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Essay: Laissez Faire economic policies are unlikely to generate sustained industrial growth in LDCs. Discuss

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  • Laissez Faire economic policies are unlikely to generate sustained industrial growth in LDCs. Discuss
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Laissez Faire system and the economic policies that stem out of the system are undoubtedly, a produce of the West i.e Global North. The likes of Adam Smith and John Stuart Mill propagated it, but that was two centuries ago. Laissez faire is a very prominent feature in the Global North in this day. In this very decade, laissez faire brought us to see a crippling of the international economy in the form of the 2008 Sub-mortgage crisis.

My argument for this essay is that the statement is true; laissez faire policies are unlikely to generate sustained industrial growth in Late Developing countries. There will be growth, undoubtedly, but ‘sustained growth’ would be elusive with laissez faire these countries.

The ‘stage of development’ is the bigger precursor, which determined the countries’ industrial development policy. Historically, 18th century Britain was the one of the forerunners of free market capitalism- it had the advantage of being highly industrialized with the industrial revolution springing in the country itself. Hence, the development finance for the country came in the form of stock markets and retained earnings of large ventures. On the contrary, Russia which was a relatively much more backward economy had to rely on a central state to drive their industrialization.

A LESSON FROM HISTORY

Introduction of Laissez Faire into an underdeveloped society, which is not ready for such a huge change from the traditional ways, can be catastrophic. The Indian famine of 1876-78 is one such example. Where erstwhile India had historically learnt how to insulate themselves from a famine, in the form of a surplus stock kept aside which could be rationed out. The British however, introduced ‘free-market’ policies during this famine. In theory, the free-market policy applied was supposed to lead food to flow to these areas. But, on the contrary Madras saw that the grain prices rose dramatically and instead of additional supplies as dictated by the theory, the result was that millions of local laborers and artisans were unable to afford their daily subsistence. (Stahl, RM 2016).

STATE OWNERSHIP AS AN ALTERNATE TO LAISSEZ FAIRE

Late Development is inherently a risky design. But as Economics dictates through the risk return trade off- higher the risk, higher the return. These countries have a high potential growth rate. Coupling this with the advantages of cheap labour, being able to acquire technology versus spending time and money on developing it and following compass policy making i.e. learning from the mistakes and success of other developing economies before them (Gerschenkron, A., 1962) makes late developing countries a very promising space.

However, low level of skill in the workforce, little manufacturing experience and dictated comparative advantage in a market led by competition would be a recipe for disaster for the economy. Combining these reasons and the aforementioned risk involved, with the situation of hard currency shortage in the developing world, government intervention became a necessity. (Amsden, A, 2009, 96-99)

THE STATE AND PROPERTY RIGHTS

The State is the single body that has the potential and power to dictate a country’s growth direction – economically as well as politically. The State in a Late Developing economy has many problems to tackle- the premier one being ‘insecure property rights’. Adam smith noted in Wealth of Nations, “tolerable administration of justice to secure property rights and allow investment and exchange to take place will see economic progress take place”.

In the state of Kerala, India, land reforms that were introduced post independence in an effort to secure said property rights, were widely considered successful as it accounted for 22.88 per cent of the total number of tenants conferred ownership rights (or protected rights) up to 2000, despite being home to only 2.31 per cent of India’s population. (Ghatak, M. and Roy, S., 2007).

Agrarian reforms as a result of secure property rights would ideally lead to the increase in productivity. With most of the unskilled labor affixed to agriculture in LDCs, the high increase in productivity means the country would be able to export primary goods and in turn gain access to foreign exchange* i.e hard currency. We will discuss the use of foreign exchange at a later stage in the essay.

INDUSTRIAL POLICIES

A late developing state broadly needs two steps to become a successful sustainable industrial growing economy. The first step would be bringing
Industry up to par with global competitors, and the second would be introducing competition as a mechanism to increase discovery. The former obviously needs to precede the latter for effective and sustained growth.

In the interest to achieve the goal of brining domestic industries up to par, the state would need to bring about successful ‘Import substitution’, which can be done through levying two major policies –Tariff Protection and Subsidies.

Tariff protection is fiscally most feasible way to promote the sunrise industry in the country. High import tax on automobiles in Japan after World War II is an example of how a state policy can nozzle the imports into the country. This effort was made to give a boost to Import Substitution. Japan’s automobiles may be a popular case of high import tariffs, but long before that, Britain in the 14th century, had aggressively shielded it’s infant industry in the same method, and levied high tariffs on manufacturing products even as late as the 1820s (Chang, H.J., 2010).

Tariff protection also includes ‘quotas’ and ‘local content management’ which have been argued to yield higher welfare than the tariff itself (Melitz, M. , 1999) . With the introduction of the GATT dictating tariff cuts and regulations on ‘goods’ as well as ‘agriculture’ since 1947, which post 1994, took form of the World Trade Organization, but withholding the same text regarding tariff regulation- it would make sense to agree with Meltiz’s idea that quotas and local content are better policy instruments.

Providing subsidies by the state is another powerful policy means by which can be welfare enhancing, and with help of which, the Import Substitution can be successfully brought about. However, it is important to note that the state must be careful in this provision. Firstly, initial subsidies should never be so high as to cause domestic output to decrease at any point in the future (Melitz, M., 1999) Secondly, industries should be carefully selected for the provision of subsidies.
It is of the essence that subsidies be provided to advance Primary Industries.

For example, the government of a late developing country could provide subsidy in the ‘steel’ industry from international firms, for a period of ten years. During which period, the domestic industry must produce to meet the domestic demand. Understandably, a large amount of production would be required to make this subsidy economically viable. i.e the steel industry would have a high set-up cost, which is non-negotiable and fixed. Therefore the large production would be essential to make back the capital spent. It is to be noted that the state cannot subsidize a thousand steel mills as that would not lead to profit. The subsidy provided would be to a handful of firms, which are usually family owned conglomerates, i.e a less specialized industrial group that can social and pool the risk, as they are undertaking a long gestating, risky enterprise. For eg the Tata group in India.

However, the State must possess the capacity to ‘promote winners’ in this arrangement, and more importantly it must exercise good political power, for example in taking away subsidy from a non performing firm, or prevent a building of oligarchy due to subsidies – which is a difficult task.

Therefore, high potential of production in late developing countries, less or no budget for Research and Development, patents and advertising are some major reasons in favor of state sponsored subsidies.

IMPORT SUBSTITUTION

We have laid a considerable focus on Import Substitution. This is because the most critical consequence of it is bringing the domestic market up to internationally competitive standards, without being trampled upon by big players in the international market, when the domestic industry is in the nascent stage. As we have seen in the case of domestic industries being crushed in Sub-Saharan Africa by China in textiles and electronics, mainly because it is cheap.
Once an international quality standard is set in the country, the import substitution can turn into ‘exports’, which is what we have been building up to.

Export of Primary Goods leads to the country gaining access to foreign exchange, as has been discussed before*. The biggest advantage for a country to gain foreign exchange is to be less vulnerable to fluctuations. As has been the case with Brazil, in it’s coffee export. In October 1962, the price in the US was 22.18 cents, 32.73 in August 1963 and 49.85 in 1964. Cocoa prices also showed comparable fluctuations. “For a country projecting a development program, and counting on a particular level of foreign-exchange income from its primary-product exports, downward movements in price can be catastrophic. The problem tends to be compounded in that at the very moment a less-developed country loses income because of price declines, its external credit position also suffers and foreign loans are hard to obtain. When prices increase (as they did by an average of 5 percent in 1964 over 1963), the increased income tends to encourage overproduction.” (Weintraub, S., 1965, 6)

This foreign exchange that is gained should be invested in the industries, which have maximum ‘linkages’ and ‘spill-overs’ to other industries, and are also ‘labour-light industries’. Linkages between sectors, as suggested by Hirschman in the theory of unbalanced growth, help in developing industry through ‘backward’ or ‘forward linkages, where one the production in one industry is directly tied to or ‘linked’ to another industry. Linkages are cause of the ‘spillover effect’ i.e. a Secondary effect as result of a
Primary effect.

Using backward linkages is the most appropriate way to produce ‘spillover’ for late developing countries. (Javorcik, 2004) In backward linkage, the ‘raw material’ is provided by local suppliers, and therefore there is no dependence on imports and primary domestic industry is given a boost. As used in the Readymade Garment export industry in Bangladesh. Exporting a finished garment for them meant converting fibers/cotton to yarn and then converting this yarn to grey fabrics, and finally the grey fabric to dyed/printed cloth. This backward linkage with emphasis on the Readymade Garment industry propelled other raw material and ancillary industries into production. (Habib, 2009)

Ultimately, we see that in LDCs there is no functional substitute for the State- from Agrarian Reforms/ securing Property Rights to tariff protection and subsidies that lead to Import Substitution which makes the country not only self sufficient, but also an exporter- which in turn leads to gain of foreign exchange and growth in GDP, can only be done by the State. However, there are some problems that come hand in hand with increase in state power in any country.

Corruption in the government is the biggest one that needs to be tackled for any sort of results to be seen. We could apply all the said industrial policies, yet with corruption, there could be no positive results. State could indulge in rent seeking behavior, which benefits elites at the expense of the general taxpayer public.

To tackle this cardinal problem, the State must separate the judiciary from the executive body. The judiciary must be a very solid one, not affiliated to the State, but only in service to protect the ideals of policy execution. Another design that could be implemented is to have a separate Commission, which tackles corruption in the State. Hong Kong’s ‘Independent Commission Against Corruption’ is one such example. The ICAC was formed to fight corruption in the government using a three-pronged approach of law enforcement, prevention and community education.

To keep the rent-seeking attitude of the State in check, late developing countries need ‘Development Banks’ or some other marketing body with ‘sector experts’ who can determine and regulate the financing. The appointment of the experts, of course depends on the sectors the country is channeling it’s capital into.

Excess power in the hands of State, raises the concern of Authoritarianism. Which means, the suppression of labor rights as well as human rights. In my view, the scale always lies between human rights and human needs. In late developing countries, the scale tips towards human needs, more than human rights. After all, what point does the right to vote serve, if one cannot eat three square meals in a day? Government power that is kept under check in developing countries can bring industrial prosperity, yet it should definitely not be at the expense of human rights, but should be able to provide basic human needs. That is the first step of development.

Having established that State Owned Enterprises are the best way for late developing countries to kick start their industrial development. One cannot argue that after a certain amount of growth, the industrial growth will come to a standstill. At this point, the country must open its arms to ‘limited’ liberalization and globalization. Getting Foreign Direct Investments, creating Special Economic Zones as the Chinese government did, and joining hands for ‘co-financing’ would keep the graph of industrial growth stable.

Alliance between the State and the free market, once the domestic industries are up to par, would introduce competition amongst manufacturers. Competition, is the best road to discovery, and also to the production of good quality goods- which can be used to for domestic consumption as well as ‘export’. Building up export means building a good GDP for the country. And one may argue that GDP is not the best measure of the welfare of humanity, yet one cannot disagree from the fact that unless the country has a good GDP i.e. finances at it’s disposal, they cannot make any investment in the country for human welfare. A high GDP would mean the State could invest in social overhead capital i.e. Education, Hospitals, Infrastructure (roads, railways, telecommunication)- which irrefutably amounts to human welfare (Pritchett et al, 1996)

CONCLUSION

In conculsion, the belief that either laissez faire industrial policies or total state directed industrial policies would create industrial growth and sustain it in late developing countries, is not ideal. Ideal would be a balance of the two- with state directed industrial policies implemented at the beginning of the era of industial development in LDCs, but eventually partially opening up to the ‘free market’ idea to sustain the growth that has been set forth by the state earlier. Gerschenkron himself derided Rostow’s five-stage ‘blue-print’ for late industrialization, saying that each country is different, and industrialization has to take it’s course according to the history, culture and geography of each individual country. (Hirchman, 1982) One cannot deride these important components of every country’s history by imposing a ‘plan’. But we can point the direction and provide the compass, which each country can follow as per their advantage and comfort.

After all, George Orwell showed us in his dystopian book 1984, what an all powerful state could lead to, and Aldous Huxley showed us in his dystopian book ‘Brave New World’, what a laissez faire controlled global society would look like, and both are far from ideal.

REFERENCES

Stahl, R. (2016). The Economics of Starvation: Laissez-Faire Ideology and Famine in Colonial India. Intellectual History of Economic Normativities, pp.169-184.

Gerschenkron, A. (1962). Economic Backwardness in Historical Perspective. Economica, 30(119), p.327

Amsden, A. (2009). The Wild Ones : Industrial Policies in the Developing World. The Washington Consensus Reconsidered, pp.95-118.

Ghatak, M. and Roy, S. (2007). Land reform and agricultural productivity in India: a review of the evidence. Oxford Review of Economic Policy, 23(2), pp.251-269.

Melitz, M. (1999). When and How Should Infant Industries Be Protected?. Research Seminar In International Economics, [online] pp.451-475. Available at: http://fordschool.umich.edu/rsie/workingpapers/Papers451-475/r451.pdf

Chang, H. (2003). Kicking Away the Ladder: Infant Industry Promotion in Historical Perspective. Oxford Development Studies, 31(1), pp.21-32..

Hirschman, A. (1982). Essays in Trespassing: Economics to Politics and beyond. Southern Economic Journal, 49(2), p.596

Javorcik, B.S , 2004, Does Foreign Direct Investment Increase the Productivity of Domestic Firms? In Search of Spillovers Through Backward Linkages http://spot.colorado.edu/~utar/javorcik.pdf

Habib, 2009 Backward Linkages in Readymade Garment in Bangladesh http://ojs.cnr.ncsu.edu/index.php/JTATM/article/view/380/615

Pritchett, L. and Summers, L.H., 1996. Wealthier is healthier. Journal of Human resources, pp.841-868. http://213.154.74.164/invenio/record/10304/files/wps1150.pdf

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