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Module 2 in AE 12 (Economic
Development)
Economic Development in Historical Perspective
Module Objectives:
At the end of Module 2, students are expected to answer: a) Discuss and assess Diamond’s evolutionary biological approach to development b) Indicate the broad outlines of world leaders in national GDP per capita during the medieval and modern periods. How do we explain the reasons for changes in world leadership? c) What are the characteristics of modern economic growth? Why was modern economic growth largely confined to the West (Western Europe, the United States, and Canada) before the 20th century? d) How important were non-economic factors in contributing to modern capitalist development in the West?
Module Overview
To analyze the economics of developing countries, we need some basic facts about their growth and development, including an evolutionary biological approach to development, a sketch of economic development in ancient and medieval times (pre15th century), world leaders in GDP capita from about 1500 to the present, the origins of modern economic growth and why it was largely confined to the West before the 20th century, non-Western (Japanese, Korean-Taiwanese, Soviet, and Chinese) growth models, the range of growth in the last 100 to 150 years, a concrete illustration of the power of exponential growth in North America in the last 125 years, the modern periods of fastest growth, the economic growth of Europe and Japan after World War II, the growth of LDCs before and after World War II, and the diverse economic performance among LDCs by country and world region. Finally, the U.N. General Assembly perceives today’s major international problem as the widening income gap between rich and poor countries. Has income indeed widened, and is narrowing the gap an important goal? The last section draws on earlier sections to ask whether income levels between DCs and LDCs are converging or diverging.
An Evolutionary Biological Approach to Development
The physiologist Jared Diamond stresses ecology and evolutionary biology, especially distinctive features of climate, environment, and wild plants and animals in explaining the fates of human societies
and their development. Despite sub-Saharan Africa’s early head start as a cradle of human evolution, Eurasia dominated Africa during the latter half of the second millennium C.E. The sub-Sahara was delayed in food production compared to Eurasia by its paucity of domesticable native animal and plant species, its smaller area suitable for indigenous food production, and its north-south axis, which retarded the spread of food production and innovations. “A wild animal, to be domesticated, must be sufficiently docile, submissive to humans, cheap to feed, and immune to diseases and must grow rapidly and breed well in captivity,” characteristics of Eurasia’s cows, sheep, goats, horses, and pigs, but not African wild animals, even in the period since the 15th century. In Africa and the Americas, as you move along a north-south axis, you traverse zones differing greatly in climate, habitat, rainfall, day length, and crop and livestock disease. Hence crops and animals acquired or domesticated in one part of Africa have difficulty moving to others. In contrast, crops and animals moved easily between Eurasian societies thousands of kilometers apart but at a similar latitude sharing similar climates and day lengths. Eurasia had the fastest migration and diffusion of technological innovations. At the other extreme, pre-modern Native America and Aboriginal Australia suffered from isolation from Eurasia. These distinctive features of ecology and biology facilitated the early civilization of the Fertile Crescent (today’s Syria, Iraq, Jordan, and Turkey), including the development of cities, writing, and empires, during the fourth millennium B.C.E. The Fertile Crescent enjoyed a wealth of domesticated big mammals, a plethora of large-seeded grass species suitable for domestication, a substantial percentage of annuals, a climate (mild, wet winters and long, hot, dry summers) favorable to cereals and pulses, and a wide range of altitudes and topographies supporting biodiversity and staggered harvest seasons, factors deficient in South Africa, Mesoamerica, Australia, and New Guinea. However, the Fertile Crescent, by the second or first century B.C.E no longer possessed further compelling geographic advantages, because of the destruction of much of its resource base and the loss of a head start from domesticable wild plants and animals. Diamond emphasizes differences in plant and animal species available for domestication, continental isolation, continental population sizes, and diffusion and migration rates dependent on continental axes and prospects for sharing innovations across similar climates and latitudes. Modern transport and communication enable the sharing of innovations among a larger community, the Atlantic economic community, including North America and Europe. For example, Mennonites from Ukraine brought turkey red wheat to Kansas in the 1870s, the basis for varieties of hard winter wheat on the U.S. Great Plains during the 20th century. But transmitting agricultural innovation from North America and Europe to Australia and New Zealand, countries of Western origin isolated in the southern hemisphere, is limited. However, researchers can disseminate new crop varieties across semitropical or tropical zones, as the high-yielding varieties of wheat in Mexico that were adapted to Punjab regions of India and Pakistan in the 1960s.
Ancient and Medieval Economic Growth
Agnus Maddison uses a vast array of historical statistics to quantify real GDP per capita and its growth in the last millennium, that is, from 1000 to 1998. Real GDP per capita increased 13-fold, population 22-fold, and world GDP 300-fold during the last millennium, contrasting with the earlier millennium, 0–1000 C.E., when world population grew by only a sixth and GDP per capita made no advances.
Beginnings of Sustained Economic Growth
Historians hesitate to name a threshold period in history when real per-capita growth took off. Although there were periods of growth before the modern period, rapid, sustained growth was rare. Living standards remained at a subsistence level for the majority of the world’s population. The rapid, sustained increase in per capita GNP characteristic of modern economic growth began in the West (Western Europe, the United States, Canada, Australia, and New Zealand) 125 to 250 years ago. Industrialization and sustained economic growth had begun in Great Britain by the last half of the 18th century; in the United States and France in the first half of the 19th century; in Germany, the Netherlands, and Belgium by the middle of that century; and in Scandinavia, Canada, Japan (a non- Western country), Italy, and perhaps Russia, by the last half of the century. China’s average economic welfare was more or less stagnant until the second half of the 20th century. In 1870, knowledgeable economists expected that India would be more economically and financially developed than Japan by 1970. India, a British colony, possessed a unified currency, rudiments of a Western-style banking system, access to the British capital market, and British industrial and financial technology, whereas Japan, just emerging from feudalism, had a negligible modern sector, a chaotic currency, and no modern financial institutions. To be sure, from 1870 to 1913, just before World War I (1914–18), one of the more successful phases of capitalist growth, India’s economy grew, albeit slowly. However, India experienced negative growth from 1914 to 1945, a period of crisis in the world economy consisting of a depression bracketed by two world wars. Japan, by contrast, had virtually the fastest growth in the world during the period 1870 to 1950, notwithstanding its massive defeat during World War II.
The rest of Asia grew modestly during the one and one-half centuries before the mid-20th century. Africa, estimated to be close to the world’s average income in 0 C.E., remained the same or declined in living standards to 1820, but after that experienced modest per-capita growth until the middle of the 20th century. Latin America and Eastern Europe outpaced Asia and Africa from 1820 to
The West and Afro-Asia: The 19th Century and Today
Gross national income per capita for developed countries in the West in the first decade of the 21st century is roughly twelve times that of Afro-Asian low-income countries, if compared using international dollars using purchasing-power parity rates, and about 60 times that of these low-income economies in nominal U.S. dollars. The gap was not so great 130 to 140 years ago, since people could not have survived on one-twelfth the per capita income of the West in the late 19th century. Nobel laureate Simon Kuznets estimates a gap of 5:1 then. Roughly speaking, at that time the West had an average real income higher than that of Africa today. Figure 3-2 shows, using a slightly different comparison, that the international spread in GDP per capita by region, the ratio of the highest region (Western offshoots: the United States, Canada, and Australia) to the lowest region (Africa), was 5:1 in 1870, 9:1 in 1913, and 19:1 in 1998. The Western or DC economic growth has been much more rapid during the past 130–140 years, and of course the DCs are adding to an already more substantial economic base.
Capitalism and Modern Western Economic Development
Why did sustained economic growth begin in the West? A major reason is the rise of capitalism , the economic system dominant there since the breakup of feudalism from the 15th to the 18th centuries. The relations between private owners and workers are fundamental to capitalism. The means of production – land, mines, factories, and other forms of capital – are privately held; and legally free but capital-less workers sell their labor to employers. Under capitalism private individuals operating for profit make production decisions. Capitalist institutions had antecedents in the ancient world, and pockets of capitalism flourished in the late medieval period. For example, a capitalist woolen industry existed in 13th-century Flanders and 14th-century Florence, but it died out because of revolutionary conflict between the workers and capitalists. Thus, the continuous development of the capitalist system dates only from the 16th century. Especially after the 11th century, the growing long-distance trade between capitalist centers contributed to the collapse of the medieval economy. As European trade activity expanded during the next few centuries, certain institutions facilitated the growth of modern capitalism. Among them were private property, deposit banking, formal contracts, craft guilds, merchant associations, joint stock companies (the precursor of the corporation), insurance, international financial markets, naval protection of trade vessels, and government support in opening markets and granting monopoly privileges for inventions.
into large political and economic units – the nation-state. The nation-state was necessary for the larger markets and economies of scale of capitalist expansion. Eventually monarchy ceded power to the bourgeoisie , the capitalist and middle classes. Where an absolute monarch existed, the capitalist class, who enjoyed only a precarious existence under autocratic authority, ultimately stripped the monarch of power and installed representatives more favorable to their economic interests.
- The declining influence of the church coincided with the Enlightenment, a period of great intellectual activity in 17th- and 18th-century Europe that led to the scientific discoveries of electricity, oxygen, calculus, and so on. These discoveries found practical application in agriculture, industry, trade, and transport and resulted in extended markets, increased efficiency of large-scale production, and enhanced profits associated with capital concentration. Furthermore, the rationalism permeating the new science and technology meshed with the spirit of capitalist enterprise.
- The philosophical rationalism and humanism of the Enlightenment, coupled with Protestantism’s spiritual individualism (the “priesthood of all believers”), emphasized freedom from arbitrary authority. In the economic sphere, this liberalism advocated a self-regulating market unrestricted by political intervention or state monopoly. These views were tailor made for the bourgeoisie in its struggle to overthrow the old order
- Intellectual and economic changes led to political revolutions in England, Holland, and France in the 17th and 18th centuries that reduced the power of the church and landed aristocracy. The bourgeoisie took over much of this power. Economic modernization in Europe would probably not have been possible without these revolutions.
- Modern capitalism is distinguished from earlier economic systems by a prodigious rate of capital accumulation. During the early capitalism of the 16th and 17th centuries, the great flow of gold and silver from the Americas to Europe inflated prices and profits and speed up this accumulation. Inflation redistributed income from landlords and wage laborers, whose real earnings declined, to merchants, manufacturers, and commercial farmers, who were more likely to invest in new and productive enterprises. Capitalism, as an engine for rapid economic growth, spread beyond Europe to the outposts of Western civilization – the United States, Canada, Australia, and New Zealand. Indeed, during most of the 20th century, capitalism has been more successful in the United States than in other Western economies. However, modern industrial capitalism was established in the West at great human costs. Physical violence, brutality, and exploitation shaped its early course. In England and Belgium, wages dropped and poverty increased markedly during the accelerated industrial growth of the latter 18th and early 19th centuries. In both countries, it took a half-century before the absolute incomes of the poor reached pre–Industrial Revolution levels. Perhaps Charles Dickens best portrays the starvation, destitution, overcrowding, and death among the mid-19th century unemployed and working class. The lives fictionalized in Nicholas Nickleby , A Christmas Carol , and Oliver Twist were grim indeed. Dickens’s novels are an accurate portrayal of not only the English working class but of other Western workers during this time.6 Although these human costs may not be inevitable, similar problems have not been
avoided by newly industrializing countries in subsequent periods. But despite these costs, even the late Marxist Maurice Dobb conceded that capitalism has improved the levels of living for a large proportion of the Western population since the early 19th century.
Economic Modernization in the Non-Western World
Capitalism led to modern economic growth in only a few non-Western countries. The relative importance of barriers to capitalism extant in traditional societies, as well as the effects of colonialism and other forms of Western political domination on the slow development of non-Western economies. Irrespective of the cause, it is clear that most non-Western countries lacked the strong indigenous capitalists and the effective bureaucratic and political leadership essential for rapid economic modernization.
THE JAPANESE DEVELOPMENT MODEL
Early capitalism’s fast growth. One notable exception was Japan, one of the five non-Western countries that escaped Western colonialism. Despite unequal treaties with the West from 1858 to 1899, Japan had substantial autonomy in economic affairs compared to other Afro-Asian countries. Japan’s level of economic development was much lower than that of Western countries in the middle to latter 19th century. However, since 1867, when Japan abolished feudal property relationships, its economic growth has been the most rapid in the world. Japan’s “guided capitalism” under the Meiji emperor, 1868 to 1912, relied on state initiative for large investments in infrastructure – telegraphs, postal service, water supply, coastal shipping, ports, harbors, bridges, lighthouses, river improvements, railways, electricity, gas, and technical research; for helping domestic business find export opportunities, exhibit products and borrow abroad, establish trading companies, and set marketing standards; for importing machines sold on lenient credit terms to private entrepreneurs; for laws encouraging freedom of enterprise and corporate organization; for organizing a banking system (with the central Bank of Japan); for sending students and government officials for training and education abroad; and (in the absence of foreign aid) for hiring thousands of foreigners to adapt and improve technology under local government or business direction. In the late 19th century, government initiated about half the investment outside agriculture but sold most industrial properties, often at bargain prices, to private business people. Additionally, government aided private industry through a low-wage labor policy, low taxes on business enterprise and high incomes, a favorable legal climate, destruction of economic barriers between fiefs, lucrative purchase contracts, tax rebates, loans, and subsidies. Japan acquired funds for industrial investment and assistance by squeezing agriculture, relying primarily on a land tax for government revenue. From the state-assisted entrepreneurs came the financial cliques or combines ( zaibatsu ) that dominated industry and banking through World War II. Keiretsu , formed after World War II, refers to groups of affiliated companies loosely organized around a large bank, or vertical production groups consisting of a core manufacturing company and its subcontractors, subsidiaries, and affiliates.
external economies of scale and learning by doing from rapid growth in investment and adapting advanced technology from more advanced DCs. Japan’s industrial policy, spearheaded by the Ministry of International Trade and Industry, still relied on cartels and restrictions to limit imports even after joining the General Agreement on Tariffs and Trade (GATT), the global organization administering rules of conduct in international trade before 1995, when GATT was replaced by the World Trade Organization (WTO). The informal protection from cartels, administrative guidance, and subsidies increased domestic costs to the detriment of Japan’s otherwise efficient export sectors. These high costs, together with a keiretu -laden banking system impaired by a 10-percent ratio of bad debts to GDP in 1990, burst the financial euphoria of the 1980s, and were followed by stagnation from 1992 to 2003. Many doubt that LDCs, once having provided protection for the catch-up phase, would have the strength to counter the special interests comparable to Japan’s Iron Triangle – politicians, the bureaucracy, and big business – that became more venal and incestuous beginning in the early 1970s. Japan’s growth collapse in the 1990s is another reason not to blindly follow its or any other country’s model of economic growth without asking how that model needs adjustment when transferred to another country and culture. Moreover, although a contemporary LDC can learn useful lessons from the early Japanese model, these lessons are limited because of Japan’s historically specific conditions and because aspects of the 1868–1937 Japanese approach also contributed to pathologies in growth, such as zaibatsu concentration, income inequality, labor union repression, militarism, and imperialism. These pathologies were not reduced until military defeat in 1945 was followed by land, educational, demilitarization, labor union, antimonopoly, monetary stabilization, constitutional, and other reforms undertaken by the U.S. occupational government, supported by the revolutionary momentum of the Japanese populace. This series of events associated with military devastation is not to be recommended or likely to accelerate economic development and democratize the political economy in LDCs as it did in Japan.
THE KOREAN–TAIWANESE MODEL
Despite Asia’s financial crisis, 1997–99, the fastest growing developing countries are the Asian tigers or newly industrializing countries (NICs) of East and Southeast Asia – South Korea, Taiwan, and Singapore, and Hong Kong, a part of China since 1997. Both Singapore and Hong Kong have been prosperous entrepot city-states, providing trade and financial links for their hinterlands, for other parts of Asia, and between Asia and the external world. As city-states, however, they are not likely to serve as models for more populous nation-states. Thus, we concentrate here on the two remaining Asian tigers, Taiwan and Korea, which have both enjoyed a real per capita growth rate of more than 6 percent since 1960 and graduated to high-income economies in the years since 1990. The model of Korea and Taiwan is similar to that of Japan, perhaps unsurprisingly for two countries that were also a part of greater Chinese civilization for centuries and that were Japanese colonies from about the turn of the 20th century through World War II. Similar to Japan, the governments of Korea and Taiwan systematically intervened to further economic development, building infrastructure, providing tax incentives and subsidized credit for export manufacturing and other selected industries,8 investing heavily in primary education and other human capital, and maintaining macroeconomic stability during external shocks (for example, from oil price increases in 1973–74 and 1979–80 and American dollar depreciation in the late 1980s), thus restraining inflation and avoiding external debt crises. A major difference between the two was that Korean government policies were
partial to private conglomerates such as Hyundai, Lucky-Goldstar, and Daewoo, whereas Taiwan emphasized aid and the dissemination of research and technology to small-to medium-sized private and state-owned enterprises. Korea and Taiwan, also like Japan, have had a high quality of economic management provided by the civil service, with merit-based recruitment and promotion, compensation competitive with the private sector, and economic policy making largely insulated from political pressures. According to Harvard’s Dani Rodrik, Korea and Taiwan had been hampered by a coordination failure before the 1970s. Labor skills, technologies, and intermediate inputs or capital goods require a large-scale movement of resources to benefit from internal and external economies of scale and well-educated workers at low cost to be competitive internationally. In the 1970s, the Taiwanese and Korean states provided “big push” polices to coordinate the mobilization of resources essential for economic transformation and a takeoff into sustained growth. Both Asian tigers have combined creating contested markets , where potential competition keeps prices equal or close to average price, with business-business and government-business cooperation. In Korea, this had meant interfirm and public private sharing of information alongside competition by a few, but usually evenly matched, firms in economic performance, especially in exports. The World Bank uses the following metaphor: Just as adults may prefer to organize party games to letting children do as they please, so running the economy as the Japanese, Koreans, and Taiwanese do as contests with substantial rewards, clear, well-enforced rules, and impartial referees (such as central banks and ministries of finance) may be preferable to laissez-faire (government noninterference). Both countries have pursued a dual-industrial strategy of protecting import substitutes (domestic production replacing imports) and promoting labor-intensive manufactures in exports, although since the 1960s, they have facilitated a shift in the division of labor to more capital- and technology-intensive exports.. Yet Korea established a timetable for international competitiveness that provided performance standards for each industry assisted. Moreover, the Koreans and Taiwanese did not cling to a given nominal exchange rate in the face of continuing inflation, as many African and Latin American countries did, but depreciated their currencies when necessary. Additionally, like early-20th- century Japan, the two tigers subsidized exports to offset tariff protection. All in all, Korea and Taiwan avoided the excessive real currency appreciation of many other LDCs, so that like early Japan, they did not discriminate against exports. During the first 25 years after World War II, industrialization in Korea and Taiwan benefited from United States aid, capital inflows, and rapidly growing demand for manufactured goods in Asia. Yet aid as a percentage of GDP in early post–World War II Taiwan was even lower than the same percentage in Africa recently (8 percent in 1987). Since the 1970s, the two tigers have been closely linked economically and geographically to Japan and other high-performing Asian economies, facilitating trade and investment flows. Beginning in late 1985, when the U.S. dollar began devaluing relative to the Japanese yen, Japanese companies have tried to retain their international price competitiveness in manufacturing by organizing the Asian borderless economy. This Japanese-led system, which encompasses a new international division of knowledge and function, selected more sophisticated activities including research and development-intensive and technology-intensive industries for the four tigers, while assigning the less sophisticated production and assembly, which use more standardized and obsolescent
prices of foreign exchange. The two tigers relied on authoritarian governments and repressed labor unions, as Japan did in their early modernization, but, unlike Japan, were successful in achieving low- income inequality before undertaking political democratization. Korea and Taiwan’s rapid economic growth and relative economic egalitarianism facilitated efforts in the late 1980s and 1990s to evolve toward greater democratic government. Since the late 1980s, DCs such as the United States have begun treating Taiwan and Korea as rich countries, withdrawing preferences they received when they were developing countries and demanding that they adhere to more liberal trade and exchange-rate policies. In addition, the two countries have faced increasing pollution and congestion that have derived, in part, from their growing affluence. Yet despite problems, the two countries’ economic development can provide lessons for today’s low-income and lower-middle-income countries. The World Bank’s The East Asian Miracle (1993a) identifies eight high-performing Asian economies: in addition to Japan, these include the four tigers – Taiwan, South Korea, Hong Kong, and Singapore; and the ASEAN three – Malaysia, Thailand, and Indonesia. Indonesia, which just graduated from a low- to a middle-income country in 1995, but, as a result of the Asian crisis in the late 1990s, a severe drought, falling export prices, and civil unrest and irregular government turnover, slid back to a low-income economy at the turn of the 21st century. Although Thailand’s 6.0-percent growth rate, 1980–92, was the fastest among lower-middle-income economies, the 1997–99 financial and macroeconomic crisis erased many of these earlier gains. Malaysia graduated to the upper-middle- income category in the early 1990s but did not retrogress much in the late 1990s when it avoided continuing short-term capital outflows and pressure on its ringget currency, thus resisting use of the contractionary monetary and fiscal policies that set back other Southeast Asian countries. The Asian crisis had much less adverse effect on Taiwan, with strong prudential supervision, limits on short-term capital inflows, substantial international reserves, and the funding of growth through retained earnings rather than debt, than on South Korea. Korea, by contrast, had keiretu-like corporate conglomerates, the chaebol , with the interlocking and cross-subsidization of industrial enterprises and commercial banks, several of which had high rates of nonperforming loans (indeed, some were technically insolvent). Still, the Korean economy bounced back faster than Southeast Asian economies, stabilizing the economy by the end of 1998.
THE RUSSIAN-SOVIET DEVELOPMENT MODEL
The Stalinist development model. The 1917 Communist revolution in Russia provided an alternative road to economic modernization, an approach usually associated with Soviet leader Joseph Stalin from 1924 to 1953. The main features of Soviet socialism, beginning with the first five-year plan in 1928, were replacing consumer preferences with planners’ preferences, the Communist Party dictating these preferences to planners, state control of capital and land, collectivization of agriculture, the virtual elimination of private trade, plan fulfillment monitored by the state banks, state monopoly trading with the outside world, and (unlike the Japanese) a low ratio of foreign trade to GNP. In a few decades, the
Soviet Union was quickly transformed into a major industrial power. Indeed, the share of industry in net national product (NNP) increased from 28 percent to 45 percent, and its share of the labor force from 18 percent to 29 percent, from 1928 to 1940, whereas agriculture’s share in NNP declined from 49 percent to 29 percent and the labor force share dropped from 71 percent to 51 percent over the same period – an output shift that took 60–70 years, and a labor force shift that took 30–50 years in the West and Japan. Moreover a 60-percent illiteracy rate, an average life expectancy of about 40 years, and widespread poverty before the revolution gave way to universal literacy, a life expectancy of 70 years, and economic security. The Soviets diverted savings from agriculture to industry (especially metallurgy, engineering, and other heavy industry). They did not use a direct tax like the Japanese, but collectivized farming (1928–38), enabling the state to capture a large share of the difference between state monopsony procurement at below-market prices (sometimes below cost) and a sales price closer to market price. Russia’s tsarist economic performance in the decades before 1917 is a matter of controversy. Walter W. Rostow dates Russia’s takeoff into sustained growth, 1890–1914, when industrial growth was rapid, though discontinuous. Even so, growth in agriculture and other sectors lagged behind industry’s. And surely the autocracy and social rigidity existing under the tsars would not have been consistent with the investment in education and capital equipment needed for economic modernization. Many economists and policy makers thought that Soviet-style central planning had transformed the economy from economic lethargy before the revolution to fast economic growth and improvement in material living standards during the four decades after 1928. The Stalinist economic model was not only emulated by Eastern European Communist governments in the Soviet sphere of influence, but also provided an inspiration (and sometimes a prototype) for many leaders in Asia, Africa, and Latin America. During the 1950s, under Chairman Mao Zedong, with centralized material balance planning, expanded heavy industry investment, the development of communes (collective farms), and heavy dependence on Soviet aid, China emphasized the slogan, “Learn from the Soviet Union.” The Fel’dman–Stalin investment strategy. China and India used the Soviet priority on investment in the capital goods industry as the centerpiece of planning in the 1950s. One of the most creative periods for debate on investment choice was from 1924 to 1928, a time of acute capital shortage in the Soviet Union. During this period, Stalin, who was consolidating his power as successor to the revolutionary leader Vladimir Ilich Lenin as head of the Communist Party, was not so rigid in his approach to economic policy as he was after 1929. The Soviet industrialization dispute during this period anticipated many current controversies on development strategies, including those of balanced versus unbalanced growth. The driving force in G. A. Fel’dman’s unbalanced growth model, developed for the Soviet planning commission in 1928, was rapid increase in investment in machines to make machines. Long-run economic growth was a function of the fraction of investment in the capital goods industry (λ1). The Feld’man model implies not merely sacrificing current consumption for current investment but also cutting the fraction of investment in the consumer goods industry (λ2) to attain a high λ1. A high λ1 sacrifices the short-run growth of consumer goods capacity to yield high long-run growth rates for
further below the 5.4-percent third-plan target. Slow growth in agricultural and capital goods sectors, as well as balance of payments crises from rapidly growing food and capital imports, convinced the Indian government to abandon the Mahalanobis approach by the late 1960s. Lessons from the Soviet investment model in LDCs. The Chinese revoked their emphasis on the Soviet investment strategy in 1960, in part because the Soviet aid agency, offended by Chinese missionary activity against Soviet Premier Nikita Khrushchev’s revisionist criticisms of Stalinism, ceased credits for Chinese purchases, canceled contracts for the delivery of plant and equipment, withdrew their scientists, engineers, and technicians, and took the blueprints for projects, such as the halfcompleted three-kilometer (two-mile) bridge in Beijing. But Chinese officials also noted that some major weaknesses of a Soviet-type unbalanced economy have been undue emphasis on accumulation while overlooking consumption, too much investment in heavy industry and too little in light industry and agriculture, and the consequent lopsided development of the economic structure. One of the aims of economic readjustment since 1979 has been to balance the branches of the economy that are seriously out of proportion, and reduce the overconcentration on heavy industry so that the process of production, distribution, circulation, and consumption can be speeded up to produce better economic results. To realize this change, the production of consumer goods will be given an important position. Indeed, these officials surmised that heavy-industry “construction can only be carried out after proper arrangements have been made for the people’s livelihood.” Thus, past experience of unbalanced investment in the capital goods industry suggests several lessons: (1) a larger investment share in this industry is likely to increase economic growth if there is sufficient demand for capital goods; (2) the squeeze on current consumption implied by the unbalanced investment pattern may be at least as long as a generation; and (3) planners in capitalist and mixed economies have too limited a control over total investment to implement a Fel’dman investment strategy. Perestroika and the Soviet collapse. Mikhail Gorbachev became increasingly aware that the Soviet economy, without reform, would succumb to some of the major economic weaknesses that became apparent in the 1970s and early 1980s (retrospective data indicate that total factor productivity, or output per combined factor inputs, fell by almost 1 percent yearly, 1971–85). The perestroika (economic restructuring) of Gorbachev, head of government from 1985 to 1991, recognized that the Soviets could no longer rely on major sources of past growth – substantial increases in labor participation rates (ratio of the labor force to population), rates of investment, and educational enrollment rates. Continued growth requires increased productivity per worker through agricultural decollectivization, more decentralized decision making, a reduced bureaucracy, greater management and worker rewards for increased enterprise profitability, more incentives for technological innovation, and more price reform. Yet ironically, the destruction of old institutions before replacing them with new ones contributed to rising economic distress, which contributed to the attempted coup against Gorbachev, the end of the Communist Party’s monopoly, the breakup of the Soviet Union into numerous states, and the replacement of Gorbachev by Russia’s President Boris Yeltsin in 1991.
CHINA’S MARKET SOCIALISM
Mao Zedong, a founding member of the Chinese Communist Party, led the guerrilla war against the Chinese Nationalist government from 1927 to victory in 1949. From 1949 to 1976, Mao, the Chair of the Communist Party, was the leader of the People’s Republic of China. Mao’s ideology stressed prices determined by the state, state or communal ownership of the means of production, international and regional trade and technological self-sufficiency, noneconomic (moral) incentives, “politics” (not economics) in command, egalitarianism, socializing the population toward selflessness, continuing revolution (opposing an encrusted bureaucracy), and development of a holistic Communist person. From 1952 to 1966, pragmatists, primarily managers of state organizations and enterprises, bureaucrats, academics, managers, administrators, and party functionaries, vied with Maoists for control of economic decision-making. But during the Cultural Revolution, from 1966 to 1976, the charismatic Mao and his allies won out, purging moderates from the Central Communist Party (for example, Deng Xiaoping) to workplace committees. After Mao’s death in 1976, the Chinese, led by Deng, recognized that, despite the rapid industrial growth under Mao, imbalances remained from the Cultural Revolution, such as substantial waste in the midst of high investment, too little emphasis on consumer goods, the lack of wage incentives, insufficient technological innovation, too tight control on economic management, the taxing of enterprise profits and a full subsidy for losses, and too little international economic trade and relations. Since 1980, near the beginning of economic reform undertaken under Deng’s leadership, China had the fastest growth in the world (consistent with cover table), a growth that continued, according to official figures, through 2001. To be sure, Western economists are skeptical about Chinese data. The Penn economists Robert Summers and Alan Heston indicate “that Chinese growth rates are overstated as they are heavily based on growth in physical output figures rather than deflated expenditure series.” Based on the reduction in energy use with no increased efficiency of energy conversion, and inconsistencies in industrial and agricultural production figures, between retail sales and household budgets, and between Chinese policy discussions and official growth data, Thomas G. Rawski estimates real GDP growth, 1998 to 2001, at 0.1–2.7 percent yearly rather than the official 7.7 percent. Managers and provincial officials understate capacity and overreport production to superiors to receive the greater reward received by those who meet or exceed plan fulfillment. Rawski thinks that China’s “National Bureau of Statistics has run afoul of the same pressures that have caused local authorities to become ‘obsessed with ... GDP growth rates – the leading criteria for evaluating cadre performance.’” In 2000, even Premier Zhu Rongji complained that “falsification and exaggeration [of economic statistics] are rampant” (ibid.). Alwyn Young contends that with “minimal sleight of hand,” you can transform China’s growth experience from extraordinary to mundane; the systematic understatement of inflation by non-agricultural enterprise requires downward adjustment by 2.5 percent yearly, 1978–1998. In addition, Maoist China’s health-care system, universal albeit at a basic, minimal level, broke down, giving way to a marketized system providing excellent care for the privileged but sometimes very little for the masses. The worsening problems of Severe Acute Respiratory Syndrome (SARS) and AIDS provide evidence for the medical system’s decline. Yet most economists agree that adjustments for overreporting only reduces annual real per-capita growth, 1980 to 2000, from 7.5 percent to 6. percent, a figure still 4.5 percentage points higher than the world’s average. Thus, despite overreporting and continuing market distortions, economists believe China’s growth under market reforms has been rapid but uneven.
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