiency . The growt h o f on e o f th e larges t publi c sector s i n th e non communist worl d a s a resul t o f th e India n government' s progres sive socialist-oriente d industria l polic y furthe r create d a hug e problem o f inefficiency , corruptio n an d ren t seeking . Private-sec tor activity , wa s systematicall y reduce d a s a proportio n o f tota l industrial activit y wit h disastrou s consequence s fo r th e India n consumer an d tax-payer . Large-scal e politica l interferenc e i n an d legislation affectin g th e lega l proces s furthe r compromise d th e ability o f Indian s t o own , use , an d transfe r thei r ow n property , leading t o th e growt h o f on e o f th e democrati c world' s larges t underground economie s an d a high-cos t economy . Confiscator y tax rate s throug h th e sixtie s an d earl y seventie s (whic h ca n b e viewed a s a sever e reductio n o f th e righ t t o collec t th e fruit s o f private propert y ownership ) furthe r exacerbate d th e situation . Thus, th e problem s tha t aros e a s a resul t o f th e statis t plannin g policies o f th e India n governmen t i n th e pos t independenc e perio d can b e see n a s th e resul t o f th e wholescal e attenuatio n o f privat e property right s tha t occurre d a s a resul t o f thes e policies .

130 Sh y am J . Kamat h An Entrepreneurship Critique of Indian Planning A third importan t bu t ofte n neglecte d ingredien t o f the economi c development process , inextricabl y linke d t o th e tw o aspect s dis cussed above , i s th e crucia l rol e o f entrepreneurship . A s Fran k Knight (1921) , Josep h Schumpete r (1934 , 1942) , Georg e Shackl e (1972), Israe l Kirzne r (1973 , 1979 , 1985) , an d a numbe r o f othe r economists hav e pointe d out , long-ru n economi c developmen t i s instigated, stimulated , an d nourishe d b y th e proces s o f entrepre neurial discovery , invention , an d innovation . I t i s th e ver y open endedness o f market-base d pric e system s tha t allow s fo r th e pro cess o f entrepreneuria l discover y an d innovatio n s o necessary fo r economic development . Economic developmen t i s a proces s o f changin g ol d way s o f doing things , o f venturin g int o th e unknown , an d o f maximizin g opportunities fo r flexibility , experimentation , an d innovation . Entrepreneurship play s a critica l rol e i n takin g advantag e o f thes e opportunities an d makin g developmen t happen . By viewing the process of economic development a s fundamen tally dependen t o n th e marke t proces s a s a facilitator o f the coor dination o f the plans of individual decisio n makers with disperse d knowledge, th e rol e o f entrepreneurshi p an d privat e propert y a s essential t o such individua l pla n coordinatio n become s clear . En trepreneurship implie s th e focusin g o f th e benefit s an d cost s o f entrepreneurial actio n o n specifi c individuals . Profit s (an d losses ) are th e resul t o f unpredictable e x ant e valu e changes . Such valu e changes signa l th e directio n i n whic h entrepreneuria l activit y should b e directed . Exclusiv e titl e t o th e ownership , use , an d transfer o f property enable s th e profits an d losse s to be focused o n the decisio n make r wh o i s responsibl e fo r thei r measurement , monitoring, an d control . Thi s facilitate s th e entrepreneuria l dis covery process. Public ownershi p o f property , o n th e othe r hand , blunt s thi s process an d make s valu e change s difficul t t o measure , monitor , and control . Th e lac k o f transferabilit y implici t i n publi c owner ship remove s th e disciplinin g mechanis m o f owner s divestin g when negativ e valu e change s occur . Othe r mechanism s o f admin -

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istrative contro l ar e poo r substitute s becaus e o f th e knowledg e problem. Buchanan an d Fait h (1981 ) have analyze d th e rol e o f entrepre neurship an d th e internalization o f externalities unde r alternativ e property rules . Afte r pointin g ou t th e asymmetri c impac t o f th e "property rule " versu s th e "liabilit y rule " i n encouragin g entre preneurship, they show how governmental rule - setting regulatio n and/or ownershi p i s wors e tha n eithe r o f thes e legall y evolve d rules i n encouragin g entrepreneurship . Thei r argumen t i s predi cated o n th e vie w tha t potentia l spillove r o r externa l cost s o r benefits o f economi c activit y ar e no t full y predictabl e i n advanc e and o n "th e elementar y fac t tha t ne w venture s wil l necessaril y b e unpredictable, both with respect t o their internal profitability an d to thei r spill-ove r effects/ ' Sinc e politica l decisio n maker s woul d typically no t hav e th e disperse d knowledg e regardin g th e poten tial marke t opportunity/activity , the y wil l necessaril y ten d t o b e relatively mor e pessimisti c tha n th e entrepreneu r an d inhibi t th e entrepreneurship s o essential fo r developmen t an d growth . Consequently, the y argu e tha t th e entrepreneuria l discover y proces s should b e unimpeded b y government regulatio n an d rule s (and b y extension, government ownership ) an d th e liability proces s of tor t law, wher e thos e wh o generat e physica l damag e t o other s stan d liable, shoul d b e allowe d t o b e th e onl y (naturall y evolved ) re straint o n this process. 56 Development plannin g an d centralize d coordinatio n introduc e rigidity an d inflexibilit y int o th e economi c developmen t proces s and stifl e entrepreneurship . The y redirec t entrepreneuria l skill s toward ren t seeking , corruption , an d politica l influenc e peddling . It presuppose s tha t governmen t official s ca n determine , select , and operat e project s bette r tha n privat e entrepreneur s can , eve n though th e latte r ris k thei r ow n fund s an d therefor e ar e les s likel y to mak e mistake s an d mismanag e specifi c endeavors . Develop ment planning , by restricting th e freedo m o f entrepreneurial free entry int o economi c activity , prevent s entrepreneuria l discover y and dynami c competition , thu s stiflin g th e proces s o f economi c growth an d development . India's experienc e wit h developmen t plannin g bear s ou t th e

132 Sh y am J . Kamat h correctness o f th e entrepreneuria l critiqu e o f suc h planning . Th e growth o f entrepreneurshi p i n Indi a wa s effectivel y strangle d i n the postindependenc e perio d b y th e government' s plannin g an d policy regime. 57 Thi s phenomeno n i s eviden t i n th e declinin g share o f private investmen t ove r th e 1951-8 5 perio d an d th e con trol o f th e "commandin g heights' ' o f th e India n econom y b y th e public sector. Entrepreneurial activit y was redirected t o rent seek ing, corruption , an d influenc e peddling , a s ha s bee n documente d by stud y afte r study. 58 Eve n a s entrepreneurshi p wa s stifled , th e relative efficienc y o f India n industr y vis-a-vi s othe r countrie s de clined rapidly. 59 Meanwhile , a s note d above , th e shar e o f India' s exports i n worl d export s als o decline d rapidl y t o les s tha n one third th e leve l tha t ha d existe d a t th e tim e o f independence , a s government contro l replace d privat e enterprise . As ha s bee n pointe d ou t b y others , th e India n developmen t planning proces s produce d th e followin g consequence s tha t ha d important impact s o n th e qualit y an d quantit y o f entrepreneur ship i n India: 60 1. India' s heav y industry-base d impor t substitutio n strateg y o f planned developmen t displace d privat e entrepreneurshi p wit h government directio n an d decisionmakin g b y bureaucrats. Despite preferentia l policie s towar d th e cottag e an d smal l indus tries sectors , th e control s an d regulation s place d o n privat e entrepreneurs i n orde r t o ge t the m t o confor m t o pla n target s severely constraine d an d inhibite d privat e entrepreneurship . Resources wer e increasingl y directe d b y decre e t o industrie s that wer e t o eithe r becom e uneconomica l o r fai l becaus e o f the lac k o f privat e entrepreneurshi p o r th e distortio n o f th e incentives for successful entrepreneurshi p throug h price, distribution, licensing, or other controls . 2. Sinc e agriculture with it s geographical dispersio n an d plethor a of producers wa s no t amenabl e t o planning, th e industria l sec tor bor e th e brun t o f th e plannin g an d contro l syste m tha t was se t up . Thi s ha d a consequen t larg e negativ e impac t o n entrepreneurship i n th e on e secto r wher e Indi a coul d hav e de veloped tremendou s comparativ e advantage s an d whic h coul d

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have bootstrappe d th e countr y ou t o f it s poverty , a s ha d hap pened i n th e cas e o f th e develope d Wester n economie s an d th e Southeast Asia n "miracle" economies includin g Japan . 3. Th e expansion o f the public secto r t o occupy th e "commandin g heights" of the Indian economy in producing "basi c goods" and infrastructure automaticall y militate d agains t th e expansion of private entrepreneurial activity . 4. Th e nature o f the instruments use d t o legislate th e plan target s and th e comple x syste m o f control s create d systemati c incen tives for divertin g entrepreneuria l activit y towar d ren t seekin g and other directl y unproductive activity . These consequence s o f India n plannin g deal t wealth-creatin g en trepreneurship a majo r blo w despit e a substantia l privat e sector , leading t o a retardatio n o f growt h an d th e failur e o f India n planning. Recent analyse s of the Indian developmen t plannin g experienc e (e.g., Chakravarti 1987 ; Jala n 1991 ) misunderstan d th e natur e o f national developmen t plannin g an d th e impor t o f th e epistemo logical an d theoretica l criticism s o f such planning detaile d above . Consequently, the y ten d t o b e unsoun d apologia for a fundamen tally flawed proces s whic h ha s th e seed s of its own failur e embed ded i n i t fro m th e start . Muc h grie f t o th e India n populatio n an d the developmen t proces s coul d hav e bee n avoide d i f the y an d the originator s o f th e India n developmen t strateg y ha d properl y understood th e natur e o f th e developmen t proces s an d th e inher ent contradiction s o f planning. 7. Conclusio n The detaile d revie w o f th e underlyin g vision , polic y framework , outcomes, an d epistemologica l an d theoretica l weaknesse s o f th e Indian developmen t plannin g proces s i n thi s chapte r demon strates th e disastrou s consequence s o f fault y economi c analysi s and inappropriat e policie s fo r th e wealt h o f nations . Th e India n development plannin g debacl e has man y lesson s t o offer fo r thos e who ar e stil l espousin g a thir d wa y o f "marke t socialism, " al -

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though th e carcas s o f tha t "hybrid " syste m ha s bee n effectivel y laid t o res t durin g th e socialis t calculatio n debate. 6 1 Wha t i s re quired i n Indi a toda y ar e fundamenta l change s i n th e plannin g and polic y framework , rathe r tha n th e half-hearte d attempt s a t liberalization tha t hav e bee n initiate d i n th e middl e eightie s an d again i n 1991 . In India' s case , suc h fundamenta l change s woul d involv e a n across-the-board scrappin g o f al l remainin g domesti c an d exter nal-sector control s an d regulations , th e dismantlin g o f th e over bearing an d nihilisti c plannin g system , a drasti c an d complet e reduction i n th e centralize d bureaucrati c edifice , comprehensiv e privatization o f th e centra l an d stat e public-secto r undertakings , a restoratio n o f absolut e right s t o privat e propert y an d voluntar y exchange, an d a comprehensiv e relianc e o n marke t force s i n ever y facet o f dail y life . A completely free-trad e regime , combine d wit h a freel y convertibl e currency , need s t o b e establishe d a s a n imme diate ste p towar d achievin g th e objectiv e o f economi c an d politi cal freedom . Social polic y need s t o b e drasticall y altere d b y a scrappin g o f all discriminator y policies , suc h a s India' s caste-base d "affirma tive action " policies , an d th e remova l o f al l stat e control s o n mobility, hiring , an d appointments . A credibl e syste m o f rul e o f law, base d o n equa l acces s t o justice bu t no t equalit y o f outcomes , needs t o b e established . A constitutiona l conventio n t o limi t th e powers o f governmen t an d guarante e a decentralized , trul y fed eral syste m o f governmen t i s als o urgentl y needed . The focu s o f suc h a radica l libera l agend a fo r chang e shoul d b e on processes rathe r tha n redistributiv e outcomes, th e latte r poli cies havin g faile d miserabl y i n Indi a an d i n ever y countr y wher e they hav e bee n tried . Th e attemp t shoul d b e t o mak e economic s dominant an d politic s subservient . I t shoul d involv e a complet e abandonment o f th e plannin g an d contro l syste m fo r a privat e property marke t syste m tha t encourage s privat e entrepreneur ship. Otherwis e Indi a wil l remai n poo r an d it s econom y wil l con tinue t o unravel . Onl y th e failur e o f India' s dirigist e developmen t planning pat h an d it s bran d o f socialis m wil l b e lef t t o burde n future generations .

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Notes 1. Bhagwat i an d Desa i (1970 ) provide s a n excellen t revie w an d analysi s of India n economi c plannin g an d performanc e fo r th e firs t thre e pla n periods (1951-66 ) an d remain s th e locu s classicu s o n th e subjec t o f industrial policy , control , an d pla n implementatio n difficultie s an d failures. Sheno y (1971 ) an d Ro y (1984 ) provid e excellen t critique s o f the rol e o f th e plannin g proces s an d politic s i n India' s economi c development. Ro y an d Jame s (1992 ) contain s recen t analyse s o f In dian planning , governance , development , an d socia l progress . 2. Official s fro m th e Britis h colonia l administratio n fo r postwa r eco nomic plannin g an d industria l developmen t wa s provide d b y th e constitution o f th e Reconstructio n Committe e o f th e Viceroy' s Coun cil i n 194 3 an d th e settin g u p o f a Departmen t o f Plannin g an d Development i n 1944 . B y 1945 , a n u m b e r o f officia l an d unofficia l planning document s an d plan s ha d bee n formulated , includin g thos e of th e Congres s Nationa l Plannin g Committe e an d th e "Bomba y Plan," a plannin g m e m o r a n d u m prepare d b y a grou p o f leadin g In dian industrialist s (Thakurda s e t al. , 1944) . Se e Tomlinso n (1992 ) fo r a recent , bu t flawed, treatmen t o f th e historica l root s o f postindepen dence India n economi c policy . 3. Th e semina l discussio n o f th e "unconstrained " visio n o f h u m a n na ture an d societ y i s t o b e foun d i n Sowel l (1987) . H e contrast s thi s vision wit h th e "constrained " visio n o f m an wher e h u m a n societ y an d development ar e see n a s th e produc t o f h u m an actio n an d adaptatio n through tria l an d error , rathe r tha n rationa l design , an d wher e th e power o f unarticulate d an d unplanne d socia l processe s t o mobiliz e and coordinat e knowledg e i s suc h a s t o rende r centralize d knowledg e collection an d decisio n makin g impossible . 4. Haye k (1973 ) ha s characterize d th e forme r vie w a s tha t o f "construc tivist rationalism " whic h see s h u m a n institution s a s " m a d e " order s or "taxis, " whil e th e latte r vie w i s characterize d a s th e "evolutionar y a p p r o a c h " whic h view s man y importan t h u m a n institution s a s spon taneous prder s o r "cosmos " (whil e recognizin g tha t ther e ar e " m a d e " orders whic h ar e als o important) . These tw o view s fal l int o th e classi fication o f th e unconstraine d an d constraine d vision s respectivel y a s identified b y Sowel l (1987) . 5. Se e Bohm-Bawer k (1949) , Mise s ([1922 ] 1981) , Haye k (1944 , 1948 , 1988) an d Poppe r ([1945 ] 1966 , 1957) . Hayek (1988 ) contain s a recen t systematic treatmen t o f th e fallacie s o f wha t h e call s th e "fata l con ceit" o f socialism—th e ide a tha t " m a n i s abl e t o shap e th e worl d around hi m accordin g t o hi s wishes. " Sowel l (1985 ) contain s a sys tematic critiqu e o f th e philosoph y an d economic s o f Marxism , whic h underlies mos t moder n attempt s a t establishin g a socialis t system .

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6. Th e majo r opposin g vision s t o Nehru's wer e tha t o f India's acknowl edged leade r o f th e independenc e movement , Mahatm a Gandh i an d his other protege , Vallabhbhai Patel . These visions can onl y be char acterized a s less unconstrained tha n Nehru's , sinc e the y to o had ele ments o f socialis m am d statis m buil t int o them . Se e Rudolp h an d Rudolph (1987) , Akbar (1988) , an d Tomlinso n (1992 ) fo r discussion s of th e struggl e o f th e thre e separat e relativel y unconstraine d vision s espoused b y thes e men , albei t fro m a differen t perspective . It i s als o necessary t o note tha t th e more constrained visio n i n the preindepen dence period wa s tha t o f the members o f the British colonia l govern ment til l th e lat e thirties , wh o espouse d laissez-faire i n matter s o f economic policy . Bu t th e Grea t Depressio n an d wartim e shortage s and control s change d thi s visio n t o a more unconstraine d one . In both th e pre - an d postindependenc e era , th e constraine d visio n wa s espoused b y C . Rajagopalachari, independen t India' s firs t governor general. Rajagopalachar i founde d th e Swatantr a (Independence ) party, whic h espouse d a liberal , market-oriente d economi c policy . India's firs t president , Dr . Rajendr a Prasad , als o espouse d a mor e constrained vision , bu t wa s considere d " a ma n o f inferio r intellect " and wa s ineffectiv e i n changin g th e dominan t polic y etho s throug h his largely ceremonia l office . 7. Quote d i n Singh (1977). 8. Quote d i n Akbar (1988, 466). 9. Quote d i n Singh (1977, 87). 10. Ibid . 11. Se e Government o f India (1951,6) . 12. Quote d i n Roy (1984, 34). 13. Governmen t o f India (1956b , 3). 14. Quote d i n Karanjia (1960 , 49-50). 15. Th e term "scientism " wa s coine d b y Hayek ([1952 ] 1979 ) to describ e the "slavish imitatio n o f the method an d languag e of Science" (or the natural sciences ) by the social sciences . See Hayek ([1952] 1979 ) for a brilliant critiqu e of scientism . 16. Quote d i n Karanjia (1960 , 50-51). 17. Se e Gopal (1976 ) and Rudolp h an d Rudolp h (1987 ) for discussion s of this aspec t o f Nehru . H e wa s a fir m believe r i n th e parliamentar y version o f the libera l state , including it s concern fo r a government o f laws and civi l rights . 18. Th e source s fo r th e discussio n tha t follow s includ e Hazar i (1966) , Hazari Committe e Repor t (1967) , Bhagwat i an d Desa i (1970) , Das gupta an d Sengupt a (1978) , and th e Government o f India, Ministry of Industry, Guidelines for Industries (1983) . 19. Th e various Industry Polic y Resolutions and other industrial control s are documented an d detaile d i n the Government o f India, Ministry of Industry, Guidelines for Industries (1983) .

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20. Se e th e Hazar i Committe e repor t (1967 ) an d th e Dut t Committe e report (1969) . 21. Th e importan t committee s includ e th e Committe e o n Industrie s De velopment Procedure s (Swaminatha n Committe e 1965) , the Commit tee o n Industria l Plannin g an d Licensin g Polic y (Hazar i Committe e 1967), th e Industria l Licensin g Polic y Inquir y Committe e (Th e Dut t Committee 1969) , and th e Committe e o n Import-Expor t Policie s an d Procedures (The Alexander Committee 1978) . 22. Se e particularl y chapte r 5 of th e Dagl i Committe e repor t (1979 ) fo r the confusion i n this area . 23. Fo r a discussio n o n mone y marke t controls , see Kamat h (1985a , 1985b). 24. Estimate s o f th e siz e o f th e blac k marke t i n Indi a var y fro m 1 5 percent t o over 50 percent of GNP. For a recent survey, see Gupta an d Gupta i n Mong a an d Sancti s (1984) . Officia l report s o n th e blac k market an d rent-seekin g activit y ar e th e Wanchoo Committe e repor t (1971) and th e Dagli Committee report (1979) . The Raj Committee o n steel control document s case s of graft an d gros s misuse of the contro l mechanism fo r steel (Raj Committee, 1963) . See Kamath (1992) . 25. Fo r a discussion, see Blaug, Layard, and Woodhall (1969). 26. A number o f committee s hav e reviewe d an d modifie d th e monopol y provisions o f th e ID R Ac t o f 1951 . These includ e th e report s o f th e Committee o n Distributio n o f Incomes and Level s of Living (Mahalo nobis Committe e 1960) , th e Committe e o n Industria l Plannin g an d Licensing Polic y (Hazar i Committee , 1967) , the Monopolie s Inquir y Commission (Governmen t o f India, 1965b) , and th e Industrial Licens ing Policy Inquiry Committee (Th e Dutt Committee 1969) . 27. Fo r a clear statement o f this view, see Dasgupta an d Sengupt a (1978). 28. Th e majo r source s fo r thi s discussio n includ e Bhagwat i an d Desa i (1970), Bhagwat i an d Srinivasa n (1975) , Dasgupt a an d Sengupt a (1978), Foreig n Exchang e Regulatio n Ac t (194 7 an d amendments) , Report of the Committee on Import-Export Policies and Procedures (Alexander Committe e 1978) , Report of the Committee on Export Strategy—1980s (Tando n Committe e 1980) , and Report of the Import Substitution Committee (Agarwa l Committee 1980) . 29. Se e Bhagwat i an d Desa i (1970 ) fo r a detaile d discussion . Shouri e (1966) contains a detaile d descriptio n an d criticis m o f th e allocatio n procedures adopted b y the Indian authorities . 30. Bhagwat i an d Srinivasa n (1975, 42-43). 31. Se e especiall y th e report s o f th e Estimate s Committe e o f th e Lo k Sabha (Parliament ) (Governmen t o f India , 1963-64 , 1967-68) , th e Santhanam Committe e o n th e Preventio n o f Corruptio n (1964) , th e Kaul Committe e (1971 ) o n leakag e o f foreig n exchang e throug h in voice manipulation , th e Wancho o Committe e o n direc t taxe s (1971) , and th e Dagli Committee (1979) on controls and subsidies .

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32. Dat a wer e obtaine d fro m th e vernacula r newspape r Vyaapar (Busi ness), publishe d dail y i n Bombay . Th e pape r fairl y regularl y pub lishes dat a o n impor t licens e an d commodit y "black-market " premi u m s b y pollin g trader s i n th e marke t a s wel l a s b y occasionall y bidding i n th e marke t throug h othe r busines s concerns . Th e Santha n a m Committe e repor t (1964 ) state d tha t impor t license s wer e wort h 100 to 50 0 percent o f thei r fac e value . 33. Se e Sheno y (1968 , 1971) , an d Ro y (1984 , part 3 ) fo r a furthe r discus sion o f th e abuse s o f tradin g an d corruptio n i n Indi a durin g th e postindependence period . 34. Regula r serie s fo r black-marke t exchang e rate s ar e t o b e foun d i n various issue s o f the Far Eastern Economic Review an d Pick's Currency Year Book. Fo r a n excellent , detaile d stud y o f black-marke t exchang e rates i n Indi a an d othe r countries , se e Gupt a (1980) . 35. Se e Report of the Estimates Committee of the Lok Sabha fo r 1967-6 8 (Government o f India 1963-64 , 1967-68) . 36. Se e Bhagwat i an d Desa i (1970) , Bhagwati an d Srinivasa n (1975 ) an d the report s cite d i n not e 28 . 37. Possibl e factor s fo r th e neglec t o f export s durin g th e first plannin g decade (1951-61 ) ar e discusse d i n chapte r 1 8 of Bhagwat i an d Desa i (1970). I t i s interestin g t o not e tha t the y attribut e thi s neglec t t o th e investment strateg y adopte d b y th e India n planners . The emphasi s i n the Secon d Pla n towar d investment s i n capita l good s industrie s an d the implici t expor t pessimis m entaile d therei n ma y hav e bee n du e t o the mos t influentia l planne r a t tha t time , Prof . Mahalonobis , bein g a physicist an d no t a n economis t an d henc e no t seein g th e foreig n trad e transformation possibilitie s a s a wa y o f procurin g capita l goods . Bhagwati an d Desa i poin t ou t tha t th e adoptio n o f a materia l bal ances-oriented Soviet-typ e plannin g mode l ("th e Mahalonobi s Model") seem s t o have bee n du e t o th e influenc e o f Sovie t thinkin g o n Prof. Mahalonobis . 38. Se e Bhagwat i an d Desa i (1970) , chapte r 19 , for a detaile d discussio n of th e characteristic s an d deficiencie s o f thes e scheme s i n th e 1960s . 39. Bhagwat i an d Desa i (1970 ) calculated th e implie d effectiv e subsidiza tion a t p r e m i u m s o f abou t 7 0 - 8 0 percen t i n 1963-6 4 t o b e aroun d R s 500 million , whic h significantl y exceede d th e subsid y fro m an y o r al l of th e othe r measure s o f expor t promotion . A s alread y mentione d i n note 32 , dat a collecte d b y th e autho r showe d th e existenc e o f highe r premiums o n impor t licenses . 40. Unite d Nation s Developmen t Programm e (1990 , 130) . 41. J a g a n n a t h a n an d Guh a Thakurt a (1991 , 53) . 42. Gupt a an d Gupt a (1982) . 43. Bhagwat i an d Desa i (1970 ) an d La i (1988a , 1988b) . 44. Dandeka r an d Rat h (1971 ) an d Chaudhur i (1978) .

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45. Fo r detailed analyse s o f the politician-cooperativ e nexus , see Bavishkar (1968, 1980). See also Kamath (1992) . 46. Bardhan(1984 , 102) . 47. Thes e figures are calculated fro m Ezekie l (1984, 149-67). 48. Economist (1992 , 57). 49. Fo r example, see Patel (1985), Chakravarti (1987) , and Jalan (1991) . 50. Th e supporter s an d advocate s o f planning i n India, suc h a s Bardha n (1984), Patel (1985) , Chakravarti (1987) , and Jala n (1991) , argue tha t it wa s th e selectio n o f inappropriat e polic y instrument s rathe r tha n any inherent weaknes s of the planning process that le d to the failure s of Indian planning . Bardhan (1984 ) also argue s tha t i t wa s th e "lac k of politica l insulatio n fro m conflictin g interests , couple d wit h th e strong powe r bas e o f th e white-colla r worker s i n th e publi c bureau cracy tha t keep s th e India n state , i n spit e o f it s pervasiv e economi c presence, largel y confine d t o regulatory functions , avoidin g th e har d choices an d politicall y unpleasan t decision s involve d i n mor e activ e development functions " (74) . Critics of Indian developmen t plannin g such a s Bhagwat i an d Desa i (1970 ) an d Bhagwat i an d Srinivasa n (1975), on th e othe r hand , hav e stresse d th e choic e o f inappropriat e policy framework s an d instruments , bu t i n additio n hav e als o stressed th e role of administrative an d political failures i n implemen tation. More cogent an d comprehensiv e critique s have been provide d by Sheno y (1971 ) and Ro y (1984), but eve n they, like the others, have ignored mor e fundamenta l epistemologica l an d theoretica l consider ations. 51. Se e Sowel l (1980 ) for a book-lengt h discussio n o f th e theoretica l un derpinnings an d consequence s o f th e knowledg e problem . Lavoi e (1985a) focuse s o n th e knowledg e proble m a s th e centerpiec e o f hi s critique of national economi c planning . 52. Ther e i s certainl y n o mentio n o f th e knowledg e proble m i n an y o f Nehru's o r Mahalonobis's writings . Another prominent architec t an d proponent o f India n planning , Chakravart i (1973 , 1987 ) mention s Hayek an d th e knowledg e proble m (an d tha t to o obliquely ) bu t dis poses o f th e issue s raise d b y th e recognitio n o f suc h a proble m a s being to o efficienc y oriente d an d therefor e no t o f muc h valu e i n understanding real-worl d plannin g i n th e contex t o f underdevelop ment an d th e major structura l change s that occu r in such economies! 53. Se e Polanyi (1958) for a discussion of tacit knowledge. Also see Lavoie (1985a), especially chapter 2 . 54. Th e majo r critic s o f socialis t calculatio n wer e Mise s ([1920 ] 1935 , [1922] 1981) , Robbin s (1934) , an d Haye k (1935) . Fo r a n excellen t revisionist accoun t o f this debate, see Lavoie (1985b). 55. Th e moder n propert y right s literatur e i s summarize d i n Furubot n and Pejovic h (1972) , Alchian (1965 , 1969) , and Demset z (1964 , 1966 ,

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1967, 1969 ) whic h contai n th e majo r contribution s t o th e moder n economics literature on property rights . 56. Fo r a full-blow n analysi s o f the inhibitin g an d detrimenta l effect s o f taxes an d regulation s o n th e entrepreneuria l discover y process , see Kirzner (1985, chapters 5 and 6). 57. Buchana n (1966 ) contains an excellent accoun t o f the development of entrepreneurship an d capitalistic enterprise i n India . 58. See , for example , Bhagwat i an d Desa i (1970) , Krueger (1974) , Bhagwati an d Srinivasa n (1975) , Jh a (1980) , Gupt a an d Gupt a (1982) , Mohammed an d Whalle y (1984) , Monga an d Sancti s (1984) , Acharya and Associate s (1985) , Kamat h (1992) , an d a hos t o f governmen t committee report s (e.g. , Santhanam Committe e 1964 , Kaul Commit tee 1971 , Dagli Committee 1979 , etc.). 59. La i (1988a). 60. Fo r example, see Lai (1988b, 24). 61. Fo r a recen t exhumatio n o f thi s discredite d an d burie d idea , se e Bardhan an d Roeme r (1992).

References Acharya, S., and Associates. 1985. Aspects of Black Economy in India. Ne w Delhi: National Institut e of Public Finance and Policy . Agarwal Committee . 1989 . Report of the Import Substitution Committee. Delhi: Govt, of India Press . Akbar, M. J. 1988 . Nehru: The Making of India. London : Penguin . Alchian, A. A. 1965. "Some Economic s o f Property Rights. " // Politico 30, no. 4: 816-29. . 1969 . "Corporat e Managemen t an d Propert y Rights. " I n Economic Policy and the Regulation of Corporate Securities, ed . Henr y Manne, 337-60. Washington, D.C.: American Enterprise Institute . Alexander Committee . 1978 . Report of the Committee on Import-Export Policies and Procedures. Delhi: Govt, of India Press . Bardhan, P . K . 1984 . The Political Economy of Development in India. Delhi: Oxford Universit y Press . Bardhan, P . K. , an d J . E . Roemer . 1992 . "Market Socialism : A Case fo r Rejuvenation." Journal of Economic Perspectives 6, no . 3 (Summer) , 101-16. Bavishkar, B. S. 1968. "Cooperatives and Politics." Economic and Political Weekly 3, no. 12, March 23, 1968, 490-95. . The Politics of Development: Sugar Co-operatives in Rural Maharashtra. Delhi: Oxford Universit y Press . 1980. Bhagwati, J. , an d P . Desai . 1970 . India-Planning for Industrialisation:

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Industrialisation and Trade Policies since 1951. Delhi : Oxfor d Univer sity Press. Bhagwati, J. , an d T . N . Srinivasan . 1975 . Foreign Trade Regimes and Economic Development: India. Ne w York : Nationa l Burea u o f Eco nomic Research and Columbia Universit y Press . Blaug, M. , R . Layard , an d J . M . Woodhall . 1969 . Causes of Graduate Unemployment in India. Harmondsworth : Alle n Lane. Bohm-Bawerk, E . V. 1949. Karl Marx and the Close of His System. Clifton , N.J.: Augustus M. Kelley. Buchanan, D.H . 1966 . The Development of Capitalist Enterprise in India. London: Frank Cass. Buchanan, J . M., and R . L. Faith. 1981 . "Entrepreneurship an d th e Inter nalization o f Externalities. " Journal of Law and Economics (April) : 95-111. Chakravarti, S . 1973 . "Theory o f Developmen t Planning : A n Appraisal. " In Economic Structure and Development: Essays in Honor of Jan Tinbergen, ed . H . C . Bos , H . Linnemann , an d P . d e Wolff . Amsterdam : Elsevier. . 1987 . Development Planning: The Indian Experience. Oxford : Clarendon Press . Chaudhuri, P . 1978 . The Indian Economy: Poverty and Development. Ne w Delhi: Vikas Publishing House . Dagli Committee. 1979 . Report of the Committee on Controls and Subsidies. New Delhi: Govt, of India Press . Dandekar, V. M., and N . Rath. 1971 . Poverty in India. Pune : Indian Schoo l of Political Economy . Dasgupta, A. , an d N . K . Sengupta . 1978 . Government and Business in India. Calcutta : Allied Book Agency. Demsetz, H . 1964 . "The Exchang e an d Enforcemen t o f Property Rights. " Journal of Law and Economics 7 (October): 11-26 . . 1966 . "Som e Aspect s o f Propert y Rights. " Journal of Law and Economics 9 (October): 61-70. . 1967 . "Toward a Theory o f Property Rights. " American Economic Review 57, no. 2 (May): 347-73. . 1969 . "Informatio n an d Efficiency : Anothe r Viewpoint. " Journal of Law and Economics 1 2 (April): 1-22 . Dutt Committee . 1969 . Report of the Industrial Licensing Policy Inquiry Committee. Delhi : Govt, of India Press . Economist. 1992 . May 23-29, 21-23, 57. Ezekiel, Hannan , ed . 1984 . Corporate Sector in India. Ne w Delhi : Vika s Publishing House . Furubotn, E . I . an d S . Pejovich . 1972 . "Propert y Right s an d Economi c Theory: A Survey o f Recen t Literature. " Journal of Economic Literature: 1137'-62.

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Gopal, S . 1976 . Jawaharlal Nehru: A Biography. 3 vols . Delhi : Oxfor d University Press . Government o f India . Variou s years . Economic Survey. Delhi : Govt , o f India Press . . 1947 . Imports and Exports (Control) Act. Delhi : Govt , o f Indi a Press. . 1951 . Industries (Development and Regulation) Act. Delhi : Govt , of India Press . . 1955a . Essential Commodities Act. Delhi, Govt, of India Press . . 1955b. Imports (Control) Order. Delhi : Govt, of India Press . . 1956a. Companies Act. Delhi : Govt, of India Press . . 1956b. Industrial Policy Resolution. Delhi : Govt, of India Press . . 1963-64, 1967-68. Report of the Estimates Committee of the Lok Sabha. Delhi : Govt, of India Press . . 1965a. Essential Commodities Act. Delhi: Govt, of India Press . . 1965b. Report of the Monopolies Inquiry Commission. Delhi: Govt. of India Press. . 1969 . Monopoly and Restrictive Trade Practices Act. Delhi : Govt, of India Press . . 1970 . Industrial Licensing Policy. Delhi: Govt, of India Press . . 1973 . Industrial Policy Government Decisions. Delhi : Govt , o f In dia Press . . 1977. Exports (Control) Order. Delhi : Govt, of India Press . . 1977 , 198 0 & 1981 . Industrial Policy Statement. Delhi : Govt , o f India Press . . Ministry o f Industry. 1983 . Guidelines for Industries. Delhi : Govt . of India Press . Gupta, S . 1980 . "A n Applicatio n o f th e Monetar y Approac h t o Blac k Market Exchang e Rates. " Weltwirtschaftliches Archiv 116 , no . 2 : 235-52. Gupta, P. , and S . Gupta. 1982 . "Estimates o f the Unreporte d Econom y i n India." Economic and Political Weekly, January 16 , 69-75. Hayek, F . A . 1937 . "Economic s an d Knowledge. " Economica 4(NS) : 33-54. . 1944. The Road to Serfdom. Chicago : University of Chicago Press. . 1945 . "Th e Us e o f Knowledg e i n Society. " American Economic Review 25, no. 4: 519-30. . 1948 . Individualism and Economic Order. Chicago: Universit y o f Chicago Press. . [1952 ] 1979 . The Counter-Revolution of Science: Studies on the Abuse of Reason. Indianapolis : Liberty Press . . 1973 . Law, Legislation and Liberty. Vol . 1 , Rules and Order. Chicago: University of Chicago Press. . 1988 . The Fatal Conceit: The Errors of Socialism. Chicago : Univer sity of Chicago Press.

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Hayek, F . A. ed. 1935 . Collectivist Economic Planning: Critical Studies on the Possibilities of Socialism. London : Routledge . Hazari, R. K. 1966 . The Structure of the Corporate Private Sector. Bombay : Asia Publishing House . Hazari Committee . 1967 . Report of the Committee on Industrial Planning and Licensing Policy. Delhi: Govt, of India Press . Jagannathan, R. , and P. Guha Thakurta. 1991 . "The Government: Wanto n Ways." India Today, April 30, 52-59. Jalan, B . 1991 . India's Economic Crisis: The Way Ahead. New Delhi : Ox ford Universit y Press . Jha, P . S . 1980 . India—A Political Economy of Stagnation. Bombay : Ox ford Universit y Press . Kamath, S . J. 1985a . "The Deman d fo r an d Suppl y o f Money i n India — 1951-76." Weltwirtschaftliches Archiv 12 1 no. 2: 501-23. . 1985b. "Money, Income and Causality in a Developing Economy. " Journal of Economic Studies 12 , no. 3 (October): 36-53 . . 1992 . The Political Economy of Suppressed Markets: Controls, Rent Seeking and Interest Group Behaviour in the Indian Sugar and Cement Industries. Delhi : Oxford Universit y Press . Karanjia, R . K. 1960 . The Mind of Mr. Nehru. London : Allen & Unwin. Kaul Committee . 1971 . Report of the Committee on Leakage of Foreign Exchange through Invoice Manipulation. Delhi : Govt, of India Press . Kirzner, I. 1973 . Competition and Entrepreneur ship. Chicago : University of Chicago Press. . 1973 . Perception, Opportunity and Profit: Studies in the Theory of Entrepreneurship. Chicago : University of Chicago Press. . 1985 . Discovery and the Capitalist Process. Chicago: Universit y o f Chicago Press, 1985. Knight, F . H . 1921 . Risk, Uncertainty and Profit. Ne w York : Houghto n Mifflin. Krueger, A . O . 1974 . "Th e Politica l Econom y o f th e Rent-Seekin g Soci ety." American Economic Review 64 (June): 291-303. Lai, D. 1988a. Hindu Equilibrium. Vol . 1. Oxford: Clarendo n Press . . 1988b . India—Country Study No. 5. Panam a an d Sa n Francisco : International Cente r for Economi c Growth . Laski, H. 1935 . Law and Justice in Soviet Russia. London : Allen & Unwin. Lavoie, D . 1985a . Rivalry and Central Planning: A Reexamination of the Socialist Calculation Debate. Cambridge: Cambridge Universit y Press . . 1985b . National Economic Planning: What Is Left? Cambridge : Cambridge Universit y Press . Mahalonobis Committee . 1960 . Report of the Committee on Distribution of Income and Levels of Living. Delhi : Govt, of India Press . Mises, L. von. [1920] 1935 . "Economic Calculation an d th e Socialist Commonwealth." Trans . S . Adler . I n Collectivist Economic Planning, ed . F. A. Hayek (originally published i n 192 0 in German) .

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Mises, L. von. [1922] 1981 . Socialism: An Economic and Sociological Analysis. Trans . J . Kahane . Indianapolis : Libert y Pres s (originall y pub lished in German) . Mohammed, S. , an d J . Whalley . 1984 . "Rent Seekin g i n India : It s Cost s and Polic y Significance." Kyklos 37 (December): 817-31 . Monga, G. S., and V. J. Sanctis. 1984. The Unsanctioned Economy in India. Bombay: Himalaya Publishin g House . National Counci l o f Applie d Economi c Research . 1978 . A Study of Price Control and the Impact of Excise Duties on Selected Industries. Ne w Delhi: NCAER. Patel, I. G. 1985 . On the Economics of Development: Towards a Consensus. Stemp Memorial Lecture , London: University of London. Pick's Currency Year Book. Various years. New York. Polanyi, M. 1958 . Personal Knowledge: Towards a Post-Critical Philosophy. Chicago: University of Chicago Press. Popper, K . R . [1945 ] 1966 . The Open Society and Its Enemies. London : Routledge. . 1957. The Poverty of Historicism. London : Routledge . Raj Committee . 1963 . Report of the Committee on Steel Control. Delhi : Govt, of India Press . Robbins, L. 1934. The Great Depression. New York: MacMillan. Roy, S . 1984 . Pricing, Planning and Politics: A Study of Economic Distortions in India. London : Institute of Economic Affairs . Roy, S. , an d W . E . James , eds . 1992 . Foundations of India's Political Economy: Towards an Agenda for the 1980s. New Delhi : Sag e Publica tions. Rudolph, L . I. , an d S . H . Rudolph . 1987 . In Pursuit of Lakshmi: The Political Economy of the Indian State. Chicago : Universit y o f Chicag o Press. Santhanam Committee . 1964 . Report of the Committee on the Prevention of Corruption. Delhi: Govt, of India Press . Schumpeter, J. A. 1934. The Theory of Economic Development. Cambridge: Harvard Universit y Press . . 1942 . Capitalism, Socialism and Democracy. Ne w York : Harpe r & Row. Shackle, G. L. S. 1972 . Epistemics and Economics: A Critique of Economic Doctrines. Cambridge: Cambridge Universit y Press . Shenoy, B. R. 1968. Indian Economic Policy. Bombay: Popular Prakashan . . 1971. India: Progress or Poverty? A Review of the Outcome of Central Planning in India, 1951-69. London : Institute of Economic Affairs . Shourie, A. 1966. "Allocation of Foreign Exchange in India." Unpublishe d Ph.D. diss., Syracuse University . Singh, V . B. , ed . 1977 . Nehru on Socialism. Ne w Delhi : Govt , o f Indi a Press.

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Sowell, T. 1980. Knowledge and Decisions. Ne w York: Basic Books. . 1985 . Marxism: Philosophy and Economics. Ne w York : Willia m Morrow. . 1987. A Conflict of Visions: Ideological Origins of Political Struggles. New York: Quill /William Morrow . Swaminathan Committee . 1965 . Report of the Committee on Industries Development Procedures. Delhi: Govt, of India Press . Thakurdas, Sir P., et al. 1944 . Memorandum Outlining A Plan of Economic Development for India (Bomba y Plan). Harmondsworth: Penguin . Tomlinson, B . R . 1992 . "Historica l Root s o f Economi c Policy. " I n Ro y and James 1992 . United Nation s Developmen t Programm e (UNDP) . 1990. Human Development Report 1990. New York: Oxford Universit y Press . Vyaapar. Various issues. Bombay . Wanchoo Committee. 1971 . Report of the Direct Taxes Enquiry Committee. Delhi: Govt, of India Press . Webb, Sidney, and Beatrice Webb. 1938. Soviet Communism: A New Civilization? Ne w York: Scribner's .

6 The Failur e o f Developmen t Plannin g in Afric a George B . N. Ayitte y

Introduction "Development p l a n n i n g " i s a beguilin g an d innocuou s ter m whic h should no t b e confuse d wit h th e dail y necessit y o f plannin g one' s life activities . Mos t peopl e hav e "som e p l a n " designe d t o achiev e a certai n objective , whic h ma y b e financial, political , o r career related. Fo r example , a n individua l ma y pla n t o sav e sa y five thousand dollar s a t th e en d o f th e year . Suc h a pla n o r goa l may entai l a n adjustment—mos t likel y a reduction—i n curren t consumption expenditures . Anothe r individua l ma y aspir e t o be come a n astronau t i n th e future . Wit h thi s goa l i n mind , sh e ma y plan o n securin g th e necessar y typ e o f trainin g an d preparation . Corporations als o pla n thei r productio n an d investmen t activi ties. Fo r example , a compan y tha t can s tomatoe s woul d no t pla n on startin g productio n whe n farmer s hav e no t harveste d thei r produce. No r woul d a fish-processing compan y pla n o n openin g a new plan t i n th e middl e o f a desert . Similarly, th e governmen t plan s it s activities . It s budge t i s really a statemen t o f it s fiscal plan s fo r th e comin g year . I t pro vides statement s o f planned expenditure s o n th e basi s o f antici pated revenue . Mor e generally , however , th e government , lik e in 146

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dividuals, also "thinks ahead. " Fo r example, if a city's populatio n is growing , a n increas e i n deman d fo r infrastructura l service s (electricity, water , schools , an d roads ) mus t b e anticipate d an d additional provision s planned for . These processes—thinking ahead , planning a career, and corporate investmen t plans—ar e al l norma l feature s o f huma n exis tence. No t al l plan s ar e realize d however . Th e perso n wh o plan s on savin g $5,00 0 at th e end o f the year ma y rathe r find himsel f i n debt (negativ e savings) . An d th e governmen t ma y discove r tha t the actual deficit a t th e end o f the fiscal year i s larger tha n antici pated o r planned . Whe n plan s fal l shor t o f expectations , eac h individual o r uni t mus t mak e painfu l correction s an d adjust ments. Development planning , o n th e othe r hand , i s a pretentiou s at tempt b y th e stat e t o plan, no t onl y it s activities , but thos e o f it s citizens a s well . Therein lie s th e fundamenta l problem . I t i s diffi cult enoug h fo r a n individua l t o formulat e a pla n an d achiev e it s objectives, let alone to do so for others . Killick (1976 ) distinguishe d si x characteristic s o f developmen t planning: 1. A definitio n o f policy objectives. Thes e ma y b e specifie d a s achieving a "targe t rate " o f economic growt h o f say 6 percent , reducing th e rat e o f illiteracy t o say 3 0 percent, an d increasin g the rate of employment . 2. A formulation o f a strategy b y mean s o f whic h th e objective s are t o b e achieved . Th e strateg y ma y tak e th e for m o f raisin g the rate of investment, from sa y 5 percent t o 20 percent of GNP, and suc h a n increas e i n investmen t ma y b e concentrate d i n industry, as opposed t o agriculture . 3. Fo r implementatio n o f th e strategy , a centrally coordinated, internally consistent set of principles and policies i s chose n a s th e optimal mean s of achieving th e plan's objectives . 4. Th e intende d are a o f impac t ma y b e th e entir e econom y i n which cas e th e plan i s comprehensive, o r a limited are a (sector ) of the economy, in which case the plan i s partial. 5. A formalized macroeconomic model provide s th e basi s o f th e plan. Th e mode l i s use d t o assur e interna l consistenc y an d

148 Georg e B. N. Ayittey optimality, a s wel l a s t o projec t th e intende d futur e perfor mance of the economy . 6. A time frame . A development pla n typicall y cover s a period o f five years an d finds physica l expressio n a s a medium-term plan document. A ten-year plan i s not unusual an d i t may b e supplemented b y annual plans. Most Africa n governments , both socialis t an d capitalist , hav e adopted a developmen t pla n o f on e typ e o r anothe r durin g thei r postcolonial history . Among the m ma y b e mentione d Ghan a (Th e Seven-Year Developmen t Pla n 1963/64-1969/70) , Zambi a (Th e First Developmen t Pla n 1965-69) , Zimbabw e (Th e Transitiona l National Developmen t Pla n 1982/83-1984/85) , Keny a (Th e Fift h Development Pla n 1984-1988) , Nigeri a (Th e Thir d Developmen t Plan 1975-1980) , an d Zair e (Th e Five-Yea r Developmen t Pla n 1986-1990). The African Rational e fo r Development Plannin g In th e 1950 s and 1960s , development plannin g wa s ver y muc h i n vogue across the Third World. The case for planning rested on fou r economic arguments . Th e first wa s th e familia r "marke t failure " argument: tha t market s i n developing countrie s ar e characterize d by imperfection s i n structur e an d operation . Commodit y an d fac tor market s ar e ofte n poorl y organize d an d th e existenc e o f "dis torted prices " often mean s tha t producer s an d consumer s ar e no t responding t o economic signal s an d incentive s whic h trul y reflec t "real" cost s t o society . Thi s failur e o f th e marke t t o pric e factor s of production correctl y ofte n lead s t o a divergence betwee n socia l and privat e valuations of alternative investmen t project s an d ulti mately t o misallocation o f present an d future resources . Externalities forme d th e basi s o f th e secon d argument . Finan cial an d skille d manpowe r resource s ar e limite d i n th e Thir d World an d mus t therefor e b e utilized wher e thei r effects woul d b e most widel y felt ; tha t is , wit h th e greates t linkage s o r externa l economies. Private investors may be unable or unwilling to undertake investmen t larg e enoug h t o exploi t thes e externalities . Fur ther, competitiv e market s ma y no t onl y generat e les s investmen t

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but ma y als o direc t thi s investmen t int o sociall y unproductive , speculative venture s (hoardin g o r consumptio n good s fo r th e rich ) and ignor e th e extr a benefit s tha t woul d accru e fro m a planne d and coordinate d long-ter m investmen t program . The thir d argumen t wa s nationa l cohesion . A developing coun try i s ofte n compose d o f a fractiousl y divers e an d fragmente d population. Th e adoptio n o f a developmen t pla n ma y hel p rall y the peopl e behin d th e governmen t i n a nationa l campaig n t o erad icate poverty , ignorance , an d disease . B y mobilizin g popula r su port acros s class , caste , racial , religious , an d ethni c divisions , a government ma y b e abl e t o " u n i t e " th e peopl e i n a collectiv e effort t o buil d th e nation . Foreign ai d provide d th e fourt h argument . Th e formulatio n o f detailed developmen t plan s wit h specifi c sectora l outpu t target s and carefull y designe d investmen t project s wa s ofte n a necessar y condition fo r th e receip t o f bilatera l an d multilatera l foreig n aid . The existenc e o f suc h a pla n "convinced " foreig n donor s o f th e commitment an d seriousnes s o f th e recipien t government' s inten tions abou t development . Indeed , i t wa s deeme d a n unpardonabl e travesty fo r a n LD C governmen t no t t o posses s a developmen t plan. In Africa , thes e argument s wer e reinforce d b y th e continent' s especial circumstance s an d historica l experience . Market s wer e simply assume d t o b e nonexisten t o r severel y underdeveloped . Even wher e the y existed , the y wer e rejecte d a s a n allocativ e mech anism sinc e Africa' s peasant s wer e assume d t o b e unresponsiv e t o market o r pric e incentives . Bound b y th e chain s o f tradition , thes e peasants produce d onl y th e bar e m i n i m u m t o fee d themselve s (subsistence agriculture) . Perhaps th e mos t compellin g nee d fo r developmen t planning , i n the eye s o f Africa n leaders , wa s Africa' s colonia l legacy . Colonia l objectives wer e no t t o develo p Afric a bu t t o undertak e onl y suc h forms o f developmen t a s wer e compatibl e wit h th e interest s o f European metropolita n powers . Sinc e the y wer e mostl y industri alized, th e colonie s wer e envisage d t o functio n a s nonindustria l appendages t o th e metropolita n economy : consumer s o f Europea n manufactured good s an d provider s o f minerals , agricultural , an d wood commodities . A s a result , th e developmen t o f th e colonia l

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economies wa s perniciousl y "skewed" : overspecialize d i n on e o r two mai n cas h crop s (mono-expor t culture) , makin g Africa n econ omies highl y vulnerabl e t o oscillation s i n commodit y price s o n the worl d market . Specialization i n cas h crops , i t wa s argued , als o destroye d Af rica's abilit y t o fee d it s peopl e an d suppl y thei r othe r need s inter nally. Mos t domesti c industrie s collapse d fro m competition : fro m cheaper an d probabl y bette r importe d manufactures . Becaus e o f collusion amon g foreig n firms an d discriminatio n fro m colonia l banks, th e moder n secto r wa s completel y i n foreig n hands . Thus , most o f th e surplu s profi t generate d b y th e econom y flowed over seas an d wa s no t investe d i n th e colony . Loca l industrializatio n was flatly discouraged . The prim e motivatin g forc e behin d colonialis m wa s exploita tion, no t socia l development . Infrastructura l facilitie s provide d b y the colonialist s wer e pitiful . Onl y a fe w roads , schools , an d hospi tals wer e built . A s N k r u m ah (1973 , 39s ) scolded : Under colonia l rule , foreig n monopol y interes t ha d tie d u p ou r whol e economy t o sui t themselves . We had no t a singl e industry . Ou r econom y depended o n on e cas h crop , cocoa . Althoug h ou r outpu t o f coco a i s th e largest i n th e world , ther e wa s no t a singl e coco a processin g factory . There wa s n o direc t rai l lin k betwee n Accr a an d Takoradi . Ther e wer e few hospitals , school s an d clinics . Mos t o f th e village s lacke d a pipe d water supply . I n fac t th e nakednes s o f th e lan d whe n m y governmen t began i n 195 1 has to have been experienced t o be believed . Kwame N k r u m a h o f Ghana , Juliu s Nyerer e o f Tanzania , an d other Africa n leader s vowe d t o demolis h tha t miserabl y distorte d colonial economi c structur e Afric a ha d inherite d an d erec t i n it s place alternative s tha t woul d serv e th e need s an d interest s o f Africa, no t thos e o f Europe . T o accomplis h this , Afric a coul d no t rely o n markets , whic h i n an y cas e wer e introduce d b y th e colo nialists an d a s suc h constitute d decayin g relic s o f th e ol d colonia l order. No r coul d Afric a rel y o n it s peasant s fo r a n agricultura l revolution because , accordin g t o Nkrumah , thes e peasant s wer e "too slo w t o adap t o r chang e thei r practice s t o modern , mecha nized scientifi c m e t h o d s " (Uphof f 1970 , 602). True Africa n developmen t require d a carefull y planne d an d massive transformatio n o f African economies . Suc h a n investmen t

The Failure of Development Plannin g in Africa 15

1

could onl y b e undertake n b y th e state . Furthermore, transforma tion o f Africa n societie s require d stat e contro l o f th e economy . This se t th e stag e fo r massiv e stat e interventionis m i n th e 1950 s and 1960 s i n Africa . Rathe r interestingly , th e Worl d Bank , U S AID, th e Stat e Department , an d eve n developmen t expert s fro m Harvard Universit y supporte d thes e argument s an d channele d considerable aid resources to African government s (Bandow 1986) . To initiat e development , i t wa s widel y hel d tha t th e Africa n state neede d wide-rangin g power s t o marsha l th e resource s fro m the rura l are a an d channe l the m int o nationa l development . Ex tensive power s wer e conferre d upo n Africa n head s o f stat e b y rubber-stamp parliaments . Othe r head s o f state simpl y arrogate d unto themselve s thes e powers . I f a piec e o f lan d wa s neede d fo r highway construction, it was simply appropriated b y the state an d if an enterpris e wa s needed, i t was established b y the governmen t without an y consultatio n wit h th e people i t was intended t o benefit. I n thi s way , all African governments , regardles s o f thei r ideo logical predilections , cam e t o assum e immens e powers . Mos t o f these power s wer e ultimatel y veste d i n th e hand s o f th e hea d o f state. A s Presiden t Feli x Houphouet-Boign y o f Ivor y Coas t pu t i t succintly: ''Here in Ivory Coast, there is no Number 1 , 2, or 3.1 am Number 1 and I don' t shar e m y decisions " (West Africa, Aug . 8 , 1988, 1428). The drif t towar d stat e interventionis m an d developmen t plan ning, however , wa s accentuate d b y th e socialis t ideology . Afte r independence, man y Africa n elite s an d intellectual s argue d fo r a n ideology t o guid e th e governmen t o n th e roa d t o development . The choic e almos t everywher e wa s socialism . Th e dallianc e an d fascination wit h socialis m emerge d durin g th e struggl e fo r politi cal independenc e an d freedo m fro m colonia l rul e i n th e 1950s . Many African nationalist s harbore d a deep distrust o f and distast e for capitalism . I n fact , capitalis m an d colonialis m wer e adjudge d to be identical an d sinc e the latter was evil and exploitative so too was th e former— a monumenta l syllogisti c error . Socialism , th e antithesis o f capitalism , wa s advocate d a s th e onl y roa d t o Af rica's prosperity . A wave of socialism swep t acros s the continent a s almost al l th e new African leader s succumbed t o the contagious ideology, copied

152 Georg e B.N. Ayitte y from th e East . Th e proliferatio n o f socialis t ideologie s tha t emerged i n Africa , range d fro m th e "Ujamaa " (familyhoo d o r so cialism i n Swahili) of Julius Nyerere of Tanzania; th e vague amal gam o f Marxism, Christian socialism , humanitarianism, an d "Ne gri tude" o f Leopol d Sengho r o f Senegal ; th e humanis m o f Kenneth Kaund a o f Zambia ; th e scientifi c socialis m o f Marie n N'Gouabi o f Cong o (Brazzaville) ; th e Arab-Islami c socialis m o f Ghaddafi o f Libya ; th e "Nkrumaism " (consciencism ) o f Kwam e Nkrumah o f Ghana ; an d th e "Mobutuism " o f Mobut u Ses e Sek o of Zaire. Only a few African countrie s such as Ivory Coast, Nigeria , and Keny a wer e pragmati c enoug h t o esche w doctrinair e so cialism. Although ther e was a general dispositio n amon g African leader s to erase the "exploitative, capitalistic tendencie s of colonial struc tures/' ther e wer e shar p individua l difference s betwee n the m o n the nee d fo r th e ideology . Kwam e Nkruma h o f Ghana , generall y regarded a s th e "fathe r o f African socialism/ ' wa s convince d tha t "only the socialist form o f society can assure Ghana of a rapid rat e of economi c progres s withou t destroyin g tha t socia l justice , tha t freedom an d equality , whic h ar e a centra l featur e o f ou r tradi tional wa y o f life " (Seven-Year Development Plan. Accra : Govern ment o f Ghana, 1963 , 1). Nyerere o f Tanzania , o n th e othe r hand , misrea d th e commu nalism o f African traditiona l lif e as readiness for socialism , whic h he was first expose d t o during hi s schooling i n Scotland . He castigated capitalis m o r th e mone y economy , whic h i n hi s view , "en courages individua l acquisitivenes s an d economi c competition/ ' as i f ther e i s anythin g wron g wit h economi c competition . Th e money econom y was , in his purview, foreign t o Africa an d i t "ca n be catastrophi c a s regard s th e Africa n famil y socia l unit. " A s a n alternative t o "the relentles s pursui t o f individual advancement" , Nyerere insiste d tha t Tanzani a b e transforme d int o a natio n o f small-scale communalists ("Ujamaa" ) (Nyerer e 1962) . Accordingly, i n 197 3 Tanzania undertoo k massiv e resettlemen t programs unde r "Operatio n Dodoma, " "Operatio n Sogeza, " "Op eration Kigoma, " an d man y others . Peasant s wer e loade d int o trucks, often forcibly , an d moved to new locations. Many lost thei r

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3

lives i n th e proces s an d t o preven t a retur n t o thei r ol d habitats , abandoned building s wer e destroye d b y bulldozers . By 1976 , som e thirteen millio n peasant s h a d bee n force d int o eigh t thousan d cooperative village s an d b y th e en d o f th e 1970s , about 9 1 percen t of th e entir e rura l populatio n h a d bee n move d int o governmen t villages (Zinsmeiste r 1987) . Al l crop s wer e t o b e bough t an d dis tributed b y th e government . I t wa s illega l fo r th e peasant s t o sel l their ow n produce . In th e res t o f Africa , planne d socialis t transformatio n o f Afric a meant th e institutio n o f a plethor a o f legislativ e instrument s an d controls. Al l unoccupie d lan d wa s appropriate d b y th e govern ment. Roadblock s an d passboo k system s wer e employe d t o con trol th e movemen t o f Africans. Marketin g Board s an d expor t regu lations wer e tightene d t o fleece th e cash-cro p producers . Pric e controls wer e impose d o n peasan t farmer s an d trader s t o rende r food chea p fo r th e u r b a n elites . Unde r Seko u Tour e o f Guinea' s program o f "Marxis m i n Africa n Clothes, " Unauthorized tradin g becam e a crime . Polic e roadblock s wer e se t u p around th e country t o control interna l trade . The state set up a monopol y on foreig n trad e an d smugglin g becam e punishabl e b y death . Currenc y trafficking wa s punishabl e b y 1 5 to 20 years i n prison. Many farm s wer e collectivized. Food price s wer e fixed a t lo w levels . Privat e farmer s wer e force d t o deliver annua l harves t quota s t o "Loca l Revolutionar y Powers. " Stat e Companies monopolized industria l production . (New York Times, Dec . 28, 1987, 28) Under Nkrumah , socialis m a s a domesti c polic y i n hi s Seven Year Developmen t Pla n wa s t o b e pursue d towar d " a complet e ownership o f th e econom y b y th e state.' ' A bewilderin g arra y o f legislative control s an d regulation s wa s impose d o n imports , capi tal transfers , industry , m i n i m u m wages , th e right s an d power s o f trade unions , prices, rents, and interes t rates . Som e o f the control s were introduce d b y th e colonialists , bu t the y wer e retaine d an d expanded b y N k r u m a h . Privat e businesse s wer e take n ove r b y th e Nkrumah governmen t an d nationalized . Numerou s stat e enter prises wer e acquired . Even i n avowedl y capitalis t countrie s lik e Ivor y Coas t an d

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Kenya, th e resul t becam e th e same : governmen t ownershi p o f most enterprises , an d a distrus t o f private-secto r initiativ e an d foreign investment . The Result s o f Developmen t Plannin g Almost everywhere , statis m an d developmen t plannin g faile d mis erably t o enginee r development . I n thei r wake , economi c atrophy , repression, an d dictatorshi p followe d wit h morbi d staccato . A s Mabogunje (1988 , 25 ) asserted , "I t i s generall y agree d tha t th e false star t i n al l Atrica n countrie s ha s bee n du e largel y t o th e high leve l o f governmenta l an d bureaucrati c dominatio n o f th e economy wit h it s consequence s o f inefficiency , profligac y an d in appropriate control. " Ghana's Seven-Yea r Developmen t Pla n achieve d littl e i f an y b y way o f development . Th e indictmen t o f Killic k (1978 , 143 ) wa s more scathing : The 7-Yea r Plan , then , was a piece of paper, with a n operationa l impac t close t o zero. Why? It coul d b e argued tha t thi s wa s du e t o defects i n th e plan itself , t o shortage s o f staf f t o monito r an d implemen t it , an d t o th e intervention o f factor s beyon d Ghana' s control , especiall y th e fallin g world coco a price s o f th e earl y an d mid-sixties . [But ] i n retrospect , w e see a n almos t tota l ga p betwee n th e theoretica l advantage s o f plannin g and th e recor d o f th e 7-Yea r Plan . Fa r fro m providin g a superio r se t o f signals, it was seriously flawed a s a technical documen t and , in any case, subsequent action s o f governmen t bor e littl e relatio n t o it . Fa r fro m counteracting th e allege d myopi a o f private decision-takers , governmen t decisions tende d t o be be dominate d b y short-term expedienc y an d wer e rarely based upo n careful appraisal s of their economic consequences. The plan was subverted, as most plans are, by insufficient politica l determina tion to make it work . Similarly i n Tanzania , Nyerere' s socia l transformatio n wa s als o a crushin g fiasco. Accordin g t o Japhet h M . M . Ndaro , directo r o f the Institut e o f Developmen t Plannin g a t Dodoma , durin g th e period 1961-70 , th e inhabitant s o f Dodom a devise d an d adopte d strategies tha t di d no t confor m wit h th e politica l sloga n o f natio n building whic h wa s dominan t i n th e earl y 1960s . In som e part s o f the district , th e concep t o f Ujamaa actuall y stifle d loca l initiative . "All i n all , th e Arush a Declaratio n o f 196 7 an d th e Ujamaa Polic y

The Failur e o f Developmen t Plannin g i n Afric a 15

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of 1968 , whic h marke d a n importan t mileston e i n th e develop ment o f th e countr y a s a whole , di d no t inspir e th e peopl e o f Dodoma t o engag e i n developmen t initiative s tha t wer e alie n t o their sociocultura l environment " (cite d i n Taylo r an d Mackenzi e 1992, 178) . Elsewhere i n Africa , th e experienc e wit h developmen t plannin g proved t o b e a n unmitigate d disaster . Fro m 196 5 t o 1986 , Africa' s annual rat e o f growt h o f gros s nationa l produc t (GNP ) average d a deplorable 0. 9 percent . Wit h a populatio n growt h rat e o f 3 per cent, tha t mean t declinin g level s o f economi c welfar e fo r th e aver age African . Rea l incom e pe r capit a droppe d b y 14. 6 percen t fo r all o f blac k Afric a fro m it s leve l i n 1965 . Unadjusted fo r inflation , GNP pe r capit a gre w b y a mer e 1. 4 percen t i n th e 1960 s an d 0. 5 percent i n th e 1970s . Th e 1980 s bega n wit h decline s i n incom e per capita . Agricultural growt h wa s negligible , wit h outpu t growin g a t les s than 1. 5 percen t sinc e 1970 . Foo d productio n di d no t kee p pac e with th e populatio n explosion . Foo d productio n per person fel l b y 7 percen t i n th e 1960s , 1 5 percen t i n th e 1970s , an d continue d t o deteriorate i n th e 1980s . Cerea l production , fo r example , fel l b y 9.2 pe r cen t i n 198 7 accordin g t o th e Foo d an d Agricultura l Orga nization (FAO) , necessitating foo d ai d t o stav e of f starvation . Industrial outpu t acros s Afric a ha s als o bee n declining , wit h some region s experiencin g deindustrialization. Th e stat e enter prises establishe d unde r Africa' s variou s developmen t plan s wer e hopelessly inefficient : There are countless examples of badly chosen and poorly designe d publi c investments, includin g som e i n whic h th e Worl d Ban k ha s participated . A 1987 evaluation reveale d tha t hal f o f the complete d rura l developmen t projects financed b y the World Ban k i n Africa ha d failed . A cement plan t serving Cote dlvoire, Ghana an d Tog o was closed i n 198 4 after onl y fou r years o f operation . A state-ru n sho e factor y i n Tanzani a ha s bee n op erating a t n o more tha n 2 5 percent capacit y an d ha s remained ope n onl y thanks to a large government subsidy . (World Bank 1989 , 27). More dramati c ha s bee n th e declin e i n foreig n investmen t i n Africa. Ne t foreig n direc t investmen t i n Afric a i n 198 5 wa s $248 2 million bu t droppe d t o $1,50 5 i n 198 7 (Worl d Bank/UND P 1989,43).

1980-1989 2.3 1.6 -1.2 6.2 3.0 0.4 -0.4

1973-80 2.3 2.5 0.4 4.9 1.7 1.9 2.5

1965-73 3.7 3.9 2.1 5.3 1.2 5.8 3.8

773 4053 480 1552 1131 433 421

Source: World Bank, World Development Report (1991, 3).

Industrial Countrie s Developing Countrie s Sub-Saharan Afric a East Asia South Asia Europe, Mid. East, North Afric a Latin America and Caribbean

Group

Population, 1989, millions

Growth of real GDP per capita, 1965-2000 (Average annual percentage change)

Table 1 . Comparative Performanc e

1.3-2.0

1.4-1.8

1.8-2.5 2.2-2.9 0.3-0.5 4.2-5.3 2.1-2.6

Projection 1990s

156 George B. N. Ayittey

The Failur e o f Development Plannin g i n Africa 15

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To maintai n incom e an d investment , Africa n government s bor rowed heavil y i n th e 1970s . Tota l Africa n foreig n deb t ha s rise n nineteen-fold sinc e 197 0 to a staggerin g $27 0 billion i n 199 0 whic h was equa l t o it s gros s nationa l produc t (GNP) , makin g th e regio n the mos t heavil y indebte d o f al l (Lati n America' s deb t amounte d to aroun d 6 0 percen t o f GNP) . Deb t servic e obligation s absorbe d 47 percen t o f expor t revenu e i n 1988 , but onl y hal f wer e actuall y paid. Th e arrear s wer e constantl y bein g rescheduled . With scarc e foreig n exchang e increasingl y bein g devote d t o ser vice deb t obligations , les s becam e availabl e fo r import s o f spar e parts, drugs , textbooks , an d othe r essentia l supplies . Infrastruc ture bega n t o crumbl e fo r lac k o f maintenance . Road s starte d t o deteriorate an d telephone s refuse d t o work . Eve n th e Worl d Bank , the fon t o f perpetual optimism , gre w uncharacteristicall y brusqu e and alarmed : The declin e i n Africa's pe r capit a outpu t durin g th e 1980s , together wit h the declin e i n th e 1970s , wil l wip e ou t al l it s ris e i n pe r capit a outpu t since 1960 . As a result , low-incom e Afric a i s poore r toda y tha n i n 1960 . Improvements over those years in health, education, and in infrastructur e are increasingl y a t risk . Fo r th e firs t tim e sinc e Worl d Wa r II , a whol e region has suffered retrogressio n ove r a generation. (World Bank 1989 , 9). The 1980 s offere d n o economi c reviva l fo r Africa . I n fact , it s economic performanc e s o deteriorate d tha t th e eightie s wer e writ ten of f a s " a los t decade. " "Africa' s deepenin g crisi s i s character ized b y wea k agricultura l growth , a declin e i n industria l output , poor expor t performance , climbin g debt , an d deterioratin g socia l indicators, institutions , an d environment " (Worl d Ban k 1989 , 2). The overal l pictur e wa s eve n mor e distressin g whe n compare d to th e performanc e o f othe r region s o f th e Thir d World . Socia l and economi c indicator s o f development , suc h a s outpu t growth , health, an d literacy , hav e show n eve n weake r performanc e i n black Africa . Consider , fo r example , th e rate s o f growt h o f gros s domestic produc t (GDP ) per capita , a s show n i n tabl e 1 . In sub-Sahara n o r blac k Africa , th e crisi s ha s bee n particularl y trenchant. I n 199 0 black Africa , wit h a populatio n o f four hundre d and fifty million , ha d a gros s domesti c produc t (GDP ) o f $13 5 billion, whic h wa s abou t th e sam e a s tha t o f Belgium , wit h a population o f onl y te n million . Worse , blac k Africa' s incom e pe r

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Table 2. GNP per capita : Averag e Annua l Rate s o f Growt h 1965-73 Black Afric a Excluding Nigeri a Exceptions: Botswana Mauritius Cameroon Senegal

1973-80

1980-1987

2.9 1.2

0.1 -0.7

-2.8 -1.2

9.3 0.8 -0.4 -0.8

7.3 3.9 5.7 0.5

8.0 4.4 4.5 0.1

Source: World Bank (1989).

capita fel l consistently , fro m $62 1 i n 198 1 t o $35 2 i n 1987 . Th e decline ha s bee n calamitou s i n Nigeria , whic h coul d no t translat e its oi l bonanz a int o sustainabl e economi c prosperity . In 1991 , twenty-four o f th e world' s thirty-fou r poores t nation s were i n blac k Afric a (World Development Report 1991 , 204). In th e 1960-80 period , fourtee n blac k Africa n countrie s ha d growt h rate s of les s tha n 1 percen t pe r a n n u m . I n th e 1965-8 4 period , thi s n u m b e r ha d grow n t o eighteen . Th e exception s t o th e genera l economic atroph y i n blac k Afric a hav e bee n few : Botswana , Mau ritania, Cameroon , an d Senegal , a s tabl e 2 shows . In th e earl y 1980s , Ivor y Coas t an d Keny a use d t o b e member s of thi s selec t clu b bu t no w suffe r fro m seriou s economi c crises . The wors t performer s hav e bee n Ethiopia , Ghana , Liberia , Mo zambique, Niger , Nigeria , Sa o Tom e an d Principe , Sudan , Uganda, Zaire , an d Zambia—al l o f whic h ar e rule d b y civilian / military dictatorships . Africans themselve s hav e realize d ho w thei r stat e ha s faile d them. Nigeria n schola r Claud e Ak e noted : Most Africa n regime s hav e bee n s o alienated an d s o violently repressiv e that thei r citizen s se e the state and it s developmen t agent s a s enemies t o be evaded , cheate d an d defeate d i f possible , bu t neve r a s partners . Th e leaders have bee n s o engrossed i n copin g with th e hostilities whic h thei r misrule an d repressio n ha s unleashe d tha t the y ar e unabl e t o take muc h interest i n anythin g els e includin g th e pursui t o f development . Thes e conditions wer e no t conduciv e t o developmen t an d non e ha s occurred . What has occurred i s regression, as we know only too well. (Africa Forum 1, no. 2, 1991,14).

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Indeed, t o solv e Zaire' s economi c crisis , Amin a Ramadou , a peasant housewife , suggested : "W e sen d thre e sack s o f angr y bee s to th e governo r an d th e president . An d som e ant s whic h bite . Maybe the y ea t th e governmen t an d solv e ou r p r o b l e m s " (Wall Street Journal Sep t 26 , 1991 , A14).

Why Statis m an d Plannin g Faile d i n Afric a Development planning , generally , ma y fai l t o achiev e it s objec tives o n accoun t o f a variet y o f problems : technical , financial, political, an d administrative . A developmen t pla n i s a technica l document an d a s suc h ca n b e flawed : th e documen t ma y no t b e internally consistent ; targe t growt h rate s ma y b e overambitious ; and th e underlyin g assumption s ma y b e unrealistic . Financin g o f the pla n ma y encounte r sever e constraints . Availabilit y o f foreig n exchange ma y b e reduce d b y a reductio n i n expor t earning s (du e to a fal l i n th e pric e o f a n expor t cas h cro p o r th e physica l volum e of exports ) and/o r b y a ris e i n th e impor t bil l (occasione d b y sa y an oi l pric e shock) . Most Africa n developmen t plan s wer e predicate d o n substantia l inflow o f foreign capita l o r aid . The actua l inflo w o f private foreig n capital int o Afric a ha s bee n les s tha n expected . Privat e foreig n investors increasingl y foun d Afric a unattractive . Lo w retur n o n investment wa s th e mai n reason . "Africa' s investmen t an d op erating cost s ar e typicall y 5 0 t o 10 0 percen t abov e thos e i n Sout h Asia—the mos t comparabl e region " (Worl d Ban k 1989 , 3). Unreliable an d decayin g infrastructur e a s wel l a s price distortion s (espe cially overvalue d exchang e rates , pric e controls , an d subsidize d credit) wer e another . Mor e fundamenta l perhap s wa s th e deterio rating qualit y o f government, epitomize d b y bureaucrati c obstruc tion, corruption, pervasiv e rent-seeking , wea k judicial system , an d arbitrary decisio n making . No t surprisingly , ne t privat e invest ment decline d sharpl y b y abou t 5 0 percent betwee n 197 0 and 198 2 (World Ban k 1984 , 13) . This declin e i n foreig n investmen t i n Africa , however , wa s mor e than m a d e u p fo r b y increase s i n officia l developmen t assistance :

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Even i n 196 5 almos t 2 0 percen t o f th e Wester n countries ' developmen t assistance went to Africa. In the 1980s , Africans, who are about 1 2 percent of th e developin g world' s population , wer e receivin g abou t 2 2 percent o f the total , and th e shar e pe r perso n wa s highe r tha n anywher e els e i n th e Third World—amountin g t o abou t $20 , versu s abou t $ 7 fo r Lati n America, and $ 5 for Asia. (Whitaker 1988 , 61) This wa s corroborate d b y th e Worl d Bank : In 1982 , Officia l Developmen t Assistanc e (ODA ) pe r capit a wa s $1 9 fo r all sub-Sahar a Africa n countrie s an d $4 6 pe r capit a fo r th e low-incom e semiarid countries—compared , fo r instance , wit h $4.8 0 pe r capit a fo r South Asia. Aid finances 1 0 percent of gross domestic investment i n Afric a as a whole , bu t u p t o 8 0 percent fo r th e low-incom e semiari d countrie s and ove r 1 5 percent fo r othe r low-incom e countries . Fo r som e [African ] countries, ODA finances not onl y all investment, but als o some consump tion. (World Bank 1984 , 13) This substantia l provisio n o f OD A howeve r di d no t mak e muc h difference t o successfu l developmen t planning , suggestin g th e op eration o f othe r factors . Absenc e o f political will , th e reluctanc e o f ministers t o submi t t o th e disciplin e o f planning , an d politica l interference b y th e hea d o f stat e impede d th e achievemen t o f planning objectives . I n addition , ther e wer e seriou s implementa tion problem s i n Africa . Africa n government s lacke d th e adminis trative capabilit y o r expertis e t o implemen t developmen t plan s successfully. I n mos t cases , implementatio n wa s execute d b y a small cadr e o f incompeten t an d corrup t bureaucrats , over whelmed b y th e dictate s o f comprehensiv e plannin g fo r th e entir e economy. Perhaps i t woul d b e usefu l t o discus s th e failur e o f on e Africa n development pla n i n som e detail . Killic k (1978) , i n a detaile d study o f Ghana' s Seven-Yea r Developmen t pla n offere d th e follow ing reason s fo r lac k o f success : • "Ghana' s i s not a ver y 'plannable ' economy , no t leas t becaus e it s export secto r i s peculiarl y sensitiv e t o th e behavio r o f on e o f th e world's mos t volatil e commodit y m a r k e t s " (136) . • " A grav e shortag e o f qualified Ghanaia n economist s wa s equall y serious; whe n th e 7Y P wa s bein g formulate d th e Offic e o f Plan ning Commissio n include d onl y 4 qualifie d Ghanaians , rein forced b y 1 6 foreign adviser s o f varyin g expertis e an d c o m m a n d

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of th e Englis h language , bu t havin g i n commo n limite d knowl edge o f th e nationa l economy " (136) . • "On e [weakness ] wa s th e attemp t a pla n coverin g a s lon g a s seven years , whic h wa s to o lon g i n vie w o f th e uncertaintie s o f the [future] . I t seem s tha t thi s wa s Nkrumah' s [th e hea d o f state's] decision , resultin g fro m a visi t t o Russi a whic h launche d its ow n first seven-yea r pla n i n 1959 " (136). • "Th e 7Y P wa s overl y preoccupie d wit h macro-economi c vari ables an d pai d insufficien t attentio n t o secto r program s an d projects. On e manifestatio n o f this was th e use m a d e o f an aggre gate gros s incrementa l capital : outpu t rati o t o deriv e overal l investment requirement s fo r th e pla n period . A ratio o f 3.5:1 wa s used, whic h togethe r wit h a targe t annua l growt h rat e o f 5. 5 percent, implie d gros s investment s o f slightl y ove r 2 billio n cedis" (137) . • "Doubt s wer e als o expresse d abou t th e realis m o f som e aspect s of th e plan . Fo r example , it s treatmen t o f privat e investmen t was unsatisfactory , bein g derive d simpl y a s th e differenc e be tween aggregat e an d governmen t investment . Asid e fro m th e aluminium smelter , foreig n privat e capita l inflow s wer e pro jected t o ris e substantially , despit e th e emergenc e b y 196 3 o f a distinctly frost y investmen t climate " (138) . • "Th e manpowe r an d educationa l aspect s o f th e pla n wer e simi larly ope n t o complaint s o f unrealism . Th e pla n wa s unrealisti c in it s projecte d outpu t o f traine d teachers , wit h actua l gradua tions fro m teachers ' trainin g college s numberin g les s tha n hal f the planne d n u m b e r " (138) . • "Despit e th e plan' s recognitio n o f th e critica l importanc e o f agriculture, th e chapte r dealin g wit h i t wa s amon g th e leas t satisfactory. Th e target s wer e ambitiou s . . . being handicappe d by a n absenc e o f statistic s o n privat e foo d production . Th e pla n m a d e n o specifi c provisio n fo r coco a a t all . Thi s industry , th e most importan t o f Ghana's exports , claimed jus t tw o paragraph s of th e whol e chapter " (138) . • "Althoug h th e 7Y P provide d detaile d fiscal projections , i t wa s conspicuously silen t o n th e coordinatio n o f it , an d it s annua l plans, wit h th e annua l budgets , an d i n practic e Minister s o f Finance pai d littl e hee d t o it. The budge t speec h o f 1963/6 4 m a d e

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only on e passin g referenc e t o th e 7Y P and , i n direc t oppositio n to its strategy , propose d a n increas e i n governmen t consumptio n relative t o capita l expenditure " (139) . • "Th e reluctanc e o f individua l Minister s t o submi t t o th e disci plines o f a pla n wa s eve n mor e seriou s fo r implementation . A struggle fo r contro l ove r th e capita l budge t quickl y develope d between th e Plannin g Commisio n an d th e Ministr y o f Fi nance. . . . Th e absenc e o f Minister s fro m membershi p o f th e Planning Commissio n probabl y contribute d t o th e estrangemen t between th e planner s an d politician s bu t Nkrumah , wh o wa s chairman, wa s n o bette r a t keepin g withi n th e limitation s o f th e p l a n " (143) . Even i f thes e technical , financial, an d politica l problem s ha d been resolved , i t wa s highl y unlikel y Africa' s experienc e wit h de velopment plannin g woul d hav e bee n successful . Th e whol e ap proach embodie d b y developmen t plannin g wa s flawed an d objec tionable o n bot h practica l an d philosophica l grounds . A contrit e World Ban k expresse d thi s rathe r neatly : The postindependenc e developmen t effort s i n Afric a faile d becaus e th e strategy wa s misconceived . Government s mad e a das h fo r "moderniza tion," copying, but no t adapting , Western models . The result wa s poorl y designed publi c investmen t i n industry ; to o littl e attentio n t o peasan t agriculture; to o muc h interventio n i n area s i n whic h th e stat e lacke d managerial, technical , an d entrepreneuria l skills ; an d to o littl e effor t to foste r grass-root s development . Th e top-dow n approac h demotivate d ordinary people , whos e energie s mos t neede d t o b e mobilize d i n th e development effort . (Worl d Bank 1989 , 3). Exploitation o f th e Peasantr y Under statis m an d developmen t planning , Africa n government s envisioned hug e surpluse s i n th e rura l secto r t o b e tappe d fo r development. Larg e resource s coul d b e transferre d t o th e stat e b y extracting wealt h fro m peasan t producers . Th e milkin g device s used include d th e following : pol l taxes , lo w produce r prices , ex port marketin g boards , hidde n expor t taxes , pric e controls , devel opment levies , an d forcin g peasan t farmer s t o sel l annua l quota s to governmen t organs . Th e assumptio n wa s that , whe n suc h re -

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sources wer e cede d t o th e state , the y woul d b e use d b y develop ment planner s fo r th e benefi t o f all . The price s peasant s receive d fo r thei r produc e wer e dictate d b y many Africa n governments , no t a s determine d b y marke t force s i n accordance wit h Africa n traditions . Unde r a syste m o f pric e con trols, Africa' s peasant s cam e t o pa y th e world' s mos t confiscator y taxes. 1 The y face d stif f penaltie s an d outrigh t confiscatio n o f thei r produce i f they sol d abov e th e government-controlle d prices . Markets wer e burne d dow n an d destroye d a t Accra , Kumasi , Koforidu a and othe r citie s whe n trader s refuse d t o sel l a t government-dictate d prices. I n Februar y 1982 , th e Tamal e Centra l Marke t wa s se t ablaze , causing th e destructio n o f larg e quantitie s o f foodstuffs , drug s an d im ported spar e parts . The n Joh n Ndeburge , th e Norther n Regiona l Secre tary, set up a 5-member Committe e of Inquiry t o investigate th e circum stances leadin g t o th e incineratio n o f th e market . (West Africa, Marc h 8 , 1982,684) Unbelievable brutalitie s wer e heape d upo n peasan t farmer s and trader s unde r Ghana' s inan e pric e control s (1982-83) . Fur thermore, Ghanaia n coco a farmer s i n 198 3 were pai d les s tha n 1 0 percent o f th e worl d marke t pric e fo r thei r produce . In Gambia , peanu t producer s receive d abou t 2 0 percen t fo r their produc e i n th e sam e year . Accordin g t o West Africa (Feb . 15 , 1989,250): On th e average , betwee n 1964/6 5 an d 1984/85 , the peasant s o f Gambi a were robbed o f 60 percent o f the internationa l pric e of their groundnuts ! For 2 0 years , th e Jawar a Governmen t 'officially ' took , fre e o f charge , 3 out of every 5 bags, leaving the peasant with a gross of 2. With deduction s for subsistence credit fertiliser, seeds , etc., the peasant would end up wit h a ne t on e ba g ou t o f five. . . . With thes e facts , i t i s simpl y wron g t o sa y that th e povert y o f th e peasan t derive s fro m th e defect s o f nature — drought, over-population, laziness , and s o on. In 1981 , the governmen t o f Tanzani a pai d peasan t maiz e farm ers onl y 2 0 percen t o f th e free-marke t pric e fo r thei r produce . "Studies b y th e Internationa l Labo r Organizatio n hav e indicate d that taxatio n level s i n th e agricultura l secto r i n Sierr a Leon e averaged betwee n 3 0 and 6 0 percent o f gross income " (West Africa, Feb. 15 , 1982,446) . In Zambia , whe n trader s refuse d t o sel l thei r produc e a t gov -

164 Georg e B.N. Ayitte y ernment-dictated prices , authorities raide d market s i n Ma y 1988 . They arreste d hundred s o f people , too k thei r money , an d tor e down marke t stalls , seizin g sugar , detergents , salt , maiz e meal , soft drinks , candles , flour, an d clothing . Bac k i n 198 4 i n Ghana , Mr. Kwame Forson , the Agona Swedr u Distric t Secretary , "calle d on some unidentified soldier s who make brief stopover s at Swedr u to check prices , and instea d threate n an d ro b innocen t traders , t o desist from suc h acts" (West Africa, July 23, 1984, 1511). In this way, the peasantry wa s systematically robbe d o f considerable resources . Fo r example , i n a Januar y 198 9 Ne w Year' s address, Presiden t Houphouet-Boign y o f Ivor y Coas t admitte d that peasan t cash-cro p producer s "hav e ove r th e year s parte d with four-fifth s o f th e valu e o f wha t the y produce d t o enabl e th e government t o finance development " (West Africa, Ma y 1-7 , 1989 , 677). But developmen t fo r whom ? The resources extracte d fro m th e peasants wer e seldom use d t o improve their lot, but instead used by the elite minority t o develop the urba n area s fo r themselves . Fo r example , ove r 8 0 percen t o f the "development" of the Ivory Coast was concentrated i n Abidja n for th e benefit o f the urban elites , not the rural peasants . The standar d o f livin g enjoye d b y th e elite s fa r outstrippe d those of the peasants. Contrast th e plush and subsidized amenitie s of the ruling class in the urban area s with th e dingy and wretche d lives o f th e rura l peasants . In Mauritania , fo r example , while th e elites, th e Arabs , had acces s t o subsidize d tap-wate r supplies , th e peasants, ofte n black , pai d seve n t o fort y time s mor e fo r thei r water from seller s with donkey carts. In 1982 , while the leadershi p in Zair e wa s makin g betwee n $5,00 0 and $9,00 0 a month , a peas ant wa s luck y to make $5 0 a month (Africa Now, Marc h 1982 , 17). In 1985 , Cameroon, with a per capita incom e of less than $1,00 0 a year, wa s th e world' s ninth-larges t importe r o f champagne . Th e elites wer e livin g high : "Th e governo r o f the Dakar-base d Africa n central ban k ca n reac h his 13t h floor office withou t havin g t o ste p out o f hi s car . On e o f th e man y perk s tha t g o wit h th e region' s highest-paying jo b i s a privat e lif t (elevator ) t o hoist hi m an d hi s Mercedes to work" (South, Ma y 1988 , 34). "Only socialis m wil l sav e Africa!!" Africa n leader s an d nation alists chanted. But the socialism practiced i n Africa wa s a peculia r

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type—"Swiss ban k socialism"—whic h allowe d th e hea d o f stat e and a phalan x o f kleptocrat s (arme d governmen t looters ) t o rap e and plunde r Africa n treasurie s fo r deposi t i n Switzerland . A s Afri can economie s deteriorated , Africa' s tyrant s an d elit e cohort s furi ously develope d pot-bellie s an d chin s a t a rat e commensurat e with th e economi c decline . Whil e Africa' s peasant s wer e bein g exhorted t o tighte n thei r belts , vampir e elite s wer e loosenin g theirs wit h fa t ban k balance s overseas . Eve n th e Pari s newspaper , Le Monde, complaine d bitterl y i n Marc h 1990 : "Ever y fran c w e give impoverishe d Africa , come s bac k t o Franc e o r i s smuggle d into Switzerlan d an d eve n J a p a n " (cite d i n Washington Post, March 26 , 1990 , A17). The manage r o f th e faile d Banque Commerciale de Benin pu t i t rather tersely : The basic proble m here , beside a lac k of competence, is total corruption . The to p peopl e lin e thei r pocket s throug h politica l influence . Th e presi dent's (Mathie u Kerekou's ) adviser , Cisse , calle d le Marabout —"the priest"—stole 5 billio n CF A (abou t $1 4 million ) fro m thi s bank . We'v e traced i t to Switzerland, Londo n and Monte Carlo. . . . The chie f bandi t i s th e president , alon g wit h hi s associate s i n th e politburo. The chief prosecuto r i s the nex t bigges t bandit . Another i s th e minister of justice: all court decisions are determined b y bribes. I went t o the presidentia l palac e alon g wit h a representativ e o f th e Worl d Bank . We wer e aske d whe n th e stole n mone y woul d b e recovered . I t wa s a rather difficul t t o answer, 'Mr. President, you hav e the money" . . . The to p me n wil l hav e 1 0 o r 1 5 mistresse s wh o use d t o ru n u p bi g debit account s here , an d the n g o t o th e Palais an d say , "You'v e go t t o straighten m e out with th e bank. " The ruler s no w admi t tha t the y neve r understoo d Marxism , an d a s a sop t o opinio n a fe w peopl e hav e bee n jailed . Bu t ne w marabouts hav e been brought in , and are still at the center of the decision-making. {American Spectator, May 1990 , 31) In Angola , th e socialis t syste m operate d a s a kin d o f revers e Robin Hood , funnelin g th e riches t benefit s t o th e leas t needy : Angolans wh o ow n car s ca n fill thei r tank s fo r les s tha n a dollar , an d international telephon e calls cost only pennies. One local boasts of getting a round-tri p ticke t t o Paris o n Ai r France fo r th e equivalen t o f tw o case s of beer . Luand a doe s no t eve n pic k u p it s ow n garbage ; th e jo b i s con tracted ou t t o a foreig n compan y usin g Filipin o worker s lure d t o Angol a with fat paychecks , special housing and Firs t World garbage trucks .

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Of course , th e chie f beneficiarie s o f al l thi s ar e th e city' s westernize d elite an d thei r foreig n busines s bedfellows . Man y o f life' s necessities , o n the othe r hand , ar e no t availabl e a t subsidize d prices . Fo r th e poores t residents, surviva l i s impossibl e withou t resor t t o candonga, o r illega l trading. (Insight, Oct . 1 , 1990, 13) But peasants , despit e thei r lac k o f forma l education , prove d that the y wer e n o fool s o r pushovers . The y rebelle d agains t nake d state exploitatio n b y withholdin g thei r produce , switchin g t o other crops , producin g enoug h t o fee d onl y themselves , o r simpl y by smugglin g thei r produc e t o place s wher e i t fetche d highe r prices. On e Ghanaia n peasant , Amoaf o Yaw , sai d exactl y that : In thi s country , muc h nois e i s bein g mad e abou t th e exploitatio n o f th e people. . . . But a s fa r a s I a m concerned , i t i s th e STATE , a s th e Chie f Vanguard, an d he r so-calle d Publi c Servants , Civil Servant s whic h actu ally exploit others in the country. . . . The mone y use d i n buyin g th e car s fo r Governmen t officials , th e ce ment fo r building estates, and other Government bungalow s which work ers obtai n loan s t o buy , th e ric e worker s ea t i n thei r staf f canteens , th e soap, toothpaste , textile s clot h whic h worker s bu y unde r th e presen t distribution syste m al l com e fro m th e farmers ' coco a [cas h crop ] an d coffee money . . . . This STATE-MONOPOL Y CAPITALIS M ha s bee n goin g o n sinc e th e days of the colonial masters and even our own Government after indepen dence have continued th e system. . . . The farmers realisin g thi s naked exploitatio n decide d tha t the y woul d no longe r increas e coco a an d coffe e production , the y woul d no t increas e food productio n an d an y othe r item s whic h th e Stat e depend s o n fo r foreign exchange . In effect, ther e will be no surplus for the state to exploit. (Daily Graphic, Accra, Feb. 17, 1982, 3) The result s elsewher e i n Afric a wer e fallin g agricultura l an d export production . Fo r example , i n 1988 , diamon d dealer s an d miners i n Sierr a Leon e tol d Mr . A . R. Turray , th e governo r o f th e Central Bank , that , "Th e government' s gol d an d diamon d market ing boar d (GGDO ) wa s bein g sidesteppe d becaus e i t doe s no t offe r attractive enoug h prices . . . . Mr. Turra y admitte d tha t smugglin g could b e minimise d i f th e GGD O pai d bette r prices' ' (West Africa, January 2 3 - 2 9 , 1989 , 125) . GGD O di d no t an d consequentl y be tween Apri l an d Decembe r 1988 , its purchase s wer e nil . In Tanza nia, th e a m o u n t o f maiz e an d ric e sol d throug h officia l channel s i n 1984 was les s tha n one-thir d th e leve l i n 1979 .

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In 1983 , th e governmen t o f Ghan a complaine d tha t coco a smuggling wa s deprivin g th e natio n o f a t leas t on e hundre d mil lion dollar s i n foreig n exchang e annually . Diamon d smugglin g cost Angola and Sierr a Leon e at leas t tw o hundred millio n an d 6 0 million dollar s respectively , yearly . I n Sierr a Leone , i n jus t on e year, "th e diamon d outpu t o f 731,00 0 carats i n 197 5 was reduce d to 481,000 i n 197 6 (34 percent decline ) mainl y b y th e activitie s of smugglers" (West Africa, Jul y 18 , 1977 , 1501) . Uganda coffe e wa s regularly smuggle d t o Kenya. Guinea-Bissau diamond s an d coffe e ended u p i n Ivor y Coast . Nigeria' s consume r good s an d petro l were regularly smuggle d t o Cameroon . Denouncing smugglin g a s a n economi c felony , Africa n govern ments responde d b y closin g thei r border s an d issue d threats : "Convicted coco a smuggler s i n Ghana wil l be shot by firing squa d in future , th e Chairma n o f a Publi c Tribunal , Mr . Agyekum , ha s said i n Accra " (West Africa, Decembe r 6 , 1982 , 3179). In Februar y 1989, Nigeria' s justic e minister , Princ e Bol a Ajibola , declare d that, "Henceforth , anyon e caugh t smugglin g o r i n possessio n o f smuggled item s will be sentenced t o life in prison" (Insight, Fe b 6, 1989, 38). For almos t a decade , 1975-84 , Tanzania close d it s bor der wit h Keny a t o preven t smuggling , bu t t o n o avail . Economi c barbarism wa s running amok . In th e 1980 s Zimbabw e use d t o b e a ne t foo d exporter , bu t b y 1992 it wa s importin g food . I t i s true th e 1991-9 2 drough t devas tated agricultura l productio n i n souther n Africa . Bu t i n th e cas e of man y countrie s i n souther n Africa , th e drough t merel y exacer bated a n alread y precariou s foo d suppl y situation . I n Zimbabwe , the culpri t wa s lo w government-dictate d prices . As John Robert son, th e chie f economis t o f th e Firs t Merchan t Ban k i n Harare , observed, "Th e Governmen t [o f Rober t Mugabe ] coul d hav e avoided hal f th e tota l foo d impor t wit h bette r policies . . .. I n th e last severa l years , th e Governmen t decide d t o pa y a lo w pric e to farmer s wh o gre w corn , th e stapl e crop . Thi s mean t tha t th e farmers switche d t o othe r crops " (New York Times, Jul y 10 , 1992, All).

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Development b y Imitatio n The resource s siphone d of f fro m th e rura l secto r wer e t o b e use d for "nationa l development. " Bu t developmen t wa s misinterprete d by Africa n leader s an d elite s t o mea n "change " rathe r tha n a n " i m p r o v e m e n t " upo n existin g way s o f doin g things . Traditiona l ways o f doin g thing s wer e denigrate d a s "unmodern, " "backwar d and primitive. " T o develop , the y thought , African s mus t adop t new ways , values, an d systems . This mentalit y reache d a lo w leve l of depravit y whe n i n 1975 , th e governmen t o f Ghan a declare d twelve imported item s a s "essentia l commodities. " Thes e wer e tinned corne d beef , sardines , rice , sugar , tinne d milk , an d flour. The implicatio n wa s tha t th e nativ e foodstuffs , upo n whic h thei r forebears h a d subsiste d fo r centuries , wer e no t "essential. " There fore, African s hav e t o foreswea r thei r cultur e o r die t i n orde r t o develop—as i f th e Japanese , Koreans , an d Singaporean s di d so . The propensit y t o cop y foreig n paraphernali a becam e pervasiv e in Africa . Cub a h a d People' s Defens e Committees ; s o to o mus t Ghana. Franc e onc e ha d a n emperor . S o i n 1976 , Bokass a o f th e Central Africa n Republi c spen t 2 0 million dollar s t o crown himsel f " e m p e r o r " jus t t o prov e tha t Afric a to o ha s com e o f age . A t hi s trial i n Bangui , i n Decembe r 1986 , Bokassa berate d th e cour t fo r strippin g hi m o f hi s self-impose d titl e o f field marsha l an d demotin g hi s t o privat e first class . "You ca n sentenc e me t o death, " h e sai d indignantly , 'bu t yo u hav e n o powe r t o reduc e me t o th e ranks! ' A t anothe r poin t Bokass a raise d hi s arm s i n a salut e reminiscent o f hi s hero , th e lat e Frenc h Presiden t Charle s d e Gaulle . " I was alway s a faithful soldie r o f Genera l d e Gaulle, " he said , "an d I hav e always done my duty." (Time, December 29 , 1986, 27) France als o ha d a revolution . I n Jun e 1989 , whe n i t hel d it s bicentennial fo r it s 178 9 Revolution , severa l Africa n despot s showed u p i n Paris . Eve n th e West Africa magazine , whic h i s 6 0 percent owne d b y th e Nigeria n government , notice d somethin g odd. According t o a n editoria l i n it s Jun e 2 4 - 3 0 , 1990 , issue : Some o f th e Africa n guests , suc h a s Presiden t Mobut u o f Zaire , whos e human right s recor d i s grim , looke d ou t o f plac e a t suc h a ceremony , although Zair e i s on e o f th e Africa n countrie s which , ironically , ha s th e word "revolution " in the name of its ruling party. . . .

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Most of the African leader s present barel y related t o the anniversary i n any case , an d woul d hav e bee n o n th e wron g sid e i n 1789 . For th e chal lenges i t stil l embodie s ar e fa r fro m bein g me t i n Africa, an d th e spectr e of chaos and bloodshed tha t haunted it , still lurk in the background . The forme r Sovie t Unio n wa s a Marxist-Leninis t state . S o Rob ert Mugab e vowe d t o establis h a one-part y Marxist-Leninis t stat e in Zimbabwe ! Eve n a foo l coul d se e clearl y tha t Mar x an d Leni n were no t blac k Africans . Sai d Eno s Nkala , th e forme r defenc e minister: "Marxist-Leninis t policie s wer e useles s t o blac k people " (New African, Jul y 1992 , 21). Rome ha s a basilica ; s o too mus t Ivor y Coast . The Unite d State s has onl y tw o politica l parties . S o th e Babangid a militar y govern ment o f Nigeri a create d exactl y tw o politica l partie s fo r th e peo ple: th e Nationa l Republica n Conventio n an d th e Socia l Demo cratic Party . The sam e unimaginativ e apin g wa s als o take n t o th e field o f development. America n farmer s us e tractors ; s o to o mus t th e peasant farmer s o f Africa. Britis h farmer s us e chemica l fertilizers ; so to o mus t Africa . Ne w Yor k ha s skyscrapers ; s o to o mus t Afric a in th e middl e o f nowhere . Th e forme r Sovie t Unio n h a d stat e enterprises; s o to o m u s t Africa . Chin a ha s stat e farms ; s o too mus t Africa. Californi a grow s apples ; s o too mus t Africa . Even th e supposedl y "backwar d an d illiterate " peasant s kno w that w h a t grow s wel l i n on e par t o f th e worl d ma y withe r i n another becaus e soi l conditions , rainfall , an d topograph y ma y b e different. Commo n sens e sugges t plantin g w h a t i s suite d t o Af rica's ow n environment . B y "environment " i s mean t th e whol e gamut o f indigenou s institution s an d system s o f th e peopl e o f Africa—the peasant s wh o ar e th e majority . The scurrilou s imitatio n b y Africa n elite s i s even drawin g atten tion i n th e foreig n press . Elaboratin g o n th e proble m o f Africa' s black elit e t o a Washington Post reporter , a diploma t fro m th e Embassy o f Cameroo n said , "G o t o th e cafe s an d th e bistro s . . . See the m i n thei r Europea n suits , readin g th e lates t edition s o f European newspapers . Th e proble m o f Africa n developmen t wa s that th e educated elite never developed indigenous models, but instead tried to transplant Europe to Africa." I t doesn' t tak e lon g i n Africa t o se e w h a t th e diploma t wa s talkin g about .

170 Georg e B. N. Ayittey Basil Davidson , a renowned Britis h schola r o n Africa, write s i n his new book, The Black Mans Burden, ho w European colonialis m in Africa se t ou t t o den y an d eventuall y eliminat e th e continent' s precolonial history . An d i n that , th e European s foun d willin g ac complices among Africa's European-oriente d elite , the "moderniz ers," who were in constant conflic t wit h Africa's "traditionalists, " including th e acknowledged triba l chiefs . These modernizin g African s clun g t o th e notio n tha t anythin g traditional wa s b y definitio n primitive . And i t wa s thi s elit e tha t came t o th e forefron t o f th e independenc e movement s an d pro ceeded t o impos e Europea n model s o n thei r ne w Africa n states . Rather than seek to build on tradition, as the Confucianist societies of East Asia have tried to do even in their revolutionary phases, the new Africans often sought to purge what was deepest and most authentic in their cultures. That influenc e ca n stil l b e seen today . Judges i n Kenya n court s wear whit e wig s an d spea k i n a flowery, archai c Englis h tha t might b e considere d "quaint. " Governmenta l institution s i n th e former Britis h colonies—fro m parliament s t o th e "specia l branch" interna l securit y forces—ar e near-duplicate s o f thei r counterparts a t Westminste r an d Whitehall . Colonia l govern ments i n Africa wer e dictatorships backe d by a top-heavy bureau cracy. Independence seem s to have substituted blac k autocrats fo r the old white colonial governors, with little thought o f Africa's tra ditions. The suppression o f indigenous culture s has been especiall y pro nounced i n the former Frenc h colonie s of West Africa, whic h wer e treated a s an overseas department o f France, noted Paulin e Baker , an Afric a specialis t wit h th e Aspe n Institut e (i n Colorado) . "Th e French tried t o have black Frenchmen," she said (Washington Post, July 12 , 1992, A26); emphasis added) . African elite s an d government s wer e fascinate d b y shin y ma chines, industry , an d ne w technology . I n thei r selectio n o f devel opment projects , the y displaye d a n abidin g fait h i n th e "religio n of development"— a predispositio n t o castigat e anythin g tradi tional an d t o exal t anythin g foreig n a s sanctified . Acros s Africa , industry wa s overemphasize d t o th e neglec t o f agriculture . A t independence, Nigeria , Sierr a Leone , Tanzania , Zambia , an d

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many othe r Africa n countrie s use d t o fee d themselves . Tw o de cades later , the y wer e importin g food . Agriculture wa s routinel y denigrate d b y Africa n elite s a s a n inferior for m o f occupation . Th e lat e Kwam e Nkruma h o f Ghan a was quit e explicit : Industry rathe r tha n agricultur e i s th e mean s b y whic h rapi d improve ment i n Africa's livin g standard s i s possible. There are , however, imperi alist specialist s an d apologist s wh o urg e th e les s develope d countrie s t o concentrate o n agriculture an d leav e industrializatio n t o some later tim e when thei r population s shal l b e well fed . The world's economi c develop ment, however, shows that i t is only with advance d industrialization tha t it ha s bee n possibl e t o raise th e nutritiona l leve l of the people b y raisin g their levels of income. (Nkrumah, 1957 , 7) N k r u m a h wa s wrong . Five year s int o hi s presidency , foo d short ages h a d becom e seriou s an d r a m p a n t i n Ghana . I n 1966 , he wa s booted ou t o f office i n a militar y coup . When Africa n government s belatedl y recognize d th e impor tance o f agriculture , Africa n leader s mad e mechanizatio n th e guiding principl e o f th e agricultura l revolution . Ton s o f expensiv e agricultural machiner y wer e importe d int o Africa ; combine-har vesters grace d th e landscap e i n Tanzania . Elsewhere , ther e wa s a persistent tendenc y t o op t fo r capital-intensiv e an d gran d monu ments. These ar e symbol s o f developmen t o r progress . But mos t o f these "developmen t projects " cam e t o grief . Amon g th e factor s which accounte d fo r thei r demis e wer e constructio n delays , poo r design, inadequat e supervision , inappropriat e technolog y (to o capital-intensive), corruption , an d pilfering . I n it s 198 1 Report , the EE C note d that : Many developmen t project s faile d i n Afric a becaus e the y wer e o n to o large a scale and were not adapted t o the population an d the environmen t they wer e suppose d t o benefit . . . . Th e project s o f mos t lastin g valu e are generall y thos e whic h ar e simples t an d directl y benefi t th e loca l community concerned . (Cited in West Africa, Jan 18 , 1982, 188) By 1990 , th e Africa n economi c landscap e wa s littere d wit h a multitude o f "blac k elephants" : basilicas , gran d conferenc e halls , prestigious airports , ne w capitals , an d sho w part y headquarters . These project s faile d fo r th e simpl e reaso n tha t the y di d no t fit into Africa' s traditiona l setup .

172 Georg e B. N. Ayittey Concentration of Too Much Economic Powe r A great dea l of economic power was invested i n the state to undertake development . Bu t th e mistak e o r fata l oversigh t wa s th e failure t o attach countervailin g check s or safeguard s agains t suc h concentration o f powers. The concentration o f too much economic power i n th e hand s o f th e stat e ha s th e followin g perniciou s ef fects: 1. I t turn s th e state int o a huge patronage machine . Factory loca tions, job creation , subsidies , an d othe r goodie s ar e dispense d by th e state . I t ma y us e thes e t o rewar d supporters , cronies , and sycophant s a s i n Mexico , Brazil , Peru , an d man y Africa n countries. I n Mexico , fo r example , membershi p i n th e rulin g PRI was necessar y t o secure a to p government post . This prac tice create s th e belie f tha t one' s succes s doe s not depen d upo n one's own abilit y bu t o n how loudl y one can sin g the praises of the state . 2. I t als o foster s th e erroneou s belie f tha t th e stat e ca n solv e all economic problem s an d thi s lead s t o politicizatio n o f almos t every economi c issu e o r problem . Th e stat e i s calle d upo n t o intervene eve n whe n suc h interventio n ma y no t b e necessary . For example, a tailor i s overcharging an d therefor e th e govern ment mus t arres t him . Th e perso n makin g thi s cal l doe s no t have th e commo n sens e t o exercis e hi s option s b y goin g t o another tailor . Th e stat e cannot solv e al l economi c problems . Unemployment, fo r example , wil l alway s exis t an d ca n neve r be reduce d t o zero . I t i s a pretentiou s stat e whic h seek s t o eliminate i t completely . 3. Concentratio n o f economi c powe r i n th e hand s o f th e stat e encourages capital flight . Foreign exchange i s controlled b y th e state an d onl y to p governmen t officials , includin g th e hea d o f state himself , hav e access . Often , i t i s embezzle d an d looted . Capital flight ha s becom e a seriou s proble m i n th e Thir d World. A t leas t 1 5 billio n dollar s leave s Afric a illegally . I t i s also a proble m i n Lati n America . I f ric h Mexican s wer e t o repatriate th e 8 0 billio n dollar s the y hav e hoarde d abroad , more tha n hal f o f Mexico' s 11 0 billio n dollar s deb t woul d b e

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repaid. Argentin a an d Venezuel a als o suffe r capita l hemor rhage. It i s equally seriou s i n th e Middl e East . O n March 24 , 1991, CBS "60 Minutes" reported tha t Iraq i president , Sadda m Hus sein, had ten-twelv e billion dollar s stashed abroad . 4. I t encourage s al l sort s o f individuals, groups , tribes, or organi zations t o compet e fo r contro l o f th e state . Suc h competitio n often result s i n civi l wars , wit h peasant s caugh t i n th e cross fire. Those who win contro l of the state naturally us e its instru ments t o further thei r own economic interest s or welfare a t th e expense o f th e others . Thos e exclude d plo t t o overthro w th e government, an d o n an d o n th e battl e continues . In th e end , i t is th e militar y whic h emerge s th e victo r becaus e i t ha s al l the guns. Concentration o f Too Much Political Powe r This also has many undesirable consequences : 1. Concentratio n o f politica l powe r i n th e hand s o f th e hea d o f state ofte n lead s t o abuse . Power corrupt s an d absolut e powe r corrupts absolutely , according t o Lord Acton. Abuse of political power i s eviden t i n electio n fraud , electio n rigging , an d th e drift towar d a one-party o r one-man dictatorship . 2. I t lead s t o brutal suppressio n o f dissent o r opposition. Ostensi bly, th e stat e ha d acquire d broa d power s t o "develop " th e economy. Anyon e wh o challenge s suc h power s therefor e mus t be "a n enemy " t o b e liquidated . Man y "dissidents " hav e bee n detained, murdered , o r exiled . I t ma y wel l b e tha t th e stat e indeed need s broa d powers . Bu t commo n sens e dictate s tha t there should be some independent mechanism s of checking suc h powers. I t i s th e heigh t o f lunacy , fo r example , t o allo w th e state t o se t u p a Huma n Right s Commissio n t o polic e it s ow n human right s violations . 3. I t lead s t o censorshi p an d denia l o f freedo m o f expression . Development i s actuall y a gropin g process . Economi c condi tions are not static. Prices are constantly changing on the world market an d consequently , developmen t decision s mus t con -

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stantly b e reviewe d t o tak e advantag e o f changin g circum stances. Mistake s ar e boun d t o occur . Suc h mistakes , however , are alway s embarrassin g an d th e stat e ma y no t wan t the m exposed. I t suppresse s the m b y imposin g draconia n censorshi p laws. Journalists , editors , writers , an d poet s wh o expos e an y wrong-doing o r mistake s ar e incarcerated . Bu t then , i f a prob lem i s covered up , i t onl y festers . 4. I t encourage s militarism . Th e stat e spend s enormou s amoun t of resource s o n th e militar y t o bac k it s politica l legitimac y o r add recognitio n an d credibilit y t o government . Militar y spend ing i n th e Thir d Worl d ha s rockete d fro m onl y $ 1 billio n i n 1960 t o nearl y $3 5 billio n b y 1987 , accordin g t o th e Worl d Bank. Obviously , thes e resource s ca n b e bette r pu t t o rea l de velopment. 2 As remarke d earlier , th e stat e ha s no w becom e the problem in Afric a an d th e enemy o f development . Wit h s o muc h powe r concentrated i n th e hand s o f th e state , i t induce s al l sort s o f groups—racial, ethnic , an d professional-t o captur e th e stat e an d advance thei r ow n grou p o r individua l interests . In aparthei d Sout h Africa , th e instrument s o f th e stat e wer e captured an d monopolize d b y th e whit e minorit y trib e an d use d to promot e th e interest s an d welfar e o f whites . Nonwhite s wer e effectively disenfranchise d an d exclude d fro m partakin g o f th e ''public g r a v y / ' I n Mauritani a an d Sudan , i t wa s th e Ara b trib e which capture d th e power s o f th e state . In Angola , Centra l Africa n Republic, Cameroon , Congo , Madagascar , Mozambique , Tanza nia, Zambia , an d Zimbabwe , th e stat e wa s rigidl y monopolize d b y one politica l p a r t y — t h e one-part y stat e system . Nonpart y mem bers, jus t lik e th e black s i n Sout h Africa , wer e shu t out . Unde r stratocracy, i t wa s th e militar y whic h usurpe d th e power s o f th e state (Benin , Burundi , Ethiopia , Ghana , Mali , Niger , Nigeria , Rwanda, Somalia , an d Uganda) . Kleptocrac y occurre d when arme d looter s too k ove r th e stat e (Beni n unde r Kerekou , Zaire). Africa need s no t jus t les s governmen t bu t als o a situatio n wher e no individua l o r grou p ca n monopoliz e th e state . I n cas e on e i s looking fo r a solutio n t o thi s problem , i t woul d b e usefu l t o con -

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sider tha t adopte d b y man y o f Africa' s "primitiv e an d b a c k w a r d " tribes. They abolishe d th e state ! Centuries ago , i t occurre d t o man y Africa n tribe s tha t th e state was evi l an d no t a t al l necessar y fo r th e maintenanc e o f la w an d order. I n fact , the y decrie d th e stat e a s necessaril y tyrannou s an d dispensed wit h centralize d authorit y ( a chie f o r king) . Yet , the y managed t o preserv e peac e an d orde r amon g thei r communities . They wer e calle d stateless o r acephalous societies, an d example s today includ e th e Abeshein i o f Kenya , th e Igb o an d Ti v o f Nigeria , the Nue r o f Sudan , an d th e Tallens i o f Ghana , t o n a m e onl y a few . They wer e th e subjec t o f intens e earl y Europea n curiosit y i n th e olden days . Baffled b y th e absenc e o f th e "state, " Europea n colonialist s dismissed thes e peopl e a s "backward. " Th e European s h a d i t i n their hea d tha t an y communit y mus t hav e a politica l ruler . Sinc e there wa s non e i n th e "stateless " societies , the colonialist s insiste d on creatin g "chiefs " o r "strongmen " (Saddams ) fo r thes e back ward people . Bu t i n "blissfu l ignorance, " th e peopl e promptl y "destooled" (removed ) suc h "colonial " o r " c a n t o n " chiefs . Suc h was th e fate , fo r example , o f th e "government " mantse o f th e G a people (Ghana ) an d th e akill o f th e Somali . Bu t th e forc e o f colo nial a r m s prevaile d an d mos t o f thes e "chiefs, " feelin g tha t the y had th e awesom e colonia l migh t behin d them , becam e corrup t and despotic . Now, th e European s an d othe r Westerner s ar e singin g a differ ent tune . Th e state, whil e necessar y fo r la w an d orde r an d th e suppression o f predator s a t hom e an d abroad , ha s show n itsel f t o be a fals e go d fo r al l thos e wh o hav e looke d t o i t t o righ t civi l wrongs, establis h justice , remov e poverty , educat e children , cur b inflation, cur e unemployment , provid e affordabl e housing , straighten ou t th e busines s cycle , safeguar d cultura l values , an d the like . The "ubiquitou s state ha s no t ensure d governmen t o f th e peo ple, b y th e people , fo r th e people . I t ha s no t brough t liberty , equality, fraternity , peace , lan d o r brea d t o million s misle d t o trust it . I t ha s disappointe d th e hope s o f Marxists , democrati c socialists, part y politica l liberal s an d paternalisti c conservative s in th e West " {Washington Times, J a n 22 , 1991 , G3).

176 Georg e B. N. Ayittey In Philadelphia , Mr . Edwar d Rendell , a Democrati c candidat e for th e mayorship , complaine d bitterly , "Governmen t doe s no t work becaus e i t i s no t designe d to . There i s n o incentiv e fo r em ployees t o d o thei r best , s o many d o not. Ther e i s no incentiv e t o save money, so it is squandered" (cite d in Wall Street Journal, Jun e 18, 1991 , A18). Mayb e thos e stateless Africa n societie s wer e no t backward afte r all . They wer e probabl y politicall y astut e an d fa r ahead o f their time . Said a traditional chief : "Here in Lesotho, we have tw o problems : rat s an d th e government " {Health & Development, March/April , 1989 , 30). Statism I s Alien The economi c system s establishe d i n postcolonia l Afric a unde r statism wer e grossl y alie n t o indigenou s Africa n culture . Th e fol lowing description i s drawn heavil y from Ayitte y (1991b). As implied b y "communa l ownership, " lan d i n th e Africa n vil lage di d no t belon g t o everybody . Lan d wa s lineage-controlled . The tru e owner s o f lan d wer e thos e wh o first settle d o n it—th e ancestors. Althoug h dead , thei r spirit s wer e believe d t o b e ever present an d guid e the living . The chief o r th e lineag e head wa s a mere custodian o f the land . His role wa s t o hold th e lan d i n trust . H e could no t den y a tribes man acces s t o th e land . Eve n stranger s coul d obtai n us e right s upon th e provisio n o f a toke n gift . Us e right s wer e virtuall y per petual s o lon g a s a smal l tribut e wa s paid , voluntar y i n som e cases, an d th e lan d wa s no t abused . Crop s raise d o n th e lan d belonged t o individua l farmers , no t t o th e villag e chie f o r head man. Wha t type s o f crop s t o cultivat e wa s a n individua l choice . All the means of production wer e privately owned, not held by th e state. Even lan d wa s not owne d b y the state or the chiefs. Lineag e heads exercised control over land i n most villages. The native s wer e fre e enterprisers , goin g abou t thei r economi c activities o n thei r ow n initiative , no t a t th e comman d o f chiefs . Profits mad e b y the m wer e their s t o keep , no t fo r th e chief s t o expropriate. Ther e wa s no Africa n la w whic h prohibite d th e na tives fro m makin g a profi t o r accumulatin g wealt h i n th e cours e of thei r economi c activities . Prosperit y an d wealt h coul d b e pur -

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sued bu t withi n th e limit s se t b y either Islam , or socia l norms , o r both. Th e wealt h o f th e ric h wa s no t sequestrate d b y th e chie f o r king for equa l distributio n t o al l th e people . All the wealth y wer e required t o do was to assist thei r poor kinsmen . There wer e fe w direc t taxes . Only tribut e wa s pai d t o th e chie f voluntarily. Th e siz e o f th e tribut e wa s determine d b y ho w wel l the chief governed . The kings derive d muc h o f their revenu e fro m their ow n roya l estate s an d gardens . I n essence , th e king s looke d after themselves . In general, there were no state or tribal government enterprises , except i n a very fe w case s suc h a s in th e Kingdo m o f Dahomey. A king o r chie f coul d operat e a farm , a mine , o r som e commercia l enterprise. Bu t i t wa s fo r hi s ow n benefit , no t fo r th e purpos e o f increasing th e welfar e o f th e people . I t wa s no t hi s traditiona l function t o use his farm, i f he chose to have one, to feed his people. The people fed themselve s an d provided fo r their needs . In man y indigenou s systems , ther e wa s generall y n o direc t in terference wit h th e productio n o r distributio n o f commodities . Agricultural productio n an d tradin g wer e activities dominate d b y women. What thes e women cultivate d an d trade d wer e thei r ow n decisions to make. Markets an d trad e wer e fre e an d open . Thoug h trad e i n som e few commodities , suc h a s slave s o r ivory , wa s reserve d fo r th e king, in genera l n o king o r chie f monopolize d trad e o r market s t o the tota l exclusio n o f hi s subjects . I t woul d hav e bee n a n unAfrican thin g t o do . Rather th e chief s encourage d thei r peopl e t o engage i n trad e an d i t wa s th e traditiona l functio n o f the chie f t o create a peaceful atmospher e for his people to engage in free trade . Prices on native markets were not fixed or controlled by the chiefs . They were , in general , determine d b y marke t forces—suppl y an d demand. Thes e principle s wer e understoo d b y th e native s an d they bargaine d ove r prices . Market s wer e wel l structure d an d organized i n West Africa unde r 'Marke t Queens / Though som e powerful merchant s trie d t o control market s an d fix prices, open competition wa s the rule. Nor could such competi tion b e eliminated . Ther e wer e numerou s suppliers , middlemen , brokers, an d trad e routes , a s wel l a s substitutes . Trade i n indige nous product s coul d no t b e controlled , bu t th e possibilitie s fo r

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control existe d ove r " i m p o r t e d " items . However , eve n i n thes e cases, contro l coul d no t b e complete , sinc e alternativ e trad e routes existed . Kendall an d Lou w (1987 , 21) als o reache d simila r conclusions : Pre-colonial Africa n la w an d custo m share d th e followin g feature s wit h the free marke t system : Assets such a s stock, crops, huts, handicrafts an d weapons were privately owned and land was privately alloted and subjec t to private grazing rights; • Ther e were no laws against fre e contrac t an d voluntary exchange ; • Ther e was no coercive redistribution o f wealth an d almos t n o taxes; • Chief s an d headme n ha d fe w autocrati c power s an d usuall y neede d t o obtain full consensu s for decisions ; • Centra l governmen t wa s limited , wit h a hig h degre e o f devolutio n t o village councils, and ther e was no central planning structure ; • Ther e wer e n o power s o f arbitrar y expropriation , an d lan d an d hut s could b e expropriate d unde r extrem e condition s afte r a ful l publi c hearing. Conclusions Development plannin g faile d i n Afric a fo r th e simpl e reaso n tha t the stat e attempte d t o d o w h a t i t shoul d no t hav e take n upo n itself. As Bauer (1984 , 23) put it : Societies ar e mad e u p o f very larg e number s o f people. Their constituen t persons an d familie s perceiv e bette r tha n d o others, or ar e eve n th e onl y ones wh o ca n perceive , thei r ow n circumstances , attitudes , preferences , opportunities an d prospects . The y ar e als o bes t qualifie d t o judge thei r own likel y response s t o change s i n thes e conditions . I n th e aggregate , they als o posses s a vas t amoun t o f othe r pertinen t knowledg e whic h th e signals an d mechanism s o f th e marke t orde r transmi t an d diffuse . Suc h transmission an d diffusio n o f knowledge i s indispensabl e fo r social , economic, scientific an d technica l innovation . No centralized agency , however powerful, ca n perform thes e function s effectively, no t eve n b y coercion . Attempts t o perfor m the m b y coercio n go counter, moreover , t o th e widenin g o f people's choice , the basic crite rion of economic development . Back i n 1932 , Kobin a Sekyi , th e Ghanaia n lawye r an d philoso pher, expresse d simila r sentiments : When eac h trib e o r natio n i s enabled t o develo p alon g it s own lines , th e respective geniuse s o f th e severa l distinguishabl e race s wil l harmonis e

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in th e establishmen t o f a settle d stat e o f peac e an d prosperity , wher e development, scientific an d social, including moral and political, advance will be steady. (West Africa, third wee k of July, 1932 ) But eac h ethni c grou p ca n develo p alon g it s ow n lines , if and only if, i t i s allowe d th e economic , political , an d intellectua l free dom t o d o so . Why ? Becaus e accordin g t o a prover b o f Nigeria' s Igbo clan , Efik : "Enyene Idem ofiok oto nte Mfat edebede enye" meaning, onl y a n organis m know s bes t it s ow n need s an d ca n bes t serve them . Yet , th e pretentiou s stat e neve r consulte d Africa n "organisms" an d sough t t o determin e an d serv e thei r needs . Now, Africa n government s see m t o hav e com e t o thei r senses . African leader s themselve s a t a historic conferenc e a t Arush a (Feb ruary 1990 ) adopte d th e Africa n Charte r fo r Popula r Participatio n in Developmen t Transformation , whic h hel d tha t th e absenc e o f democracy ha s bee n a majo r caus e o f th e chroni c unemploymen t of Africa : We affirm tha t nation s canno t b e buil t withou t th e popula r suppor t an d full participatio n o f th e people , no r ca n th e economi c crisi s b e resolve d and th e huma n an d economi c condition s improve d withou t th e ful l an d effective contribution , creativit y an d popula r enthusias m o f the vast ma jority o f th e people . After all , i t i s t o th e peopl e tha t th e ver y benefit s o f development shoul d an d mus t accrue . We are convinced tha t neithe r ca n Africa's perpetua l economi c crisi s b e overcome , no r ca n a brigh t futur e for Afric a an d it s people see the ligh t o f day unless th e structure , patter n and politica l contex t o f th e proces s o f socio-economi c developmen t ar e appropriately altered . {Africa Forum 1 , no.2, (1991), 14) But the n as k thes e sam e leader s t o creat e th e condition s neces sary fo r ful l politica l participatio n o f th e peopl e i n developmen t and the y woul d perfor m th e "Rawling s shuffle/ ' "Mo i m a s a m b a , " " K a u n d a twist, " an d th e "Babangid a boogie" : on e ste p forward , four step s back , a sid e kic k an d a somersaul t t o lan d a t th e sam e place. Much ad o abou t nothing . Notes 1. Ther e wa s a politica l motiv e fo r payin g peasan t farmer s lo w prices . Most Africa n government s derive d thei r politica l suppor t fro m urba n elites: workers , students , etc . African government s pursue d a "chea p

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food" polic y t o ensur e continue d politica l suppor t fro m thi s constitu ency. Bu t thi s polic y wa s economicall y stupid . A s w e hav e ha d th e occasion t o remark, pric e controls d o not make food "cheap. " Instead , they mak e foo d more expensive b y creatin g shortages . Thi s i s tru e o f any commodity whos e price is controlled . 2. I n 1990 , the United State s surpassed th e Sovie t Unio n and becam e th e top arm s supplie r t o th e Thir d World . U.S . arms sale s jumpe d fro m nearly $ 8 billion i n 198 9 to $18. 5 billion i n 1990 , compared t o Sovie t arms deal s wort h abou t $12. 1 billion i n 199 0 (Washington Times, Au gust 12 , 1991, A3). Although th e bli p i n Unite d State s arm s sale s wa s attributed t o the Iraqi threa t an d th e subsequent Gul f War, the U.S. is expected t o remain th e leadin g arm s supplier , wit h th e forme r Sovie t Union converting militar y establishments t o civilian use. References Ayittey, George B. N. 1991a. "No More Aid for Africa." Wall Street Journal, Oct 18 , 1991 . . 1991b . Indigenous African Institutions. Irvington-on-Hudson , N. Y.: Transnational Publishers . . 1992. Africa Betrayed. New York: St. Martin's Press . Bandow, Doug . 1986 . "The Firs t World' s Misbegotte n Economi c Legac y to the Third World." Journal of Economic Growth 1 (4) : 17. Bauer, P . T. 1984 . Reality and Rhetoric. Cambridge : Harvar d Universit y Press. Kendall, Frances, and Leo n Louw . 1987 . After Apartheid: The Solution for South Africa. Sa n Francisco: Institute of Contemporary Studies . Killick, Tony . 1976 . "Development Planning , Fre e Market s an d th e Rol e of the State. " Oxford Economic Papers 41, no. 4 (October): 161-84 . . 1978 . Development Economics in Action: A Study of Economic Policies in Ghana. London : Heinemann Educationa l Books . Mabogunje, A. 1988. "Africa afte r th e False Start." Paper presented t o th e 26th Congres s o f th e Internationa l Geographica l Union , Sydney , Australia. Nkrumah, Kwame . 1957 . Ghana: An Autobiography. London : Nelson . . 1963. Africa Must Unite. New York: International Publishers . . 1968 . Handbook on Revolutionary Warfare. London : Pana f Pub lishers. . 1969. Dark Days in Ghana. London : Panaf Publishers . . 1973 . Revolutionary Path. New York: International Publishers . Nyerere, Juliu s K . 1962 . Ujaama: The Basis Of African Socialism. Da r e s Salaam: Government Printer . Taylor, D . R . F. , an d Fion a Mackenzie , eds . 1992 . Development from Within. Ne w York: Routledge .

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Todaro, Michael P., ed. 1983 . The Struggle for Economic Development. New York: Longman . . 1987 . Economic Development in the Third World. Ne w York : Longman. Uphoff, Norma n T . 1970 . Ghana's Experience in Using External Aid for Development. Berkeley and Lo s Angeles: University of California Press . Whitaker, Jennifer . 1988 . How Can Africa Survive? Ne w York : Harpe r & Row. World Bank . 1984 . Toward Sustained Development in Sub-Saharan Africa. Washington, D.C. . 1989 . Sub-Saharan Africa: From Crisis to Self-Sustainable Growth. Washington, D.C. . Annually . World Development Report. Ne w York : Oxfor d Univer sity Press. World Bank/UNDP. 1989. African Economic and Financial Data. Washington, D.C. Zinsmeister, Karl . 1987 . "Eas t Africa n Experiment : Kenya n Prosperit y and Tanzania n Decline. " Journal of Economic Growth 2 (2): 28.

7 The Worl d Ban k an d th e IMF : Misbegotten Sister s David Osterfel d On opposit e side s o f 19t h stree t i n Washington , DC , stan d tw o o f th e world's mos t powerfu l institutions . A s lender s i n thei r ow n right , the y directly contro l billion s o f dollar s eac h year ; indirectly , ten s o f billion s more. The y si t i n judgmen t o n governments , usin g thei r financial clou t to influenc e economi c polic y i n score s o f developin g countries . Th e fat e of hundred s o f million s o f peopl e turn s o n th e decision s thes e institutions make . Th e worl d the y wer e create d t o serv e n o longe r exists, yet thei r rol e i s undiminished. (1991b , 5) —Economist

Overview One o f thes e institution s i s th e Worl d Bank , th e othe r th e Interna tional Monetar y Fund , o r IMF . Bot h wer e th e outcom e o f th e conference o f th e Unite d States , Britain , an d thei r Worl d Wa r I I allies hel d a t Bretto n Woods , Ne w Hampshire , i n Jul y 1944 . Th e purpose o f th e conferenc e wa s t o construc t an d manag e a postwa r economic order . Initially, th e Worl d Bank' s tas k wa s t o mak e long-ter m loan s o n a commercia l basi s fo r th e purpos e o f Europea n reconstructio n i n the aftermat h o f Worl d Wa r II . Ver y quickly , however , th e focu s shifted fro m reconstructio n t o development , wit h it s first missio n 185

186 Davi d Osterfel d to a Less-Develope d Countr y (LDC) , Columbia, coming a s early a s 1949 (Pomfret 1992 , 133 , 165). The IMF , largely th e brainchil d o f John Maynard Keynes , was designed t o insure monetary stability , that is , prevent devaluation s excep t i n emergencies , an d promot e freer trad e b y makin g short-ter m loan s t o countrie s experiencin g balance o f payment s difficulties . Th e IM F was , a s Pomfre t ha s pointed ou t (1992 , 113) , the monetar y counterpar t t o ye t anothe r postwar internationa l institution , th e Genera l Agreemen t o n Tar iffs an d Trad e (GATT) , whos e purpos e wa s t o encourag e negoti ated reduction s i n trade barriers. Unlike the World Bank , the IM F was no t intende d t o b e a n ai d agency . Lik e GATT , i t i s a club . Member nation s pa y a quota , o r "subscription, " t o th e Fund , based o n thei r relativ e economi c size s an d ar e permitted t o dra w from thi s pool of "liquid reserves " (Harrod 1958 , 171) when necessary i n orde r t o tid e the m ove r temporar y balanc e o f payment s problems, thereb y avoidin g devaluation s relativ e t o othe r members' currencies. Similarly, a central tene t of GATT is nondiscrimination, tha t is , tha t ever y member-natio n i s t o trea t good s from al l othe r member s equally . I t i s implemente d throug h the most-favore d natio n (MFN ) principle , i n whic h eac h mem ber agree s t o accor d t o al l othe r member s th e sam e treat ment i t extend s t o tha t natio n receivin g it s mos t favorabl e treatment. The thre e pillar s o f th e postwa r economi c worl d wer e th e World Bank, intended t o make long-term loan s for th e reconstruc tion o f a Europ e ravage d b y wa r an d t o Third Worl d countrie s t o stimulate economi c developmen t b y th e creatio n o f wealt h (Krauss 1984 , 165) ; the Internationa l Monetar y Fund , designe d t o insure monetary stabilit y throug h th e use of short-term loans ; and the Genera l Agreemen t o n Tariff s an d Trade , whos e purpos e wa s to promot e a n ope n internationa l tradin g order . Together , i t wa s thought, th e thre e institution s woul d preven t a retur n t o th e economic nationalis m tha t characterize d th e depressio n year s o f th e 1930s when man y nation s engage d i n "competitiv e depreciation " of thei r currencie s i n orde r t o stimulat e export s whil e enactin g tariffs i n a n effor t t o preven t imports , thereby , i t wa s hoped , stimulating domesti c productio n an d reducin g unemployment . The breakdow n o f internationa l trad e wa s th e logica l resul t an d

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that contributed , m a n y believe , t o th e outbrea k o f w a r (e.g. , Mise s 1969; Osterfel d 1972) . The Bretto n Wood s sisters , th e Worl d Ban k an d th e IMF , hav e come t o assum e overridin g importance , althoug h no t i n th e wa y intended b y thei r founders . The Worl d Ban k is , i n fact , a quasi-autonomou s grou p o f fou r agencies: th e Internationa l Ban k fo r Reconstructio n an d Develop ment (IBRD) , th e Internationa l Developmen t Associatio n (IDA) , the Internationa l Financ e Corporatio n (IFC) , an d th e Multilatera l Investment Guarante e Agenc y (MIGA) . The IBR D obtain s it s fund s throug h paid-i n contribution s fro m m e m b e r countries , commercia l borrowing , an d loa n repayments . The bul k o f it s fundin g i s obtained fro m bon d sale s o n th e interna tional capita l market . Becaus e o f it s excellen t credi t rating , th e volume o f it s business , an d it s larg e capita l base , compose d o f both "paid-i n capital, " tha t is , money i n hand , an d "callabl e capi tal," tha t is , essentially loa n guarantee s o r obligation s fro m mem ber countrie s t o cove r ba d loans , th e IBR D i s abl e t o borro w a t very favorabl e rates—i n 198 7 it s averag e rat e wa s 7.7 3 percent . More tha n 9 0 percen t o f it s approximatel y $17 0 billio n capita l base i s callabl e capital . Th e IBR D the n relend s thi s mone y t o developing countrie s a t a slightl y highe r rate-8.7 8 percen t i n 198 7 (Hancock 1989 , 53; Goldman 1985 , 94). As Graham Hancoc k ha s writte n (1989 , 53), For the poorest nations—which ar e generally regarded a s a "bad risk " by bankers—the IBR D i s a sourc e o f finance whic h woul d simpl y neve r b e forthcoming fro m commercia l sources . O n th e othe r hand , fo r middle income developing countries (Brazi l an d Indonesia , for example)—whic h take u p th e bul k o f it s loans—th e term s tha t i t offer s ar e generall y significantly bette r tha n thos e the y themselve s coul d obtai n o n th e ope n market. Moreover, IBR D loan s com e wit h five-year grac e period s an d twenty-year maturities . A s th e Economist (1991b , 9 ) recentl y pu t it, whil e "borrower s pa y wha t th e Ban k call s a marke t rat e o f interest," almos t "alway s thi s is , in fact , a lower-than-marke t rate ; the Ban k i s chargin g a prim e rat e t o non-prim e borrowers. " I n short, whil e officiall y denyin g it , th e Ban k i s i n th e busines s o f supplying subsidize d loans .

188 Davi d Osterfel d Established i n 1960 , the ID A serves a s th e "sof t loa n window " of th e Worl d Bank . I t i s financed b y grant s o r "subscriptions " from Worl d Ban k member-state s an d make s "concessional " o r subsidized loans , tha t is , loans a t 0 percent interes t an d paybac k periods extending up to forty years , recently scale d back from fifty years, includin g a ten-yea r grac e period . It' s officia l purpos e i s t o provide "developmen t credit s o n specia l terms , wit h particula r emphasis o n project s no t attractiv e t o privat e investors " (Bank s 1991, 933). These loans are targeted t o the those LDCs with officia l per capit a income s o f $83 5 o r les s i n 198 6 dollars , althoug h th e bulk o f ID A loans g o to countrie s wit h averag e annua l pe r capit a incomes below $40 0 (Banks 1991 , 934). The loan s ar e restricte d t o government s onl y an d durin g it s thirty-year existence , cumulative approval s totale d $6 4 billion fo r more than 2,10 0 projects (Bank s 1991 , 934). As of Jun e 30 , 1991 , the IBRD' s outstandin g loan s totale d $9 1 billion; th e IDA' s $4 5 billion . Throughou t it s histor y th e loan s from bot h th e IBR D an d th e ID A were, a s th e Economist (1991b , 10) acknowledges , "overwhelmingl y t o government , governmen t agencies an d state-owne d enterprises. " Thi s i s hardl y surprisin g since Articl e III , Sectio n 4(i ) o f th e Bank' s Articles of Agreement requires al l loan s t o receiv e a n official , tha t is , a government , guarantee. Interestingly, th e IF C wa s create d i n 195 6 wit h th e specifi c charge o f extendin g unguarantee d loan s directl y t o privat e busi nesses i n th e Thir d Worl d an d t o advis e government s o n ho w t o privatize thei r state-owne d enterprise s (SOEs) . However, th e IF C has had littl e impac t an d a s late as 198 7 loan commitments t o th e IFC totalled a mere $92 0 million (Economist 1991a , 18 ; Economist 1991b, 10) . MIGA, establishe d i n 1985 , bega n operation s i n 198 8 wit h a capital subscriptio n o f $1. 1 billion . I t provide s borrower s wit h protection agains t noncommercia l risk s such as war, and loses due to uncompensated expropriation s an d repudiatio n o f contracts b y host governments (Bank s 1991 , 929). Since th e IBRD' s authorize d capita l wa s increase d t o $17 1 billion i n 198 8 whil e th e IDA' s currentl y stand s a t mor e tha n $18 0 billion (Bank s 1991 , 931, 944), it i s clea r tha t whe n on e speak s of

The World Bank and th e IMF 18 9 the Worl d Bank , fo r practica l purpose s on e i s speakin g o f th e IBRD and th e IDA. Evolution As originally conceived , th e divisio n o f labo r betwee n th e Worl d Bank an d th e IM F was clear : th e IM F was t o concer n itsel f wit h short-term monetar y stabilization ; th e Bank was to focus o n long term economi c development . Ove r time , thi s distinctio n becam e increasingly blurred , a s th e World Ban k has com e t o require suc h things as exchange rate adjustments t o facilitate monetar y stabili zation a s par t o f it s loa n conditions , while th e IM F now demand s such polic y change s a s trad e liberalizatio n i n orde r t o stimulat e long-term development . Biersteke r ha s commente d tha t th e tw o institutions operat e "virtuall y interchangeably " (1990 , 483) ; Economist (1991b , 19 ) has writte n tha t "th e IM F has take n o n th e unaccustomed rol e o f developmen t lender, " whil e th e Ban k "ha s moved t o mee t th e Fun d fro m th e othe r direction , . . . makin g stipulations no t jus t abou t th e particula r project s i t finances bu t about fiscal an d monetar y policy , trad e policy , exchange-rate pol icy." The "overla p o f the IMF's activitie s wit h thos e of the Bank, " it concludes , "is al l to o obvious." In fact , loan s fro m th e Bank ar e contingent upo n membershi p i n the IMF. How and wh y did thi s merger come about ? The World Bank The Worl d Bank' s origina l missio n deal t wit h th e reconstructio n of war-ravage d Europe . Sinc e thi s wa s quickl y assume d b y th e Marshall Plan , the Bank shifted it s focus t o Third World economi c development. Bank loans , bot h IBR D an d IDA , ar e predominantl y project oriented. Man y o f th e Bank' s project s ar e designe d solel y o r al most solel y b y Ban k official s o n th e groun d tha t th e LDC s do no t have th e expertis e t o desig n thei r ow n developmen t project s (see , e.g., Hancoc k 1989 , 124-28 , and Economist 1991b , 10) . Nevertheless, by the Bank's own accounts, a large percentage of its project s were failing t o achieve eve n it s own criteri a fo r success . The Ban k

190 Davi d Osterfel d decided tha t th e caus e o f it s failur e la y no t wit h it s project s bu t with th e environmen t insid e th e borrowin g countries . Regardles s of it s merits , a n individua l projec t wa s doome d t o fai l i f i t wer e being implemente d i n a environmen t characterize d b y pric e con trols, inflation , tariffs , hig h taxes , hug e budge t deficits , an d th e like. Sinc e " a goo d projec t i n a ba d econom y wa s likel y t o b e a bad project , i t followe d tha t loa n condition s ha d t o loo k beyon d the projec t t o th e econom y a s a whole " (Economist 1991b , 13) . The result wa s th e developmen t o f "conditional" loan s commonl y known a s Sectoral Adjustmen t Loans , or SECALs . Part o f the loa n would b e earmarke d fo r a specifi c projec t whil e th e res t woul d be use d t o finance adjustment s i n th e relevan t sector , suc h a s transportation, energy , or agriculture . The difficulty wit h SECAL s was tha t projec t loan s tende d t o be both to o smal l and , wit h th e extensiv e paperwor k entaile d i n project desig n an d monitoring , to o time-consumin g t o giv e th e Bank muc h leverag e ove r governmen t polic y making . The logica l next ste p wa s t o divorc e th e loan s entirel y fro m project s an d attach the m t o policy . Henc e wer e bor n Structura l Adjustmen t Loans, o r SALs . SAL s ar e i n essenc e a brib e i n whic h th e Ban k lends on th e condition tha t th e recipient countr y adop t particula r economic o r financial reforms . Thi s had th e grea t merit , fro m th e point o f vie w o f bot h th e Ban k an d th e recipien t countries , o f permitting loan s t o b e bot h increase d i n siz e an d disburse d quickly. Ban k official s coul d no w dispens e loan s faste r an d mor e easily, an d th e ruler s i n recipien t countrie s obtaine d mor e o r les s discretionary contro l ove r larg e sum s o f capital . I t i s clea r tha t SALs violat e th e spirit , i f no t th e letter , o f th e Bank' s Articles which stipulat e that , "excep t i n specia l circumstances " loan s ar e to "be fo r specifi c project s o f reconstruction o r development " (Ar ticle III , Sectio n 4[vii] . Fo r thi s reaso n the y constitut e n o mor e than 1 0 percent o f Bank lending . But thi s doe s no t mea n tha t the y ar e unimportant . I n man y LDCs, World Bank and other aid money has come to total as muc h as 8 percen t o f thei r GNPs , o r mor e tha n 5 0 percen t o f gros s investment (Economist 1991b , 10) . Sinc e th e Ban k i s a lendin g institution, bu t a lendin g institutio n tha t becaus e o f it s quasi governmental statu s i s largel y insulate d fro m marke t forces , jo b

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promotions hav e com e t o b e obtaine d mor e b y meetin g o r ex ceeding lendin g target s tha n b y worryin g abou t th e soundnes s o f loans. I t i s muc h easie r t o mee t th e targe t wit h a fe w bi g loan s than wit h man y smal l ones . A s a consequence , th e incentiv e quickly becam e "len d big , len d fast " (Hancoc k 1989 , 143) . As on e World Ban k officia l admitted , "We'r e lik e a Sovie t factory . Th e . . . pressures t o len d ar e enormou s an d a lo t o f peopl e spen d sleeples s nights wonderin g ho w the y ca n unloa d projects . Ou r abilit y t o influence i n a wa y tha t make s sens e i s completel y u n d e r m i n e d " (cited i n Bando w 1989 , 115) . An d a Worl d Ban k consultan t com mented tha t anyon e wh o stop s t o rais e question s abou t th e verac ity o f a particula r loa n "i s considere d a n outcast—no t a goo d team m a n " (cite d i n Lapp e e t al. , 1981 , 8 5 - 8 6 . Als o se e Bartlet t 1986, 5 ; Sowel l 1983 , 238; Tendler 1971 , 91; Irwin 1990b , A10). In addition , th e focu s o f Worl d Ban k activitie s change d funda mentally durin g th e 1970s . Under Rober t McNamara , presiden t o f the Ban k fro m 196 8 t o 1981 , the Ban k shifte d it s focu s fro m creat ing wealt h b y stimulatin g developmen t t o transferrin g wealt h b y initiating socia l welfar e program s (se e Clar k 1981) . A s An n Hughey commente d (1980 , 123.) , McNamar a seemed almost possesse d wit h redistribution o f income. He seems to have turned awa y fro m th e concep t o f helpin g th e poo r b y raisin g overal l national economi c standards . H e seem s t o fee l tha t dam s an d road s an d ports and stee l mill s . . . may help th e economy but the y don' t necessaril y put extr a foo d int o the stomachs of the teemin g poor . As a result , whil e increasin g onl y modestl y durin g th e decad e prior t o McNamara' s tenure , Ban k lendin g balloone d fro m $93 4 million i n 196 8 t o $12. 3 billio n i n 1981 , nearl y a thirteen-fol d increase (Bando w 1989 , 74 ; Bartlet t 1986 , 3) . Significantly , th e percent o f Ban k lendin g goin g fo r suc h socia l service s a s slu m improvement, populatio n control , education , an d constructio n o f residential sites , increase d fro m 3. 6 i n 196 8 t o 14. 5 b y 198 1 (Ban dow 1989 , 74 ; Kraus s 1984 , 166) . A t best , suc h project s ar e onl y tangentially relate d t o th e Bank' s officia l purpos e o f stimulatin g economic development . According t o it s Articles, th e purpos e o f th e Ban k wa s t o stimu late self-sustainin g economi c developmen t b y promotin g "privat e

192 Davi d Osterfel d foreign investmen t b y mean s o f guarantee s o r participatio n i n loans an d othe r investment s mad e b y privat e investors " (Articl e I[ii]). Over the years, however, it has evolved into an agency focus ing o n promotin g developmen t b y supplyin g capita l t o govern ments a t wel l belo w marke t rate s o f interest , an d the n int o a n institution tha t concerne d itsel f no t s o muc h wit h th e creatio n o f wealth a t al l a s wit h it s transfer . I n th e process , wit h th e emer gence o f SECAL s an d SALs , th e Bank' s rol e ha s evolve d fro m being a facilitator o f private capita l flows to the LDC s to a would be polic y make r i n th e LDCs , concernin g itsel f wit h suc h IMF related matter s a s exchang e rate s an d balanc e o f payment s problems. The IMF The IMF' s primar y responsibilit y wa s t o insur e exchang e rat e stability, thereb y promotin g internationa l trade . Unde r th e IM F system th e U.S . dollar serve d a s the primary internationa l reserv e asset. Th e dolla r wa s pegge d t o gol d a t th e rat e o f $3 5 per ounce . Nations wer e willin g t o hol d dollar s s o lon g a s the y ha d confi dence tha t the y coul d conver t th e dolla r t o gol d a t tha t rate . Th e system of fixed exchange rates works, Melvyn Krauss has observe d (1984, 178-79) , "onl y whe n th e domesti c monetar y authorit y behaves responsibly . . . . [I] t i s th e practic e o f fiscal control , not th e exchang e rat e regime , tha t reall y count s fo r economi c health." Once Presiden t Lyndo n Johnso n decide d i n th e mid-1960 s t o finance th e foreig n Wa r i n Vietna m an d th e domesti c Wa r o n Poverty b y inflation , tha t is , resor t t o th e printin g press , rathe r than taxation , i t soo n becam e apparen t tha t continue d convert ibility o f the U.S . dollar a t th e official rat e o f $35 per ounce woul d be impossible . Originally , th e officia l rat e wa s raise d and , whe n that prove d insufficient , Presiden t Richar d Nixo n suspende d con vertibility i n Augus t 1971 . By 197 2 man y nation s wer e floating their currencie s i n violatio n o f th e IM F Articles. Th e Bretto n Woods syste m wa s essentiall y dea d an d th e IM F a n agenc y without a purpose . A s Rober t Alibe r wrot e (i n th e Economist 1991b,8)

The Worl d Ban k an d th e IM F 19

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Within a fe w year s al l tha t remaine d o f th e IM F system wa s th e IMF— a pool of currencies modes t i n size and largel y irrelevan t i n function, give n the rapid growt h i n international reserves , and 1,80 0 highl y paid interna tional civil servants t o police a set of rules that n o longer existed . The IM F responde d b y easin g th e condition s fo r it s loans . I n 1974 i t create d th e Specia l Oi l Facility , a separat e "borrowin g window" allowin g member s t o cove r tha t par t o f thei r balanc e o f payments deficit s attributabl e t o highe r oi l price s (Bank s 1991 , 941-42). I n th e sam e yea r i t als o establishe d a n Extende d Fun d Facility (EFF ) t o ai d countrie s experiencin g paymen t problem s stemming fro m "structura l difficulties. " I n th e process , i t length ened repaymen t period s fro m three-to-fiv e year s t o five-to-ten years. An d i n 197 6 i t create d a Trus t Fun d fo r th e specifi c purpos e of lendin g t o LDC s subjec t t o " c o n d i t i o n a l l y , " a practic e o f ques tionable legalit y sinc e conditionalit y wa s no t envisione d b y th e Fund's origina l agreemen t (Reynold s 1992 , 5) . Whil e EF F loan s were no t concessional , a s th e Economist noted , "incom e pe r hea d became a criterio n fo r th e first time. " No t surprisingly , IM F lend ing skyrocketed , increasin g thirteen-fol d betwee n 197 1 an d 197 6 (Economist 1991b , 9 , char t 3) . Since th e economie s i n man y LDC s stagnate d o r eve n deterio rated durin g thi s period , the y foun d themselve s unabl e t o repa y the loan s a s the y fel l du e b y th e lat e 1970 s an d earl y 1980s . I n response, th e IM F "liberalized " it s "compensator y facility " b y creating a ne w loa n windo w i n 1985 , th e Structura l Adjustmen t Facility (SAF) . The SA F provide d loan s fo r ten-yea r period s a t 0. 5 percent interes t an d a five-and-a-half-year grac e period . I n con trast t o th e Bank' s SALs , SA F loan s wer e targete d specificall y t o the poores t countries . SA F wa s followe d tw o year s late r b y th e Enhanced Structura l Adjustmen t Facilit y (ESAF) , permitting bor rowers t o obtai n twic e th e amoun t the y coul d ge t throug h SAF , but o n stricte r condition s (Bank s 1991 , 943; Economist 1991b , 18) . Thus, ove r tim e IM F loan s becam e mor e concessiona l an d carrie d longer maturities . Everyon e agree d tha t b y th e 1980 s ther e wa s little differenc e betwee n th e Ban k an d th e Fund .

194 Davi d Osterfel d Evaluation The World Bank What ha s bee n th e overal l impac t o f th e Worl d Ban k an d IMF ? The evidence strongly suggests that on balance the Bank has faile d either t o stimulate developmen t o r to raise living standards i n th e LDCs. This is so even if one looks at th e Bank's own reports . A 1986 Worl d Ban k stud y conclude d tha t th e Bank-funde d en terprises "represen t a depressin g pictur e o f inefficiency , losses , budgetary burdens , poo r product s an d service s an d minima l ac complishment o f the noncommercial objective s s o frequently use d to excus e thei r poo r economi c performance " (cite d i n Bovar d 1988, 185) . Following independence , sub-Sahara n Afric a ha s bee n the majo r recipien t o f Worl d Ban k attention . Betwee n 197 3 an d 1980 alone, th e Worl d Ban k investe d $2. 4 billion i n Africa fo r th e stated purpos e o f boosting agricultura l output . Yet, between 196 0 and 198 5 per capit a foo d outpu t i n Africa decline d b y 2 0 percent . A 198 7 Worl d Ban k stud y admitte d tha t full y 7 5 percen t o f it s African agricultura l project s ha d faile d (Hancoc k 1989 , 145) . Another 198 7 Worl d Ban k stud y classifie d nearl y 6 0 percen t o f it s projects aroun d th e worl d a s eithe r havin g "seriou s shortcom ings" o r bein g "complet e failures. " I t als o conclude d tha t 6 0 per cent o f thos e judge d t o b e successe s wer e no t sustainabl e afte r completion (Bando w 1989 , 77-79; Hancock 1989 , 145). The World Bank dat a (1983 , 18 ) sho w tha t officia l developmen t assistanc e (ODA) totale d jus t 5 percent o f th e gros s domesti c investmen t o f the low-incom e countrie s o f Sout h Asi a but mor e tha n 4 0 percen t in the low-income countries of Africa. They also indicate (1980, 11, table 2.8 ) tha t fo r th e decad e o f th e 1970 s pe r capit a incom e i n South Asia's low-income countries grew over five times faster tha n it did in the low-income countries of Africa . If anything , th e Bank' s succes s rat e i s exaggerated . Thi s i s s o for tw o reasons . First , "fund s ar e fungible. " Thi s mean s tha t th e project tha t th e Ban k ha s approve d an d i s officially funding ma y be economically sound , but tha t projec t woul d have been financed even i n th e absenc e o f a Ban k loan . Th e loan , therefore , free s u p domestic money which can now be spent on another project. Thus,

The World Bank and th e IMF 19 5 the projec t tha t th e Ban k i s actually fundin g i s likel y t o b e a marginal, o r economicall y unsoun d on e whic h woul d no t hav e been funde d ha d tha t projec t bee n advance d fo r approval . I f so , Bank loan s should b e judged b y the rates of return o n the project s it actually fund s rathe r tha n b y th e one s i t officially funds . Th e problem is , as the Economist (1991b , 10 ) points out, these project s ''are unknown , an d possibl y unknowable. " On e thing, however, i s clear: basin g accountin g figures o n th e officially funde d project s rather than thos e the Bank actually funded exaggerate s th e success rate o f World Ban k loan s (se e Osterfeld 1992 , 159). And second, i n a stud y generall y friendl y t o th e Bank , Rober t Ayre s (1983 , 108 ) acknowledges tha t i n orde r t o mak e themselve s an d thei r pro grams loo k good , "som e Ban k official s admitte d tha t the y cooke d up th e evidence. " Not onl y ha s th e Ban k faile d i n it s missio n t o stimulat e Thir d World development , on e ca n probabl y conclud e that , o n balance , the Bank' s impac t o n bot h developmen t an d livin g standard s i n the LDC s has bee n negative . There ar e severa l reason s fo r thi s as sessment. Distortions. Withi n a market system , priorities ar e set by consum ers' buyin g an d abstentio n fro m buying . Entrepreneurs , anxiou s to maximize profits , will ten d t o produce thos e goods and service s with th e greates t discrepanc y betwee n tota l revenu e an d tota l cost. I t i s throug h th e fluctuatio n o f price s an d cost s tha t th e unhampered marke t syste m i s abl e t o disseminat e th e relevan t information t o marke t participants . I f consume r deman d fo r a good o r servic e increase d o r it s suppl y decreased , then , ceteri s paribus, it s pric e woul d rise , thereb y encouragin g increase d pro duction. Conversely, i f consumer deman d decrease d o r th e suppl y increased, th e pric e woul d fall , thereb y discouragin g productio n of that particula r good . Thus, the marke t proces s work s i n suc h a way a s t o produc e thos e good s an d service s tha t consumer s wis h to buy in the quantity an d qualit y desire d by them . The proble m o f th e efficien t allocatio n o f resource s i s handle d in th e sam e wa y tha t th e proble m o f prioritie s i s handled : th e price system . T o produce thei r good s th e entrepreneur s mus t bi d for the factors the y need. They therefore stan d in the same relatio n

196 Davi d Osterfel d to th e factor s o f production a s consumers d o to the seller s of fina l goods. Thus, prices for th e various factors o f production reflec t th e demand fo r the m b y entrepreneurs. Since what entrepreneurs ca n bid i s limite d b y thei r expecte d yiel d fro m th e fina l sal e o f thei r products, factor s o f production ar e spontaneousl y channele d int o the productio n o f thos e good s mos t intensel y desire d b y consum ers. Those who best serv e the consumers earn th e most profits an d are therefor e abl e t o offe r th e highes t bid s fo r th e factor s the y need. If returns ar e not high enough to cover the costs of a particu lar operation, thi s means that , from th e standpoint o f the consum ers, ther e i s a mor e productiv e us e fo r thos e factor s elsewhere . The fre e marke t therefor e allocate s factor s t o thei r mos t value productive point , relativ e t o th e priority syste m tha t th e consum ers have established . It follow s tha t i t i s economicall y rationa l t o pursu e a projec t only when the (expected) revenues exceed the costs. The rule hold s for an y countr y intereste d i n economic development . This poses a serious difficult y fo r th e recipient s o f ODA. As pointed ou t above , World Ban k loans , whether fro m th e IBR D which ar e moderatel y concessional, o r th e IDA , whic h ar e essentiall y free , ar e i n fac t subsidies. Since the transferred resource s are scarce, their transfe r at reduce d o r eve n zer o cost s to the recipients seriousl y distort s cost data . Thus , eve n assumin g tha t publi c official s ar e hones t and hav e th e bes t interes t o f thei r citizen s a t heart , th e artificia l lowering o f costs entailed i n th e Bank loan s mak e man y economi cally unsoun d project s appear profitable . Tryin g t o determin e whether cost s exceed benefit s i n th e absence o f accurate cos t dat a is a lo t lik e tryin g t o cu t a piec e o f pape r wit h a singl e scissor s blade. Inevitably, numerou s mistake s wil l be made an d th e wast e of resources will be enormous . Moreover, privat e investor s riskin g thei r ow n capita l ar e unde r the economi c constrain t o f servin g consumers . Publi c official s t o whom resource s ar e transferre d ar e largel y relieve d fro m thi s constraint. I n fact , sinc e the y receiv e resource s a t zero costs to themselves, the y ar e abl e t o trea t thes e a s fre e goods . Even whe n public official s ar e no t corrupt , the y ar e human . Relie f fro m th e economic constrain t o f serving consumer s enable s publi c official s to substitut e thei r ow n priorities , howeve r wel l intentioned , fo r

The World Bank and the IMF 19 7 those of the consumers . The World Bank, itself, is certainly awar e of this . In it s 198 9 report (55 ) the Ban k observe d tha t i n Pakista n fully 7 0 percent o f al l ne w lendin g wa s "targeted' 1 b y th e govern ment; i n Yugoslavi a th e figur e wa s 5 8 percent ; an d i n Brazi l i t stood a t 70 percent. Since economi c developmen t i s often confuse d wit h industrial ization, th e resul t ha s bee n th e diversio n o f resource s fro m th e satisfaction o f consumer want s t o use in capital-intensive project s even whe n ther e i s no rea l deman d fo r suc h product s o r the y ca n be produce d mor e cheapl y elsewher e o r b y private companies . I n the sam e repor t (1989 , 57), the Ban k note d tha t a larg e portion o f government-directed credi t wen t t o state-owne d enterprise s (SOEs). In Guyan a 5 6 percent o f al l nongovernmenta l borrowin g was b y SOEs ; i n Mexic o i t wa s 4 3 percent , i n Nepa l 2 5 percent , and i n Brazil 1 8 percent. Even though many ar e legal monopolies , they operat e s o inefficiently , an d ar e s o corrupt , tha t the y stil l manage t o los e mone y an d ca n b e kep t i n operatio n onl y wit h continued subsidie s and directe d credit s (Hudgins 1989 , 7). It i s hardl y surprisin g t o find th e Thir d Worl d littere d wit h ultramodern stee l mills , hydroelectri c dams , moder n airports , double-deck suspension bridges for nonexistent railroads, giant oil refineries i n countrie s tha t neithe r produc e no r refin e oil , hug e crop-storage depot s tha t hav e neve r bee n use d becaus e the y ar e not i n location s tha t ar e accessibl e t o farmers , an d numerou s other white elephants (Ayittey 1987,210-11 ; 1988; Bauer 1987 , 15; Chapman 1986 ; Fitzgerald 1980 , 284-85). Although undertaken i n the nam e o f development , the y d o no t contribut e t o economi c growth. The y ar e th e moder n counterpar t o f th e Egyptia n pyra mids: colossal , impressive , an d a wastefu l drai n o n th e resource s of the country . Incentives. B y makin g loan s t o SOE s o r t o sector s tha t ar e failin g because o f governmen t policies , th e Ban k no t merel y remove s whatever incentiv e recipien t government s migh t hav e t o intro duce market-oriented reforms , it actually rewards them for pursu ing economically detrimenta l policies . To cite just a few examples , Tanzania ha s bee n on e o f th e larges t recipient s o f Ban k money . Yet, eve n followin g a Ban k repor t tha t blame d th e collaps e o f

198 Davi d Osterfel d Tanzanian agricultura l productio n o n oppressiv e domesti c ta x policies, Tanzani a receive d anothe r $6. 8 billio n fro m th e Ban k for agricultura l projects . On e finds simila r situation s i n Ghana , Ethiopia, Romania, the Philippines, and numerous other countrie s (Bandow 1989 , 79-80; Waters 1985 , 7; Hudgins 1989 , 7). SECALs and SALs have not altered th e situation. In fact, a 1986 Bank report on the ten largest SA L recipients concluded tha t non e had introduce d seriou s polic y refor m (i n Bandow 1989 , 84). Th e reasons are not difficult t o uncover. First, only about 1 0 percent of Bank lendin g i s i n th e for m o f SALs . Thi s clearl y limit s th e amount o f leverage th e Bank coul d hav e over the domestic affair s of recipient countries . Moreover, th e pressure t o lend—most SAL proposals originate with the Bank—further undermine s the ability of th e Ban k t o entic e marke t reform s i n th e recipien t country . Recipient countrie s know full wel l that th e Bank is unlikely to cut off loan s t o a nonperformin g country—Zaire , fo r example , ha s been "adjusting " fo r years . I n fact , b y adoptin g th e reform s de manded b y th e Bank , a countr y woul d effectivel y reduc e it s chances of receiving futur e Ban k loans . There would be no reason to exten d a n SA L to a countr y tha t ha s alread y reforme d itself . Thus, despite its free-market rhetoric , the incentive created by the method o f disbursin g Ban k loan s ha s th e unfortunat e effec t o f penalizing countries adopting free-market reforms . ODA entails othe r untowar d incentives . Michael Irwin , forme r director o f th e Healt h Service s Departmen t a t th e Worl d Ban k who recentl y resigne d i n disgust a t the Bank's "bloated , overpai d bureaucracy, it s wastefu l practices , an d it s generall y poo r man agement/' ha s stated tha t "publi c proclamation s t o the contrary , poverty reductio n i s the las t thin g o n mos t Worl d Ban k bureau crats' minds" (Irwin 1990a , 2). Unless, perhaps, the poverty reduction they are concerned with is their own. In a response to increasing complaint s abou t it s excessiv e staff , Worl d Ban k presiden t Barber Conable launched a major reorganizatio n effor t i n 1987. At the time th e Bank staf f totale d 6,150 , with a n administrative bud get of $816 million. At the end of the reorganization effor t i n 1989, the staff ha d been reduced t o 6,100. The cost of the reorganizatio n was $148. 9 millio n (Irwi n 1990a , 2). By the end of 199 1 the Bank staff totale d over 6,200, more than when the reorganization began .

The Worl d Ban k an d th e IM F 19

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World Ban k salarie s ar e no t onl y high , the y ar e ta x free . Hun dreds o f vice-presidents , directors , an d eve n "technica l advisers " earn i n exces s o f $100,00 0 pe r year . Moreover , thei r annua l in creases regularl y excee d th e inflatio n rat e i n th e Unite d States . Further, ever y staf f m e m b e r whos e spous e earne d les s tha n $10,000 th e previou s yea r wa s entitle d t o a $3,00 0 salar y supple ment. I n additio n t o fre e medica l car e an d lif e insurance , ever y m e m b e r i s eligibl e fo r $5,48 0 i n educatio n grant s pe r chil d age s 5 to 24 , home-leave trave l fo r themselve s an d thei r famil y includin g $1,070 i n pocke t mone y fo r themselve s an d $53 4 fo r a spous e an d each chil d pe r tri p (Irwi n 1990a , 5) . Finally , abou t 1 0 percen t o f its tota l administrativ e budge t i s spen t o n travel , first class , Irwi n adds, "neve r economy " (1990a , 7) . Moreover, th e Bank' s incentiv e t o "len d big , len d fast " ha s redounded t o th e benefi t o f larg e Western-base d multinationa l corporations (MNCs) . For example , a $1 5 millio n high-tec h irriga tion projec t buil t o n th e bank s o f th e Nige r Rive r i n Afric a wa s financed b y a n ID A gran t an d buil t b y Wester n contractors . I t ha s been abandone d b y th e Nige r governmen t becaus e i t canno t affor d the extraordinar y operatin g cost s o f th e project . Yet , jus t a fe w miles awa y ID A mone y i s bein g spen t t o finance th e constructio n of another , identical , project . Th e onl y beneficiarie s o f suc h multi million-dollar project s ar e th e Wester n consultant s an d contrac tors (Hancoc k 1989 , 155) . Th e Worl d Ban k acknowledge s tha t 7 0 percent o f th e mone y i t loan s ou t t o Thir d Worl d government s i s actually spen t o n good s an d service s provide d b y businesse s i n th e wealthy industrialize d countrie s (Hancoc k 1989 , 159 ; Lapp e e t al . 1981,90). And finally, i t i s important t o understand tha t OD A "goes no t t o the pitiabl e figures w e se e on ai d poster s o r i n ai d advertisements " (Bauer an d Yame y 1983 , 125) , i t goe s t o thei r rulers . Dispensin g aid o n th e basi s o f need , a s ha s becom e increasingl y th e cas e with th e IBR D an d th e IDA , create s a trul y pervers e incentive : i t provides Thir d Worl d ruler s wit h a veste d interes t i n perpetuatin g the povert y o f thei r ow n subjects . I f th e recipien t countr y wer e actually t o develop , it s ruler s woul d los e thei r ai d money . Thus , the incentiv e fo r th e Ban k t o len d i s i n par t responsibl e fo r th e enormous corruptio n commo n i n s o man y Thir d Worl d countries .

200 Davi d Osterfel d It i s not a n acciden t tha t som e o f the world's wealthies t individu als were or are rulers of some of the world's poorest countries. The figures reac h int o th e billion s o f dollars : a n estimate d $1 0 billio n for the Marcoses in the Philippines, $5 billion for Mobutu i n Zaire, and mor e tha n a $ 1 billion fo r Duvalie r i n Haiti . Thi s i s done , i t should b e noted , wit h th e implici t approva l o f th e agencie s in volved. The official nam e for suc h larceny i s "leakage." In brief , foreig n ai d bring s togethe r thre e separat e group s whose interest s li e i n perpetuatin g rathe r tha n eliminatin g Thir d World poverty : th e ai d bureaucrac y itself , gian t corporation s i n developed countries , and ruler s in recipient countries . Crowding out Capital. Finally , ther e ca n b e littl e doub t tha t th e World Ban k ha s retarde d developmen t b y crowdin g ou t privat e capital. I t ha s don e thi s i n a numbe r o f ways. First, b y retardin g market-oriented reforms , i t ha s discourage d privat e investmen t by permittin g government s t o maintai n environment s hostil e t o private enterprise . Second , OD A ha s politicize d th e economy , thereby divertin g energ y fro m productiv e economi c activit y int o lobbying for political largess . And third, the World Bank has regu larly financed projects , an d entir e sectors , tha t woul d hav e bee n developed b y privat e capital . Fo r example , th e Worl d Ban k ha s spent million s of dollars to finance th e Bombay High oil project i n India. Sinc e th e mos t likel y land s fo r finding oi l hav e bee n take n by th e government , th e resul t i s tha t privat e capita l ha s bee n dissuaded from enterin g the area (Krauss 1984 , 169-70). The same is true not only of Bank-financed energ y projects i n general, but of many othe r project s a s well , suc h a s Bank-finance d SOE s i n th e cement busines s i n Algeria, steel i n Brazil, and fertilize r i n India , to cit e jus t a handfu l o f examples . I t i s hardl y surprisin g tha t while LD C borrowin g skyrockete d durin g th e 1970 s an d 1980 , foreign direc t investmen t (FDI ) i n th e LDC s actuall y decline d (Tammen 1989,2) . Not onl y d o suc h project s inhibi t th e Bank' s officia l goa l o f facilitating th e flow o f privat e capita l t o th e Thir d World , th e inefficiency resultin g from th e capital crowd-out retards economi c development an d lower s th e standar d o f livin g o f th e averag e individual i n th e recipien t countries . Thus , th e Ban k i s a t leas t

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in par t responsibl e fo r bot h th e "deb t crisis " an d th e economi c stagnation experience d b y s o man y Thir d Worl d countrie s durin g this period . As Alan Waters , forme r chie f economis t fo r th e U.S . Agency fo r International Development , ha s summarize d (1985 , 7): Foreign ai d i s inherentl y bad . I t retard s th e proces s o f wealt h economi c growth an d th e accumulatio n o f wealt h (th e onl y mean s o f escap e fro m poverty an d degradation) ; i t weaken s th e coordinatin g effec t o f th e mar ket process ; i t pull s entrepreneurshi p an d intellectua l capita l int o non productive an d administrativ e activities ; i t create s a mora l ethica l ton e which denie s th e har d tas k o f wealt h creation . Foreig n ai d make s i t possible for . . . societies to transfer wealt h from th e poor to the rich . The IMF The recor d o f th e IM F i s n o bette r tha n tha t o f th e Worl d Bank . Ironically, create d t o avoi d devaluations , th e IM F ha s becom e their singl e mos t prominen t proponent . Following Mexico' s 198 2 defaul t o n it s foreig n loans , th e IMF , desperately searchin g fo r a ne w rol e followin g th e collaps e o f th e Bretton Wood s syste m i n th e 1970s , assume d th e responsibilit y o f managing th e Thir d Worl d deb t crisi s o f the 1980s . The IM F devel oped a s t a n d a r d packag e o f polic y requirement s a s condition s fo r receipt o f a n IM F loan . Th e condition s wer e (1 ) currency devalua tion i n orde r t o reduce balanc e o f payments difficulties ; (2 ) restric tions o n th e a m o u n t o f credi t an d a reductio n i n th e public-secto r deficit, bot h intende d t o cur b inflatio n b y reducin g domesti c de mand, an d (3 ) removal o f restriction s o n foreig n trad e an d capita l movements, designe d t o facilitat e economi c growt h throug h trad e (Reynolds 1992 , 5-6) . The basi c ide a i s tha t sinc e les s mone y an d credi t woul d b e available, th e pric e o f foreig n good s relativ e t o domesticall y pro duced good s an d service s wil l rise , thereb y reducin g th e deman d for them . Conversely , sinc e domesti c productio n cost s wil l fal l relative t o foreig n costs , th e positio n o f th e devaluatin g countr y will "improve, " tha t is , it s good s wil l becom e les s costly , thereb y stimulating th e d e m a n d fo r it s product s abroad . Thus , import s will fal l a t th e sam e tim e tha t export s increase , thereby alleviatin g its foreig n deb t " p r o b l e m " b y runnin g a hug e trad e surplus .

202 Davi d Osterfel d Significantly, a review o f thirty-four nation s pursuin g IMF-pre scribed devaluatio n policie s foun d tha t inflatio n increase d sig nificantly following devaluatio n an d tha t economi c activit y dropped measurably , a s well . For example , Mexico' s mone y bas e was expandin g a t a rat e o f 11. 6 percent i n 1976 , when i t devalu ated th e peso . B y 1978 , tha t rat e ha d jumpe d t o 108. 9 percen t (Reynolds 1992 , 6-7). Thi s suggest s tha t th e IM F theory contain s a seriou s flaw . It does . Governments burdene d b y debt mus t rais e taxes, whic h i s encourage d b y th e IMF , anyway , i n orde r t o dampen th e deman d fo r foreig n goods . Thi s ha s tw o effects : i t taxes awa y domesti c saving s a t th e sam e tim e renderin g foreig n capital good s mor e expensive . The resul t i s a reductio n i n invest ment, an d thu s productivity . Significantly , th e justification o f th e domestic austerit y progra m i s tha t i t stimulate s exports . Th e problem i s tha t exports ' cost s rise , o r d o no t fall , i n spit e o f th e austerity measures , sinc e th e cost s o f th e capita l good s necessar y to produce th e exports rise as the price of foreign capita l goods , or domestic capital-competin g goods , increase s followin g devalua tion. Thus , IMF-impose d devaluatio n ha s generall y faile d i n it s goal o f stimulatin g increase d exports . Moreover, th e reductio n i n domestic economi c activit y reduce s th e ta x base . Th e resultin g government deficit s requir e increase d taxes , which furthe r retar d economic activity . Wher e thi s i s no t politicall y feasible , th e onl y option i s the printing press, and massive inflation. All of this is the exact reverse of what th e IMF intended (Reynold s 1992 , 5-8). The key question is : Why is a current account s defici t bad ? Th e IMF had pu t muc h emphasi s o n "export-le d growth/ ' Bu t a s Alan Reynolds (1992 , 10-11 ) point s out , wha t i t fail s t o not e i s tha t practically al l o f the world' s develope d countrie s bega n a s debto r nations, that expor t led-growt h followed import-led investment . In order t o understand th e folly o f the IMF devaluation polic y it is necessar y t o examin e th e cause s o f th e so-calle d Thir d Worl d debt crisi s of the 1980s . The oil-price shock of 1973-7 4 resulted i n a massiv e surplu s o f saving s i n th e oil-producin g nations , whic h were recycled t o banks in the developed countries. Since the recession cause d b y th e oil-pric e shoc k reduce d th e deman d i n devel oped countries for investment capital , interest rates declined dras -

The World Bank and the IMF 20 3

Figure 1 . Interest Rate s o n Externa l Borrowing s o f Developin g Countries, 1976-198 7 LIBOR = Londo n interban k offere d rate . Th e nomina l rat e i s th e averag e six month dolla r LIBO R durin g eac h year : th e rea l rat e i s th e nomina l LIBO R de flated b y th e change i n th e export pric e inde x fo r developin g countries . Source: World Bank, World Development Report 1988, Fig. 1.9 , p. 29

tically, with real rates at time s actually below 0 percent (figur e 1) . The 197 4 U.N. Resolution o n th e Establishment o f a New Interna tional Economi c Orde r deliberatel y discourage d foreig n invest ment an d applaude d th e nationalization o f MNCs as the mean s t o liberate LDC s from dependenc e o n th e develope d countrie s o f th e world. Th e resul t wa s a massiv e increas e i n lendin g t o th e LDCs , encouraged, i t mus t b e noted , b y th e availabilit y o f concessiona l loans fro m th e Worl d Ban k an d th e IMF . Significantly, "loan s t o central government s an d stat e owne d enterprise s wer e especiall y

204 Davi d Osterfel d favored b y commercia l banks . Becaus e o f thei r sovereig n statu s these entities were considered t o be low risk. Developing countrie s were happ y t o tak e advantag e o f thi s unaccustome d acces s t o cheap loan s with fe w string s attached" (Worl d Bank 1988 , 28-29). The resul t o f th e confluenc e o f thes e tw o factor s wa s t o reinforc e the declin e o f FDI' s shar e o f tota l foreig n capita l flows t o th e LDCs. The problem wa s that borrowin g and investmen t decisions , for reasons outlined above , were "often impruden t an d resulted i n excessive indebtedness i n a number o f countries. And in a numbe r of countrie s borrowin g fuele d a flight o f capita l tha t draine d th e pool o f resource s fo r investmen t eve n a s th e burden s o f foreig n debt mounted " (Whitehea d 1987 . Also see World Ban k 1988 , 29). One tragic consequence of this is that th e burden o f debt repay ment fel l precisel y o n th e shoulder s o f those leas t abl e t o manag e it: the poor citizens i n the LDCs . They shouldered i t i n the form of higher taxe s an d cutback s i n services . The iron y i s that , fa r fro m liberating th e LDCs , th e switc h fro m FD I t o Ban k loans , fro m equity o r investmen t t o loan s o r debt , place d th e LDC s in a posi tion of even greater dependenc y on the developed world . The proble m i s no t s o muc h a n externa l account s debt , a s th e IMF believes . Afte r all , ever y develope d countr y excep t Englan d became develope d onl y by importing capita l fro m abroad . In fact , as th e Economist (1984 ) pointe d out , th e Unite d State s i n th e nineteenth centur y was , relativ e t o it s gros s domesti c product , even more in debt i n terms of capital flows, than countries such a s Brazil and Mexico were in the mid-1980s. The difference, however , is twofold : (1 ) th e flow o f capita l wa s primaril y i n th e for m o f equity rathe r tha n ban k loans , an d (2 ) th e flow o f capita l wa s primarily t o privat e investor s rathe r tha n t o governments . Th e advantage t o the LDCs of allowing MNC investment i n their coun tries i s tha t i f th e MN C fails , i t i s th e stockholder s i n th e hom e country, and not , as is the case with bank loans, the citizens in th e LDCs, who must bea r th e loss. As Reynolds has summarized (1992 , 10), Developing countrie s ca n clearl y benefi t b y exploiting investmen t oppor tunities beyon d thos e tha t ca n b e financed b y thei r ow n pas t accumula tions o f wealth . Therefore , i t i s no t inherentl y sinfu l fo r growin g econo mies t o remain debto r nations—tha t is , run a current account-deficits —

The Worl d Ban k a n d the IMF 20 5 for man y year s o r eve n decades . If current-account deficit s ar e financed by voluntary, private capita l inflows , the y reflect improve d opportunitie s for profitabl e investmen t an d production, an d make suc h improve d pro duction possibl e (e.g. , b y financing import s o f high-tech equipment) . I n turn, i t i s growth-oriente d policie s tha t mak e th e financing o f current account deficit s possible , becaus e th e prospect o f enlarged outpu t i n the future ca n be discounted i n higher prices of equity and bonds today . In brief , th e curren t accoun t defici t wit h whic h th e IM F seem s so obsesse d i s no t a ver y meaningfu l figure. I f anything , b y com parison wit h bot h th e develope d countrie s durin g thei r formativ e years an d suc h curren t Thir d Worl d succes s storie s a s th e "Asia n NICs," th e deficit s ar e to o small , no t to o larg e (Reynold s 1992 , 18-19). Th e critica l issu e i s no t th e siz e o f th e defici t bu t it s composition.

Conclusions The Worl d Ban k an d th e IM F were bot h establishe d i n 1944 . The former wa s create d t o promot e self-sustainin g economi c develop ment b y facilitatin g th e flo w o f privat e investmen t capital ; th e latter wa s established t o promote a n environmen t o f free trad e b y insuring monetar y stability . Neither succeeded . Th e Worl d Ban k has , on balance , probabl y retarded r a t h e r tha n promote d development , an d supplemente d private capita l rathe r tha n facilitate d it s flow t o the LDCs. Despit e its free-marke t rhetoric , throughou t it s histor y Ban k loan s hav e gone overwhelmingl y t o parastatal s an d SOE s whic h th e Bank , itself, ha s repeatedl y acknowledge d t o b e drain s o n th e economy . The IM F has no t onl y faile d i n it s effort s t o maintai n monetar y stability, bu t ha s pursue d a polic y tha t ha s inflicte d needles s suf fering o n some o f the poorest people s o f the world . Neither wa s needed . A specia l institutio n wa s no t neede d t o insure tha t th e LDC s h a d enoug h capital . I t i s hardly a n acciden t that som e o f th e nation s o f th e worl d ar e highl y develope d whil e others la g fa r behind . Thos e countrie s tha t hav e pursue d w h a t Richard Richardso n a n d Osma n Ahme d (1987 , 23 ) hav e terme d an "enablin g environment " hav e prospered ; thos e nation s tha t haven't, hav e remaine d mire d i n povert y (see , e.g. , Moor e an d

206 Davi d Osterfel d Simon 1989) . An "enabling environment" i s nothing mor e nor les s than a traditiona l nineteenth-centur y libera l economi c order. Th e essential componen t o f a libera l orde r wa s th e limitatio n o f th e government's function s t o th e protectio n o f th e perso n an d prop erty o f eac h individual . Th e law s o r rule s impose d i n th e libera l order wer e essentially negative, that is , they tol d individual s wha t they could not do. This meant tha t i n a such an order each individ ual possesse d a "protecte d domain " (Haye k 1969 , 167 ) withi n which h e o r sh e ha d complet e autonomy . N o one , no t eve n th e state, wa s permitte d t o intervene . Individuals ha d th e righ t t o d o anything the y wished a s long as they di d not violate th e protecte d domain o f othe r individuals . I t followe d tha t al l interaction s be tween individual s wer e voluntary ; the y wer e th e resul t o f mutua l consent and thu s redounded t o the mutual benefit o f all parties in volved. In suc h a n environmen t acces s t o capita l wa s no t a problem . Since investor s di d no t hav e t o fea r tha t thei r capita l woul d b e seized b y th e governments , the y wer e willin g t o inves t a s lon g as the y ha d a reasonabl e expectatio n tha t th e investmen t woul d produce a positiv e return . Th e America n railroad s i n th e nine teenth century , fo r example , wer e buil t wit h Britis h capital , an d America was a debtor nation until World War I. To the extent tha t capital becam e a problem , i t wa s traceabl e t o a country' s ow n domestic policie s o f governmen t interferenc e wit h privat e prop erty and th e market process . Nor wa s a specia l institutio n necessar y t o aver t balanc e o f payments "difficulties. " A nation buyin g mor e abroa d tha n i t wa s importing sa w it s gol d reserve s dwindle , causin g price s t o fall . The lower prices reversed th e flow o f gold as foreign buyer s bega n purchasing domesti c product s a t bargai n prices . Thus , balanc e of payment s problem s wer e self-correcting . Similarly , monetar y stability wa s als o encouraged , sinc e domesti c inflatio n no t onl y discouraged foreig n investmen t bu t encouraged capita l flight . Finally, neithe r th e Ban k no r th e Fun d i s neede d now . A s al ready pointe d out , bot h hav e become , i n essence , institution s i n search o f purposes. Th e Bank wa s originall y establishe d t o facili tate th e flow of private capital an d t o make long-term commercia l

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loans fo r developmen t purposes . It s loan s ar e no w ofte n highl y concessional an d hav e th e effec t o f crowdin g ou t privat e capital . Moreover, th e Ban k increasingl y concern s itsel f wit h short-ter m balance o f payment s problems . Th e IM F wa s create d t o dea l wit h balance o f payments issue s an d t o mak e short-ter m loan s t o facili tate monetar y stability . I t no w make s longer-ter m loan s fo r wha t are, fo r practica l purposes , long-ru n developmen t purposes . Coun tries seriousl y intereste d i n economi c developmen t must , likewise , move t o adop t a n ''enablin g environment' ' b y limitin g govern ment, protectin g privat e property , reducin g taxes , an d allowin g the fre e marke t t o allocat e resource s (see , e.g. , Osterfel d 1992 ; Asman 1992 ; Hudgin s 1990) . Neither th e Ban k no r th e Fun d wa s necessar y i n 1944 ; neithe r is neede d now . Bot h hav e cause d fa r mor e h a r m tha n good . The y should b e abolished .

References Asman, David. 1992 . "Wealth of Naciones." Policy Review (Spring): 38-45. Ayittey, George. 1987 . "Economic Atroph y i n Black Africa." Cato Journal (Spring/Summer): 195-222 . . 1988 . "Afric a Doesn' t Nee d Mor e Foreig n Aid ; I t Need s Less. " Hartford Courant (August 4): B-12. Ayres, Robert. 1983 . Banking on the Poor. Cambridge , Mass.: MIT Press. Bandow, Doug . 1989 . "What's Stil l Wron g wit h th e Worl d Bank? " Orbis (Winter): 73-89, 115. Banks, Arthur . 1991 . Political Handbook of the World 1991. Ne w York : CSP. Bartlett, Bruce . 1986 . "Barber Conabl e at th e World Bank: New Hope fo r World Economic Growth." Heritage Foundation Backgrounder, April 4. Bauer, Peter . 1987 . "Creating th e Thir d World : Foreig n Ai d an d It s Off spring." Journal of Economic Growth (Second Quarter): 11-22 . Bauer, Peter, and Basil Yamey. 1983 . "Foreign Aid : What Is at Stake? " In The Third World, ed. Scott Thompson, 115-35 . San Francisco: ICS. Biersteker, Thomas . 1990 . "Reducing th e Rol e o f th e Stat e i n th e Econ omy: A Conceptual Exploratio n of IMF and World Bank Prescriptions. " International Studies Quarterly 34: 477'-92. Bovard, James . 1988 . "The Worl d Ban k vs . th e World' s Poor. " Freeman (May): 184-87.

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Chapman, Stephen. 1986 . "The Futility of Aid to Africa." Chicago Tribune, June 8 , section 5 , 3. Clark, William . 1981 . "Robert McNamar a a t th e Worl d Bank. " Foreign Affairs (Fall): 167-84. The Economist. 1984 . "Beggaring th e Poor." February 18 , 15-16. . 1991a. "Aid and Enterprise. " May 25, 18. . 1991b . "The IM F and th e Worl d Bank. " Octobe r 12 : special sup plement, 1-48 . Fitzgerald, Randall . 1980 . When Government Goes Private. Ne w York : Universe Books. Goldman, Morris . 1985 . "Multilateral Institution s an d Economi c Devel opment." In U.S. Aid to the Developing World, ed. Doug Bandow. Washington, D.C.: The Heritage Foundation . Hancock, Graham . 1989 . The Lords of Poverty. Ne w York : Atlanti c Monthly Press . Harrod, Roy . 1958 . International Economics. Chicago : Universit y o f Chi cago Press. Hayek, F . A . 1969 . Studies in Philosophy, Politics and Economics. Ne w York: Simon & Schuster. Hudgins, Edward . 1989 . "Wh y th e Worl d Ban k Shoul d Rea d It s Ow n Report." Heritage Foundation Backgrounder, September 22. . 1990 . "Private Property : Th e Basi s o f Economi c Refor m i n Les s Developed Countries." Heritage Foundation Backgrounder, May 24. Hughey, Ann . 1980 . "I s th e Worl d Ban k Bitin g Of f Mor e Tha n I t Ca n Chew?" Forbes May 26, 122-23, 127-28. International Ban k for Reconstructio n an d Development . 1989 . Articles of Agreement. Washington, D.C. : World Bank . Irwin, Michael . 1990a . "Bankin g o n Poverty : A n Insider' s Loo k a t th e World Bank. " Cato Institute Foreign Policy Briefing, Washington, D.C. , September 20 . . 1990b . "Why I'v e Ha d I t wit h th e Worl d Bank. " Wall Street Journal, March 20, A10. Krauss, Melvyn. 1984 . Development without Aid. New York: McGraw-Hill. Lappe, Frances, Joseph Collins , and Davi d Kinley . 1981 . Aid as Obstacle. San Francisco: Institute for Food and Developmen t Policy . Mises, Ludwig von. 1969 . Omnipotent Government. Ne w Rochelle: Arlington House . Moore, Stephen, an d Julia n Simon . 1989 . "Communism, Capitalism, an d Economic Development : Implication s fo r U.S . Economic Assistance. " Heritage Foundation Backgrounder, December 8 . Osterfeld, David . 1972 . "Th e Natur e o f Moder n Warfare. " Freeman (April): 205-11. . 1992. Prosperity versus Planning: How Government Stifles Economic Growth. New York: Oxford Universit y Press .

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Pomfret, Richard . 1992 . Diverse Paths of Economic Development. Heme l Hempstead, England : Harvester-Wheatsheaf . Reynolds, Alan . 1992 . The IMF's Destructive Recipe of Devaluation and Austerity. Indianapolis : Hudson Institute . Richardson, Richard , an d Osma n Ahmed . 1987 . "Challeng e fo r Africa' s Private Sector." Challenge (January/February): 16-25 . Sowell, Thomas . 1983 . The Economics and Politics of Race. Ne w York : William Morrow . Tammen, Melanie . 1989 . "Energizing Thir d Worl d Economies : Th e Rol e of Debt-Equity Swaps. " Heritage Foundation Backgrounder, Novembe r 8. Tendler, Judith . 1971 . Inside Foreign Aid. Baltimore: Johns Hopkin s Uni versity Press . Waters, Alan. 1985 . "In Africa' s Anguish , Foreig n Ai d Is a Culprit. " Heritage Foundation Backgrounder, August 7 . Whitehead, Joh n C . 1987 . "Thir d Worl d Dilemma : Mor e Deb t o r Mor e Equity?" Address t o the Council on Foreign Relations , New York City. Washington, D.C. : Department o f State, October 21. World Bank. Various years. World Development Report. New York: Oxfor d University Press .

8 Does Easter n Europ e Nee d a Ne w (Marshall) Plan ? Steven Horwit z

With th e collaps e o f th e Sovie t Unio n an d th e Soviet-styl e econo mies o f Easter n Europe , th e questio n o f refor m ha s com e t o th e forefront. Mor e particularly ther e has been much discussio n of the role o f th e West i n an y refor m program . Thoug h mos t peopl e fee l that ther e i s somethin g Wester n countrie s ca n d o fo r Easter n Europe, ther e i s a sens e o f los s o r confusio n abou t exactl y wha t should b e done . One ide a tha t ha s bee n th e focu s o f som e signifi cant discussio n i s t o devis e anothe r versio n o f th e so-calle d Mar shall Plan , officiall y th e "Europea n Recover y Program " (ERP) , implemented i n 194 8 t o rescu e th e war-tor n economie s o f post World Wa r I I Wester n Europe . Proponent s o f thi s ide a sugges t that a new Marshall Pla n could provide th e resources and policie s that th e forme r Soviet-styl e economie s nee d t o mak e th e transi tion to market economies . Before adoptin g a ne w Marshal l Plan , i t i s crucia l tha t w e understand th e ol d on e a bi t better . I n particular , w e nee d t o examine thre e aspect s o f th e Marshal l Plan : (1 ) why Wester n Eu rope neede d America n help ; (2 ) th e for m suc h hel p took ; an d (3 ) the politica l an d economi c idea s tha t informe d th e Pla n an d it s creators an d implementers . Wit h thi s understandin g o f th e Mar 210

Does Eastern Europ e Need a New (Marshall) Plan? 21 1 shall Plan , we can tur n t o the present situatio n i n Eastern Europ e and explor e th e implication s o f a ne w Marshal l Pla n there . Wha t we wil l find i s tha t th e idea s tha t informe d th e origina l Marshal l Plan, namel y tha t conscious , planne d politica l interventio n an d design ar e neede d t o creat e economi c institution s an d guid e eco nomic growth, are th e very same idea s responsible fo r th e curren t economic disaste r i n Eastern Europe . Given this, proposing a ne w Marshall Pla n t o solv e it s problem s ca n b e likene d t o givin g fre e liquor to an alcoholic .

Economic Developmen t an d Economic Plannin g As a numbe r o f other contributor s t o thi s volum e hav e indicated , there are important link s between how one views debates over th e relative merit s o f market s an d plannin g an d ho w on e view s th e appropriate policie s fo r economi c development . Fo r defender s o f planning, government , perhap s i n combination wit h busines s an d labor, bot h ca n an d shoul d pla y a majo r rol e i n directin g th e path o f economi c developmen t throug h particula r policie s an d strategies. Fo r defender s o f markets , n o suc h directio n i s neces sary. B y simpl y ensurin g th e rul e o f la w an d th e protectio n o f voluntary contrac t an d exchange , government s ca n cultivat e a fertile soi l for economic growt h an d development . As a result, it i s crucial t o understan d theoretica l debate s ove r th e feasibilit y o f planning before on e prescribes development policies . These issue s becom e eve n mor e relevan t i n discussin g develop ment i n Easter n Europe . For fifty years or more , the economies of Eastern Europ e ha d bee n guide d b y th e ideolog y o f economi c planning. Th e officia l economi c philosoph y state d tha t market s were bot h exploitativ e an d inefficien t an d tha t onl y conscious , collective plannin g guide d b y th e enlightene d Part y leadershi p could ensur e bot h economi c growt h an d som e notio n o f socia l justice. However, bot h th e actua l experience s o f thes e economie s and th e theoretical discussion s amon g economists lea d t o a differ ent conclusion . Despit e apparentl y acceptabl e growt h a s mea sured b y GDP , Eastern Europea n economie s hav e bee n unabl e t o provide th e averag e citize n wit h a standar d o f living clos e t o tha t

212 Steve n Horwit z of th e West . Thi s lac k o f economi c growt h i s on e ke y facto r i n fueling th e political an d economic changes currently takin g place. Although th e economic s professio n i n genera l sa w n o reason t o believe tha t plannin g wa s doome d t o fail , som e economist s ha d long argued tha t planning would be unable to match the efficienc y of th e market . Th e origina l argumen t wa s mad e b y Ludwi g vo n Mises ([1920 ] 1935). 1 Mises argue d tha t th e efficien t allocatio n o f resources required som e standard b y which t o compare the value s of thei r alternativ e uses . Suc h a standar d coul d b e provide d b y money price s becaus e al l good s trade d i n market s exchange d against money , which provide s th e standard o f comparison. How ever, fo r mone y price s t o b e meaningfu l the y ha d t o resul t fro m true market exchange , and tru e market exchang e required privat e ownership o f resources , particularl y th e mean s o f production . Thus, th e planne d economy , whic h almos t b y definitio n exclude s the privat e ownershi p o f productio n goods , woul d no t hav e ex change, markets , o r mone y prices . Lackin g mone y prices , Mise s claimed, planner s woul d b e unabl e t o kno w whethe r the y ha d rationally allocate d thei r resources . A s a result , on e woul d no t expect planne d economie s t o achiev e rate s o f growt h an d stan dards of living equal t o those of market economies . F. A. Hayek followe d u p o n Mises's original insight s by arguin g that th e rea l issu e wa s epistemological . Th e advantag e tha t mar kets have ove r planning i s that the y ca n mak e use of more knowl edge. In a serie s o f paper s i n th e 1930 s an d 1940s , Hayek argue d that markets , throug h th e proces s o f exchange, could incorporat e and disseminat e knowledg e tha t coul d no t b e communicate d through socia l coordinatio n processe s base d o n languag e alon e (Hayek 1948) . Much that huma n being s know (and that i s relevant for th e allocatio n o f resources) i s not know n i n a form tha t ca n b e articulated. Ye t thi s knowledg e ca n stil l b e utilize d b y other s when i t i s embodie d i n socia l institution s suc h a s prices . Mises' s original poin t concernin g th e indispensabilit y o f price s i s ampli fied b y Hayek , wh o pointe d ou t tha t thi s indispensabilit y wa s based on the ability o f prices to communicate knowledge . The problem fo r plannin g i s that th e attemp t t o centrally mar shal economi c knowledg e canno t possibl y incorporat e a s muc h knowledge a s can a decentralized pric e system. The prices forme d

Does Eastern Europ e Need a New (Marshall) Plan? 21 3 from unhampere d marke t exchang e enabl e actor s t o us e mor e o f the knowledg e o f others , heightenin g economi c coordinatio n an d order. Th e ke y t o economi c developmen t i s t o giv e th e pull s an d tugs of the marke t maximu m feasibl e freedo m t o drive th e forma tion o f prices an d th e allocatio n o f resources. To the exten t price s are establishe d b y markets , economi c system s wil l b e abl e over come th e inevitabl e dispersio n o f knowledge tha t plague s huma n attempts a t social interaction . What thi s argumen t implie s i s a differen t wa y o f lookin g a t how economie s achiev e growt h an d development . Onc e on e get s beyond directe d plannin g a s the mean s t o growth, one should as k what kind s o f institutiona l arrangement s ar e mor e likel y t o lea d to prices best performing thei r coordinative role . Economic devel opment, o n thi s view , refer s t o th e abilit y o f individual s t o for m increasingly reliabl e set s of expectations base d o n th e signals em bodied i n marke t price s an d profits . Th e mor e price s ar e abl e t o accurately reflec t th e knowledg e o f others , th e mor e easil y ca n individual economi c actor s mak e us e o f tha t knowledg e t o for m expectations abou t others . The mor e reliabl e ar e expectation-for mation processes , th e easie r i t i s fo r individual s t o coordinat e their decision s wit h eac h other . I t i s thi s coordination , i n combi nation wit h th e increasin g complexit y an d creativit y i t brings , that constitute s economic growth an d increasing economic order. 2 The ver y botto m lin e fo r economi c developmen t i s whethe r indi viduals ar e mor e easil y achievin g mor e o f thei r ends . If the y ar e doing so, then th e economy is developing. It i s als o importan t t o poin t ou t tha t thi s argumen t i s no t simply a critique of comprehensive attempt s at planning; it applie s to more piecemeal type s of intervention a s well. Economic regula tion, central ban k policy , an d othe r macroeconomi c tools , as wel l as antitrust policy , are all plagued by smaller, but no less intracta ble, version s o f thi s knowledg e problem. 3 Thi s order-base d per spective o n economi c growt h ca n als o explai n th e problem s Keynesian-type activis t polic y ha s face d ove r th e las t thirt y year s and wh y usin g suc h policie s i n th e pursui t o f economi c devel opment i s likel y t o fail . Wit h thes e idea s i n mind , w e tur n to the Marshall Pla n an d Easter n Europea n recover y mor e specifi cally.

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The Goals , Ideology , an d Policie s o f th e Marshal l Pla n The circumstance s tha t gav e ris e t o th e Marshal l Pla n ar e fairl y straightforward. A t th e en d o f Worl d Wa r II , Western Europ e wa s in ruins , i n term s o f bot h physica l an d h u m a n capital . Politica l systems ha d bee n undermine d b y th e w a r an d th e event s prio r t o it, an d economi c resource s ha d bee n destroye d o r ha d dramati cally deteriorated . Th e tas k facin g th e victoriou s Allie s wa s re building an d revitalizin g Wester n Europ e t o bring i t bac k int o th e world economy . I n addition , tha t rebuildin g proces s coul d no t overlook th e threa t pose d b y th e apparen t militar y an d economi c power o f th e Sovie t Union . On e grea t fea r amon g th e architect s o f the Marshal l Pla n wa s tha t i f th e Unite d State s di d nothin g fo r Western Europe , i t woul d quickl y fal l unde r Sovie t militar y and / or economi c domination . Th e tas k the n wa s t o provid e fund s fo r rebuilding th e resource s destroye d b y th e war . Aside fro m a genera l rebuildin g o f thei r economies , postwa r analysts wer e ver y concerne d tha t th e nation s o f Wester n Europ e be reintegrate d int o th e worl d economy . A s historia n Michae l Hogan (1987 , 26 ) argues , "Policymaker s i n th e Truma n adminis tration wer e convince d tha t a 'dynami c economy ' a t hom e re quired America n trad e an d investmen t abroad , whic h i n tur n re quired th e reconstructio n o f majo r tradin g partner s i n Europ e an d their reintegratio n int o a multilatera l syste m o f worl d t r a d e / ' There wer e tw o majo r reason s behin d th e pus h fo r integration . One wa s tha t Wester n Europ e wa s a n importan t sourc e fo r U.S . trade an d tha t onl y health y economie s ther e coul d provid e th e resources tha t American s desired . Th e secon d wa s tha t th e mor e Western Europ e becam e integrate d int o th e worl d economy , th e stronger i t becam e an d th e mor e abl e i t woul d b e t o hol d it s ow n against th e Sovie t threa t fro m th e east . In additio n t o thi s typ e o f integration , U.S . polic y maker s wanted t o se e Wester n Europ e internally integrated . Thi s interna l integration woul d als o be a n effectiv e barrie r agains t Sovie t incur sion an d woul d heighte n th e prospect s fo r a stron g Europea n economy. Importan t t o thi s integratio n wa s th e mode l hel d b y th e architects o f th e Marshal l Plan . A s Hoga n (1987 , 27 ) notes , "Th e Marshall Planner s woul d replac e th e ol d Europea n stat e syste m

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. . . b y applyin g th e America n principl e o f federalis m an d usin g i t to creat e a n integrate d Europea n econom y simila r t o th e on e tha t existed i n th e Unite d S t a t e s / ' Thi s vie w wa s par t o f a mor e genera l strategy o n th e par t o f America n polic y makers . Tha t strateg y envisioned a n exportin g o f th e U.S . political econom y o f th e 1940 s to Wester n Europe . Th e kind s o f change s tha t ha d take n plac e i n the Unite d State s durin g th e Progressiv e Er a an d th e Ne w Deal , specifically th e buildin g o f a corporatis t economi c syste m base d on variou s type s o f private-publi c mixes , wer e t o b e extende d across th e Atlanti c throug h th e vehicl e o f th e Marshal l Plan. 4 Hogan (1987 , 3) describe s th e America n politica l econom y i n question a s founded o n self-governin g economi c groups , integrate d b y institutiona l coordinators an d norma l marke t mechanisms , le d b y cooperating publi c and privat e elite s . . . [which] marrie d th e olde r tradition s . . . [of] indi vidualism, privatism , competition , an d antitrust , t o th e twentieth-cen tury tren d towar d a n organize d capitalis m characterize d b y nationa l economies of scale, bureaucratic planning, and administrative regulation . The resul t becam e a n econom y somewher e i n betwee n a genuin e market econom y an d th e attempt s a t mor e comprehensivel y planned system s emergin g i n th e Sovie t Unio n an d China . Crucia l to understandin g th e evolutio n o f th e U.S . political econom y wa s that th e increas e i n governmen t interventio n wa s generall y wel comed b y th e corporat e communit y wh o sa w governmen t a s a force fo r stability , order , an d securit y agains t th e uncertaint y o f intensifying competition . A s Kolko , Wiebe , an d Weinstei n docu ment, muc h o f th e Progressiv e Er a legislation , an d late r th e Ne w Deal, wa s see n b y corporat e interest s a s a wa y t o loc k i n thei r wealth an d status , becaus e i t woul d b e the y wh o woul d hav e the mos t expertise , an d therefor e influence , i n th e newl y create d regulatory structures . With thes e change s an d thei r apparen t popularit y an d succes s as th e backdrop , th e Marshal l Pla n becam e a n obviou s wa y t o extend America n idea s int o a reconstructe d Wester n Europe . I n particular, thi s effor t wa s infuse d wit h a n optimisti c (i n retro spect, naive ) sens e o f wha t consciou s reconstructio n coul d do . Hogan (1987 , 19 ) captures thi s spiri t whe n h e argue s tha t "Ameri can Marshal l Planner s . . . trie d t o transfor m politica l problem s

216 Steve n Horwit z into technica l one s tha t wer e solvable , the y said , whe n ol d Euro pean way s o f conducting busines s an d ol d habit s o f clas s conflic t gave way t o American method s of scientific managemen t an d cor porative collaboration/ ' On e majo r se t o f player s i n thi s proces s were privat e foundation s an d researc h institution s suc h a s th e Ford Foundation . A s Salli e Pisan i (1991 , 47 ) describe s it , "Th e Ford Foundatio n wa s established o n th e principle tha t th e behav ioral science s provide d a scientifi c basi s fo r expert s t o hel p th e citizens o f underdeveloped nation s improv e thei r standar d o f liv ing/' Pisan i point s ou t tha t a numbe r o f Marshall Pla n personne l had connection s wit h th e For d Foundatio n an d tha t i t wa s at tempting t o be an additiona l ar m fo r implementin g U.S . development policy . Mor e specifically , For d peopl e though t tha t th e ke y to U.S. economic success was that i t had a class of small business men who were supportive o f government intervention . As a result , Ford "attempte d t o recreate America , a s the y imagine d it , i n for eign lands . This typ e of mythological handlin g o f whole classes of individuals appeare d i n Marshal l Pla n effort s i n Europe " (Pisan i 1991, 48). For th e intellectual s behin d th e Marshal l Plan , it was a chance t o make Europe in their own image: the corporatist state . An exampl e o f thi s mi x o f scientisti c plannin g an d private public combination woul d be the investment guarantee s provide d by th e U.S . governmen t unde r th e Marshal l Plan . U.S . corpora tions coul d submi t investmen t project s t o Pla n official s and , i f they wer e consisten t wit h th e aim s o f th e Pla n an d approve d by th e Pla n bureaucrats , th e U.S . governmen t woul d provid e a guarantee fo r th e valu e o f th e projec t (Wexle r 1983 , 88) . I f th e project shoul d fail , th e U.S . government woul d pa y bac k th e pri vate investor . Unde r th e guidanc e o f knowledgeabl e pla n imple menters, private source s of capital could be tapped an d redirecte d toward "prope r usages " wit h littl e effectiv e ris k t o th e investor . Ironically, th e progra m wa s a failure, a s only abou t 1 0 percent o f the fund s allocate d fo r guarante e purpose s wer e actuall y used . Immanuel Wexle r (1983 , 89) argues tha t eve n with th e guarantee , U.S. firms wer e reluctan t t o hav e thei r investmen t project s over seen b y bot h th e administrator s o f th e Marshal l Pla n an d th e various European governments . In essence, the Marshall Plan was an attempt a t noncomprehen -

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sive economi c planning . Enlightene d an d experience d economists , businesspeople, an d administrator s fro m th e Unite d State s woul d formulate an d implemen t a serie s o f proposals tha t woul d provid e the concret e step s towar d Europea n economi c recovery . I n addi tion t o th e genera l tren d towar d governmenta l plannin g i n tha t era, i t wa s als o th e heigh t o f th e Keynesia n revolutio n i n econom ics. Th e managemen t o f macroeconomic s wa s deeme d t o b e ame nable t o th e sam e principle s o f scientifi c managemen t an d public private cooperatio n tha t wa s happenin g a t th e industr y level . Many o f th e specifi c provision s o f th e Marshal l Pla n deal t wit h financial integratio n an d macroeconomi c managemen t an d wer e based o n explicitl y Keynesia n premises. 5 W e ca n ge t a flavo r fo r the plannin g aspec t o f th e Marshal l Pla n b y lookin g a t bot h th e general directio n i t se t fort h an d som e o f th e specifi c polic y direc tives i t initiated . W e wil l conclud e thi s sectio n wit h som e brie f remarks o n it s successe s an d failures . While acknowledgin g tha t th e long-ter m goa l o f th e Europea n Recovery Progra m wa s integratio n base d o n generall y market oriented principles , th e short-ter m strategie s adopte d b y th e implementers o f th e Marshal l Pla n wer e anythin g bu t market oriented. Thei r broa d approac h include d a "supranationa l plan ning authorit y wit h th e powe r t o allocat e resources , se t produc tion targets , an d foste r integration " (Hoga n 1987 , 57 ) Th e Mar shall Pla n explicitl y di d no t wis h t o allo w Europea n recover y an d integration t o tak e plac e throug h spontaneou s marke t mecha nisms, rathe r th e pla n wante d " a Europea n orde r superintende d by centra l institution s wit h th e powe r t o coordinate nationa l econ omies" (Hoga n 1987 , 328) . A s Nichola s Eberstad t (1991 , 27 ; em phasis i n original ) observes , "th e ER P actuall y required recipien t states t o engag e i n economi c plannin g i n orde r t o obai n aid." 6 The mos t obviou s exampl e o f thes e attempt s a t economi c plan ning, an d thei r ultimat e failure , revolve d aroun d th e us e o f pro duction target s a s recover y goals . Productio n plan s an d target s were centra l t o th e ERP . Europea n leader s wer e expecte d t o pla n for strategi c economi c decision s an d us e "indicativ e economi c planning" t o stee r th e p a t h o f recover y (Hoga n 1987 , 151-52) . The Economi c Cooperatio n Administratio n (ECA) , whic h ra n th e Marshall Pla n i n Europe , propose d usin g it s contro l ove r th e loca l

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currency disbursemen t o f America n grant s ''t o brin g th e Europe ans int o lin e wit h it s production , trade , an d financial objectives' ' (Hogan 1987 , 152) . This confirm s Eberstadt' s linkag e betwee n U.S . aid an d planning . Thes e productio n target s wer e se t no t simpl y for overal l output , bu t als o fo r variou s individua l commodities , such a s coal , iron , steel , etc . Fo r example , Wexle r (1983 , 75 ) re ports tha t afte r th e first yea r o f th e ER P onl y thre e o f twelv e major commodit y productio n target s ha d bee n exceeded , thos e fo r coarse grains , tin , an d suga r beets . Not surprisingly , th e proces s o f settin g productio n target s wa s not th e objectiv e scientifi c plannin g proces s tha t th e planner s might hav e hope d for . A s Wexler (1983 , 82ff. ) notes , meetin g thos e targets wa s complicate d b y variou s special-interes t provision s that th e U.S . Congres s ha d incorporate d int o th e Marshal l Plan . For example , ther e wa s a requiremen t tha t a t leas t 5 0 percen t o f cargo financed b y th e ER P an d procure d i n th e Unite d State s b e shipped i n vessel s flagged i n th e Unite d States . No t onl y di d thi s add a n additiona l regulator y burde n o n th e plan' s administrators , it mad e achievin g productio n target s mor e difficul t i f the requisit e ships coul d no t b e found . There wa s als o a requiremen t tha t a quarte r o f al l whea t ex ports financed b y th e ER P ha d t o b e exporte d a s flour mille d i n the Unite d States . Another gav e th e Departmen t o f Agriculture th e ability t o declar e tha t th e Unite d State s ha d surpluse s o f variou s agricultural commodities , forcin g th e EC A t o purchas e th e com modity i n questio n fro m U.S . farmers fo r us e i n Wester n Europe . These purchase s wer e als o subsidize d b y th e U.S . government "b y as muc h a s 5 0 percen t o f th e marke t cost " (Milwar d 1984 , 121) . Mil w a rd conclude s tha t "i t i s ver y likel y tha t th e ER P induce d a higher leve l o f Unite d State s foo d export s t o Wester n Europ e tha n would hav e otherwis e bee n th e case. " Althoug h thi s polic y migh t have hel p U.S . farmers , wha t i t di d fo r Wester n Europea n recov ery, an d U.S . taxpayers , i s questionable . Tyle r Cowe n (1985 , 71-72) als o discusse s variou s special-interes t provision s fo r Vir ginia tobacc o growers , U.S . drie d frui t manufacturers , past a pro ducers, truc k manufacturers , an d oi l companies . Th e latte r wer e able t o sel l oi l throug h th e EC A a t price s wel l ove r th e cos t o f production, thank s t o Marshal l Pla n ai d provisions .

Does Eastern Europ e Need a New (Marshall) Plan? 21 9 A further proble m wit h productio n target s wa s tha t the y wer e inevitably quantitativ e an d aggregative . Th e Marshal l Planner s were infatuate d wit h meetin g aggregat e productio n target s an d paid littl e i f any attentio n t o th e compositio n o f output. 7 Succes s of the Plan was to be determined b y whether these aggregate goal s were met , independen t o f ho w tha t productio n migh t relat e t o the demand s o f consumers . Give n ou r previou s discussio n o f th e importance o f coordinatio n fo r economi c growth , thi s resul t should no t b e surprising . T o th e exten t tha t planner s canno t ac quire th e detaile d knowledg e neede d t o perfor m thes e coordina tive functions, th e best the y ca n d o is to rely on aggregate targets . Even if such production target s are met, there is no assurance tha t they relat e t o th e want s o f th e public . On e ca n easil y increas e output a s measure d b y GD P b y producin g item s tha t peopl e d o not reall y want . Th e questio n i s whethe r w e wan t t o cal l thi s economic growt h an d us e i t a s a n appropriat e strateg y fo r devel oping an economy . One o f th e majo r strategie s fo r integratin g th e Europea n econ omy wa s t o brea k dow n th e nationa l barrier s agains t fre e trad e and organiz e som e for m o f currenc y payment s process . Th e implementers o f th e Marshal l Pla n attempte d t o d o s o throug h various negotiatin g strategie s an d a sequentia l proces s o f movin g toward genuin e multilatera l trade . Rathe r tha n allo w trad e agreements an d payment s institution s t o emerge throug h sponta neous market processes , the planners attempte d t o rationally con struct variou s schemes , a number o f which prove d t o be les s tha n successful. Eberstad t (1991 , 27), for example, mentions th e syste m of bilateral drawin g rights established b y the Marshall Plan. 8 Thi s was intende d t o b e a n intermediar y ste p towar d tru e multilater alism, bu t woun d u p "subsidizin g government s wit h overvalue d currencies an d larg e trad e deficit s an d . . . penalized government s that attempted t o maintain disciplin e in their accounts/' Belgium , for example , which hel d th e lin e on fiscal policy, lost four-fifths o f its dolla r ai d durin g thi s bilatera l drawin g system . Onc e again , a well-intentioned attemp t a t constructin g economi c institution s was disrupted b y unforseen an d unintended consequences . One las t poin t shoul d als o b e noted . A s the ER P continue d on , the nature of much of the direct ai d changed. With the outbreak of

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the Korea n Wa r i n 1950 , an d generall y heightene d fea r o f th e Soviet military , muc h o f th e direc t ai d becam e tie d t o militar y considerations. Th e Marshal l Pla n slowl y evolve d int o a n attemp t to r e a r m Wester n Europ e t o forestal l th e Sovie t threat . Man y o f the plan s an d productio n target s wer e altere d t o fit thi s ne w direc tion. I n thinkin g abou t futur e Marshal l Plan-typ e ai d packages , the possibilit y o f thi s kin d o f outcom e shoul d b e considered . Thi s result shoul d als o no t b e a surprise . As some author s hav e argued , any a t t e m p t a t economi c plannin g wil l hav e t o involv e th e coerce d mobilization o f peopl e an d resources , no t unlik e ho w on e migh t prepare fo r war . Do n Lavoi e (1985b , 320 ; emphasi s i n original ) makes thi s poin t quit e clearly : "Plannin g doe s no t accidentall y deteriorate int o th e militarizatio n o f th e economy ; i t is th e milita rization o f th e economy. " These ar e jus t a fe w example s o f th e plannin g aspect s o f th e Marshall Plan . My purpose her e i s not t o discuss thi s point exhaus tively; rathe r I w a n t t o giv e a flavo r fo r th e kind s o f policie s an d attitudes enforce d b y th e Plan' s creator s an d implementers . I als o want t o touc h briefl y o n whethe r th e Pla n wa s a success . I f b y a success w e mea n di d th e economie s o f Wester n Europ e recove r t o prewar levels , th e answe r i s yes. But ho w muc h o f tha t recover y i s due t o th e ERP ? Scholar s ar e unclea r o n th e answe r t o this . Th e general consensu s i n recen t year s seem s t o b e tha t th e effect s o f the Marshal l Pla n wer e marginal . Whethe r tha t margi n wa s th e crucial margi n i s th e issue . Ala n Milwar d (1984 , 91 ) argue s tha t Marshall Pla n ai d simpl y spe d u p a recover y tha t wa s alread y under way : "quantitativ e measure s o f [ERP's ] impac t o n th e Eu ropean economie s sugges t tha t th e contributio n wa s greatl y exag gerated b y Col d Wa r historians." 9 Hoga n (1987 , 437ff. ) i s a bi t more positive , arguin g tha t althoug h th e effec t o f th e Marshal l ai d was marginal , i t wa s a margi n tha t m a d e a difference. 10 Howeve r the success , o r lac k thereof , o f th e Marshal l Pla n i s independen t o f whether i t i s a usefu l mode l fo r Easter n Europ e today . A s we shal l see below , th e circumstances , goals , an d especiall y th e ideolog y have changed , an d s o ha s th e relevanc e o f a Marshal l Plan-typ e o f aid package .

Does Eastern Europ e Need a New (Marshall) Plan? 22 1 A New Marshal l Pla n for Eastern Europe ? Fundamentally, th e proble m face d b y a ne w Marshal l Pla n fo r Eastern Europ e i s tha t th e Marshal l Pla n wa s a plan . Th e condi tion tha t Easter n Europ e finds itsel f i n i s the resul t o f the failure s of economi c plannin g a s discusse d earlier . Wh y shoul d w e no w believe tha t a new pla n wil l b e an y bette r tha n th e ol d one(s) ? As the histor y o f th e Marshal l Pla n indicates , i t wa s no t simpl y a package o f pur e financial assistance . I t involve d th e us e o f eco nomic plannin g an d intentiona l macroeconomi c coordinatio n i n the countrie s tha t receive d ER P aid . Wit h a les s naiv e vie w o f what ca n be accomplished throug h economi c planning, we can b e notably mor e skeptica l concernin g th e succes s of any ai d packag e modeled afte r th e Marshall Plan . That havin g bee n pointe d out , we can als o see that th e circum stances an d need s of Eastern Europ e ar e very differen t fro m thos e faced b y th e Wester n Europea n economie s afte r Worl d Wa r II . Those economie s wer e onc e developed economie s tha t ha d bee n destroyed b y th e war . Th e ai m o f th e Marshal l Pla n wa s t o hel p them "reattain thei r prewar levels of output" (Eberstadt 1991 , 27). The pla n wa s clearl y no t a progra m fo r economi c development ; instead "th e Marshal l Pla n financed Wester n Europe' s return to normalcy. I t di d no t sponso r it s progres s t o som e ne w stag e i n economic o r politica l development " (Pfaf f 1987 , 72 ; emphasi s i n original).11 On e explanatio n i s tha t althoug h th e wa r destroye d resources, it did not destroy a history of economic institutions an d practices tha t coul d fairly easil y be recovered once resources wer e back i n place. 12 Mor e specifically , Wester n Europ e wa s discon nected fro m th e broadly libera l institution s o f property right s an d freedom o f contrac t an d exchang e fo r onl y a fe w shor t years . Eastern European s hav e ha d a t leas t tw o generation s pas s sinc e those institution s wer e eve n a smal l par t o f th e fabri c o f thei r societies.13 The task facing refor m i n Eastern Europ e is not merel y acquiring resources , bu t discoverin g a n institutiona l framewor k within whic h resource s ca n b e use d efficientl y an d economi c growth ca n tak e place. The important poin t i s that n o matter ho w well o r ho w poorl y th e Marshal l Pla n worke d a t th e time , th e problems facin g Easter n Europ e ar e vastly differen t fro m thos e of

222 Steve n Horwit z Western Europ e afte r Worl d Wa r II . Ad d t o tha t th e critiqu e o f economic planning an d th e Marshall Pla n becomes a doubly dubi ous model for economic development i n Eastern Europe . Given this perspective, the question facin g Easter n Europ e con cerns ho w libera l institutiona l framework s gro w an d evolve . One answer t o thi s questio n come s fro m th e sam e thinker s wh o wer e so influentia l i n arguin g tha t economi c plannin g wa s doome d t o fail. Fo r Haye k (1988) , th e flip sid e o f th e impossibilit y o f con scious socia l plannin g i s tha t beneficia l socia l institution s hav e and shoul d aris e a s set s o f unintende d consequence s drive n b y humanity's constan t searc h fo r ne w knowledg e an d ne w way s o f improving itself . Haye k an d othe r Austria n Schoo l economist s have argue d tha t thes e spontaneou s evolutionar y processe s appl y not jus t t o th e economi c activitie s tha t tak e plac e i n a societ y under th e rul e o f la w an d bounde d b y a stabl e monetar y system , but t o the very institutions o f law and mone y themselves . If a preconditio n fo r economi c growt h i s a stron g lega l frame work protecting propert y right s an d contracts , then suc h a frame work ca n bes t b e foun d throug h a proces s o f lega l evolution , no t through a conscious attempt a t design . The same can be said for a monetary order . A stable monetar y framewor k ca n best be discov ered by allowing monetary arrangement s t o evolve within the rul e of law. 14 Fo r Easter n Europ e t o recove r wha t i t ha s lost , Wester n attempts t o "create " legal an d monetar y institution s wil l hav e t o be abandone d i n favo r o f allowin g th e discover y processe s o f th e market, a s the y emerg e i n eac h o f th e reformin g countries . Onl y these evolutionar y processe s ca n mak e us e o f th e knowledg e needed t o effec t economi c coordinatio n an d enhanc e economi c growth. Give n th e stat e o f th e U.S . lega l syste m an d financial system, sendin g lawyer s an d centra l banker s t o the former Sovie t Union t o assis t i n designin g lega l an d monetar y system s ther e i s highly questionable . These argument s ar e no t limite d t o microeconomi c plannin g and th e plannin g o f institutions , the y als o appl y t o th e kind s o f Keynesian macroeconomic policies used by the Marshall Planners . In th e sam e wa y tha t microeconomi c coordinatio n canno t b e produced b y consciou s design , neithe r ca n macroeconomi c coordina tion. Wester n marke t economie s hav e learne d th e lesson s o f at -

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tempts a t Keynesia n deman d management . Th e inflatio n an d stagnation i n th e Unite d State s i n th e 1970 s shoul d cautio n East ern European s agains t attempt s t o imitat e thos e policie s i n th e reform process . The sam e kind s o f knowledge problem s tha t le d t o the downfal l o f plannin g i n thos e countrie s ar e likel y t o plagu e less comprehensiv e attempt s t o " m a n a g e " (i.e. , plan ) th e macro economy. How , fo r example , ar e macroeconomi c manager s t o know th e d e m a n d fo r money , o r th e "appropriate' ' leve l o f aggre gate demand ? Wha t industrie s shoul d b e th e recipient s o f at tempts t o boos t aggregat e deman d throug h governmen t expendi tures? Wha t i s t o ensur e tha t th e chose n industrie s ar e one s tha t will delive r th e good s tha t consumer s w a n t ? 1 5 And , ho w ar e suc h policies differen t fro m th e plannin g processe s responsibl e fo r th e current economi c situatio n i n Easter n Europe ? Rather tha n focusin g o n U.S . financial ai d o r immodes t at tempts a t designin g ne w socia l an d economi c institutions , re forming Easter n Europ e require s th e expor t o f ideas an d practices . What th e Wes t ha s t o offe r i s no t mone y an d capita l bu t a mode l of ho w t o achiev e economi c growt h b y givin g a s muc h scop e a s possible t o th e spontaneou s force s o f entrepreneurial discovery . O f course, th e Unite d State s i s no t perfec t i n thi s regard , bu t th e history o f th e las t tw o hundre d year s i s no t t o b e take n lightly , and th e Wester n tradition s o f privat e property , freedo m o f con tract, an d marke t exchang e hav e reveale d themselve s t o b e th e true cause s o f economi c growth . A s Cowen (1985 , 73) argues, "Th e basic proble m wit h foreig n ai d i s tha t economi c growt h i s no t a creature o f centra l plannin g an d direction . Growt h i s th e resul t of individua l initiativ e an d enterpris e withi n a soun d lega l an d economic framework. " Critics migh t respon d b y grantin g thos e ideas , but stil l claimin g that Easter n Europ e need s capita l t o kick th e proces s int o motion . However, a s Pete r Baue r ha s argued , thi s i s a fallacy . I f th e acqui sition o f capital precede d economi c growth , "th e worl d woul d stil l be i n th e Ol d Ston e Age." 1 6 Rathe r th e acquisitio n o f capital i s th e effect o f economi c growt h an d no t th e cause . Th e caus e i s th e se t of idea s an d practice s tha t allo w th e creatio n o f capita l an d thu s increase th e productivit y o f h u m an labo r an d tota l h u m a n wealth . We emerge d fro m th e Ston e Age , b y

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unintentionally conformin g t o certain traditiona l an d largel y moral practices, many o f which me n ten d t o dislike, whose significance the y usuall y fail t o understand , whos e validit y the y canno t prove , an d whic h hav e nonetheless fairly rapidl y spread by means of an evolutionary selection — the comparative increas e of population an d wealth—of thos e groups tha t happened t o follow the m (Haye k 1988 , 6). The drivin g forc e o f economi c developmen t i s th e se t o f idea s embodied i n th e mora l restrain t tha t permit s spontaneou s pro cesses o f socia l an d economi c discover y t o tak e thei r cours e an d lead u s int o a n unknow n future . Thes e ideas , an d th e institution s that resul t fro m them , canno t b e bough t wit h U.S . tax dollars . I n fact, th e ver y premis e o f usin g ta x dollar s t o " g u i d e " developmen t directly contradict s thos e ideas . Rather , thos e idea s wil l b e imi tated t o th e exten t the y ar e practice d b y th e Wes t an d delive r success. In fact , a s Eberstad t point s ou t (followin g a n u m b e r o f recen t thinkers, especiall y Pete r Bauer) , th e relationshi p betwee n U.S . aid an d economi c developmen t i s a ver y tenuou s one . Eberstad t (1991, 25 ) argues tha t "America n development-assistanc e policies , for man y years , hav e bee n mor e likel y t o lea d a prospectiv e bene ficiary towar d a n Easter n Europe-styl e economi c moras s tha n t o help i t escap e fro m on e towar d economi c healt h an d self-suffi ciency." H e als o point s ou t tha t th e curren t problem s facin g East ern Europ e ar e strikingl y simila r t o th e condition s foun d i n othe r Western an d Africa n countrie s tha t have already been receiving U.S . development ai d fo r te n o r twent y years . I f so , "wh y shoul d U.S . aid b e expecte d t o hel p Easter n Europ e evolv e away fro m it s current characteristics? " (Eberstad t 1991 , 25). It ca n b e adde d tha t th e likel y beneficiarie s o f an y Wester n aid ar e no t goin g t o b e th e citizen s o f Easter n Europe . Potentia l beneficiaries includ e Wester n firms wh o ca n effectivel y lobb y fo r special-interest clause s an d industria l guarantee s lik e thos e o f th e original Marshal l Plan . Othe r likel y winner s ar e th e governments of Easter n Europe . Mos t U.S . ai d ha s historicall y bee n govern ment-to-government ai d whic h assume s tha t th e recipien t govern ment no t onl y know s wher e t o us e th e funds , bu t i n fac t doe s us e them o n th e citizenr y rathe r tha n enhancin g it s ow n wealth . Fi nally, th e bigges t beneficiarie s ma y b e Wester n politician s wh o

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can bot h sel l thei r influenc e t o domesti c specia l interest s an d claim tha t the y "di d something " t o hel p Easter n Europe . T o re state Eberstadt' s point , Wester n politician s hav e bee n "doin g something" fo r muc h o f th e underdevelope d worl d fo r twent y years wit h ver y littl e t o sho w fo r it . Th e questio n i s reall y " w h o are the y doin g somethin g for?" Conclusion The proble m wit h developin g a ne w Marshal l Pla n fo r Easter n Europe i s tha t i t seem s t o assum e tha t th e crisi s face d i n tha t par t of th e worl d i s tha t th e ol d plan s wer e ba d plan s an d tha t th e solution i s a ne w plan . T o th e contrary , th e argumen t abov e i s that th e proble m i s th e whol e notio n o f planning , an d tha t th e original Marshal l Pla n suffere d fro m th e sam e fals e belie f i n th e power o f consciou s directio n o f economi c processe s a s di d th e failed government s o f th e forme r Sovie t Unio n an d Easter n Eu rope. For countrie s ravage d b y ove r forty-fiv e year s o f plans, plans , and mor e plans , th e las t thin g neede d i s a ne w plan . Thi s i s no t t o deny tha t th e Wes t shoul d d o somethin g fo r Easter n Europe . In stead, w e nee d t o understan d tha t wha t drive s ou r ow n economy , and it s histor y o f productivity , ar e th e idea s embodie d i n it s lega l and monetar y institutions . Th e idea s o f th e rul e o f law , freedo m o f exchange an d contract , an d privat e propert y combine d wit h th e moral restrain t t o no t subjec t suc h institution s t o th e hubri s o f "scientific" plannin g ar e th e bes t ai d packag e fo r Easter n Europe . Anything els e wil l onl y repea t th e mos t fundamenta l an d tragi c errors o f th e twentiet h century . Notes 1. Th e debate tha t Mises' s article sparke d i s best summarize d i n Lavoi e (1985a). 2. O n th e ide a o f economi c orde r a s involvin g creativity , complexity , and coordination , see Horwitz (1992, chapter 2). 3. O n regulatio n generally , se e Kirzne r (1985) . On centra l ban k policy , see Selgi n (1988 ) an d Horwit z (1992) . O n antitrust , se e Armentan o (1982). For a general discussio n of the problems of noncomprehensiv e planning, see Lavoie (1985b).

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4. Thi s corporatis t politica l econom y (calle d "politica l capitalism " b y some) i s best explore d i n variou s revisionis t historie s o f the Progres sive Era. See Wiebe (1962), Kolko (1963), and Weinstein (1968). 5. Se e Hogan (1987 , 23): "Supplementing th e planners' approaches wa s a commitmen t t o Keynesia n technique s o f macroeconomi c man agement." 6. Se e also Cowen (1985, 66ff.) and Hogan (1987, 71). 7. Se e Wexle r (1983 , 95-96) , wher e h e quote s a high-rankin g Pla n ad ministrator a s making this point afte r assessin g the Plan when it concluded. 8. Als o see the discussion i n Cowen (1985, 68). 9. Als o see Cowe n (1985 , 73) : "A t best , it s effect s o n postwa r Europ e were mixed. " 10. Th e reader migh t als o want t o see the combined revie w of the Hoga n and Milward books in Diebold (1988). 11. Als o see Eberstadt (1991 , 27). 12. Se e Cowe n (1985 , 73-74) : "No t onl y wa s th e Europea n econom y already industrialize d an d fairl y wel l integrated , bu t Europ e ha d a long tradition o f capitalistic institutions. " 13. Se e Eberstad t (1991 , 29) : "Th e population s o f Easter n Europ e hav e been separated fro m tha t framewor k [o f legal protections for individ uals] fo r mor e tha n fou r decades . Th e majorit y hav e n o memor y o f firsthand exposur e to it, to say nothing of personal familiarity. " 14. Fo r a spontaneou s orde r vie w o f law , se e Benso n (1990) . On money , see Hayek (1978), Selgin (1988), and Horwit z (1992). 15. Se e Lavoie (1985b, chapters 4-6), for more on this point . 16. Pete r Bauer, as quoted i n Pfaff (1987 , 72).

References Armentano, Dominick. 1982 . Antitrust and Monopoly: Anatomy of a Policy Failure. New York: Wiley. Benson, Bruce . 1990 . The Enterprise of Law. Sa n Francisco : Pacifi c Re search Institute . Cowen, Tyler . 1985 . "The Marshal l Plan : Myth s an d Realities. " I n U.S. Aid to the Developing World, ed. Doug Bandow. Washington, D.C.: Heritage Foundation . Diebold, William . 1988 . "The Marshal l Pla n i n Retrospect : A Review o f Recent Scholarship. " Journal of International Affairs 4 1 (Summer) : 421-35. Eberstadt, Nicholas . 1991 . "How No t t o Aid Easter n Europe. " Commentary 92 (November): 24-30. Hayek, F. A. 1948. Individualism and Economic Order. Chicago: University of Chicago Press.

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. 1978 . The Denationalisation of Money. London : Institut e fo r Eco nomic Affairs . . 1988. The Fatal Conceit: The Errors of Socialism. Ed . W. W. Bartley III. Chicago: University of Chicago Press. Hogan, Michael. 1987 . The Marshall Plan: America, Britain, and the Reconstruction of Western Europe, 1947—1952. Cambridge : Cambridg e Uni versity Press . Horwitz, Steven . 1992 . Monetary Evolution, Free Banking, and Economic Order. Boulder: Westview . Kirzner, Israel . 1985 . "Th e Peril s o f Regulation : A Market Proces s Ap proach." I n hi s Discovery and the Capitalist Process. Chicago: Univer sity of Chicago Press. Kolko, Gabriel. 1963 . The Triumph of Conservatism. Ne w York : Th e Fre e Press. Lavoie, Don. 1985a. Rivalry and Central Planning: The Socialist Calculation Debate Revisited. Cambridge : Cambridge Universit y Press . . 1985b . National Economic Planning: What Is Left? Cambridge , Mass.: Ballinger . Milward, Alan . 1984 . The Reconstruction of Western Europe, 1945-51. Berkeley: University of California Press . Mises, Ludwi g von . [1920 ] 1935 . "Economic Calculatio n i n th e Socialis t Commonwealth." I n Collectivist Economic Planning, ed . F . A . Hayek . Clifton, N.J. : Augustus M. Kelley. Pfaff, William . 1987 . "Perils o f Policy : Th e Marshal l Pla n Onl y Worke d Once." Harper's 21A (May): 70-72. Pisani, Sallie. 1991 . The CIA and the Marshall Plan. Lawrence: Universit y of Kansas Press. Selgin, George . 1988 . The Theory of Free Banking: Money Supply under Competitive Note Issue. Totowa , N.J.: Rowman an d Littlefield . Weinstein, James . 1968 . The Corporate Ideal in the Liberal State, 1900-1918. Boston : Beacon Press. Wexler, Immanuel . 1983 . The Marshall Plan Revisited: The European Recovery Program in Economic Perspective. Westport Conn. : Greenwoo d Press. Wiebe, Robert. 1962 . Businessmen and Reform. Chicago : Ivan R . Dee.

9 Industrial Polic y a s th e Engin e o f Economic Growt h i n Sout h Korea : Myth an d Realit y Young Bac k Cho i

The rapid transitio n o f th e Sout h Korea n econom y fro m a "hope less baske t case " i n th e 1960 s t o a n "economi c miracle' ' i n th e 1980s has become a subject o f much discussion , in popular a s well as academic media. Many marvel a t th e fact tha t Sout h Kore a ha s pulled itsel f u p fro m a majo r U.S . ai d recipien t t o th e twelfth largest tradin g natio n i n th e world , fro m a largel y agraria n na tion t o a majo r exporte r o f manufacture d goods , an d fro m a pe r capita GN P of a mer e $10 0 i n 196 0 to ove r $6,00 0 i n 1991 . Along with othe r rapidl y growin g economie s i n Asi a suc h a s Taiwan , Hong Kong , Singapore , an d Thailand , th e Korea n experienc e keeps on e hopefu l tha t industrializatio n an d prosperit y ar e no t impossible fo r non-Europeans , latecomers , or resource-poor coun tries. Some g o beyon d admiratio n an d perceiv e Sout h Kore a a s a potential threat , i f not already a threat. Those who see the countr y as a nex t "Japan , Inc. " fre t ove r th e fac t tha t Sout h Kore a ha s become th e second-larges t shipbuilde r i n th e worl d afte r Japan , or that i t is one of the four producer s of large-scale random-acces s memory chips , wit h 1 3 percen t o f th e worl d marke t share . Th e 231

232 Youn g Back Choi perceived threa t i s enhanced wit h th e possibility of the unificatio n of the tw o Korea s generatin g a substantia l regiona l powe r wit h a combined population o f almost sevent y million . There ar e als o thos e wh o ar e inten t o n learnin g fro m Sout h Korea, finding th e experienc e paradigmati c bot h fo r les s devel oped countrie s (LDCs ) an d eve n fo r th e Unite d State s (Amsde n 1989). Different peopl e dra w differen t lesson s from th e Sout h Ko rean experience , dependin g o n thei r view s o n ho w an d wh y th e country ha s enjoye d suc h rapi d economi c growt h i n recen t de cades. The most common an d popular view , by far, i s that govern ment dirigisme i s responsible fo r th e Sout h Korea n growt h (Wad e 1990, 8) . Robert Wad e define s dirigism e a s th e directiona l thrus t by government t o strongly influence th e market. Others think that , while governmen t involvemen t ha s bee n ver y pervasive , policie s have tende d t o b e marke t friendl y (Agarwal a 1983 ; La i 1988) . They argu e tha t despit e al l th e governmen t interventions , pric e distortions i n Sout h Kore a hav e bee n muc h les s tha n i n othe r countries that have been less successful i n economic growth. Then, there ar e thos e wh o se e othe r factor s a s significan t i n explainin g the Sout h Korea n experience , fo r example , suc h cultura l factor s as Confucianism , th e Japanes e colonia l experience , th e larg e U.S . aid, or education . The purpos e o f thi s chapte r i s t o criticall y evaluat e som e o f these commonl y hel d view s an d offe r wha t I woul d regar d a s a more balanced position . The apparent succes s of industrial polic y in Sout h Kore a i n th e 1960 s an d 1970 s wa s a resul t o f man y fortuitous event s which ar e neither eas y to replicate no r necessar ily desirable . I wil l first examin e th e "uniqueness " vie w tha t re sources, Confucianism , colonia l experience , an d foreig n ai d ar e responsible fo r Sout h Korea' s recen t growth . Next, I will examin e the "activ e government, " (o r industrial polic y argument) , and th e "relatively littl e pric e distortions, " (o r pro-market), propositions . After criticizin g thes e views, I will suggest an alternativ e explana tion that i s compatible with pervasive government involvemen t i n South Kore a an d th e marke t proces s theor y b y usin g Mancu r Olson's (1982 , 47-53 ) notio n o f "encompassin g organization. " I will conclud e th e chapte r wit h a numbe r o f conjecture s o n ques tions that nee d further clarifications .

Industrial Polic y in South Kore a 23 3 Record of Economi c Developmen t A better sens e of the magnitude an d the pace of economic develop ment i n Sout h Kore a ca n b e gained fro m th e following considera tions. It i s apparent tha t pe r capit a GN P has far surpasse d th e al most triplin g o f the population i n about thre e decades . Per capit a GNP, expresse d i n U.S . dollars , ha s increase d mor e tha n eight y times in nominal terms since 196 2 which is equivalent to a roughly twenty-fold increas e i n rea l term s (Son g 1990 ; Ban k o f Korea , 1991). In 1962 , South Kore a wa s poorer tha n Zaire , Congo, or Su dan (Wade 1990,35) , but in 199 1 it was richer than Czechoslovakia , Portugal, o r Greece . Thoug h stil l a relativel y poo r countr y com pared t o Western Europe , North America, or Japan, Korea has im proved its standing in the international communit y significantly . In littl e mor e tha n tw o decades , th e proportio n o f th e wor k force i n agriculture decline d fro m almos t 6 0 percent t o around 2 0 percent. I n valu e terms , agricultur e decline d fro m almos t 4 0 per cent o f GN P i n 196 0 to abou t 1 0 percent i n 1989 , while manufac turing increase d fro m som e 1 2 percen t t o mor e tha n 3 0 percen t during th e sam e period. The value of exports increase d mor e tha n two hundred-fold , i n nomina l terms , durin g thi s period . I n 1989 , South Kore a becam e th e tenth-larges t tradin g natio n i n th e world, an d i s currently th e seventh-larges t tradin g partne r o f th e United State s (Worl d Ban k 1991) . Social indicator s als o attes t t o significan t improvement s i n South Korea . Fo r example , durin g th e sam e period , lif e expec tancy increase d fro m les s tha n 6 0 t o mor e tha n 70 , closer t o th e level o f Nort h Americ a o r Wester n Europe . Othe r indicators , fo r example, literacy , infan t mortality , education , an d s o forth, sho w equally impressiv e improvements . Few , therefore , woul d disput e the fac t o f social an d economi c growt h i n Sout h Korea . There ar e disparate views , however , o n wh y an d ho w thi s stat e o f affair s has com e about . Resources, Confucianism, Colonia l Experience , and U.S. Aid Before w e move on to the issue of dirigisme, let us briefly conside r the rol e o f (1) natural resources , (2) Confucian legacy , (3) colonia l

234 Youn g Back Choi experience unde r Japan , an d (4 ) U.S . ai d i n Sout h Korea n eco nomic development . Th e discussio n o f th e rol e o f educatio n i s postponed t o a later section . (1) Natura l resource s ar e th e leas t likel y candidat e i n ex plaining Sout h Korea n economic development, unless one regard s its poo r resourc e endowment s a s a blessin g i n disguise . Sout h Korea i s a small , densel y populated , an d resource-poo r country . It i s one-fourt h th e siz e o f Californi a an d ha s th e third-highes t population densit y afte r Banglades h an d Taiwa n (ignorin g cit y states.) Sinc e th e Sout h Korea n terrai n i s mountainous , onl y 2 0 percent o f it s lan d i s suitabl e fo r agricultura l o r urba n use . It i s also minera l resource-poor , wit h th e exceptio n o f tungste n an d limestone. Sout h Korea , therefore , ha s t o impor t mos t o f it s ra w materials, along with food stuff . (2) To some people the Confucian legacy , which the South Kore ans shar e wit h th e Japanes e an d Chinese , seem s a littl e mor e promising. This supposed Orienta l counterpart of''Protestan t eth ics" emphasize s diligence , education , an d harmoniou s relation ships withi n famil y an d hierarchy . Thi s propositio n seem s t o make sens e i n ligh t o f th e fac t tha t Confucianis m wa s th e stat e ideology o f th e Le e Dynasty i n Kore a fo r five hundred year s unti l the turn o f this century . Two facts militat e against this proposition. First, Confucianism , at leas t a s i t wa s practice d i n Korea , wa s no t ver y supportiv e of industr y o r commerce . I n fac t durin g th e Le e Dynast y (A.D . 1392-1910), artisans an d merchant s wer e accorded a lower statu s than peasant s an d onl y higher tha n slaves . If Confucianism seem s to exert a positive influenc e o n th e enterprising spiri t o f people i n South Korea , a s wel l a s i n othe r Asia n countries , i t mus t b e i n a significantly altere d for m fro m th e traditiona l (Maso n et al . 1980 , 284-85; se e als o Son g 1990 , 48-53). Secondly, Sout h Kore a i s n o longer dominate d b y Confucianism . I n fact , religiou s believer s i n South Korea , wh o accoun t fo r th e grea t majorit y o f people , ar e roughly equall y divide d amon g Confucianism , Buddhism , an d Christianity. That is , one might a s well describ e Sout h Kore a a s a Buddhist o r a Christian nation . (3) Som e peopl e believ e tha t th e Japanes e colonia l rul e ove r Korea (1910-45 ) ha s ha d somethin g t o do with th e latter' s recen t

Industrial Polic y in South Korea 23 5 economic developmen t (Wo o 1991 , 207-8). The suggestio n i s tha t Japanese colonialis m transforme d Kore a fro m a feuda l econom y into a capitalis t one , if onl y i n embryoni c form . Som e g o furthe r to sugges t tha t Japa n lef t Kore a i n a n advantageou s positio n amongst LDC s in terms o f infrastructure an d som e key industries , such as textiles, chemicals, and machinery . This suggest s tha t someho w Japa n ha d intention s differen t from thos e o f othe r colonizers . Colonia l rul e i s base d o n forcefu l annexation, not on voluntary consent ; th e colonized d o not see the benefit o f colonization tha t th e colonizers anticipate . Initially, th e Japanese intende d t o tur n Kore a int o a "ric e bowl " fo r Japan , a s well a s t o keep i t dependen t o n manufacture d good s fro m Japan . It wa s no t th e Korean s wh o chos e t o specializ e i n growin g rice , however. Throug h cadastra l survey , lan d registration , an d expro priation o f th e stat e land , larg e tract s o f land wer e transferre d t o Japanese colonist-farmers . Drive n off th e land, millions of Korea n farmers migrate d t o bandit-infeste d Manchuri a an d th e commu nist dominate d Sovie t Fa r Eas t fo r bette r luck . Les t enterprisin g Koreans might ventur e into manufacturing, the y were not permit ted t o star t factorie s (Wo o 1991 , 31). To kee p Korean s ignorant , the Japanes e discourage d Korean s fro m establishin g schools , keeping onl y on e university ope n i n Korea , mainl y t o educate th e sons o f Japanes e colonists . A t th e tim e o f thei r liberatio n fro m Japan, Korean s wer e i n dir e povert y (Son g 1990 , 39 ; se e als o Mason e t al . 1980) . To argue tha t someho w Japanes e colonialis m helped Korean s t o prepar e fo r late r economi c developmen t i s t o argue tha t th e belate d growt h o f a chil d afte r gettin g ri d o f para sites tha t infecte d hi m sinc e his infancy wa s made possible by th e parasitic infection . After 1930 , admittedly , Japa n buil t heav y industria l plant s i n Korea, t o bette r manag e it s growin g empir e an d t o tur n i t int o a competin g economi c bloc , a s Wester n nation s becam e mor e protective o f their ow n markets . This, however, helped Sout h Ko rea preciou s littl e i n it s late r economi c developmen t fo r th e fol lowing reasons. First, Koreans had bee n systematically kep t at th e level of menial work , reservin g manageria l an d engineerin g post s for Japanese. Secondly, since much of what th e Japanese had buil t between 193 0 an d 194 5 wa s locate d i n norther n par t o f Korea ,

236 Youn g Back Choi when Kore a wa s divide d int o tw o countries , few o f the industrie s they ha d buil t wer e locate d i n Sout h Korea . Thirdly , th e thre e years o f devastatin g wa r i n Kore a (1950-53) , responsibl e fo r th e deaths o f over tw o millio n Koreans , left fe w urba n an d industria l structures intact . Sout h Korea n economi c development , more over, bega n i n earnes t almos t twent y year s afte r it s liberatio n from Japa n an d almos t te n year s afte r th e terribl e Korea n War . Perhaps a better case can be made of the U.S. aid. (4) Sout h Kore a receive d massiv e foreig n aid , largel y bu t no t exclusively fro m th e Unite d State s Militar y an d economi c ai d from th e Unite d State s fro m 194 5 t o 197 6 was mor e tha n twelv e billion dollar s (Wo o 1991 , 45). Before th e Korea n War , U.S . economic ai d t o Sout h Kore a wa s abou t sixt y millio n dollar s a year . After th e war , upo n Presiden t Eisenhower' s urgin g tha t "al l eye s would b e o n Sout h Kore a afte r th e armistice, " th e U.S . economic aid t o Sout h Kore a jumped t o two hundred millio n dollar s a yea r (cited i n ibid. , 57 ; Parr y 1988 , 98) . T o ge t a prope r sens e o f th e magnitude o f U.S . aid t o Sout h Korea , on e mus t remin d onesel f that U.S . federa l nondefens e spendin g wa s les s tha n five billio n dollars i n 195 0 an d abou t nin e billio n dollar s i n 1953 . More im portantly, U.S . economic aid represented ove r 1 0 percent o f Sout h Korean GN P i n 1950s , o r ove r 2 5 percen t i f militar y ai d i s in cluded. Th e U.S . economic ai d o f 38 3 million dollar s i n 1957 , for example, wa s equivalen t t o 7 0 percen t o f Sout h Korea n govern ment revenu e (Woo 1991 , 46). The economi c impac t o f U.S . involvement i n Sout h Kore a wa s probably eve n greate r tha n th e U.S . ai d figures migh t indicate . For instance , i n 195 6 th e Unite d State s gav e Sout h Kore a ove r four hundre d millio n dollar s i n militar y aid , i n additio n t o ove r three hundred millio n dollar s i n economic aid. Moreover, the U.S. spent anothe r thre e hundre d millio n dollar s i n tha t yea r t o cove r the cost s o f th e U.S . troop s statione d i n Sout h Korea , som e o f which mus t hav e bee n use d i n purchasin g loca l good s an d ser vices. Th e massiv e U.S . aid , alon g wit h othe r foreig n aid , di d help Sout h Korean s surviv e an d rebuil d a s the y emerge d povert y stricken fro m Japanes e colonialism , an d i n eve n greate r destitu tion fro m th e utte r destructio n o f th e Korea n Wa r wher e armie s from ninetee n nation s fough t u p an d dow n th e peninsula fo r ove r

Industrial Polic y in South Kore a 23 7 three years . Economi c hardshi p wa s mad e wors e b y ove r tw o million refugee s fro m Nort h Kore a swarmin g dow n o n Sout h Ko rea, whe n twent y millio n Sout h Korean s themselve s wer e o n th e verge o f starvation . Despit e th e massiv e U.S . aid , Sout h Kore a seemed t o be doome d a s a developmen t project . Syngma n Rhee' s government exacte d a high price fro m th e Unite d State s fo r bein g an outpost i n the Cold War, but refuse d t o trade with Japan i n th e name o f anticolonialis m o r t o adop t measure s recommende d b y the experts from th e United State s t o stabilize the economy on th e ground of political expediency. Rhee used his control over the U.S. aid flo w t o furthe r hi s ow n politica l aims , resultin g i n rampan t corruption. Th e frequen t verdic t o n th e Sout h Korea n economy , up t o th e middl e o f 1960s , was tha t i t wa s " a bottomles s pit, " " a permanent U.S . ward, " o r tha t th e massiv e ai d douse d Sout h Koreans with " a welfare mentality " (ibid. , 46). Active Governmen t More promisin g i s th e propositio n tha t governmenta l policie s have been instrumenta l i n th e rapid growt h o f South Kore a i n th e past thre e decades . The star t o f rapid economi c growt h coincide d with a radica l shif t i n governmen t policie s fro m aroun d 1963 , with th e inceptio n o f Presiden t Park' s Thir d Republi c afte r th e military cou p h e le d i n 1961 . Compared t o th e earlie r Republic s that meddle d throug h b y distributin g foreig n aid , whil e at tempting t o develop import-substitutio n industries , the Thir d Re public wa s consciou s o f it s rol e a s a regim e o f economic develop ment. President Park , who did not hesitate to violate human right s and suspen d politica l freedom , place d al l hi s politica l bet s o n economic development . Hi s motto s wer e "Natio n buildin g through export, " "Alleviatio n o f poverty throug h economi c devel opment," an d "Politica l freedo m i s a luxur y th e starvin g ca n ill afford," an d th e like . H e undertoo k ideologica l campaign s t o re form people' s attitudes , an d rounde d u p lumpens an d thug s an d sent the m t o labo r camps . He nationalized bank s an d kep t politi cians and businessmen under a tight leash , vanquishing thos e who did no t compl y wit h hi s wishes . H e assemble d a cor p o f techno crats t o pla n fo r economi c developmen t an d personall y attende d

238 Youn g Back Choi monthly meeting s wher e expor t strategie s wer e discusse d amongst bureaucrat s an d businessmen . Par k personall y awarde d those who exceeded th e export target s se t by th e government, bu t export encouragemen t wen t beyon d hi s persona l appreciation ; i t involved low-interes t loan s an d th e grantin g o f right s t o impor t goods t o a tightl y protecte d consume r good s marke t fo r extr a profits. B y 1979 , whe n Presiden t Par k wa s assassinated , Sout h Korea ha d experience d a n averag e annua l growt h rat e o f almos t 10 percent fo r ove r fiftee n year s an d seeme d t o be well on it s wa y to industrialization . Sout h Kore a seeme d t o hav e bee n radicall y transformed sinc e 1960 , when man y expert s decide d tha t i t was a "basket case, " int o a n econom y wher e rapi d growt h i s th e norm , thanks to President Park' s policies, one may observe . With a few popular anecdotes , the case for th e efficacy o f industrial policie s i n Sout h Kore a seem s t o b e closed . Fo r example , South Kore a i s currently on e of the lowest-cost producer s o f steel. When th e Sout h Korea n governmen t decide d t o buil d a n inte grated stee l mil l i n th e lat e 1960s , however, a Worl d Ban k stud y team advise d th e government tha t suc h a project wa s not econom ically feasible , give n Sout h Korea' s lac k o f iro n ore , cokin g coal , steel-making skills , domesti c market , an d capita l (Amsde n 1989 , 291). Going against th e experts' advice, the Sout h Korea n govern ment investe d almos t fou r billio n dollar s t o creat e th e Pohan g Iron an d Stee l Company , Ltd . (POSCO ) i n 1968 , appointin g a retired genera l a s its president. Man y expecte d POSC O to becom e another whit e elephan t projec t foun d i n LDCs . In five years, however, POSC O bega n productio n wit h a n annua l capacit y o f abou t one million tons , and afte r severa l expansions, the mill reached a n annual capacit y o f ove r nin e millio n ton s o f crud e stee l i n 1983 , feeding stee l int o th e the n expandin g shipbuilding , automobile , and constructio n industries . In 1986 , POSCO entere d a joint ven ture wit h U.S . Steel t o moderniz e th e latter' s plan t i n California , providing hal f th e capital , th e basic desig n o f the facility , an d th e training o f America n manager s an d worker s i n operation s an d maintenance (ibid., 291-92). Consider anothe r example . I n 199 1 Sout h Korea n producer s had ove r 1 3 percent o f th e worl d marke t shar e i n dynami c ran dom-access memorie s (DRAM ) (Wall Street Journal, Jul y 14 , 1992,

Industrial Polic y in South Kore a 23 9 Bl). Th e semiconducto r industr y wa s starte d whe n th e govern ment establishe d a researc h institut e t o cultivat e i t i n 197 6 an d provided investmen t incentive s i n 198 2 an d thereafter . Lat e i n 1988, Samsung , th e leadin g Sout h Korea n semiconducto r pro ducer, introduce d engineerin g sample s o f 4 Me g DRAM , only si x months behin d Toshiba , th e worl d leader , an d bega n shippin g i n bulk in late 198 9 (Wade 1990 , 313-17). Anecdotal evidence such a s this seem s t o demonstrat e ver y convincingl y tha t well-conceive d and execute d industria l policie s ca n d o wonder s fo r economi c development. The late President Park , who viewed his own role i n Korean history as similar t o that o f Emperor Meiji of Japan, coul d not have agreed mor e with thi s proposition . The Pro-Market Propositio n Such arguments , however , d o no t establis h th e effectivenes s o f government i n managin g economi c growth . Fo r a t on e end o f th e spectrum, ther e ar e man y example s o f faile d economie s despit e industrial policie s t o stimulat e economi c growth . O n th e othe r side, ther e ar e thos e economie s suc h a s Hon g Kon g tha t hav e grown rapidl y withou t muc h governmen t prodding . T o observ e that Sout h Korea n governmen t policie s hav e bee n effectiv e be cause it s econom y gre w fast , withou t showin g how , is circular. I n addition, eve n i f it i s established tha t governmen t policie s ca n b e helpful i n economic growt h unde r certai n genera l conditions , on e cannot automaticall y assum e tha t th e governmen t ha s th e will o r the ability t o undertake th e necessary policies. For the proponent s of industrial polic y to be persuasive, therefore, the y must sho w (1) how governmen t policie s uniquel y contribute d t o industrializa tion, (2 ) ho w th e governmen t avoide d bein g swarme d b y rent seeking, special-interes t groups , an d (3 ) tha t th e correlatio n be tween economi c growt h an d governmen t policie s i s no t spuriou s by showin g tha t ther e i s n o othe r facto r tha t ca n sufficientl y ex plain th e growth . I n thi s section , I wil l addres s th e first an d th e last issues , leaving the second for th e next section . To show ho w governmenta l policie s hel p develo p th e econom y one mus t sho w th e existenc e o f condition s unde r whic h privat e enterprises cannot , singl y o r jointly , tak e advantag e o f potentia l

240 Youn g Back Choi gains. As far a s orthodo x economic s i s concerned, ther e ar e thre e kinds o f situation s unde r whic h governmen t involvemen t i n th e economy i s i n principl e justified—publi c goods , marke t failur e due t o externalities , an d increasin g return s t o scale . Th e propo nents o f th e efficac y o f Sout h Korea' s industria l policie s a s th e engine o f economi c developmen t hav e i n min d mainl y th e latte r two categorie s (Westpha l 1990) . For example , i t i s often observe d that th e protectio n o f domesti c markets , togethe r wit h expor t subsidies, ensures infan t industrie s operat e o n a sufficientl y larg e scale, developing viabl e industrie s tha t otherwis e woul d no t hav e taken roots . Ofte n cite d ar e th e successfu l Sout h Korea n ship building, automobile , steel , an d semiconducto r industries . Alon g the lin e o f externalities , i t i s observe d tha t th e Sout h Korea n government policie s helpe d Korea n firms t o obtai n technologie s which the y themselve s would no t have obtained becaus e of multinational firms' unwillingnes s t o transfe r importan t technologie s and th e excessive competition amongs t loca l firms. Similarly , it is observed tha t governmen t coul d overcom e th e externalitie s tha t stem fro m th e foreig n lender' s inabilit y t o asses s th e credit-wor thiness o f loca l firms i n th e absenc e o f sufficien t informatio n (Krauss 1991) . O r alternatively , som e hol d t o Alexande r Gerschenkron's thesi s o f th e ''economic s o f backwardness " that , given th e relativ e scarcit y o f skille d manpowe r i n les s develope d countries, the latecomers have to rely on capital-intensive project s to economiz e o n skille d manpower . Thi s tren d i s mor e an d mor e pronounced. Sinc e only the state can mobilize such large resource, so th e argumen t goes , economi c developmen t increasingl y in volves the state (Amsden 1989) . While th e abov e argument s see m t o suppor t th e propositio n that governmen t policie s played a crucial role in the industrializa tion o f Sout h Korea , upo n clos e examinatio n thing s d o no t see m as simple . First , whe n th e stat e act s a s th e condui t o f foreig n credit o n th e groun d o f externalities , o r imperfec t information , credit doe s no t necessaril y com e cheaply . I t ha s bee n reporte d that a s muc h a s 1 0 percent o f al l foreig n loan s wer e retaine d b y President Park' s governmen t fo r discretionar y use , politica l an d personal. 1 I n addition , i n man y publi c project s i t wa s discovere d that th e pricin g o f foreig n capita l good s wa s muc h higher , any -

Industrial Polic y in South Kore a 24 1 where betwee n 2 0 percen t t o 10 0 percen t highe r tha n th e norm , the difference bein g remitted t o the key figures i n the ruling part y as kickbacks . Moreover , th e manne r o f allocatin g credi t (remem ber bank s ha d bee n nationalized ) canno t b e sai d t o b e a n idea l form o f pickin g winners . Th e owner s o f bi g busines s bribe d thei r way t o gai n acces s t o th e government-ratione d credits , tha t ar e priced muc h below the market, or rather th e black-market, rates . Secondly, eve n whe n a n industr y promote d b y governmen t seems t o b e successful , i t ma y no t b e necessaril y du e t o govern ment policies. South Korea n semiconducto r firm s ar e doing bette r in recent years , but i t is due to factors beyon d thei r wildest imagi nation—the U.S . protectionism. Impor t restriction s o n Japanes e DRAM since 198 6 have not been extended t o South Kore a becaus e it was not a significant produce r o f DRAM at th e time. As a result , Japanese firms producin g 4 Me g DRA M ar e operatin g a t 50-6 0 percent capacit y wherea s thei r Sout h Korea n counterpart s ar e producing a t ful l capacity , unhampere d b y th e U.S . regulation . The whi m o f U.S . protectionism , however , ca n chang e a t an y moment. Thirdly, a "successful" creatio n of an industry where economie s of scal e ar e importan t i s no t necessaril y beneficial . I n les s tha n two decade s sinc e i t bega n exportin g ships , fo r example , Sout h Korea ha s becom e th e second-larges t shipbuildin g natio n i n th e world, producin g mor e tha n th e E C an d COMECO N combine d (Amsden 1989 , 270; see also Woo 1991, 135-38). But South Korea n shipbuilders nee d periodi c governmen t bail-out s t o sta y i n busi ness. S o what i s th e poin t o f having a large-scal e industr y excep t the fact tha t the y tend t o be "too big to fail" ? Fourthly, the industries where the economies of scale and exter nalities ar e important , th e industrie s fo r whic h governmen t ma y in principl e b e calle d upo n t o act , ar e neithe r necessar y no r suffi cient fo r economi c development . Amon g th e latecomers , Taiwan , Singapore, an d Hon g Kong , fo r example , hav e don e a s wel l a s South Korean s withou t shipbuilding , automobiles , semiconduc tors, an d s o forth . Thes e countrie s hav e don e i t mostl y wit h con sumer product s suc h a s toy s an d electronic s i n whic h productio n economies o f scale or externalitie s ar e les s significant. I f industri alization i s possibl e withou t eve r mor e massiv e project s fo r late -

242 Youn g Back Choi comers, a s i t seem s t o b e th e cas e i n thes e countries , Gerschen kron's thesis of the economics of backwardness and its implicatio n for th e necessit y fo r a greater rol e of the state i n th e developmen t of a latecome r ar e suspect . Gerschenkron' s thesi s i s base d o n th e assumption tha t latecomer s adop t th e sam e kind s o f industrie s that develope d countrie s ha d t o develop. But tha t i s shown no t t o be th e case . Th e moder n economi c skepticis m abou t th e willing ness and th e ability o f the state t o pursue common goods , namely, the failur e o f socialis t plannin g an d ren t seeking , onl y reinforce s this view . Finally, ther e i s a sufficien t explanatio n fo r economi c develop ment—education. A recen t stud y b y Rober t Barr o show s tha t much o f th e observe d growt h rate s o f differen t countrie s ca n b e explained b y th e ga p betwee n th e actua l leve l o f per capit a GN P and th e pe r capit a GN P expecte d base d o n th e leve l o f educatio n (Barro 1991) . Tha t is , muc h o f th e hig h rate s o f growt h i n Eas t Asian countrie s ca n b e explaine d b y inordinatel y lo w level s o f income i n 196 0 relative t o their leve l of education. In a way, thes e countries hav e grow n fas t t o catc h u p wit h th e leve l o f incom e expected o f the m base d o n thei r leve l o f education . Althoug h Barro report s a n underestimatio n o f growt h rate s i n th e cas e o f South Kore a and Taiwan (ibid. , 418), that is , they grew faster tha n they wer e expecte d base d o n thei r educationa l level , thi s ca n b e explained. It is not necessary to attribute the remainder to government dirigisme . The massiv e inflo w o f refugees i n both countries , who represented abov e the average qualit y o f human resources , is a fa r mor e promisin g candidate . I n othe r words , th e measur e o f educational level , no t reflectin g th e specia l circumstance s o f Ko rea o r Taiwan, understated th e level of human capital . If the leve l of educatio n i s sufficient , a s I thin k i t is , t o explai n th e recen t growth rate s i n Eas t Asia , includin g Sout h Korea , th e cas e fo r industrial polic y becomes even more tenuous . Encompassing Organizatio n If the Sout h Korea n government , nevertheless, seemed t o be mor e effective i n promotin g industrializatio n tha n othe r LDCs , i t i s because th e rulin g elite s acte d a s th e "encompassin g organiza -

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tion." Mancu r Olso n define s th e encompassing organization a s a n entity tha t ha s incentive s "t o mak e th e societ y i n whic h [i t oper ates] mor e prosperous " no t becaus e i t i s altruistic , b u t becaus e i t expects disproportionat e gain s fro m i t (Olso n 1982 , 53) . Tha t is , the lat e Presiden t Par k an d hi s politica l allie s ra n th e econom y a s if the y wer e th e owners/manager s o f Korea , Inc . To bette r understan d m y characterizatio n o f Presiden t Park' s rule a s a n encompassin g organization , on e mus t understan d th e circumstances aroun d th e militar y cou p i n 196 1 tha t brough t Lieutenant Genera l Par k t o powe r fo r th e nex t ninetee n years . Only a yea r befor e th e coup , Presiden t Rhee' s governmen t (1948-60) ha d bee n overthrow n i n popula r uprising s le d b y stu dents. Th e majo r grievanc e wa s th e stealin g o f th e presidentia l election throug h vot e rigging , bu t th e uprisin g reflecte d th e popu lar disconten t wit h deterioratin g economi c condition s a s well . President Rhe e wa s mainl y know n fo r hi s anticommunism , antico lonialism, an d stubbornness . I n th e contex t o f th e Col d War , an d the destructiv e w a r i n Korea , Presiden t Rhe e use d hi s anticommu nist rhetori c an d stubbornnes s t o exac t fro m th e Unite d State s large sum s o f aid . Th e ai d helpe d th e war-ravage d Sout h Korean s to surviv e an d t o rebuild . Bu t Presiden t Rhee' s polic y o f pursuing , against th e wisdo m o f U.S . economi c advisers , import-substitu tion industrializatio n o n th e cushio n o f th e U.S . ai d an d hi s ver sion o f anticolonialism , create d a syste m o f marke t protection , import licenses , an d monopol y rights , a classi c settin g fo r ren t seeking. A change o f moo d i n Washington , brough t abou t b y th e worry tha t Sout h Kore a wa s " a bottomles s mone y pit, " a s wel l as b y Washington' s ow n growin g budge t deficits , insiste d o n a stabilization polic y i n Sout h Kore a an d bega n t o reduc e ai d (Wo o 1991, 69-72) . Thes e le d t o a prolonge d recessio n i n Sout h Kore a and t o th e eventua l overthro w o f Rhee' s government . Prime Ministe r Chang' s governmen t tha t cam e t o powe r i n th e aftermath o f th e studen t uprisin g lacke d authority , an d remaine d paralyzed i n th e fac e o f conflictin g demand s fro m variou s interes t groups an d ideologues . Hug h Farley , a CI A field office r i n Sout h Korea, wrot e i n Marc h 1961 : "Th e Republi c o f Kore a i s a sic k society [wit h an ] endemi c Orienta l proble m o f graft , corruptio n and fraud " (cite d i n ibid. , 78) . I n les s tha n a year , th e Secon d

244 Youn g Back Choi Republic wa s overthrow n i n th e militar y cou p le d b y Genera l Park. The leader s o f th e cou p wer e ful l o f revolutionar y zeal , pro fessing t o get ri d o f corruption, t o reform society , and t o alleviat e economic hardships. But their authority was precarious—the mil itary junt a consiste d o f relativel y obscur e an d margina l figures, unknown t o th e genera l public . And th e ide a o f bein g rule d b y a military junta , le t alon e a junta o f obscure general s an d colonels , did no t appea l t o Sout h Korean s steepe d fo r centurie s i n th e ideology o f th e Le e Dynast y tha t pu t civi l orde r abov e th e mili tary. Polic y maker s i n th e Unite d State s wer e ver y suspiciou s o f the natur e o f th e junta . (Some , including official s i n Washington , even thought Genera l Par k was a Communist.) I n short, man y di d not believ e that th e military junta coul d last . To solidif y politica l power , Genera l Par k trie d t o wi n people' s hearts an d gai n legitimac y b y a two-pronge d approach— a popu list anticorruptio n campaig n an d a campaign fo r economi c devel opment. Th e tw o wer e no t mean t t o be separate . Expropriate th e rich, whose fortunes wer e regarded as being accumulated by illicit means unde r Rhee' s regime , an d us e th e proceed s t o finance eco nomic development . Tw o o f th e anticorruptio n campaign s ar e noteworthy. On e wa s a currenc y reform , claime d t o be fashione d after tha t o f West Germany . I t wa s intende d t o registe r an d con fiscate idl e cas h hoards , bu t wa s onl y successfu l i n worsenin g inflation. Th e other wa s th e roundin g u p o f the wealthiest me n i n South Kore a o n charge s o f corruptio n an d treason . Roundin g u p corrupt politician s i s on e thing ; roundin g u p busines s leaders , whether o r not corrupt , is another. With the most prominent busi nessmen i n jail , th e econom y deteriorate d eve n further . Ou t o f desperation, Genera l Par k mad e a dea l wit h th e businessmen : i n exchange fo r th e exemptio n fro m crimina l persecutio n an d th e expropriation o f property—commercia l bank s wer e nationalize d anyway—the busines s leader s wer e t o redee m themselve s b y es tablishing industria l firms an d donatin g shares to the governmen t (Woo 1991 , 84; see also Haggard e t al. 1991, 859). From thi s initia l attemp t t o refor m society , th e militar y junt a emerged as the encompassing organization, afte r utterl y destroyin g the old political networ k often throug h brutal repression , publicl y

Industrial Polic y in South Kore a 24 5 shaming the business leaders and charging them with a new patriotic duty t o industrialize an d export , having nationalized bankin g to tightl y contro l credits , an d havin g place d al l stake s i n th e political gam e o n economi c development . Th e member s o f th e junta wer e no t ascetics , o r inordinatel y publi c minded , bu t the y realized tha t thei r politica l survival , a s wel l a s materia l gai n a s the majo r stakeholders , depende d o n th e overal l performanc e o f the South Korea n economy . Park's Export Promotio n In th e fac e o f declinin g U.S . aid , th e desir e t o ear n foreig n ex change t o purchase th e capita l good s neede d fo r industrializatio n and t o build u p th e military , therefore , wa s translate d int o an allout war on export promotion. Th e junta tha t soo n became a civilian government upo n th e general' s retiremen t fro m th e arm y ra n th e country a s a militar y commande r migh t i n directin g a n arm y unit—setting goals , i n th e manne r o f "Tak e tha t hill, " wit h rela tively littl e concern fo r th e costs, or "casualities." Out of the blue , it woul d declar e "Thi s yea r GN P shal l gro w b y 9 percen t an d exports shall double. " As faithful soldier s might, businessmen an d bureaucrats scramble d t o meet th e targets . President Park' s governmen t di d everythin g i n it s powe r t o create a n environmen t favorabl e t o mee t th e targets . Whil e th e domestic consumptio n good s marke t wa s stil l heavil y protected , the exporter s coul d impor t dut y fre e al l th e necessar y good s fo r the productio n o f exports. Additional incentive s wer e provide d t o exporters i n th e for m o f impor t licences , monopol y franchise s i n domestic consumptio n good s markets , an d s o on , a s mentione d above. Moreover, the government wa s in general goal-oriented, fo r example, th e goa l o f meetin g certai n expor t targets , an d lef t i t t o the private secto r t o decide how th e goal s should be met, in term s of choosin g th e lin e o f business, organizin g production , an d finding the buyers, and s o forth . The pragmati c approac h o f Sout h Korea n governmen t i n largely limitin g itsel f t o settin g goals , i n allowin g exporter s t o trade freely , an d i n providin g the m wit h expor t subsidie s ha s le d some peopl e t o observ e tha t Sout h Kore a ha s grow n fas t becaus e

246 Youn

g Bac k Cho i

its governmenta l policie s wer e "marke t friendly/ ' o r "marke t con forming/' Wha t coul d on e possibl y mea n b y governmen t eco nomic policie s bein g marke t friendly ? Ther e see m t o b e thre e versions o f thi s proposition : (1 ) Th e degre e o f intervention , a s measured b y th e degre e o f pric e distortions , ha s relativel y bee n small; (2 ) Th e governmen t promote d exports ; an d (3 ) Th e govern ment di d no t persis t i n supportin g industrie s o r project s onc e the y were foun d t o be unsuccessfu l i n th e worl d market . Le t u s conside r each i n turn . 1. Ramgopa l Agarwala' s cross-sectio n alaysi s o f thirty-on e countries—including Sout h Korea—find s a negativ e correlatio n between th e leve l o f pric e distortio n an d th e lon g ter m growt h rates (Agarwal a 1983). 2 Althoug h Sout h Korea' s cas e i s consisten t with th e abov e findings, i t i s u n w a r r a n t e d t o conclud e tha t it s government intervene d relativel y little . The price distortio n index , which i s base d o n broa d categories , ca n b e misleadin g becaus e there hav e bee n tw o productio n regime s i n Sout h Korea—on e fo r domestic market s an d anothe r fo r exports . Domesti c market s ha d been heavil y protected. 3 I n orde r no t t o handica p th e expor t in dustries i n th e worl d market , th e governmen t ha s permitte d firms in th e export-oriente d industrie s t o impor t al l ra w materials , in termediate products , an d capita l good s dut y free . Thi s mean s tha t price distortion s wer e significan t i n som e categorie s an d ni l i n others. Th e averagin g o f th e tw o set s cause d th e pric e distortio n to appea r t o b e relativel y low . Therefore , t o conclud e tha t govern ment policie s entaile d littl e pric e distortio n o r wer e eve n marke t friendly i s misleading . 2. Sout h Korea n governmen t ha s activel y promote d export s since th e earl y 1960s . Bu t expor t promotio n i s no t equivalen t t o being marke t friendl y b y an y means . Sinc e Sout h Kore a starte d out wit h heav y protection , unles s exempte d fro m dutie s o n neces sary input s i n expor t industries , exporter s woul d hav e bee n se verely handicappe d i n th e worl d market . Bu t expor t promotio n went beyon d exemptin g suc h inputs . I f successfu l i n meetin g ex port targets , exporter s wer e ofte n give n th e right s t o impor t good s duty fre e i n exces s o f thei r ow n us e i n th e productio n fo r expor t and t o sel l the m i n domesti c market s fo r hig h markups . I n addi tion, larg e exporter s wer e ofte n give n th e right s t o operat e a mo -

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nopoly o r a quasi-monopol y firm i n th e protecte d marke t fo r extr a profits. Moreover , exporter s ha d privilege d acces s t o government rationed credi t a t eve n negativ e rea l rate s o f interest . Som e ob serve tha t thi s coul d b e interprete d a s merel y counteractin g dis tortions cause d b y tariff s o n othe r good s tha t kep t wage s an d other cost s o f doin g busines s highe r tha n the y woul d hav e bee n otherwise (La i 1988 , 213-14) . Bu t wh o coul d tel l whethe r th e supposed countermeasure s wer e exactl y right , o r to o much ? T o speak o f expor t promotio n policie s a s marke t friendl y i s t o stretc h the ter m beyon d recognition . 3. Th e Sout h Korea n governmen t policie s ma y b e describe d a s market friendl y onl y i n th e sens e tha t regardles s o f how a firm go t started—subsidies, low-interes t loans , monopol y right s i n domes tic markets , etc.—i f tha t firm wa s judge d t o b e generatin g insuf ficient profit s afte r a nurturin g period , i n genera l i t wa s allowe d to fol d b y withholdin g privilege d credits . Tha t is , the governmen t regularly subjecte d busines s firms i t promote d t o th e marke t test s (with exception s o f course) . I argue d i n th e precedin g sectio n tha t this tendenc y i s generated b y th e rulin g elite s a s th e encompassin g organizations. In a way , Sout h Kore a wa s abl e t o gro w becaus e th e ruler s wer e able t o pursu e wha t the y define d a s th e nationa l goal , disre garding muc h o f special-interes t pleas , an d t o mobiliz e th e peopl e with a combinatio n o f incentive s an d exhortation , a s wel l a s bru tal repression . Thi s was possibl e becaus e a n obscur e group , uncon nected t o th e existin g interes t groups , too k powe r b y force , de stroyed th e the n existin g old-bo y network , an d publicl y shame d all existin g authoritie s i n it s populis t anticorruptio n campaigns , and the n stil l lackin g legitimacy , place d al l politica l bet s o n eco nomic growth . Th e junta's surviva l depende d o n growth . Further Factor s Influencin g Growt h Still, th e ide a tha t a n econom y straddle d b y a n authoritaria n ruling grou p actin g a s a n encompassin g interes t ca n gro w fas t may see m les s tha n full y believabl e i n ligh t o f the fac t tha t govern ment ma y no t c o m m a n d enoug h informatio n t o pla n o r direc t th e economy a s wel l a s a fre e economy . I offe r tw o factor s tha t migh t

248 Youn g Back Choi explain this : th e leve l o f technology , timing , an d proximit y t o growing economies , an d certai n governmenta l action s suc h a s sending troops to Vietnam. The leve l o f industria l productio n i n Sout h Kore a wa s s o lo w that i t wa s eas y t o impor t technologies , i n th e for m o f turnke y projects o r capita l goods , o r throug h foreig n direc t investments , that wer e n o longe r economica l i n man y develope d countrie s be cause o f risin g labo r costs , o r tha t wer e n o longe r tolerabl e be cause o f pollution . Give n th e dir e economi c condition s i n Sout h Korea i n the early 1960s , and th e corresponding lo w wages, man y declining industrie s i n more developed countries became econom ically viable , and eve n profitable whe n transplante d t o Sout h Ko rea. Sout h Korea n businessmen , i n fulfillin g thei r "patrioti c du ties t o buil d th e natio n throug h export, " importe d al l necessar y inputs fo r production—ra w materials , machinery , an d eve n for eign technician s an d engineer s t o teac h the m ho w t o produce, al l of which were obtained o n credit—hired loca l labor, and exporte d the finished product s t o th e largel y know n market s i n th e West . Despite al l th e call s fo r a highe r "domesti c content/ ' muc h o f what Sout h Korea n businessmen di d is arbitrage, pure and simple . It i s precisel y becaus e i t too k n o geniu s t o replicat e th e proces s that Sout h Korean s nowaday s worr y tha t thei r labor-intensiv e industries ar e threatene d b y suc h latecomer s a s mainlan d China , Indonesia, Malaysia, Bangladesh, Sr i Lanka, and India . Also importan t i s th e timin g o f th e earnes t attempt s a t eco nomic development . Sout h Korean s ha d man y contemporar y ex amples i n clos e proximit y t o stud y an d imitate . I n additio n t o Japan tha t wa s growin g a t a phenomena l pac e thank s t o th e booms create d b y th e U.S . wa r effort s i n Kore a an d Vietnam , Taiwan, Hon g Kong , an d Singapor e bega n t o sho w significan t growths fro m th e mid-1950 s onward . Wit h th e combinatio n o f plentiful example s t o follow , man y project s wit h prove n market s to pic k from , an d th e genera l tendenc y o f th e Sout h Korea n gov ernment t o be content wit h th e fact tha t expor t target s wer e met , or exceede d a s ofte n wa s th e case , an d tha t businessme n mad e regular contribution s t o th e rulin g party , i t wa s difficul t no t t o grow.

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Two o f th e Sout h Korea n governmenta l action s i n th e 1960 s are particularl y noteworthy : th e normalizatio n o f relation s wit h Japan, an d th e participatio n i n th e Vietna m Wa r a s a U.S . ally . The normalizatio n o f relation s wit h Japan , conclude d i n 196 5 twenty year s afte r th e Korea n liberatio n fro m Japan , ha d th e effect o f opening th e flood gat e o f trad e tha t ha d bee n kep t shu t b y President Rhee' s anticolonialism , permittin g th e inflo w o f Japa nese investmen t an d capita l goods . Som e 80 0 millio n dollar s i n extra fundin g fro m J a p a n a s reparatio n cam e i n hand y i n financing initia l developmen t projects , includin g th e aforementione d POSCO (Wo o 1991 , 87).4 Dispatching troop s t o Vietnam , ove r thre e hundre d thousan d soldiers betwee n 196 5 an d 1972 , prove d t o b e critica l t o Sout h Korean economi c development , a s well . I n return , th e Unite d States no t onl y increase d militar y ai d t o Sout h Korea , an d equipped an d pai d it s troop s statione d i n Vietnam , bu t bestowe d many civilia n contract s o n Sout h Korea n firms, wort h u p t o a billion dollars , providin g critica l outlet s fo r Korea n infan t indus tries an d enablin g Sout h Korea n firms t o gai n experienc e i n over seas contract s (ibid. , 85 , 93-97). 5 Presiden t Park' s governmen t no t only charge d businessme n an d bureaucrat s t o mee t target s i n exports, GN P growt h rates , an d s o forth , bu t trie d t o provid e funding an d eve n t o secur e markets . A t th e heigh t o f th e credi t crunch i n 1971 , th e governmen t eve n declare d a moratoriu m o n all corporat e deb t owe d t o (Korean ) privat e lender s fo r thre e years, t o reliev e busines s firms fro m th e crushin g burde n o f deb t service o n foreig n loan s (ibid. , 113) . In keepin g wit h th e traditio n of helpin g ou t business , when Sout h Korean s face d anothe r sever e credit crunc h i n th e earl y 1980s , Presiden t Chu n demande d an d obtained fou r billio n dollar s o f extr a fundin g fro m J a p a n (h e ini tially demande d te n billio n dollars!) , fo r shoulderin g muc h o f th e defense o f Nort h Eas t Asi a fro m communis m (ibid. , 187) . Thi s is wh y th e Sout h Korea n government' s approac h t o economi c development i s bes t describe d a s enterprising. I t i s no t tha t Sout h Koreans avoide d ren t seeking , bu t tha t th e dominan t grou p mo nopolized it , claimin g th e lion' s shar e o f th e gain s fro m economi c growth.

250 Youn g Back Choi Costs of Authoritarian Rul e The heady experienc e o f nearly a decad e o f fast growt h an d som e unbelievable feat s suc h a s POSC O an d th e shipbuildin g industry , however, mad e Presiden t Par k ver y confiden t abou t hi s abilit y t o direct economi c developmen t i n Sout h Korea. 6 Consequently , from th e mid-1970s , the government becam e more interventionis t and chos e t o develo p "heav y an d chemica l industries, " identifie d as winners, to steer Sout h Kore a int o a truly industrialize d natio n and t o becom e self-sufficien t i n armament s i n th e fac e o f a n en hanced threa t fro m th e belligeren t communis t Nort h Kore a an d the decreasing U.S . commitment t o South Korea n defens e (durin g the Carte r administration. ) Th e governmen t borrowe d heavil y from oversea s to construct massiv e projects i n heavy and chemica l industries, causin g inflatio n an d th e proble m o f servicing th e for eign loans. And it turne d ou t t o be impossible t o plug holes of thi s magnitude, even for a government a s resourceful an d enterprisin g as that of South Korea . There were many doubts about th e government's abilit y t o servic e it s debt s a s th e the n fourth-larges t in debted natio n afte r Brazil , Mexico, and Argentina . Foreign invest ors eve n bega n t o shu n Sout h Kore a a s a plac e o f investment . Furthermore, b y th e tim e thes e project s wer e complete d i n th e late 1970s , man y o f th e factorie s buil t remaine d idl e fo r lac k o f demand, causin g hig h unemployment . Th e ambitiou s economi c plans of President Park , who wanted t o be remembered a s "beare r of th e historica l missio n o f rebuilding Korea, " thoroughl y under mined hi s legitimacy , whic h h e himsel f place d exclusivel y o n th e track record s o f economic success . In 1979 , in th e mids t o f sever e recession, massiv e riots , and protest s al l ove r Sout h Korea , Presi dent Par k was assassinated b y the chief of KCIA. A discussion o f th e Korea n experienc e woul d b e grossl y defi cient if the costs of the authoritarian rul e that forcefully mobilize d people ar e lef t out . To o man y sacrifice s wer e force d upo n th e ordinary citizen s o f Sout h Kore a i n th e nam e o f economic devel opment. For example, when inflation wa s almost 20 percent a year throughout th e 1960 s an d 1970s , governmen t force d citizen s t o buy long-ter m bond s tha t quickl y becam e worthless , an d a t th e same tim e gav e favore d businessme n interest-fre e loans , o r low -

Industrial Polic y in South Kore a 25 1 interest loans . Whe n bi g busines s firm s complaine d abou t th e difficulty o f remainin g solven t durin g recession , fo r exampl e i n the wak e o f the oi l crisis i n th e earl y 1970s , government declare d a moratoriu m o n privat e loan s (unofficia l loan s sinc e al l bank s were nationalized) t o corporations fo r thre e years, de facto forcin g ordinary citizen s from factor y worker s an d maid s t o small invest ors t o giv e interest-fre e loan s t o bi g corporation s fo r thre e years ! On to p o f that , Sout h Korean s ha d bee n force d t o pay exorbitan t prices fo r shodd y product s i n protecte d consume r good s market s dominated b y government-sanctione d monopolie s an d oligopo lies. A t th e sam e time , member s o f th e rulin g part y enriche d themselves by selling to themselves larg e tracts of land fo r next t o nothing, i n th e nam e o f privatization , knowin g ful l wel l tha t th e government-financed project s bein g planne d woul d driv e u p th e value o f th e rea l propertie s i n question . Peopl e ar e no t stupi d when i t come s t o th e issu e o f someon e gettin g ric h a t thei r ex pense. Th e peopl e wh o proteste d th e unfairnes s o f th e wa y th e economy wa s manage d wer e brutall y suppresse d o n th e charge s of seditio n an d eve n treason . Ove r tw o decade s o f thi s typ e o f shady sid e of industrial polic y made man y me n an d women , som e of who m d o no t hav e visibl e mean s o f earnin g a living , le t alon e amassing a great fortune , ver y wealthy, while makin g man y mor e others resentful . The rulin g elite s too k a persona l interes t i n th e growt h o f th e South Korea n econom y becaus e the y claime d a lion' s shar e o f the gain , whil e forcin g th e genera l publi c t o bea r th e cost s o f adjustments an d thei r mistakes . Thi s ha s lef t lingerin g doubt s about th e legitimacy o f the status quo . Many Sout h Korean s see m to hav e a sens e o f lawlessnes s an d doub t th e legitimac y o f th e fortunes o f th e rich . Fo r example , i n th e earl y 1980s , a certai n thief, Ch o DaeHyung , becam e a sensatio n b y robbin g wealth y neighborhoods ove r a n extende d period . Wheneve r h e narrowl y escaped a polic e pursuit , citizen s cheere d an d wishe d hi m well . When Ch o was finally capture d an d man y stole n good s recovered , no on e cam e forwar d t o reclai m hi s o r he r good s fo r months , t o the amazement o f the police. It wa s late r reveale d tha t th e peopl e robbed b y Ch o wer e to o embarrasse d t o acknowledg e tha t th e stolen good s belonge d t o them . I t wa s impossibl e t o ow n suc h

252 Youn g Back Choi goods—millions o f dollar s wort h o f diamonds , fo r example — based o n thei r know n incom e sources . Th e lingerin g sens e o f th e illegitimacy o f fortunes i s th e graves t threa t t o th e orderl y devel opment o f the Korea n econom y i n the future . Conclusions What ar e the lessons from th e Sout h Korea n experience? One may still insis t tha t industria l polic y ma y wor k if it is done skillfully under certain circumstances. A usurper o f political power in a poo r country may provide a background where one may try to replicate the Korea n experienc e base d o n th e followin g considerations : (1 ) industrial polic y ma y b e bes t promote d a s a mean s o f promotin g the commo n good , define d b y a n encompassin g organization , im mune fro m th e plea s o f specia l interest s a s wel l a s genuin e dis sents; (2 ) industria l polic y shoul d consis t o f settin g broa d goal s and providin g a n environmen t conduciv e t o th e achievemen t o f the goals , instea d o f pickin g winner s o r directl y regulatin g an d managing projects ; an d (3 ) the government shoul d maneuve r dip lomatically t o gain access to markets created by others' follies, fo r example, war. One should realize that th e first of these involves dictatorial rule. The thir d facto r make s on e wonde r whethe r ther e i s likel y t o b e another Unite d State s tha t single-handedl y financed tw o majo r wars i n Kore a an d Vietnam . For without th e demand s create d b y both wars , th e Japanes e econom y woul d no t b e wha t i t i s today . And without th e Vietnam War , th e Sout h Korea n econom y woul d not b e wha t i t i s today . Eve n thoug h ther e see m t o b e som e generalizable feature s i n th e Korea n experienc e tha t ca n b e ap plied t o othe r LDCs , I a m les s tha n confiden t tha t othe r LDC s would b e abl e t o replicat e th e Korea n experienc e sinc e ther e ar e so many features tha t ar e crucial yet unique t o Korea . Moreover, th e apparen t benefit s o f th e industria l policie s mus t be judge d agains t harm s the y hav e caused . Fo r th e industria l policies that exacte d enormous sacrifices fro m peopl e also plante d a cance r tha t ma y kil l th e socia l covenant . W e ough t t o b e ver y cautious i n suggestin g tha t industria l polic y i s desirabl e fo r eco nomic development .

Industrial Polic y i n Sout h Kore a 25

3

But other s ma y observ e tha t a fre e econom y wit h les s govern ment intrusio n i n th e for m o f industria l polic y i s preferable o n th e following grounds . Afte r al l th e expor t promotio n schemes , al l th e five-year plans , al l th e effort s t o secur e th e outlet s fo r industria l products fro m hastil y create d industries , eve n b y sendin g nearl y half a millio n troop s thousand s o f mile s awa y (man y o f who m never returned) , an d al l th e sacrifice s force d upo n ordinar y citi zens, th e Sout h Korea n economi c developmen t recor d i s nothin g special when compared to thos e o f Taiwan , Singapore , o r Hon g Kong. Thes e countrie s embarke d o n th e cours e o f rapi d economi c growth earlie r tha n Sout h Kore a an d the y kep t themselve s wel l i n front wit h thei r pe r capit a GN P rangin g fro m 5 0 percen t t o mor e than 10 0 percen t highe r tha n tha t o f Korea . Sinc e th e govern ments o f thes e countrie s hav e bee n in varying degrees les s intrusiv e in th e economi c sphere , Hon g Kon g bein g th e closes t t o free trade , without doin g an y les s spectacularl y tha n Sout h Korea , on e won ders whethe r al l th e ravin g an d rantin g abou t economi c develop ment strategie s sponsore d b y governmen t ha d bee n necessary . Moreover, a s Kore a ha s narrowe d th e ga p betwee n itsel f an d the mor e develope d countries , an d th e ga p betwee n it s potentia l and actua l attainment , i t ha s becom e mor e an d mor e difficul t fo r discretionary policie s o f th e governmen t t o b e o f muc h use . If anything, dirigist e government s ten d t o b e hindrances , rathe r than a help , t o entrepreneur s wishin g t o exploi t opportunitie s they discover . Th e gradua l realizatio n o f thi s ha s le d a grea t man y South Korean s t o see k t o lesse n th e governmen t dominatio n i n th e economy an d t o cal l fo r liberalization . I n par t respondin g t o U.S . demands t o liberaliz e th e economy , an d i n p a r t adoptin g th e ad vice o f free-market-oriente d economists-technocrats , Sout h Kore a has sinc e th e earl y 1980 s liberalize d graduall y an d steadily .

Notes 1. Wo o (1991 , 108 ) report s eve n highe r estimate s a t 10-1 5 percent , o r even up to 20 percent. 2. Barr o (1991 ) confirm s th e finding i n a stud y wit h a muc h large r sample. 3. Th e prevalence of contraband an d counterfeits o f foreign product s only

254 Youn

g Bac k Cho i

testifies tha t ther e wer e significan t pric e distortion s i n man y produc t categories. Unti l ver y recently , on e coul d see a t Kimp o Internationa l Airport (near Seoul) that the luggage of people entering South Korea — both that of Koreans and of foreign nationals—wa s inordinatel y large , full o f valued foreig n good s tha t coul d b e sol d beyon d custom s fo r fa t profits. Wit h increasin g liberalization , traveler s enterin g Kore a no w tend t o travel much lighter . 4. I t consisted o f 300 million dollars in grants, 200 million in governmen t loans, and 30 0 million i n commercial credits . 5. Fo r example , Vietna m absorbe d almos t 9 5 percen t o f tota l Korea n steel exports , an d ove r 5 0 percen t i n transportatio n equipmen t ex ports, etc. 6. Abou t thi s tim e Nam , a U.S . traine d economis t an d one-tim e prim e minister, publicl y confesse d tha t h e wa s awe d b y Presiden t Park' s "innate economic knowledge. " References Agarwala, Ramgopal . 1983 . "Price Distortio n an d Growt h i n Developin g Countries." World Bank Staff Paper No. 575. Amsden, Alice H. 1989 . Asia's Next Giant: South Korea and Late Industrialization. Ne w York: Oxford Universit y Press . Bank of Korea. 1991 . Economic Statistics Yearbook. Barro, Rober t J . 1991 . "Economic Growt h i n a Cros s Sectio n o f Coun tries." Quarterly Journal of Economics (May) : 407-43. Datta-Chaudhuri, Mrinal . 1990 . "Marke t Failur e an d Governmen t Fail ure." Journal of Economic Perspective (Summer): 25-39. Haggard, Stephan , Byung-Kook Kim , and Shung-I n Moon . 199 1 "Transition t o Export-le d Growt h i n Sout h Korea : 1954-1966. " Journal of Asian Studies 5 0 (November): 850-73. Hayek, F . A . 1945 . "The Us e o f Knowledg e i n Society. " American Economic Review (September): 519-30. Hogendorn, Ja n S . 1992 . Economic Development. 2 d ed . Ne w York : Har per-Collins. Kirzner, Israe l M . 1979 . Perception, Opportunity, and Profit: Studies in the Theory of Entrepreneur ship. Chicago : University of Chicago Press. Korea Developmen t Institute . 1992 . Quarterly. (Spring) . Krauss, Lawrence . 1991 . "Japanes e Capitalism : A Mode l fo r Others? " International Economic Insight. (Nov./Dec) : 6-10 . Krueger, Ann e O . 1990 . "Government Failure s i n Development. " Journal of Economic Perspective (Summer): 9-23. Lai, Deepak . 1988 . "Ideolog y an d Industrializatio n i n Indi a an d Eas t Asia." I n Achieving Industrialization in East Asia, ed . Hele n Hughes , 195-240.. New York: Cambridge Universit y Press.

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Lim, Youngil . 1981 . Government Policy and Private Enterprise: Korean Experience in Industrialization. Kore a Researc h Monograp h No . 6. Institute of East Asian Studies , University of California . Mason, Edward , e t al . 1980 . The Economic and Social Modernization of the Republic of Korea. Cambridge: Harvard Universit y Press . Nassar, Sylvia . 1991 . "Industrial Policy : Th e Korea n Way. " New York Times, July 12 . Olson, Mancur . 1982 . The Rise and Decline of Nations. Ne w Haven : Yal e University Press . Parry, Thomas G . 1988. "The Role of Foreign Capital i n East Asian Industrialization, Growth , and Development. " I n Achieving Industrialization in East Asia, ed. Helen Hughes, 95-128. New York: Cambridge Univer sity Press. Song, Byung-Nak . 1990 . The Rise of the Korean Economy. Ne w York : Oxford Universit y Press . Srinivasan, T . N . 1990 . "Developmen t Thought , Strateg y an d Policy : Then an d Now. " Unpublishe d backgroun d pape r fo r World Development Report 1991 (October). Wade, Robert. 1990 . Governing the Market: Economic Theory and the Role of Government in East Asian Industrialization. Princeton : Princeto n University Press . Westphal, Larry E . 1990 . "Industrial Polic y in an Export-Propelle d Econ omy: Lesson s fro m Sout h Korea' s Experience. " Journal of Economic Perspective. (Summer): 41-59. Woo, Jung-en. 1991 . Race to the Swift: State and Finance in Korean Industrialization. Ne w York: Columbia Universit y Press . World Bank. Various years. World Development Report.

10 The Politica l Econom y o f Post-Worl d War II Japanese Development : A Rent-Seeking Perspectiv e Shigeto Naka , Wayne T . Brough , and Kiyokaz u Tanak a

Introduction After Worl d Wa r I I Japa n experience d ver y rapi d economi c growth whil e maintainin g a stabl e democrati c politica l regime. * When th e America n Occupatio n o f Japa n ende d i n 1952 , Japa n was economicall y insignificant . Toda y Japa n i s a no t onl y demo cratic, bu t als o a ric h an d technologicall y advance d nation , wit h its per capita incom e exceeding thos e of many Western countries . Many attempts have been made to explain postwar Japan's economic an d politica l miracles . Broadl y speaking , tw o school s o f thought hav e emerge d (se e Patric k an d Meissne r 1986) . The first emphasizes th e uniqueness of Japan's sociopolitica l institution s i n coordinating Japan' s industria l policies . I t maintain s tha t Japa nese bureaucrats provided the optimal mix of a market system an d a command system. The second school of thought focuses purely on the technica l relationship s amon g economi c variable s t o explai n Japan's growth . It s proponent s asser t tha t th e growt h o f postwa r Japan was mainly a market phenomenon. Neither of these views is 256

Post-World Wa r I I Japanese Developmen t 25

7

satisfactory. Th e sociopolitica l approac h fall s shor t becaus e o f it s methodological inconsistency , whil e th e neoclassical-economic growth approac h i s weak becaus e o f its institutiona l vacuum . In thi s chapter , w e us e a n alternativ e framewor k t o analyz e and explai n th e growt h o f Japan' s politica l economy. 1 Ou r analy sis draw s upo n th e theor y o f publi c choice . Thi s theor y utilize s the rational-choic e mode l t o analyz e th e interaction s betwee n pri vate an d politica l markets . I t hold s tha t th e stat e i s a nexu s o f contracts i n whic h self-seekin g individual s interac t wit h on e an other fo r persona l gain , a n assumptio n consisten t wit h th e behav ior o f marke t participants . Further , becaus e suc h interaction s take plac e fro m withi n a constitutiona l framework , a n analysi s o f institutional structure s i s necessary . In th e cas e o f moder n Japan , th e rule s o f th e gam e wer e sig nificantly altere d b y th e Occupatio n force s (1945-52 ) a s a resul t of Worl d Wa r II . The chang e destroye d th e nexu s o f contract s tha t had comprise d th e Japanes e stat e an d create d institutiona l insta bility; Japanes e politica l operative s wer e force d t o adjus t thei r behavior. However , onc e thes e adjustment s wer e made , a stabl e nexus o f contract s emerged , a s observe d b y th e stabilit y o f th e political regim e i n th e subsequen t postwa r years . I t ca n b e sai d that th e sociopolitica l stabilit y i n postwa r J a p a n wa s structurall y induced b y th e Occupatio n forces . How di d J a p a n mov e fro m disequilibriu m t o a stable , ne w equilibrium? I n thi s process , w h a t rol e di d th e Occupatio n force s play? Wha t di d Japanes e politica l operative s d o t o gai n o r protec t their interests ? I n analyzin g thes e questions , w e introduc e th e main thesi s o f thi s chapter : tha t is , under th e structur e o f th e ne w equilibrium, ren t seekin g becam e relativel y mor e efficien t tha n i n other industria l nations . B y efficien t ren t seekin g w e mea n tha t the socia l cost s o f wealt h redistributio n ar e relativel y lowe r tha n in othe r countries . Thi s doe s no t mean , however , tha t efficien t rent seekin g i s a desirabl e goa l fro m a societa l poin t o f view . B y definition, an y ren t seekin g entail s a decreas e i n socia l wealth . I n addition t o redefinin g th e rent-seekin g game , th e Occupatio n forces strengthene d marke t institutions . Thes e point s shoul d b e considered significan t variable s contributin g t o th e growt h o f th e Japanese economy .

258 Shiget o Naka, Wayne T. Brough, and Kiyokaz u Tanak a An Overview o f the Japanese Politica l Econom y Japan's postwa r histor y bega n i n Augus t 194 5 whe n Japa n sur rendered t o th e Allie d Powers . Thre e period s ar e identifie d i n postwar Japanes e economi c history : th e recover y perio d (fro m 1945 to the early 1950s) , the high-growth er a (from th e early 1950 s to th e earl y 1970s) , and th e er a o f economi c slowdow n (fro m th e early 1970 s to the present). The recover y perio d roughl y coincide d wit h th e occupatio n period (1945-1952) , in which th e Unite d State s too k the initiativ e in occupyin g Japan . Genera l MacArthu r becam e th e Suprem e Commander o f the Allied Power s (SCAP ) and establishe d th e Gen eral Headquarter s (GHQ ) t o demilitariz e an d democratiz e Japan . While establishin g th e ne w democrati c constitutio n o f Japan , MacArthur implemente d thre e importan t socia l reforms: (1 ) labor reform, (2 ) land reform , an d (3 ) economic deconcentratio n o r zai batsu dissolution . Thes e reform s significantl y affecte d th e subse quent developmen t o f postwar Japan . Japan regaine d he r sovereignt y i n April 1952 , which mark s th e beginning o f the high-growth period . The high-growth perio d wa s characterized a s a n er a o f modernization an d rapi d technologica l progress. As shown i n tabl e 1 , Japan's rea l GN P grew a t a n aver age annual rat e of about 1 0 percent between 195 1 and 1973 , representing a seven-and-a-half-fol d increas e i n production . I n 1952 , the pe r capit a GN P o f Japa n wa s onl y $188 , ranking th e countr y lower tha n bot h Brazi l an d Malaysi a (Patric k an d Rosovsk y 1976 , 11). B y 1973 , Japan' s pe r capit a GN P gre w t o abou t $3,700 , a figure whic h wa s greate r tha n pe r capit a GN P in Ital y an d Grea t Britain, an d abou t three-fifth s o f that i n th e Unite d States . In th e mid-1960s Japan' s GN P exceede d tha t o f Wes t Germany , becom ing the third larges t econom y i n the world . The high-growt h perio d brough t no t onl y a n improvemen t o f living standards , bu t als o a shif t i n th e internationa l accoun t balance. Exports bega n t o grow in the 1960 s and ful l employmen t was attaine d wit h a mild inflation . Thes e achievements wer e sai d to b e mad e possibl e b y a hig h investmen t rat e that , i n turn , wa s supported b y a high personal saving s rate. Hayashi (1986 ) report s that persona l savin g rates i n Japan hav e been roughly 1 0 percent-

Post-World Wa r II Japanese Development 25 9 Table 1 . Gross Nationa l Produc t o f Japan , 1951-197 5 (1970=100)

Year

Real GNP (hundred million yen)

1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975

126,130 140,829 151,636 155,841 172,680 183,299 197,594 209,366 232,728 261,832 297,115 316,151 355,746 393,495 415,913 462,177 522,568 589,042 653,668 721,444 774,003 849,780 904,235 901,788 932,596

% Increase — 11.7

7.7 2.8 10.8

6.1 7.8 6.0 11.2 12.5 13.5

6.4 12.5 10.6

5.7 11.1 13.1 12.7 11.0 10.4

7.3 9.8 6.4 -0.3

3.4

Real GNP Per CapitaC (yen) 52,479 60,822 69,001 74,734 81,797 90,689 102,918 104,827 119,038 142,084 167,174 186,363 214,618 240,820 265,951 308,038 361,654 423,126 486,190 570,459 627,456 710,841 845,503 1,033,004 1,139,271

Source: Ministr y o f Finance , Showa Zaiseishi (Tokyo : Toy o Keiza i Shinpo-sha , 1978), 29.

age point s highe r tha n thos e o f th e Unite d States , eve n afte r ad justing for th e accounting difference s i n these nations . Three mai n factor s ar e considere d t o hav e ende d th e postwa r Japanese miracl e whe n Japa n entere d th e 1970s : (1) the oil crisis , (2) th e decreas e i n investmen t demand , an d (3 ) th e slowdow n i n technological progres s (se e Kosa i [1981 ] 1986 ; Lincol n 1988 ; It o 1991). Th e oi l crisi s raise d th e cos t o f productio n an d reduce d expected earning s i n th e busines s sector , resultin g i n a declin e

260 Shiget o Naka, Wayne T. Brough, and Kiyokaz u Tanak a in investmen t demand . Thi s decline , i n turn , place d downwar d pressure o n th e equilibriu m leve l o f income . Together , thes e fac tors decrease d th e deman d fo r advance d technologie s an d slowe d the economic growt h o f Japan. Sinc e th e 1970 s Japan ha s entere d an era of "economic maturity " (Lincol n 1988) . Alternative View s Japan's remarkabl e economi c developmen t durin g th e high growth er a ha s sparke d man y theorie s o f it s rapi d growth . A glance a t th e literatur e o n th e Japanes e econom y reveal s th e fol lowing as commonly accepte d explanations : 1. Japa n ha s bee n a highly market-oriente d economy , using mar ket mechanism s rathe r tha n th e comman d syste m t o allocat e resources; 2 2. Japa n ha s adopte d industria l enterpris e groups—th e so-calle d "keiretsu" structure—fo r it s industrial organization; 3 3. Japanes e firm s ten d t o utiliz e indirec t financing ove r direc t financing an d th e capita l marke t wa s heavil y regulate d an d underdeveloped unti l recently; 4 4. Th e Japanes e labo r marke t tend s t o b e les s mobil e an d inter nalized within firms, utilizin g enterprise unions and employin g long-term jo b contracts ; thi s le d t o wha t i s no w calle d Japa nese-style management; 5 an d 5. Th e Japanes e politica l system , dominate d b y th e conservativ e Liberal Democrati c Part y (LDP) , seems ver y stabl e despit e th e prevalence o f factionalism, an d th e governmen t seem s t o hav e maintained cooperativ e rathe r tha n adversaria l relationship s with business. 6 Each aspect of the above characterizations o f Japanese politica l economy ha s bee n examine d extensively. 7 Fo r example , focusin g upon th e harmoniou s labor-managemen t an d cooperativ e busi ness-government relationship s i n Japan , on e popula r schoo l o f thought assert s tha t thes e characteristic s aris e fro m th e uniqu e culture o f Japan . I t emphasize s th e group-oriente d behavio r among th e Japanese , an d attribute s Japan' s economi c succes s t o

Post-World War II Japanese Development 26 1 the willingness of the Japanese people to endure personal sacrific e to maintain th e harmony o f the group. 8 As note d earlier , tw o mai n school s o f thought s hav e emerge d (Patrick 1986) . One schoo l o f thought i s characterized b y th e neo classical economi c paradig m an d focuse s upo n th e analysi s o f Japan's marke t system . Observin g Japan' s larg e private-marke t economy, thi s schoo l analyze s th e source s o f Japan' s succes s purely fro m th e perspectiv e o f a n economi c growt h model . Theo rists conclud e tha t Japan' s economi c growt h i s explaine d b y th e usual macroeconomi c variables . A s a result , i n explainin g th e development o f the Japanese economy, they discount th e effective ness o f direc t governmen t assistanc e an d contro l o f Japanes e in dustries a s well as many cultura l element s i n Japan. Instead, the y focus o n th e Japanes e government' s abilit y t o maintai n a stabl e macroeconomic environment . The alternativ e schoo l o f thought , mor e popula r amon g politi cal scientists, emphasizes th e role of Japan's sociopolitica l institu tions. 9 Focusing upon managemen t b y Japanese economic bureau crats, thi s schoo l attribute s th e economi c succes s o f Japa n t o direct governmen t plannin g an d contro l (e.g. , Johnson 1982) . It s proponents maintai n tha t Japan' s economi c succes s wa s largel y engineered b y well-discipline d an d public-minde d economi c bu reaucrats. Thus , this.schoo l no t onl y maintain s a public-interes t view o f th e state , bu t assume s tha t th e bureaucrati c syste m ha s information-processing capacit y superio r t o tha t o f th e marke t system. The debat e betwee n th e tw o school s focuse s o n whic h resourc e allocation method—th e marke t syste m or the command system — is mor e effectiv e fo r promotin g economi c growth . T o date , th e issue ha s no t bee n resolved . W e contend tha t th e debat e mus t b e elevated t o a highe r leve l tha t include s a broade r examinatio n of th e institutiona l framework . A s lon g a s researcher s rel y upo n different behaviora l system s an d spli t th e analysi s o f economi c and politica l marke t transactions , ther e i s n o commo n groun d t o compare an d evaluat e thei r results . A meaningfu l comparativ e study mus t begi n wit h th e premis e tha t th e politica l econom y represents a nexu s o f contract s o f self-seekin g individuals . Th e theory of public choice offers suc h a paradigm .

262 Shiget o Naka, Wayne T. Brough, and Kiyokaz u Tanak a The Framework: Th e Theory of Publi c Choic e Public choic e employ s a rational-choic e mode l t o analyz e th e in teractions o f private an d politica l markets . The state i s viewed a s a nexu s o f contract s i n whic h self-seekin g individual s engag e i n exchanges with one another for personal gains ; this is very simila r to marke t behavior , bu t th e constraint s ar e different . A stabl e regime implie s th e existenc e o f stabl e contractua l relationships . This, i n turn , implie s th e existenc e o f effectiv e institutiona l en forcement mechanisms . I n thi s exchang e paradig m o f th e state, 10 the primar y functio n o f th e stat e i s t o redistribut e wealt h amon g different set s of individuals or groups. We assume tha t rationa l individual s engag e i n exchanges wit h one anothe r b y choosin g th e bes t availabl e institutiona l alterna tive t o writ e an d enforc e contracts . I n this , w e deemphasiz e th e distinction no t onl y betwee n th e marke t an d hierarchie s bu t als o between marke t institution s an d politica l institution s becaus e al l these institution s represen t alternativ e mechanism s fo r writin g and enforcin g contracts. 11 This methodology enable s us to analyz e consistently both economi c and politica l marke t transactions . One importan t implicatio n her e i s that an y significan t regim e change, suc h a s a foreig n invasio n o r revolution , wil l lea d t o dis equilibrium b y altering the relative price structure of institutiona l choice. Whe n suc h a disequilibriu m occurs , rationa l individual s must adjus t thei r behavio r t o reac h a ne w equilibriu m b y adopt ing and inventin g new institutions . In addition, we assume that i n choosing between differen t insti tutional arrangements , rationa l individual s utiliz e institutiona l comparative advantage s derive d fro m withi n th e fundamenta l rules of the game (i.e., constitutional structure) . The constitutiona l framework, bargainin g strength , an d natur e o f contracts ar e con sidered majo r determinant s fo r a choic e o f institutiona l alterna tives. Finally, the choice among institutiona l arrangement s i s considered t o hav e welfar e implication s becaus e i t affect s th e resourc e allocation i n th e politica l economy . I n thi s w e emphasiz e th e deadweight losse s o f wealt h transfers . Rent-seekin g costs—th e costs impose d upo n societ y throug h politica l exchanges—ar e a

Post-World War II Japanese Development 26 3 part o f these losses. Following the theory of pressure groups developed by Becker (1983) , each interes t grou p i s assumed t o have th e incentive t o maximiz e it s privat e gain s b y minimizin g it s ow n deadweight losse s fro m wealt h transfers . Thi s incentiv e i s on e o f the drivin g force s fo r rationa l actor s choosin g betwee n differen t institutions. Based upo n th e abov e framework , w e propos e th e followin g hypotheses concernin g th e developmen t o f th e politica l econom y of postwar Japan : 1. Th e American Occupation of Japan initially induced disequilib rium i n th e nexu s o f contracts i n th e Japanes e stat e b y signifi cantly alterin g th e fundamental rule s of the game; 2. Th e stabilit y o f th e postwa r regim e i n Japa n wa s induce d b y the shif t i n Occupatio n polic y whic h establishe d ne w institu tional choice s withi n a ne w constitutiona l orde r fo r a marke t economy over a command economy ; an d 3. Th e incentive s o f Japanes e interes t group s t o maximiz e thei r own privat e gain s b y minimizin g thei r ow n deadweigh t losse s from wealt h transfer s promote d a n institutiona l structur e tha t reduced th e overall deadweigh t losse s at social level; thus, contributing t o its economic growth . Each of these hypotheses i s examined i n sections below . The U.S. Occupation an d the Structura l Disequilibriu m For transactiona l reason s (se e Olso n 1965) , thre e majo r interes t groups dominate a political economy. These are bureaucrats, politicians, an d special-interes t groups . Th e genera l publi c supplie s wealth t o thes e group s vi a coercio n (taxation ) an d function s merely a s a constrain t upo n politician s (Macka y an d Weave r 1981). In prewa r an d wartim e Japan , th e Japanes e bureaucrac y ap peared t o hav e exercise d vas t powe r i n Japan' s resourc e alloca tion. However , ther e i s substantia l evidenc e t o sugges t tha t th e bureaucracy wa s significantl y constraine d b y politicians an d eco nomic special-interes t groups. 12 Fo r instance , Curti s (1988 , 4-5 ) examined th e Japanes e part y syste m durin g th e wa r an d con -

264 Shiget o Naka, Wayne T. Brough, and Kiyokaz u Tanak a eluded: "wartim e totalitarianis m i n Japa n wa s neve r quit e total , and som e o f th e ol d part y leader s continue d t o b e politicall y active" Similarly , Friedma n (1988 , 38 ) examine d th e prewa r de velopment o f Japan's machin e too l industr y an d concluded : "Th e prewar governmen t an d th e zaibats u wer e locke d i n a powe r struggle tha t prevente d eithe r sid e from implementin g it s favore d industrial policy/ ' These conclusions sugges t tha t th e political equilibriu m i n prewar Japa n wa s maintaine d b y th e balanc e o f powe r amon g th e three dominan t interes t groups—bureaucrat s (includin g th e mili tary), dominan t economi c special-interes t groups , an d conserva tive politician s a t loca l an d nationa l levels . Each o f thes e group s engaged i n exchang e wit h on e anothe r b y constrainin g on e an other's behavior . Whe n th e Occupatio n began , th e balanc e wa s significantly altered , resulting i n disequilibrium . The initia l disequilibriu m wa s create d b y SCAP' s policie s t o promote th e civi l libertie s o f th e Japanes e peopl e an d decentral ization o f th e government . Thes e policie s change d th e relativ e price structure o f institutional choic e for Japanese political opera tives by lowering the cost of political participation an d by increasing socia l mobility . Initially , thes e policie s weakene d Japanes e capitalists, conservativ e politicians , an d militarists , whil e strengthening civi l bureaucrats, socialists, and unions . In particu lar, economi c bureaucrat s gaine d vas t powe r ove r othe r group s and bega n t o dominate th e Japanese political economy. 13 Three policies by SCAP are responsible for the dominance of the command system . The y ar e labo r reform , antitrus t reform , an d land reform . Labo r refor m strengthene d th e bargainin g power s of labo r unions , th e Japa n Socialis t Part y (JSP) , an d th e Japa n Communist Part y (JCP) . B y thei r nature , thes e group s preferre d collective ownershi p t o private ownership , thu s contributin g t o a stronger state . Table 2 shows a dramati c increas e i n th e percent age of unionized worker s during th e Occupation . Zaibatsu dissolutio n weakene d th e bargainin g power s o f tradi tional capitalist s b y separatin g ownershi p fro m contro l (se e Had ley 1970) . Prewar Japanes e market s wer e dominate d b y wealth y capitalists wh o controlle d family-owne d holdin g companie s known a s zaibatsu . Zaibats u dissolutio n bega n i n Octobe r 1945 ,

Post-World Wa r I I Japanese Developmen t 26

5

Table 2. Growth o f Unions for Selecte d Years , 1945-195 5

Year 1945.6 1945.12 1946.6 1946.12 1947.6 1947.12 1948 1949 1950 1951 1952 1953 1954 1955

Number of Unions

Number of Union Members

Number of Labor Disputes

0 707 11,579 17,265 23,323 28,014 33,926 34,688 29,144 27,644 27,851 30,129 31,456 32,012

0 378,481 3,748,952 4,849,329 5,692,179 6,268,432 6,677,427 6,655,483 5,773,908 5,686,774 5,719,560 5,842,678 5,986,168 6,185,343

0 — 0 920 — 1,035 1,517 1,414 1,487 1,186 1,233 1,277 1,247 1,345

Number of Participants — — — 2,772,582 — 4,415,390 6,714,843 3,307,407 2,348,397 2,818,688 3,383,435 3,398,667 2,635,426 3,748,019

Source: Junnosuke Masum i ([1983] 1985 , 19, Appendix).

which marke d th e beginnin g o f Japan's antitrus t policy . The Hold ing Compan y Dissolutio n Commissio n wa s forme d i n 194 6 t o dis pose o f th e stock s o f zaibatsu-owne d companies. 1 4 I n 1947 , th e Law fo r th e Eliminatio n o f Excessiv e Concentratio n o f Economi c Powers an d th e Anti-Monopol y La w wer e passe d t o eliminat e ex cessive concentration . Antitrus t refor m weakene d th e power s o f traditional capitalist s wh o favore d privat e ownership . Land reform , togethe r wit h th e dissolutio n o f th e Agricultura l Association (Nokai ) tha t controlle d th e allocatio n o f foodstuff s and credi t i n th e countryside , weakene d th e bargainin g power s o f traditional rura l elite s wh o supporte d conservativ e politicians. 1 5 With th e economi c an d politica l purg e tha t remove d man y capi talists an d conservativ e politician s fro m publi c office, 16 lan d re form furthe r weakene d th e powe r o f traditiona l conservatives . By contrast, th e bargainin g powe r o f economic bureaucrat s wa s greatly strengthene d becaus e SCA P kep t th e civil-bureaucrati c system relativel y intac t t o implemen t it s policies . The governmen t adopted a centra l plannin g syste m t o contro l th e Japanes e econ -

266 Shiget o Naka, Wayne T. Brough, and Kiyokaz u Tanak a omy and established th e Economic Stabilization Boar d and fiftee n public corporation s (Kodan ) t o control commerce . Attempts wer e made t o nationaliz e th e coa l industry . Durin g thi s period , ta x rates reache d a maximu m o f 8 5 percen t o n individua l income s and 52. 5 percent on corporate profits (Packma n and Kaizuka 1976 , 320). Wilde s (1954 , 92 ) reporte d tha t Japan' s bureaucrac y ex panded it s siz e b y 8 4 percent , a s measure d b y th e numbe r o f government employees . The Occupatio n altere d th e structure s o f virtually al l politica l institutions, includin g th e Parliamen t (Diet) , court system , polic e system, educatio n system , electora l system , an d loca l govern ments. I t generate d uncertaint y an d change d institutiona l con straints unde r whic h eac h special-interes t grou p operated . Over all, i t strengthene d th e powe r o f anticonservativ e group s an d th e economic bureaucrac y b y removin g previou s institutiona l con straints. As a result, th e initial institutiona l arrangement s o f postwar Japa n becam e biase d i n favor o f state allocatio n o f resource s rather tha n marke t allocation . Durin g th e immediat e postwa r pe riod, thos e who could gai n from a command syste m rathe r tha n a market syste m dominate d th e Japanese political economy . The Path towar d th e New Equilibriu m By 1948 , it ha d becom e apparen t tha t th e Col d War woul d inten sify. Confrontin g th e possibilit y tha t Japa n woul d fal l int o Com munists' hands , th e U.S . decide d t o rebuil d Japa n a s a bulwar k nation an d change d it s Occupation polic y (Masumi 1985 ; Schaller 1985). Thi s shif t i s know n a s th e "revers e course, " whic h onc e again altered th e balance of power among Japanese political oper atives b y repealin g man y o f th e recen t liberalizatio n program s (see Masumi 1983) . Unionization wa s discourage d rathe r tha n en couraged. The Red Purge expelled many radicals while reinstatin g previously purged conservatives . The attack on big businesses wa s weakened and antitrust enforcemen t wa s relaxed. Joseph Dodge— a Detroi t financier—was dispatche d t o Japa n t o reviv e th e Japa nese economy . Wit h th e implementatio n o f th e so-calle d Dodg e policy i n 1949 , the exchang e rat e wa s fixed to foster internationa l trade; bureaucrats ' fiscal an d monetar y power s wer e restrained ,

Post-World War II Japanese Development 26 7 central plannin g wa s terminated ; al l Kodan s wer e abolishe d (se e Shiraishi 1983 ; Kosa i [1981 ] 1986) ; an d a fre e econom y wa s re vived (Kosai 1986) . As a result, th e political econom y o f Japan wa s altere d i n favo r of thos e wh o coul d gai n fro m a marke t syste m rathe r tha n a command system . This shif t onc e again affecte d th e relative pric e structure o f institutional choic e and produced mutuall y beneficia l exchange opportunitie s fo r thos e reinstated economi c an d conser vative politica l actors . The revers e cours e lai d th e foundatio n fo r Japan's industria l organizatio n durin g th e high-growt h era. 17 Ja pan's relianc e o n th e marke t syste m wa s strengthene d b y th e reverse course . I n thi s respect , th e rol e o f th e U.S . Occupatio n of Japa n wa s forcibl y t o chang e th e relativ e pric e structur e o f institutional choice s for Japanese politica l operative s by acting a s a decisiv e agenda-sette r an d enforce r (se e Naka 1990 ; Brough an d Naka 1990) . As we shall see , the structur e o f Japan's politica l econom y dur ing the high-growth er a reflecte d th e institutiona l choice s of thes e reinstated actor s t o extrac t maximu m gain s fro m ne w exchang e relationships b y minimizing thei r own deadweight losses . The Nature of th e New Equilibriu m Because th e exchang e relationship s betwee n majo r economi c an d political actor s tha t emerge d throug h th e Occupation' s revers e course were relatively stable, many political scientist s and foreig n observers use d a corporatis t mode l (triad-model , power-elite model, Japa n Incorporate d model , o r bureaucracy-led-model ) t o describe th e economi c growt h o f Japan. 18 Thi s ma y b e wh y s o many researcher s asser t tha t Japa n ha d a "dual" industrial struc ture i n whic h efficient , large-scal e businesse s dominate d ineffi cient, small businesses (see Miwa 1990) . In fact, i n 1963 , "the 10 0 largest nonfinancia l corporation s con trolled 53. 2 percen t o f al l paid-i n corporat e capital " (Cave s an d Uekusa 1976 , 470). Moreover, many larg e Japanese firms belonge d to enterpris e group s tha t develope d aroun d banks . This structur e underlies Japan' s capita l an d produc t markets , a s wel l a s it s dis tribution channels , an d i s commonl y referre d t o a s "keiretsu." 19

268 Shiget o Naka, Wayne T. Brough, and Kiyokaz u Tanak a Each keiretsu grou p has a semihierarchical structur e wit h a mai n bank a t th e core tha t i s encircled b y large manufacturin g o r trad ing firms; many small-to-medium-sized subcontractin g firms com prise th e outer level . In addition, Japanese politics has been almost continually dom inated b y th e conservativ e Libera l Democrati c Part y (LDP) . A powerful, autonomou s bureaucrac y als o existed , wit h economi c bureaus suc h a s th e Ministr y o f International Trad e an d Industr y (MITI) seeming t o have exercise d vas t contro l ove r industria l pol icy i n Japan . Al l thes e observation s sugges t tha t th e Japanes e political econom y wa s dominated b y a triad o f power-elites. However, subsequen t studie s hav e raise d question s a s t o th e accurac y of such depictions . Table 3 shows comparativ e statistic s o f concentration ratio s i n Japanese and U.S . industries. The weighted averag e concentratio n ratio fo r U.S . manufacturing firms i n 196 3 was 40.9 percent, com pared t o 35.4 percent fo r Japa n (Cave s and Uekus a 1976 , 471-72). Similar studies show that Japan's industrial structur e was technologically no t uniqu e whe n compare d wit h othe r Wester n indus trial nations. 20 Further, various statistical studies have shown tha t keiretsu affiliation di d not result in significantly highe r profit rate s on equit y o r o n assets ; i n fact , i t eve n lowere d the m (Cave s an d Uekusa 1976 ; Nakatan i [1984 ] 1990 ; Miw a 1990) . If Japanes e in dustrial organizatio n represente d a biase d structur e i n favo r o f large corporation s i n collaboratio n wit h rulin g LD P politician s and elit e economi c bureaucrats , the n th e profit s o f thos e keirets u firms shoul d b e higher o n average tha n thos e of nonmember firms (Caves an d Uekus a 1976 ; Miw a 1990 ; It o 1991) . A monopoly o r monopsony explanation , o r a power-elit e hypothesis , canno t ade quately describ e postwar Japan's political economy . We propos e th e followin g alternativ e hypothesis : Th e Occupa tion's revers e cours e altere d th e structur e o f ren t seekin g i n Ja pan. 21 Th e revers e cours e generated : (1 ) relativel y longer-ter m political contracts , (2 ) a relativel y mor e effectiv e syste m o f political contract s tha t include s a set o f prime contractor s an d subcon tractors, an d (3 ) a relativel y mor e encompassin g politica l con tracting system , compare d t o other industria l nations . Because of

Post-World Wa r I I Japanese Developmen t 26

9

Table 3 . Number o f Industries an d Value s of Shipments , b y Concentration Rati o fo r th e Fou r Larges t Firms , United State s an d Japan,1963 By Number of Industries United States Concentration Ratio 80-100 70-79 60-69 50-59 40-49 30-39 20-29 0-19 Total

Japan

Number

Cumulative Percent

Number

Cumulative Percent

27 18 29 43 49 80 81 90 417

6.5 10.8 17.8 28.1 39.8 59.0 78.4 100.0 —

46 21 29 61 56 63 79 157 512

9.0 13.1 18.8 30.7 41.6 53.9 69.3 100.0 —

By Value of Shipment Japan

United States Concentration Ratio 80-100 70-79 60-69 50-59 40-49 30-39 20-29 0-19 Total

Billions of Dollars

Cumulative Percent

50.9 14.3 23.8 49.3 31.9 72.8 90.5 82.4 415.7

12.2 15.6 21.3 33.2 40.9 58.4 80.2 100.0 —

Billions c)f Cumulative Dollars Percent 3.7 3.5 1.8 10.6 8.5 7.6 9.7 22.7 68.2

5.6 10.8 13.4 28.9 41.3 52.5 66.7 100.0 —

Source: Cave s an d Uekus a (1976 , 471).

these characteristics , Japan' s rent-seekin g structur e durin g it high-growth perio d wa s no t onl y relativel y mor e efficient , bu wealth-enhancing, compare d t o othe r rent-seekin g industria l na tions. W e argu e tha t thi s structur e emerge d becaus e thos e rein stated economi c an d politica l actor s sough t t o maximiz e thei own rent s b y minimizin g th e deadweigh t losse s o f wealt h trans

s t r -

270 Shiget o Naka, Wayne T. Brough, and Kiyokaz u Tanak a fers. T o derive thi s conclusion, we examine th e incentives o f thre e major group s o f Japanes e politica l operative s whe n th e revers e course began . The following incentive s fo r bureaucrats , politicians, and inter est group s ar e considere d t o hav e emerge d whe n th e revers e course began. 22 First, the incentive of bureaucrats was to maintai n or eve n t o increas e contro l o f resourc e allocation . Thi s behavio r may bes t b e describe d a s "takings' ' i n th e for m o f taxe s o r th e attenuation o f privat e propert y right s i n favo r o f accruin g rent s for bureaucrats. 23 However , becaus e th e ne w constitutio n o f 194 7 made Japan' s parliamen t (Diet ) th e highes t law-makin g orga n in th e state , majorit y coalition s o f politician s coul d effectivel y constrain bureaucrati c takings. 24 Moreover , becaus e th e revers e course promote d a fre e econom y rathe r tha n a controlle d econ omy, bureaucrats ha d t o alter th e form o f their intervention . Second, because th e new constitutio n increase d socia l mobilit y by decentralizin g th e governmen t an d b y assurin g civi l liberties , politicians becam e mor e susceptibl e t o th e preference s o f voters , including special-interes t groups . Politician s becam e residua l claimants o f rent seeking . Politicians had th e incentive t o increas e their residua l incom e throug h politica l brokerag e activities ; tha t is, arbitratin g propert y right s arrangement s betwee n th e bureau crats an d special-interes t group s (se e McCormic k an d Tolliso n 1981). However , becaus e incom e level s i n Japa n wer e low , onl y economic special-interes t group s ha d th e capita l necessar y t o en gage i n rent-seekin g behavio r an d generat e residua l incom e fo r conservative politicians . Assumin g tha t thes e group s ha d onl y a fixed amoun t o f rent-seekin g capital, 25 taking s b y bureaucrat s would reduc e th e politicians ' residua l incom e b y reducin g th e capital availabl e t o economi c interes t groups . Thus , politician s had th e incentiv e t o contro l bureaucrat s t o reduc e thei r taking s from economi c special-interes t groups . Ceteris paribus, both poli ticians an d interes t group s coul d gai n mor e b y creatin g mutuall y binding arrangement s t o constrai n bureaucrats ' takin g activ ities.26 Each of these three groups of actors had incentives to expand it s power b y utilizin g it s ow n institutiona l comparativ e advantage .

Post-World War II Japanese Development 27 1 However, agenc y problem s emerged , whic h mad e contrac t en forcement amon g group s mor e difficult . Initially , th e Occupatio n created significan t level s o f uncertaint y i n Japan' s politica l mar ket. Agenc y problem s wer e substantia l i n an y contractua l rela tionship. Th e bureaucrats , politicians , an d interes t group s re neged o n contract s wit h on e another ; opportunis m manifeste d itself eve n withi n eac h group . Eve n thoug h th e revers e cours e decreased th e powe r o f economic bureaucrat s b y dismantlin g th e controlled economy, the foremost agenc y problem was still cause d by bureaucrats . Becaus e initia l Occupatio n policie s demolishe d many organizations, effective institutiona l mechanism s t o enforc e contracts wit h governmen t bureaucrat s di d no t exist . Th e com mittee syste m i n legislature wa s ineffective, 27 an d part y organiza tion wa s als o i n a stat e o f flu x (se e Masum i [1983 ] 1985 ; Curti s 1988). Virtuall y al l legislatio n wa s initiate d an d drafte d b y bu reaucrats (se e Johnso n 1982) . T o pu t i t simply , th e bureaucrat s dominated al l other groups. 28 With th e Occupation' s revers e course , industrialist s regaine d lost ground . However , a s Dodge' s stabilizatio n policie s pro gressed, not only did competition i n the marketplace intensify , bu t capital scarcit y wa s create d b y decreasin g industria l subsidies. 29 Industrialists demande d politica l protectio n throug h legislatio n in th e politica l marke t (se e Samuel s 1987 , 102-104) . To assur e a favorable regulator y environment , industrialist s ha d t o pa y bro kerage fee s (campaig n contributions ) t o conservativ e politician s and giv e u p som e industria l control s t o bureaucrat s (effectiv e taxes/fees) i n retur n fo r regulation s tha t provide d preferentia l financing, ta x breaks , an d protectio n fro m foreig n competition . T o insure thi s exchange , mechanism s wer e needed , however , t o en sure tha t bureaucrat s woul d no t reneg e o n contract s create d b y politicians an d industry . At th e sam e time , taking s b y bureaucrat s fro m industrialist s reduced th e level s o f expenditures availabl e fo r campaig n contri butions t o politicians . Conservativ e politician s ha d a n incentive , therefore, t o decreas e taking s t o protect thei r campaig n contribu tions fro m industrialists . Politician s strengthene d thei r organiza tions t o offe r high-qualit y an d reliabl e service s t o industrialists .

272 Shiget o Naka, Wayne T. Brough, and Kiyokaz u Tanak a Mutual incentive s existe d betwee n conservativ e politician s an d industrialists t o creat e bindin g institutiona l arrangement s t o fa cilitate political exchange . The bindin g institutiona l arrangement s wer e maintaine d through a continual legislativ e majority i n the Diet. The imminen t threat fro m th e left-win g urge d bot h conservativ e politician s an d industrialists t o inves t thei r resource s i n th e unificatio n o f tw o conservative partie s (se e Masum i 1983) . A legislativ e majorit y would als o enabl e politician s t o monito r bureaucrat s mor e effec tively by increasing thei r veto power and by controlling th e prim e minister's office . A s a result , th e LD P was forme d i n 1955 . While both partie s continue d t o inves t thei r resource s t o sustai n th e legislative majority , thes e investment s becam e nonsalvageabl e assets for both politician s an d industrialist s (se e Klein and Leffle r 1981; Crain , Shughart , an d Tolliso n 1988 , fo r th e theory) . T o maintain th e ne t discounte d futur e value s o f these intangibl e an d nontransferable assets , mutual incentive s t o create "longer-term " political contract s were generated . Industrialists an d conservativ e politician s als o move d t o con strain th e power o f bureaucrats. Two institutions emerge d t o per form thi s function . A s we shall see , these tw o institution s charac terize the political econom y of postwar Japan . First, industrialist s an d politician s move d t o reduc e th e fre quency o f negotiation s wit h bureaucrats . Frequen t negotiation s penalized industrialist s b y increasin g transaction s costs ; more over, they reduce d th e supply of campaign contribution s t o politicians. The greater th e risk of moral hazard i n the political market , the large r th e penalt y th e industrialist s ha d t o pay . Becaus e en forcement mechanism s wer e stil l underdeveloped , th e incentiv e to reduc e th e frequenc y o f negotiation s wa s generated , furthe r strengthening th e incentive t o maintain longer-ter m politica l con tracts (see Naka, Brough, and Tanak a 1992) . Second, t o reduc e taking s b y th e state , a dual-syste m o f politi cal contractin g represente d b y prim e an d subcontractor s wa s de veloped (se e Naka , Brough , an d Tanak a 1992) . Industrialists wh o sought privat e gain s fro m th e Occupation' s revers e cours e face d two choice s fo r writin g an d enforcin g thei r contract s wit h other s They coul d eithe r writ e an d enforc e contract s privatel y o r the y

Post-World War II Japanese Development 27 3 could rely on political mechanisms . To maximize gain s from thei r contractual engagements , rationa l individual s woul d choos e th e method whic h minimize d transactio n costs . Considering th e exis tence o f a dominan t stat e tha t excise d takings , an d weighin g th e risk o f mora l hazar d i n th e politica l marke t du e t o underdevel oped politica l enforcemen t mechanisms , privat e contractin g wa s the least-cos t alternative . At th e sam e time , becaus e Dodge' s stabilizatio n polic y de creased industria l subsidies , a ne w metho d t o allocat e financial resources—the so-calle d th e mai n ban k system—wa s develop ing i n th e financial marke t (Shiraish i 1983) . Thi s developmen t had variou s spillove r effects. 30 T o reduc e mora l hazar d amon g lendees, th e mai n ban k syste m promote d interlockin g sharehold ings (se e tabl e 4 ) an d interlockin g directorate s betwee n lender s and lendees . A s describe d b y many , thi s le d t o th e emergenc e o f the keirets u system . Moreover , t o stav e of f radica l labo r influ ences, industria l manager s bega n t o develo p enterprise-base d unions. Th e enterprise-base d unio n i s a company-specifi c organi zation containin g no t onl y blue-collar , bu t als o white-colla r em ployees (Aoki 1988). 31 This institutional arrangemen t reduce d pri vate contractin g cost s wit h respec t t o labor-managemen t relations. In short , a n efficien t syste m o f privat e enforcemen t mecha nisms was developing i n Japanese industria l markets , while polit ical institution s wer e evolving . Th e existenc e o f privat e enforce ment mechanism s generate d th e incentiv e fo r industrialist s t o first contrac t privatel y amon g themselves , then , brin g thei r pre determined matter s t o th e legislativ e market . I n thi s way , indus trialists coul d no t onl y economiz e o n transactio n costs , but coul d reduce thei r payment s t o bureaucrats . Thi s institutiona l choic e was mad e possibl e becaus e cross-shareholding s an d cross-board memberships o f th e keiretsu , a s wel l a s th e us e o f enterprise based union s amon g larg e keirets u firms, lowere d contractin g costs i n th e marke t relativ e t o thos e i n alternativ e institutions . This dual-syste m o f politica l contractin g wa s als o beneficia l t o ruling politician s becaus e i t increase d thei r residua l incom e b y reducing fee s impose d b y bureaucrat s upo n thei r clients . This structur e permeate d Japan' s keirets u syste m an d th e en -

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Table 4. Corporate Stoc k Ownershi p b y Classificatio n i n Japan , 1949-1980 Year

Governmerit

Finance firms

Trust firms

1949 1950 1951 1952 1953 1954 1955

2.8 3.1 1.8 1.0 0.7 0.5 0.4

9.9 12.6 13.0 15.8 16.3 16.7 19.5

— — 5.2 6.0 6.7 7.0 4.1

1956 1957 1958 1959 1960

0.3 0.2 0.3 0.2 0.2

21.7 21.4 22.4 21.7 23.1

1961 1962 1963 1964 1965

0.2 0.2 0.2 0.2 0.2

1966 1967 1968 1969 1970

Other firms

Individuals

Foreign

12.6 11.9 9.2 8.4 7.3 7.1 7.9

5.6 11.0 13.8 11.8 13.5 13.0 13.2

69.1 61.3 57.0 55.8 53.9 54.0 53.1

— — — 1.2 1.7 1.7 1.8

3.9 4.7 6.6 7.6 7.5

7.1 5.7 4.4 3.7 3.7

15.7 16.3 15.8 17.5 17.8

49.9 50.1 49.1 47.8 46.3

1.5 1.5 1.5 1.5 1.4

21.4 21.5 21.4 21.6 23.4

8.6 9.2 9.5 7.9 5.6

2.8 2.5 2.2 4.4 5.8

18.7 17.7 17.9 18.4 18.4

46.7 47.1 46.7 45.6 44.8

1.7 1.8 2.1 1.9 1.8

0.2 0.3 0.3 0.3 0.3

26.1 28.2 30.3 30.7 30.9

3.7 2.4 1.7 1.2 1.4

5.4 4.4 2.1 1.4 1.2

18.6 20.5 21.4 22.0 23.1

44.1 42.3 41.9 41.1 39.9

1.9 1.9 2.3 3.3 3.2

1971 1972 1973 1974 1975

0.2 0.2 0.2 0.2 0.2

32.6 33.8 33.9 33.9 34.5

1.3 1.3 1.2 1.6 1.6

1.5 1.8 1.5 1.3 1.4

23.6 26.6 27.5 27.1 26.3

37.2 32.7 32.7 33.4 33.5

3.6 3.5 2.9 2.5 2.6

1976 1977 1978 1979 1980

0.2 0.2 0.2 0.2 0.2

35.1 35.9 36.6 36.9 37.3

1.4 2.0 2.2 1.9 1.5

1.4 1.5 1.8 2.0 1.7

26.5 26.2 26.3 26.1 26.0

32.9 32.0 30.8 30.4 29.2

2.6 2.3 2.1 2.5 4.0

Source: Okumura (1990 , 55).

Security firms

Post-World War II Japanese Development 27 5 terprise-based unio n o f ever y larg e firm. A s such, th e syste m be came necessaril y encompassing. 32 Contractua l settlemen t mad e at th e subcontractin g leve l covere d man y smal l -an d medium sized firms. T o avoi d exploitatio n b y larg e firms, furthe r ''back ward " or "forward " integratio n wa s commo n withi n interlockin g keiretsu groups . Whe n agreement s wer e brough t t o th e politica l stage b y prim e contractors , the y reflecte d th e majorit y interest s of al l firms involved. 33 Accordingly , distributiona l gain s wer e widely share d b y a larg e numbe r o f members , whil e cost s wer e dispersed t o outsid e group s (mostl y consumer s an d foreig n pro ducers). This i s one reaso n wh y i t wa s difficul t t o explain Japan' s industrial dual-structur e base d upo n a simpl e monopol y o r mo nopsony model . The followin g welfar e implication s emerg e fro m thi s analysi s (these implication s shoul d b e interprete d i n a relativ e sens e rather tha n i n a n absolut e sense) : First, industria l policie s emerg ing throug h thi s syste m o f rent seekin g ar e likel y t o be efficiency enhancing fo r th e encompassin g keirets u system . Cost s ar e likel y to b e externalize d outsid e th e groups . I n thi s respect , on e majo r function o f the prim e contractor s i s to maintai n intr a grou p coor dination whil e internalizin g intergrou p externalities . The contin ual existenc e o f ver y encompassin g an d ver y broa d economi c as sociations suc h a s Keidanre n (th e Federatio n o f Economi c Organizations) suggest s th e existenc e o f such functions . Second, followin g th e first implication , th e tota l amoun t o f rent-seeking expenditure s spen t i n thi s syste m i s smalle r du e t o less rent-avoidanc e activities , i n term s o f thei r frequenc y an d number. Because many contracting decision s are made at subcon tracting level , decision-makin g cost s a t thi s leve l becam e highe r (e.g., longe r workin g hours) . However , onc e decision s ar e made , less rent-seeking an d rent-avoidanc e activitie s woul d occu r a t th e national level . On balance, the total amount of rent-seeking expen ditures may be lower than i n other industrial countries . Third, th e deadweigh t losse s o f rent-seeking expenditure s ma y be smalle r du e t o th e longe r durabilit y o f political contract s an d the extensiv e us e o f private contractin g rathe r tha n politica l con tracting. A s such , efficienc y losse s ar e likel y t o b e reduced . Fur ther, the incentive to use private contracting at the subcontractin g

276 Shiget o Naka, Wayne T. Brough, and Kiyokaz u Tanak a level induce s th e Japanes e econom y t o remai n largel y a marke t economy i n which th e price syste m an d name-bran d capita l func tion as enforcement mechanisms . Fourth, a longe r market-tim e horizo n i s likel y t o resul t fro m a longe r political-tim e horizo n du e t o th e relativ e stabilit y an d durability o f politica l contracts. 34 Th e Japanes e econom y ma y be mor e conduciv e t o longer-ter m busines s investmen t decision s partly becaus e th e political tim e horizon ma y be longer and mor e stable, not because bureaucrats an d industrialist s ar e far-sighted . Finally, there are opportunity cost s associated with this institu tional framework . Resource s hav e bee n allocate d t o privat e con tracting rather tha n political contracting . As a result, the development o f political contractin g ha s been deterred. 35 Thi s may be th e reason wh y s o man y politica l scientist s commen t tha t postwa r Japan's democrac y i s "immature" compare d t o that o f the Unite d States. Fro m a n efficienc y poin t o f view , however , thi s institu tional choic e woul d reduc e rent-seekin g an d rent-avoidanc e cost s at th e social level. These implication s togethe r sugges t tha t th e structur e o f ren t seeking i n postwa r Japa n durin g th e high-growt h er a wa s rela tively efficien t an d relativel y mor e wealth-enhancing , compare d to othe r industria l nations . Further , thi s structur e reduce d dead weight losse s i n th e political econom y b y largely utilizin g marke t institutions fo r th e allocatio n o f resources . W e argu e tha t thi s structure i s a n importan t explanator y facto r fo r Japan' s rapi d economic growth . Conclusion In thi s chapter, w e used th e theor y o f public choice to analyze th e post-World Wa r I I political econom y o f Japan . W e focus o n ho w Japan's nexu s o f contract s wa s altere d b y th e America n Occupa tion, an d ho w Japanes e politica l operative s reacte d t o suc h alter ations. We argue tha t Japa n achieve d a new political equilibriu m with th e hel p o f th e Occupatio n forces . Finally , w e examine d the natur e o f th e ne w equilibriu m base d upo n Becker' s (1983 ) theory. The mai n conclusio n o f this chapte r i s tha t Japa n place d mor e

Post-World War II Japanese Development 27 7 emphasis o n market s rathe r tha n comman d element s t o allocat e resources, no t becaus e Japanes e bureaucrat s ingeniousl y calcu lated th e optima l balanc e betwee n th e marke t an d th e govern ment, bu t because , quit e simply , th e cost s o f negotiatin g an d en forcing contract s i n privat e market s wer e lowe r tha n thos e i n the politica l markets , du e t o th e peculia r developmen t o f Japan' s industrial organizatio n afte r th e America n Occupatio n o f Japan . We suggest tha t thes e contractua l arrangement s generate d lowe r deadweight losses , contributing th e economi c growt h o f postwa r Japan. Finally, because th e exchange relationship s betwee n reinstate d economic an d politica l actor s ar e th e foundatio n o f Japan's post war industria l organization , an y change s i n thes e relation s wil l induce change s i n th e foundatio n o f Japan' s industria l structure . Such change s hav e bee n occurrin g sinc e th e beginnin g o f th e 1970s when Japa n entere d th e era of economic slowdown. Various factors hav e cause d suc h changes , including: (1 ) the emergenc e of a variet y o f special-interes t group s whic h coul d suppl y residua l incomes to politicians (see Sato and Matsuzaki 1986 ; Inoguchi an d Iwai 1987) ; (2) the growt h o f per capit a incom e an d th e resultin g change i n th e taste s o f voters , includin g special-interes t group s (see Yakushij i 1987) ; (3 ) shift s i n industria l comparativ e advan tages caused b y changes i n technologies; (4 ) further specializatio n and divisio n o f labor i n th e political marke t (se e Sat o an d Matsu zaki 1986 ; Inoguchi an d Iwa i 1987) ; an d (5 ) shifts i n th e interna tional environment , wit h increasin g foreig n pressur e t o ope n th e Japanese economy . Our analysi s suggest s tha t thes e change s wil l caus e efficienc y losses i n allocatin g resource s throug h th e politica l econom y o f Japan, graduall y producin g large r deadweigh t losse s i n Japan. As the structures o f keiretsu an d enterprise-base d union s change , th e relative pric e structur e o f institutiona l choic e wil l als o change . Political contractin g rathe r tha n privat e contractin g ma y becom e the dominan t strateg y o f interes t groups . Futur e researc h mus t outline thes e changes , explai n ho w the y occur , an d deriv e th e welfare implication s fro m suc h changes .

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Notes * W e woul d lik e t o than k Pete r Boettke , Tyle r Cowen , Bil l Shughart , and Bo b Tolliso n fo r encouragemen t an d helpfu l comments . Henr y Butler als o provided useful comment s on an earlier draft . 1. Previously , w e hav e attempte d t o explai n postwa r Japan' s politica l economy base d upo n th e theor y o f publi c choice . Se e Nak a (1990) ; Brough an d Nak a (1990 , 1991) ; Naka an d Broug h (1991) ; and Naka , Brough, and Tanak a (1992). 2. See , fo r instance , Patric k an d Rosovsk y (1976) ; Treziz e an d Suzuk i (1976); Kosa i ([1981 ] 1986) ; Takahash i (1986) ; an d Noguch i (1986) . McCraw (1986 , 19 ) writes; "Mos t outsid e observers , lookin g bac k o n the miracle , ten d t o overemphasiz e th e rol e playe d b y th e govern ment, an d commensuratel y t o understate th e degre e t o which Japa n was, an d remain s t o thi s day , a company-oriented societ y character ized by intense inter-corporate rivalry. " 3. Se e Noguch i (1986) ; Okumur a (1983) ; Aok i (1988) ; Kawasak i an d McMillan (1987) ; Hodde r (1988) ; Asanum a (1989) ; Nakatan i ([1984 ] 1990) and Miwa (1990). 4. Fo r Japanese financial markets , see, for instance, Wallich and Wallich (1976); Suzuk i (1986) ; Hamada an d Horiuch i (1987) ; and Cargil l an d Royama(1988). 5. Se e Koik e (1977) ; Aok i (1988) ; It o (1991) ; an d Ozak i (1991 ) fo r a general discussion . 6. Almos t al l student s o f th e politica l econom y o f moder n Japa n hav e mentioned this . See , fo r instance , Baerwal d (1986) ; Johnso n (1982) ; McCraw (1986); Ouchi (1984); and Curtis (1985). 7. Se e Vogel ([1975 ] 1985) ; Patrick an d Rosovsk y (1976) ; Kodansh a In ternational ([1979 ] 1987) ; Thuro w ([1985 ] 1986) ; Patric k an d Meiss ner (1986) ; McCra w (1986) ; Yamamur a an d Yasub a (1987) ; Shove n (1988); and Komiya , Masahiro, and Kotar o (1988 ) for editorial work s on each of these aspects . 8. Cultura l norm s creat e constraint s upo n huma n behavior . A s such , analysis o f culture s i s important . However , researcher s wh o rel y o n culture ten d t o assum e cultura l norm s a s given . N o clea r explana tions as to the sources of these norms are offered . 9. Se e Voge l ([1975 ] 1985) ; Curti s (1985) ; Johnso n (1982) ; an d Ouch i (1984). See Murakami (1987 ) for a survey of Japanese models . 10. Th e exchange view of the state is derived from Buchana n an d Tulloc k ([1962] 1965) ; Brenna n an d Buchana n (1980) ; Weingas t (1990) ; an d North (1990). 11. Beginnin g wit h Coas e (1937) , the moder n theor y o f the firm assume s that ther e i s no theoretica l distinctio n betwee n th e marke t an d hier archies becaus e thes e institutiona l arrangement s represen t alterna -

Post-World Wa r I I Japanese Developmen t 27

9

tive mechanisms fo r writin g an d enforcin g contracts . The same logi c can b e applie d t o th e distinctio n betwee n th e marke t an d politica l institutions. A rational individua l wil l choos e on e institutiona l for m over anothe r i f tha t institutio n reduce s transactio n costs . Se e Wil liamson (1975 , 1985). 12. Fo r instance , Samuel s (1987, 2 ) examine d Japan' s energ y industry , and concluded : "Th e Japanes e stat e i s a market-conformin g playe r not becaus e . . ., bu t becaus e i n th e developmen t o f Japanes e com merce an d industr y powerfu l an d stabl e privat e actor s emerge d wh o established endurin g alliance s wit h politician s an d bureaucrats . These sam e actor s vigilantl y checke d market-displacin g inter vention." 13. Thi s chang e was , fo r instance , describe d b y Calde r (1988 , 150) : "Throughout th e prewar an d wartim e periods , for example , the Min istry o f Commerc e an d Industry , predecesso r o f MITI , ha d wage d a constant struggl e wit h th e zaibatsu an d th e industrial contro l associ ations regardin g pricing , output , an d resourc e allocatio n decisions . But SCAP , declaring th e zaibats u responsibl e fo r th e wa r economy , banned privat e cartel s an d insiste d tha t governmen t officials—tha t is, technocrats—exercis e th e power s previousl y accrue d t o th e con trol associations . I t thu s helpe d reinforc e th e bureaucrati c preemi nence in industrial matters—. " 14. Se e Hadley (1970) for zaibatsu dissolution . 15. Th e refor m virtuall y wipe d ou t th e rura l landlor d clas s b y affectin g about 8 0 percen t o f al l tenanc y land . Se e Calde r (1988 , 14 ) wh o stated: "It undermined traditiona l conservativ e mechanisms'of socia l control an d significantl y increase d uncertaint y fo r th e conservative s in the Japanese political process. " 16. "2,21 0 officer s fro m 63 2 zaibats u corporation s an d som e 2,50 0 high ranking officers an d large stockholders of other larg e companies wer e purged fo r wartime activities " (Caves and Uekusa 1976 , 465). 17. Se e Muramatsu an d Kraus s (1987). 18. Al l of thes e model s ar e base d o n th e notio n tha t Japanes e societ y i s somewhat mor e controlle d b y power-elites . See Murakami (1987 ) fo r a survey of Japanese models . 19. On e shoul d realiz e tha t ther e ar e a t leas t thre e type s o f keirets u structures i n postwa r Japan . Th e first typ e consist s o f thos e group s that ar e direc t descendant s o f prewa r zaibatsu . Th e secon d typ e i s made u p o f thos e group s tha t hav e emerge d afte r Worl d Wa r II . These tw o type s contai n mai n bank s a t thei r cores . Th e las t typ e is comprise d o f thos e group s centere d aroun d larg e manufacturin g corporations, such as Toyota. 20. Se e Caves and Uekus a (1976) and Miwa (1990) for a reference . 21. Thi s poin t wa s originall y mad e b y Nak a (1990 ) an d Naka , Brough , and Tanaka (1992).

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22. Thi s discussio n wa s base d upo n a lin e o f argumen t mad e b y Becke r (1983) and Michaels (1988). 23. Th e powe r t o ta x shoul d b e interprete d rathe r broadly . Ou r us e o f this term i s derived from Brenna n an d Buchanan (1980 , 149-55). 24. Accordin g t o Calde r (1988 , 153) : "Coupled wit h th e change s i n stat e administrative structur e note d above , and th e dissolutio n o f the cor poratist agricultura l associatio n (nokai ) i n 1947 , this proliferation i n private-sector interes t grou p formatio n severel y circumscribe d th e technocratic autonom y o f the prewar period i n many area s of domestic policymaking. " 25. Thi s i s a reasonabl e assumptio n becaus e th e Japanes e econom y ha d still not recovered fro m th e devastation o f the World War II. 26. Th e present value s o f thei r contract s ar e increase d b y creatin g bind ing agreements. See Landes and Posne r (1975) for th e theory of dura ble political contracts . 27. Se e Weingast and Shepsl e (1981) for the role of the committee syste m as an enforcement mechanism . 28. Fo r instance , accordin g t o Johnso n (1982 , 199) : "Th e tool s i n th e hands o f th e economi c bureaucrat s include d contro l ove r al l foreig n exchange an d import s o f technology , whic h gav e the m th e powe r t o choose industrie s fo r development ; th e abilit y t o dispens e prefer ential financing, ta x breaks , an d protectio n fro m foreig n competi tion." 29. Durin g th e initia l phas e o f th e occupation , th e Reconstructio n Fi nancing Ban k (RFB ) was establishe d t o provide industria l subsidies . Because thes e subsidie s wer e financed throug h issuin g governmen t bonds, inflation increased . When th e Dodg e policy wa s initiated , th e activities of the RFB were terminated. See Shiraishi (1983 ) and Kosa i ([1981] 1986). 30. Th e developmen t o f Japan' s industria l organizatio n ha s bee n exam ined by many researchers . Recently, new institutional economic s ha s been utilize d t o analyz e Japan' s industria l organization . I n thi s re spect, see Aoki ([1984] 1990 , 1988) ; Shimokawa (1985) ; Inoue ([1985 ] 1986); Horiuchi , Packer , an d Fuckud a (1988) ; Hodde r (1988) ; Miw a (1990); Kawasaki an d McMillan (1987); and Asanuma (1989). 31. Forme r member s o f executive committee s o f enterprise-based union s often becam e corporat e boar d member s o f Japanes e firms. A survey by Nikkeire n (th e Japa n Managemen t Association ) i n 197 8 showe d that 1,01 2 director s ou t o f a tota l o f 6,45 7 director s (15. 7 percent) a t 352 surveye d companie s wer e forme r executiv e member s o f thei r enterprise-based union s (see Aoki 1988 , 92). 32. Thi s encompassin g natur e o f Japanes e interes t group s wa s pointe d out b y Olso n (1965 , 1982) . However , h e di d no t explai n wh y i t emerged an d ho w i t has bee n maintained . I n thi s sense, our explana tion is an extension of Olson's theory .

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33. Casua l evidenc e provide d b y variou s researcher s show s tha t indus trial polic y i n Japa n rarel y ha s bee n targete d fo r aidin g narrowl y concentrated interests . For instance, Patrick (1986 , 13 ) states: "Japa nese industria l polic y ha s bee n a t th e industr y level , usuall y rathe r broadly defined. " 34. Fo r instance , upo n examinin g postwa r Japan' s LD P regime , Calde r (1988, 158 ) asserts: "In a content analysi s of political speeches durin g the 195 5 Japanese genera l electio n campaign , for example , 'stability ' or 'stabilization ' (antei ) wa s clearl y an d consistentl y use d mor e b y the Righ t tha n b y th e Left ; thi s wa s th e onl y on e o f twenty-on e political terms to show such a clear pattern. This consistent emphasi s on stability ha s continued t o the present day. " 35. Fo r instance , i n 1981 , U.S. Congressiona l staf f totale d ove r 25,000 , including 85 8 staff member s a t th e Librar y o f Congress. By contrast , Japan's Die t employe d 3,36 9 staf f members , includin g 15 5 Die t Li brary staf f members . Th e numbe r o f secretarie s attache d t o U.S . Congressmen wa s 11,125 , while onl y 1,52 6 secretarie s wer e attache d to Japanese counterparts. See Sato and Matsuzaki (1986 , 83). References Aoki, Masahiko. 1988 . Information, Incentives, and Bargaining in the Japanese Economy, Cambridge : Cambridge Universit y Press, 1988. . ed . The Economic Analysis of the Japanese Firm. Amsterdam : North-Holland. Asanuma, Banri . 1989 . "Manufacturer-Supplie r Relationshi p i n Japa n and the Concept of Relation-Specific Skill. " Journal of the Japanese and International Economies 3 : 1-30 . Baerwald, Hans H. 1986 . Party Politics in Japan. Boston : Allen & Unwin. Becker, Gar y S . 1983 . "A Theory o f Competition amon g Pressur e Group s for Politica l Influence. " Quarterly Journal of Economics 9 8 (August) : 371-400. Brennan, Geoffrey , an d Jame s M . Buchanan . 1980 . The Power to Tax: Analytical Foundations of a Fiscal Constitution. Cambridge : Cambridg e University Press . Brough, Wayne T., and Shiget o Naka. 1990 . "Political Broker s and Politi cal Governanc e Structures. " Unpublishe d pape r presente d a t th e An nual Meeting of the Public Choice Society . . "Th e Rol e o f th e America n Occupatio n o f Japan. " Unpublishe d paper presente d a t th e Annua l Meetin g o f the Souther n Economi c Association. Buchanan, Jame s M. , Robert D . Tollison, an d Gordo n Tullock . 1980 . Toward a Theory of the Rent-Seeking Society. Colleg e Station : Texa s A&M University Press .

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Buchanan, Jame s M. , an d Gordo n Tullock . [1962 ] 1965 . The Calculus of Consent, Ann Arbor: The University of Michigan Press. Calder, Ken t E . 1988 . Crisis and Compensation: Public Policy and Political Stability in Japan, 1949-1986. Princeton : Princeton Universit y Press. Cargill, Thomas F. , and Shoich i Royama . 1988 . The Transition of Finance in Japan and the United States. Stanford : Hoove r Institution . Caves, Richar d E. , an d Mas u Uekusa . 1976 . ''Industria l Organization, " 459-524. In Patrick and Rosovsky 1976 . Coase, Ronald H . 1937 . "The Natur e o f the Firm. " Economica 4 (Novem ber): 386-405. Crain, Mar k W. , Willia m F . Shughar t II , an d Rober t D . Tollison . 1988 . "Legislative Majorities a s Nonsalvageable Assets. " Southern Economic Journal 55 , no. 2 (October): 303-14. Curtis, Gerald . 1985 . "Bi g Busines s an d Politica l Influence, " 33-70 . I n Vogel 1985. . 1988 . The Japanese Way of Politics. Ne w York : Columbi a Univer sity Press. Friedman, David . 1988 . The Misunderstood Miracle. Ithaca: Cornel l Uni versity Press . Hadley, Eleanor . 1970 . Anti-Trust in Japan. Princeton : Princeto n Univer sity Press. Hamada, Koiichi , an d Akiyosh i Horiuchi . 1987 . "The Politica l Econom y of the Financial Market," 223-62. In Yamamura an d Yasuba 1987 . Hayashi, Fumio . 1986 . "Wh y I s Japan' s Savin g Rat e s o Apparentl y High?" In NBER Macroeconomics Annual 1986 . Hodder, James E. 1988. "Corporate Capital Structure in the United State s and Japan," 241-64. In Shoven 1988 . Horiuchi A. , F. Packer, an d S . Fukuda . 1988 . "What Rol e Ha s th e 'Mai n Bank' Played i n Japan?" Journal of the Japanese and International Economics!: 159-80 . Inoguchi, Takashi , an d Tomoak i Iwai . 1987 . 'Zoku-Giin no Kenkyu ( A Research on the Tribal-Politicians). Tokyo: Nihonkeizai Shinbunsya . Inoue, Munemichi . [1985 ] 1986 . "Competitio n an d Cooperatio n amon g Japanese Corporations," 139-59 . In Thurow [1985 ] 1986. Ito, Takatoshi. 1991 . The Japanese Economy. Cambridge : MIT Press. Johnson, Chalmers . 1982 . The MITI and the Japanese Miracle: The Growth of Industrial Policy. Stanford: Stanfor d Universit y Press . Kawasaki, Seiichi , an d Joh n McMillan . 1987 . "The Desig n o f Contracts : Evidence fro m Japanes e Subcontracting. " Journal of the Japanese and International Economies 1 : 327-49. Klein, Benjamin, an d Keit h B . Leffler. 1981 . "The Rol e of Market Force s in Assurin g Contractua l Performance. " Journal of Political Economy 89, no. 4: 615-41. Kodansha Internationa l Ltd. , ed. , [1979 ] 1987 . Politics and Economics in Contemporary Japan, ed . Murakam i Hyo e an d Johanne s Hirschmeier .

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New York : Kodansh a Internationa l Ltd . Previousl y publishe d b y th e J a p a n Cultur e Institute . Koike, Kazuo . 1977 . Shokuba-no Rodokumiai to Sanka (Labo r Union s a t Enterprises an d Thei r Participation) . Tokyo : Toyokeiza i Shinposya . Komiya, Ryutaro , Okun o Masahiro , an d Suzumur a Kotaro , eds. , 1988 . Industrial Policy of Japan. Tokyo : Academi c Press . Kosai, Yutaka . [1981 ] 1986 . The Era of High-Speed Growth: Notes on the Postwar Japanese Economy. Tokyo : Universit y o f Toky o Press . Krauss, Elli s S. , an d Michi o Muramatsu . 1987 . "Th e Conservativ e Polic y Line an d th e Developmen t o f Patterne d Pluralism, " 516-54 . I n Yama m u r a an d Yasub a 1987 . Landes, William , an d Richar d A . Posner . 1975 . "Th e Independen t Judi ciary i n a n Interest-Grou p Perspective. " Journal of Law and Economics 18 (December): 8 7 5 - 9 0 1 . Lincoln, E d w a r d J . 1988 . Japan: Facing Economics Maturity. Washington , D.C.: Brookings Institution . McCormick, Rober t E. , an d Rober t D . Tollison . 1981 . Politicians, Legislation, and the Economy. London : Martinu s Nijhoff . McCraw, Thoma s K. , ed . 1986 . "From Partner s t o Competitors : A n Over view o f th e Perio d sinc e Worl d Wa r II. " I n America Versus Japan. Boston: Harvar d Busines s Schoo l Press . Mackay, R . J. , an d C . L . Weaver . 1981 . "Agenda Contro l b y Budge t Max imizers i n a Multi-Burea u Setting. " Public Choice 37' , no. 3: 4 4 - 7 2 . Masumi, Junnosuke . 1983 . Sengo Seiji (Th e Postwa r Politic s o f Japan) , Vol. 1 . Tokyo: Toky o Daigak u Shuppan-kai . . [1983 ] 1985 . Sengo Seiji (Th e Postwa r Politic s o f Japan) , Vol . 2 . Tokyo: Toky o Daigak u Shuppan-kai . Matsuzaki, Tetsuhisa , an d Seizabur o Sato . 1986 . Jiminto-Seiken (Th e Lib eral Democrati c Regime) . Tokyo : Chuo-Koro n Inc . Michaels, Robert . 1988 . "The Desig n o f Rent-Seekin g Competitions. " Public Choice 56 : 17-29 . Ministry o f Finance , ed . 1978 . Syowa Zaisei-shi: Tokei (Financia l Histor y of th e Syow a Period : Statistics) . Tokyo : Toyokeiza i Shinpo-sya . Miwa, Yoshiro . 1990 . Nihon-no Kigyo-to Sangyo-Soshiki (Japan' s Fir m and Industria l Organization) . Tokyo : Tokyodaigak u Syuppan-kai . Munemichi, Inoue . [1985 ] 1986 . "Competitio n an d Cooperatio n amon g Japanese Corporations, " 139-59 . In Thuro w [1985 ] 1986 . Murakami, Yasusuke . "1987 . Th e Japanes e Mode l o f Politica l Economy, " 3 3 - 9 2 . I n Y a m a m u r a an d Yasub a 1987 . Muramatsu, Michio , an d Elli s S . Krauss . 1987 . "Th e Conservativ e Polic y Line an d th e Developmen t o f Patterne d Pluralism, " 516-54 . I n Yama m u r a an d Yasub a 1987 . Naka, Shigeto . 1990 . "Towar d a Publi c Choic e Analysi s o f th e Politica l Economy o f th e Postwa r J a p a n . " Unpublishe d Ph.D . diss. , Georg e Ma son University .

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Naka, Shigeto , an d Wayn e T . Brough . 1991 . "Th e Strucur e o f Politica l Resource Allocatio n i n Post-Wa r Japan : A Rent-Seeking Perspective. " Paper presente d a t th e Annua l Meetin g o f th e Souther n Economi c Association, Nashville , Tenn. , Novembe r 2 4 - 2 6 . Naka, Shigeto , Wayn e T . Brough , an d Kiyokaz u Tanaka . 1992 . "Th e In dustrial Organization , Rent-Seeking , an d th e Economi c Growt h o f Postwar J a p a n . " Unpublishe d pape r presente d a t th e Annua l Meetin g of th e Publi c Choic e Society . Nakatani, Iwao . [1984 ] 1990 . "The Economi c Rol e o f Financia l Corporat e Grouping." 2 2 7 - 5 8 . In Aok i [1984 ] 1990 . Noguchi, Yukio . 1986 . "Th e Developmen t an d Presen t Stat e o f Publi c Finance," 3 6 - 4 9 . In Shibat a 1986 . North, Douglas s C . 1990 . Institutions, Institutional Change and Economic Performance. Cambridge : Cambridg e Universit y Pres s 1990 . Okumura, Hiroshi . 1983 . Shin Nihon no Rokudai Kigyo-Syudan (Ne w Si x Enterprise Grouping s i n Japan) . Tokyo : Daiamon d Sya . . 1990 . Hoji n Shihonsyug i (Corporat e Capitalism) . Tokyo : Ocha nomizu Syobo . Olson, Mancur . 1965 . The Logic of Collective Action. Cambridge : Harvar d University Press . . 1982 . The Rise and Decline of Nations. Ne w Haven : Yal e Univer sity Press . Ouchi, William . 1984 . The M-Form Society: How American Teamwork Can Recapture the Competitive Edge. Reading , Mass. : Addison-Wesley . Ozaki, Robert . 1991 . Human Capitalism: The Japanese Enterprise System as World Model. Tokyo : Kodansya . Packman, J. , an d K . Kaizuko . 1976 . "Taxation, " 317-82 . I n Patric k an d Rosovsky 1976 . Patrick, Hugh . 1986 . "Japanese Hig h Technolog y Industria l Policy, " 3 - 3 3 . In Patric k an d Meissne r 1986 . Patrick, Hugh , an d Larr y Meissner , eds . 1986 . Japan s High Technology Industries. Seattle : Universit y o f Washington Press . Patrick, Hugh , an d Henr y Rosovsky , eds . 1976 . Asia's New Giant: How the Japanese Economy Works. Washingto n D.C. : The Brooking s Institution . Samuels, Richar d J . 1987 . The Business of the Japanese State: Energy Markets in Comparative and Historical Perspective. Ithaca : Cornel l Uni versity Press . Sato, Seizabur o an d Tetsuhis a Matsuzaki . 1986 . Jiminto Seiken (Th e Lib eral Democrati c Part y Regime) . Tokyo: Chu o Koron-sha . Schaller, Michael . 1985 . The American Occupation of Japan. Oxford : Ox ford Universit y Press . Shibata, Tokue , ed . 1986 . Public Finance in Japan. Tokyo : Toky o Univer sity Press . Shimokawa, Koichi . 1985 . "Japan' s Keirets u System : Th e Cas e o f th e

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Automobile Industry, " Japanese Economic Studies 13 , no. 4 (Summer): 3-31. Shiraishi, Takashi . 1983 . Sengo Nihon Tsusyo Seisaku-shi (Postwa r Ja pan's Public Policy toward Industries) . Tokyo: Zeimu Keir i Kyokai . Shoven, Joh n B. , ed . 1988 . Government Policy toward Industry in the United States and Japan., Cambridge : Cambridge University Press . Suzuki, Yoshio . 1986 . Money, Finance, and Macroeconomic Performance in Japan. Ne w Haven: Yale University Press . Takahashi, Makoto. 1986 . "The Publi c Secto r i n th e Nationa l Economy, " 24-35. In Shibata 1986 . Thurow, Leste r C , ed . [1985 ] 1986 . The Management Challenge: Japanese Views. Cambridge, Mass.: MIT Press. Trezise, Phili p H. , an d Yuki o Suzuki . 1976 . "Politics , Government , an d Economic Growth i n Japan," 753-812. In Patrick and Rosovsk y 1976 . Tullock, Gordon . 1980 . "Efficien t Ren t Seeking, " 97-112 . I n Buchanan , Tollison, and Tulloc k 1980 . Vogel, Erza F. , ed., [1975 ] 1985 . Modern Japanese Organization and Decision-Making. Tokyo : Charles E. Tuttle. Weingast, Barr y R . 1990 . "The Rol e o f Credibl e Commitment s i n Stat e Finance." Public Choice 66, no.l (July) : 89-97. Weingast, Barr y R. , an d Kennet h A . Shepsle . 1981 . "Structure-Induce d Equilibrium an d Legislativ e Choice." Public Choice 37: 503-19. Wildes, Harry Emerson . 1954 . Typhoon in Tokyo: The Occupation and Its Aftermath. Ne w York: Macmillan . Williamson, Olive r E. 1975 . Markets and Hierarchies. New York: The Free Press. . 1985 . The Economic Institutions of Capitalism. Ne w York : Th e Free Press. Yakushiji, Taizo . 1987 . Seijika vs Kanryo (Politician s vs . Bureaucrats) . Tokyo: Toyokeizai Shinposya . Yamamura, Kozo , and Yasukich i Yasuba , eds. , 1987 . The Political Economy of Japan: The Domestic Transformation, Vol . 1. Stanford: Stanfor d University Press .

11 Privatization an d Development : The Cas e o f Sr i Lank a Manisha H . Perer a an d Mark Thornto n What impel s ever y ma n t o th e utmos t exertio n i n th e servic e o f hi s fellow ma n an d curb s innat e tendencie s towar d arbitrarines s an d malice is , i n th e market , no t compulsio n an d coercio n o n th e par t o f gendarmes, hangmen , an d pena l courts ; i t i s self-interest . Th e membe r of a contractua l societ y i s fre e becaus e h e serve s other s onl y i n servin g himself. Wha t restrain s hi m i s onl y th e inevitabl e natura l phenomeno n of scarcity. For th e res t h e i s free i n th e rang e o f the market . —Mises 1963 , 283

Introduction In th e earl y twentiet h century , man y developmen t economist s an d political leader s considere d planne d developmen t th e mos t direc t route t o economi c progress. * Th e popularit y o f developmen t plan ning wa s base d o n th e belie f tha t centralize d nationa l govern ments coul d offe r th e essentia l institutiona l an d organizationa l mechanism fo r overcomin g th e majo r obstacle s t o developmen t and ensur e a hig h rat e o f economi c growth . Th e recor d o f develop ment plannin g i n th e Thir d World , lik e centra l plannin g i n th e former Communis t world , di d no t liv e u p t o expectations. 1 Th e failure o f plannin g ha s le d a n increasin g n u m b e r o f polic y maker s 289

290 Manish a H . Perera an d Mar k Thornto n to advocat e th e us e o f th e marke t mechanis m t o promot e effi ciency and economi c growth. Privatization, deregulation , an d fre e trade ar e a t th e forefron t o f thi s market-oriente d approach , an d are als o th e ke y component s o f th e Austria n accoun t o f economi c development. Th e focu s o f thi s stud y wil l b e th e privatizatio n o f public enterprise s i n Sr i Lank a i n ligh t o f th e Austria n approac h to economic development . Austrian Economics an d Economic Developmen t Adam Smit h wrot e hi s Wealth of Nations explainin g th e "natur e and causes " o f th e dramati c economi c developmen t tha t ha d taken plac e i n England . Lik e Smith , Austria n economic s incorpo rates th e subjec t o f economi c developmen t an d growt h int o gen eral economi c reasoning . Indeed , th e Austria n understandin g ha s much i n common wit h th e lessons of Adam Smith. This is in shar p contrast t o th e stud y o f economi c developmen t i n th e twentiet h century whic h ha s bee n transforme d int o a separat e an d distinc t discipline. The "developmen t economist " i s typicall y a specialis t wh o de signs and implements development programs and specific project s for nationa l governments . Th e Austria n economis t operate s a t a more basi c level , examining ma n an d th e worl d a s the y ar e i n a n attempt t o understan d ho w th e marke t work s an d wh y i t some times doe s not . H e doe s no t produc e gran d plan s o r implemen t projects a s th e developmen t economis t would. 2 I n fact , Austria n economists wer e amon g th e first critic s o f development planning . The wor k o f Austrian economis t an d Nobe l Laureat e F . A. Hayek represents a concerte d attac k o n thi s typ e o f constructivis t ratio nalism, th e ide a tha t societ y ca n an d shoul d b e engineere d an d designed for better performance. 3 Information i s a key t o understanding th e Austrian perspectiv e on stability , growth , an d development . Informatio n abou t th e scarcity o f resources an d th e valu e o f goods i s carried throughou t the econom y vi a th e pric e system . Thi s knowledg e ca n the n b e used b y individual s t o perfor m economi c calculation s an d dis cover profi t opportunities . Th e perceptio n o f profi t opportunitie s spurs o n entrepreneuria l action , whil e losse s reallocat e resource s

Privatization an d Developmen t 29 1 from th e unsuccessfu l t o th e mos t aler t entrepreneurs—t o th e extent private property an d th e rights to profit exis t and are main tained i n an economy . Like centra l planner s an d bureaucrats , th e developmen t plan ner suffer s fro m a n informatio n problem . H e ha s acces s t o mor e information the n h e ca n use , an d ye t doe s no t hav e acces s t o enough informatio n t o make economi c calculations . Developmen t planning appear s t o work bette r whe n i t i s limited an d don e wit h the assistance of a growing market economy . A price system base d on private propert y i n conjunction wit h a well-functioning mone tary syste m reduce s th e scop e o f th e informatio n problem . Gov ernment planning appears less effective whe n the planning is comprehensive, th e project s ar e larg e an d intrusive , and th e econom y is primitive. In th e attemp t t o understan d th e working s o f th e marke t pro cess an d governmen t intervention , Austria n economist s hav e es tablished a genera l conclusio n tha t fre e market s ar e efficien t an d are superio r t o governmen t interventio n o r direc t governmen t control. This conclusion i s well illustrated b y past experience. The key element o f a free-market economi c system i s private property . Individuals mus t hav e th e righ t t o own property an d b e given th e greatest possibl e control over the use of this property . The absenc e o f government interventio n an d th e threa t thereo f allows th e marke t t o flourish. Th e fre e marke t i s a socia l syste m superior t o democrac y i n term s o f efficiency. 4 A free-market soci ety mus t hav e institution s tha t protec t propert y right s (especiall y in capital ) an d th e inequalit y o f economi c results . Indeed , thi s protection an d th e relativ e lac k thereo f i s th e majo r differenc e between th e developmen t i n th e Wes t an d th e slowe r develop ment elsewhere . The star t whic h th e people s o f th e Wes t hav e gaine d ove r th e othe r peoples consist s i n th e fac t tha t the y hav e lon g sinc e create d th e politica l and institutiona l condition s require d fo r a smoot h an d b y an d larg e uninterrupted progres s o f th e proces s o f larger-scal e saving , capita l accumulation, an d investment . Thus , b y th e middl e o f th e nineteent h century, the y h a d alread y attaine d a stat e o f well-bein g whic h fa r sur passed tha t o f race s an d nation s les s successfu l i n substitutin g th e idea s of acquisitiv e capitalis m fo r thos e o f predator y militarism . (Mise s 1963 , 497)

292 Manish a H . Perera an d Mark Thornto n One clear sig n o f the impac t o f extensive governmen t interven tion in the market i s the growth of the informal sector . The growth of informa l businesse s i n Sr i Lank a ha s bee n quit e dramati c an d can onl y b e understoo d a s a reactio n t o th e cost s o f complianc e with regulation s an d taxes . "Informality, " whic h i s a resul t o f the market' s attemp t t o circumven t th e "bureaucrati c mode l o f planning/' simpl y mean s ignorin g an d avoidin g th e negativ e in fluence o f government (Chickerin g and Salahdin e 1991) . The infor mal secto r ha s mad e a n importan t contributio n t o economi c growth an d th e developmen t o f th e entrepreneuria l spiri t i n Sr i Lanka. Policie s tha t remov e th e distinctio n betwee n forma l an d informal business , such a s reducing regulation s an d taxes , shoul d also contribut e t o th e growt h an d developmen t o f bot h sector s (Sanderatne 1991) . For th e Austria n economist , th e mos t sophisticate d for m o f development i s th e formatio n an d advancemen t o f institution s that ar e no t designed , bu t tha t evolv e t o solve problems, mitigat e "felt uneasiness, " an d stimulat e cooperation . Institution s suc h a s language, law , marketplace s (cities) , money, th e internationa l di vision of labor, and stoc k markets are important example s of such institutions. Whil e thes e institution s ma y hav e take n centurie s to evolve , undevelope d countrie s ca n mak e grea t advance s b y imitating, borrowing , an d integratin g preexistin g institution s from th e West , makin g necessar y adaptation s an d improvement s wherever possible. 5 However, the basic requirement fo r social an d economic developmen t i s privat e ownershi p an d relativel y un restricted contro l of property. Political Histor y o f Sr i Lank a Early Sr i Lank a wa s characterize d b y a feuda l (hegemonic ) soci ety. Village ownershi p wa s subordinate d t o th e kin g a s sovereig n of al l th e lan d an d h e coul d dispos e o f i t a s h e sa w fit . Th e Sr i Lankan versio n o f feudalism, however , differe d significantl y fro m the European , especiall y th e Englis h an d Frenc h varieties , in tha t it di d no t develo p large-scal e demesn e farming , a manoria l sys tem, and th e military aspect s of feudalism. However , there was, in common wit h Europea n feudalism , a n obligatio n t o servic e a s

Privatization an d Developmen t 29 3 a conditio n o f holdin g land , whethe r fro m secula r o r religiou s landlords, bu t wit h on e vita l difference . I n Sr i Lanka , th e natur e of tha t obligatio n wa s determine d b y th e cast e syste m (d e Silv a 1981,35). This feuda l economi c syste m wa s modifie d b y th e arriva l o f Portuguese an d Europea n commercialis m i n 1505 . Later, Portu guese wer e displace d b y th e Dutc h an d th e Dutc h b y th e British . Although Portuga l an d th e Netherland s lef t thei r mark s o n Sr i Lanka, th e greatest influenc e ove r th e islan d wa s exercised b y th e British. Th e change s brough t abou t b y th e Britis h wer e se t fort h with th e developmen t o f th e Colebrooke-Camero n Repor t (1833) . The economi c policie s o f th e Colebrooke-Camero n Repor t helpe d promote a n atmospher e i n which privat e capitalis t venture s wer e viewed wit h favor . Colebrooke , as a followe r o f Adam Smith , wa s against monopolies ; a s a consequence, the monopol y o f the cinna mon trad e wa s eradicated . Othe r monopolies , suc h a s fish, salt , and othe r form s o f governmen t trading , wer e als o brough t t o a n end. Th e Colebrooke-Camero n Repor t als o recommende d aboli tion o f the centuries-old feuda l concep t o f labor. As a result o f th e policies introduce d b y th e British , th e Sr i Lanka n econom y o f th e nineteenth centur y wa s change d t o on e o f entrepreneuria l free dom. By World War I, Sri Lanka (Ceylon ) was a classic example of a fre e an d ope n economy , wit h a minimu m o f stat e intervention . Almost al l commercia l an d busines s activit y wa s handle d b y th e private sector . Development Plannin g i n Sri Lank a The desir e t o brea k awa y fro m laissez-fair e doctrin e cam e t o th e forefront i n th e mid-twentiet h century . Stat e interventio n wa s advocated o n th e ground s o f bringing abou t a n equa l distributio n of income an d economi c opportunity t o all classes of citizens. The politicians an d nationalist s provide d th e ideologica l backgroun d for intervention . Sr i Lanka n member s o f th e Legislativ e Counci l in th e 1920 s champione d stat e interventio n a s a remed y fo r th e economic ills of the island. The early interventionis t act s include d the establishmen t o f wag e board s fo r plantatio n labo r an d th e regulation o f certai n workin g condition s o n th e plantations . Th e

294 Manish a H . Perera an d Mar k Thornto n increase i n unemployment als o invited intervention , an d th e mea sures adopte d include d relie f work , welfar e measures , an d poo r relief. All politicians, however, di d not deman d stat e intervention . Some peopl e wit h libera l idea s oppose d protectio n an d restric tions. In fact , a fe w legislativ e member s oppose d th e governmen t system o f taxatio n i n 1919 , an d i n 193 1 mad e th e oppositio n t o income ta x it s majo r platform . Th e majorit y o f th e educate d groups, however, though t tha t th e Stat e shoul d initiat e al l possi ble economi c ventures . A s a result , nationalizatio n an d publi c enterprises emerge d a s th e tw o majo r form s o f stat e interventio n (Warnapala 1988 , 27-29). Nationalization a s a n instrumen t o f state interventio n cam e t o the forefron t i n 1956 . Th e motivatio n fo r nationalizatio n i n Sr i Lanka, a s Joa n Robinso n stated , wa s t o "thro w of f th e swaddlin g bands o f colonialis m an d t o acquir e freedo m t o contro l he r ow n economy." Anothe r ai m wa s t o pus h ou t th e foreig n businesses. 6 The polic y base d o n suc h objective s resulte d i n a numbe r o f na tionalizations; th e nationalizatio n o f roa d transpor t i n 195 8 wa s followed b y th e nationalizatio n o f por t carg o handlin g i n 1959 . The nationalizatio n o f insuranc e cam e late r i n 1960 , followed b y the nationalization o f petroleum distributio n i n 1962 . In 1972 , the State fixed a ceilin g o n th e exten t o f agricultura l lan d tha t a person coul d ow n an d i n 1975, the governmen t implemente d it s program o f estat e nationalization . Als o in 1971 , the Busines s Un dertaking Acquisitio n Ac t wa s introduced , whic h wa s use d t o ac quire private-sector companie s (Warnapala 1988 , 30-31]) The second for m o f state interventio n wa s th e establishmen t o f public enterprises . Th e desir e t o transfor m th e colonia l econom y led t o th e creatio n o f public enterprise s t o engag e i n commercia l and industria l activities . Publi c enterprise s gav e th e stat e a pre dominant rol e i n providing th e service s essentia l t o th e lif e o f th e community. Thes e publi c enterprise s fel l withi n th e followin g areas: 1. Industria l an d Commercia l Enterprises , 2. Cultural , Educational, and Socia l Servic e Enterprises , 3. Financia l Enterprises , and , 4. Regulator y Enterprises .

Privatization an d Development 29 5 Table 1 . Number of Public Enterprises, 1958-197 7 Sector Manufacturing Trading Agriculture Service and Other Total

1958 1963 1965 1968 1970 7977 1972 1973 797; 12 1 1

18 1 1

20 2 1

23 2 1

24 2 1

25 10 1

27 12 2

29 13 4

29 13 4

14 28

20 40

22 45

30 56

35 62

45 81

50 92

60 106

67 107

Source: Karunatilake (1987 , 146).

Examples o f the above enterprises include : the Sr i Lank a Fibr e Board, th e Stat e Printin g Corporation , th e Tracto r Corporation , the Ge m Corporation , th e Sr i Lank a Transpor t Board , th e Fil m Corporation, and the Tea Board. This vast network of public enter prises wa s establishe d o n th e basis o f the Governmen t Sponsore d Corporations Ac t No . 1 9 of 1955 , amended b y Ac t No . 55 of 1957 , and th e Stat e Industria l Corporation s Ac t No . 49 o f 1957 . Due t o the abov e legislation , publi c enterprise s gre w ver y rapidly , a s shown i n tabl e 1 . The number o f public enterprise s gre w fro m 2 8 in 195 8 to 10 7 in 197 7 (Warnapala 1988 , 30-33). Not onl y di d th e publi c enterprise s gro w i n numbe r bu t th e sectors wher e th e stat e wa s directl y involve d i n economi c activi ties als o increased . Thes e sector s include d manufacturing , min ing, agriculture , transport , energy , tourism , construction , an d re search. I n agriculture , th e publi c secto r own s two-third s o f th e total acreag e unde r cultivation , i n tea , one-thir d unde r rubbe r cultivation an d one-tent h unde r coconu t cultivation . State-owne d enterprises i n Sr i Lank a accoun t fo r abou t 4 0 percen t o f gros s output i n manufacturing , ove r 4 0 percen t o f employmen t i n manufacturing, an d nearl y 6 0 percen t o f industria l production . Given th e relativ e importanc e o f th e publi c sector , th e perfor mance o f th e publi c enterprise s hav e a direc t effec t no t onl y o n the livin g standard s o f the people but als o on future prospect s fo r the socioeconomi c developmen t o f th e countr y (Vidanapathiran a 1988, 15).

296 Manish

a H . Perer a an d Mar k Thornto n

Table 2. Profits/Losses o f Selecte d Publi c Enterprise s (Rs million ) 1977 1978 1979 1980 State Fertilizer — Manufacturing Corp. Ceylon State — Hardware Corp. National Mil k - 7 2 Board National Textil e —1 7 Corp. Ceylon Steel 6. 5 Corp. Ceylon Govern- —16 3 ment Rail way Sri Lanka 42 Transport Board

1981

1982

——

—

-67

- 5 4 0.

8 1.

0 -2. 4 - 1

-85 -6

0 -9

6 (*

36 - 8

7 (*

)

14 4

12

82

1983

9 -16 1 - 2

1984 5 -30 2

0 -1

9 -2

7

4 -4

9 -6

2

)

8 -2

- 6 1 -10 8 -17 6 -23 6 -32 4 -45 2 -62 1 - 5 6 -31 6 -47 2 -42 9 -51 8 -39 6 -44 1

Source: Karunatilake (1987, 158-237). (*) denotes the year in which the public enterprise was privatized .

Performance o f Publi c Enterprise s The performanc e o f public enterprise s unde r closed-econom y poli cies ha s bee n poor . Tabl e 2 illustrate s th e performanc e o f selecte d public enterprise s i n Sr i Lanka . Thi s poo r performanc e o f publi c enterprise ma y b e attribute d t o monopol y power , lac k o f incen tives fo r workers , lac k o f manageria l expertise , interferenc e i n production an d price s b y th e government , an d employmen t poli cies o f th e publi c enterprises . In 197 7 a ne w governmen t cam e int o powe r wit h th e promis e of liberalizin g th e economy . Th e ne w governmen t announce d th e closing dow n o f loss-makin g publi c enterprise s an d th e handin g over o f certai n ke y industria l enterprise s t o th e privat e sector . Poor performanc e an d inefficien t management , couple d wit h th e political ideolog y o f th e government , le d t o th e conversio n o f pub lic enterprises int o privatize d ventures .

Privatization an d Developmen t 29 7 Privatization Proces s in Sri Lank a The first step s towar d privatizatio n wer e take n i n 1977 . Man y public enterprises , whic h wer e no t economicall y viabl e o r coul d not be made viable, were closed dow n or sold to the private sector . These public enterprises include d th e State Fertilizer Manufactur ing Corporation , th e Tobacc o Inc|ustrie s Corporation , th e Packag ing Material s Corporation , Governmen t Owne d Busines s Under taking Til e Factories , Minneriy a Textiles , th e Wellawatt e Spinning an d Weavin g Mills , Ceylo n Silks , th e Mil k Board , an d certain unit s o f th e Hardwar e Corporation . Th e purpose an d pro cess o f privatizin g som e o f thes e publi c enterprise s ar e describe d below. State Rubbe r Manufacturing Corporatio n (SRMC ) Background SRMC was established unde r th e State Industria l Corporatio n Ac t of 1973 . The ai m o f th e SRM C was t o provide assistanc e t o smal l landholders. Befor e th e SRM C wa s se t up , smal l holder s tappe d latex fro m rubbe r trees , converte d i t int o low-grad e ribbe d smoked sheets , an d sol d the m t o middlemen . Wit h th e establish ment o f th e SRMC , th e SRM C woul d bu y late x fro m individua l small holders , ad d value , an d expor t a high-grad e rubber . Th e SRMC i s th e onl y corporatio n providin g thi s service . Th e SRM C has eigh t factories , mainl y i n th e rubber-growin g district s o f th e Ratnapura, Kapawalle , an d Kelan i valleys . Th e eigh t factorie s employ abou t 25 0 workers. Process of Privatization To fre e th e SRM C fro m governmen t contro l an d t o brin g dyna mism int o it s management , th e governmen t decide d t o conver t the corporatio n int o a joint-stoc k compan y (partia l divestiture) . On Decembe r 31 , 1981, the SRM C wen t int o liquidatio n an d wa s dissolved. I n it s place , a ne w limite d liabilit y compan y wa s formed, value d a t 7 8 millio n rupees . I n th e ne w company , 6 0

298 Manish

a H . Perer a an d Mar k Thornto n

Table 3. Profit Statement s o f th e State Rubbe r Manufacturin g Co. , 1979-198 7 Year 1980 1981 1982 January-Jun e 1982/1983 1983/1984 1984/1985 1985/1986 1986/1987

Profit (Loss)

(5,801,334) 827,736 (201,655) 4,325,637 2,942,156 570,516 1,759,642 4,704,317

Source: Nankani (1988 , 12). * Converte d Jul y 198 2 t o Sr i Lank a Rubbe r Manufacturin g Company.

percent o f ownershi p wa s kep t b y th e governmen t an d 4 0 percen t was offere d t o bot h employee s an d th e public . Since th e formatio n o f th e limite d liabilit y compan y th e onl y layoffs wer e a t headquarters , wher e fort y o f th e tota l staf f o f sixt y were lai d off . Thos e unemploye d wer e compensate d wit h si x months' salar y o r 20,00 0 rupees , whicheve r wa s less . Tabl e 3 shows tha t th e compan y ha s increase d profit s sinc e divestiture . Workers wer e als o give n a bonu s o f tw o months ' salar y a yea r which compare d wel l wit h th e bonu s o f les s tha n hal f a month' s salary receive d b y worker s i n previou s years . The SRM C exampl e show s tha t publi c companie s ca n b e changed int o privat e companie s an d perfor m a t a profit . However , for thes e privat e companie s t o wor k a t a n o p t i m u m level , furthe r steps mus t b e take n t o enforc e th e independence o f thes e ne w com panies. Cooperative Wholesal e Establishmen t (CWE ) Background CWE i s a larg e state-owne d holdin g compan y establishe d i n 195 0 by a n Ac t o f Parliament . Lik e mos t enterprise s se t u p a t th e time , the objective s o f th e CW E wer e t o provid e service s an d employ -

Privatization an d Development 29 9 ment. CWE has 4,800 employees an d annua l sale s of 2,000 millio n rupees. I n recognitio n o f th e nee d t o adop t moder n technolog y and strengthe n manageria l efficiency , thre e of CWE's subsidiarie s were converted int o joint-stock companies . The three subsidiarie s were CWE Computer Services , CWE Printers Ltd. , and Lank a Milk Foods, Ltd. CWE Computer Services This joint-stoc k compan y wa s se t u p t o handl e accountin g an d managerial systems . Seventy-fiv e percen t o f ownershi p wa s hel d by th e paren t compan y (CWE ) and employee s an d allie d corpora tions hel d 12. 5 percent each . A s of Marc h 1986 , the join t ventur e had asset s wort h 2.5 4 millio n rupee s an d 4 5 employees . Also th e company ha s operate d a t a profi t sinc e th e partia l divestitur e o f CWE Computer Services . CWE Printers Ltd. The mai n functio n o f CW E Printer s i s t o provid e printin g an d advertising service s t o CW E subsidiarie s an d th e Ministr y o f Trade. Its outmoded machinery , however, could not cop e with th e increased demand . To inject ne w capital into this subsidiary, CWE Printers Ltd . was se t u p a s a joint-stock company . Tota l asset s a s of Marc h 198 6 wer e 19. 1 millio n rupees . Befor e th e formatio n of th e joint-stoc k company , CW E Printer s wer e incurrin g losses . However, since privatization th e company i s operating profitably , although actua l profi t statement s fo r CW E Printer s Ltd . ar e no t available. Lanka Milk Foods, Ltd. Lanka Mil k Food s (LMF ) wa s se t u p t o replac e th e CW E mil k powder packin g plan t tha t burne d dow n i n th e earl y 1980s . LMF was set up as a "private sector" company with government partic ipation i n th e equit y capital . Th e plan t i s designe d t o pac k mil k powder int o tripl e laminate d foi l package s withou t exposur e t o the atmospher e o r t o huma n hands . LM F is sai d t o b e moder n i n

300 Manish a H . Perera an d Mar k Thornto n Table 4. Financial Statistic s fo r Lank a Mil k Foods, Ltd . (Rs thousand ) Trading Results Turnover Gross Profi t Profits afte r Taxation Dividends

1983

1984

1985

1986

57,369 7,564

527,083 99,979

460,611 145,511

488,195 117,776

1,987 —

(24,228) —

65,183 33,372

55,401 36,663

Source: Nankani (1988 , 15).

concept an d design , and i s one of the largest mil k powder packag ing complexes i n the world . The compan y ha s performe d profitabl y sinc e it s establishmen t in 198 2 a s show n i n tabl e 4 . Profit s befor e taxe s i n th e quarte r ending i n March 198 7 were 74.4 million rupees , 1 0 million rupee s more tha n th e quarte r th e previou s year . LM F has maintaine d a tax-free dividen d o f 12. 5 percen t sinc e 1985 . LMF als o doe s no t rely o n governmen t subsidies . I n 198 5 an d 1986 , th e retur n o n assets employe d wa s 2 5 percen t an d 18. 5 percent , respectively . Given a current interes t rat e on term loan s of 1 4 percent, LMF can be considered a successful publi c company . National Textil e Corporatio n Background Prior t o 1977 , the fou r state-owne d textil e mills—Thulhiriya , Pu goda, Veyangoda, and Mattegama—operated togethe r as a virtua l monopoly. Wit h th e liberalizatio n o f th e econom y i n 1977 , th e mills were predictably unable to compete with foreign an d domes tic firms du e t o obsolet e machiner y an d inefficien t management . The accumulate d losse s i n th e fou r textil e mill s exceede d 40 0 million rupees i n 1979 . Process of Privatization and Results In th e cas e o f th e textil e mills , th e metho d o f privatizatio n use d by th e governmen t wa s managemen t contracts . Th e Ministr y o f

Privatization an d Developmen t 30 1 Table 5 . Sale s o f Majo r Textil e Mills , 1982 an d 198 5 (R s Million ) Mills

1982

1985

Thulhiriya Pugoda Veyangoda Matlegama

255.5 97.0 122.0 72.9

400.0 335.0 281.0 105.5

Source: Nankani (1988 , 19).

Textile Industries arranged t o have the three major mill s manage d by three foreign companies . The medium- and long-ter m objectiv e of the management contract s wa s to move toward ful l divestiture . The managemen t contract s wer e expecte d t o mak e th e mill s via ble and attractiv e t o invite equity participation fro m th e public. According to the Ministry of Textile Industries, there has been a major improvemen t i n th e performanc e o f th e fou r mills . Table 5 shows tha t sale s hav e increase d dramaticall y i n th e firs t stag e o f privatization. In 1986 , for th e first tim e i n the history o f the mills, they paid a dividend o f 1 0 millio n rupee s t o th e Treasury . Th e individua l performances o f the Thulhiriya, Pugoda , and Veyangod a mill s ar e as follows .

Thulhiriya Textile Mills Thulhiriya mill s ar e manage d b y a consortiu m o f thre e compa nies, including Bomba y Dyein g Manufacturing Co . Ltd, one of th e largest composit e textil e mill s i n India . Operatio n o f th e Thul hiriya Textil e Mill s unde r th e ne w managemen t bega n i n 1980 , and under the new management arrangemen t th e mills have mad e profits sinc e 1983 . Th e mill s hav e als o earne d abou t 4 0 millio n rupees i n foreig n exchang e an d th e earning s pe r employe e hav e increased abou t 3 0 percent. Fro m tabl e 6 , it ca n b e observed tha t in additio n t o sales , ther e ha s bee n a significan t increas e i n bot h profits an d employment .

302 Manish

a H . Perer a an d Mar k Thornto n

Table 6. Thulhiriya Textil e Mills , 1981-198 6

Net Profi t (Loss) (Rs million ) Employees Average Earnings pe r Employee/Month

1981

1982

1983

1984

1985

(Jan-Sept) 1986

(12.34)

(2.76)

8.33

12.88

56.04

49.57

2,551

2,845

3,128

3,321

3,802

3,703

984

1,140

1,250

1,450

1,502

1,614

Source: Nankani (1988,19).

Pugoda Textile Mills Pugoda ha s bee n unde r th e managemen t o f Lakshm i Textile s o f India. Lakshmi , th e sixth-larges t manufacture r o f textil e machin ery in the world, has been managing Pugoda mills since July 1980 . Sales turnove r unde r ne w managemen t ha s improve d fro m 89.4 2 million rupee s t o 336.3 7 millio n rupees , a n increas e o f abou t 27 6 percent. With respec t t o profits, th e mill s starte d t o show positiv e results sinc e 1985 . Employmen t i n Pugod a mill s ha s als o in creased sinc e 1981.

Veyangoda Textile Mills Veyangoda mill s ar e manage d b y th e Tootal s Ltd. , a UK-base d international group . Veyangod a mill s mad e profit s i n 198 6 an d also i n 1986 . There ha s als o bee n ove r a 10 0 percent increas e i n average employee earnings .

Sri Lank a Telecommunication s Departmen t (SLTD ) The inefficienc y o f SLT D was s o glaring an d custome r frustratio n so grea t tha t ther e wa s enormou s pressur e fro m th e governmen t and th e private secto r for a major restructurin g o f services.

Privatization an d Development 30

3

Privatization Process With th e decisio n t o privatize SLTD , a Presidentia l Committe e o f Inquiry a s wel l a s th e Worl d Ban k wer e aske d t o outlin e broa d policy option s fo r it s reorganization . Bot h th e Committe e o f In quiry an d th e Worl d Ban k arrive d a t simila r conclusions , whic h included: 1. Th e creatio n o f a ne w telecommunication s entit y (a s oppose d to a government department) , 2. Th e nee d t o transfe r th e SLT D int o a join t ventur e wit h a foreign partner , an d 3. Th e formatio n o f a regulator y bod y t o oversee th e telecommu nications sector . A new telecommunication s boar d (TBSL ) ha s bee n forme d t o articulate an d execut e telecommunication s policy . Privatizatio n has bee n broke n int o tw o phases . I n phas e one , th e stoc k woul d remain government-owned , bu t i n al l othe r respect s th e compan y would operat e a s a "private " commercia l enterprise . Phas e tw o involves th e actua l introductio n o f privat e participatio n an d i s scheduled t o begin in 1992 .

Government-Owned Busines s Undertaking s Tile Factories There were thre e majo r til e factories: Nooran i Tiles , Shaw Indus tries, and Vijaya Til e Works. Noorani Tiles, built i n the 1940s , was the larges t o f its type . In 1960 , it was reconstructed an d mad e th e most moder n til e factory i n th e country . Situate d a t th e bes t cla y deposit are a i n Colombo , it produce d a n averag e o f 25,00 0 tile s a year, as well as wire-cut brick s and earthenware pipes . It employ s about five hundre d workers . I n 1975 , due t o labo r unres t withi n the company , th e governmen t acquire d Nooran i Tile s unde r th e 1971 Business Undertaking s Act . It wa s the n manage d b y Ceylo n Ceramics Corporation , a governmen t holdin g compan y tha t als o managed eightee n othe r bric k an d til e companies . Th e compan y

304 Manish

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was place d directl y unde r th e Ministr y o f Industrie s an d a repre sentative o f th e ministr y wa s appointe d t o manag e th e firm. There i s littl e informatio n o n th e backgroun d o f Sha w Indus tries an d Vijay a Til e Works . I t i s no t know n whe n the y wer e established bu t the y wer e als o take n ove r b y th e governmen t i n the 1980 s an d manage d b y a governmen t authority . Sha w Indus tries an d Vijay a Til e Work s employe d 32 5 an d 20 0 workers , re spectively. Th e thre e millio n rupee s i n asset s owne d b y Sha w Industries wer e dwarfe d b y liabilitie s o f approximatel y fiften mil lion rupees . Vijay a Til e Work s wa s value d a t si x millio n rupees , with si x millio n rupee s i n liabilities . By 1982 , two factor s le d t o a chang e i n th e government' s benev olent attitud e towar d thes e thre e til e companies. The public polic y of th e countr y h a d shifte d towar d privatizatio n an d th e til e com panies pose d a continuou s drai n o n th e federa l budget . Th e Cabi net therefor e decide d t o sell al l thre e companies . The privatizatio n technique use d b y th e Cabine t wa s ful l divestitur e throug h privat e sale afte r tenderin g an d transferrin g o f stat e activit y t o a ne w company t o b e forme d b y privat e parties . Th e final negotiation s for al l thre e til e factorie s wer e complete d i n 1988 . Unfortunately , the financial result s o f thes e ne w companie s wer e no t ye t available. Conclusions Privatization ha s attracte d muc h attentio n i n th e recen t year s an d it reflect s a worldwid e interes t i n reducin g th e rol e o f th e stat e i n national economies , whil e enhancin g th e scop e o f privat e owner ship an d th e privat e sector . Thi s movemen t towar d privatizatio n in Sr i Lank a an d elsewher e i s th e resul t o f th e recognitio n o f the interna l inefficiencie s o f publi c enterprises . Studie s b y Davie s (1971), D e Aless i (1974) , Crai n an d Zardkooh i (1978) , Free h an d Ginsburg (1981) , Davie s (1981) , an d Perer a (1992 ) hav e clearl y illustrated th e inefficiencie s foun d i n publi c enterprises . The inefficienc y o f publi c enterprise s i s predictabl e fro m a n understanding o f th e contribution s o f Austria n economists . Bu reaucratic organization s suc h a s publi c enterprise s ar e rule guided rathe r tha n profit-motivated . Thes e organization s suffe r

Privatization an d Developmen t 30 5 from a n informatio n proble m tha t onl y worsen s ove r tim e an d a s more industrie s ar e nationalized . Th e onl y solutio n t o thi s prob lem is privatization . Privatization ha s man y practica l advantages . Privatization ca n increase th e quantit y an d qualit y o f good s an d service s availabl e in the market. The profit motiv e keeps the privatized firms respon sive to consumer needs and demands. As the entrepreneurial spiri t is released , ne w technique s ar e adopted , machine s fre e u p labor , and new products ar e discovered. Through th e free-market alloca tion of resources, privatization ove r the long term can create mor e jobs an d opportunitie s fo r all . Privatizatio n ca n lea d t o open , competitive economie s tha t produc e hig h income s an d mor e per manent jobs . Privatization allow s government s t o eliminat e sub sidies t o unprofitabl e state-ru n enterprises , thereb y creatin g th e potential fo r reduce d deficits , inflation , an d taxes . Therefore, pri vatization no t onl y solves the problems o f state-run enterprises , i t also provide s th e fue l t o furthe r remov e governmen t fro m th e economy an d thereb y promote s furthe r economi c development . In short , privatizatio n i s th e correc t procedur e t o liberat e th e economies of developing countries from th e slow growth and stag nation tha t have plagued s o many for so long. The limite d privatizatio n i n Sr i Lank a provide s a n importan t illustration o f th e benefit s o f th e Austria n approac h t o economi c development. Th e first step s towar d privatizatio n wer e take n i n 1977, but th e actua l divestitur e o f government-owne d businesse s did no t tak e plac e til l th e earl y 1980s . A s show n above , al l th e privatization venture s thu s fa r hav e bee n successful . Th e Stat e Rubber Manufacturin g Corporation , Cooperativ e Wholesal e Es tablishment, an d Nationa l Textil e Corporatio n ar e jus t a fe w ex amples of how through privatization previousl y public enterprise s with larg e losses are now making large profits . While successful, privatizatio n i n Sr i Lank a ha s bee n slow , du e mainly t o the special interest s opposed t o privatization an d t o th e large-scale communa l problem s tha t engulfe d th e countr y i n th e late 1970s . Partial privatizatio n entail s partia l success . Delayin g privatization onl y delay s th e succes s o f privatization. Whil e tim e will provid e mor e fact s concernin g th e succes s o f privatization , there i s littl e doub t tha t th e succes s s o fa r ha s helpe d creat e th e

306 Manish a H . Perera an d Mark Thornto n right political and economic environment tha t promises to expand private ownershi p withi n th e partiall y privatize d firms, exten d privatization t o al l othe r publi c enterprises , an d thereb y contrib ute to further economi c development . Notes * Th e author s woul d lik e t o than k Rober t B . Ekelund , Jr . an d Jeffre y Herbener fo r thei r helpfu l comment s an d suggestions . 1. Se e Waterston (1965 ) for a detaile d stud y o n th e developmen t plannin g experience o f fifty-fiv e countries . 2. Ludwi g vo n Mise s (1963 , 869 ) note d tha t th e "professiona l economist " was a hindranc e t o th e marke t economy , referrin g t o the m a s special ists "instrumenta l i n designin g variou s measure s o f governmen t inter ference wit h business. " 3. F . A . Hayek' s mos t famou s contribution , The Road to Serfdom (1949) , clearly showe d tha t plannin g an d extensiv e interventionis m wer e no t "planning fo r freedom. " H e discusse d th e fundamenta l aspec t involve d in th e failur e o f plannin g an d indeed , th e failur e o f th e economic s profession, i n hi s Nobe l Memoria l Lecture . H e conclude d her e (1989 , 7) tha t If ma n i s no t t o d o mor e har m tha n goo d i n hi s effort s t o improv e th e socia l order, he will hav e t o learn tha t i n this , as in all other fields where complexit y of a n organize d kin d prevails , h e canno t acquir e th e ful l knowledg e whic h would mak e mastery o f the events possible... . The recognition o f the insupera ble limits to his knowledge ought indee d t o teach th e student of society a lesson of humility whic h shoul d guar d hi m agains t becomin g a n accomplic e i n men' s fatal strivin g t o control society— a strivin g whic h make s him no t only a tyran t over hi s fellows , bu t whic h ma y wel l mak e hi m th e destroye r o f a civilizatio n which n o brai n ha s designe d bu t whic h ha s grow n fro m th e fre e effort s o f millions of individuals. Mises (1952 ; 1963 , 285) wa s als o a n importan t earl y criti c o f develop ment p l a n n i n g — b u t i n contras t t o Hayek , Mise s di d believ e tha t yo u could rationall y desig n a successfu l socia l orde r i n term s o f the genera l rules an d institution s o f society . 4. I t i s als o successfu l i n term s o f translatin g individua l inpu t int o socia l valuation an d i n term s o f equit y an d justice . I t cannot , however , b e said t o b e superio r i n thes e respect s becaus e som e standard s o f equit y and justic e ar e diametri c t o othe r standard s an d economi c analysi s cannot determin e whic h standar d i s superior . 5. Fro m th e Austria n perspective , eve n th e plannin g o f simpl e institu tions, suc h a s transportatio n system s an d citie s involve s a n insolubl e information problem . Thi s theoretica l humilit y lead s man y Austrian s

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to recommend tha t th e governmen t restric t it s concerns t o protectin g property right s an d resolvin g disputes . Eve n i n th e judicia l realm , the fre e marke t i s greatl y expandin g int o area s o f crim e protection , arbitration, an d maintenanc e o f priso n facilities . Recently , Benso n (1990) ha s argue d tha t well-functionin g judicia l institution s ca n de velop without a monopoly of force. 6. Thi s type of policy does irreparable harm t o a country's connections t o the internationa l capita l market , th e ke y lin k fo r th e proces s o f eco nomic development . Sr i Lank a becam e independen t i n 1948 , but i t i s difficult t o lin k th e us e o f nationalizatio n exclusivel y t o anticolonial ism becaus e simila r project s wer e bein g pu t int o plac e aroun d th e world, including i n Sri Lanka's colonial ruler, Great Britain . References Alchian, Armen. 1965 . "Some Economic s o f Property Rights. " 77 Politico. (December): 369-82. Alchian, Armen, an d Reube n Kessel . 1962 . "Competition, Monopoly , an d the Pursuit o f Money." Aspects of Labor Economics 14 . Barletta, Nicolas . 1987 . Prefac e i n Privatization and Development, ed . Steve H. Hanke. San Francisco : Institute for Contemporary Studies . Benson, Bruce. 1990 . The Enterprise of Law: Justice without the State. Sa n Francisco: Pacific Researc h Institut e fo r Public Policy. Chenery, Hollis , an d Mose s Syrquin . 1975 . Patterns of Development, 1950-1970., London : Oxford Universit y Press . Chickering, A. Lawrence, and Mohame d Salahdine . 1991 . The Silent Revolution: The Informal Sector in Five Asian and Near Eastern Countries. San Francisco: ICS Press. Crain, Mark, and Asgha r Zardkoohi . 1978 . "A Test of the Propert y Right s Theory o f th e Firm : Wate r Utilitie s i n th e Unite d States. " Journal of Law and Economics (October) . Da vies, Davi d G . 1971 . "The Efficienc y o f Publi c versu s Privat e Firms : The Cas e o f Australia' s Two Airlines. " Journal of Law and Economics (April): 149-65. . 1981 . "Property Right s an d Economi c Behavio r i n Privat e an d Government Enterprises : Th e Cas e o f Australia' s Bankin g System. " Research in Law and Economics 3 . De Alessi , Louis . 1974 . "Manageria l Tenur e unde r Privat e Governmen t Ownership i n th e Electri c Powe r Industry. " Journal of Political Economy (May/June): 645-53. . 1980 . "The Economic s o f Propert y Rights : A Review o f th e Evi dence." Research in Law and Economics 3 , 1-47 . De Mel, Ronnie. 1977 . Budget Speech 1978. Ministry o f Finance an d Plan ning, Republic of Sri Lanka .

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de Silva , K . M . 1981 . A History of Sri Lanka. Berkeley , Lo s Angeles : C. Hurst. De Soto, Hernando. 1989 . The Other Path: The Invisible Revolution in the Third World. Ne w York: Harper & Row. De Walle, Nicholas, "Privatization i n Developin g Countries : A Review of the Issues," World Development, Volume 17 , 1989. Ekelund, Robert , an d Rober t Tollison . 1981 . Mercantilism as a Rent-Seeking Society. Colleg e Station: Texas A&M University Press . Finsterwalder, Ottokarl . 1990 . "From Marxis m t o Market: Reformin g th e CMEA Economics." Vital Speeches, May 15 , 457-60. Freeh, H. E., and Pau l Ginsberg. 1981 . "Property Right s and Competitio n in Healt h Insurance : Multipl e Objective s fo r Nonprofi t Firms. " Research in Law and Economics 3 : 155-72. Hanke, Steven . 1986 . Privatization: Theory, Evidence and Implementation. Auburn, Ala.: Ludwig von Mises Institute. . 1987 . "Introduction i n Privatization and Development, ed. Steve H. Hanke. San Francisco: Institute fo r Contemporary Studies . Hayek, F . A. 1944 . The Road to Serfdom. Chicago : Universit y o f Chicag o Press. . 1989 . "Th e Pretenc e o f Knowledge. " Nobe l Memoria l Lecture , December 11 , 1974 , printe d i n American Economic Review 79 , no . 6 (December): 3-7. IMF. 1989 . "ADB Attributes Succes s o f Asian Economie s t o Libera l Poli cies, Reliance on Market Forces. " IMF Survey, August 7, 241. Kaletsky, Anatole . 1988 . "Privatizatio n i n th e Developin g Countries. " Central Bank of Sri Lanka News Survey (March/April) . Karunatilake, H. N. S. 1987. The Economy of Sri Lanka. Sr i Lanka: Sridev i Printing Works. McPherson, Peter . 1987 . "The Promis e o f Privatization. " I n Privatization and Development, ed . Stev e Hanke . Sa n Francisco : Institut e fo r Con temporary Studies . Mises, Ludwig . (1920 ) 1990 . Economic Calculation in the Socialist Commonwealth. Auburn , Ala.: Praxeology Press. . 1952. Planning for Freedom. South Holland, 111.: Libertarian Press . . 1963. Human Action: A Treatise on Economics. 3 d ed., New Haven: Yale University Press . Nankani, Helen . 1988 . "Selecte d Countr y Cas e Studies. " I n Techniques of Privatization of State-Owned Enterprises. Worl d Ban k Publication , Technical Pape r No. 88. Perera, Manisha . 1992 . "Efficiency o f th e Publi c an d Privat e Bu s Trans port Sector s in Sri Lanka." Journal of Advanced Transportation 26 . Sanderatne, Nimal . 1991 . "The Informal Secto r i n Sr i Lanka : Dynamis m and Resilience. " in Chickering and Salahdin e 1991. Vidanapathirana, Upananda . 1988 . "Privat e an d Stat e Sectors : Thei r

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Contribution t o th e Economi c Developmen t o f Sr i Lanka. " I n Aspects of Privatization in Sri Lanka, ed . Ger d Botterweck , 13-21 . (Colombo : Friedrich-Eberi-Shiftung). Warnapala, Wiswa . 1988 . "Sr i Lanka : Laisse z Fair e Stat e o r Welfar e State?" I n Aspects of Privatization in Sri Lanka, ed . Ger d Botterweck , 22-38. (Colombo: Friedrich-Ebert-Shiftung) . Waterston, Albert . 1965 . Development Planning: Lessons of Experience. Baltimore: John Hopkins University Press .

12 Financial Refor m an d Economi c Development: Th e Currenc y Boar d System fo r Easter n Europ e Steve H . Hank e an d Kur t Schule r

One o f th e grea t debate s i n economic s pitte d prominen t member s of th e Austria n Schoo l agains t so-calle d marke t socialist s i n th e 1920s an d 1930s . Whe n th e dus t ha d settled , th e Austrian s ha d gotten th e bes t o f th e socialist s o n theoretica l grounds . That wa s a well-kept secre t i n th e economic s professio n fo r man y years . I n 1971, however, n o les s a perso n tha n Pau l Samuelso n crowne d th e Austrians th e victors . H e wrote , "I t wa s Hayek , wit h hi s poin t about ho w th e marke t syste m bring s informatio n t o bear upo n th e outcome, wh o reall y wo n th e d e b a t e " (Samuelso n [1971 ] 1977 , 876). Ye t althoug h th e economi c wast e associate d wit h state owned enterprise s an d publi c work s project s ha d bee n acknowl edged fo r som e tim e b y a broa d cros s sectio n o f economists , man y still clun g t o th e belie f tha t comprehensiv e economi c plannin g worked. Notable , fo r example , wer e th e observation s mad e b y John Kennet h Galbrait h afte r a 198 4 tri p t o Russia . H e remarke d That th e Sovie t econom y ha s mad e grea t materia l progres s i n recen t years—certainly i n th e nea r decad e sinc e m y las t visit—i s eviden t bot h from th e statistic s (eve n i f the y ar e belo w expectations ) and , a s man y have reported , fro m th e genera l urba n scene . On e see s i t i n th e appear 310

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ance o f solid well-bein g o f the peopl e o n th e streets , the clos e t o murder ous traffic, th e incredible exfoliation o f apartment house s and th e genera l aspect o f restaurants , theater s an d shops—thoug h thes e ar e not , t o b e sure, the most reliable of indices. (Galbraith [1984 ] 1986 , 270) Well, b y th e tim e th e Berli n Wal l cam e dow n i n 1989 , i t wa s clear tha t Galbrait h an d economist s o f hi s il k literall y di d no t know wha t the y wer e talkin g about . Centra l plannin g h a d pro duced mor e ruinou s result s tha n eve n th e Austrian s imagined . Even thoug h th e collaps e o f socialis m ha s demolishe d th e gen eral cas e fo r centralize d economi c planning , th e vogu e fo r plan ning i n certai n sector s o f th e econom y remain s strong . I n particu lar, mos t person s hav e assume d tha t th e issu e o f currenc y shoul d be centrall y planned , b y a governmen t monopolist—th e centra l bank. Plan s t o refor m th e econom y o f th e forme r Sovie t Union , such a s th e Shatali n "50 0 d a y s " plan , th e Harvar d "Gran d Bar gain" scheme , an d proposal s considere d t o dat e b y th e Interna tional Monetar y Fund , al l stres s th e importanc e o f controllin g th e supply o f mone y b y grantin g mor e independenc e t o centra l bank s (e.g., Alliso n an d Yavlinsk y 1991 , 4 1, 89). Tha t flies i n th e fac e o f both theor y an d history , whic h sugges t tha t centra l bank s wil l no t produce stabl e currencie s i n Easter n Europe. 1

Why Centra l Bankin g I s No t th e Answe r East Europea n nation s ar e tryin g t o becom e marke t economies , yet paradoxicall y the y ar e placin g muc h o f th e responsibilit y fo r doing s o o n centra l banks , whic h ar e essentiall y no t marke t insti tutions. Marx an d Engel s wrot e i n th e Communist Manifesto tha t on e o f the step s fo r achievin g communis m wa s "centralizatio n o f credi t in th e hand s o f th e state , b y mean s o f a nationa l ban k wit h stat e capital an d a n exclusiv e monopoly " (Mar x an d Engel s [1848 ] 1948, 30) . Befor e th e revolution s o f 1989 , Eas t Europea n nation s followed Mar x an d Engel s t o th e lette r i n thi s par t o f th e Commu nist program . The y h a d " m o n o b a n k " systems , in whic h n o distinc tion existe d betwee n centra l banking , commercia l banking , an d subsidizing state-owne d enterprises . T o tr y t o achiev e administra -

312 Stev e H. Hanke and Kur t Schule r tive efficiency , som e nation s spli t th e function s o f th e monoban k into separat e "banks " correspondin g t o differen t sector s o f th e economy ( a consume r saving s bank , a ban k fo r constructio n an d heavy industry , a bank fo r foreig n trade , and s o on). The separat e banks wer e all ultimately subjec t t o control b y th e same planner s at th e top , however; the y wer e no t independen t an d di d no t com pete with one another . East Europea n nation s ar e no w tryin g t o spli t th e monoban k into it s components : a centra l bank ; profit-making , competitiv e commercial banks ; an d explici t subsidie s t o state-owne d enter prises throug h th e stat e budget , separate d fro m th e bankin g sys tem. Bu t a s lon g a s the y retai n centra l banking , the y retai n th e most importan t featur e o f centralize d economi c plannin g i n money. To kill th e principle s o f central plannin g embodie d i n th e monobank system , i t i s necessar y t o cu t of f th e system' s hea d b y abolishing o r nullifying th e power of the central bank . The argument s agains t socialis t economi c plannin g develope d by th e Austrian s i n th e 1920 s an d 1930 s (se e Haye k 193 5 [1975] ) have i n recen t year s bee n extende d t o mone y an d bankin g b y William Buto s (1986 ) an d especiall y Georg e Selgi n (1988 , 64-69, 82-107). Selgi n ha s explaine d ho w concentratin g reserve s i n a central ban k slow s th e adjustmen t o f th e suppl y o f credi t t o th e demand fo r credit . Becaus e reserve s ar e mor e concentrate d tha n they woul d b e i n a fre e market , i t take s longe r fo r losse s o r gain s in reserves to affect th e behavior of the banking system as a whole. Changes i n reserve s ar e signal s tha t indicat e t o bank s whethe r they hav e correctl y anticipate d th e public' s willingnes s t o gran t credit throug h them . Unde r centra l banking , th e signal s becom e sluggish o r eve n inoperativ e fo r relativel y lon g periods , enablin g banks t o establis h a structur e o f credit s tha t i s no t i n harmon y with th e wishes of the public and i s hence unsustainable . So muc h fo r th e theor y o f centra l banking . Whe n w e examin e the history of central banking , we find that man y banking system s have gotte n alon g bette r withou t centra l bank s tha n wit h them . Central bankin g i s a recen t development ; mos t countrie s di d no t have centra l bankin g unti l afte r th e Firs t Worl d War , ye t man y developed sophisticated , stabl e bankin g system s wel l befor e (Schuler 1992a , 1992b) . (Easter n Europ e wa s a n exception ; th e

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rise o f moder n bankin g di d no t occu r i n mos t o f Easter n Europ e until th e lat e nineteent h centur y o r later , b y whic h tim e nationa l governments i n the region had establishe d centra l banks. ) The history o f central bankin g i n Easter n Europ e suggest s tha t central banks are unlikely t o provide credible currencies. After all , central bank s ar e responsibl e fo r th e dir e conditio n o f th e rubl e and th e Yugosla v dinar , an d fo r th e weak conditio n o f most othe r East Europea n currencies . We who liv e i n Western nations , mos t of whic h hav e relativel y goo d centra l banks , ten d t o forge t ho w rare goo d centra l bank s are . Wester n centra l bank s ar e th e sta r pupils o f th e class . The y produc e convertibl e currencie s tha t de preciate "slowly/ ' However , fo r mos t o f th e ninety-nin e nation s that th e World Bank classifies a s low- and middle-income , centra l banks produce inconvertible , unsound currencies . For example, in those nations , averag e annua l inflatio n wa s 16. 7 percen t fro m 1965 t o 198 0 an d 53. 7 percen t fro m 198 0 t o 198 9 (Worl d Ban k 1991,25). To issu e a fiat currenc y tha t function s properly , centra l bank s must posses s credibility . That wil l b e difficul t i n Easter n Europe , especially i n th e forme r Sovie t Union , wher e th e behavio r o f th e Russian centra l ban k an d th e newl y establishe d centra l bank s i n other forme r Sovie t republic s ha s mad e mos t citizen s distrustfu l of the rubl e an d o f th e ne w currencie s intende d t o replac e it . Th e ruble zon e i s no w (Augus t 1992 ) in th e earl y stage s o f a textboo k hyperinflation, wit h deman d fo r cash outrunning th e ability of the printing presses to print notes. Convertibility of the ruble, initially promised t o occur on June 1 , 1992, has been delaye d unti l a t leas t 1993. Non e o f th e currencie s issue d s o fa r b y outlyin g forme r Soviet republics t o replace the ruble i s yet fully convertible . The poor performance o f East Europea n centra l bank s explain s why Pau l Volcker , th e forme r chairma n o f th e U.S . Federa l Re serve System , ha s indicate d tha t h e ha s littl e fait h tha t centra l banks i n formerl y Communis t nation s ca n achiev e ful l currenc y convertibility. Addressin g centra l banker s i n Jackso n Hole , Wyoming, i n 1990 , Mr . Volcke r note d tha t market s develope d lon g before centra l banks , an d stresse d tha t Easter n Europ e migh t actually retar d it s transitio n t o market s b y relyin g o n centra l banks (Volcker 1990) .

314 Stev e H. Hanke and Kur t Schule r Many believ e tha t no w tha t Eas t Europea n countrie s hav e joined th e Internationa l Monetar y Fun d (IMF) , th e credibilit y problem wil l b e solved . That i s a false hope . Let u s loo k a t recen t experience i n Yugoslavia , whic h ha s bee n a membe r o f th e IM F since 1945 . The experienc e o f Yugoslavia prio r t o th e outbrea k o f civil wa r show s that , i n a n environmen t tha t ha s man y similari ties to that i n the former Sovie t Union , good behavior, credibility , and soun d mone y hav e prove d elusiv e (Hank e an d Schule r 1991c).2 In Decembe r 198 9 the monthl y inflatio n rat e wa s 5 0 percent i n Yugoslavia, an d fo r th e entir e yea r i t ha d bee n 2,72 0 percent . Armed wit h a n IM F stabilizatio n plan , Yugoslavi a introduce d a currency refor m i n Decembe r 198 9 tha t establishe d a "hard " pegged exchang e rate of seven dinars per German mark . To main tain th e peg under condition s of low credibility, real lending rate s were abou t 4 0 percen t an d rea l deposi t rate s wer e abou t 2 5 per cent pe r yea r i n mos t o f 1990 . Although inflatio n cam e dow n i n Yugoslavia durin g 1990 , i t remaine d muc h highe r tha n i n Germany. Hence, the dina r becam e grossl y overvalued an d th e Yugoslav econom y slumpe d int o a dee p depression . Eventually , Yugo slavia had t o give up on th e hard pe g and pum p massiv e amount s of credi t int o bankrup t stat e enterprise s an d commercia l bank s owned b y them . A t presen t (Augus t 1992 ) th e officia l exchang e rate o f the dina r i s 1,20 0 pe r mark, while on the black marke t i t i s about 1,50 0 pe r mark . Th e governmen t i n Belgrad e fear s tha t inflation coul d hi t 100,00 0 percent o n a n annualize d basi s b y th e end of 199 2 (Silber 1992). 3 Eastern Europ e appear s t o have one exception t o the pattern o f inflation i n th e mid-doubl e digit s or tripl e digits : Czechoslovakia . That i s largel y th e resul t o f th e uprigh t characte r o f it s finance minister, Vacla v Klaus . But Klau s ha s n o counterparts elsewher e in Eastern Europe , and instea d o f relying on luck to produce othe r Klauses, i t woul d b e mor e pruden t t o instal l a monetar y syste m that wil l b e tamper-proo f eve n agains t imprudent , spendthrif t finance ministers . Fortunately, suc h a system exists . The currenc y board syste m i s a n alternativ e monetar y syste m wel l suite d fo r Eastern Europe. 4

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The Currenc y Boar d Solutio n A currenc y boar d i s a n institutio n tha t issue s note s an d coin s convertible int o a foreig n "reserve " currenc y o r commodit y asse t at a fixed rat e an d o n demand . I t typicall y doe s no t accep t depos its. A s reserves , a currenc y boar d hold s high-quality , interest bearing securitie s denominate d i n th e reserv e currenc y (o r com modity). A currenc y board' s reserve s ar e equa l t o 10 0 percen t o r slightly mor e o f it s note s an d coin s i n circulation , a s se t b y law . (Commercial bank s i n a currenc y boar d syste m nee d no t hol d 10 0 per cen t reserve s i n reserve-currenc y asset s agains t thei r deposits , though.) Th e boar d generate s profit s (seigniorage ) fro m th e differ ence betwee n th e interes t earne d o n it s reserv e asset s an d th e expense o f maintaining it s not e an d coi n circulatio n (liabilities) . I t remits t o th e governmen t al l profit s beyon d wha t i t need s t o cove r its expense s an d t o maintai n it s reserve s a t th e leve l se t b y law . The currenc y boar d ha s n o discretio n i n monetar y policy ; marke t forces alon e determin e th e mone y supply , wher e th e mone y suppl y is define d a s th e public' s holding s o f note s an d coin s plu s deposit s held wit h th e commercia l bankin g system . The mai n characteristic s o f a currenc y boar d ar e a s follows :

Convertibility. Th e currenc y boar d maintain s unlimite d convert ibility a t a fixed rat e o f exchang e betwee n it s note s an d coins , o n the on e hand , an d th e reserv e currenc y (o r commodity) , o n th e other hand . Althoug h th e currenc y boar d doe s no t conver t loca l deposits denominate d i n it s currenc y int o reserv e assets , th e ex change rat e tha t i t set s wil l determin e th e term s o f arbitrag e between th e reserv e currenc y an d domestic-currenc y deposit s a t commercial banks .

Reserves. A currency boar d hold s reserve s adequat e t o ensur e tha t even i f al l holder s o f th e board' s note s an d coin s (liabilities ) wis h to conver t the m int o th e reserv e asset , th e boar d ca n d o so . Cur rency board s hav e usuall y hel d reserve s o f 10 5 o r 11 0 percen t o f

316 Stev e H. Hanke and Kur t Schule r their liabilities , so that the y would hav e a margin o f protection i n case the interest-earning securitie s tha t the y held lost value. Seigniorage. Unlik e securitie s o r mos t ban k deposits , note s an d coins d o not pa y interest . Hence notes an d coin s ar e lik e an inter est-free loa n fro m th e peopl e wh o hol d the m t o th e issuer . Th e issuer's profi t equal s th e interes t earne d o n reserve s minu s th e expense o f puttin g th e note s an d coin s int o circulation . Thes e expenses ar e usuall y les s tha n 1 percent o f assets a year . I n addi tion, i f th e note s an d coin s ar e destroye d th e issuer' s ne t wort h increases, becaus e liabilitie s ar e reduce d bu t asset s ar e not . Seigniorage generated b y a currency board i s significant . The chie f economi c differenc e betwee n usin g currenc y issue d by a currenc y boar d rathe r tha n note s an d coin s issue d b y a foreign ban k (fo r instance , th e U.S . Federa l Reserve ) i s tha t a currency boar d capture s seigniorag e fo r domesti c use, rather tha n letting it accrue to the foreign bank . A currency board als o has th e political advantag e of satisfying nationalisti c sentiment fo r a local issue of currency . Monetary policy. B y design, a currency boar d ha s no discretionar y powers. It s operation s ar e completel y automatic , consistin g onl y in exchangin g it s note s an d coin s fo r th e foreig n reserv e currenc y at a fixed rate. Unlike a central bank , a currency boar d canno t ac t as a tool of inflationary governmen t finance, no r can i t offer state owned enterprise s credi t a t below-marke t interes t rate s t o ac commodate a "sof t budge t constraint " becaus e a currenc y boar d cannot issu e fiduciary money . Unde r a currenc y boar d system , government expenditure s ca n onl y b e financed b y taxin g o r bor rowing. Interest rates and inflation. Give n th e fixed exchange rat e betwee n the loca l currenc y an d th e reserv e currency , interes t rate s an d inflation rate s fo r tradabl e good s i n th e currenc y boar d countr y will ten d t o b e roughl y th e sam e a s thos e i n th e reserve-currenc y country.

Financial Refor m an d Economi c Development 31 7 Record of th e Currency Boar d Syste m The currenc y boar d syste m i s a well-trie d syste m wit h a n excel lent recor d (Schule r 1992b , Hank e an d Schule r forthcoming) . I t has existed i n about sevent y countries . Most were British colonie s or forme r colonies , bu t currenc y board s hav e als o existe d else where, including tw o places in Eastern Europe . North Russia , the region around Archange l and Murmansk, ha d a currenc y boar d i n 191 8 an d 1919 , durin g th e lif e o f a n anti Bolshevik governmen t i n th e region . Th e Nort h Russia n boar d was the idea of John Maynard Keyne s (Hanke and Schule r 1991a) . It issue d a ver y successful , stabl e rubl e currenc y redeemabl e a t a fixed rat e o f 4 0 ruble s pe r £ 1 sterling . It s currenc y circulate d parallel t o th e inconvertible , unstabl e currencie s issue d b y othe r Russian government s a t th e time . Th e board' s sterling-backe d ruble drov e th e other s ou t o f circulation becaus e i t wa s preferre d by inhabitants o f the region . Another Eas t Europea n currenc y boar d existe d i n th e fre e cit y of Danzi g (no w th e Polis h cit y o f Gdansk ) i n 192 3 and 1924 . The currency boar d wa s establishe d t o replac e th e Germa n mark , which was in the final throe s of hyperinflation, wit h a stable loca l currency, th e gulden . Th e Danzi g currenc y boar d wa s a privatel y owned cooperativ e enterpris e o f banks in the city. It maintained a fixed exchang e rat e o f 2 5 gulde n pe r £ 1 sterling . Gulde n note s were backe d 10 0 percen t b y a sterlin g deposi t a t th e Ban k o f England. Althoug h th e currenc y boar d worke d well , Danzi g re placed i t with a central ban k becaus e economic theor y of the tim e claimed (incorrectly , i n ou r view ) tha t a centra l ban k wa s mor e appropriate fo r a n independen t territor y (Schule r 1992b , chap ter 6). Economic growt h wa s satisfactor y unde r currenc y boar d sys tems. Foreig n investmen t poure d int o territorie s wit h currenc y boards becaus e ther e wa s n o exchange ris k with th e reserv e asse t (usually th e currenc y o f th e larges t tradin g partner ) an d becaus e property right s were secure. Foreign investmen t financed th e rub ber plantation s an d ti n mine s o f Malaya , th e coco a an d peanu t plantations o f West Africa, an d th e ports of Hong Kong and Singa pore. Because mos t currenc y boar d system s fixed their currencie s

318 Stev e H. Hanke and Kur t Schule r to stabl e foreig n currencies , inflatio n wa s low . As under th e gol d standard o r th e gol d exchang e standard , th e suppl y o f reserve s was outsid e th e contro l o f the domesti c government . Adjustment s in the balance of payments too k the form o f reserve gains or losse s or changes i n net foreig n capita l investment . In practice, currenc y board system s ra n curren t accoun t deficit s fo r decade s a t a time , while increasin g thei r not e issue s an d ban k deposit s yea r afte r year, becaus e the y wer e abl e t o attrac t sufficien t foreig n capita l investment. Despite th e succes s o f currenc y boards , mos t countrie s tha t once had currenc y board s replace d the m wit h centra l banks . Economic theor y playe d a role : Keynesian s expecte d wonderfu l re sults fro m discretionar y monetar y policy . Bu t th e mai n reason s for change were political. Politicians saw central banking as a way of manipulating th e money suppl y t o their own advantage. Newl y independent nation s attache d grea t symboli c importanc e t o cen tral bank s a s suppose d symbol s o f political maturity . Today , cur rency board s stil l exis t i n Hon g Kong , th e Falklan d Islands , th e Cayman Islands , th e Faro e Islands , Gibraltar , an d (i n modifie d form) Bermuda , Singapore , and Brunei . Options for Establishing a Currency Boar d Currency board s coul d b e establishe d i n severa l way s i n Easter n Europe. Most currency board s have been monopol y issuer s of currency tha t use d a foreign currenc y a s the reserve asse t int o whic h they maintaine d convertibilit y o f thei r currency . Som e currenc y boards, however , hav e bee n competitiv e issuer s o f currency , an d some hav e use d gol d o r a baske t o f foreig n currencie s a s th e reserve asset. Hence the currency board system is compatible wit h proposals fo r a gol d standard , wit h o r withou t monopol y issue , and wit h proposals t o allow free banking . Since w e have elsewher e discusse d i n detai l th e step s i n estab lishing a currenc y boar d (Hank e an d Schule r 1991b ; Hanke , Jo nung, an d Schule r 1992) , we shal l merel y summariz e the m here . The tw o bi g decision s i n establishin g a currenc y boar d ar e whether th e boar d wil l b e a monopol y issue r o r a paralle l issuer , and wha t reserv e asset i t will use.

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The currenc y boar d ma y replac e th e centra l bank , o r i t ma y issue currenc y i n competitio n wit h th e centra l bank . Establishin g the currenc y boar d a s th e issue r o f a paralle l currenc y alongsid e the centra l ban k ma y b e desirabl e fo r politica l reasons . En trenched politica l force s tha t favo r centra l bankin g may prevent a nation fro m abolishin g th e centra l ban k outright . I n a parallel currency system , th e centra l ban k ca n continu e t o functio n wit h its existin g staf f an d it s existin g assets ; nothin g nee d b e take n away fro m i t t o giv e t o th e currenc y board . Th e tw o currencie s will no t hav e a fixed exchang e rat e unles s th e centra l ban k als o decides t o pe g it s currenc y t o th e sam e reserv e currenc y tha t th e currency boar d uses . The currency board' s note s and coin s shoul d be give n equivalen t lega l tende r statu s t o thos e o f th e centra l bank. A parallel currenc y wil l giv e th e centra l ban k th e choic e of ceasing t o depreciat e it s currenc y o r witherin g awa y a s peopl e switch t o using th e currenc y board' s currency . If the central ban k continues it s ol d ways , it s currenc y wil l eventuall y b e drive n ou t of circulation. Suc h was the case with th e North Russia n currenc y board, whos e currenc y drov e currencie s o f competin g issuers , such a s those issue d b y th e Bolsheviks an d anti-Bolshevi k govern ments, out of use in North Russia . A currenc y boar d nee d no t b e th e onl y issue r o f a paralle l currency. Banks coul d als o be permitted t o issue note s an d coins , whether convertibl e int o th e sam e reserv e asse t a s th e currenc y board, convertibl e int o a differen t reserv e asset , o r fiat money . Their note s an d coin s woul d compet e wit h thos e o f th e currenc y board an d th e centra l bank , i f i t stil l existed . Thi s woul d b e a system o f fre e bankin g (advocate d withou t a currenc y boar d b y Annelise Anderson 1991) . Currency board s hav e issue d note s competitivel y alongsid e banks i n th e past , i n th e Philippine s unti l 194 9 an d i n man y British Caribbea n colonie s fro m th e 1930 s t o th e 1950s . We hav e no quarrel wit h free banking—indeed, w e would welcome it—bu t it i s importan t t o understan d th e factor s tha t hav e historicall y led t o stabilit y o r instabilit y fo r fre e bankin g systems . Th e mos t important requisit e o f stabl e fre e bankin g ha s bee n strong , com petitive banks. Decades of socialism have left Easter n Europ e wit h no real banker s an d hav e bankrupte d existin g larg e banks . If fre e

320 Stev e H. Hanke and Kur t Schule r banking wer e permitte d toda y i n Easter n Europe , i t woul d ini tially b e characterize d b y feebl e competitio n amon g poorl y capi talized loca l banks , manage d b y person s wit h n o experienc e i n banking i n a market econom y an d operating i n an environment i n which few people trus t loca l institutions . At leas t fo r severa l years , then , i t i s vital tha t on e unquestion ably reliabl e domesti c currenc y shoul d exist . A currency boar d can provide such a currency. That will speed the development o f a mature financial syste m i n whic h soun d competitor s t o th e cur rency board ca n arise and perhaps eventually displac e it. Whether the currenc y boar d woul d continu e t o exis t afte r a matur e fre e banking syste m develope d woul d depen d o n whethe r consumer s wanted t o continue holdin g it s notes an d coins . If not, th e board' s note and coi n circulation woul d declin e toward zer o as competin g issuers gaine d circulation . Becaus e th e boar d woul d hav e 10 0 percent foreig n assets , i t woul d easil y b e abl e t o mee t competin g issuers' demand s t o redeem it s note s an d coins . The board woul d fade away after havin g served as a bridge between central bankin g and free banking . Now tha t w e have considere d th e rol e of the currenc y boar d a s a monopol y issue r an d a paralle l issuer , le t u s conside r th e othe r big decisio n involve d i n establishing a currency board : th e choic e of a reserve asset . The most logica l choice s for currenc y board s i n Eastern Europ e ar e th e Germa n mar k an d th e U.S . dollar . Th e mark i s the d e facto reserv e currency o f Western Europe , which i s Eastern Europe' s larges t tradin g partner . Usin g th e mar k a s th e reserve asset would therefore eliminat e currency risk in trade wit h Western Europe . Th e dolla r i s th e mos t widel y use d unofficia l currency i n part s o f Easter n Europ e an d i n th e forme r Sovie t Union. The European Currenc y Uni t (ecu) is another possibility. It recommends itsel f a s the possible future unifie d currenc y o f Western Europe. At the moment, though, doubts remain abou t whethe r it wil l actuall y mak e th e transitio n fro m a currenc y cocktai l t o a currency i n everyday use. Gold i s anothe r possibl e reserv e asset . Som e economist s argu e that t o obtain credibility , th e Russia n rubl e shoul d b e convertibl e into gold o r som e other commodit y (Angel l 1989 ; Wanniski 1990) . A currency boar d whos e reserve asset was gold could len d gol d o n

Financial Refor m an d Economic Development 32 1 the Londo n gol d loa n market . At present, interes t o n gold loan s i s 3 t o 4 percen t a year . (Rate s ar e quote d dail y i n th e Financial Times,) Th e mai n disadvantag e o f gol d i s tha t i t i s no t th e mone tary standar d o f any o f Eastern Europe' s tradin g partners . Estab lishing gol d a s th e reserv e currenc y woul d no t eliminat e ex change-rate ris k wit h an y foreig n nation , unlik e usin g th e dolla r or mark . The price of gold i n term s o f major worl d currencie s ha s at time s bee n extremel y volatil e sinc e th e en d o f th e Bretto n Woods system , althoug h th e volatilit y migh t b e dampene d i f on e or mor e nation s returne d t o the gold standard . Another disadvan tage of gold or other commodities i s that nomina l rate s of interes t from gol d loan s o r commodit y backin g ar e lowe r tha n th e rate s presently availabl e o n securitie s i n th e leadin g har d currencies . This reflect s no t onl y a slightl y lowe r inflatio n rat e tha n mos t currencies, but higher transaction s costs . Whatever sor t o f arrangemen t i s adopte d fo r establishin g th e currency board , an d whateve r reserv e asse t th e boar d uses , ther e should b e n o restriction s o n th e us e o f foreig n currencies . Peopl e should b e fre e t o ope n ban k deposit s an d mak e contract s i n an y foreign currency , or in gold and othe r commodities . The ability t o switch int o othe r currencie s wil l reduc e th e dependenc e o f th e currency boar d syste m o n th e reserv e currency . I f th e reserv e currency becomes highly inflationary (a s sterling did in the 1970s) , people wil l b e abl e t o us e mor e satisfactor y currencie s instead . Another safeguar d agains t th e deterioratio n o f th e reserv e cur rency woul d b e fo r th e currenc y boar d constitutio n t o includ e a provision permittin g a switc h t o a les s inflationar y reserv e cur rency shoul d inflatio n i n th e original reserv e currency excee d pre determined limit s (see Hanke and Schule r 1991b , Appendix). Advantages of th e Currency Boar d Syste m fo r the Economi c Development o f Easter n Europ e The currenc y boar d syste m ha s a numbe r o f advantage s fo r Eas t European nations . The foremost i s that i t depoliticize s th e mone y supply b y requirin g 10 0 percent foreig n reserve s agains t govern ment not e an d coi n issue . The fixed, binding reserv e requiremen t leaves th e suppl y o f note s an d coin s t o b e determine d b y marke t

322 Stev e H. Hanke and Kur t Schule r forces alone . Th e suppl y ca n expan d onl y i f peopl e com e t o th e currency boar d wit h additiona l supplie s o f th e reserv e asse t fo r conversion into notes and coins. The supply contracts when peopl e decide tha t the y woul d lik e t o hol d fewe r currenc y boar d note s and coins . (A s w e explaine d above , thi s doe s no t mea n tha t th e supply o f note s an d coin s i s rigidl y linke d t o th e curren t accoun t balance.) The currency board i s passive: it responds to the public' s demand, bu t doe s no t initiat e change s i n th e suppl y o f notes an d coins of its own volition . Most currenc y boar d system s hav e no t require d bank s t o hol d any particula r rati o o f reserve s agains t deposits ; instead , the y have lef t bank s t o decid e wha t reserv e rati o wa s appropriate . I f the governmen t impose s n o reserve requirements , or a t leas t doe s not var y reserv e requirement s i n a n attemp t t o influenc e ban k credit, th e deposi t componen t o f th e mone y suppl y i s als o deter mined by market force s alone . Depoliticizing th e suppl y o f mone y make s har d budge t con straints effectiv e o n th e government , o n stat e enterprises , an d on privat e persons . A currenc y boar d generate s a n amoun t o f seigniorage compatibl e wit h lo w inflation , bu t i t canno t b e use d as a too l o f inflationar y finance. Th e governmen t mus t rais e money b y explici t taxatio n o r b y borrowing ; i t canno t us e infla tion a s a hidde n tax . Tha t put s pressur e o n th e governmen t t o reform it s finances b y reducin g th e mos t unproductiv e activitie s in th e economy : th e military , loss-makin g stat e enterprises , cer tain pric e subsidie s fo r consumers . Becaus e i t enforce s a har d budget constraint , th e currency boar d syste m should , in our opin ion, be established earl y i n the sequence of economic reform mea sures. Har d budge t constraint s ar e no t a preconditio n fo r th e currency boar d system ; rather , the y ca n b e th e resul t o f th e cur rency board system . Another advantag e o f th e currenc y boar d syste m i s tha t i t i s transparent. Th e peopl e o f Easter n Europ e hav e bee n fe d lie s systematically fo r year s unde r socialism—lie s abou t th e compe tence of political institutions , about th e economy, about thei r ow n well-being. The last thin g the y want no w is more muddying o f th e waters. A central ban k i s a guarantee o f a monetary polic y lackin g transparency. T o achiev e it s desire d effects , a centra l ban k mus t

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surprise marke t participants , whic h frequentl y mean s hidin g it s intentions. Becaus e i t i s s o transparent , a currenc y boar d i s fa r more easily held accountabl e t o its goals than a central bank , an d accountability i n economic policy making is a very desirable thin g to encourage i n Eastern Europ e now . The currenc y boar d syste m i s eas y t o maintai n becaus e i t i s simple t o operate . Few Eas t Europea n countries , an d non e o f th e former Sovie t republics , have sufficient traine d personne l t o run a central ban k adequately . Th e currenc y boar d syste m require s n o fine judgments an d year s o f experience; it s mai n wor k i s a count ing-house routine tha t ca n be easily taught an d supervised . To ensur e tha t th e advantage s brough t b y th e currenc y boar d system remain , a currenc y boar d constitutio n coul d combin e fea tures use d b y past currenc y boards . A properly designe d constitu tion will forestall attempt s a t governmen t manipulation . The constitution coul d specify , fo r instance , tha t a majorit y o f th e currency board' s director s b e foreign nationals , chosen b y privat e institutions i n thei r hom e countries . Importan t decision s coul d require a supermajority . Th e currenc y boar d coul d b e incorpo rated in a safe-haven countr y such as Switzerland, with ownershi p of the board's asset s remaining wit h th e board itself , not wit h th e government. We have discusse d thes e measures elsewher e (Hank e and Schule r 1991b) . We hav e spoke n o f th e advantage s o f establishin g currenc y boards. Wha t i s th e monetar y cost ? Surprisingly , i t i s modest . The rea l suppl y o f domestic currenc y i s small i n Easter n Europe , especially i n th e forme r Sovie t Union . Years of high inflatio n an d currency restriction s hav e induce d peopl e t o hold rea l asset s an d hard foreig n currenc y i n preferenc e t o domesti c financial asset s and domesti c currency . A t presen t marke t rate s o f exchang e th e reserves necessary fo r currenc y board s would range from $7 0 million i n Albani a t o n o mor e tha n $ 6 billion i n Russia . Th e experi ence o f currency boar d system s show s tha t afte r currenc y stabili zation wit h a currenc y board , th e inflow s o f foreig n capita l necessary t o expan d th e suppl y o f currenc y wil l b e readil y forth coming, provided tha t right s to private property ar e secure . The currenc y boar d syste m i s a well-prove n on e tha t i s mor e compatible tha n centra l bankin g wit h th e transitio n fro m social -

324 Stev

e H . Hanke an d Kur t Schule r

ism t o a marke t economy . Th e questio n remains , wil l a currenc y board solutio n se e the ligh t o f day ? Unti l recently , i t receive d littl e more tha n dismissiv e comment s i n officia l circles . Bu t tha t ha s changed i n recen t months . I n earl y Ma y 1992 , Thoma s Dawson , the U.S . Executiv e Directo r o f th e IMF , tol d th e Senat e Foreig n Relations Committe e tha t th e IM F wa s seriousl y considerin g th e currency boar d syste m fo r Russi a (Hit t 1992) . In July , Senato r Phi l G r a m m successfull y introduce d a n a m e n d m e n t t o th e Russia n ai d bill (calle d th e Freedo m Suppor t Act ) t o encourag e currenc y boards. Th e a m e n d m e n t allow s America n fund s supplie d t o th e IMF's rubl e stabilizatio n fun d t o b e use d t o establis h a currenc y board (o r boards ) i n an y o f th e forme r Sovie t republic s (Hank e and G r a m m 1992) . In Russia , a grou p fro m th e Tyume n region , i n the easter n Ura l mountains , ha s establishe d th e framewor k fo r a regional currenc y board. 5 Th e grou p ha s printe d "Ura l franc' ' notes an d ha s bee n incorporate d i n Liechtenstein . Th e currenc y board coul d b e u p an d runnin g withi n week s o f receivin g permis sion fro m Moscow . Afte r all , i t too k Keyne s jus t eleve n week s t o establish th e currenc y boar d o f Nort h Russia . Notes 1. Fo r th e sak e o f convenienc e w e us e "Easter n Europe " i n a n extende d sense, to include all of the former Sovie t Union . 2. Stev e Hanke observed th e recent Yugosla v experience firsthan d a s th e personal economi c adviso r t o Mr . Zivko Pregl, deputy prim e ministe r of Yugoslavia (1990 to June 1991) . 3. Fo r informatio n abou t th e scandal s afflictin g th e Nationa l Ban k o f Yugoslavia, see Sudetic (1991) and World Bank (1989). 4. Othe r economist s wh o hav e recentl y voice d suppor t fo r currenc y boards i n th e forme r Sovie t Unio n an d Easter n Europ e includ e Milton Friedma n (1991) , Daniel Gresse l (1989) , Rober t Hetze l (1990) , Jerry Jorda n (1991) , Alla n H . Meltze r (1991) , an d Si r Ala n Walter s (1991). 5. Stev e Hanke has advised th e group. References Allison, Graham , an d Grigor y Yavlinsky . 1991 . Window of Opportunity. New York: Pantheon Books .

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Contributors

George B . N . Ayitte y i s Associat e Professo r o f Economic s a t th e American University , Washington , D.C . Dr. Ayitte y i s th e autho r of Indigenous African Institutions (Transnationa l Publishers , 1991 ) and Africa Betrayed (St. Martin's, 1991) . Peter J. Boettke i s Assistant Professo r o f Economics a t Ne w Yor k University. Dr . Boettk e i s th e autho r o f The Political Economy of Soviet Socialism: The Formative Years, 1918-1928 (Kluwer , 1990 ) and Why Perestroika Failed: The Politics and Economics of Socialist Transformation (Routledge , 1993) . Wayne T . Broug h i s Directo r o f Researc h a t th e Citizen s fo r a Sound Econom y Foundatio n i n Washington , D.C . He received hi s Ph.D. in economics from Georg e Mason University , specializing i n industrial organizatio n an d publi c choice . Dr . Broug h ha s pre viously worke d a t th e Offic e o f Managemen t an d Budget , th e Agency for International Development , an d in the research branc h of an investment bank , where he covered U.S . domestic policies . Young Back Choi is Assistant Professo r o f Economics and Financ e at St . John' s University . Dr . Cho i i s th e autho r o f Paradigms and Conventions: Uncertainty, Decision Making, and Entrepreneurship (University of Michigan, 1993) . 327

328 Contributor s Steve H . Hank e i s Professo r o f Applie d Economic s a t Joh n Hop kins University . Dr . Hanke als o serves as Chairman o f the MERI T Group, Inc. , i n Baltimore , a s underwritin g manage r fo r specia l risk programs , an d a s a Lloyd' s o f London Correspondent , an d a s Vice Presiden t o f FCM I Financia l Corporatio n i n Toronto , cur rency trader s an d internationa l mone y managers . Steven Horwit z i s Assistant Professo r o f Economics an d th e Flor a Irene Egglesto n Facult y Chai r a t St . Lawrenc e University . Dr . Horwitz specialize s i n monetar y economics , comparativ e eco nomic system s an d th e histor y o f economi c thought . H e i s th e author o f Monetary Evolution, Free Banking, and Economic Order (Westview, 1992) , a s wel l a s numerou s article s i n professiona l journals. Shyam J . Kamat h i s Professo r o f Economic s a t Californi a Stat e University a t Ha y ward. Dr . Kamat h i s th e autho r o f The Political Economy of Suppressed Markets (Oxford , 1992 ) a s wel l a s numer ous article s i n professiona l journal s suc h a s Public Choice an d Economic Development and Cultural Change. Shigeto Nak a i s Assistan t Professo r o f Internationa l Studie s a t Hiroshima Cit y University , Japan . Dr . Naka receive d hi s Ph.D . in economics fro m Georg e Maso n Universit y an d specialize s i n pub lic choice , industria l organization , an d th e politica l econom y o f Japanese development . David Osterfel d i s Professo r o f Politica l Scienc e a t St . Joseph' s College. Dr. Osterfeld's mos t recen t work is Prosperity Versus Planning (Oxford, 1992) . Manisha H . Perer a i s receive d he r Ph.D . i n economic s fro m Au burn University . Dr . Perera previousl y taugh t a t th e Universit y of Northern Colorad o an d i s no w a privat e economi c consultan t i n San Jose, California . Jan S . Prybyl a i s Professo r o f Economic s a t Pennsylvani a Stat e University and author of, amon g other books, Reform in China and

Contributors 32 9 Other Socialist Economies. H e was Visiting Professor o f Economic s at Nankai Universit y Tainjin i n 1987-88 . Ralph Raic o i s Professo r o f Histor y a t Stat e Universit y o f Ne w York Colleg e a t Buffal o an d autho r o f numerou s article s o n th e history of European liberalism . Kurt Schule r i s Postdoctora l Fello w a t John s Hopkin s Universit y in Baltimore . Dr . Schule r receive d hi s Ph.D . from Georg e Maso n University an d i s th e autho r o f numerou s article s i n monetar y economics. He is the coauthor (with S . H. Hanke and Lar s Jonung ) of Russian Currency and Finance (Routledge , 1993) . Parth J. Shah is Assistant Professo r o f Economics a t Universit y of Michigan a t Dearborn . Dr . Sha h receive d hi s Ph.D . from Aubur n University an d specializes in monetary economics . Kiyokazu Tanaka has been Professo r o f Economics at Sophi a Uni versity, Japan, since 1983 . Dr. Tanaka specializes in public choice. Mark Thornto n i s th e O . P . Alford II I Assistan t Professo r o f Austrian Economic s a t Aubur n Universit y an d th e Directo r o f Aca demic Program s a t Aubur n Universit y fo r th e Ludwi g vo n Mise s Institute. Dr . Thornton i s the autho r o f The Economics of Prohibition (Utah , 1991) , as well as numerous professional articles .

Index

Agarwala, Ramgopal , 24 6 agency problem , 27 1 Ajibola, Bola , 16 7 Ake, Claude, 15 8 Alexander Committee , 11 0 American Occupatio n (o f Japan), 256 , 263, 266 , 276; reverse cours e of , 266 , 270,271,272 Arndt, H . W., 5 Austrian Schoo l o f Economics , 8 , 9 , 10 , 15, 1 7 , 2 2 2 , 2 9 0 , 2 9 1 , 3 0 4 , 3 1 0 authoritarian politica l rule , 25 0 Ayres, Robert, 19 5 Baechler, Jean , 3 9 balance o f payments , 20 6 banking system , 17 , 10 4 Barro, Robert , 24 2 Bauer, P . T., 37, 38 , 43, 46, 52 , 53, 178 , 223 Becker, Gary , 263 , 27 6 Berman, Harold , 4 4 Bhagwati, J. , 102 , 10 9 Bohm-Bawerk, E. , 2 3 Bolshevik Revolution , 2 , 3, 93, 9 4 Buchanan, James , 13 1 Buddhism, 23 4 Butos, William, 31 2 calculation, economi c proble m of , 29 0 capital, 9 , 17 , 101 , 103 , 200, 26 0

Carlyle,A.J.,45 central banking , 311-1 4 Chang, Prim e Ministe r (Korea) , 24 3 Christianity, 23 4 Chun, Presiden t (Korea) , 24 9 Clark, J . B., 2 3 Colebrooke-Cameron Repor t (Sr i Lanka), 29 3 colonial rul e (Japanes e ove r Korea) , 234-35 common law , 1 9 Companies Act , 10 6 Conable, Barber , 19 8 Confucian legac y (i n Korea) , 23 4 Conquest, Robert , 7 contract law , 1 6 Cooperative Wholesal e Establishmen t (of Sr i Lanka) , 29 8 corporatist economi c system , 215-1 6 Cowen, Tyler , 218 , 22 3 credibility (o f central banks) , 313-1 4 currency boar d system, 314-1 5 current accoun t deficit , 20 5 Davidson, Basil , 17 0 depoliticizing policy , 321-2 2 deregulation, 29 0 Desai, P. , 10 2 devaluation policy , 20 2 development, 9 , 25, 31, 90 direct foreig n investment , 7 9

331

332 Inde x discovery, a s economi c procedure , 125 , 290 division o f labor , 1 , 2 0 Dodge, Joseph, 266 , 271, 27 3 Domar, Evsey , 5 Dutch experiment , 4 8 Eberstadt, Nicholas , 217 , 219 , 22 4 Economic Cooperatio n Administration , 217 Economic Stabilizatio n Board , 26 6 education, 24 2 Eisenhower, Dwight , 23 6 enabling environmen t (fo r develop ment), 206 , 20 7 encompassing interest , 232 , 242, 243, 247,268 entrepreneurship, 28 , 63, 82, 124 , 128 , 130,131,290 equilibrium theor y (i n economics), 2 Essential Commoditie s Act , 10 4 European "miracle, " 3 8 European Recover y Program , 21 0 Export Credi t Guarante e Corporation , 113 external accoun t debt , 20 4 externalities, 131 , 14 8

General Agreemen t o n Tariff s an d Trade, 18 6 Gerschenkron, Alexander , 240 , 24 2 gold (a s monetar y standard) , 32 0 government failur e theory , 12 4 Great Depression , 4 , 9 7 growth theory : Harrod-Doma r mode l of, 5 , 24; neoclassical, 5 , 9 Hancock, Graham , 18 7 hard budge t constraint , 32 2 Hayek, F . A., 2, 16 , 124 , 212, 222, 29 0 Hicks, John, 3 9 Hogan, Michael , 214 , 22 0 Houphouet-Boigny, Felix , 151 , 16 4 Hughey, Ann , 19 1

Fair Price Shops , 10 5 Faith, Roger , 13 1 Farley, Hugh , 24 3 federalism, 21 5 feudalism, 29 2 financial intermediation , 17 , 24, 25, 27 , 31; a s creative endeavor , 26 , 3 0 financial markets , 8 2 fixed exchang e rat e system , 316 , 31 9 Ford Foundation , 21 6 foreign aid , 9 , 149 , 159 , 200, 23 6 foreign capital , 32 3 Foreign Exchang e Regulatio n Act , 11 1 foreign investment , 31 7 formalism i n economics, 2 - 4 Forson, Kwame , 16 4 free trade , 29 0

ideology, 3 , 21 1 import licensing , 107- 8 indigenous institutions , 169 , 170 , 17 7 Industrial Credi t an d Investmen t Cor poration o f India, 10 4 Industrial Developmen t an d Regula tion Act, 10 5 Industrial Developmen t Ban k o f India , 104 Industrial Financ e Corporatio n o f India, 10 3 industrial policy , 232 , 239, 240, 251, 252 informal sector , 29 2 institutions (a s key determinan t i n de velopment), 1 , 9, 10 , 19 , 38, 40, 42, 49, 62 , 65, 75, 92, 119 , 221, 222, 257 , 262,277,291,292 International Ban k fo r Reconstructio n and Development , 18 7 International Developmen t Associa tion, 18 7 International Monetar y Fund , 185 , 311, 314 international trade , 18 6 investment (private) , 19 6 Irwin, Michael, 19 8

Galbraith, Joh n Kenneth , 31 0 Gandhi, Rajiv , 118 , 12 3

Johnson, Lyndon , 19 2 Jones, E . L., 5 3

Index 33 3 Kaunda, Kenneth , 15 2 Keidanren, 27 5 keiretsu structure , 260 , 267, 268 , 273 , 275,277 Kendall, Leon , 17 8 Keynes, John Maynard , an d Keynesian ism,2,4, 5 , 8,24,217,223,32 4 Khanin, Grigory , 7 Killick, Tony , 147 , 154 , 16 0 Klaus, Vaclav, 31 4 kleptocrats, 16 5 Knight, Frank , 2 , 2 3 knowledge (proble m of) , 9 , 16 , 124 , 125, 126 , 128 , 130 , 212, 222, 29 0 Kodan, 266 , 26 7 Kolko, Gabriel, 21 5 Krauss, Melvyn, 19 2 Krishna, Raj , 11 4 Krueger, Ann , 11 0 Lai, Deepak , 27 , 12 4 land refor m (Japan) , 26 5 Landes, David , 40, 41 Lange, Oskar , 2 Laski, Harold , 9 4 Lavoie, Don , 22 0 Law fo r the Eliminatio n o f Excessiv e Concentration o f Economi c Powers , 265 Lee Dynasty , 23 4 Lenin, Vladimir, 3 , 6 5 liberalism, 1 , 5 0 , 2 0 6 , 2 2 2 linkages (i n development), 14 8 Louw, Francis , 17 8 Mabogunje, A. , 15 4 MacArthur, Dougla s (General) , 25 8 Mao, Chairman, 66 , 68, 6 9 market failur e theory , 14 8 Marshall Plan , 210, 21 4 Marx, Karl , 51,94 , 31 1 McKinnon, Ronald , 2 4 McNamara, Robert , 19 1 Menger, Carl , 2 3 military aid , 23 6 Milward, Alan , 22 0 minimum wag e laws , 10 5

Ministry o f Internationa l Trad e an d In dustry, 26 8 Mises, Ludwi g von , 212, 28 9 monetary system , 1 , 9, 20, 22, 22 2 Monopolies an d Restrictiv e Trad e Prac tices Act , 10 7 moral hazar d problem , 272 , 27 3 Mugabe, Robert , 16 9 Multilateral Investmen t Guarante e Agency, 18 7 Nardo, Japhet h M . M., 15 4 National Industrie s Developmen t Cor poration o f India, 10 3 national resources , 23 4 National Textil e Corporatio n (Sr i Lanka), 30 0 nationalization o f industry , 266 , 29 4 Nehru, Jawaharlal , 93 , 94, 95, 125 ; socialist visio n of , 9 6 Neo-Institutionalist Schoo l o f Econom ics, 9 - 1 0 neo-Stalinist mode l o f planning, 6 8 New Dea l policie s (U.S.) , 21 5 New Economi c Polic y (Sovie t Russia) , 3 N'Gouabi, Marien , 15 2 Nixon, Richard , 19 2 Nkala, Enos , 16 9 Nkrumah, Kwame , 150 , 153 , 17 1 Nove, Alec , 4 Nyerere, Julius , 150 , 152 , 15 4 Office o f th e Chie f Controlle r o f Import s and Export s (India) , 11 2 Olson, Mancur, 232 , 243; theory o f en compassing interest , 232 , 242, 243, 247, 26 8 Park, Presiden t (Korea) , 237, 238 , 239 , 240,243, 244 , 249, 25 0 Parliament (Japanes e Diet) , 266, 270 , 272 Pirenne, Henri , 4 3 Pisani, Sallie , 21 6 planning, 16 , 90, 98, 124 , 211, 213; central, 265 ; comprehensive, 213 , 310;

334 Inde x planning (continued) discretionary, 2 ; noncomprehensive , 217 political environment , economi c im pact of , 6 6 positivist revolutio n i n scienc e (impac t on economi c science) , 2 , 3 private enforcemen t mechanisms , 27 3 privatization, 75 , 290, 29 7 Progressive Er a (U.S.) , 21 5 property rights , 1 , 16 , 19 , 41, 52, 66, 75, 77,127,130,222,291,292 public choic e theory , 124 , 257, 261 , 26 2 public enterprises , 30 4 public ownership , 9 0 Ramadou, Amina , 15 9 rent-seeking, 249 , 257, 262, 268, 269 , 270, 27 5 Reserve Ban k o f India, 11 1 Rhee, Syngman , 237 , 24 3 Robinson, Joan , 29 4 Rosenberg, Nathan , 5 1 Rostow, W . W., 5 2 ruling elites , 25 1 Samuelson, Paul , 31 0 Schoeck, Helmut , 4 6 Schumpeter, Joseph , 2, 2 9 - 3 0 Sekyi, Kobina , 17 8 Selgin, George , 28 , 31 2 Selyunin, Vasily, 7 Senghor, Leopold , 15 2 Shenoy, B . R. , 12 4 Smith, Adam , 1 , 3, 9, 19 , 63, 65, 290 , 293 socialism, 8 , 64 , 93, 94, 151 ; Fabian model of , 93 , 9 4 soft budge t constraint , 31 6 Soviet socialism , 63 , 94, 9 7

Special Economi c Zone s (China) , 7 0 special interes t groups , 247 , 30 5 Sri Lank a Telecommunication s Depart ment, 30 2 Srinivasan, T . N., 10 9 Stalinist mode l o f planning, 4 , 8 , 7 3 State Rubbe r Manufacturin g Corpora tion (Sr i Lanka) , 29 7 state-owned enterprises , 19 7 tariff system , 12 0 tax rates , 129 , 17 7 Third World , 4 , 195 , 197 , 199 , 200, 201, 289; deb t crisi s of , 20 2 time-horizon, 27 6 Toure, Sekou , 15 3 transaction costs , 27 3 transparency (o f law) , 32 2 unions (labor) , 106 , 27 3 United Trus t o f India , 10 4 Viner, Jacob, 4 5 vision: a s influenc e o n public policy , 9 1 - 9 2 , unconstrained , 9 6 - 9 7 , 1 2 5 Volcker, Paul , 31 3 Wade, Robert , 23 2 War Communism (Sovie t Russia) , 3 , 65 Waters, Alan, 20 1 Webb, Sidne y an d Beatrice , 9 4 Weinstein, Joel , 21 5 Wexler, Immanuel, 21 6 Wiebe, Robert , 21 5 Xiaoping, Deng , 69 , 7 0 Yaw, Amoafo , 16 6 Zaibatsu, 264 , 26 5