New Directions in Development Economics

These challenges were interpreted by some as reflecting a decline in the discipline of development economics (Hirschman 1981). However, from the middle and late 1980s there has occurred a revival of interest in development economics, which may be inter­preted as ushering in a fourth phase in the history of the discipline.

This phase continues to be dominated by the neoclassical approach which emphasizes the policies of liberalization, privatization and globalization - the so-called Washington Consensus view - and locates the problems of development in the allegedly misguided policies of interventionist and protectionist governments (see Meier 2005). According to this approach, the solution lies in rolling back the state by reducing government regulation of the economy and privatizing state-owned enterprises, reducing restric­tions on trade, reducing financial regulation and reducing restrictions on international capital movements. These policies coupled with those which impose austerity measures involving fiscal and monetary contraction continue to be enthusiastically and vigorously supported by the International Monetary Fund when it provides external financing to countries with payments problems, and by the World Bank, as part of its structural adjustment programs when it provides development assistance to LDCs. The World Trade Organization has also promoted free trade, in addition to reducing regulations that LDCs can impose on the activities of transnational corporations and imposing intel­lectual property rights protections internationally. Even when policies of this type have had disastrous consequences, the policy of getting the prices right through such measures has not lost favour. Rather, the sequencing of reforms, the incompleteness of reforms (for instance, not liberalizing labour markets), and not having proper institutions in place have taken the blame.

The first strand refers to new neoclassical approaches that examine issues such as agrarian relations, income distribution, the causes of poverty, and general institu­tional issues. While applications of neoclassical microeconomic theory to development economics - with its ubiquitous optimization agent - have a long history, the recent flowering in this literature applying the tools of industrial organization, game theory and information economics - reviewed, among others, by Ray (1998) - is unprecedented in volume and scope. A flavour of the analysis can be gleaned from the following examples. First, if an economy with imperfect competition in goods markets has different produc­tion technologies available to it, it can be caught in a low-level equilibrium trap using constant returns to scale technology rather than using the increasing returns technology which requires a higher level of production. This analysis uses neoclassical methodol­ogy to formalize Rosenstein-Rodan’s argument for a big push. Second, in the presence of asymmetric information in which lenders possess incomplete information about the actions of borrowers, it is argued that credit is rationed to poor borrowers with smaller endowments of wealth and collateral, resulting in an inefficient allocation of resources and the perpetuation of inequality. A similar logic explains why capital, rather than flowing from rich to poor countries with an allegedly higher marginal productivity of capital and profitability, can flow the other way, implying growth divergence. Third, in agricultural sectors with sharecropping tenure systems, land reforms granting tenants greater security of tenure and regulating the tenant share can strengthen the bargaining position of tenants, increase their share of output, increase their incentives and effort and thereby improve efficiency.

Two, in the macroeconomic sphere, an empirical and theoretical literature on long-term growth has expanded rapidly, triggered in the late 1980s by the revival of neoclassical growth economics in the form of new growth theories. Cross-country and panel growth regressions have examined factors explaining variations in growth rates across countries (Temple 1999). The role of numerous variables, including the rates of investment and saving, the level of human capital formation, research and devel­opment expenditures, political stability, financial variables, inequality, the extent of openness to international trade, and foreign direct capital inflows, have been explored. The robustness of these results, however, has been called into question, with only a few variables - such as investment rates - being found to have a positive and significant effect.

Three, also in the macroeconomic sphere, there has developed what can be called the neo-structuralist approach, which blends macroeconomic approaches drawn from the classical economists, Marx, Keynes and Kalecki, with early structuralist contributions from the second phase described above, to analyse the determinants of growth and income distribution (see, especially, Taylor 1983). This approach uses mathematical methods involving accounting identities and behavioural and equilibrium equations, and uses dynamic equations to examine the time path of the economy. Several features of this approach can be noted. First, aggregate demand determines capacity utiliza­tion and the rate of growth with the price level determined by a fixed money wage and a given mark-up set by firms. While early development economists argued that LDCs were mainly constrained by saving, foreign exchange and other supply-side bottlenecks, this approach places aggregate demand issues at centre stage, given the many sources of uncertainty present in the economy (see Dutt 1996). Second, the approach examines how the distribution of income between wages and profits affects capacity utilization and growth. Growth can be wage-led - because a redistribution of income towards wage earners from profit recipients who save a higher fraction of their income increases consumption demand, capacity utilization, and investment, which depends positively on capacity utilization - thereby formalizing a long tradition which argues that inequality causes economic stagnation.

Four, less formal literatures have re-examined the actual experience of developing economies, especially the successful East Asian newly industrialized countries (NICs) and, more recently, China, and drawn broad general conclusions from this analysis. Going beyond the boundaries of economics narrowly defined to incorporate and develop ideas from sociology, political science, and other disciplines, this study of the NICs experiences has shown that the success of these countries cannot be interpreted as an accomplishment of free market economics, and that the state played an active role in the development process (see Wade 1990; Amsden 1991; Stiglitz 2002; Chang 2008). The experience of these countries seems to be no different from those of late develop­ment in backward countries of the past, as argued in the early historical analysis of Gerschenkron (1962). In countries such as Korea and Taiwan, the state intervened in the economy, established state-owned enterprises, provided import protection, and allocated credit to particular sectors and firms. However, when it provided protection and credit it demanded that the recipients meet performance criteria in terms of eventual export success, without which the help they received was withdrawn. The recent interdiscipli­nary work suggests that markets and states can play a synergistic role in the development process, and that the nature of markets and of the state are more important than whether the state or the market is allowed a greater role. Markets push producers to become more competitive, but only after they have overcome initial handicaps against more techno­logically advanced foreign producers, as stressed earlier by List. The state can guide the market to get the best out of firms, playing a strategic role. Successful developmental states which have promoted economic development have been relatively autonomous from civil society and not become captive to powerful groups who act in their narrow self-interest, but have also been embedded within society - through Weberian bureauc­racies and political parties - to obtain appropriate information and develop trust with private partners (see Evans 1995).

Five, also using an empirical approach, several mainstream economists are looking carefully at institutions and behaviours, and designing policies, that affect develop­ment and poverty (see, for instance, Banerjee and Duflo 2011). This approach exam­ines historical evidence, econometric studies often using survey data, and randomized experiments to study how people actually behave, how norms and other institutions affect their behaviour and how their behaviour reacts to policy interventions. Although this approach generally takes a microeconomic perspective, it draws on the ideas of behavioural economics rather than using the neoclassical optimizing agent.

Six, following the early focus on growth in per capita income and the criticisms which gave rise to the interest in poverty and basic needs, a strand in development economics focuses on the meaning and measurement of economic development. Sen (1999) distinguishes between opulence (or income and production), utility and func­tionings and capabilities. While opulence - for countries as a whole or for individuals, for instance, in the measurement of poverty - refers to the means of development, it cannot be considered an end. Utility - which is now measured in happiness studies by surveys of subjective well-being - can be considered an end, but is subjective because it depends on individual feelings, and may reflect the fact that people adapt to changes in their circumstance; thus, for instance, the poor may get used to their impoverished conditions and not feel too unhappy. Thus, Sen prefers to emphasize functionings - the extent to which people are obtaining and achieving goods that they justifiably value, such as nutrition, healthy lives, education and dignity - and even more, capabilities, that is, whether people have the ability to achieve these valued goods (without neces­sarily achieving them). Despite the difficulties in compiling lists of such goods and of measuring and aggregating over them, there have been attempts to construct such measures of development, including the Human Development Index which takes into account achievements in education and health in addition to income. While many of these concepts examine how individuals are doing, others may refer to overall societies, for instance, regarding environmental issues, which have received increasing attention not just because of what it does for growth and health, but also as an end. Aside from the fact that this strand clarifies the meaning of development, it also leads to an exami­nation of how different people in an economy are doing relative to each other - for instance, people of different genders and ethnic groups - and how the different elements of development affect each other - for instance, how growth and poverty, and the envi­ronment and poverty, interact. On the last issue, although it is possible to have growth without improvements in distribution and average levels of functionings, the experience of LDCs analysed in the previous strand, suggests that sustained growth seems to be required for such improvements.