1. Trade & Development II: Economic Reform
International Political Economy
Prof. Tyson Roberts

2. Brief history globalization & development
Mercantilism (1500s-1700s)
Classical liberalism (1800s– early 1900s )
World Wars & interwar period ( )
Breakdown of free trade system, nationalist, fascist & communist movements
Structuralism, ISI policies
Embedded Liberalism (1945 – 1970s)
Bretton Woods institutions: WTO, IMF, GATT
“Big Push”
Neoliberalism (1980s-2000s)

3. Causes of Shift from Structuralism to Neoliberalism
Economic imbalances from ISI
East Asian countries with export-oriented policies outperforming other developing countries
Financial crisis in late 1970s/early 1980s forces developing countries to reform – World Bank & IMF push neoliberal reforms

4. $2 $1 $1
Pictures from

5. Assume the world equilibrium price for cocoa is $2
Assume the world equilibrium price for cocoa is $2. How much would Ghana cocoa farmers be willing to produce?
Price of cocoa SC 3 2 DC 1
Quantity of Ghanaian Cocoa 2 4 6

6. Assume the world equilibrium price for cocoa is $2
Assume the world equilibrium price for cocoa is $2. How much would Ghana cocoa farmers be willing to produce?
Price of cocoa SC 3 2 DC 1
Quantity of Ghanaian Cocoa 2 4 6

7. How would cocoa farmers respond if the government sets the producer price at $1?
Price of cocoa SC 3 2 DC 1
Quantity of Cocoa 2 4 6

8. How would cocoa farmers respond if the government sets the producer price at $1?
Price of cocoa SC 3 2 DC 1
Quantity of Cocoa 2 4 6

9. Ghana’s producer price was consistently below the international price from the mid-1950s – 1980s
Source: IMF, prepared by Bulir, 1998

10. Cocoa production held up ‘til ~1970 (trees), then fell for 15 years Cocoa production dominance switched hands from Ghana to Cote d’Ivoire (where producer prices were higher)
Source: IMF, prepared by Bulir, 1998

11. Overvalued exchange rates and industrialization
Why would an overvalued exchange rate facilitate industrialization?
How would the market-based response of manufacturers, farmers, international traders, or bureaucrats undermine development?
Use supply and demand diagram

12. Overvalued exchange rates (which makes foreign currency cheaper) lowers costs of imported capital good and inputs
Cedis per $ S$
Fewer dollars needed to buy foreign goods D$
Number of Dollars

13. But overvalued exchange rates (which makes foreign currency cheaper) makes domestic goods more expensive
Cedis per $ S$
Fewer foreign buyers want to buy more expensive exports D$
Number of Dollars

14. Demand for foreign currency exceeds supply of foreign currency => shortage of foreign currency, opportunity for rent seeking
Cedis per $ S$ D$
Number of Dollars

15. What policies need to accompany overvalued exchange rates for ISI to work?
Trade barriers on manufactured goods
Tarriffs, import quotas, etc.
But…
If the state is weak, government officials corrupt, exceptions will be made for the politically connected
As global trade increases, increasingly difficult to target trade barriers

16. Results of State Intervention Policies
High government spending, commodity prices enabled growth
Debt build-up
State intervention + weak state => Poor governance, corruption, inefficient firms, etc.
1979:
Increase in interest rates & oil prices, global recession, fall in commodity prices => crisis

17. 1970s & 1980s: Latin America & Africa: Good to Flat East Asia Booms
GDP/capita growth
1960s & 70s
1980s
Latin America
2.3%
-0.3%
Sub-Saharan Africa
1.4%
0.2%
Middle East & N. Africa
3.7%
-1.3%
East Asia
5.2 %
5.0%
South Asia
1.2%
2.0%
Southeast Asia
3.1%
3.3%
Source: pwt_grgdpch for countries with pwt_pop>1000

18. Some lessons from “Asian miracle”
Macroeconomic stability promotes investment in capital & education
Low inflation encourages savings & investment
Competitive exchange rates promote investment in manufacturing
High domestic savings enables little foreign borrowing
Low budget deficits enable private borrowing & signal stable tax rates

19. Some lessons from “Asian miracle”
Export orientation enables sustainable economic growth
World market enables economies of scale
World competition force improvements in efficiency
Foreign currency earnings reduce risk from global financial crisis

20. Why would governments continue to pursue ISI policies when they result in trade & budget deficits & stagnant growth?
Winners from ISI policies oppose economic reform
ISI policy supporters can solve collective action problems more easily than reform supporters
Urban vs. rural
Private goods vs. public goods
Government vs. private citizens
Reform becomes possible when benefits from ISI are exhausted

21. Shift in economic development paradigm
Post-independence:
Problem: Lack of capital, market failures (poverty trap, etc.)
Solution: Aid and state intervention
Post-debt crisis:
Problem: State intervention created inefficiencies
Solution: Conditional aid to encourage withdrawal from state intervention to allow market forces to work

22. Washington Consensus Fiscal discipline
Shift public spending from subsidies & bureaucracy to health, education, infrastructure
Tax reform
Liberalize interest rates
Competitive exchange rate
Trade liberalization
Liberalization of inward investment (e.g., FDI)
Privatization
Deregulation
Property rights

23. Neoliberalism success?
Many studies find structural adjustment policies did not increase growth
Pro-neoliberal argument
Short term downturn followed by growth
Strict application of SAPs did lead to success
Anti-neoliberal argument
Macroeconomic stability & trade helps, but…
The state still plays an important role
“Keep the windows open, but don’t forget the mosquito screen”

24. Post-Washington Consensus ?
Underinvestment in education & healthcare has human & economic costs
IMF/WB response: PRSPs
Neoliberal policies don’t necessarily => growth
“Good” policies with weak institutions => poor results
Order of reforms matters
The state plays an important role in development
State is necessary to create efficient markets, etc.
Developmental industrial policies can work if there is sufficient state capacity & good governance

25. An example of state-facilitated markets: Singapore’s healthcare system
Universal healthcare coverage
Spends 4% of GDP on healthcare (vs. 17% in US)
1/3 of healthcare expenses paid by individuals (vs. 1/10 in US) => encourages price competition
Ministry of Health publishes hospital price information
Healthcare savings accounts mandated by government (20% of wages by employees, 13% by employers)
Gov’t-provided safety net for the poor
Gov’t subsidizes 80% of costs in acute care hospitals
Public sector provides 80% of acute care; private sector provides 80% of primary care

26. Conclusions ISI did enable industrialization
Some argue that this laid the groundwork for future growth for some successful economies
For many others, ISI created imbalances that undermined later growth, especially if…
Secondary ISI instead of export substitution
Weak state (captured by uncompetitive interests)
Low state capacity (bureaucratic quality, etc.)

27. Conclusions Long-term growth appears to be facilitated by
Integration in the world trade market (but not too open?)
Pro-export policies in agriculture and/or replacement of ISI with export orientation
Stable macroeconomic policies (inflation, exchange rate, budget deficit)
State capacity, investment in education, public health, infrastructure, R&D, etc.

28. Midterm Prep Review readings & lecture slides
Self-test using reading quizzes
Self-test using class exercises (in slides) & problem sets
Cheat sheet: index card, double sided, handwritten
Get lots of sleep, bring a drink

29. Questions?