Chapter 11

Development
Policymaking
and the Roles of
Market, State,
and Civil Society

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Introduction

In this chapter:
•We examine the roles and limitations of planning and
development policymaking as practiced in developing
nations,
•Consider the problems of economic transition to more
competitive market economies, and
•Ask fundamental questions as to the proper role of the
state and how public and private economic activity can
best be made mutually supporting.

11-2
Development Planning

Economic planning may be described as:

•a deliberate governmental attempt to coordinate
economic decision making over the long run and
•to influence, direct, and in some cases even control the
level and growth of a nation’s principal economic
variables (income, consumption, employment,
investment, saving, exports, imports, etc.) to achieve a
predetermined set of development objectives

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Development Planning

• An economic plan : is simply a specific set of

quantitative economic targets to be reached in a given
period of time, with a stated strategy for achieving those
targets.
• Economic plans may be:
– Comprehensive: A comprehensive plan sets its targets to cover all
major aspects of the national economy.
– Partial: A partial plan covers only a part of the national economy—
industry, agriculture, the public sector, the foreign sector, and so
forth.
• Planning process: The procedure for drawing up and
carrying out a formal economic plan.
11-4
Planning in Mixed Developing
Economies
The private sector in developing countries typically comprises four
traditional forms of private ownership:
1.The subsistence sector, consisting of small-scale private farms and
handicraft shops selling a part of their production to local markets
2.Small-scale individual or family-owned commercial business and
service activities in the formal and informal urban sectors
3.Medium-size commercial enterprises in agriculture, industry, trade,
and transport owned and operated by local entrepreneurs
4.Large jointly owned or completely foreign-owned manufacturing
enterprises.

11-5
Planning in Mixed Developing
Economies
In the context of such an institutional setting, we can identify two principal
components of development planning in mixed economies:
1.The government’s deliberate use of domestic saving and foreign
finance to carry out public investment projects and to mobilize and
channel scarce resources into areas that can be expected to make the
greatest contribution toward the realization of long-term economic
objectives (e.g., the construction of railways, schools, hydroelectric
projects, and other components of economic infrastructure).
2.Governmental economic policy (e.g., taxation, industrial licensing,
the setting of tariffs, and the manipulation of quotas, wages, interest
rates, and prices) to stimulate, direct, and in some cases even control
private economic activity.

11-6
The Rationale for Development
Planning
• Government role in development planning has four
fundamental economic and institutional arguments:
1. Market Failure: A phenomenon that results from the
existence of market imperfections (e.g., monopoly
power, lack of factor mobility, significant externalities,
lack of knowledge) that weaken the functioning of a
market economy. This market failure argument is
perhaps the most often quoted reason for the expanded
role of government in less developed countries.

11-7
The Rationale for Development
Planning
There are three general forms in which market failure can be
observed:
•The market cannot function properly or no market exists;
•The market exists but implies an inefficient allocation of
resources;
•The market produces undesirable results as measured by
social objectives other than the allocation of resources.

11-8
The Rationale for Development
Planning
2. Resource Mobilization and Allocation: This argument
stresses that developing economies cannot afford to
waste their very limited financial and skilled human
resources on unproductive ventures.
• Economic planning is assumed to help by recognizing the
existence of particular constraints and by choosing and
coordinating investment projects so as to channel these
scarce factors into their most productive outlets.
• In contrast, it is argued, competitive markets will tend to
generate less investment and to direct that investment into
areas of low social priority.

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The Rationale for Development
Planning
3. Attitudinal or Psychological Impact: Economic planning
may succeed in rallying the people behind the
government in a national campaign to eliminate poverty,
ignorance, and disease or to boost national prowess.
• By mobilizing popular support and cutting across
class, caste, racial, religious, or tribal factions with the
plea to all citizens to work together toward building the
nation, it is argued that an enlightened central
government, through its economic plan, can best
provide the needed incentives to overcome the
inhibiting and often divisive forces of sectionalism
and traditionalism.
11-10
The Rationale for Development
Planning
4. Foreign Aid: Developing countries must
put an approved plan in place to receive
various forms of assistance.
• The formulation of detailed development
plans has often been a necessary condition
for the receipt of bilateral and multilateral
foreign aid.

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Government Failure and Preferences
for Markets Over Planning

• The results of development planning have been generally

disappointing.
• What went wrong? Why has the early euphoria about planning
gradually been transformed into disillusionment and
dejection
• We can identify two interrelated sets of answers:
1. one dealing with the gap between the theoretical economic
benefits and the practical results of development planning,
and
2. the other associated with more fundamental defects in the
planning process, especially as they relate to administrative
capacities, political will, and plan implementation.

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Government Failure and Preferences
for Markets Over Planning

• The principal economic arguments for planning have often

turned out to be weakly supported by the actual planning
experience.
• The experience of government policy in many developing
countries has been one of often exacerbating rather than
reconciling market failures, often due to the presence of
a government failure.

• Government failure: A situation in which government

intervention in an economy worsens outcomes.
11-13
Government Failure and Preferences
for Markets Over Planning

• Deficiencies in Plans and Their

Implementation: Plans are often overambitious
as they try to accomplish too many objectives
at once.
• Moreover, the gap between plan formulation
and implementation is often enormous (many
plans, for reasons to be discussed, are never
implemented).

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Government Failure and Preferences
for Markets Over Planning

• a) Insufficient and Unreliable Data The economic value of

a development plan depends to a great extent on the quality
and reliability of the statistical data on which it is based.
• When these data are weak, unreliable, or nonexistent, as
in many poor countries, the accuracy and internal
consistency of economy-wide quantitative plans are
greatly diminished.
• And when unreliable data are compounded by an
inadequate supply of qualified economists, statisticians,
and other planning personnel the attempt to formulate and
carry out a comprehensive and detailed development
plan is likely to be frustrated at all levels.
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Government Failure and Preferences
for Markets Over Planning

• b) Unanticipated Economic Disturbances,

External and Internal: most developing countries
have open economies that are dependent on
international trade, aid, speculative capital
inflows, and private foreign investment, it
becomes exceedingly difficult for them to
engage in even short-term forecasting.
• For example, the oil price increases of the
1970s caused havoc in most development plans.

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Government Failure and Preferences
for Markets Over Planning

• c) Institutional Weaknesses The institutional

weaknesses of the planning processes of most
developing countries include the separation of
the planning agency from the day-to-day
decision-making machinery of government; the
failure of planners, administrators, and political
leaders to engage in continuous dialogue and
internal communication about goals and
strategies.

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Government Failure and Preferences
for Markets Over Planning

• d) Lack of Political Will: Poor plan performance

and the wide gap between plan formulation and
plan implementation are also attributable to a lack
of commitment and political will on the part of
many developing-country leaders and high level
decision makers.

• Political will: A determined effort by persons in

political authority to achieve certain economic
objectives through various reforms.
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Government Failure and Preferences
for Markets Over Planning

• e) Conflict, Post-conflict, and Fragile

States In extreme cases, violent conflict or
the large-scale failure of a state to
otherwise function meaningfully has
resulted in catastrophic failure of even the
most basic development objectives.

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The 1980s Policy Shift toward
Free Markets
• As a result of the disenchantment with planning and the
perceived failure of government intervention, many
economists, in developing countries advocated increased use
of the market mechanism as a key instrument for promoting
greater efficiency and more rapid economic growth.
• Therefore developing countries pursued domestic-market
liberalization programs, which sought to:
1. reduce the role of the public sector,
2. encourage greater private sector activity, and
3. eliminate distortions in interest rates, wages, and the prices
of consumer goods.

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The Washington Consensus on the
Role of the State in Development

• For much of the 1980s and into the 1990s, the so-called
Washington Consensus on development policy held
sway.
• This consensus, encapsulated by John Williamson,
reflected the free-market approach to development
followed by the IMF, World Bank, and key U.S.
government agencies, along with some other developed
countries at the time.
• It contained 10 points, summarized in column 1 of Box
11.1.

11-21
The Washington Consensus on the
Role of the State in Development

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The Washington Consensus on the
Role of the State in Development

• We find limited applicability of the Washington Consensus on

to two of the most successful cases in the history of economic
development, South Korea and Taiwan.
• These cases not only represent among the highest rates of
economic growth over the past half-century but also have
often been cited as examples of shared growth, in which
absolute poverty was eliminated early on, and the lower-
income groups have continued to benefit from the development
process, despite an upturn in inequality since the late 1990s.
• It can be concluded that the state has had a broader role in
the most successful development experiences than
encapsulated by the Washington Consensus.

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The New Consensus

• The New Consensus view represents in part:

– a renewed recognition that markets do fail;
– that at times these failures cannot be addressed
without a significant and ongoing role for
government—
– that market failure can be significantly worse
than government failure after all; and
– that when governance is poor, it can often be
improved.
11-24
The New Consensus

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Development Political Economy: Theories
of Policy Formulation and Reform

Until recently, two extreme views seem often to have dominated

the discussions of the role of government in economic
development.
•The first view has been that effective government was not only
necessary due to market failure but possibly even sufficient to
achieve economic development.
•The second view, associated with the neoclassical
counterrevolution or new orthodoxy school viewed participants in
government, such as politicians and bureaucrats, as selfish
and self-interested as owners of companies but lacked the
market to restrain them and argued that beyond a minimum
role, governments could only make things worse.

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Obstacles to constructive
policy reform
Voting patterns
•Sometimes reform is designed to maximize the benefits of the few. It
is natural that the majority would oppose this, if they have the power to
do so. Or they may think it likely that they will lose in the process of
reform and, perhaps reflecting their previous experience, not believe that
they will be adequately compensated through redistribution
•But sometimes a majority of the public opposes policies that the
majority would likely gain from. This may in part be due to lack of
understanding of the nature of economic policy choices among the
general public. It may be due to uncertainty over who will likely gain or
lose from the policy.

11-27
Obstacles to constructive
policy reform
Institutions and path dependency
•Nobel laureate Douglass North has suggested a framework that is
useful for understanding qualitative differences in policy
formulation across countries.
•North distinguishes between institutions and organizations.
– Institutions are “formal and informal rules of the economic game.”
For instance, humanly devised constraints, such as contract enforcement,
that define incentives for savings, investment, production, and trade. They
affect benefits and costs, and economic behavior that may lead to
development or decline
– Organizations are largely defined and shaped by the incentives that
emerge from the rules of the game. In a widely cited quote, North says, “If
the institutional matrix rewards piracy, then [only] piratical
organizations will come into existence.”

11-28
Obstacles to constructive
policy reform
Institutions and path dependency
•Once these inefficient rights are in place, there are generally no
incentives for the people in power to change them, especially when
these rights can provide leaders with greater private gains than an
alternative regime that may be better for society as a whole.
•Thus, inefficient institutions continue at the expense of overall
welfare or of growth; the market cannot guarantee the evolution of
efficient institutions.
•This trap is an example of path dependency, a condition in which the
past condition of an individual or economy affects future conditions.

11-29
Obstacles to constructive
policy reform
• Democracy versus Autocracy: Which Facilitates Faster
Growth?
• The comparative merits of democratic or autocratic regimes for
development performance (especially economic growth) have been
much debated.
Democracy
Advantage Disadvantage
Under democracy, politicians On the other hand, a looming election gives an incentive
seeking re-election have an to pursue short-term accomplishments that can be
incentive to reflect the will and pointed to during a campaign, rather than what is
interests of a majority of the necessarily good for long-term development.
people.
The corrupt politician who knows he or she will soon be
voted out of office has an interest to steal as much as
possible in the meantime.
11-30
Obstacles to constructive
policy reform
Democracy versus Autocracy: Which Facilitates Faster
Growth?

Autocracy
Advantage Disadvantage
The politician who is reasonably confident There are fewer constraints on what
of remaining in power for a long time can can be stolen and for how long. For
pursue long-term development strategies example,

The positive effect of autocracy on Autocrats have the power to use

growth-enhancing policies seems to the state for strictly private gains,
have worked best when a regime sees for instance in the Democratic
that its greatest chance of remaining in Republic of Congo.
power lies in achieving a maximum rate
of growth. For example, South Korea
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Obstacles to constructive
policy reform
Democracy versus Autocracy: Which Facilitates Faster
Growth?
•In the face of this long standing debate, it is no wonder that
the empirical results are closely divided.
•About a third of studies find a positive effect for
democracy, a third a neutral effect, and the remaining
third a negative effect.
•Therefore, while the relationship between democracy and
economic growth is not robust, a widespread view is that
democracy is good for development objectives, such as
equity, education, health, and famine prevention.

11-32
Development Roles of NGOs and the
Broader Citizen Sector

• Development success depends not only on a vibrant

private sector and an efficient public sector but on a
vigorous citizen sector as well.
• Organizations of the citizen sector are usually termed
nongovernmental organizations (NGOs) in the
development context but are also referred to as nonprofit,
voluntary, independent, civil society, or citizen
organizations.

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Development Roles of NGOs and the
Broader Citizen Sector

• Public goods are nonexcludable (it is impossible to

prevent individuals from consuming them except at
excessive cost) and nonrival (consumption by individuals
does not reduce the amount of the good available for
consumption by others).
• In contrast, private goods are excludable and rival.
• NGOs have a comparative advantage in activities that lie
between conventional private and public goods. In
particular, they tend to be partially rival, partially
excludable, rival but not excludable, or excludable but
not rival.

11-34
Development Roles of NGOs and the
Broader Citizen Sector

• Figure 11.2 reflects this range of activities in the two dimensions:

excludability and rivalry.
• The result is a typology that includes “Private goods” (high
excludability, high rivalry) in the upper right- hand corner, referred
to here as Type I goods. The production and distribution of Type I
goods are generally assigned to the market.
• “Public goods” (low excludability, low rivalry) in the lower left-
hand corner, referred to here as Type III goods. The production and
distribution of Type III goods are generally assigned to the public
sector.
• The other two corners represent goods that are hybrids of the other
two.

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Development Roles of NGOs and the
Broader Citizen Sector

11-36
Development Roles of NGOs and the
Broader Citizen Sector

• In the lower right-hand corner are found common-pool

(or common-property) resources, characterized by low
excludability but high rivalry. Examples of such Type II
goods are natural resources such as fisheries, pastures,
and forests, with open access. (Note, that these
resources often tend to be overused and under-
invested).
• NGOs play an important role in providing common property
resources.

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Development Roles of NGOs and
the Broader Citizen Sector

• In the upper left-hand corner are Type IV goods (non-

rival and excludable). For example:
– productive ideas can be used by all without their becoming used
up or degraded and so are nonrival, but they can often be
effectively kept secret, so they are excludable.
– Technology transfer to developing countries. Technical
knowledge is not a rival good once it is transferred and absorbed
into the local economy, as ideas may often spread rather freely
across firms within a locality, but it is excludable in that without
active intervention, productive ideas often do not cross
national boundaries.

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Development Roles of NGOs and the
Broader Citizen Sector
There are at least seven types of organizational comparative
advantage for NGOs.
1.Innovation. NGOs can play a key role in the design and implementation of
programs focused on poverty reduction and other development goals.
2.Program flexibility. An NGO can address development issues that are
viewed as important for the communities in which it works.
3.Specialized technical knowledge. National and international NGOs may be
greater repositories of technical expertise and specialized knowledge than
local governments (or businesses).
4.Targeted local public goods. Goods and services that are rival but
excludable, including those targeted to socially excluded populations, may
be best designed and provided by NGOs that know and work with these
groups. For example, local public health facilities, non-formal education etc.

11-39
Development Roles of NGOs and the
Broader Citizen Sector

There are at least seven types of organizational

comparative advantage for NGOs.
5.Common-property resource management design and implementation.
NGOs, including federations of local CBOs, can play an important role in
common- property management and targeted local public-good provision.
6.Trust and credibility. In practice, NGOs may have other advantages
over government in gaining the trust of, and providing effective services to
groups with special needs, notably those in extreme poverty.

7.Representation and advocacy. NGOs may hold advantages in

understanding the needs of the poor, who otherwise are often
excluded from political processes and even local community
deliberations.

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Trends In Governance and
Reform
• Corruption is the abuse of public trust for private gain; it is
a form of stealing.
• Indexes of corruption regularly rate the incidence of
corruption far higher in developing countries than in
developed countries.
• This is understood to reflect both cause and effect.
– Cause: (high corruption  low growth)
– Effect (Lack of development, poor institutions  high
corruption)

11-41
Trends In Governance and
Reform
The elimination of corruption is important for
development for several reasons.
•First of all, honest government may promote growth and
sustainably high incomes.
•Second, there is an association of eliminating corruption
with public empowerment.
•Third, the effects of corruption fall disproportionately on
the poor and are a major restraint on their ability to
escape from poverty.

11-42
Trends In Governance and
Reform
• Corruption may be viewed as a regressive tax on the
absolutely poor.
– Low-income households pay a much larger percentage of their
incomes in bribes than higher-income households
– In addition, microenterprises of the poor pay a much higher
fraction of their sales in bribes than larger firms do.
– Figure 11.3 illustrates this for the case of Ecuador.

11-43
Trends In Governance and
Reform

11-44
Positive association between rule of
law and per capita GDP

11-45
11-46
Question

• What is the supposed rationale for

subsidizing higher education in many
developing countries? Do you think that it is
a legitimate rationale from an economic
viewpoint? Explain your answer.

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Case Study:
The BRAC
Model in
Bangladesh

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Concepts for Review

• Accounting prices • Economic planning

• Aggregate growth • Government failure
model • Input-output model
• Comprehensive plan
• Interindustry model
• Cost-benefit analysis
• Internal rate of return
• Development
• Market failure
Participation
• Economic infrastructure • Market prices
• Economic plan • Net present value

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Concepts for Review (cont’d)

• NGOs • Rent seeking

• Partial plan • Shadow prices
• Path dependency • Social profit
• Planning process • Social rate of discount
• Political will • Voluntary failure
• Project appraisal

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The Planning Process: Some
Basic Models
• Characteristics of the planning process
• Planning in stages: 2 basic models
– Aggregate growth models
– Multisector input-output, social accounting, and CGE
models
• 3 stages of planning
– Aggregate
– Sectoral
– Project

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Aggregate Growth Models:
Projecting macro Variables

K (t )  kY (t ) (11.1)

Where
K(t) is capital stock at time t
Y(t) is output at time t
k is the average and marginal
capital-output ratio

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Aggregate Growth Models

I (t )  K (t  1)  K (t )K (t )  sY  S (t ) (11.2)
Where
I(t) is investment at time t
s is the savings rate
S is national savings
 is the depreciation rate
If g is the targeted rate of output growth, then
Y (t  1)  Y (t ) Y (t )
g  (11.3)
Y (t ) Y (t )
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Aggregate Growth Models

K kK kK / Y Y
   (11.4)
K K K /Y Y
sY  K s
g   (11.5)
K k
s
n  p   (11.6)
k
Where n is the labor force growth rate and p
is the growth rate of labor productivity
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Aggregate Growth Models

W   Y (11.7)
Where W and  are wage and profit incomes

s   sW W  I (11.8)

Where s and sW are the marginal propensities

to save from wage income and profit

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Aggregate Growth Models


k ( g   )  ( s  sW )( )  sW (11.9)
Y

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Multisector Models and Sectoral
Projections

• Interindustry or input-output models

• Can be extended in 2 ways
– SAM models where data from national
accounts, BOP, and flow-of-funds databases is
supplemented with household survey data.
– CGE models where utility and production
function are estimated and impacts of policies
are simulated.

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Project Appraisal and Social
Cost-Benefit Analysis
• Basic concepts and methodology
– Specify objective function
– Compute social measures (shadow prices)
– Establish decision criterion
• Setting objectives
– National cohesion, political stability, income
distribution etc.

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Project Appraisal and Social Cost-
Benefit Analysis

• Computing shadow prices and social

discount rates
– Calculating the social rate of discount or social
time preference

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The Social Rate of Discount

Net present value, or NPV is given by

Bt  Ct
NPV   (11.10)
t (1  r )
t

Where
Bt is the expected benefit at time t
Ct is the expected cost at time t
r is the government’s social rate of
discount
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Project Appraisal and Social
Cost-Benefit Analysis
• Choosing projects: some decision criteria
– NPV rule
– Compare the internal rate of return with an
interest rate
• Conclusions: planning models and plan
consistency

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The Market Economy
• Sociocultural preconditions and economic requirements
– Trust in banks etc.
– Law and order
– Security of property and persons v
– Balance between competition and cooperation
– Division of responsibility and diffusion of power
– Social mobility
– Materialistic values as a stimulus to greater production
– Deferring gratification to generate private saving
– Rationality
– Honesty
– Efficiency
– Freedom of information
– Free flows of information

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The Market Economy

• Well functioning market economy requires

– Clear property rights
– Laws and courts
– Freedom to establish business
– Stable currency
– Public supervision of natural monopolies
– Provision of adequate information
– Autonomous tastes
– Public management of externalities
– Stable monetary and fiscal policy instruments
– Safety nets
– Encouragement of innovation

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The Market Economy

• Role and limitations of the Market in LDCs

– Imperfections, lack of information and
uncertainty
– Presence of externalities
– Resource constraints
– Income distribution
– Structural change

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The “Washington Consensus” on the
Role of the State in Development and
its Limitations
• The consensus reflected a free market
approach to development espoused by the
IMF, the World bank, and key Government
agencies

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Table 11.1 The Washington
Consensus and East Asia

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The “Washington Consensus”
on the State in Development
• Toward a new consensus
– New emphasis on government's responsibility
toward poverty alleviation
– Importance of health and education
– A recognition that markets can fail
– Governments can secure conditions for an
effective market based economy

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Development and Political
Economy
• Understanding voting patterns on policy
reform
• Institutions and path dependency
• Democracy versus autocracy: which
facilitates faster growth?
• Role of NGOs in development and the
broader citizen sector

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Figure 11.1 Typology of Goods

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Development and Political
Economy
• Comparative advantages of NGOs in
– 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

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Trends in Governance and
Reform
• Tackling the problem of corruption
– Abuse of public trust for private gain
• Good governance enhances capability to
function
• Effects of corruption fall disproportionately
on the poor
• Good governance is broader than simply an
absence of corruption

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Figure 11.2 Corruption as a Regressive
Tax: The Case of Ecuador

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Figure 11.3 The Association between
Rule of Law and Per Capita Income

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Trends in Governance and
Reform
• Decentralization
• Development participation- alternate
interpretations
– Genuine participation and role of NGOs

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Developing Planning and the
State: Concluding Observations

• Pragmatism is needed in dealing with the

role and limitations of economic policies in
LDCs
• Regardless of ideology, governments in
LDC have been heavily involved in the
economy
• LDC governments shouldn’t necessarily do
less, but do better
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Case Study 7

• What do we learn about the consequences

of rural-urban migration for the economy
based on the experiences of India and
Botswana? [10]

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