The Role of the Market Mechanism, the State,

NGOs and the Development Process

ECON 3508 March 7 and 12. 2013

See text book, Chapter 11. pp. 511-516, and 524-552

Agenda:1. Overview of the Market Mechanism

Functioning, History, Strengths ,Weaknesses

2. Overview on Public Planning and the State Sector.

Functioning, History, Strengths ,Weaknesses

3. Development Roles of NGOs and the Broader Citizen Sector

4. “Resurgence of the Market” 1980s and 1990s.

5. The “New Consensus” or the “Santiago Consensus”

6. Development Planning7. Political Economy of Planning

I. The Market Mechanism: Role, Advantages and

DisadvantagesHistorical Background

- Ubiquity of markets, though not necessarily the “market mechanism.”

- Independently invented in all parts of the world;

- Within older civilizations, long predating contact with “the west;”;

- Within centrally planned economies;

Emergence of market-oriented societies in recent decades or the last few centuries

What Markets Do:– Resource Allocation: determination of what

is produces, how, and for whom;

– Market prices as “communications systems” communicating demands of producers to suppliers of goods and services;

– As “incentive systems” providing suppliers or producers with the incentives and means to fulfill the demands of purchasers

– As “orchestration systems” coordinating innumerable economic actors and actions

– Can serve as “mechanisms for the social control of economic activity.”

Advantages or Strengths of the “Market Mechanism”

– Spontaneity of functioning; automaticity;– Makes possible “consumer sovereignty;”– Makes possible socio-cultural pluralism

– Permits genuine multi-culturalism

– Decentralization of economic decision-making; permits immense varieties of goods and services;

– Incentive structures permit and encourage self-activation by all economic actors;

– Enforces “economic discipline” on market actors: the “hard budget constraint.”

– Permits private, co-op, & state (all levels) enterprise , micro, medium and large to co-exist

Weaknesses or Disadvantages: “Market Failures”

– public goods are not provided acceptably (free rider problem) ;

– undesirable results as measured by social objectives (e.g. public health)

– income distribution and equity are not generated in socially acceptable ways;

– external costs and benefits from individual actions generate socially and economically inappropriate results;

Weaknesses or Disadvantages: “Market Failures” continued:

– producers and not consumers may (try to) exercise “sovereignty”

– tendencies towards monopoly, oligopoly or collusion may weaken the social control of economic activity exercised through markets

– the environment as a public good is not managed acceptably through markets.

– Coordination failures can occur when coordination is costly; e.g. with Big Push problems

– Capital markets are particularly prone to failure

Legal and Economic Factors Facilitating

the Functioning of Markets1. Clear Delineation of Property Rights and

their Transfer2. Stable Currency and Macro-economic

Environment3. Appropriate Legal Framework

Contract law, Patent and copyright law, Commercial law

4. “Freedom of Enterprise” i.e. Freedom to establish independent businesses

• subject to the regulatory environment

6. An Appropriate Regulatory Environment (to reduce negative externalities and for social protection)Environmental law; Health and safety legislation; Labour legislation

10.Provision of Public Goods by various levels of Government

12.Competition Policy, Control of Natural Monopolies

13. Social Policy, Social Safety Net

Legal, Institutional, Cultural and Social Factors Relevant for the Effective Functioning of Markets

• Maintenance of Law and Order; • Personal security;• Enforcement of contracts• Maintenance of a Level of Trust

Honesty and Non-Corruption in Government and Enterprises, Public and Private

• Diffusion of Power, especially an Independent Judiciary

• Competition, not Monopoly Control• Altruistic or Public Action to Maintain the Relevant

Communities• Provision of public goods• Social policies and social safety net• Free Flows of Information• ?Rationality unconstrained by Tradition?

Source: Todaro, citing Keyfitz and Dorfman, modified by A. Ritter

II. The State and Development Processes: Role, Advantages and Disadvantages

Historical Background:– ubiquity of “Planning “ since

time immemorial;– provision of public goods and in

all complex civilizations as well as simpler societies

– Post-War development planning; excessive expectations followed by disenchantment.

Teotehuacan, Mexico

The Role of the State and Public Planning: Central Tasks– Maintenance of a basic civilized order

for the functioning of society and economy

– Law and order and personal security;– Provision of Public Goods and Services,

including those necessary for basic human development

– Adjust for external costs and benefits;– Environmental Protection;– Achieve a more socially and politically

acceptable distribution of income– A regulatory framework

Strengths of the Public Sector– May represent the Commonweal; – No reasonable alternatives often

for the provision of public goods;– Capacity to improve equity and

social justice in ways markets can not achieve;

– Macro-flexibility:” the capacity to mobilize resources rapidly and in large magnitude for collective action.

Weaknesses of the Public Sector: “Public Sector Failure”

1. “Weaknesses of Public purpose:”

• Is Government in fact incorrupt, altruistic, benevolent and public-spirited?

• Or is it corrupt, predatory, kleptocratic?

• Is it privilege-protecting, class-based or ethnically based?

2. Susceptibility to capture by pressure groups, vested interests, especially the economically and politically powerful?

3. General Problems Intrinsic to Bureaucracy:

– Deformation of incentive structures;– Inexorable tendencies to expansion;– Absence of “Hard Budget Constraints”

or clear financial discipline;– Tendencies towards rigidity,

inflexibility and sclerosis over time.

4. Promotion of “Rent-Seeking Behavior:” shaping rules, policies, taxes and expenditures for private gain;

5. Possible Imposition of Centrally-Determined preferences on people

6. Specific Weaknesses of “Development Planning”

Potential problems of government intervention in developing countries (Todaro)

• Individuals know more about their preferences, circumstances

• Government may increase risks by moving in same direction on a large scale rather than via trial and error;

• Government may be more rigid and inflexible in decision making;

• Governments may lack capabilities to administer detailed plans;

• Bureaucratic obstacles may block private sector initiative• Hard to replicate market incentive system within

governments• Different parts of government may be poorly coordinated• Underground economy may place constraints on

government (note cigarettes and taxes in Canada)• Controls create incentives for rent seeking• Planning may be manipulated by narrow, privileged groups

3. Development Roles of NGOs and the “not for profit” and Cooperative SectorDefinitions: “Not-for-profit voluntary citizens group at

local, regional national or international level aimed at providing goods, services, analysis, advocacy, or humanitarian functions”

Potentially important roles in:– Cooperatives in many areas;– Common property resource management– Local public goods– Economic and productive ideas– Possibly other activities that are either:

• Excludable but not rival• Rival but not excludable• Partly excludable and partly rival

Typology of GoodsMore

Less

Less More

Typology, continued

Excludability: – Can others be prevented or “excluded”

from consuming the product?– High Excludability: Yes– Low: No

Rivalry– Does Consumption by one person (or

group) reduce the amount available for others?

– Non or Less Rivalrous: No– Highly Rivalrous: Yes

Development Roles of NGOs and the Broader Citizen Sector

Potential comparative advantages of NGOs– Harness a range of motives and

incentives– Innovative design and implementation– Program flexibility– Specialized technical knowledge– Provision of targeted local public goods– Common-property resource management

design and implementation – Trust and credibility– Representation and advocacy

Limitations: NGO or “voluntary failure”

1. Have their own self-interest and agendas to push regardless of need or results; Captured by goals of funders rather than intended beneficiaries;

2. May be less significant, owing to small scale and reach.

3. Lacking necessary local knowledge to develop and implement an appropriate mix of programs to address relevant problems

4. May be selective and exclusionary, elitist, and or ineffective

5. May lack adequate incentives to ensure effectiveness

Limitations: NGO or “voluntary failure”

7. Fund-raising may become an end in itself, providing salaries with less regard for results.

9. Lacking immediate feedback (as private firms get in markets, or elected governments receive at the polls); this may let the weaknesses go on for some time before being corrected

10. Single-purpose organizations may not see the bigger picture

11. May substitute for domestic government or NGO action

Following the 1950s - 1970s (when the “market mechanism” was de-emphasized)

Reasons for this resurgence

The so-called “Washington Consensus”•a free market approach to development

espoused by the IMF, the World bank, and key U.S. government agencies

4. “Resurgence of the Market” 1980s and 1990s.

The “Washington Consensus”1. Fiscal Discipline2. Tax Reform, broadening base, cutting

rates;3. Focused public expenditures: health,

education and infrastructure;4. Unified and competitive exchange rates;5. Trade liberalization6. Liberalize Direct Foreign Investment7. Privatization8. Financial liberalization9. Deregulation10.Secure property rightsSource: Todaro & Smith, from Dani Rodik, JEL 34 March

1996.

Politics and History of the Washington Consensus– Polemics re “Neo-Liberalism”, pro and

con– Economic Prosperity and such policies

Weaknesses of the “Washington Consensus”– De-emphasis on equity issues;– Doctrinaire implementation in some

cases– Over-emphasis on the value of the

market mechanism and undervaluation of the need for state action

Leading to: The “Santiago Consensus”

1. Development must be “Market-Based” But “Market Failures” occur

2. Development also must be Public Sector Based , But “Public Failure” occurs

3. Governmental Responsibility (National, Regional & Local) for

• Provision of fundamental public goods, e.g. legal structure, law and order, security of property rights

• Basic public goods;• Social Equity: and Inclusive growth; • Fairness in income distribution • Poverty reduction• Health and Education • Macroeconomic management• Tech transfer• Environmental protection• Help private sector overcome “co-ordination failures”

Source: Text; Santiago Chile: UN and Chilean example; and World Bank pronouncements

5. The “New Consensus” or the “Santiago Consensus”

Currently:Is the pendulum swinging to the

“left” ?African casesAsian CasesLatin America: Co-existence of

•Santiago Approach, •Washington Approach and •Neo-Populist/Socialist Approach: ALBA

(Alianza Bolivariana para los Pueblos de Nuestra América)

Or back to the “right”?

A. DefinitionB. The Potential and Promise of

“Planning: in the 1950s -1970s

C. Types of PlanD. What was in a Plan?

A. Planning and Budgeting

6. Development Planning

E. Specific Weaknesses of Development Planning

– Politics of Planning was often ignored(See accompanying Charts)

– Implementation was often weak– Unrealistic planning documents– Logistical weaknesses (staffing,

information, implementation mechanisms)

– Assumption of Good Governance was nit always correct

A. The Politics of Policy Making (See charts below)See the text.

B. The Problem of Corruption

C. Democracy and Development

7. Political Economy of Planning

1. Definition:

• Appropriation of public – or private – resources for private profit or use through the use of official power, influence, or access.

• Abuse of public – or private – trust, position or access for private gain;

B. The Problem of Corruption

2. Varieties of Corruption• Theft of public property, goods or services;• Illicit payments to suppliers or supporters

for political gain• Use of public property for personal

purposes• Influencing design or application rules

regulations and permissions for personal gain

• Twisting or influencing by briber of public policy for personal gain

• Discriminatory provision of public services (to home town or ethnic group or political supporters

• Nepotism: hiring from family or friends

3. Consequences of Corruption– Unfairness; – Impact on income distribution

(Corruption as a regressive tax on the poor); See chart 11.2)

– Sacrifice or general well-being for personal interests

– Slow-down of investment and economic growth

– Impairs ability of government to function in all areas due to erosion of “trust”

– Deformation of public policy

Figure 11.3 Corruption as a Regressive Tax: The Case of Ecuador

Figure 11.4 The Association between Rule of Law and Per Capita Income

4. Solutions to Corruption?

• Free media for shining lights in dark corners;

• Open Democracy, for scrutiny, criticism and rejection of corrupt leaders;

• An independent judiciary;• Reduce immunity of members of the

executive, legislative and judicial branches from prosecution for wrong-doing;

• Separate financing of political parties from general government expenditures;

4. Solutions to Corruption?

• Make public expenditures and procurement transparent ;

• Eliminate unnecessary regulations and rules and make others simpler, more transparent;

• Promote civil service professionalism with adequate pay scales;– Meritocratic promotion policies in civil

service;• Avoid large monopolies (e.g. as in

petroleum);– Promote competition and entry into the

economy;

Democracy versus autocracy: which facilitates faster growth?

What is the relationship between Democracy and Development? – Does democracy promote development? – Does development promote democracy?

Central conclusion: Strong correlation; circular causation or mutual reinforcement– Generally, the more democratic the country,

the better the policies and the better the economic performance in terms of growth and incomes

– But what is cause and what is effect?

C. Democracy and Development

Methodology and Source:

http://en.wikipedia.org/wiki/Democracy_Index

The Economist Democracy index map for 2011, with lighter colours representing more democratic countries. Countries with DI below 3 (clearly authoritarian) are black.

The Economist Democracy Index

Figure 11.1 Global Trends in Governance, 1946-2008

Note: “Anocracy”:

A society in which central authority is weak (or doesn't exist at all). Power is not vested in public institutions but spread amongst elite groups who are constantly competing with each other for power. Examples of anocracies in Africa include the warlords of Somalia, the shared governments in Kenya and Zimbabwe, and the spread of power between political executive, the transnational mining companies (especially those from China), and criminal elements in the DRC.

By another definition an “anocracy” lies mid way between a democracy and an autocracy.

Does Authentic Democracy Promote Development?

How might democracy promote development?1. Note that Democracies are vital for their own sake.2. Genuine Democracy may ensure that policies

promote the common well being more so than authoritarianism

3. Democracies are more accountable. 4. Peaceful regime change is possible when

governments mess-up, or when times and conditions change. Citizens can “throw the rascals out” when performance is weak. Policy adjustment , improvement and evolution can occur

5. In democracies, individual economic rights are protected better than in authoritarian regimes where the rule of law is dubious.

But on the Contrary: Might special interests dominate and

pervert policies towards their own interests?, Yes but….

Can autocracies mobilize resources for change, investment and development more effectively than democracies? Yes , but……

How often is democracy genuine and effective?

Does Development Promote Democracy.

Yes! How? Higher GDPpc better education,

more urbanization, more organized with independent civil organs of society, better communications … stronger demands for political inclusion and eventually democracy

OR, as authoritarian regimes prosper, they produce the conditions for democratization (one hopes)

Main conclusion?

Development Democracy, and Democracy Development

Note some varying historical cases:

– Singapore under Lee Kuan Yew

– South Korea 1953 to +/- 1975– China 2011 vis-à-vis India– Chile under Pinochet and Frei