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Vulnerabilities in Market-led Growth Strategies and Challenges for Governance Mushtaq H. Khan1 Summary: This paper is the first in a series of four papers developing an alternative approach to growth-enhancing governance in poor countries. Its argument follows an earlier paper where we argued that ‘market-enhancing’ governance, also referred to as ‘good governance’ is not strongly correlated if at all with growth in poor countries (even though many of the goals of good governance are desirable in their own right). The core argument is that ‘growth-enhancing governance’ refers to governance capabilities for correcting significant market failures that poor countries face when they try to catch up with advanced countries. For a long time, this debate has been dominated by a discussion of the North East Asian NICs like South Korea and Taiwan, which clearly had very strong growth-enhancing capabilities. Since most developing countries clearly do not have these capabilities, the conclusion was that this was an interesting but not very relevant discussion for poor countries. Our argument is that while the grand capabilities of the North East Asian countries are indeed unviable policy goals for most developing countries, there is no alternative to developing specific, carefully selected growth-enhancing governance capabilities on a country-by-country basis. To establish the importance of this approach, we select five ‘second tier’ growth economies: Thailand, the states of Maharashtra and West Bengal in India, Bangladesh and Tanzania, which are all frequently described as market-led growth stories. The assumption is that growth in these economies took off without much state assistance, and in fact in some cases directly as a result of abandoning interventionist policies. We argue that this view is only partially true and can even be misleading. We show that even in these second tier countries, business-government relationships, accidental rents and rent creation and the presence of appropriate governance capabilities for managing these rents were critical for explaining the development of critical capabilities and for sustaining the growth that happened, the sectors that grew, and indeed the vulnerabilities of these economies. All these economies have vulnerable growth processes precisely because the range of sectors and technologies that could benefit from growth-enhancing governance capabilities is typically limited. Moreover, in many cases, the understanding of the growth process is inadequate, and many of the domestic stakeholders can be unaware of the unintended consequences of many of these arrangements. This paper sets the background for a detailed analytical examination of specific aspects of growth-enhancing governance in these countries in subsequent papers. 1 Department of Economics, SOAS, University of London. E-mail: [email protected]. The author would like to thank DFID for a research grant that made this research possible. The arguments expressed here are of course solely those of the author and should not be attributed to DFID. Excellent research assistance by Pallavi Roy, Nisar Ahmed, Kabira Namit and Akshay Paonaskar is gratefully acknowledged. CONTENTS 1. Introduction................................................................................................................4 2. Background................................................................................................................6 3. Five Growth Stories .................................................................................................10 4. Growth-enhancing governance: An analytical framework......................................19 Market failures in Capital Markets .........................................................................22 Market failures in Labour Markets .........................................................................24 Market failures in Land Markets.............................................................................25 Market failures in the Knowledge Market ..............................................................26 ‘General’ versus ‘specific’ policy approaches to market failure ............................27 ‘High-Capability’ versus ‘Low-Capability’ growth-enhancing governance ..........29 5. Thailand: Rapid growth with lagging technological capabilities ............................34 Overview.................................................................................................................34 Rent allocation and rent capture to create domestic capitalist conglomerates........38 Rent allocation for learning and technology acquisition.........................................42 Non-discriminatory rent allocation to technology providers ..................................46 6. South Asia: Background to the growth acceleration of the 1980s...........................51 Overview.................................................................................................................51 The First Liberalization: growth with limited capabilities under colonialism........53 Capability development with dirigiste policies 1947-1980 ....................................55 The Second Liberalization: capability-led growth acceleration 1980 onwards......57 Productivity and FDI...............................................................................................63 7. Maharashtra: Industrial success and slowdown.......................................................65 Overview.................................................................................................................66 An industrial policy winner.....................................................................................68 Growth acceleration after 1980...............................................................................71 Political fragmentation, populism and the shift to services ....................................72 8. West Bengal: The limits of an agrarian growth strategy .........................................74 Overview.................................................................................................................75 Falling behind during the license raj.......................................................................77 Agriculture-led growth in the 1980s .......................................................................79 Challenges for a new pro-big business Left Front ..................................................80 9. Bangladesh: Growth with low-technology exports..................................................81 Overview.................................................................................................................81 The fifties and sixties: Accumulation with limited success in learning..................83 Socialism and primitive accumulation in the seventies ..........................................86 The MFA and the acquisition of garments technologies ........................................88 10. Tanzania: Growth led by natural resources and aid...............................................92 Overview.................................................................................................................92 Ujamaa Socialism and the missing Tanzanian capitalist class................................94 Market-enhancing reforms and the growth takeoff.................................................96 11. Brief Conclusions.................................................................................................100 12. References............................................................................................................101 2 Tables Table 1 Income and Population in our Five Growth Economies 1980-2005 ..............11 Table 2 Comparative Growth Rates of GDP and across Sectors 1980-2005 ..............12 Table 3 Conventional Good Governance Indicators for Sample Countries 1996 .......15 Table 4 Thailand: Phases of Growth 1951-2003 .........................................................34 Table 5 Thailand: Growth of Output and Productivity................................................45 Table 6 The South Asian Growth Acceleration in the 1980s ......................................51 Table 7 Dirigiste Growth in India................................................................................55 Table 8 Dirigiste Growth in Pakistan (including Bangladesh) ....................................56 Table 9 Rapid Import Substitution in 1950s India.......................................................56 Table 10 South Asian Growth Rates of Gross Domestic Product 1980-2003.............60 Table 11 Divergence in South Asia 2000-2004...........................................................61 Table 12 India’s Productivity Acceleration .................................................................63 Table 13 Sectoral Shares in GDP Selected Indian States 1981-2005..........................65 Table 14 Registered Factories in Major Indian Provinces 1946..................................68 Table 15 Statewise Industrial Investment License Allocations 1956-66.....................69 Table 16 Statewise Employment and Value Added 1959-1978 ..................................69 Table 17 Annual Growth Rates of Industry 1960-70...................................................69 Table 18 Comparative Allocations of Finance to West Bengal 1950s and 1960s.......77 Table 19 Growth in East Pakistan / Bangladesh 1950-80............................................85 Table 20 Industrial Investment in West and East

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