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

Brief history globalization & development Mercantilism (1500s-1700s) Classical liberalism (1800s– early 1900s ) World Wars & interwar period (1914-1945) 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)

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

$2 $1 $1 Pictures from http://blog.lizearle.com/lizearle/2011/04/cocoa-beans-great-adventure.html http://gamoonbat.blogspot.com/2007/03/valco-ghana-kwame-nkrumah.html http://www.cirad.fr/en/research-operations/research-results/2011/evaluating-cocoa-agroforestry-systems-to-design-new-cropping-systems

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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”

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

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 http://www.moh.gov.sg/content/moh_web/home/costs_and_financing.html http://www.washingtonpost.com/wp-dyn/content/article/2010/03/03/AR2010030301396.html http://www.forbes.com/sites/timworstall/2013/08/23/how-to-provide-health-care-to-all-americans-for-the-price-of-medicare-its-all-in-the-prices/

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.)

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.

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

Questions?