Overview Analytical Framework & Transformation Strategy Policy Formulation in Developing Countries

About This Course  Design, implementation and assessment of growth-oriented development policies  Collection and comparison of international best and worst practices (not abstract theory or cross- country regressions)  Both positive and normative aspects (situation analysis and policy advice)  Interactive, evolving and open-ended discussion

Ideas & Concepts for the Course  Politics and economics  Relationships among key players  Policy learning  Institutional dynamics  Middle income traps

Creation of a Developmental State: An Operational Question Predatory/patrimonial state — power and state machinery for perpetuating private benefits of leader, his family and friends Developmental state — policies and institutions for value creation & competitiveness for all people and enterprises How can we promote DS instead of PS?  Political approach — encourage emergence of developmental agenda, actors and coalitions  Technical approach — provision of pragmatic & concrete cases of international best policy practices for willing governments to learn & adopt

Development Policy: Desirability vs. Feasibility Development is both a political process and an economic process. What should be done HRD & technology Infrastructure Integration & competition Systemic transition, etc What can be done Leadership and elites Coalition formation Popular mindset Administrative capacity  Each country is unique in what needs to be done (economics) as well as what can actually be done (politics & administrative capacity).  Any policy maker must work with economic and political space simultaneously. (mainly economics)(mainly politics)

Key Relations and Coalitions 1. Leadership style 2. Horizontal coordination within central government 3. Vertical coordination between central and local governments 4. Relation with non-government stakeholders 5. Relation with foreign players We assume that these five relations are critical in determining policy effectiveness. We do not pre-impose an ideal form on each relation. Each country must create its own.

Key Relations and Coalitions

Policy Learning Latecomer countries must learn three kinds of policy making: Growth policies Social policies to cope with growth-generated problems (income & wealth gaps, migration, traffic, housing, corruption, environment … ) Macroeconomic management under integration  Unless all these are learned, development effort will stall. They can be efficiently learned from comparative study of international best (and worst) practices.

Growth & Social Policy: An East Asian Pattern Economic growth Emergence of new problems Social stability & popular support Growth policy by developmental state START Income & wealth gaps, environmental damage, congestion, cultural change, land & stock bubbles, macro instability, corruption… Social policy years later Democratic, high- income society FINISH Maturity of middle class and political aspiration

What Must Be Learned?  Policy measures  Policy procedure and organization  Policy structure — vision, strategy, action plans, monitoring  National movement for mindset change The purpose is to acquire capability to create policy package suitable for each country using foreign models as building blocks. Government can learn by self-study or with help from advanced countries (policy dialogue).

Learning from Other Countries  DO NOT copy some policy adopted in some other country without local context. Ad hoc or random copying should be avoided.  The claim that “ our country is unique ” should not be used as an excuse for not learning from others.  Learn mindset and methodology for conducting industrial strategies effectively. Learn how to make policies.  Early achievers (Japan, Korea, Singapore … ) improvised through self-effort and trial-and-error. For today’s latecomers, more systematic learning is desirable.

Institutional Dynamics After knowing current status and desired system, how can we move from the one to the other? Common obstacles: --Political resistance: corruption, vested interests, neo-patrimonialism, predatory state --Incompetence: leaders and officials do not know or care --Lack of knowledge or a mistake in designing transition steps --Bureaucratic sectionalism: no ministry or department has full authority or responsibility to execute reform

Comparative Institutional Analysis  Prof. Masahiko Aoki and others at Stanford Univ. and Tokyo Univ.  Based on evolutionary game theory  Some questions --Why do multiple systems emerge and coexist, without any system dominating all others? --What is the dynamic mechanism of moving from one system to another?

Key Concepts  Institutional complementarity E.g., OJT, life-time employment, keiretsu system, main banks were mutually consistent in Postwar Japan  Strategic complementarity E.g., people in competitive society study professional skills; people in connection society give parties & gifts.  Path dependence E.g., because of these complementarities, a system, once started, will have little incentive to deviate.

Forces of Systemic Change  Collective mutation  Foreign pressure (contact with another system)  Policy as deus ex machina --Strong leader --Political parties, interest groups, people ’ s movement --Researchers, advisors, intellectuals Those who are inside the country but do not follow the rules of the existing system initiate change against resistance  Combining policy and foreign pressure

Collective mutationForeign pressure PolicyPolicy and foreign pressure

Lazy Workers in Japan (Early 20th Century) Survey of Industrial Workers, Ministry of Agriculture and Commerce, 1901  Japanese workers are only half as productive as American workers.  They stop working when supervisors are not watching.  Skilled workers are few, and they are often too proud and lazy.  Job hopping is rampant in comparison with US.  Japanese workers never save.  Even today’s high performers started with low capacity in private and public sectors.

The Lessons of East Asia – Korea, K. Kim & D.M. Leipziger (1993)  Heavily dependent on US foreign aid for food, fuel and other raw materials, Korea was not seen as a promising place for major investments.  During the period from 1940 to 1960, the Korean bureaucracy was a kind of spoils system. The East Asian Miracle, The World Bank (1993)  At late as 1960, the Korean civil service was widely viewed as a corrupt and inept institution.  In less than two decades, this view has been dramatically altered. By the late 1970s, the bureaucracy had become one of the most reputable in developing world. How did this come about? South Korea: Unpromising Place with Inept Institution

Middle Income Traps  A middle income trap is a situation where an economy is stuck at income dictated by given resources and initial advantages, and cannot rise beyond that level (growth is given, not created).  The level of income where the trap may occur depends on the amount of given advantages relative to population. Low endowment  Poverty trap Moderate endowment  Middle income trap High endowment  High income stagnation

 Countries may reach certain income by liberalization, privatization and integration, but reaching higher income requires strong policy effort to stimulate private dynamism, not laissez-faire.  Growth based on FDI, aid, big projects, natural resources, or locational advantages will eventually end. The true source of development is value creation by people and domestic enterprises (skills, knowledge, technology, innovation).  Government must produce policies & institutions that promote human capital formation. This is possible even under globalization, but appropriate action is different from past policies. I call it “ proactive industrial policy. ” Trap (cont.)

Why Do Countries Diverge? Per capita income Time High Middle Low Country that creates internal value through human capital upgrading Country that grows by given advantages only – natural resource, trade opportunity, FDI, ODA, big projects, asset bubbles; No creation of internal value Initial growth by liberalization, privatization, integration Skills, technology, knowledge, innovation Critical point in history Middle income trap years

Speed of Catching Up: East Asia Sources: Angus Maddison, The World Economy: Historical Statistics, OECD Development Centre, 2003; the Central Bank of the Republic of China; and IMF, World Economic Outlook Database, April 2010 (for updating). Per capita real income relative to US (Measured by the 1990 international Geary-Khamis dollars)

Latin America Sources: Angus Maddison, The World Economy: Historical Statistics, OECD Development Centre, 2003; the Central Bank of the Republic of China; and IMF, World Economic Outlook Database, April 2010 (for updating). Per capita real income relative to US (Measured by the 1990 international Geary-Khamis dollars)

South Asia Sources: Angus Maddison, The World Economy: Historical Statistics, OECD Development Centre, 2003; the Central Bank of the Republic of China; and IMF, World Economic Outlook Database, April 2010 (for updating). Per capita real income relative to US (Measured by the 1990 international Geary-Khamis dollars)

Africa Sources: Angus Maddison, The World Economy: Historical Statistics, OECD Development Centre, 2003; the Central Bank of the Republic of China; and IMF, World Economic Outlook Database, April 2010 (for updating). Per capita real income relative to US (Measured by the 1990 international Geary-Khamis dollars)

Russia & Eastern Europe Sources: Angus Maddison, The World Economy: Historical Statistics, OECD Development Centre, 2003; the Central Bank of the Republic of China; and IMF, World Economic Outlook Database, April 2010 (for updating). Per capita real income relative to US (Measured by the 1990 international Geary-Khamis dollars)

Hypothesis of Policy Quality The main determinant of the success/failure of development (and overcoming a middle income trap) is the quality of industrial policy.  Policy quality is correlated with income achievement  Policy quality varies widely across countries.  Within a country, policy quality is relatively uniform across different policy components Other factors are also important but not critical— location, geography, natural resources, infrastructure, population, FDI, ODA, mega projects…

Income Performance vs. Quality of Industrial Policy Note: Policy assessment excludes results of external factors, private effort or foreign support.