Notes taken from S.I. Cohen's Book
"World Development and Economic System"
Chapter 1 INTRODUCTION
·
The objective of this book is to present an
integrative theory of economic systems, demonstrate its applicability time wise
and worldwide, and make use of its implications for policy and designs. In
assessing studies of economic systems, it is necessary to distinguish between
those which focus on the indepth study of (one) economic system, ISEC,
and those that undertake a comparative study of (several) economic systems (CSES).
·
ISEC have commonly distinguished between three
broad economic systems that are generally labelled as the traditional
system, the (centrally) planned system and the (decentralized) market
system.
The first major contributions on the working
of the traditional system came from anthropologists. It suffices to mention
Malinowski (1922), being the first to describe the institution of reciprocity
as a guiding rule for exchange of goods and services, conceived as gifts among
kinship and tribesmen in Polynesia. Their conclusion is that in traditional
settings, exchange is determined in the context of institutions of reciprocity
and of sharing that are typical of closely knit personal relationships based on
loyalty to shared kinship, community and belief. Another wave of studies was concerned
with the informal economy in rural and urban areas, especially in the
developing world, among the first to coin the term was Lewis (1955). The
informal economy was traditional in its sociological relations and production
technology and was politically non-participative.
Studies of the planned system were short
lived, starting around the initiation of Soviet Plans in the 1920s, and ending
with the collapse of the communist regime towards the end of the century.
Studies of the functioning of the market
system and the history of economic thought have been tied to each other from
the very start. The elements of the market system that were outlined by Adam
Smith (demand and supply determining prices in competitive markets, combined
with utility maximization and profit maximization by consumers and producers)
required refinements and extensions involving great economists including
Pareto, Walras, Marshal, Samuelson, Arrow, Debreu and others before these
elements were rigorously integrated and formalized in a static general
equilibrium theory of interlinked markets, some three centuries later. The
growth dynamics of the market system is due to Schumpeter (1943), which he saw
as being led by innovations and entrepreneurs, but is retarded by increased power
of corporatism and greater monopoly. This is a form of market failure that
urged Schumpeter to argue for a shift from a capitalist distribution of wealth
and decision-making powers to a socialist distribution. In due course, other
economists pointed to other market failures and the need for market and
non-market solutions to mend these failures, i.e. Stigler (1971) on capture
practices; Coase (1960) on internalizing externalities, Stiglitz (2008) on
reducing financial instability and so on. As the market system evolves over time, it
sets in motion other effects and norms that can be experienced as negative or
positive, depending on the value judgment of the evaluator. The most prominent
negatively conceived effects are human alienation and conspicuous consumption.
Marx (1867) was moved by the negative effects: the market system with its focus
on private property, business capitalism and strict division of labour degraded
and dehumanized labor, and estranged him from his true nature. The theme of
estrangement and alienation was revisited and elaborated further by Polanyi
(1944): The market system with capitalism as its driving force gave birth to a
new economy that is disembodied from its social environment. By commoditizing
not only goods but also labour in terms of exchangeable money, the market
capitalist system dismantles a whole lot of protective institutions for the
common people. Veblen (1899) focused on the pecuniary culture and conspicuous
consumption that are seen as an outgrowth of the market system economy.
Conspicuous consumption served as a public display of the spender of his
economic power and is as such a waste. Levy-Gerboa (1979) elaborated on
conspicuous consumption by linking the joint collaboration of producing firms
and admired leaders of consumption styles in the introduction and communicating
of new consumption styles and products in the market. Friedrich Hayek and
Milton Friedman are convinced that the market system fosters freedom and
democracy. All the above negatively and positively conceived side effects of
the market system have some truth and are recognizable by the objective
observer.
·
We can move now from the ISES to the CSES, whose
contributions have been remarkably lower. In the first part of the past
century, there were some outstanding theoretical contributions that compared
the market system with the planned system, such as by Barone (1909) and with
the traditional system such as by Polanyi (1944). In the past century, CSES was
influenced by the ideological divide and the cold war between a western and an
eastern camp. s. It is not surprising, therefore, that as the communist regime
faltered by late 1980s, CSES came to face an identification crisis. Instead,
many CSES repeated their custom of the past century of elaborating typologies
of double and triple term labels and sticking them to the countries studied, in
what is named varieties of capitalism. For instance, Hall and Soskice (2001)
started humbly by classifying the industrialized countries into a liberal
market system (i.e. USA, UK) and coordinated market system (i.e. Germany,
Japan). Amable (2003) extended the classification of the market system to five
types or models: market-based model (USA, UK), social-democratic model
(Scandinavia), Continental European model (Germany, France, Netherlands,
Belgium), Mediterranean model (Greece, Italy, Portugal, Spain), Asian model
(Japan, Korea). Lane and Myant (2007) added four more categories to fit
transition countries in the capitalist picture. Bohle and Greskovis (2007)
brought in even more complexity by adding another four–isms: neoliberalism,
embedded neoliberalism, neocorporatism and transnational capitalism. Formally
speaking, CSES should be backed by an integrative analytical framework that
explains how and why different economic systems emerge.
·
We identify three subsystems: households,
firm settings and state settings (that is, governmental settings). We model
the economic transformations within the three subsystems, as well as
inter-transactions, inter-communications and inter-mobility of agents between
the subsystems. We postulate that over long time periods of agent interactions,
three prototypes dominant systemic behaviours would emerge in different
environments and histories, leading to three distinguishable prototype economic
systems: (1) a household intensive system where agent interaction is centred
around social sharing household settings, (2) a firm intensive system where
profit maximizing firm settings dominate agent preferences, institutional
conducts and system performances, and (3) a state intensive system where rent
acquiring governmental settings dominate agent preferences, institutional
conducts and system performances.
Chapter 2 An Integrative Theory of Economic Systems
·
In this chapter, we outline a theory on the
formation, evolution and differentiation of economic systems. Our framework
emphasises the location and interaction of agents in distinct behavioural
subsystems and constituent settings, as the clue for understanding how agents,
and the economic system they form, become aligned with particular behavioural
setting, take over the typical behavioural type that associates with that
behavioural setting, and spread it to other settings via various channels. We
display the mechanisms involved that lead to one subsystem dominating other
subsystems and drive prototypes of economic systems that associate with each of
these settings.
Components of the economic system
·
Behavioural settings relevant for economic
analysis are those that generate for their participants added value from the
economic transformation of some production and/or exchange activity. Agents
inhabiting a behavioural setting engage thus in a value-added transformation of
goods and services. Actions of agents are subjected to physical technological
boundaries and guided by institutional rules and information schemes. Setting -
household, firm and state settings. These three types of settings will
be denoted by h, f and s.
·
A specific subsystem consists of a vast number
of behavioural settings of the same specific type. The subsystems corresponding
with the household, firm and state setting will be denoted by H, F and S,
respectively. Each subsystem has its own institutional rules and information
schemes for guiding actions of the agents present in that subsystem. Agent
behaviour and institutional conduct in a subsystem and its constituent settings
are driven by an intrinsic goal function typical of the subsystem. Household
settings h form together the household subsystem H, firm settings f form
together the firm subsystem F and state settings s form together the state
subsystem S. One represents delivery of agents of one subsystem to another
subsystems and related agent interactions; another represents delivery of
transformed goods and related monetary transactions between the subsystems. The
long arrowed lines linking the subsystems stand for inter-deliveries of agents
and their related communications, and for transformed goods and related
monetary transactions.
·
In the developing world taken as a whole, about
60% of the labour force are in rural household-based settings and in urban
informal settings where self-employment and family workers in tiny undertakings
is the primary employment mode. The remaining 40% is about evenly divided with
20% in the modern private sector employment (firm settings) and 20% in the
modern public sector employment (state settings).
·
In the
developed world, there is only a few percentage points of the labour force, say
5%, that pursues economic activities that can be described as non-commercially
household based, or as belonging to the social economy (i.e. voluntary,
cooperative and non-profit). Roughly about 70% of employment is in the private
sector (firm settings), while about 25% is in the public sector (state
settings).
·
starting from the micro layer of settings, then
to the meso layer of subsystems and last to the macro level of the whole
system.
SETTINGS (h,f,s)
·
First, what are the major ‘types’ of settings
that engage in economically relevant transformation processes; what are the
intrinsic goals of these types of settings and their forms of transformation?
·
In any society, there are tens and tens of
distinct types of behavioural settings, with each type having its own goal with
which participating agents associate and identify. Our concern is limited to
settings that are economically active. Agents inhabiting such a behavioural
setting engage in a value-added transformation of goods and services, with
given physical technological transformation capacities, making use of
information flows and subjected to institutional rules. We have distinguished
between three main settings of relevance for the study of economic systems:
household settings, firm settings and state settings. The intrinsic goal in household settings can
be described as affinity sharing, the goal of firm settings is generally stated
as profit maximization, and the goal of state settings is best described as
securement of polity rent, in short, rent politicization. The coordination
mechanism in traditional household settings is typically sociologic in
character; in firm settings, coordination is economic and in state settings,
coordination is political.
The distinct behavioural motives of the three types of settings,
we call them also intrinsic goals, can be expressed formally as is done in Eqs.
(2.1–2.3). In the household setting, the agents lump together their benefits
and costs in an effort to make total benefits exceed total costs. In Eq. (2.1),
Vh stands for the value added in the household setting, while
rewards R and efforts E of agents i and i ‘ are lumped together and somehow
shared among all i. The institutional rules that regulate conduct in the
household organization are so designed that agents would thrive to distribute
these benefits and costs between i and i ‘ in ways that contribute to a maximum
value added or at least a positive result for the whole setting.
Vh ≡ Ri
+ Ri’ − Ei − Ei’ ≥ 0. (2.1)
In the firm setting, each
agent would like to realize the highest economic returns to one self, which
implies aiming at realizing the highest return to the firm as a whole, in
competition with other firms. Institutions for regulating conduct within and
between firms are designed towards that end. In Eq. (2.2), Vi stands for the
value added in the firm when agents i and i’
maximize their relative returns, defined as benefits less costs per unit
of capital invested; the latter can be approximated by taking multiples of the
total costs, or to simplify things we set the total costs as the denominator.
Vf ≡ Σ(Ri − Ei)/ΣEi
≥ ρ. (2.2)
To model the state setting, we introduce in the variables R,
E, V , the subscript ps to denote the situation before engagement of the state,
and subscript s to denote the situation after engagement of the state. We also
employ k to represent agents with state authority. Equation (2.3) shows a lower
value added in the pre-state situation compared to the situation with state
engagement, that is Vps < Vs. This is due to a reorganized transformation
with intervention of state agents k that results in ΣRi > ΣRpsi and/or ΣEi +
ΣEik < ΣEpsi. Part of ΣEi is a privately incurred cost and the other part is
the collectively invested expenditure that allows for the higher value added
transformation.
Vps ≡ ΣRpsi
− ΣEpsi ≤ 0, Vs ≡
ΣRi − ΣEi − ΣEik ≥ 0. (2.3)
Institutional rules
in state settings give the governing agent, k, the exclusive authority to
acquire a polity rent from all agents for the polity services rendered, denoted
by Eik . Furthermore, institutional rules in state settings tend to
be moulded in manners that require prolonged dependency of agents, i, on agents
with state authority, k, and collection of polity rent in the future if
transformation is to be realized and maintained in future transactions.
·
Second, what are the means of transformation
in the (economically relevant behavioural) setting, and how do they jointly
drive the transformation process?
-
In any of the three types of settings, four
means (or factors of production) are combined in the transformation process,
and applied to realize the specific goals. The four means are (a) interacting
agents, (b) institutional rules, (c) a given physical–technological
transformation capacity and (d) information schemes. Interacting agents play a central role: The
transformation is operated by a population of interacting agents unified by the
same goal setting. Some agents turn up to be more suited to lead and take
initial decisions and actions, we called them leading agents; while others wait
and see, evaluate and follow or simply trust or act blindly in a herd
behavioural manner. All these are called follower agents in one sense or the
other. The transformation process is set into motion by a complex of
information flows communicated by agents to each other.
·
Third, how do these means change over time? In
particular, how do agents participate in settings?
-
But there is also a more insightful answer to
the question, which elaborates on the dynamics between settings. These dynamics
occur through reshuffling of agents across settings and through the
redistribution of transformation volumes across settings. Major shifts in agent
membership of alternative settings are put into motion by the mobility of
agents between settings, preceded by a search by agents for settings in which
the individual agent can combine his/her endowments and preferences most
satisfactorily. As a result, the distribution of persons and transformations
among settings is adjusted and new configurations are reached, which in turn has
important implications for adaptations and changes in the institutional rules,
transformation capacity and information flows of each and every setting.
- The distributed rewards of competing
settings are crucial for an evaluation that participants regularly do, and
which guides them in their decision to continue in the setting or move to
another setting.
[i] Stays in the setting, functions in full
conformity with roles and rules (i.e. loyalty).
[ii]
Stays but protests. Attempts to enact changes in functioning of organisation
(i.e. protest). [iii] Stays but acts passively and practices moral hazard (i.e.
undermine).
[iv]
Exits, searches and enters eventually another organization (i.e. exit).
Hirschman (1970) was among the first to emphasize
the notions of loyalty, voice, exit and entry. Leader and follower agents move
from one setting to another. the mobility continues up to the point where the
propensity to move satiates in the sense that the marginal utility for an
individual of shifting a unit of effort between settings is equal to the
marginal cost of the shift.
·
Fourth, what is the role of the (external)
environment in conditioning the settings?
-
Different external environments generate typical
coordination structures that coincide and fit with typical behavioural
settings. This (h) external environment promotes sharing behaviour and
solidarity structures coinciding with and taking place in household settings.
The f setting promotes profit maximization and commercial exchange structures
taking place in firms and markets. External environments typical of state
settings s are characterized by highly skewed human endowments, esteem and rank
among differentiated population groups
THE SUBSYSTEMS (H,F,S)
·
Proceeding from the level of settings to the
level of subsystems involves objectifying the settings, that is to say
depersonalizing them and turn them into entities that relate to each other as
such, and supplementing these entities by additional institutions for
safeguarding the sustainability and expansion of the subsystem. there is a
widening of the scope of economic activities at the subsystem level when
compared to the setting level.
·
A subsystem is much more than the sum of its
constituent settings, i.e. constituent entities. All entities in a subsystem
have the common interest of sustaining the common goal of their subsystem. To
that end, the entities within a subsystem join together and erect institutions
at the subsystem level that promote their typical transformation processes, and
secure their sustainability. The
deepening of the motivational goal of the setting towards that of a collective
motivational goal for the subsystem as a whole is the case in point why the
whole is greater than the sum of the parts.
·
How do acts of free riders affect the collective
motivational goal of the subsystem?
The non-competitive practices of
free-riding firms raise their profits but undercut the profit potential for the
subsystem of all firms; and to illustrate, the free riding reduces achievement
level of profit maximization for complying firms.
·
Each subsystem erects institutions aiming at
strengthening its sustainability and growth. The degree of success that the
subsystem achieves in holding its members together and avoiding free riding is
conditioned by how the external environment develops.
INFLUENCES AND DOMINANCE OF ONE
SUBSYSTEM OVER SUBSYSTEMS
1. Interactive
influence
·
The interactive influence focuses on agents and
is determined by the degrees of participation and activity of the agents. The
same agents can be members of more than one setting simultaneously.
·
The squares, triangles and circles (in above
fig.) refer to the three organizational settings, each with its own members;
the arrowed lines linking them are engagement lines which indicate
transformation and mutual exchanges taking place among agents in or between the
organizations, as well as communicated behaviours. Each engagement line can be
interpreted as consisting of a large number of bits of exchanged
transformations and communicated traits. Such an engagement line can be denoted
by Gibi’b’. As these bits are not uniform in intensity in
terms of time, effort or effects, they can be normalized making use of some
scale of engagement intensity, which can be denoted by N, and expressed in
terms of time, effort or effect. The engagements weighted by intensities can be
expressed by Σib(Gibi’b’.Nibi’b’).
This term can be eventually divided by the sum of all engagements weighted by
intensity in the whole economy to give a relative measure of the strength and
dominance of the engagement lines.
·
The
engagement lines express agent mobility between alternative settings. A better
performing subsystem attracts more agents from less performing subsystems, and
tends to become dominant. Over time, the behavioural motive of the dominant
subsystem becomes the norm for whole system. Thus, one subsystem is very likely
to evolve into, and be identifiable with the whole system.
·
Some six mechanisms, that may include
overlapping, can be singled out as determining the formation of the common, its
spread and dominance.
(1) Sharing of the same external
environment and past history fosters convergence towards a common behavioural
type. Furthermore, accumulated agent interactions and economic activity over
long periods of time enhance agent uniformity.
(2) Intensive and extensive
interactions and communications of agents participating in several settings are
prone to extend the prevalence of the advantaged behavioural type that
associates with dominant setting or subsystem.
(3) Agents observe the
transformation outcomes in alternative settings, and move to the advantaged
setting or copy its behaviour thus resulting in the prospect that the typical
behaviour of the advantaged setting becoming prevalent.
(4) Network externalities enforce
convergence towards the advantaged behavioural type.
(5) The deep-rooted social-psychological inclination of agents, or for
that matter all individuals, toward consistency in their relationships and
cognitions, ends up in adopting a positive attitude towards the preferential
behaviour of the dominant counterpart. This is the premise in balance theory of
Heider (1958), which holds that individuals constantly seek to achieve balance
where social relationships enter into conflict, by either changing their
sentiments or attitudes toward dominant persons or situations, or by
subjectively diminishing the importance of the conflict.
(6) There is a wide range of labelled mechanisms that have been
approached from different corners in the literature on convergence and
concentration of social systems around specific behavioural types. These
labelled mechanisms overlap with our six broad channels. These mechanisms
include imitation, convention, focal points, information cascades, reciprocal
behaviour, group learning, Markov chain inversions, melting pot and power of
dominant shares, among others.
·
We propose to formulate a Dominance Index (DI)
to express the interactive influence of subsystem B on other subsystems,
denoted by DI B. The index has two arguments: relative share of
agents in B and relative share of transformations in B. See Eq. (2.4).
DIB = (ω1AB
+ ω2CB) ≥ ν
(2.4)
In this equation, there are two
share parameters that affect prevalence. AB is the share of
agents in subsystem B. CB is the share of commodities most
suitably transformed in subsystem B, in all commodities. Personal commodities
are most suitably transformed in firm settings. Collective needs are most
suitably transformed in state settings. The probability that a behavioural type
characteristic of subsystem B prevails over all other Bi occurs when
DI for B exceeds a high value of ν. In this equation, ω1 and ω2
are weights applying to these two shares, whereby ω1 + ω2
= 1. Equation (2.4) proposes that the greater the shares of those agents
and commodities associated with a particular setting, the greater is the
probability that the behavioural type underlying this setting prevails over
other behavioural types.
We introduce ν which is a proportion that represents a critical mass.
Once the practice of a particular behavioural type reaches this critical mass,
this behavioural type can be expected to benefit from network externalities and
to extend its maintenance to practically the whole population. There are
different views concerning the likely value of the critical mass. A value of
3/4th (0.8) is among the most quoted in the literature on a critical
mass, cf. Simon (1993). Once this threshold is reached, the dominance of the
subsystem concerned and its characteristic behavioural type, this
characteristic behaviour can be expected to gain momentum in view of network
externalities. Network externalities push the dominance of one subsystem over
other further.
2. Regulative
influence
·
By regulative influence, we mean a situation in
which a behavioural setting b happens to stand higher in relation to b’ in the
hierarchy of settings; allowing b to set behavioural rules typical of b that
other settings b’ should abide with. In this way, the behavioural type of b
overrides b’ , allowing the further spread of behavioural norms of b at the
cost of those of b’ . The origin of the regulative influence lies in the
ability of the higher settings to impose binding rules of conduct on the lower
settings. n.. The interactive influence represents the results of horizontal
integration. Regulative influence is a vertical relationship. In the horizontal
channel, agents in setting b are many and have a high intensity of interaction.
These agents participate as well in setting b and interact with agents in b ,
and thus transfer their behavioural type to b , so that in time, agents in
setting b’ take over the behavioural type characteristic of setting b. In the
vertical channel setting, b stand higher up than b in a relational hierarchy.
Binding rules of conduct are imposed by setting b that setting b should
observe, resulting in behaviours and outcomes of b that are consistent with
those of b. The dominant power of the firm subsystem is the result of the past
growth of interactive influence and is less the result of a regulative
influence of the firm subsystem on other subsystems.
DOMINANT SUBSYSTEMS AND RELATED
PROTOTYPE SYSTEMS: HIS, FIS, SIS
·
It is unlikely in the real world that complete
convergence occurs, in the sense of 100% of all agents converging towards the
same motivational behaviour of the dominant subsystem, we speak of prototypes
of economic systems rather than absolute systems.
The first prototype, and the
oldest, is the economic system that centres on households and in which agent
behaviour and institutional rules in the whole social system have adapted to
household behavioural traits. This can be called the household intensive system,
HIS.
The second prototype is the economic system where agent behaviour and
institutional rules in the whole social system adopt a firm-like behavioural
type, i.e. maximization of economic returns. The firm intensive system, FIS,
has many copies in the real world; the best example is the US.
The third prototype is the
economic system where agent behaviour and institutional rules have adapted to a
statelike behavioural type that is characterized by rent acquisition and
political advantages. In the real world, Soviet Russia was the typical example
of a country that operated along the state intensive system, SIS.
·
We postulated that the intrinsic goal functions
of the minor subsystems are modified so as to accommodate to the goal function
of the dominant subsystem. But the latter is not totally immune from some
influence due to the minor subsystems. The indirect planning methods by the
state in France that is otherwise an FIS-centred country is one example.
Another example is the polder consensus model in the Netherlands which has its
origin in the 16th–17th century. Some aspects of the sharing economy in Japan
go back to tribal sharing centuries ago. The Chinese kinship-business model
which esteems competition and deals between kinship-related entrepreneurs is
traceable in the current conduct of the F and S subsystems in modern China.
Many transition countries traces of rent politicization and rent seeking from
past communist regimes.
EXPLORING PATHS OF DOMINANCE FROM A
COMMON STARTING SITUATION
·
It is helpful to postulate the development of
the three subsystems as an outgrowth from some common origin, which is by
definition, the customary household settings. Now that there are firm-centred
and state-centred economic systems, then how did they proceed from the
customary households? There are two main approaches in answering these
questions. One approach would start by emphasizing the differentiated effects
of differentiated external environments, which is very basic, and revert to
external events and internal dynamics in a historical-institutional
timeline fashion and trace their impact on the developments of the
subsystems/system in different countries. An alternative is an analytical
modelling approach that would examine how changes in external forces affect
the comparative advantages (i.e. the prospects) of the subsystems; such
external factors would include technological change, demographic growth, higher
welfare and the changing patterns of human needs with respect to private and
public goods.
·
The starting point is conveniently the situation
where household settings are already there. Which settings followed: firm
settings or state settings? Hicks (1969) is among the many economists who
contend that tribal chief, feudal landlord, army and state settings
historically preceded firm and market settings. Social anthropologists, like
Firth (1967), maintain that economic organization and the transformation and
exchange of products within and between neighbouring primitive societies came
first and preceded political organization.
·
The formation and development of a subsystem is
subject to weakening and strengthening effects that associate with events and
traits occurring in the external environment. Weakening of subsystem B is
defined in the sense of agents and transformations leaving B and going to B’ ,
thus leading to a decline in the significance of subsystem B and a rise in the
significance of B’ . Another form of weakening is when agents shirk from the
goal function, succeed unsanctioned in violating the institutional rules and
realize personal gains at the cost of a greater loss for the conforming agents;
thus resulting in a net loss for the subsystem. For agents to leave or shirk,
some inducing changes in the external environment (challenges, opportunities)
must have occurred.
·
The ages of geographical discovery and colonial
conquest in the 14th–17th centuries strengthened both subsystems in Europe,
though more so for S than F. The industrial revolution in the 18th–19th
centuries brought technological advances which enhanced major diversifications
in demanded private goods, a huge jump in personal needs of the newly settling
migrating populations and a significant push for the firm subsystem; this
period also saw the subjection of state governance to constitutional law which,
in terms of dominance, was equivalent to a downgrade of the state subsystem.
Frustrations with an unfair and insecure social order and nationalist
aspirations in the 20th century encouraged calls for authoritarian rules and
led to a dominant state in various parts of the world; in some cases, the
duration was temporary as in the ex-Soviet Union, in other cases, it is still
going on. The financial crises in the western world and the rise of China and
India as leading economies in the 21st century are fresh and the directions of
their long-term effects for the F and S subsystems.
·
Which subsystem came first: F or S? We present
here a modelling framework of long-range systemic development that allow for
both scenarios. The framework is basically microeconomic, and is based on
several premises.
(1) Agents inhabiting household
settings, and interacting with each other in a communal environment, experience
specific needs, or can be attended to uncovered needs, and they are ready to
embrace these needs. Agents are also innovative and capable of finding
solutions and creating new transformation settings that satisfy these needs.
(2) The needs of an agent can be personal or collective. Personal needs of one agent can be directly
satisfied by the innovative and responsive transformation offered by another
agent; opening ways for exchange and firm settings. Collective needs are
indivisible and their satisfaction would require a joint effort of agents and a
third-party intervention to coordinate the task at a higher level; which opens
ways for public goods, delegated authority and state settings.
(3) In communities where personal
needs happen to have an overweight, the firm setting will emerge and prosper.
In communities with an overweight of collective needs, the state setting will
emerge and prosper.
(4) The model assumes tentatively
that the external environment is kept constant, and allows for subsequent
refinements.
EXPLORING ABSENCE OF DOMINANCE: THE MULTI-POLES SYSTEM (MPS)
·
In this multi-poles environment, the need to
streamline the vast heterogeneity of agents has enhanced the significance of
what can be called persuasion settings, an adapted notion from Murphy and
Shleifer (2004), where divergent groups with different interests are parts of a
network of trustees who aim at proposing common agenda and coordinating actions
to meet the collective needs of the divergent groups. Figure
sketches main contours of MPS.
·
Persuasion settings take place in the context
of large family firms with state participation, joint business-state ventures,
township and village enterprises, urban and rural cooperatives, as well as in
the widely publicized influential events that recur in party congresses,
judiciary courts, populous rallies, government decrees and intellectual and
media disclosures. While persuasion settings do not constitute economic
transformation settings in the conventional sense, they do perform value-added
transformations in the sense of arranging negotiated deals and producing
trading services in ways that are formally not different from what traders do
in the market.
·
Our consideration of persuasion settings is
short of treating them as a subsystem.
MORE DYNAMICS: INTERACTIONS BETWEEN WORLD
DEVELOPMENT AND ECONOMIC SYSTEMS
·
We have chosen as title for this volume “World
Development and Economic Systems”, but it could have also been “Economic
Systems and World Development”. There is a continuous interaction between (a)
world development and (b) economic systems. Changes in (a) can change (b), and
changes in (b) do not go unnoticed in (a).
THE EVALUATION FRAMEWORK FOR ECONOMIC
SYSTEMS
·
In welfare economics, it is usual to distinguish
between welfare criteria, such as economic efficiency and social equity and
performance indicators, such as economic growth rate, income distribution,
poverty incidence, inflation rate, etc.
·
The objective measure of economic efficiency is
conventionally taken to be Pareto optimality which states that any change that
makes at least one individual better off and no one worse off is an improvement
in social welfare. Rephrasing, a situation in which it is impossible to make
anyone better off without making someone worse off is said to be Pareto-optimal
or Pareto-efficient. It should be emphasized that the Pareto criterion is a
value judgment as it might not be shared by everybody.
·
The attainment of maximum economic efficiency is
obstructed by the following four complications in the real world. (1)
Production indivisibilities allow increasing returns to scale which give cost
advantages to giant producers able to monopolize and limit competition. (2)
Imperfect governance caused by imperfect information heightens uncertainty, and
reduces activity, noting that imperfect information associates with adverse
selection and moral hazard. (3) Presence of externality effects violates the
independence of utility functions of consumers from each other and the
independence of production functions. (4) Public goods cannot be marketed but
they have to be produced and financed.
·
But this maximum is not unique, for it presupposes
a given distribution of income. Here comes the equity criterion. Besides,
whatever degree of Pareto-efficiency attained, this is subjectively related to
the underlying distribution of endowments (income and wealth).
Chapter 3 EMPIRICAL VALIDATIONS
·
This chapter falls in the next section that
proposes the positioning of country (groups) along the prototypes of household
intensive system (HIS), firm intensive system (FIS) and state intensive system
(SIS). There are tens of international agencies that have set up their own
databanks resulting in a multitude of overlapping country groupings. We shall
focus on and make use of the databank of the World Bank (WB) as our main
source, as it is the one most used and most flexible to modify. The classified
groupings may have been meaningful and useful when it was initiated in the
past, but may have become absolute and confusing over time. We have adjusted
the WB databank to the above-mentioned modifications. In summary, the
modifications relate primarily to the introduction of two additional country
groupings: RRTC which is closest to a contemporary SIS, and CAC which is a
dynamic development region that saw its birth some two decades ago.
One additional elaboration can be
mentioned. In pursuing the analysis of SIS, and how relating economies
restructured and performed during their transition towards mixed economies, we
made an additional temporary distinction between the Baltic, Central and East
European countries (BCEE),1 which later went up in the EU et al., and the
XSIR,2 which later substantiated the CAC development region.
·
We have in mind, four levels of system
interaction which we came across in Chapter 2, and which can be briefly
described as
(1) identity of the attitudinal behaviour
of agents with the subsystem or system which they inhabit,
(2) institutional conduct is specific to
the subsystem or system considered,
(3)
economic performance is specific for the subsystem or system considered and
(4)
the relative influence of subsystems is measurable via the dominance index, and
together with other deductive indicators, they can be indicative of convergence
tendencies of the total system towards the dominant subsystem.
AGENT ATTITUDES
·
One line of validation of the theory is to check
on the degree of conformity between the motivations and attitudes of agents and
the contended motivation of the subsystem, or system, to which these agents are
affiliated. An important data source on agent attitudes is the World Value
Surveys (WVS). The survey is a compilation of national surveys on values and
norms on a wide variety of topics. It started in 1981 and was carried out in
1981– 1984, 1990–1993, 1995–1997 and 1999–2004.
·
The WVS data also show a higher prominence of
family settings and family related attitudes in the FIS industrial countries
than in the SIS transition countries; suggesting that firm settings have been
more accommodative to familial institutions than state settings. Especially in
the context of the ex communist rule in the transition countries, the state
appears to have undermined household settings at a greater pace. This is also
apparent in the low ratings reported for China and Vietnam.
INSTITUTIONAL CONDUCT
·
There is the well-known index of firm
competition — also called ‘Index of Economic Freedom’, which is based on 10
indicator groups: (a) business, (b) trade, (c) fiscal, (d) government control,
(e) monetary, (f) investment, (g) financial, (h) property rights (i) corruption
and (j) labour mobility. Higher values of the index for a country represent a
greater strength of its firm subsystem.
·
Another indicator that reflects on the influence
of the state subsystem in FIS countries is the share of state revenue in the
GDP.
OUTCOME PERFORMANCE
·
It was mentioned earlier that a household
intensive economic system is less capable than firm-centred or state-centred
economic systems in producing larger valued transformations.
·
(a) in its economically optimal form, competing
firms in the firm-centred economy would maximize their profits to the point
where inefficient profits would be eliminated by more entry and exit of firms;
and if this is realized, the maximum economic welfare obtains; and
(b)
the state in a state-centred economy can achieve the same maximum economic
welfare, if it succeeds in obtaining the right information flows and
coordinating them; and if it is able to calculate its exploitation margin right
and implement it, that is to say, it will not impose a too high inefficient
margin that could reduce the size of the cake and the ultimate margin as well.
Both conditions may not be tenable.
·
Both groups [ SIS and FIS countries] experienced high growth [ average annual
growth of the GDP, and the GDP per capita]
from 1950 to 1970. The growth of SIS countries started declining in the
mid-1970s and reached a standstill in late 1980s. What is the source of the
decline? To get more insight in the problem, distinguish between extensive
growth that is identical with growth of factors of production such as labour
and capital inputs (which need not be specific to the system), and intensive
growth that is identical with growth in total factor productivity, i.e. more
output per unit of input (which is usually specific to the system). It is
generally acknowledged that during the early stages of economic development,
economic growth tends to be of the extensive growth type, as output expansion
is achieved largely from mobilising and using more factor inputs. At higher
stages of economic development, intensive growth dominates as factor
productivity increases significantly through better use of the factors of
production, higher technology, more efficiency, etc. It is generally recognized
that the pace of factor productivity is greatly determined by the structure and
conduct of the economic system concerned.
·
The usefulness of these distinctions is readily
seen from Eq. (3.1). Take v, for growth rate of output, to consist of
the two components: growth in factor use and growth in factor productivity. The
first component is the weighted sum of the growth rates of inputs of labour l
and capital k, the respective weights should reflect their
respective marginal returns as represented, under market equilibrium
conditions, by each input’s share in the national income, thus rl
and rk. The second component is the growth in factor productivity,
y. v
= (rll + rkk) + y. (3.1)
By
inserting the value of the growth of output v and the growth of weighted input
(rll + rkk) and deducting, the growth in factor productivity y is obtained as
residual.
·
Rather than becoming more intensive, the growth
of the communist regimes continued to be more extensive. For a modern economy,
the opposite pattern of intensive growth should have happened. The very low
past performance with regard to factor productivity has manifested itself in
what was previously mentioned as failing outcomes of the communist system, such
as persistent shortages, waste due to misallocations, backward technology, low
quality of goods and services and retarded advancement of well-being.
·
The other outcome that we focus on is the
distribution of the value added on the agents. Because of the sharing norms in
HIS, income distribution here is likely to be most equitable among the three
systems. In FIS, distribution of the value added is likely to show greater
concentrations of returns for agents who are more suited as profit maximizers,
and given their smaller number among all agents, this implies a skewer
distribution in firm settings than in state settings. In SIS, although the
average remuneration for agent k is higher than the average level of net
benefits left over for agents i, it is in the interest of the governing agent k
to satisfy the governed agent i in terms of material needs and observed
remuneration, which would generally result in a less skew distribution in state
settings compared to firm settings. Moving from a SIS system to a FIS system
will necessarily result in a skewer distribution of primary income.
·
A readily available indicator for both FIS and
SIS countries that comes a long way towards fulfilling the relevance conditions
is the ratio of per capita income for persons in the 75th percentile to the per
capita income for persons in the 25th percentile.
Chapter 4
EVOLUTION AND EVALUATION OF THE
FIRM INTENSIVE SYSTEM IN FIS-CENTRED COUNTRIES
·
We have described the Anglo American countries,
European Union (EU), Japan, Korea and a few other countries as firm intensive
system (FIS)-centred countries. US as closest to the pure FIS, while Europe and
Japan are placed on the sidelines that link with state intensive system (SIS)
and household intensive system (HIS), respectively. As all FIS countries
interact with each other intensively, they can be viewed as a world system that
holds together in maintaining its FIS-centred character.
·
The configuration in Figure is consistent with descriptive studies of
capitalist economies. These studies generally agree on a distinction between
three configurations for industrialized economies: the liberal-oriented,
the regulation-oriented capitalist and the reconciliation-oriented
systems.
·
In the liberal-oriented capitalism, coordination
is run along commercial logic and profit maximization by firms, moderated
competition monitoring and limited public goods provisions and income
transfers. This profile is typical of the Anglo-American industrialized
countries, in particular UK, Canada, Australia and led by United States.
The regulation-oriented capitalism supports
regulated competition, moderate factor mobility, moderated income differences
and a larger state budget. Firms tend to shift part of their response in the
correction of market failures towards the state. Although the resulting state
interventions can be interpreted as serving the social interest, they may at
times serve the benefit of special interests, and if they are too many, they
can restrict the free operation of commercial exchanges. This profile is
typical of most continental European countries. The orientation can be related
to the state subsystem that used to be more influential up to the 18th century
in continental Europe.
The reconciliation-oriented capitalism is
one based on frequent negotiations between firms, workers, community leaders
and public authorities at various levels of decision making with the object of
reaching consensus agreements among these groups on restrictive and promotional
measures that correct for market failures and bolster group welfare. The
reconciliation approach in Japan often contains elements of fair sharing of
benefits and costs among the involved parties, which is a common principle in
household settings, and can be seen to be a surviving influence from the
otherwise practically extinguished tribal-customary household subsystem.
HISTORICAL DEVELOPMENTS
·
In Europe, the marathon began in a period of
fragmentation and vacuum, around 900 or 1000 AD. Once the race was started, the
leading subsystem at the time (that of traditional household settings)
experienced a continuous loss of agents and transformation to the benefit of
rising subsystems. A spectacular gainer in the 11th–13th centuries was the
theocratic subsystem (church and related settings), but this dwindled in later
centuries. The feudal–lordship–manorial subsystem (an overlapping combination
of feudal, lordship and manorial settings) was another spectacular gainer in
the 10th–13th centuries, but was destined to disappear completely five
centuries later. It took manor law, urban communes and the central monarch
another five centuries of reformist and constitutional revolutions to evolve
and fuse into the democratically elected state subsystem that is characteristic
of western countries today. Small in size but rising in terms of agents and
transformations were merchants and craftsmen. Although the trading, crafting
and cottage industry settings expanded with growing markets for goods, labour
and finance, it was only six centuries later, with the industrial revolution
(IR), that these settings developed into firm settings; and it took the firm
subsystem two more centuries to evolve to their present dominant position in
western countries.
The period of 1000 to 1400
·
Uncertainty, fragmentation and defeat in the 6th
to 10th century were at maximum levels, the dominant traditional household
subsystem already started to crack down, and newly emerging subsystems started
showing their mussels. The 11th to 14th centuries provided historically the
right times for newly emerging settings to consolidate themselves into emerging
subsystems and establish institutions that assure their sustainability.
Foremost among the newly emerging subsystems
1. The
Papal revolution and crusade wars : It was only in the 11th century
with the commencement of the Papal Revolution that the Christian Church
organized itself as a coherent and unified theocratic subsystem, and was able
to exercise substantial influential powers on other subsystems. Dictatus papae,
initiated by Pope Gregory VII, circa 1050–1080, has been named by legal
historians as the Papal Manifesto. Legal historians, Berman (1983), trace the
origin of the Western legal tradition back to the Papal revolution. The crusade
wars were a major world development of the time. The traditional household
subsystem was further weakened.
2. The
feudal–lordship–manorial subsystem: The feudal subsystem was
strengthened by manorial laws. In the feudal subsystem in Europe, the monarch
loaned land to vassals (i.e. lords, often belonging to nobilities) in exchange
for loyalty and protection. At a lower order, the lords loaned land to their
own vassals (i.e. peasants), and so forth. There were thus different levels of
‘vassalage’. The lord granted lands to peasant households in exchange for
military service and working the land, whilst the vassals were ensured work,
homes and protection. The feudal subsystem gained momentum with the crusade
wars. It was a main supplier of soldiers and food. But the growth of the feudal
subsystem and manors began cracking in later centuries as social mobility among
peasants increased and the bondage with land decreased.
3. Urban
communes: Councils and parliaments were an integral part of the
organization of the commune, which showed quite a high degree of participation
in the making of decisions cf. Hyde (1973).
4. Trade
guilds: The crusades required production and maintenance of
transportation means on land and sea, costumes, metal weapons and related
tools, which meant an enhanced role for traders, transporters and craftsmen and
an emphasis on acquiring skills and training apprentices. Merchant and
occupational guilds came into being in these years. As trade and travelling
increased, road piracy increased. This prompted lords to employ armed guards
for protecting traders, in exchange for fees; which set in motion the
introduction of standardized currencies that propelled the exchange economy
further. The trade and craft guilds formed the seeds of the firm subsystem, F,
which became dominant in later centuries.
The period of 1400 to 1700
·
We focus on four major developments that
occurred in this period. Two additional major developments took place later in
the period.
1.
The Renaissance: After
reaching their climax in the 12th century, the grip of the Papal revolution and
the supremacy of the supernatural began to diminish in the 13th century.
Reliance upon absolute faith weakened. The Renaissance, or re-birth, began in
Florence, Italy, a few decades before 1400, and spread later to the rest of
Europe. The two outstanding revolutionary changes in this age were those of the
protestant reformation and of the parliamentary democracy, which have been
labelled by historians as the German revolution and the English revolution (in
contrast to the Papal revolution which was based in Italy). Humanists like
Niccol`o Machiavelli, and Thomas More emphasized the virtues of intellectual
freedom and individual expression.
2.
The Reformist Revolutions: Martin
Luther started the German revolution in 1517 by challenging ecclesiastical
authority in the most radical terms. In 1529, ruling princes and city
representatives, in support of Luther, protested the imperial decree, and civil
war broke out. It is from this protest that the name Protestant is derived.
The English revolution was led by
Reformist Puritans, who in 1640 formed a majority in the parliament that was
seldom convened, they opposed the absolute reign of the monarch. The Puritans
were English followers of the French reformer, John Calvin, who established a
protestant community in Geneva which denied the authority of the Roman church. “A
civil war broke out in 1640 between the Puritans (mostly reformist trading and
craft guilds in towns and countryside) and supporters of the monarchy
(conservative churchmen and landlords). The Puritans seized power, formed a
commonwealth government, trialled and executed King Charles I for treason and
abuse of power in 1649. As it often happened in history the immediate
governments after a revolution had a short life, this was also the case in
England. Ten years later, the Puritan rule collapsed in 1658. The king’s son,
Charles II, was restored as monarch. When the next monarch, James II, resumed
abuse of power, he was forced to abdicate and a new dynasty was installed in
1688. Henceforth, the governing authority was the parliament and not the king.
3.
The world discoveries :
Although the roots of the discovery age go back to the Vikings, the crusaders,
and the eyeopeners of the Renaissance, the immediate need for explorations came
from the war successes of the Ottoman Empire in the Middle East and their
ability to obstruct overland trade routes from European to the spice-growing
Asian countries. In reaction to these barriers, governments and traders in
Portugal and Spain started exploring new ocean routes to Asia. Political power
and economic trade were major motivations. While succeeding in opening a
southern trade route to Asia by sailing around Africa into the Indian Ocean;
Spain and Portugal stumbled across the Americas. Soon after, the Dutch, British
and French followed. Italian citizens (C. Columbus) and ports (Genoa, Venice)
played central roles in explorations and trade.
4.
The colonial conquest: After the discovery of the Americas
With limited native populations in the colonies, the colonial governments and
traders looked for other workforce sources: slaves. Triangular trade involved
three stages: Carry first goods such as cloth, spirit, tobacco, beads, metal
goods and guns from Europe to Africa. The goods were sold to Afro-Arab slave
traders in exchange for more slaves. The guns were used to help expand empires
and subjugate slaves. The second stage was an inhumane shipping of the slaves
to the Americas. The third stage was the return to Europe with the produce from
the slave-labour plantations: cotton, sugar, tobacco, molasses and rum. To
increase their income from taxes in the triangular trade, European monarchs
encouraged the formation of joint stock companies. Stocks (or shares) were sold
to investors who shared the expense and risk of expensive ocean trading
voyages. If a ship went down, no single investor lost everything, but if a
voyage was successful, all stockholders shared in the profits. Most voyages
succeeded, and many investors made good money. Since the joint stock companies
of the colonial era were chartered by governments, they were a form of
state-sponsored firm ownership. This is a bright example of how the state
subsystem has strongly supported the firm subsystem.
5.
The rise of nation states: .
Generally speaking, the state is a coordinated polity system with geopolitical
boundaries, while the nation implies a unified population along cultural,
religious, linguistic and other related dimensions, territorially bounded. The
term nation state implies that the two combine in one, and thus reinforce each
other. The rise of nation states in 1400–1700 boosted significantly the
authority and strength of the state subsystem in Europe. portant roles in the
development of the nation state in different countries. The nation state
gathered strength in the age of world discoveries and colonial conquests.
Mercantilism rationalized that the nation state should apply national political
norms in ruling over national economic interests, and that the objectives of
the nation as identified by the central monarch were superior to those of
traders and craftsmen. The goal of national policy was thus to strengthen the
national economy and weaken foreign adversaries by monopolizing crafts and
markets, restricting imports, accumulating surpluses in the balance of trade
and expanding overseas colonies.
6.
The rise of business metropolis: A crucial development in the economic
history of Europe was the major shift of economic power from the Mediterranean
Sea to the North Sea, which went along with the creation of multi-purpose
business metropolis in the latter. A business metropolis is a large city or
urban area which is a significant economic, political and cultural centre for a
country or region, and an important hub for regional or international
connections, commerce and communications. By building the business metropolis,
the merchant class minimized the cost of exchanges (i.e. search, negotiation,
enforcement and financing costs). Enforcement costs of contracts were
facilitated by public notaries attached to the markets and sanctioned by
government. Another major breakthrough was the development of a financial
market which was driven for a part by fiscal borrowing needs of foreign
governments, France and Spain among others. The liquid business leaders were
ready to lend. Short-term and long-term depositing and lending to many sorts of
customers grew significantly, facilitated by establishment of banks and the
legal right of transferring and endorsing obligatory letters of payment to
third parties.
The period of 1700 to 1900
1.
Enlightenment and the Constitutional
Revolutions: The Enlightenment era (1700–1850) is held to be the source
of critical ideas, such as democracy, rights, liberty and reason as primary values
of society. Montesquieu’s Spirit of the Laws had expounded the theory of
separation of powers; by placing the functions of legislation, executing, and
judging in three wholly separate compartments, with legislation supreme over
the other two. Rousseau taught that law should rectify inequalities that arise
from natural differences among people. In his Discourse on Inequality, he
proposed that inheritances ought to be reduced by taxes, and that those who
owned no land receive some. As is generally known, the American Revolution
(1775–1783) started with Jefferson’s Declaration of Independence (which
contained ideas from the Political Enlightenment), establishing the
independence of 13 North American colonies from Great Britain and creating the
republic of the United States of America. At around the same time, the events
of the French Revolution rolled.
2.
Economic thought and the IR: Technically speaking, the IR began in
Great Britain around 1760 and within a few decades spread to Western Europe and
the United States. A first phase ending in 1840 converted hand production
methods into mechanical ones, introduced new chemical manufacturing and iron
production processes, and developed machine tools. As regards energy, wood was
replaced by coal, steam power introduced, and water power improved. A second
phase, between 1840 and 1870, saw increasing adoption of steam-powered boats,
ships, railways and factories, and the large-scale production and use of
machine tools.
Even
though the prerequisites were present, yet the IR once started, it overturned
the whole socio-economic and polity system upside down. The IR fuelled the
creation of the profit maximizing firm settings as we know them today. The firm
is hence a factory or a workshop that the risk-bearing owner/manager/entrepreneur
sets up, and it is populated by hired regular employees who engage in the
mechanical transformation of inputs into outputs (intermediate and final
products). The outputs, scheduled for sale at stipulated prices by the owner,
can end up in other prices once subjected to market forces of demand by all
consumers and market forces of supply by all producers. These modes of
production, distribution, pricing and clearance were made real by the IR.
Classical economists, i.e. Adam Smith (1776), succeeded in specifying and
knitting these different modes into a consistent static economic system in
which consumers and producers pursuing utility maximization and profit
maximization, respectively, and left to their own, would equalize their respective
demand and supply at variable prices in perfectly operating markets. s.
Classical economists highlighted the circular flow and the growth dynamics of a
profit maximizing firm-driven economic system. Because profit rates tend to
diminish as more competing firms enter into production, competing firms seek to
innovate and widen the scope of production towards more goods with higher
profit margins.
The conclusion to draw at this point is
that economic thought laid down the foundations for promoting the processes of
the IR and the dominance of the firm subsystem on other subsystems. By the end
of the 18th century, feudal manors and urban communes were fused in the state
subsystem, trade and craft guilds became part of the firm subsystem; and
theocratic settings seized to have significance in the economic system. Before
ending this section, it is important to emphasize one major difference between
the classical economists (1700–1850) and neoclassical economists (1850 and
later), which we consider as crucial for our analytical framework. While the
attention of the classical economists was foremost on markets, the neoclassical
economists brought the firm explicitly in the picture.
The
period of the 20th century and recent years
·
The state subsystem in the western world, after
going through the German, English, American and French constitutional
revolutions, can be said to have reached its polity trajectory and satiation
point already by 1820 or some two decades later. In the 20th century and later years, we single
out the following major events and comment on their [firm] systemic impacts. The major events include
two world wars, two great financial collapses and several breakthroughs in
political and economic western integration.
1.
WWI (1914–1918): The enormous
cost of the war undermined the financial stability of all of the countries
involved and their state subsystems had to bear a burden of debt for many years
to come. These financial losses, combined with the battlefield deaths and
physical destruction, severely weakened the western front European powers, and
pushed US to become a world political power and the world’s largest economy. On
the east front and one year after the war, the Russian Revolution replaced the
czarist regime by communist rule.
2.
WWII (1939–1945): The contra
parties were the same as in WWI, except that this time Germany’s allies
included Italy and Japan. The outcome in terms of gainers and losers was also
the same as in WWI. The terms of peace were totally different, however. Instead
of losers paying war indemnities, the losers and the west European gainers
entered in a period of post-war construction financed for a large part by the
US, while the Soviet Union (with allied and/or subjugated east European
countries) continued along its communist track.
3.
Great
Depression (1929– 1942): Began in the US and spread to most FIS
countries. The “Roaring” 1920s in US was a prosperous time, allowed excessive
enrichment of some, inflated expectations of many, fuelled the demand for
financial credit, leading to a bull market and ending in a bursting speculative
bubble in October 1929. The financial meltdown was followed by the longest
recession in modern times. By early 1932, banks failed massively, wiping out
the savings of millions of Americans. Unemployment reached 25% at a time when
unemployment benefits did not exist. Mortgages on many homes and farms were
foreclosed. Furthermore, a severe drought spread across the Great Plains in
1930 and lasted for a decade. Recovery started with the election of President
Roosevelt (his New Deal introduced programs to reduce unemployment, assist
firms, regulate banking and the Stock Market, and help the needy). With the
outbreak of World War II in 1939, the US began spending on armament and other
war expenses materials, which further strengthened a period of industrial
growth. The event of the Great Depression allowed the Federal Government to
expand its domain to meeting collective needs in social welfare, and regulate
the financial market. In the early 1930s, regulations were introduced to
restrict stock purchase on margin and coordinate risk taking in banking; in the
hopes that another severe crash could never happen again. But history replayed
itself some 75 years later.
4.
The financial crises (2007–2009): Started
in US in 2007, took the proportions of a financial meltdown in late 2008, and
spread globally to other linked financial markets economies, bringing them into
economic recession in 2008 and 2009. The main cause is an overexpansion of
lending activities that started from 2001 much beyond the ability of borrowers
to meet obligations to pay back (the unregulated shadow market in US reached a
worth of US$50 to 60 trillion). The overexpansion was facilitated by the use of
very risky, dubious, undisclosed and complex newly introduced financial
products and credit default swap insurance contracts that defy monitoring and
regulation. In attempts to restore financial confidence and recover the
economies from recession, state interventions in FIS countries ranged from
temporary nationalization of financial institutions to capital injections, and
bailouts of troubled investment banks; next to massive stimulus spending in the
economy to combat the recession.
5.
Integration of the FIS into a
consolidated firm intensive world subsystem: The establishment of the
North Atlantic Treaty Organization (NATO), the Organization for Economic
Cooperation and Development (OECD) and the EU were major steps in the
integration. Extension and harmonization of trade liberalization policies under
the auspices of the General Agreement on Tariffs and Trade (GATT) set into
motion business forces that are eager to introduce more competition and secure
mutual gains for the FIS as well as for other countries.
6.
Globalization: Globalization entered the world scene
in the mid 1988 as the GATT initiatives gained momentum with various rounds of
mutual tariff cuts, reduction of non-tariff barriers, passing norms for
government purchases from firms, export and farm subsidies, and dumping
practices. Replacement of GATT by the World Trade Organization (WTO) with
additional tasks of liberalizing trade in services, settling trade disputes and
facilitating investment between member countries promoted globalization
further. Freer trade, together with higher mobility of capital, labour,
knowledge, shared media and interactive communications worldwide gave a big
push to globalizing processes with significant impacts on business and state
organizations.
A
summary illustration of the changed relative powers of main subsystems in FIS
countries
1.
Early centuries: H, R
2.
9th–10th Century: H, T, M, R
3.
11th–14th Century: H, M, T, F, R, S
4.
End of the 17th Century: H, F, R, S, M, T
5.
End of the 19th Century: F, H, S, R, T
6.
End of the 20th Century: F, S
H : Traditional Household settings R: Royal settings, T:
Theocratic settings, M: Feudal
manorial settings, R: Royal settings,
F: Trade-->Firm settings,
S: Commune-->State
settings
CHALLENGES AND RESPONSES
The free market
economy model, market failures and policy responses
·
Welfare economics derived four efficiency
conditions that need to be satisfied for achieving economic efficiency in the
sense of Pareto-optimality. The efficiency conditions are the absence of
production indivisibilities, imperfect governance, externality effects and
collective needs. If because of various barriers the efficiency conditions
are not fulfilled in a market economy, one can speak of corresponding market
failures.
·
If all firms and agents behave competitively
there will be free entry and exit, there will be no barriers whatsoever to
exchange, all firms and agents will be price-takers at the same price for the
same commodity, and a simultaneous equilibrium will be obtained by all agents
in all markets — hence the term general equilibrium. In this pure model, market
prices carry significant information. Each commodity price would reflect the
buyer’s marginal valuation relative to other commodities. Moreover, the price
of a commodity will be equal to its marginal costs. This guarantees the lowest
possible costs that society is ready to sacrifice for a commodity. The First
Theorem of Welfare Economics is a proof of the above account: If the marginal
rules hold, then the resulting competitive market equilibrium is
Pareto-optimal. Guided by equilibrium prices the self interested decision of
the economic agents lead to a social optimum in the Paretian sense. This is
another way of viewing Adam Smith’s notion of the invisible hand mechanism. The
performance of the perfect market economy in the hands of firms depends on how
firms respond to four problem areas. There are technical barriers and
behavioural distortions that hinder fulfilment of these conditions. The
solutions lie respectively in strengthening competition, reforming governance,
internalizing externalities and the balanced provision of public goods.
·
There is the Second Theorem of Welfare Economics
that prescribes that any Pareto optimal position is an equilibrium for some
initial distribution of endowments. There is a dilemma here since any initial distribution
of endowments or income is arbitrary, implying there is no one Pareto optimal
position. The economist’s solution to this dilemma is to assume that a
democratically elected parliament or an appointed council of wise elders men
would review the income distribution situation at the end of the year and
resets this ex-post, giving due consideration to the perception of a desirable
initial distribution and unintended differential outcomes during the year.
Transfers are then affected in consistency with the resetting. If the resetting
is well done and duly implemented, then the outcomes of the FIS can be
described to be in harmony with the desired equity perspectives, even though
this happens with a lag in time. Deviations of the actual from the desired
distribution of income can be thus seen as a market failure, in addition to the
four other market failures mentioned earlier. Traditionally, welfare economics
has given less attention to the topic of how to deal with wealth distribution.
More recently, there is renewed interest in this problem area, Piketty (2014).
Table: A sketch of market failures in FIS countries.
Production
indivisibilities
·
In the real world, technological
indivisibilities in some vital industries persist and translate in increasing
returns to scale (or decreasing costs) making it likely that the industry will
end up with one single firm. Even if a natural monopoly does not arise, the
presence of indivisibilities gives an advantage to incumbent firms, which could
restrict entry, promote non-competitive practices, fix a high price and receive
a monopoly profit. 11 infrastructural industries that are characterized by high
indivisibilities are post,
telecommunications, electricity, gas and water, oil, coal, railways, airlines,
motors, steel and ship building. The discussion below examines the challenges
and responses regarding
1.
Natural
monopoly: appears when economies of
scale are important. With a natural monopoly, average costs are declining, and
marginal costs are below average costs. Hence, if prices were set equal to
marginal cost, as in the case of perfect competition, it would be less than
average costs and the firm would be losing money. If the community wanted a
natural monopoly to produce at the point where marginal cost equals price, it
would have to somehow support the industry to offset these losses up to the
point of nationalizing the industry and fully regulating it. The opposite
alternative is that the industry is privately owned and run but that the
production and price of the product are regulated in some degrees. These two
alternatives, nationalization versus regulation, are found in various
combinations in FIS countries.
Considering the nationalization
alternative, the presence of large capital costs and economies of scale turn
some industries into natural monopolies such as electricity and railways. There
are several problems that accompany nationalized industries. It is hard to
ensure that the industry does minimize costs. This is a problem of information
access and mechanism design between agent (management) and principal
(ministry). The managers of nationalized industries often lack adequate
incentives to cut costs and modernize vigorously; particularly given the fact
that government is frequently willing to subsidize the industry when it loses
money. In the regulation alternative, the dominant firm persuades other firms,
and the state, to accept this dominant firm as the sole owner of the natural
monopoly, while entrusting the government with the role of ensuring that price
is kept at the lowest possible level, commensurate with the monopolist’s
obtaining an adequate return on its investment. Prospects for the regulatory system
in FIS countries are constrained by two levelled objections. The first
objection is that regulations often result in inefficient practices. The second
objection relates to regulatory capture, which implies that the regulator
gradually comes to identify with the interests of the company it regulates.
The US approach towards controlling
infrastructural industries with large indivisibilities and potential monopolies
avoided nationalization, favoured entrusting ownership of these industries to
the private sector, and preferred to regulate the business practices of these
industries. In contrast, European countries were more for nationalization of
infrastructural activities. The national share degree is defined as the share
of the state in the ownership of an industry and calculated as a simple average
over the 11 industries.
2.
Imperfect competition: As most
industries operate under less than full capacity, they are able to set a market
price that is higher than marginal costs. The advantage will not be as permanent
as in the case of the monopolist but may be just sufficient to serve as a
barrier for entry. Seen from the monopolist point of view, monopolistic
practices (reducing supply and increasing price) lead to more profits. Seen
from the viewpoint of competing firms, the monopolistic practices limit the
gains and perspectives of the competing firms. Viewed by the community as a
whole, the monopolistic practices result in (a) restricted output with higher
prices, (b) efficiency loss as the monopolist lacks incentives to economize and
falls in managerial slack, (c) wasteful costs incurred to limit competitive
entry in case the monopolist intensifies rent seeking actions and (d) retarded
growth and lesser equity in the economy.
3.
The trade-off between perfect competition
and technological advance: entrepreneurs facing strong competition may
simply lack time for long-term planning and for undertaking more elaborate
projects of R&D. Besides, in a situation of heavy competitive pressure,
profits are usually so low that little room is left for the internal financing
of R&D activities. These considerations led to adopting national policies
that are receptive to a restricted competition that promotes rapid growth of
cost efficiency in the long term, on the condition that the restricted
competition does not lead to a monopoly power that eliminates competition. The
opposite scenario was recognized as well. Firms orient their investment,
R&D efforts towards making profits, which are highest with monopoly power.
This consideration led FIS countries to adopt national policies for fostering
competition-oriented technological growth.
Technology policy in FIS countries can be
stylized in two approaches: the single company approach and the perspective
synergy approach. In the first approach, individual firms are seen as
technology leaders and the state would focus on the innovating firm and attempt
to find the right balance between firm behaviour that capitalizes on
innovations and sufficient incentives to motivate development and application
of innovations. In the econd approach, the focus is less on firms and more on
industries: the presence of market imperfections is accepted but more emphasis
is put on the future perspective of alternative technologies at the industry
level. In this approach, an evolutionary framework is followed which seeks to
find the right balance between the knowledge cycle and information synergies,
and suitable forms of cooperation between industries and the state.
Imperfect
information and imperfect governance
·
Imperfect information is classified by two types
of sources, depending on whether the source is technical or behavioural.
1. Incomplete
information: In essence, the demand for and the price of the product that
the producing firm face are random. As a result, profit is also random, and
strictly speaking, is difficult to set at a maximum. As a substitute for profit
maximization, optimal decision-making theory perceives the objective function
of the firm to consist of the firm’s attitude towards risk, and the firm’s
perception of the likelihood of various outcomes. The greater the uncertainty,
the greater is the departure from risk-neutral attitudes. Furthermore, the more
incomplete the information on expected outcomes, the greater is the randomness
of profits and the less is the validity of the profit maximization objective.
2. Asymmetric
information: Akerlof (1970) was among the first to draw attention to
behavioural mischief, which is synonymous with imperfect governance. His
example was that in the market for sale of used automobiles, the seller will in
general have more information about the properties of the cars sold than the
buyers. Initially, buyers might think that the odds are 50–50 that a car they
buy will be high quality. When making a purchase, buyers would therefore view
all cars as being of “medium” quality. (Of course, after buying the car, they
will learn its true quality.) As a result, fewer high-quality cars and more
low-quality cars will be sold. This shifting continues until only low quality
cars are sold. At that point, the market price would be too low to bring forth
any high-quality cars for sale, so consumers correctly assume that any car they
buy will be low quality. Because of adverse selection, low-quality goods drive
high-quality goods out of the market.
Externality effects
·
In general terms, an externality can be said to
exist when a decision variable on buying or selling of one producer or consumer
cannot be excluded from entering directly into the utility or production
function of some other producer or consumer. This can be expressed by the
following expression Ui = Ui (xi1,...,xin,
yi ) where utility U of agent i depends on excludable goods x
ranging from 1 to n, produced and/or consumed by agent i, as well as some
non-excludable activity y carried by agent j. The externality problem relates
to economic interdependencies, which are not incorporated, or so as to say not
effectively internalized in the exchange economy. Two additional comments need
to be made before dealing with examples. First, an externality was defined as a
side-effect, either good or bad, that results whenever a person or firm making
a decision does not consider social costs or social benefits of the particular
decision, and, as a consequence, directly affects the utility or profits of
other consumers or producers. Second, externalities can be positive or negative
( development of the railway system and seaports / Air or water pollution ) .
·
Industrial and trade policy is a suitable
example for illustrating responses to positive externalities. Commonly,
industrial policy would refer to government actions which aim at growth and
change either via (a) a general shift of productivity and/or enhanced activity
across the board or via (b) a reallocation of means in the economy in such a
way that current and new activities with better perspectives (high rates of
social benefits to social costs) get higher weights at the cost of other
activities which are less attractive (low rates of social benefits to social
costs). The first channel is often called the neutral approach; the second
channel is the targeted approach. The approach adopted by the US government can
be described as a ‘missionoriented’ approach. Industrial policy in Western
Europe is mixed. British industrial policy is based on a liberal philosophy,
that industrial performance is best left to the private sector, assisted only
at the margin by state activity. Germany has applied both approaches to
industrial policy. Japan has mostly promoted a sectoral approach. Trade policy
is best seen in the context of the WTO which plays a central role in the
promotion of greater competition between firms in member countries and in
enhancing international trade via encouraging neutral industrial policies and
trade liberalization.
·
In FIS countries, a variety of firm-market
solutions and state measures have emerged to internalize polluting effects.
Firm responses include creating internal markets via forcing unitization, and
defining and enforcing property rights. Unitization is the creation of single
ownership and control of resources whose uses might conflict to create an
externality. Unitization does pose one problem, however. Creating a single
owner for the different activities may create a firm with market power. Then
solving one problem — an externality — creates another problem — a monopoly
Collective needs
·
If certain goods are not profitable, the firms
will fail to produce them. If nevertheless a community collectively considers
such goods as necessary, they become public goods and the state is called upon
to be the organizer/funder/ contractor to the hired producers of the public
goods.
·
In the
extreme, the first feature of a public good is that it cannot be supplied to
one consumer without simultaneously being supplied to others. When the good is
provided for one agent, it will bring external benefits to many other agents.
This feature is known as non-excludability
·
Also in the extreme, the second feature of the
public good is that once the good has been supplied to a single consumer, there
is no additional cost in supplying it to others. The supply of benefits
generated by the good is in no way depleted no matter how many people use it.
This feature is known as non-rivalry, implying that the cost of supplying an
extra user with the good is zero.
Endowments
distribution: Income and wealth
·
Welfare economics postulates that for a given
endowment distribution (income wealth), the market mechanism will result in an
economically efficient outcome whereby costs will be minimized while
satisfaction will be maximized.
·
The problem arises when more agents feel that
the existing distribution is unfair, to them or to others; and when this
feeling is transformed in actions that would affect the economically efficient
outcome of that moment negatively. To prevent a market failure, or better said
a system failure, major leaders in the private and state sectors respond
jointly with actions that assure ‘fair’ outcomes for all agents. Conceptually,
there are two approaches economists use in treating the question of what is
‘fair’: a positive and a normative.
·
Transfer payments consist of unemployment
benefits, pensions, and so on. It is important to notice that these payments do
not represent a claim on the absolute resources of society (in contrast with
exhaustive expenditures). Rather, transfer payments are flows of income from
individuals in society to other individuals in society passing the government
sector as an intermediary.
THE POLITY SYSTEM IN FIS COUNTRIES
·
The relationship between the state and firms in
a capitalist economy has been a regular subject of modern political and
economic thinking.
Schumpeter contributed to the view that the
capitalist system would be dominated by monopolist firms which would
collaborate with a powerful state. The partnership would strengthen both forces
to the detriment of other players.
There is an opposing view by Hayek that
monopoly firms are transient and the capitalist economy will manifest a
competitive and continuous entry and exit of firms, which by implication will
exclude coalitions between firms and the state.
There is a third position that lies
somewhat in between. Stigler coined the word capture to denote the tendency of
monopolistic firms to use the regulatory state to bolster the firm’s own market
power. Stigler allows also for newcomer firms to lobby for their entry and use
the state accordingly. In all three cases, the firms are dominant actors and
the state rulers are side-line beneficiaries.
·
There were periods in recent history in which
large firms collaborated with a powerful state along the lines of Schumpeter.
But contemporary FIS-centred countries correspond more with the viewpoints of
Hayek and Stigler, than Schumpeter. Regulatory captures and state lobbying by
incumbents and newcomer firms occur in Europe, US, Japan, but these captures
are transient in a FIS economic system where regular entry and exit of firms
wipe out such captures. While Stigler holds in the short run, Hayek holds more
for the long run.
·
The intrinsic motive in political behaviour,
which we termed rent politicization, is replaced by profit maximization in the
firm intensive economy. In FIS countries, it is therefore plausible to consider
profit maximization as the underlying common behavioural pattern of most
actors, thus in firms and state, and households. Correspondingly, the political
process in such a system can be described as a commercialized exchange process.
This comes to saying that the S subsystem operates just like the F subsystem in
the FIS-centred country.
·
The political market can be described basically
as consisting of buyers and sellers who undertake mutually beneficial exchanges
of political compromises and material benefits within a world of varying
uncertainties. The voters are the buyers: they demand security, regulations,
services and redistributions from the political parties and governing leaders.
In exchange, they pay taxes.
The
governing party is comparable to an incumbent company that supplies goods; the
opposition party is an aspiring company. The roles of the political party and
its political leaders are comparable to those of the company shareholders and
the company board of directors. Political leaders in government, as ministers
or deputy ministers, or in opposition strive to maximize votes gained, and once
elected, most political leaders may opt for short-run personal gains, acquire
rewards and satisfactions while in office, or use the office to maximize future
influence outside politics.
State bureaucrats executing plans of
ministers, can be compared to business managers, are responsible for overseeing
and implementing regulations and provision of public goods like defence, roads,
health, education, etc. The appointed ministers and state bureaucracies run the
government and are the final suppliers of political solutions. The relationship
between the minister and the bureaucrat has much to do with principal-agent relationships
and asymmetric information. Bureaucracies are experts on their field of
research whereas their political superiors, the ministers, only have the
general view of what is going on in the departments. Because it is too costly
for any individual minister to monitor bureaucracies, the latter have an
opportunity to influence the quantity and efficiency of public sector output in
biased ways.
Although public sector employees are not
active agents in the political process, they indirectly play a central role in
shaping the polity and economy. Another set of actors in the political market
place consists of interest groups like individual firms or associations of
firms, employer organizations, trade unions, regional areas and so on. In
reaching their objectives, interest groups mobilize bureaucrats and politicians
to circumvent regulations, and raise public provisions to the advantage of the
pressure group concerned.
Political media is the next political
actor, it engages in information search and dissemination. Their role is close
to that of advertising agencies that highlight the merits and demerits of
political suppliers, their leaders, associates and operations.
·
In the FIS-centred country, the economic and
political markets share various similarities. Just like a normal market for
economic exchanges, the political market can be described to face similar
limitations in the way of a perfect functioning. Perfect competition, in the
context of political market, exists if parties would compete and thereby eliminate
abnormal ‘profits’ that might arise due to discretionary behaviour on the
supply side. However, in reality, a lot of these conditions are not satisfied,
just like in normal markets. Turning to polity mechanisms, the urge for
political parties to win as many votes as they can, drives them to adopt
policies favoured by the median voter. Thus, the majority-voting equilibrium is
the policy preferred by the median voter.
PRIVATE AND PUBLIC SHARES IN FIS
COUNTRIES
·
On the whole and for many decades, public
spending has been increasing at a higher rate than private spending in FIS
countries.
·
Second, what does the economic literature say on
the growing share of the public sector? Adolf Wagner (1835–1917) was among the
first to specify the relationship between the public sector and GNP. Wagner’s
law, as it became to be known, states that an increasing share of public
expenditure in GNP accompanies the development of an industrial economy. Wagner
observed and predicted that public spending grows at a higher rate than GDP.
·
Firms and households alike have an increasing
demand for public goods and this requires more public spending and an extended
state sector; besides, there are inevitable exogenous forces such as periods of
wars and emergencies that raise the need for collective action and a greater
share of public spending, and the community as a whole recognizes and endorses
these needs and their implications.
State and politically motivated agents strive to enlarge their spheres
of influence and public spending. These agents fall under politicians,
bureaucrats ( Maximization of ministerial budgets, Underestimation of specific
costs, Overestimation of general costs) , interest groups and public employees.
·
The works of Musgrave (1969) and Rostow (1971)
have looked at the time pattern of public expenditure in the development
process of countries fitting most in the FIS. Following them, three phases in
the development process are commonly distinguished: the start-up phase, the
growth phase and the maturity phase.
·
Third, how to interpret the effects of the
rising public share on the dominance of the F subsystem on the S subsystem? A
substantial part of the increase in the public share is in the form of
transfers and subsidies which end up with the public. The numbers of public
employment have barely changed in FIS countries, and in some countries, there
were cutbacks so as to meet budget deficit ceilings. Public revenue has been
short of public spending. While interactive influence is not affected by the
rise of public share, regulative influence of the state subsystem is likely to
have increased with a higher public share. However, the state relies on the
business community for a large part in financing the budget deficit, which
gives business a mutual control leverage on the state.
·
Fourth, an intriguing issue is the negative
relationship between government size and economic growth. The two variables of
public share and GDP growth show opposite trends since the 1960s, as is
demonstrated in Table.
Baumol’s
model
Baumol (1967) formulates the problem
formally in the following model. Take X1 as the output of the
non-progressive sector, and X2 as the output of the progressive
sector. The production functions of each sector are then as follows:
X1t
= a1L1t (4.1)
X2t
= (a2ert) L2t, (4.2)
with
L1 and L2 being the labour force in the non-progressive
and the progressive sector respectively, t is the time index and a1
and a2 are constants. The production in the progressive sector is
assumed to grow at an exponential rate of r. Equations (4.1) and (4.2) are used
to derive the ratio of government output to total output, as shown in Eq.
(4.3).
X1t/(X1t
+ X2t) = a1L1t/(a1L1t + (
a2ert )L2t) . (4.3)
An implication is that if the ratio of
public sector output to private sector output is to remain constant, then it
must be that labour is transferred from the private to the public sector. This
is indeed observed in reality. It is assumed that wage rates are equal between
both sectors and that they follow increases in productivity in the private
sector. w0 is a constant, and wt is the wage in period t.
wt = w0ert.
(4.4)
From
the equations above, unit costs are derived for the public and private sectors
in the next two equations.
C1t
= [(w0ert )L1t ] / [a1L1t] = w0ert/a1
(4.5)
C2t
= [(w0ert) L2t ] / [(a2ert)L2t] = w0/a2. (4.6)
From
Eqs. (4.5) and (4.6), it follows that unit costs in the public sector will rise
steadily, while private sector costs remain constant. Together with Eq. (4.3)
another conclusion of the model is that public exhaustive expenditures will
rise faster than private sector expenditure on inputs. The growth potential of
the economy is only partially realized.
Chapter 5 EVOLUTION AND EVALUATION
OF THE
STATE INTENSIVE SYSTEM IN SIS-ORIENTED
COUNTRIES
·
The state intensive system (SIS) orientation in
these countries had in common the sharing of a communist regime for about 70
years (since 1919 in case of Russia) to for about 40 years (in case of allied
countries) with significant effects on agent behaviour and the institutional
makeup. We have made a distinction in Chapter 3 between a hard core
SIS-oriented Russia and Russian tied countries (RRTC), and the country groups
of Baltic, Central and East Europe (BCEE) and the ex-Soviet Islamic Republics
(XSIR), which manifest SIS tendencies though in lesser degrees. The three
groups pursued different transitional paths from 1990 onwards.
DEVELOPMENT
·
The timeline offers brief descriptions of
systemic changes in the communist regime in the upper half, and of the
political engagement of the SU in world development in the lower half. While
the upper half focuses on the economic system, the lower half focuses on world
development.
·
A civil war followed during 1918–1920 between
the left and liberal wings of the communist party, ending in absolute authority
for the left wing. Once the inner left-liberal crises of the communist party
was settled, the first major economic decision taken by the communist regime
was initiation of the New Economic Policy (NEP), in 1921, which was meant to
partially integrate the market economy in the command economy. However, NEP was
reversed in 1924, and the SU started adopting a constitution that reinforced
public ownership of means of production and their management by the state. This
centralist line gained in strength as Stalin succeeded Lenin. Adoption of the
first FiveYear Plan was in 1928, with the state setting goals and priorities
for the whole economy. This signified the end of the New Economic Policy, NEP.
As collectivization of agriculture proceeded, property of millions of peasant
households was confiscated, and numerous relatively prosperous peasants lost
their life.
The
development of the communist regime as an economic system, from the early 1920s
and up to its end in the late 1990s, is best described by Kornai (1967) as a
confrontation between a control and the real. It was the task of Lenin, and his
followers starting with Stalin, then Khrushchev, Brezhnev, etc., and ending
with Gorbachev to defend the declared communist ideology and soviet promises,
safeguard state capitalism and develop control procedures for running the
economy in ways which will hopefully approach these promises. The real world
diverged from the control world and this was the central barrier in the
fulfilment of the soviet promises.
During 1985–1989, Gorbachev, the last to
lead the SU, declared policies of openness (glasnost), restructuring (perestroika),
and acceptance of a freely operating private sector. The initiatives were
obstructed by the Chernobyl nuclear explosion, and by nationalist outbreaks in
Afghanistan, and in other parts of the SU. As the pace of reforms by Gorbachev
was criticized by Yeltsin, his challenger, regime instability heightened. As an
economic-political breakdown appeared eminent, the Communist Party was forced
to vote for ending the one-party rule. At the other end, on election of Yeltsin
as president of the Russian Soviet Federative Socialist Republic by the
latter’s parliament, Yeltsin dismembered himself from the Soviet Communist
Party, banned the Soviet Communist Party in Russia and seized its assets; thus
formalizing the end of the communist regime in Russia, and factually the whole
SU, which is seen by some historians as basically a construction inspired by
Russian national interests.
Recovery returned with transitional reforms.
RRTC continued their attachment to the SIS orientation, the BCEE group
integrated with the EU and the XSIL group integrated with the Central Asian and
Caspian development region.
·
During this span of 50 years, the SU exploded
its first atomic device; recognized the Communist government in China,
supported North Korea, instituted the Warsaw Treaty Organization (which gave
ground for Soviet intervention in Eastern Europe to maintain their satellite
status), launched the first manned orbital flight and placed missiles in Cuba
which led to a war-likely crises between US and SU in 1962. Settlement of the
Cuban crises by withdrawal of the missiles opened a period of East–West
d´etente which lasted between 1963 and 1978. During this period, the SU joined
the US and Britain in 1963 in signing a treaty banning atmospheric nuclear
tests; and SU and US set up a ‘hot line’. Clashes across the border between
Soviet and Chinese troops in 1969 brought SU closer to US. In 1972, SU and US
signed the SALT-1 arms control agreement, heralding the start of d´etente.
·
The
period of d´etente was formally ended in 1979 when Soviet troops invaded
Afghanistan. The East–West cold war was once again on the running, with
conflict areas mainly sought in the developing world. But the SU was at a
disadvantage in this phase of the cold war as nationalist outbreaks erupted in
the European allies and in Afghanistan, forcing Russia to draw its troops from
Afghanistan under heavy casualties. Other setbacks such as the death or removal
of five top communist leaders in the SU in 5 years, the political duels between
the last two leaders Gorbachev and Yeltsin, and the instability and weakening
of the communist regime and its predictable breakdown, encouraged nationalist
independence in the Baltic republics Armenia, Azerbaijan, Kazakhstan and
Georgia. With the end of the communist regime in 1990, and with the recognition
by Russia’s president Yeltsin of the independence of the Baltic republics,
Ukraine choose for independence, followed by other republics; the Congress of
People’s Deputies of the SU had no other option than to vote for the
dissolution of the SU; thus, practically speaking, reducing the territory of
Russia to what Russia used to be before Soviet communism.
Development of the communist regime:
Contradictions between the control and real worlds
·
The communist regime of the SU contained four
control rules, which generally speaking apply to an all-political state
intensive economic system, SIS:
(i)
The state’s ideology: The state has a
communist ideology that offers the best promising prospects for the people. In
the real world, Russian national interests and ideals were given higher
priority than the communist ideology in the organization, implementation and
content of pursued policies.
(ii)
The state’s party: The communist ideology and realization of its
promises are contracted to the state’s one and only communist party. In the SU,
the party cadres was known as nomenklatura. The top of the nomenklatura
is the politburo, whose decisions become the law of the land. Members of
the politburo do not have tenure. To be removed from the politburo is a very
great loss, hence the eagerness of persons in the top to form protective
alliances among themselves. In practical terms, the economic system no matter
how it will turn out to be, it was embedded in a predetermined polity. This
meant the subjection of the economic order to the political order. By
simultaneously politicizing all information and decisions, the party eliminated
possible corrective feedback mechanisms. Politics superseded economics.
(iii)
State ownership of property: State is the sole owner of property.
Collective farms and gardening plots for the collective farmers were tolerated
but were not transferable. The only fully accepted private property was that of
consumption goods which people pay for from the earnings or transfers they
received from state enterprises or state authorities, respectively. In the real
world, the law of state ownership was reducible to merely a facade hiding the
true owner.
(iv)
The central planning system: State is the sole coordinator and driver
of the economy via a directive system of resource allocations. With
nationalization of the means of production in the SU by the ruling Politburo, a
system of central planning and administrative command was put in place in 1928.
We shall explore this system in terms of procedure, methods, practical
operation and planning reforms.
·
The
economic plan used to be formulated along the following procedures. General
directives on economic development were provided by the politburo, and
converted into control figures by the central planning department, Gosplan.
Tentative production targets for major commodities were then sent to the
ministries for further specification, and from there down to the level of
individual enterprises falling under the supervision of each ministry. The
enterprises were supposed to send back comments and information on limitations
and prospective. Ministries adjust and send ministerial plans to Gosplan.
It was here that the final matching between inputs and outputs for a large
number of commodities, varying at times between a few hundred to a few thousand
took place via the use of material balancing methods, resulting in final
production targets. These were disaggregated further and disseminated to the
ministries and through them to the concerned individual enterprises. Consequently,
there were ministerial plans focussing on aggregates, and enterprise plans that
took up details. The plan for each enterprise contained detailed directives on
input provisions, operations, outputs and deliveries — from whom and to whom —
for the forthcoming year. While the enterprise plans were legally binding, they
were simultaneously supported by incentive designs to comfort and motivate
enterprise managers in fulfilling the enterprise plans.
·
Gosplan applied some kind of planning-in-stages
methods. Two main types of methods were used. In the upper stage, the material
balancing method was used to formulate commodity plans, for which the
respective ministries carry the responsibility to implement. The material
balance method is an iterative process of concurrent adjustment of the supply
and demand for each commodity considered, resulting from an exchange of
information between Gosplan, ministries and enterprises, and ending when the
closing balance shows the sum total of all demands for a commodity equal the
sum total of the supply for that commodity. In principle, this balance should
hold simultaneously for all commodities considered.
At the lower stage, the
investment effectiveness method was used in the selection of expansion
projects at the enterprise level. It is placed as a stage below that of
material balances where the production targets are determined. Soviet
authorities used the investment effectiveness method for choosing among
proposed investment projects that expand production capacity of a specific
product. The equation can be written as
Ci + rKi = Ai,
(5.1)
Where,
Ci = annual operational costs of
investment project i;
Ki = capital costs of investment
project i;
Ai = annual total costs of investment project i, and
r = normative rate for discounting capital use, exogenously fixed.
The objective is to select projects with the lowest Ai. In
periods and sectors in which capital was especially scarce, the value of r was
raised. From 1969, a standard value of r = 0.12 was used, although it was
sometimes allowed to vary per sector. C, K and A can be eventually specified
per unit of production to allow for economies of scale.
·
We review here the practical operation of the
planning system from the points of view of different agents involved in the
process, consider the problems they face, how they are affected and the effects
of their responses in consecutive order.
The Gosplan level: Theoretically speaking, the role which the
auctioneer of Leon Walras, or the invisible hand of Adam Smith, plays in
bringing equilibrium prices and an efficient allocation of the quantities of
goods and resources in the perfect market economy, this same role can be played
by the state. In the first place, indivisibilities, uncertainties,
externalities and collectivities persist in all economies and make it
impossible to reach an efficient allocation. Second, there was no way for the
Gosplan of getting all the correct information and processing it. The
subordinates may transmit distorted information, unknowingly or on purpose. In
the transmission of information, important parts are lost. Third, the Politburo
fed the Gosplan with information on its own preferences which were in variance
with that of the population at large; as a result, the targeted allocations
would be different than the spontaneously desirable allocations of the
population and this would cause imbalances in supply and demand. This problem does
not occur in competitive markets. Fourth, for specific goods, direct contact
between demander and supplier is necessary to settle design questions, and this
is impossible to settle at the central level. Also in competitive markets,
these specific goods have to be negotiated personally between buyer and seller.
The ministry level: In a previous chapter, we made reference to
bureaucratic behaviour within ministries, and its distortion effects for the
economic process. These apply here too and more significantly.
Enterprise managers: The plans were imperative orders and not
desirable forecasts. The availability of physical inputs was necessary for
achieving the production targets. For the enterprise, it was far more important
to obtain an allocation certificate for scarce physical inputs than money. The
risk of not securing the physical inputs in time for production of its own
output brought tension in the enterprise. The response of the enterprise
manager in such a context was varied and betrayed many deficiencies in the
planning system. We list here some eight responses. First, frequently,
the plans sent by the ministries arrived late at the enterprises, so the
enterprises continued to operate on the basis of the old plan. Second,
the monitoring of the execution of enterprise plans was weak and the sanctions
for counter-actions by the state in case of management failures were limited,
for ministerial authorities responsible for the failure would be uncovered as
well. So there were tendencies for cover-ups. Third, in a situation of a
general scarcity of excellent managers, the state paid managers average bonuses
of 25% of their base salary, and reaching 50% for top managers. Fourth,
fulfilling the gross output targets was a crucial condition for safeguarding his
position as enterprise manager. To do that, he bargained intensely and lobbied
for obtaining allocation certificates of inputs, and he use the resources of
his office for exchanging favours with local party and state officials. Fifth,
alternatively, the enterprise manager may expand his informal delivery network
and engage unofficial supply agents in arranging deals in the hidden economy,
but he may also neglect assortment targets and adjust quality downwards to meet
the quantity targets. Sixth, in communications with the responsible
ministry, enterprise managers supplied information that underestimated
production capabilities for next year, in this way biasing the ministry to opt
for easy gross output targets which the manager can achieve with least effort. Seventh,
the state guaranteed that the operations of loss-making public enterprises
would be continued nevertheless, a condition known as soft budget constraint.
As a result, there was no incentive for the enterprise manager to economize in
the use of capital and to minimize on other costs. Finally, in the
framework of principal-agency theory, some of the above responses are linked to
each other in the context of cross-subsidization, as when the ratcheting of
output targets for the better performing enterprises is used to finance the
soft budget constraints of the loss-making enterprises. Responding rationally
to this cross-subsidization, both enterprises will not maximize their effort
and will end up in lower efficiencies.
Individual consumers: The overruling of the preferences of the
Politburo over the preferences of the consumers manifested itself in the
chronic dissatisfaction of the latter, widespread shortages of consumer goods
and queues, a limited assortment of goods and services, poor qualities, very
slow introduction of new goods.
Informal dealers: In the communist regimes, the planned or control
economy was often identified as the first economy, in contrast to the second
economy that has developed, to the dismay of planners, to resolve imbalances
between demand and supply created by plan directives. As was clear from the
above accounts, the imbalances arose in the contexts of (a) inter-deliveries
among enterprise managers, and (b) sale of scarce goods to individual
consumers. Transactions of type (a) arose because it was not easy to fulfil the
enterprise plans with the issued allocation certificates of inputs. Enterprise
managers often used the services of a tolkach. This was an unofficial
supply agent or organization whose job was to see that the necessary materials
and equipment would arrive from one enterprise to another. Transactions of type
(b) created a small class of market-oriented business people who sold scarce
goods and services to affording consumers, such as owners of vehicles providing
private transport services; producers of farm products from gardening plots and
collective farms; craftsmen fixing repairs privately in exchange in kind, and
medical doctors charging more for better treatment.
Bureaucratic bias: Economic distortions due to catch and/or
corruptive behaviour of bureaucracies and/or enterprises in the actual
implementation of regulation rules was discussed in the previous chapter.
Economic distortions due to incentive problems commonly encountered in publicly
owned and run enterprises, and known as the ratchet constraint, and the soft
budget constraint. The ratchet constraint arises in a situation where the
ministerial authority (or central planners) fix a future output target for the
public enterprise Qt+1 at a higher level than the achieved current output Qt.
Calculative managers of the public enterprises will deliberately produce low Qt
and pass to the central planners underestimates of their real production to
avoid compelling targets. The ratcheting of targets by the central planners
creates an X-inefficiency. The soft budget constraint problem applies in
situations when the state guarantees that the operations of loss-making public
enterprises will be continued nevertheless. As a result, there is no incentive
for the public enterprise to economize in the use of capital and to minimize on
other costs. The ratchet and the soft budget constraints are incentive problems
that are best analyzed in the framework of principal–agency theory. Both
constraints are also linked to each other in the context of
cross-subsidization, as when the ratcheting of output targets for the better
performing enterprises is used to finance the soft budget constraints of the
loss-making enterprises. Responding rationally to this cross-subsidization,
both firms will not maximize their effort and will end up in lower
efficiencies.
Pursued policies and reform
strategies
(i)
Pursued policies: On the one hand, they
were committed to the socialist aim of maintaining incomes for all citizens at
levels sufficient to buy basic goods at cheap prices; this in addition to
freely provided collective goods. On the other hand, they were committed to the
communist ideology that saw a deepening of capital formation as the development
strategy, which would bring success in the longer run. They saw the shortage to
be associated with the underdeveloped industry, so they diverted even more of
the scarce resources to huge investment programs, resulting in a vicious circle
of chronic shortages. The policy makers faced a policy conflict between cheap
consumption now and investment now in capital extensive industrial projects
with long gestation periods permitting more consumption much later. Whenever
they chose for the latter solution, the results were less goods to consume, and
greater shortages, now and in the future.
The following two equations throw light on the policy conflict. To reach
equilibrium, aggregate demand D should equal aggregate supply S. In the
communist context, aggregate demand D can be simply written as the wage income,
i.e. the average wage W multiplied by number of earners L, less hoarded savings
H. The aggregate supply S is the physical quantity of consumer goods Q plus the
change in inventories from last year I, these multiplied by the price level of
consumer goods P. Note that prices for most consumption goods are based on
cost, they are fixed and are hardly affected by imbalances.
D = WL – H
(5.3)
S = (Q + I)P. (5.4)
To satisfy the population, the soviet authorities were under pressure to
increase wages, and with more earners, the aggregate demand increased
appreciably; but as is well known, the physical production of consumer goods Q
lagged behind due to reasons of lagging priority and general shortages caused
by increasing inefficiencies. At the same time, prices P were not allowed to
increase fast enough to absorb the increase in demand. In such circumstances, equilibrium
between a demand that is driven by money and a supply that is physically fixed
can only be reached by increased hoarding by consumers and a depletion of
inventories, implying delayed consumption and repressed inflation. The
accumulated tension will turn to be significant in empowering the inflationary
pressure, once at some time later, when the economy in transition would allow
price liberalization.
Conceptually,
the ruling class will invest in capital deepening up to a point where its own
gains from the last unit invested is equal to its own costs from violating the
preferences of the consuming public. So, Soviet leaders responded favourably to
consumer grievances between now and then. In the late 1960s, under Khruschev,
consumption growth caught up with investment growth, but lagged again from the
early 1970s. In the late 1980s, under pressure of public opinion, investment
plans were again interrupted to allow for an enhancement of consumer goods. The
limited interruptions in investment, which were necessary to satisfy the
public, tended to increase gestation lags, postpone production operations of
installed capacity, and accentuate the shortages of goods.
(ii)
Reform
strategies: It was observed above
that the limitations of the central planning techniques manifest themselves in
processing distorted information, delayed and frequent revisions in enterprise
plans, disturbances in the production process, wrong deliveries and so on; causing
significant losses in labour time that some estimate to amount to 10%. The
reforms applied in the 1970s in the SU and Eastern Europe focussed on improving
the information structure, planning techniques and incentives. Furthermore, in
later years and especially in Eastern Europe, economic reforms were tried with
the purposes of introducing commercial considerations in running public
enterprises, and integrating the hidden economy with the official economy. The
multi-information channels were reduced to two only, those of the ministry and
the enterprise. An attempt under Khruschev to decentralize and involve the
regional governments was abandoned when he left.
Regarding planning techniques, Kosygin introduced greater use of
mathematical programming, management information systems and computers. The
efforts were effective in shortening the planning process but the pressure for
more advanced technologies kept outpacing the introduced efforts. Kosygin
reforms have also tackled the incentive problem at the enterprise level. This
was done via taut plans. The equation for rewarding the enterprise with a bonus
B can be written as
B = aVp + b(Va − Vp),
(5.5)
where Vp is the planned value of the bonus forming index that
can simply consist of output but can include other indicators as well,
Va is the actual value
for the bonus forming index, and
a and b are rewards whereby
a>b> 0.
The first term provides an incentive to adopt a big plan. The bigger the
planned value, the higher is the bonus. Besides aiming at taut plans, the
second term in the bonus equation encourages the over-fulfillment of plan
targets. There is higher weight for the first term than for the second term.
The intended result of avoiding the ratchet effect did not work as was
anticipated. Instead of mobilizing the hidden reserves of enterprise resources,
it strengthened the inclination of enterprise managers to strive for slack
plans, that is a smaller Vp, and in a bonus on the second term, while ignoring
the bonus on the first term.
Just as they did in the 1960s, Soviet leaders under Gorbachev debated the
perestroika reform in the mid-1980s with the objective of changing incentives
of enterprise managers by relating their rewards to enterprise profitability.
This has been defined as the ratio of profits to the stock of capital. The
reformer’s hope was that managers would then go for less use of capital, seek
efficient production techniques, more innovation and upgrade quality. To let work
the reform implied changing the management’s property rights in capital goods.
However, to implement the principle of profitability, the Politburo must accept
a reduction in its own property rights as regards its authority on the stock of
capital held by business firms, and the future pattern of capital formation.
This is a conflict in principles, and conflict of interests of rulers versus
ruled, which brought the inadequacy of the institutional rules in the communist
regime in the open.
Finally, some brave attempts of economic reform were tried in
Czechoslovakia, Hungary, Poland and the GDR in the late 1950s and 1960s to
increase decentralized decision-making at the enterprise level and make it more
commercially conscious. But these reforms were doomed to fail at that time due
to the absence of four prerequisite conditions. These are microeconomic
consistency (this requires that cost calculation, profit maximization,
price fixing and competitive bidding should fit to each other and form a
harmonious whole), macroeconomic consistency (the input and output
outlets, should be readily available and undisturbed by instability and
uncertainty), institutional governance that guarantee fairness in case
of mischief, and a peaceful and benevolent political environment.
Economic performance of the communist
regime
·
In terms of the theory of economic systems,
agents are inclined to compare the outcomes they receive from the setting in
which they are actively working and living, with the outcomes of competing
settings. If their system is seen as an underperformer beyond doubt, then they
will either transform the foundations of their setting towards the superior
one, or if feasible, they will physically move from their system/country to the
superior system/country. Obviously, under the communist regime, there were no
possibilities for any large-scale movement of people from their country to
other countries with brighter prospects. Hence, the drive to abandon the
communist foundations became the only alternative left, and to replace them
with more successful foundations. The comparatively failing economic
performance of the communist regime played a central role in its breakdown.
·
The average annual growth of the GDP, and the
GDP per capita, for SIS and FIS-related countries were displayed in Chapter 3.
Both groups experienced high growth from 1950 to 1970. The growth of SIS
countries started declining in the mid-1970s and reached a standstill in late
1980s.
·
The other measure of the performance of economic
systems concerns fairness in the distribution of income and wealth. For what
they are worth, various income distribution indicators in Chapter 3 were
applied, showing that income was more equally distributed in the SIS than in
the FIS countries. Clearly, state property and centrally fixed remuneration
levels were the two conditions in the SU that produced a more equitable income.
·
Regarding other performance indicators,
unemployment did not exist in an open form in SIS, although hidden
underemployment in ministries and enterprises was common. As for inflation,
prices were fixed for long periods. After the mid-1970s, sporadic rounds of
price increases took place. More significant was the price hike which producers
charged to willing consumers for delivery of scarce goods or better quality in
the second economy. Important too, was the built-in repressed inflation that
took the form of hoarded savings for lack of consumption outlets, and which was
the result of pursued allocation policies.
Breakdown of the communist regime and
the SU 1989–1991
·
Our interpretation of the communist failure is
closely linked with Russia’s rise and fall as a world power. The systemic
adaptation that took place was geared to the tunes of politically behaving
state settings and plans. Because important aspects of the real world could not
be incorporated in politically motivated plans, the control system deviated
from the real system. We gave examples of deviations between the control and
real systems in many areas of economic activity. State agents had to live with
these deviations by pursuing hidden conducts that resulted in excluding
competition, and creating rents. Such a political behaviour — typical for pure
state settings — permits the better-equipped agent to extract and secure a
quasi-permanent rent from the less-equipped agent, and it promotes the spread
of non-transparent behaviour among non-state agents, making it ultimately the
dominant behaviour in the SIS. This political behaviour was reinforced again
and again by state settings that behaved politically. When the coverage of a
political behaviour extends beyond some threshold, it tends to become the norm
that is expected in mutual behaviour, and gains more momentum.
·
In a systemic analysis of Russia’s fall, we like
to distinguish between internal pressures and external pressures that caused
the end of the communist regime.
The internal pressures date from around the
1960s to 1970s, when by that time, the population increased significantly and
its profile changed appreciably. Demand for more goods, and of a more specific
nature, contrasted with a draining up of factors of production. To meet the
demands, a shift upward in production possibilities was badly needed. The
apparent harmony that characterized the first few decades of the communist
regimes cracked from the 1970s onwards. With contradictions between the control
and real worlds increasing, and the same old policies continuing;
inefficiencies, waste and shortages multiplied, leading to reductions in
overall growth.
The external pressures increased appreciably
in the 1970s and 1980s. As the closed regimes gradually opened up, their public
was in a position to compare and evaluate their performance versus that of
neighbouring market economies, and come to the evaluation that their regime
performed less. In terms of the theory of economic systems, the evaluation
leads to three options. The first option is to remain loyal to the regime in
the hope that promises made will one day materialize; some did that, but in
relative terms that was only a very small minority. The second and third
options are either to exit or to voice. Possibilities of exit were extremely
limited, even though some outflow took place from East to West Germany.
·
Pejovic (1982), extended in Pejovic (2001),
maintains that the original terms of contract between the Politburo and the
Soviet people lost validity due to the realization that the Marxist thesis that
socialism is a historically superior system to capitalism is refuted in view of
the proven lower performance of socialism as compared to capitalism.
·
Eggersston (1990), close to Winiecki (1986),
place their interpretation within the analytical frameworks of agency problems,
transaction costs and property rights. They argue that (a) the managers of
state enterprises respond to incentives which discourage cost minimization, and
(b) the organizational structure of state enterprises have not adapted to
technological developments, resulting in rising transaction costs. The solution
of these problems would require replacing the command by prices, i.e. writing
off the communist regime and instituting a profit-maximizing market economy. A
competitive market for managers would represent a huge transfer of wealth away
from party functionaries who hold property rights at the managerial levels.
Hence, is the opposition of party cadres to meaningful reforms.
·
Stiglitz (1993) focuses on problems of
incentives and information in his interpretation of the communist failure. The
interpretation of Stiglitz fits neatly within the principal–agency analytical
framework. The principal is the planning bureaucrat while the agent is the
enterprise manager. Bureaucrats did not possess the requisite information to
know how to allocate resources efficiently. Managers of firms had no incentive
to tell the bureaucrats what the minimum inputs required to meet their
production goals were.
RECESSION AND RECOVERY
The recessions of 4–10 years depending on the transition
economy wiped on average about 40% of the GDP of the pre-transition period, but
this average hides significant difference, as Table 5.2 shows that output has
fallen in BCEE by about 31% on average by the time it bottomed out. By 2000,
six countries have recovered back their loss in the GDP, and by 2005, 11 of the
12 reported BCEE countries have recovered the GDP loss. The magnitude of the
recession in RRTC is much higher with an average loss in the real GDP of 60% in
the lowest year of GDP as compared to 1988. The XSIR group occupies a middle
position with an average loss of 49% in their worst year. Recovery followed,
but as Column 6 shows, the GDP of BCEE is better off in 2005 compared to 1988
by +14% (with Poland scoring +56%), RRTC are less off by about −11% (Russia
scoring worse at −14%). The XSIR occupy middle positions with a loss of −3%
(oil-rich Kazakhstan scored +10%).
·
When countries change from one system to another
they go through heavy adjustments that reduce activity now but can promise more
growth in the future. The decline was severe and varied appreciably per country
group. What are the causes of the downfall in production? And how do these
causes apply to the three groups of transition countries? Two major causes are
behind the downfall: system disorientation and transition policies.
·
System disorientation in Russia took various
forms.
(a)
Plan instructions, supported by informal networks on deliveries of intermediate
inputs, ceased to be obligatory as the old system collapsed, leading to a
melting down of obligations to mutual delivery between enterprises and to a
widespread inter-industrial supply defaults and production decline.
(b)
Laws requiring self-financing caused a credit crunch that held production back.
(c)
Financial arrears between enterprises, based on real production deliveries that
could not take place, accumulated and there was no mechanism to settle them,
resulting in the obstruction of input deliveries for regular production plans.
(d)
Bank managers, in control of supplying credit, favoured enterprises from which
they profited most at a personal level, thus leading to misallocations, and a
deadweight loss in production.
(e)
Confusion and uncertainty encouraged expropriation of public enterprises by
managers and ministries, and subsequent foreign flight of appropriated capital,
reducing investment and production further.
(f) Labour inputs diminished as people
encountered shortages, political confusion and discouraged work appetite.
Enterprises diverted their reserves to buying consumption necessities for their
workers, at the cost of provisions for investment and production.
(g) Regions,
anticipating shortages, took measures to restrict mobility of goods to other
regions, thus causing production bottlenecks in all regions.
·
A few observations are in place on the
differentiated transition policies. At an early phase of the transition,
repressed inflation and hoarded savings, especially in Russia, contributed to
an excess of money over the value of goods demanded and available. The monetary
overhang drove prices up. Besides, once prices were made free to move, they
soared under a shockoriented price liberalization strategy. The fiscal budget
balance deteriorated due to falls in revenue and insufficient cuts in
expenditures. Simultaneously, the foreign payments balance was destabilized by
huge currency devaluations. Pushed by political unrest and capital flight, the
Russian rubble fell to 1/10th of its pre-transition level.
In a next phase of the transition, firms
needed finance and workers demanded more wages in the face of rising prices.
Most of the BCEE transition economies did not give into the demand for issuing
more money, and kept wages within temporary control. They held tight credit and
sharp cuts in subsidies. In BCEE, the fiscal deficit went down to around 6%.
This is to be compared with Russia’s 12%, and the other ex-Soviet countries,
which were in between. Currencies of most BCEE reforming countries recovered in
foreign exchange value due to remarkable export growth and trade surpluses.
Russia and the other ex-Soviet countries went the opposite way and were
generous in the money supply growth and net domestic credit, which grew by
150-fold during 1992–1994. The growth of this credit to dubious enterprises and
clients at negative real interest rates in Russia has been interpreted in terms
of rent-seeking and corruption practices between a too closely linked
government to enterprises. Moreover, Russia experienced a series of foreign
exchange crises that retarded investment and growth furthermore.
·
The recession in BCEE was shorter followed by a
quicker recovery/the recession in XSIR and Russia is extended to 1995 and 1998,
respectively. The BCEE group contained countries that are economically more
advanced than XSIR and Russia. BCEE countries situated close to the EU have
gone through reforms that were directed towards their eventual integration in
the EU, and had the benefit of a larger inflow of foreign assistance per head
than countries of the former SU. Weak oil prices did not help Russia, and the
war in Chechnya diverted resources to non-productive uses.
THE SHORT TRANSITION AND THE LONG
TRANSITION
·
Transitional reforms can be broken down between
those occurring during a short and a long transition.
The
short transition took on average 2 to 3 years, and focused on macroeconomic
stabilization and microeconomic liberalization (i.e. deregulation of product
markets and privatization of state-owned production factors, in particular,
small enterprises).
The long transition, which is a
restructuring phase that requires a decade or more to get the economy on track,
concentrates on resolving market failures in a transition economy, and thus
deals with (a) extended deregulation of factor markets, extended privatization
of state enterprises and institutionalizing market competition; (b) increasing
market confidence; (c) internalizing inherited externalities; (d) balanced
provisions of public goods; and (e) sustained financing of income maintenance
for those in need.
·
‘gradual change’ strategy or a ‘sudden shock’
strategy: Hungary, Slovenia, Slovakia, Romania are considered to have
followed a gradual change approach. Poland went for the sudden shock. Other
countries in the BCEE group manifested a mix between the two manners. In
contrast, Russia and all republics of the ex-SU have initiated their transition
in a sudden shock environment.
STRENGTHENING COMPETITIVENESS IN
MARKETS AND STATE
·
When government sells shares of privatized companies
to the general public at the stock exchange, or organizes a competitive sale
among contending buying companies, or a takeover in an investment fund,
domestically or foreign, the resulting enterprise governance tends to be an outsider
governance. When the method of privatization takes the form of management–
employee buyouts, the resulting enterprise governance is insider governance.
This applies also in case of a partial privatization when the state owns a
major share and mobilizes a selected financial group to own remaining shares.
The privatization of state enterprises that occurred in the recent past in
Western Europe were of the outsider type, privatization in the transition
economies of Eastern Europe followed a mixture of outsider and insider governance
with more emphasis on the latter.
·
The privatization modes pursued promoted
outsider governance in BCEE, and insider governance in RRTC and XSIR. BCEE
transferred about 28% of state ownership to outside owners, and thus departed
from insider governance (Hungary and Estonia transferred about 40% of state
ownership to outside owners). The Czechs Republic distributed equal access
vouchers to citizens, which is also primarily an outsider governance-oriented
policy. Poland combined transferring
ownership to outsiders with transfers to municipalities and semi-public bodies that
maintained strong links between management and state. In contrast, the Russian
government’s management buyouts were a choice for insider governance. This has
been rationalized on the grounds that Russia had no stock markets to float
initial public offers, the public lacks purchasing power, there are no high
performing domestic companies to take over the ailing state enterprises, and
selling to foreign companies was felt to be against the national interest and
would raise unsolvable negotiations on asset valuation. The position of
insiders was strengthened furthermore by the 1998 financial crisis, as their
potential challengers — domestic and foreign outside investors — lost the
ability or appetite to invest in Russian firms.
Chapter 6 ECONOMIC SYSTEMS IN THE DEVELOPMENT REGIONS
·
In considering a more historic and regional
scope, we have proposed in Chapter 3 to distinguish between six development
regions comprising East Asia and Pacific (EAP), South Asia (SA), Central Asia
and Caspian (CAC), Middle East and North Africa (MENA), Sub Saharan Africa
(SSA) and Latin America and Caribbean (LAC).
The EAP region, consisting of China,
Indonesia, Philippines, Vietnam and others in East Asia and the Pacific, is
positioned close to the HIS corner, but also along the HIS–FIS axis, reflects
the two facts that the majority of agents in the region are still in rural
areas where household settings are dominant, and that sizable populations have
already moved to and are living in urban cities during a relatively short
period of high economic growth; this population manifests the impact of firm
settings.
The
SA region consisting of India, Bangladesh, Pakistan, Sri Lanka, among others is
placed in the HIS corner, which reflects the relatively high dominance of
household settings in this region. The region lies also on the HIS–FIS axis but
affiliation with FIS in SA is less than in EAP.
The
CAC region has become a vital region in the last three decades with the
strengthened roles of Turkey and Iran in the region and the access of the
ex-Soviet Islamic Republics to this region, among them some oil-rich countries
like Kazakhstan and Azerbaijan. The state has strong authoritarian rule which
is reflected in positioning CAC closer to SIS than HIS.
The MENA region is practically speaking,
the Arab countries, led by Egypt and Saudi Arabia among others. They are placed
halfway the HIS–SIS axis, in view of histories and traditions that have largely
stayed intact, and by which households voluntarily entrust state leadership. The
region includes some oil-rich Arab Gulf countries modern business segments,
bringing them close to firm settings.
The SSA region, led by diverse countries
such as Nigeria, Ethiopia, South Africa, Angola and including a total of 48
countries is positioned close to the household settings, HIS corner, as kinship
and ethnic ties are well known to occupy a central role in agent interaction in
most African countries. SSA lies also on the HIS–SIS axis in view of the quick
rise of state authorities as powerful players after gaining independence.
Finally, the LAC region, led by Brazil and
Mexico and including a total of 41 countries, is positioned along the HIS–FIS
axis, but closer to FIS than HIS, reflecting long periods of a significant
impact of firm settings on the economic system, and a relatively higher degree
of urbanization than other developing countries.
TIMELINE OF DEVELOPMENT EPOCHS
·
We
distinguish six historical epochs and speculate on their effects on the
subsystems. The historical epochs are: (1) colonial rule, (2) nation building,
(3) democratic reforms, (4) demographic transition, (5) economic development
and (6) global integration. Epochs 1–3 are loaded with political events; while
epochs 4–6 are more driven by economic forces. The table distinguishes between
the rural and urban locations of household, firm and state settings in an
analysis of the systemic impacts of the various historical epochs.
·
The resulting colonial configurations
between the colonizer and the impacted country can be described to have evolved
over time towards four forms that ranged from (a) a fully absorbed commonwealth
country, to (b) settled colonies, (c) occupied colonies and (d) loosely linked
strategic relationships with autonomous regions.
The first form is that of the fully
absorbed commonwealth countries, such as US, Canada and Australia. Very large
European migrations took place to these countries, allowing them to form, in a
relatively short time, the over majority of the total population. Soon
afterwards, they went for nationhood and independence in the 17th and 18th
centuries; and remained closely affiliated to their European ancestors and
institutions.
The second form is that of regions settled
by migrants, and supported by armies, but nevertheless with substantial native
populations working in mining and plantations, and residing in rural areas,
such as in Latin America. . Realization of nationhood and independence in these
countries took more time to mature, i.e. in the 19th century.
The third form took the shape of
army-occupied and annexed colonies, and applied to many countries in Asia and
Africa. There was no permanent role for colonial settlers, instead there were
relatively limited numbers of foreign soldiers and related officials who
maintained the colonial rule. The colonial epoch endured longer in this
category than in the other categories, and the accomplishment of political
independence was mostly accompanied with resistance and wars of liberation.
The fourth form was based on relationships
of a more calculative nature that emerged between the colonial powers and
autonomously run countries that have remained politically and economically
independent of the rest of the world. One can include here bigger countries
such as Japan and China, but also much smaller and distanced Islamic countries
such as Iran and the Arab peninsula. It is somewhat striking that in spite of
the absence of a colonized history in these countries, their economic systems
have undergone more fundamental changes than others due to other historical
interactions such as the global integration of Japan, the communist revolution
in China and oil discovery in Central Asia and the Middle East.
Focusing on the developing world, we have
argued above that the colonial epoch had its largest impact on host countries
in category (b), much less in (c) and very least in (d).
·
Colonial rule had to give way to national
independence. With the advent of national independence, in one country
after another, political authority was transferred from colonial powers to
national governments guarded by elite leaders.
National independence, identity and
integration, usually described as nation building, was the driving force for
the first round of governments in the developing world.
A significant role was created for the
state, via reorganization and creation of centralized governmental institutions
and civil and administrative rules, an extension of the bureaucracy to assist
and control, assignment of prominent roles for police and military defence
capabilities, using media in focalizing the state and state officials, and
emphasis on national sentiment and allegiance to the nation state. As a result,
the state gained influence in most developing countries.
However, in some countries, these state
actions generated counteracting forces that contradicted the very nature of
nation building, brought civil divides and resulted in weakening the
institutions of the state subsystem. In the EAP region, Cambodia is the
foremost example. In the SA region, the split up of Pakistan was the foremost
example. Ethnic exclusion has been a major cause of civil violence in the
Middle East with foremost examples being Iraq and Syria. In some African countries,
i.e. Nigeria, Burundi, Congo, Rwanda and Sudan this type of conflict led to
civil violence and in some cases to civil war with winning and losing groups.
In other countries, the military
disintegrated and collided with affiliated ethnic groups in self-defence or in
search of dominance over others, i.e. Afghanistan in SA, Syria and Iraq in MENA
and Angola, Congo DR, Liberia, Mali, Mozambique, Sudan and Somalia in SSA.
Finally, ideological confrontations between
conformists and reformers disrupted the stability of national governments in
many countries of the developing world and tended to have mixed effects on the
focalizing of the state in the system.
·
More recently, more countries have adopted
parliamentary elections and majority rules, these being political solutions
that are the most logical if violence is to be avoided in reaching political
compromises between different factions.
Table shows the share of authoritarian regimes has declined from 73 to
31%, while the share of multiparty democracies increased from 15 to 53%. By the
turn of the 20th to the 21st century, the shift towards democratic
institutions is seen to be highest in the Latin American region, followed by
the Asian, African and Arab regions.
·
Household-led demographic transition: Demographic
transition refers to the transition from high birth rates and death rates to
low birth and death rates in the process of economic development. In due
course, as households move from rural to urban areas, and become subjected to
modernization, education, emancipation, rising incomes and considerations of
opportunity cost, the reproduction behaviour of households changes towards
smaller size families; and thus causing birth rates to decline.
·
State-led economic development: In a
nutshell, economic development required structural transformation from an
agricultural into an industrializing economy, and from a closed to an open
economy, with due attention to both the enhancement of agriculture and of
building viable industries capable of becoming net exporters in competitive
world markets. The structural transformation required raising and upgrading the
factors of production of capital and labour to assure a greater production on
the supply side, and an expansion of purchasing power to assure an equal
balance on the demand side.
Removal of labour from agriculture to
industry will not hurt agriculture, and will moderate the wage rate in industry
and attract industrial investment. The transformation from agriculture to
industry was seen to require a shift of labour and capital (forced savings)
from the first to the second sector. Building an industrial infrastructure and
providing industrial capital requires taking capital (either voluntarily or via
forced savings) away from agriculture and invest it in industry. If the capital
is to be channelled voluntarily, then this would mean that rich landholders
would directly or indirectly become industrial investors. When the channel is
that of forced savings, this can be done centrally via state nationalization of
agriculture, like in China, or in decentralized ways via tax levies and via
state boards purchasing agricultural crops from farm producers at lower prices
and selling at higher prices, like in India and other developing countries; the
proceeds are then invested by the state in the development of industry. Because
rich landholders in most developing countries at the time were not well
prepared or willing for industrial entrepreneurship, this meant that the state
had to take the responsibility of collecting forced savings from agriculture
and investing them in industry.
With respect to industry, it was accepted
by policy advisors that a takeoff required next to skill formation and capital
deepening, an investment programme across all industrial sectors that makes use
of industrial linkages and economies of scale.
The
striking of a balance between incentives for export promotion and import
substitution, which generates high levels of net foreign exchange, is a major
challenge for he state’s management of economic development. The protection of
infant industries by restricting imports was seen as an intermediate step in a
strategy of export promotion. In principle, import protection and foreign trade
regulations are supposed to be temporary, and are to be phased away as the
concerned industry realizes its comparative export advantage.
·
Firm-led economic development: Nevertheless,
in some large and small countries, there was the realization that the time was
ripe to reduce state regulations, liberalize the economy and encourage private
business to integrate with the world economy through exports and more reliance
on foreign direct investment (FDI). These countries played leading roles in
attracting other countries to follow suit. The first country to take such a
leading role was Japan immediately after WWII, followed later by Korea,
Singapore, Taiwan and Hong Kong in the 1970s. Among the development regions, it
was China in EAP that shifted gear in 1980 and opened opportunities for private
firms to expand outwards. In SA, economists tend to agree that India started
this process in the 1990s.
In CAC, Turkey is acclaimed to having
entered the firm-led economic development in the late 1970s. In MENA, Israel
aside, the obvious example is the United Arab Emirates, and a couple of
neighbouring Arab Gulf countries, whose economic development was fully firm-led
since its establishment in 1971, though there are significant participations of
the ruling authorities in the governance structures of leading firms in the
country. Other countries in MENA are still functioning with a predominantly
state-led development orientation.
The SSA region is very diverse. There are
huge firm-led bilateral ventures in mineral-rich African countries, though
their operations are rather enclave. Most other African countries have
maintained and strengthened their state subsystem.
WB circles tend to signal Ghana as one of
the first African countries to move from a state-led to a firm-led economic
development, but Kenya qualifies as well.
Although firm-led economic development is
anchored in the LAC region, the influence of the state subsystem tended to go
up and down in various countries and at various times. Cuba, Bolivia, Nicaragua
and Venezuela are the conventional examples of LAC countries leaning towards a
state-led economic development.
WB circles pose the liberalization measures
of the 1970s and 1980s in Mexico, and Chile, and later on Colombia and Brazil,
as major steps in the bolstering a firm-led outward development. Other LAC
countries followed suit.
·
Globalization-led and firm-led integration
with the world economy: It was
stated earlier that the pace of economic development depends significantly on
the availability of foreign exchange, which is obtainable via exports of goods
and services, and via foreign financial flows in the forms of official
development assistance (ODA), net foreign loan transfers (FLT), and net foreign
direct investment (FDI).
The share of exports from developing
countries in total world exports increased from 16% in 1990 to 20% in
2000 and to 34% in 2012. With respect to foreign financial flows, the
prominence of ODA in the early development decades gave way to foreign
loans and foreign investment in latter decades. While practically all regions
experienced declines in their shares in world ODA over the years, SSA increased
its share and has become in recent years the major recipient of ODA with about
a quarter of the total ODA in 2012. The flow of net FLT, which was
previously positive, reversed direction into net transfers of foreign debt
repayments from the late 1980s onwards, mostly due to debt repayments that were
higher than fresh loans and investment booms creating financial crises; this
applied particularly for the LAC and EAP regions. In contrast, net FDI
has become by the turn of the century the dominant force in the financial
global integration of development regions, with the EAP and LAC regions as the
main beneficiaries.
The greater openness of an economy to the
international financial markets makes it usually vulnerable at times to serious
financial crises. In LAC, this occurred in 1982 when Mexico was unable to meet
its obligations to pay foreign debts after an over-borrowing spree in preceding
years. Fearful of risk of default payment, international lending banks reduced
their financial flows to defaulting and other countries in LAC and beyond. This
combined with a surge in oil prices led to a slow economic growth in most
development regions for a couple of years.
The vulnerability of the integrating
developing economies in unstable world financial markets reappeared again in
EAP in 1998, when the devaluation of the Thailand currency was followed by
other devaluations in the EAP, downfalls in stock markets and withdrawals of
foreign financial resources from the region.18 The confidence crisis was
fuelled by the lack of transparency in corporate governance and state dealings,
and a future economic outlook that was seen to be bleak against the background
of over-expanded investment in construction and other production capacities.
REASSESSMENT OF STRUCTURAL CHANGE AND
DEVELOPMENT PERFORMANCE
·
In development economics, we are used to focus
on the positive change in factor productivity as factors move from the less
productive agriculture to the more productive industry. System economics would
highlight the shift in agent behaviour from the household sharing type to the
profit maximizing type as more and more agents move from the household
subsystem H (say agriculture as a proxy) to the firm subsystem F (industry as
proxy). The shift of agents and value added from agriculture to industry, next
to causing rises in productivity and growth, constitute the reset of pursued
preferences, and a remix of behavioural types in favour of that of F at the
cost of that of H. Our reset shifts focus from sectors to subsystems, which is
a richer notion in the analysis of economic systems. The F subsystem has its
own subsystem dynamics supported by institutions facilitating free entry of
business entrepreneurs and market competition. A subsystem overshadows and
extends much beyond the economist’s conventional focus on sectors of economic
activity.
·
How do agents get engaged in producing services
fare in this approximation? They form a mixture of
(a)
informally operating households that rely mostly on self-employed and family
workers and thus associate with the household subsystem;
(b)
formally operating firms that maximize profit and where the mode of employment
is that of employer–employee;
(c) a fluent combination of the informal
and formal modes and
(d)
employment in the public sector.
Rough estimates for the developing world
suggest that over half or more of agents delivering services are found in the
informal household settings relating to (a), the other half is spread on (b),
(c) and (d), whereby public sector employees are often higher than the formally
engaged service workers in the private sector.
·
The two indicators we shall use for representing
state influence relate to agent participation and transformed value added in
the public sector. One indicator we use is the share of public revenue in
the GDP. Measured at the regional level, this share ranged between 11 and
31% for the development regions in 2012, being lowest in the Asian regions and
highest in MENA, reflecting a greater influence of the state in the Arab
countries than in other regions. The share has been rising in all regions
between 2000 and 2012, by some 4% on the average.
The other indicator attempts to construct
the share of public employment in total employment. A study by the
International Labour Office (ILO), Hammouya (1999), contains estimates based on
an ILO survey questionnaire carried out in 1995–1997 for a small number of the
larger developing countries with which we are primarily concerned, and a larger
number of tiny countries that matter less. The estimates would suggest that the
share of public employees in total wage and salary paid employees in this
period amounted to 36% in China, 70% in India and averages of 38% in MENA, 5.5%
in SSA and 12% in LAC.22 The data surveyed by the study are very scanty and too
static for our purpose. However, the survey showed a high concentration of
public employees in the services sector, reaching an average of 83% for the
developing countries (in Brazil 95%); a fact which we can build upon.
For lack of alternative indicators, we
propose to construct and apply an equivalent indicator for the share of public
employees in total employment defined as (employment in services/total
employment) × (public revenue/GDP). This indicator should not be read as the
absolute share of public employment in total employment in the country
concerned; it cannot give that. The values of the indicator should be viewed as
indicative of where and when the state is more or less influential, when then
indicator is applied for comparisons between countries and over time. Note that
share of public revenue/GDP is a direct determinant of state influence, but
it is also embodied in the specification of the share of public employees in
total employment.
·
The GDP growth achieved in a specific country
can be viewed as the result of
(a)
available factors of production that went into producing the GDP, and
(b)
the efficiency degree accomplished in the system wise utilization of these
factors of production, i.e. the growth in factor productivity.
While (a) falls under country specific
data, (b) is an efficiency notion that is tied to the organizational setup of
the economic system.
Growth accounting decomposition allows
separating the effect of the country-specific factors of production, from the
effect of factor productivity which is system specific. We shall apply growth
accounting decompositions to separate country specific effects from system
specific effects.
·
Table 6.11, Columns 1 to 2, give GDP growth in
1960–2000 and 2000– 2012, showing the two Asian regions of EAP and SA as best
performers. This is partially accounted for by significant structural
transformations from agriculture to industry in both regions, as well as early
and stronger shifts from import protection to export promotion in EAP and later
in SA. Growth accounting decompositions add insight over differences between
the development regions regarding determinants of economic growth. Such an
analysis is feasible for the period 1960–1994, Table 6.11, Columns 3–6.
For EAP, the annual GDP growth of 6.8% over the years
1960–1994 is accounted for by a country effect of 5.7% (annual growth in
factors of production labour and capital were 2.3%, and 3.4%) and a systemic
effect of 1.3% (an annual growth in total factor productivity accounted for the
remaining 1.3%). The contribution of systemic effecting SA is 17% (that is,
0.8%/4.6%). Efficiency growth in SA contributed 19% as well (i.e. 0.8/4.2).
·
Proceeding from growth of GDP to growth of GDP
per capita (GDP pc), these are reduced after neutralizing for demographic trends,
which are for a part due to uncontrolled nature and for a part due to system
control. The reduction due to demographic growth is least in EAP (8.0 − 8.9 =
−0.9), which is partly due to system-controlled demographic growth, i.e. China.
Compare with SA where the reduction is bigger due to uncontrolled nature (5.2 −
6.8 = −1.6).
It is noted that these growth rates of the
GDP pc are based on consolidated regional totals of the GDP and population.
These rates can be higher than the mean growth rates of the GDP pc, Column 2,
which are calculated as non-weighed means of countries in the region. For
instance, the total growth rate of EAP of 8.0%, largely due to China’s growth
rate of 9.4%, is reduced to a mean growth rate of 4.7% because countries
included like Philippines and Malaysia had growth rates of only 2.9% and 2.8%.
How did the development regions combine
higher well-being (that is growth in GDP pc) with performance on the dimension
of income distribution (this is measured by such indicators as the Gini index
and other ratios of income concentration)?
Another relevant indicator of income
inequality is the ratio of income shares of the richer top 20% of the
population (T20%) to the poorer bottom 20% of the population (B20%). This
indicator modified to apply to 10% of the population (that is T/B 10%) shows
even greater tendencies towards income inequality.
·
Development economics states that GDP growth is
achieved as labour (and other factors of production) shift from low to high
productivity activities, that earn more, thus causing a rise in income
inequality. This initial rise need not be overwhelming or permanent since the
achieved higher well-being would subsequently increase the demand for all
earners, and upgrade those with a low to a higher productivity, thus reducing
or eliminating the initial rise in income inequality. This being the normal
path in received theory, it follows that the quantifiable difference between
the observed and the normal path is accountable to the socio-economic system in
which economic development takes place.
COUNTRY VARIATIONS WITHIN REGIONS
·
We shall discuss structural and performance
features of the six leading countries in each region, which is sufficiently
wide to give a representative picture of regional diversity.
·
East Asia Pacific (EAP): States
and firms in countries of the EAP tend often to see the development formula
followed by Japan and Korea followed as ideal models of economic
development that are applicable and adaptable to their developing economies.
The development formula of these economies is outward industrialization. This
required the ending of centuries of feudal agriculture, the swift reallocation
of labour, capital and purchasing power from agriculture to industry and
services and the mobilization of these forces in expanding merchandise exports
to, and attracting foreign investment from the richer and more developed
economies.
Once the basics for the take-off was
established, China encroached on a stepwise diminished dependence on state
enterprises in favour of private business, and a controlled but extensive
orientation towards foreign trade and joint ventures. In a similar vein, Vietnam
followed a largely calculated development course. Other major countries in EAP
such as Indonesia, Philippines, Malaysia and Thailand followed more
spontaneous development courses and had less control on the pace of their
outward industrialization. This permitted a greater dependence of their
national economies on foreign finance, which made them more susceptive to risky
international financial transactions, showing itself in the Asian financial
crises that started from a distrust by international financial institutions in
corporate and banking commitments in Thailand in 1997–1998, and spread to other
ASEAN countries, causing a recession in these countries, with a duration of 3
to 5 years. EAP includes other countries and other small territories and
islands that lag behind, some of them can be described to be still in the
pre-phase of a take-off and are not yet in the stage of an outward
industrialization.
Although political authority is highly
esteemed, the size of government (that is the public share) is kept relatively
low in EAP. Development policy has been of the targeted type with coordination
between business and state at high levels and in specific sectors that are
considered strategic.
·
South Asia (SA): The inward-oriented economic
development and the reliance on state enterprises, regulation and planning,
typical of the 1950s–1970s, strengthened political power of the state, but did
not eliminate the soft state character. Starting from the late 1980s, state
policy emphasized more outward-oriented outlook, greater reliance on private
enterprises and reduced state intervention. The deregulation reforms and the
efforts towards global integration proceeded later in SA than in EAP.
Traditionally, the state in the SA region has
been often described as a soft state due to the strength of the feudally
oriented customary household subsystem and state capture by feudal leaders.
While these features were more prominent in the past, they have managed to
survive though at a lower degree.
·
Central Asia and Caspian (CAC): The CAC region comprises the two large
countries of Turkey and Iran and six smaller ex-Soviet Union Islamic Republics,
XSIR. Four of the eight countries are oil rich. Turkey and Iran dominate the
region. All eight countries share religious belief, cultural heritage,
attitudinal traits and similar external environments. The region is probably the
most homogeneous group among the six development regions.
In spite of this high income growth, the Gini
index has fallen on average. The underlying tendency of higher growth with more
equality is a systemic property that applies generally to all countries of the
region, and stands in remarkable contrast with most developing countries which generally
show higher growth with less equality.
·
Middle East and North Africa (MENA): MENA, as defined in this book, is
practically speaking the ‘Arab world’. This description does not automatically
mean the MENA region is economically a homogeneous group of countries. Just as
in the case of CAC, there are oil-rich countries cooperating together in the
Gulf Cooperation Council (GCC), and non-GCC non-oil countries which constitute
the over majority of the population but a relatively smaller share of the GDP
of MENA. GCC countries have relocated their agricultural labour force (and
their customary household settings) to urban employment long ago. In GCC, the
firm subsystem has grown rapidly, but its establishment as an institutional
subsystem comparable to those found in FIS countries is still far ahead.
While the F subsystem is significantly
diversified in MENA, the common feature for the MENA is the relatively high
shares of public revenue and public spending in the GDP, and their
applicability for all countries in the region.
·
Sub-Saharan Africa (SSA): Prior to and during colonial rule,
kinship settings dominated life in SSA. When newly emerging commercial firms
and state agencies started functioning in the SSA environment, it was
imperative that their structure, conduct and performance would manifest the
allegiance of agents to kin groups. Kin groups will attempt to favour their own
members in the assignment of jobs in firms or government, and the allocation of
other benefits and costs. While kinship settings have efficiency advantages in
minimizing transaction costs among its members, the same kinship settings have
efficiency costs when favouritism leads to misallocation of physical and human
resources. When ethnic favouritism spreads to state settings, the probability
is high that civil discontent, disorder and violence accelerate. The positive
associations between ethnic fractionalization, political instability and
economic underperformance are highest for the SSA region, when compared with
other development regions. The functioning of firm and state settings in SSA
are thus embedded within a behavioural system that prioritize the value of kin
relations and loyalty.
The region contains a very large number of
countries: 48 countries. To obtain a grip on the diversity of countries, it is
helpful to subdivide the region roughly into an upper belt that corresponds
roughly with the Sahel lines consisting of 24 countries and a lower belt below
the Sahel that is consisting of 24 countries. The upper belt is more arid and
is subjected to more desertification when compared to the more temperate and
water-rich lower belt. Although both belts are rich in natural resources, these
are less exploited in the upper than the lower belt. While the upper belt is
more Islamic, the lower belt is more Christian. The upper belt had less
in-migration of labour and capital from other countries and colonial
settlements than the lower belt. France was more present as a colonial power in
the upper belt, Britain more in the lower belt.
French is more spread in the upper belt,
English in the lower belt. The decolonizing of the upper belt and achievement
of national independence in these countries occurred quite peacefully, compared
to various wars of independence and liberation in most countries of the lower
belt. All these circumstances taken together have resulted in an upper belt
that is economically less developed and poorer than the lower belt. But there
are significant exceptions (in the upper belt, Nigeria in the upper belt is
rich in oil and well off, Ethiopia is least; in the lower belt, South Africa is
richest, while Congo DR is mineral rich but strikingly poor).
·
Latin America and Caribbean (LAC): Although North America (in reference
to USA and Canada) and South America were discovered and populated at around
the same time, they have become two totally different environments: an
economically advanced and rich USA and Canada, and a development region of LAC
consisting of 33 developing countries. Explanations for the different courses
abound: geographical distance of LAC to Europe is longer, timing and scale of
people and capital moving to LAC was later, colonists who settled in LAC were
less entrepreneurial, the struggle for independence in LAC was five decades
later than that of USA, attempts after independences at uniting LAC failed
while USA succeeded, adherence to passed constitutions and the rule of law in
LAC countries was very weak compared to USA. The current huge material gap
between LAC and US is also directly explainable in terms of socio-economic and
political barriers in LAC that stand in the way of intensive communication
between populations placed in stratified socio-economic classes.
Mexico is the dominant leader in the upper
belt which consists of small Caribbean countries; while Brazil is dominant in
the lower belt in terms of population and GDP, followed by Argentina and
Colombia. Indicators of state influence show a more pronounced role of the
state in the lower belt than in the upper belt. As regards indicators of global
links, the share of export/GDP is higher in Mexico than Brazil, Argentina and
Colombia. In contrast, the share of FDI/GDP is higher in the later countries.
PATTERNS OF CONVERGENCE AND
DIVERGENCE
·
What kind of significance should be attached to
the difference between US$ and PPP$? A PPP exchange rate equalizes the
purchasing power of different currencies in their home countries for a given
basket of goods. It is a better measure of standards of living between
countries, more so than GDP pc in US$. Because the share of non-traded goods
and services, and their prices, are lower in countries with lower income
levels, the standard of living of poorer countries is raised and that of richer
countries lowered when PPP$ is used instead of US$.41 As a result, the gap in
the income per capita between richer and poorer regions is reduced remarkably
when PPP$ is applied.
APPENDICES
Page num: 287-300
DISPLACEMENT CALCULUS
·
The displacement calculus was first brought to
popular attention by the so-called BRIC report. The BRIC model by Wilson and
Purushothaman (2003) was a first attempt to use simple country models, for
Brazil, Russia, India and China among others, hence BRIC, to examine likely
displacement scenarios for major countries. The BRIC model sees emerging
economies catching up with and overrunning industrial economies due to (a)
higher real growth in GDP expressed in real US$, and (b) growing appreciation
of their national currencies, as a country’s market exchange rate against the
US$ in the future converges towards its purchasing power parity (PPP).
·
The forecasts obtained for 2040 and 2050 were
startling at the time they were issued. BRIC-2003 forecasted in 2003 that China
and India will pass the US and Japan due to both a and b. China and US were
forecasted to have equal shares of the world GDP, about 23%, in 2040, but China
would surpass US by some 5 percentage points in 2050. By then, India would
surpass EU by 4 percentage points. The top four countries in 2050 would be
China, US, India and EU, with the following GDP shares: 26.0, 20.6, 16.3 and
10.4. These four big countries would be followed by the group of four smaller
countries of Japan, Russia, Brazil and Mexico with GDP ratios varying between 3
and 4%. However, the gaps in the income per capita between the richer western
countries and others would remain, though lower.
·
Today, the projected displacement timeline of
BRIC-2003 is best described as outdated when compared with the latest
revisions, for instance PWC (2013), which use the same BRIC model but with more
updated and accumulated data, and improves on methods applied for forecasts of
foreign exchange rates. The PWC forecasts show the displacement to occur much
earlier than was thought. It is predicted that the GDP of China would overpass
the GDP of US in 2017, in terms of PPP and by 2027, in terms of market exchange
rates. India would come close to US in 2050, and a long way ahead of the next
batch of medium-sized countries.
·
China and India are recorded to have been
leading economies in the world until about the 18th century. After two
centuries of downfall, their economies have risen again and are forecasted to
regain their leading positions by 2040. After 2040, the growth rate in India’s
GDP is forecasted to be higher than that of China’s GDP. The then would-be-held
expectations of the relative future prospects of the two economies could play a
significant role in determining the future courses of the two economies. The
displacement of world leadership is comparable in significance to the ages of
discoveries and the industrial revolution. The growth of the FIS and its spread
to other countries in the 20th century was driven and shaped by the US, EU, and
Japan being its largest contenders. If in the 21st century, the economies of
US, EU and Japan are on the retreat as world leaders, then the FIS as we know
it today in the FIS-centred countries is also likely to retreat, be modified or
be outgrown by the prototype economic systems that associate with the newly
emerging world leaders. It defies prediction and relevance to discuss whether
the multi-poles system (MPS), will be realized, and if so whether MPS will
replace the firm intensive system (FIS), as the forerunner in the 21st or 22nd
century, or that some synthesis will emerge. But modifications in FIS so as to
accommodate and adapt elements of the MPS (like persuasion settings and
consensus coordination, and likely more than these two elements) are almost
certain due to the more rapidly growing interactive and regulative influences
of China and India in world development.
CHINA
·
Around the 10th century, the population of China
counted about 60 millions, compared to about 40 millions in Western Europe, and
a total world population of about 300 million. With an estimated size of an
extended household of 10 members, it can be estimated that China had about 4
million households in the 10th century. About 95% of these households were rural
and about 5% lived in urban areas.3 The rural farming population had the burden
of feeding itself as well as the urban population. The latter consisted of
imperial rulers, bureaucrats, military, craftsmen and other court supporters.
At the same time, a significant shift in the concentration of households took
place from North China where three-quarters of the population lived and where
wheat and millet were the main crops around the 8th century, to the region
below the Yangtze where rice cultivation dominated. This change permitted the
population of China to double by the 13th century, release labour for
handicraft production and raise general welfare to among the highest income per
capita at the time.
·
First, how did the economy of millions of
extended households with varying riches perceive and resolve the apparent
conflict between kinship sharing and profit making?
The prevalent view is that while the Chinese family
traditions favour kinship sharing, they oppose the full pooling of resources
among family members. Hence, rivalry among brothers is encouraged, and rewards
for leadership, performance and trust are applied. Proponents of this view
point to past and present evidence on the emergence of prosperous family-based
large-scale enterprises and new riches in China and by Chinese abroad,
emphasizing that whenever the external circumstances were/are favourable, such
opportunities were/are seized by the more fortunate households; and their
successes were/are hailed and aspired by more households.
·
Second, how was the polity managed in the
context of a vast country with millions of rural households and their catering
economy?
Already from the 7th century, the Chinese dynasty was
recruiting professionally trained public servants on a meritocracy basis,
admission was subjected to examinations and advancement required evaluation.
They serviced the central, provincial and district administrations. At the
level of the district, the magistrate was tax collector, judge, record keeper
and the local administrator, with a command on recruited clerks, policemen,
guards and alike. The bureaucracy was a privileged class; their families
enjoyed esteem and were exempt from many levies. Candidate bureaucrats, who
qualified academically but failed to become officials, formed a supportive
buffer stock, and enjoyed similar privileges but at a lower level. To
discourage corruption, bureaucrats were regularly rotated.
·
The bureaucracy functioned in a primarily feudal
agricultural economy. The bureaucracy invested enthusiastically and effectively
in agriculture and got its due share in a growing agricultural income. They
introduced hydraulic works and new crops, spread best techniques and
innovations, resettled farmers in more fertile areas and developed stockpiling
to mitigate famines. The concentration of the bureaucracy and gentry of
Imperial China on agriculture had the consequence of ignoring industry. The
urban workforce employed in industry, trade, transport, etc., basically
representing firm settings, was deferential to the bureaucracy and depended on
their good will. These firm settings did not enjoy legal protection.
Bureaucratic decisions could not be challenged. Furthermore, the reserved
attitude towards foreign elements and towards trading with the rest of the
world (ROW) did not encourage the opening up of foreign markets and related
commercial activities. The above biases failed to launch the country in the
industrial age. The Chinese economy lagged further due to internal rebellions
and external interventions involving wars with Japan, France and the United
Kingdom.
·
The modernization of China started with the
communist take-over in 1949. Being a federation of regions, each with vast
territories and populations, decentralized decision making dominated. While the
economic system was subordinated to political motives under the Maoist regime
(1949 to 1978), economic considerations played increasingly a greater role
thereafter, in the Deng and Zemin regimes. A series of economic reforms and a
gradual introduction of private ownership pushed the economy to new heights,
outperforming other major economies in the world. Crucial factors behind the
outstanding economic performance of the Chinese economic system in the past
three decades are usually categorized into three groups: the
socio-cultural-political environment in which China was historically
embedded, systemic features and government policies.
The socio-cultural and political
environment in China relates to strong family loyalties, strength of
ancient roots of entrepreneurship and a vast base of traditional and
technological knowledge, the attitude to conserve owns culture, the relatively
small size of ethnic minorities which fostered a homogeneous cultural outlook,
and the high population pressure on farmland which imposed moderation in
consumption and efficient resource use. The favourable systemic features
refer to the traditional bureaucratic proficiency in administrating matters of
interest to the state. The communist regime relied on the geographically
decentralized, competitively oriented and rigorously selected party and
non-party bureaucrats, in bolstering cooperation with the provincial rural
population to achieve the most for the province, and control population growth,
albeit distributing the outcome among the bureaucracy and the rural population
under tacitly presumed sharing arrangements. The ruling regime has encouraged
and has been guided by this selective approach in drawing up systemic changes
for the future. Finally, the policies pursued by the ruling regime from 1978
onwards were economically sound. As was reviewed above, the agricultural
mobilization was swiftly followed by the industrial restructuring and by an
outward orientation of foreign trade and financial relations, within restrained
tasks for the public sector.
·
The economic development of China can be broken
down in four phases, which were also characteristic of the economic success
stories of Japan and Korea, a few decades earlier. These are
(1) an agricultural shake-up that allows
freeing of resources for industry;
(2) balanced physical, human and
institutional infrastructures that allow industrial structuring and industrial
breakthroughs;
(3) outward orientation of foreign trade
and financial relations in harmony with circumstantial comparative advantages
and
(4) restrained and effective tasks for the
public sector.
·
China went through an agrarian reform that
confiscated about half of the cultivated land, belonging to landlords, and
redistributed this land to tenants and landless farmers. From the mid-1950s, agriculture
was collectivized in the form of cooperatives with an average size of 200
families. In their free time, farmers can cultivate their own private tiny
plots and sell them in limited free markets. These private plots did not count
more than 5% of the total arable land. The Great Leap Forward between 1958 and
1962 enlarged the cooperatives to 5,000 families was associated with food
shortages and distribution of food on basis of work points. Between 1962 and
1979 cooperatives reversed back to the other extreme of 20 to 30 families with
about 7% in private plots.
Modern reforms started from 1979 with (a)
extension of the limited free markets to household products such as poultry,
livestock and related; (b) introduction of the responsibility system, which
tied more closely received rewards to the targeted work performed. In a few
years, the system developed into that of (c) collective units of individual
households with cultivation rights for periods of about 15 years and (d)
binding contracts on the collective units to deliver certain portions of the
crops to the state/province at crop prices that were fixed by the state. As
private incentives, (e) the state paid premiums for extra deliveries above the
contract, and prices for attractive crops were raised. As transitional
strategies, (f) the state introduced a dual system with a tendency for the
official price to move towards widely known market prices.
The reforms resulted in a rocketing of the
growth rate of agricultural output from 4.3% pa during 1971–1975 to 7.5% pa
during 1980–1982 to 13.0% pa during 1982–1986. This significant growth in
agriculture is fundamental for the industrial push that occurred.
·
Following the Soviet example, industrial
enterprises became state enterprises in 1950, their objective was to maximize
output subject to given input constraints as planned by the central or regional
governments. The Great Leap Forward (1958–1960) introduced more centralization
and dogma, resulted in economic failures and was followed by a substantive
decentralization in decision making towards provincial and county levels. Most
enterprises obtained inputs from own province and sold output in own province.
Trade between provinces was in the hand of state trading firms in the
provinces. Production in strategic sectors remained in Beijing.
The industrial reform, from around 1980 and
onwards, consisted of four components:
(a) Creating product markets for inputs and
outputs.
(b)
Making enterprise managers behave in accordance with market rules via the pursuit
of profits, bankruptcy laws, government pre-determined rates of interest,
creating boards of directors independent from bureaucracy.
(c) Introduction of competition and
abolition of monopoly power especially manifested in loosening the inter-trade between
provinces that was until then run solely by state trading firms, and in
liberalizing the organization and provision of services.
(d) Setting prices in accordance with
relative scarcities.
Differentiated stimulation and reform
policies in industry were applied towards state-owned and state-participating
enterprises, SOE, and various types of non-state owned enterprises, non-SOE,
which discouraged SOE but favoured non-SOE. On the eve of economic reforms in
1978, SOE’s share in industrial output and employment amounted to 79% and 52%,
respectively; some three and a half decades later in 2003, these shares fell to
37% and 14%.
The categories of SEO and non-SEO in China
cover a complex differentiation of enterprises by status of ownership and
registration. Within state ownership, the share of purely state-owned
enterprises diminished, that of state participating enterprises, where the
state controls a minority share, has increased significantly. While the bulk of
state ownership has been shifted to the infrastructural sectors of energy,
mining, electricity, water, communication, iron, chemicals and tobacco, the
state participating enterprises are active in the consumer and intermediate
goods industrial activities, including production for domestic and foreign
markets. The state-owned enterprises are highly decentralized and are
affiliated to one of three levels of government: central, provincial and
county, with most of them under direction of the provincial and county
governments. The Chinese economy is known to have multi-layer and
multi-regional features. Furthermore, the traditional small size of state
enterprises in terms of the average employment per enterprise has been
maintained, compared to larger sizes of public enterprises in Russia and other
former transition countries in the pre-transition period.
China’s capital market started from 1995,
but its coverage is not inclusive, and its functioning suffers from its
short-lived learning experience (uncertainties and speculations due to ambiguities
in regulations, loose supervision, non-transparency, limited information access
and use).
As regards the non-SOE sector, two
important developments can be highlighted. First, in the first decade of
the industrial reforms, roughly between 1980 and 1990, the emergence and growth
of the collectives and cooperatives, especially township and village
enterprises, known as TVEs, was crucial for shaping the domestically oriented
industrial structure. In TVE, the means of production are owned collectively by
the owners/workers, local government and more funds can be raised from the
public. TVEs are generally characterized by ambiguous property rights, in the
sense that rights of owners are not guaranteed beforehand. Instead,
owners/workers have to fight for actual remuneration, ex-post. Second,
in the second decade of the industrial reform and later, roughly from 1990
onwards, the driving force of industrial development shifted from the
domestically oriented collectives and cooperatives to the outward-oriented
commercial companies such as limited liability companies, shareholding
corporations and foreign funded multinationals. Entrepreneurship in these
companies focused increasingly on innovations, cost reduction, linking with
exports and foreign direct investment (FDI) and increasing their share of both
the domestic market that hence commands a huge purchasing power, and the
foreign markets. In similarity with industrial restructuring, the ownership
structure in construction and services shifted significantly from state and
collective to private and other modes. While in 1978, state and collective
ownership accounted for 90% of these two sectors, by 1996, the situation
reversed with private and other types of ownership accounting for 93%.
·
The Stalin–Mao agreements of 1950 made China
heavily dependent on the Soviet Union for purchase of foreign capital equipment
and technical skills, and Chinese foreign trade went also in the direction of
the Soviet Union. Soviet–Chinese geo-political relations deteriorated in the
late 1950s, leading to a withdrawal of Soviet technicians and capital, and
uncompleted investment projects. The economic isolation of China from the ROW
(Rest of the World) was reinforced
furthermore by the Western boycott of China following its military manoeuvres
in North Korea from 1950. As a result, foreign trade of China, which had a very
limited scope in 1950, dropped further by a fifth during 1960–1970. As the
Western economic boycott of China was relieved gradually, ending formally in
1971, and as the new political leadership in China saw the benefits of an open
economy as was demonstrated by Japan, Taiwan, Korea, Singapore and Hong Kong,
the Chinese government started from mid-1970s on relaxing foreign trade
control, decentralizing foreign trade decisions and pricing, devaluating the
yuan, setting up free trade zones with duty-free inputs and exports, and
putting to use in the areas of production, trade and investment the very close
relationship between Hong Kong and China.
The foreign trade policy of China with the
rest of the world, ROW, focused on accelerated exports as the source of foreign
exchange income, the predominance of manufactured goods in these exports, and
the increased alignment of these manufactured exports with FDI and joint
ventures.17 The negative foreign trade balance of 1980 shifted into positive
from 1990 onwards, and reached staggering levels as the growth of merchandise
exports became more closely attached to foreign funded enterprises and joint
ventures empowered by large inflows of FDI. The early reliance of the country
on international borrowing to finance investment in infrastructures came to a
stop in years adjacent to 1995. At the same time, portfolio investment and FDI
increased dramatically, and together with a mounting positive trade balance,
China was able to form by 2003 the largest foreign exchange reserve held by a
single country, at US$403,251 million, next to a substantive gold reserve. The
accumulated foreign exchange reserves allowed China to become a capital
importing to a capital exporting economy with due emphasis on development and
possession and safeguarding future supply of natural resources for China from
other development regions abroad.
The outward orientation of the Chinese
economy is also gradually felt in its capital market. Trade is conducted in A
shares and B shares. A shares are local shares and can only be bought by local
(Chinese domestic) investors. B shares are only available to foreign investors.
Only recently, Chinese are allowed to buy B shares, conditioned on the fact
these purchases are done with foreign held capital. Foreign investors can buy A
shares when they have official Qualified Foreign Institutional Investor (QFII)
status. The stock exchanges of Shenzhen and Shanghai had capitalization values
end 2012 of $2.31 trillion and $1.16 trillion, respectively; with these values,
they count as the 6th and 15th largest stock exchanges in the world.
·
China has been able to restrain the tasks of the
public sector and limit the shares of public revenue and public expenditure in
the GDP. Furthermore, public revenue has become about equally divided between
central and local governments, while public expenditure has shifted from the
central to local levels. China makes use of extra public budgetary revenues and
expenditures but the shares of these in the GDP have been falling down, and
they are primarily meant to supplement the local fiscal balances. The budgetary
deficit has been kept within the internationally respectable limits of 2.5% of
the GDP.
INDIA
·
The origin of the Indian culture and territories
is postulated by historians to be a merger between an Indus Valley civilization
and invading Aryan tribes from the northwest. The modern history is dated from
the 8th century, with the Arab invasion of India, followed in the 12th century
by the Turks. Unification of the country occurred in the 17th century under the
Moghul rule. While the involvement of European traders dated from the 15th
century, British rule assumed political control by the 19th century. The Indian
society, for several centuries before, under the Moghul rule, and under the
British rule has greatly kept its characteristic feudally organized traditional
village society. While as elsewhere, the feudal system divided the population
into patronizing landlord households who owned land, and peasant households who
cultivated the land and shared the produce with landlords, for the obtained
patronage, typical for India was the village culture and the castes society.
Extended households related to each other
by kinship populated the thousands of villages. All generations of the family
lived together, pooled their income and consumed collectively. Because of the
intra household intensive relationships, inward orientation of the villages,
poor transport and contact between villages, the villages were largely
self-sufficient. The feudal regime was backed by a castes society, which
divided the population into rigid hereditary groups with clearly defined
societal functions and ranked downwards from priests and landlords to warriors,
traders, peasants and outcastes. By prohibiting inter group agent flows and
emphasizing rank, the caste society discouraged self-esteem, social mobility
and the development of strong nationalistic aspirations among the less privileged.
The first major foreign invader — the
Moghuls — dominated India from about 1500 to around 1700, established control
on Northern India that was mainly Muslim and Southern India that was all Hindu.
The Moghul regime introduced the royal court and a bureaucratic aristocracy
that was considerably foreign based. Moghul official consisted of controllers,
accountants and judges installed at the level of collections of villages called
jagir. They earned their incomes from revenues made by jagirs. The Moghul
central government levied a land tax that was collected by controllers of
jagirs, equivalent to about one-third of the crop production. The tax was used
to support occupying troops and construction works. The Indian economy
flourished during the Moghul rule, but political control on the various regions
of India disintegrated by 1700 due to ethnic intolerance by Moghul rulers. The
collapse of the Moghul empire led to a break-up of India in independent mostly
run by warlords.
British rulers filled the political vacuum
gradually, by conquering Bengal in 1757, and extending control to Madras and
Bombay in 1803, and Punjab and Sindh in 1849. The British controlled India via
a compact army of British soldiers and Indian mercenaries and an efficient
bureaucracy that had a watchdog character. The zamindari played a crucial role
as the watchdog. These were a group of landlord’s intermediary between
government and land operating peasants; the British created them in 1793 from
the tax-gatherers in Mughul India with the purpose of using them for the
collection of land taxes and for the exercise of political control in rural
areas.
Although village life and feudal features
were paramount, some urban cities and towns in India under the Moghul rule experienced
relatively high levels of industrious activities and economic welfare. The
Indian cottage and textile industries were highly renowned at the time, and
might have come close to a firm intensive setting, but they suffered
significantly in terms of expansion under British rule. The region was also a
magnet for regional trade in the 18th century, but again did not grow and lost
much of its attraction in relation to other world regions in the 19th century
and up to independence in the mid-20th century.
Non-violent resistance to British
colonialism under M. Gandhi and J. Nehru led to independence in 1947. Gandhi
idealized and urged for a communal and a traditional village life as the most
humane way of life, but this fell out of step with the modernization paradigm
of Nehru.26 Through a combination of factors like land reform,
commercialization and the green revolution, traditional agricultural structure
in India went through major changes. In the early years of independence, the
central objective of land reform measures was the abolition of Zamindari.
Fuelled by mainly nationalistic motivations, the abolition of semi-feudal
intermediaries and the absentee landlords, who were allies of the British in
British India, was successful.
From the hitherto absentee landlords
emerged a small group that was ripe for transformation into capitalistic
farmers, Kulaks. 27 Legislation on tenancy abolition encouraged these landlords
to become rich and direct cultivators of their land, named Legislation towards
elimination of feudal tenancy had also the effects of increasing the more
purely commercial tenancy where labour works for a wage and raising the amount
of land rented by kulaks. As a result, the kulaks were well on the way to
becoming the new masters of the countryside. Greater demand for agricultural
products and cultivated land, and the green revolution increased the wealth of
the already prosperous and powerful kulaks.
·
The economic development of India was hardly any
world news in the 1950s– 1990s. India’s potential became recognized a few years
later than China’s potential. India had its own version of tackling the four
prerequisites of systemic change necessary for a sustained take-off. These are,
it is remembered:
(1) an agricultural shake-up that allows freeing
of resources for industrialization;
(2)
balanced physical, human and institutional infrastructures that allow
industrial structuring and industrial breakthroughs;
(3) outward orientation of foreign trade
and financial relations in harmony with circumstantial comparative advantages
and
(4) restrained tasks for the public sector
·
The green revolution, whose effects came later
in time, is generally seen to be more crucial than land reform in transforming
agriculture and supporting industry. While the Indian government fulfilled a
role in transferring resources from agriculture to industry via its fiscal and
double pricing systems, other factors played crucial roles in the transfers of
labour and capital. The demographic pressure, failure of land reform, success
of the green revolution and commercialization of agricultural land, all led to
higher land prices compared to farm wages and compelled the out-migration of
landless peasants to urban areas, and cheap labour was essential for starting
industry.
·
In their effort to bolster national
industrialization, Indian governments followed centralized policy making and
implementation. This took the forms of nationalized infrastructural sectors
such as public utilities, transport, communications; permission of state-owned
firms to participate in and control iron and steel, cement, chemicals,
electronics and other major manufacturing industries; regulated markets and
policies that reserve certain activities of small-scale production to the
unregistered and registered small establishments and exclude large-scale
production; and imposition of protective import substitution measures, high
tariffs and non-tariff barriers and foreign capital controls.
Furthermore, in the 1970s, India
nationalized banking, mining, textile mills, wholesale grain and jute trade in
rescue operations of failing private enterprises and threatened unemployment.
During this and adjacent periods, the share of public investment in total
investment increased, and that of private investment fell down. Private
investment was subjected to a hoard of licences and regulations resulting in
cooling the investment climate. These shifts from the private to the public
sectors in India contrast remarkably with opposite shifts occurring in China
and other East Asian countries.
In spite of the marginally greater
resources put in the public sector, and despite the strong regulatory regime of
the private sector, the annual growth rate of public sector GDP declined from
7.8% in the period 1960– 1975 to 7.2% in the period 1975–1990; while that of
the private sector rose from 2.6 to 3.7%. Industrial restructuring suffered
from an inadequate physical infrastructure in transport, communication and
energy. The human infrastructure that was built and supported by the state was
more oriented to higher than middle and vocational education and not conducive
to industrial development. The financial infrastructure necessary for modern
industry was absent. Recognition of the above gaps, together with gained
knowledge on the positive effects of favourable investment climates and export
promotion regimes for a few East Asian economies contributed to a reversal of
state policies in India. By late 1970s, economists on trade and development
were able to show that import substitution measures were often overextended and
obstructed export promotion and the flow of FDI, both of which are important
ingredients of economic development.
The newly elected Indian government in
1980, under Indira Gandhi, and later Rajiv Gandhi, made important openings to
leading industrial firms and implemented targeted industrial measures towards
major firms ranging from granting import licences to tax holidays, location
wavers and credit guarantees. The measures created a positive investment
climate and have been named as pro-business reforms in contrast to the
pro-liberalization reforms that was launched in 1990 by the next government and
that introduced liberalization domestic and foreign trade markets and export
promotional reforms across the board, and started implementing a modest
privatization programme of state enterprises. Indian growth was triggered by an
attitudinal shift on the part of the national government towards a pro-business
approach from 1980, as opposed to a pro-liberalization approach that started in
1990. Reliance in the 1980s was on existing business interests while in the
1990s, the emphasis was on restructuring and new entrants via liberalization.
Of course, it is most likely that the performance of the 1980s would have run
out of steam if the true liberalization reforms of 1990s were not implemented.
The combination of targeted and neutral
outward-oriented economic reforms, and their phasing in that order, is not
unique to India. It was done before by Japan and Korea, and has been followed
by many developing countries. What is unique in the economic development of
India is that the effects of the outward-oriented economic reforms, given
internal structures and external circumstances, culminated in a higher economic
growth in services than in industry, and set into motion a comparative
advantage in modern services over industrial merchandise.
·
The higher comparative advantage of India in
modern services over industrial merchandise has come as a surprise to many.
Exports of modern services include software development, and information
communication technologies (ICT)-enabled services ranging from back office
operations, revenue accounting, data entry and conversion, database
development; to the processing of medical transcriptions, insurance claims,
educational content and publications; remote maintenance and support; and call
centres.
ECONOMIC GROWTH AND ECONOMIC
ORIENTATION
·
China’s growth of the GDP for the period
of 1993–2004 is accounted for by almost equivalent contributions of the growth
of capital inputs and growth of factor productivity at about 44 and 42%,
respectively; and their contributions have been increasing compared to the
previous period of 1978–1993. The contributions of growth in labour quantity
and labour quality (i.e. labour education) inputs to economic growth are
relatively low at 12% and 2%; and these are down compared to the previous
period. Growth accounting for India for the periods 1960–1980 and
1980–2004 shows the contribution of capital growth to economic growth to be
stable at about 24%, a diminishing contribution of labour quantity growth at
33.3%, and increasing contributions of labour education growth, with factor
productivity growth reaching 7% and 35%, respectively. The comparisons
show that growth in capital and factor productivity play greater roles in
economic growth in China than in India, though the lag is being closed with
factor productivity. In contrast, labour education and labour quantity are more
significant as contributing factors to economic growth in India than in China,
but here too, the contribution of labour quantity is diminishing as was
observed for China, earlier.
In China, during 1993–2004, the
contributions of the primary, secondary and tertiary sectors — more or less
agriculture, industry and services — amounted to 8, 59 and 29%, respectively.
Industry is thus the highest. The remaining 21% is due to reallocations between
the sectors, mainly from agriculture to industry and services. The reallocation
accounts thus for about 2% annual economic growth of an aggregate growth of
9.6%. For India in the period 1993–2004, the contributions of
agriculture, industry and services amounted to 11, 19 and 45%, respectively.
The services sector is thus the highest contributor in India in contrast to
China where industry is the highest contributor. The remaining 25% is due to
reallocations between the sectors, mainly from agriculture to industry and
services. The relative contribution
of the reallocation component is slightly higher in India than in China,
suggesting that in that period the economic restructuring in India was higher
than in China.
·
In an assessment of the displacement hypotheses,
it is important to determine whether the economies of China and India are
tending more towards becoming fierce competitors of each other or filling
complimentary positions in a globalizing economy. If they are fierce
competitors, then one of the two will probably be more successful than the
other in the long run, and the group of world leading economies will be joined
by one newcomer resulting in the displacement of one incumbent. On the other
hand, when both the economies of China and India have tendencies to occupy
complimentary positions in a globalizing world, and grow rapidly in more or
less equivalent rates, both countries would at some time become leading
newcomers resulting in the displacement of two incumbents. A complimentary
relationship between the economies of China and India viewed in a global
perspective is likely to widen the displacement effects for the leading
incumbents.
The ensuing comparative advantage in
foreign trade can be viewed from a demand side and a supply side. Take the demand
side, countries at about the same level of income per head have similar
demand patterns and would be competitors of each other in that respect.
Countries with differing levels of economic welfare have different demand
patterns, and thus minimizing inter-competition. This latter situation would
apply more to China and India. Taking the supply side, decomposition
analysis of GDP growth in industry and services shows China to surpass India
with a higher factor productivity growth in industry, and in contrast, India is
shown to surpass China with a higher productivity growth in services. As in
China, so also in India the incoming FDI tended to be invested in lines that
associate with the lines of exports. But there is a significant difference
between the two countries. In China, the lines of FDI and exports are primarily
concentrated in the production of merchandise goods with little in services.
This is otherwise in India, where FDI is more focussed in services.
Even though the two countries occupy for now
complementary positions, they still compete for foreign sources of trade and
investment from the ROW. Under austere scarcity conditions, ROW cannot escape
at one time making economic choices between the two giant economies. The then
would-be-held expectations of the relative future prospects of the two
economies could play a significant role in determining the future courses of
the two economies. In the meantime, however, the domestic component of these
economies is becoming larger and can be become the self-propelling growth
mechanism, with less dependence on the foreign sector and ROW flows.
ECONOMIC GROWTH AND INCOME INEQUALITY
·
As usual, the forecasts and analysis on the
displacement hypothesis are conditional on the absence of major external and
internal constraints. At the external front, assumed is the absence of economic
calamities caused by world recessions, credit crunch, trade protectionism,
inelastic supply of energy resources; and at the internal front assumed is
absence of social and political instability caused by inequality divides,
poverty hazards, ethnic conflicts, civil disorder, polity shake-up or financial
mismanagement. Regarding internal risk constraints, the ultimate realization of
the future economic prospects would require stable and sustainable societies
and polities.
·
The evaluation of increases in income inequality
cannot be done in isolation from the growth in income per capita, since both
effects associate in the development context, and there is a trade-off between
the two effects. We formulated and applied an inequality well-being trade-off
defined as change in the Gini index between t and t − 1 divided by the growth
rate of GDP per capita in t. Higher positive values of the elasticity are
indicative of a greater tension between inequality and wellbeing, meaning that
there is a larger increase in the Gini index with every one percentage growth
in the GDP per capita.
·
growth–inequality disruption crisis: critical
test of balancing growth with inequality
CONCLUDING REMARKS
· We described the bigger and highly dualistic countries of China and India as multi-poles and emphasized the important role of persuasion settings in the coordination of their social system. Although China does not have an active parliament that can contribute to persuasive outcomes, the country has developed other forms of persuasion settings. The Congress of the Communist Party, held every five years, is a major persuasion setting that outlines future actions to be taken in terms of institutions and policies, and appoints the right authorities to lead, defend and implement the actions. Other very popular persuasion settings in China are councils of knowledgeable experts that attempt to reach consensus solutions to outstanding problems.
LEADING REGIONS AT THE WORLD LEVEL
·
The larger the number of agents and the larger
the size of the economic transformation in one subsystem, the greater the
influence will be of that subsystem in its interactions with other subsystems.
We formulated a DI based on the relative shares of agents and gross domestic
product (GDP) to represent the degree of influence of subsystems in the whole
system. Once the dominance of one specific subsystem overpasses the signals of
an over majority (say >80%), this specific subsystem tends to overrun the
whole system. We can look at the economy of the whole world as one world
economic system, and the economies of the eight regions as subsystems in
the world economic systems. The relative shares of the regional subsystems in
the total world population and in the total world GDP are the arguments that
determine the DI of the regional subsystems.
LEADING COUNTRIES AT THE REGIONAL
LEVEL
·
The higher the index of a leading country x the
greater is x’s influence in passing the behavioural features of x to follower countries.
The leading country is likely to become the one and only one dominant player in
the region once a threshold value of DI is passed; which related literature
suggests to be around 80%. Once this threshold is passed, there is a surge in
the likelihood that the behavioural features of the dominant player spread
vigorously and ending up as the standard mode in follower countries.
·
LEADING COUNTRIES AT THE WORLD LEVEL
·
Leading countries played prominent roles in past
world development. Italy as the playground for the Papal Revolution, and in
resemblance the German, English, American, French and Russian revolutions,
Spain and Portugal leading the age of discoveries, Britain leading the
industrial revolution and US leading firm intensive anchoring in economic
systems, etc., China and India, as upcoming global leaders, can be expected to
bring new ideas and new ways of conducting things that can be adapted, spread
worldwide and impacting as to become aspects of world development, with lasting
impacts on economic systems.
We presented earlier in Table
the DI of leading regions, r, at the world level, w; the operation can be
expressed as (r/w); and we presented the
DI for leading countries, c, at the regional level, r; this operation can be
expressed by (c/r). This section deals with leading
countries at the world level, or (c/w). Calculation of the DI for (c/w) is
straightforward. It is obtained by multiplying DI results for (r/w), by DI
results for (c/r ) giving the value of DI for each country at the world level
LEADING COUNTRIES IN THE NEAR FUTURE
To compute the DI for leading countries in future
years, one needs projections of the population shares and the GDP shares of
leading countries in the world’s total population and GDP, respectively. United
Nations Demographic Division is the primary source for population projections.
Reference was already made to PWC (2011) as our source of projections for the
GDP. These two types of projections are employed to compute DI for leading
countries for 2030 and 2050.
EXPLORING DESIGNS FOR WORLD
GOVERNANCE
·
The current world governance system was shaped
in the advent of WWII, and has undergone a few additional changes since then.
The United Nations assembly consists of 193 member states. The UN security
council consists of five permanent members with veto rights: China, France,
Russian Federation, the United Kingdom and the United States, and 10
nonpermanent members elected for two-year terms by the General Assembly. There
are permanent international agencies on trade, finance, law and all areas of
major social and economic activities, and intermittent conferences on newly
rising global challenges. The latest development in world governance is the
establishment of the G-20, which is a forum of political leaders of the 20
leading economies in the world.
·
Responsive actions to global failure require a
world governance that is fairly representative of regional and country
interests. A world polity that circles around individual countries with the
highest GDP is ineffective in a world of 193 countries with 173 of them not
participating. We worked our way in this book by focusing on eight world
regions that were shown to be internally converging. It is instructive to
demonstrate how the composition of a world top of presidential leaders (to be
entrusted with coordinating world governance and resolving global failure)
along our lines of thought would look like. Our list will be very different
from the above-mentioned G-20 for several reasons.
First, we employ influence potential
based on population and GDP, which is more democratic and more real. Second,
our starting point will be regional representation, followed by naming
countries, which is more democratic and more logic. Third, subject to
explicitly set minimum and maximum rules, our outcome regarding representation
is straightforward. This is not the case with G-20, which includes countries
that do not qualify for the GDP criteria, and excludes others which do qualify,
pointing thus to manipulated selections. Fourth, a forum of 20 top
leaders is too big to be effective. Our list is restrained to 14 members
By eliminations, it ends up in a list of
W-14. The list consists of US, Japan, Germany, France (for FIS), Russia (for
RRTC), China, Indonesia (for EAP), India (for SA), Turkey (for CAC), Saudi
Arabia (for MENA), Nigeria, South Africa (for SSA) and Brazil, Mexico (for
LAC). It is noted that this list of 14 leading countries account for about two thirds
of the full scale of the world DI, with the rest of the countries, about 180
controlling one-third of the world DI.
There is a rationale for supplementing the
W-14 by a chamber of regional ambassadors who can represent the interests of
the countries in the region other than that of the leading country. We refer
here to the EU in the FIS group, the ASEAN in EAP, SARC in SA, the Arab League
in MENA, etc. A chamber of eight regional ambassadors (say, the presidents of
the above-mentioned organizations) can be installed to that effect, call it
R-8, and it can convene on a regular basis in much the same way as W-14, and
cooperate together in fixing world governance and global failures. Such an
arrangement is already accommodated in the G-20 with respect to the EU; and it
proves essential for streamlining policies at the country, regional and world
levels.
THANK YOU !
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