The misconceptions of "development economics"

Supplanting the price mechanism by government intervention Deepak Lai does not necessarily promote development

Ideas have consequences. The body of and panaceas for solving the economic different "strategies of development," and thought that has evolved since World War problems of the Third World have come to (4) the role of the price mechanism in II and is called "development economics" form the corpus of a "development eco- promoting development. (to be distinguished from the orthodox nomics." These include: the dual economy, The last is, in fact, the major debate that "economics of developing countries"—see labor surplus, low level equilibrium trap, in a sense subsumes most of the rest, and box) has, for good or ill, shaped policies unbalanced growth, vicious circles of pov- it is the main concern of this article; for the for, as well as beliefs about, economic erty, big push industrialization, foreign major thrust of much of "development development in the Third World. Viewing exchange bottlenecks, unequal exchange, economics" has been to justify massive the interwar experience of the world econ- "dependencia," redistribution with growth, government intervention through forms of omy as evidence of the intellectual defi- and a basic needs strategy—to name just direct control usually intended to supplant ciencies of conventional economics (em- the most influential in various times and rather than to improve the functioning of, bodied, for instance, in the tradition of climes. or supplement, the price mechanism. This Marshall, Pigou, and Robertson) and seek- Those who sought a new economics is what I label the dirigiste dogma, which ing to emulate Keynes' iconoclasm (and claimed that orthodox economics was (1) supports forms and areas of dirigisme well hopefully renown), numerous economists unrealistic because of its behavioral, tech- beyond those justifiable on orthodox eco- set to work in the 1950s to devise a new nological, and institutional assumptions and nomic grounds. unorthodox economics particularly suited (2) irrelevant because it was concerned The empirical assumptions on which this to developing countries (most prominently, primarily with the efficient allocation of unwarranted dirigisme was based have been Nurkse, Myrdal, Rosenstein-Rodan, Bal- given resources, and hence could deal nei- repudiated by the experience of numerous ogh, Prebisch, and Singer). In the subse- ther with the so-called dynamic aspects of countries in the postwar period. This article quent decades numerous specific theories growth nor with various ethical aspects of briefly reviews these central misconcep- the alleviation of poverty or the distribution tions of "development economics." Refer- of income. The twists and turns that the ences to the evidence as well as an eluci- unorthodox theories have subsequently Development economics is used to denote dation of the arguments underlying the economics with a particular view of developing taken may be traced in four major areas: analysis (together with various qualifica- countries and the development process, in (1) the role of foreign trade and official tions) can be found in the author's work contrast to the mere application of orthodox or private capital flows in promoting eco- cited in the accompanying box. economics to the study of developing countries. nomic development, (2) the role and ap- Denial of "economic principle" For a discussion of this topic, seeA.O. Hirsch- propriate form of industrialization in de- man's Essays in Trespassing, (Cambridge, veloping countries, (3) the relationship The most basic misconception underly- 1981). between the reduction of inequality, the ing much of development economics has alleviation of poverty, and the so-called been a rejection (to varying extents) of the

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©International Monetary Fund. Not for Redistribution behavioral assumption that, either as pro- much different in developed or develop- real world of imperfect markets and im- ducers or consumers, people, as Hicks said, ing countries. Changes in relative factor perfect bureaucrats is a second best. But "would act economically; when the oppor- prices do influence the choice of technology judging between alternative second best tunity of an advantage was presented to at the micro level and the overall labor outcomes involves a subtle application of them, they would take it." Against these intensity of production in Third World second-best welfare economics, which pro- supposedly myopic and ignorant private economies. vides no general rule to permit the deduc- agents (that is, individuals or groups of tion that, in a necessarily imperfect market Market vs. bureaucratic failure people), development economists have set economy, particular dirigiste policies will some official entity (such as government, A second and major strand of the un- increase economic welfare. They may not; planners, or policymakers) which is both warranted dirigisme of much of devel- and they may even be worse than laissez- knowledgeable and compassionate. It can opment economics has been based on faire. the intellectually valid arguments against overcome the defects of private agents and Foretelling the future compel them to raise their living standards laissez-faire. As is well known, laissez-faire through various dirigiste means. will only provide optimal outcomes if per- Behind most arguments for dirigisme, Numerous empirical studies from differ- fect competition prevails; if there are uni- particularly those based on directly con- ent cultures and climates, however, show versal markets for trading all commodities trolling quantities of goods demanded and that uneducated private agents—be they (including future "contingent" commodi- supplied, is the implicit premise of an peasants, rural-urban migrants, urban ties, that is, commodities defined by future omniscient central authority. The authority workers, private entrepreneurs, or house- conditions, such as the impact of weather must also be omnipotent (to prevent people wives—act economically as producers and on energy prices); and if the distribution from taking actions that controvert its dik- consumers. They respond to changes in of income generated by the laissez-faire tat) and benevolent (to ensure it serves the relative prices much as neoclassical theory economy is considered equitable or, if not, common weal rather than its own), if it is would predict. The "economic principle" could be made so through lump-sum taxes to necessarily improve on the working of is not unrealistic in the Third World; poor and subsidies. As elementary economics an imperfect market economy. While most people may, in fact, be pushed even harder shows, the existence of externalities in people are willing to question the omnip- to seek their advantage than rich people. production and consumption and increas- otence or benevolence of governments, Nor are the preferences of Third World ing returns to scale in production, or either there is a considerable temptation to believe workers peculiar in that for them too (no of them, will rule out the existence of a the latter have an omniscience that private matter how poor), the cost of "sweat" rises perfectly competitive Utopia. While, clearly, agents know they themselves lack. This the harder and longer they work. They do universal markets for all (including contin- temptation is particularly large when it not have such peculiar preferences that gent) commodities do not exist in the real comes to foretelling the future. when they become richer they will not also world, to that extent market failure must Productive investment is the mainspring seek to increase their "leisure"—an as- be ubiquitous in the real world. This, even of growth. Nearly all investment involves sumption that underlies the view that there ignoring distributional considerations, pro- giving hostages to fortune. Most invest- are large pools of surplus labor in devel- vides a prima facie case for government ments yield their fruits over time and the oping countries that can be employed at a intervention. But this in itself does not expectations of investors at the time of low or zero social opportunity cost. They imply that any or most forms of govern- investment may not be fulfilled. Planners are unlikely to be in "surplus" in any ment intervention will improve the out- attempting to direct investments and out- meaningful sense any more than their comes of a necessarily imperfect market puts have to take a view about future Western counterparts. economy. changes in prices, tastes, resources, and Nor are the institutional features of the For the basic cause of market failure is technology, much like private individuals. Third World, such as their strange social the difficulty in establishing markets in Even if the planners can acquire the nec- and agrarian structures or their seemingly commodities because of the costs of making essary information about current tastes, usurious informal credit systems, neces- transactions. These transaction costs are technology, and resources in designing an sarily a handicap to growth. Recent appli- present in any market, or indeed any mode investment program, they must also take cations of neoclassical theory show how, of resource allocation, and include the costs a view about likely changes in the future instead of inhibiting efficiency, these insti- of excluding nonbuyers as well as those of demand and supply of myriad goods. Be- tutions—being second-best adaptations to acquiring and transmitting the relevant in- cause in an uncertain world there can be the risks and uncertainties inherent in the formation about the demand and supply no agreed or objective way of deciding relevant economic environment—are likely of a particular commodity to market par- whether a particular investment gamble is to enhance efficiency. ticipants. They drive a wedge, in effect, sounder than another, the planned out- Finally, the neoclassical assumption about between the buyer's and the seller's price. comes will be better than those of a market the possibilities of substituting different The market for a particular good will cease system (in the sense of lower excess de- inputs in production has not been found to exist if the wedge is so large as to push mand for or supply of different goods and unrealistic. The degree to which inputs of the lowest price at which anyone is willing services) only if the planners' forecasts are different factors and commodities can be to sell above the highest price anyone is more accurate than the decentralized fore- substituted in the national product is not willing to pay. These transaction costs, casts made by individual decision makers however, are also involved in acquiring, in a market economy. There is no reason processing, and transmitting the relevant to believe that planners, lacking perfect This article is based on the author's The Poverty information to design public policies, as foresight, will be more successful at fore- of Development Economics, Institute of Eco- well as in enforcing compliance. There may, telling the future than individual investors. nomic Affairs, London, 1983, where supportive evi- dence for his arguments can be found. An American consequently, be as many instances of bu- Outcomes based on centralized forecasts edition is to be published in 1985 by Harvard Uni- reaucratic as of market failure, making it may, indeed, turn out to be worse than versity Press—Editor. impossible to attain a full welfare optimum. those based on the decentralized forecasts Hence, the best that can be expected in the of a large number of participants in a market

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©International Monetary Fund. Not for Redistribution economy, because imposing a single cen- order to promote a distribution of income Thus, while the pursuit of efficient growth tralized forecast on the economy in an desired on ethical grounds. Since the dis- may worsen some inequality index, there uncertain world is like putting all eggs in tribution resulting from market processes is no evidence that it will increase poverty. one basket. By contrast, the multitude of will depend upon the initial distribution of Surplus labor and "trickle down" small bets, based on different forecasts, assets (land, capital, skills, and labor) of placed by a large number of decision mak- individuals and households, the desired As the major asset of the poor in most ers in a market economy may be a sounder distribution could, in principle, be attained developing (as well as developed) countries strategy. Also, bureaucrats, as opposed to either by redistributing the assets or by is their labor time, increasing the demand private agents, are likely to take less care introducing lump-sum taxes and subsidies for unskilled labor relative to its supply in placing their bets, as they do not stand to achieve the desired result. If, however, could be expected to be the major means to lose financially when they are wrong. lump-sum taxes and subsidies cannot be of reducing poverty in the Third World. This assumes, of course, that the govern- used in practice, the costs of distortion However, the shadows of Malthus and ment does not have better information from using other fiscal devices (such as Marx have haunted development econom- about the future than private agents. If it the income tax, which distorts the indivi- ics, particularly in its discussion of equity does, it should obviously disseminate it, dual's choice between income and leisure) and the alleviation of poverty. One of the together with any of its own forecasts. On will have to be set against the benefits major assertions of development econom- the whole, however, it may be best to leave from any gain in equity. This is as much ics, preoccupied with "vicious circles" of private decision makers to take risks ac- as theory can tell us, and it is fairly poverty, was that the fruits of capitalist cording to their own judgments. uncontroversial. growth, with its reliance on the price mech- This conclusion is strengthened by the Problems arise because we lack a con- anism, would not trickle down or spread fact, emphasized by Hayek, that most rel- sensus about the ethical system for judging to the poor. Various dirigiste arguments evant information is likely to be held at the the desirability of a particular distribution were then advocated to bring the poor into level of the individual firm and the house- of income. Even within Western ethical a growth process that would otherwise hold. A major role of the price mechanism beliefs, the shallow utilitarianism that un- bypass them. The most influential, as well in a market economy is to transmit this derlies many economists' views about the as the most famous, of the models of information to all interested parties. The "just" distribution of income and assets is development advanced in the 1950s to chart "planning without prices" favored in prac- not universally accepted. The possibility the likely course of outputs and incomes tice by some planners attempts to supersede that all the variegated peoples of the world in an overpopulated country or region was and suppress the price mechanism. It are utilitarians is fairly remote. Yet the that of Sir Arthur Lewis. It made an as- thereby throws sand into one of the most moral fervor underlying many economic sumption of surplus labor that, in a capi- useful and relatively low-cost social mech- prescriptions assumes there is already a talist growth process, entailed no increase anisms for transmitting information, as well world society with a common set of ethical in the income of laborers until the surplus as for coordinating the actions of large beliefs that technical economists can take had been absorbed. numbers of interdependent market partic- for granted and use to make judgments It has been shown that the assumptions ipants. The strongest argument against encompassing both the efficiency and eq- required for even under-employed rural centralized planning, therefore, is that, even uity components of economic welfare. But laborers to be "surplus," in Lewis' sense though omniscient planners might forecast casual empiricism is enough to show that of their being available to industry at a the future more accurately than myopic there is no such world society; nor is there constant wage, are very stringent, and private agents, there is no reason to believe a common view, shared by mankind, about implausible. It was necessary to assume that ordinary government officials can do the content of social justice. that, with the departure to the towns of any better—and some reason to believe There is, therefore, likely to be little their relatives, those rural workers who they may do much worse. agreement about either the content of dis- remained would work harder for an un- It has nevertheless been maintained that tributive justice or whether we should seek changed wage. This implied that the pref- planners in the Third World can and should to achieve it through some form of coercive erences of rural workers between leisure directly control the pattern of industriali- redistribution of incomes and assets when and income are perverse, for workers will zation. Some have put their faith in math- this would infringe other moral ends, which not usually work harder without being ematical programming models based on are equally valued. By contrast, most moral offered a higher wage. Recent empirical the use of input-output tables developed codes accept the view that, to the extent research into the shape of the supply curve by Leontief. But, partly for the reasons just feasible, it is desirable to alleviate abject, of rural labor at different wages has found discussed, little reliance can be placed upon absolute poverty or destitution. That alle- that—at least for India, the country sup- either the realism or the usefulness of these viating poverty is not synonymous with posedly containing vast pools of surplus models for deciding which industries will reducing the inequality of income, as some labor—the curve is upward-sloping (and be losers and which will be winners in the seem still to believe, can be seen by con- not flat, as the surplus labor theory pre- future. There are many important and es- sidering a country with the following two supposes). Thus, for a given labor supply, sential tasks for governments to perform options. The first option leads to a rise in increases in the demand for labor time, in (see below), and this irrational dirigisme the incomes of all groups, including the both the industrial and the rural sectors, detracts from their main effort. poor, but to larger relative increases for the can be satisfied only by paying higher rich, and hence a worsening of the distri- wages. Redressing inequality and poverty bution of income. The second leads to no The fruits of growth, even in India, will Finally, egalitarianism is never far from income growth for the poor but to a re- therefore trickle down, in the sense either the surface in most arguments supporting duction in the income of the rich; thus the of raising labor incomes, whenever the the dirigiste dogma. This is not surprising distribution of income improves but the demand for labor time increases by more since there may be good theoretical reasons extent of poverty remains unchanged. Those than its supply, or of preventing the fall in for government intervention, even in a concerned with inequality would favor the real wages and thus labor incomes, which perfectly functioning market economy, in second option; those with poverty the first. would otherwise occur if the supply of

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©International Monetary Fund. Not for Redistribution labor time outstripped the increase in de- For in most of our modern-day equiva- investment, coupled with higher savings mand for it. More direct evidence about lents of the inefficient eighteenth-century rates, provides the major explanation of movements in the rural and industrial real state, not even the minimum governmental the marked expansion in the economic wages of unskilled labor in developing functions required for economic progress growth rates of most Third World countries countries for which data are available has are always fulfilled. These include above during the postwar period, compared with shown that the standard economic pre- all providing public goods of which law both their own previous performance and sumption that real wages will rise as the and order and a sound money remain that of today's developed countries during demand for labor grows, relative to its paramount, and an economic environment their emergence from underdevelopment. supply, is as valid for the Third World as where individual thrift, productivity, and Yet the dirigistes have been urging many for the First. enterprise is cherished and not thwarted. additional tasks on Third World govern- There are numerous essential tasks for all ments that go well beyond what Keynes, Administrative capacities governments to perform. One of the most in the work quoted above, considered to It is in the political and administrative important is to establish and maintain the be a sensible agenda for mid-twentieth- aspects of dirigisme that powerful practical country's infrastructure, much of which century Western polities: arguments can be advanced against the requires large, indivisible lumps of capital the most important Agenda of the State dirigiste dogma. The political and adminis- before any output can be produced. Since relate not to those activities which private trative assumptions underlying the feasi- the services provided also frequently have individuals are already fulfilling, but to those bility of various forms of dirigisme derive the characteristics of public goods, natural functions which fall outside the sphere of the from those of modern welfare states in the monopolies would emerge if they were individual, to those decisions which are made West. These, in turn, reflect the values of privately produced. Some form of govern- by no one if the State does not make them. the eighteenth-century Enlightenment. It ment regulation would be required to en- The important thing for governments is not has taken nearly two centuries of political sure that services were provided in ade- to do things which individuals are doing evolution for those values to be internalized quate quantities at prices that reflected their already, and to do them a little better or a and reflected (however imperfectly) in the real resource costs. Government interven- little worse; but to do those things which at political and administrative institutions of tion is therefore necessary. And, given the present are not done at all. Western societies. In the Third World, an costs of regulation in terms of acquiring From the experience of a large number acceptance of the same values is at best the relevant information, it may be second of developing countries in the postwar confined to a small class of Westernized best to supply the infrastructure services period, it would be a fair professional intellectuals. Despite their trappings of publicly. judgment that most of the more serious modernity, many developing countries are These factors justify one of the most distortions are due not to the inherent closer in their official workings to the in- important roles for government in the de- imperfections of the market mechanism but efficient nation states of seventeenth- or velopment process. It can be argued that to irrational government interventions, of eighteenth-century Europe. It is instructive the very large increase in infrastructure which foreign trade controls, industrial li- to recall that Keynes, whom so many dirig- censing, various forms of price controls, istes invoke as a founding father of their and means of inflationary financing of fiscal faith, noted in The End of Laissez-Faire: deficits are the most important. In seeking But above all, the ineptitude of public admin- to improve upon the outcomes of an im- istrators strongly prejudiced the practical man perfect market economy, the dirigisme to in favor of laissez-faire—a sentiment which Deepak Lai which numerous development economists has by no means disappeared. Almost every- from India, became have lent intellectual support has led to thing which the State did in the 18th century Economic Adviser to the policy-induced distortions that are more in excess of its minimum functions was, or Bank's Development serious than, and indeed compound, the seemed, injurious or unsuccessful. Research Department in supposed distortions of the market econ- It is in this context that anyone familiar 1983, and since 1984 has omy they were designed to cure. It is these with the actual administration and imple- been Research Administrator, lessons from accumulated experience over mentation of policies in many Third World Economics and Research. the last three decades that have under- He is on leave from countries, and not blinkered by the dirigiste University College (London) mined development economics, so that its dogma, should find that oft-neglected work, where he is Professor of demise may now be conducive to the health The Wealth of Nations, both so relevant and Political Economy. of both the economics and economies of so modern. developing countries.

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