Arguments for State Intervention through Planning

There are two types of state intervention that shape the process of economic development. The state may intervene in economic affairs on an ad hoc basis to deal with particular problems and cases of market failure. Alternatively, the purpose of state intervention may be to implement a plan of development covering the whole or a large part of the economy as has been the case, for example in Oman, China, India and the East Asian economies. Many instances of the former type of state intervention are found in the history of economic development of USA, UK, Germany and other developed market

economies \ State intervention through planning relates to actions and policies of

governments to attain, within a given time-ffame, certain pre-determined objectives and targets of economic development. State intervention in the socialist economies (China, Cuba, Vietnam, the former USSR^ and East European countries) and in the developing mixed economies of Asia, Africa and Latin America belong to this second category.

In the post-war period, development planning was adopted as a means for overcoming obstacles to development and for ensuring systematic economic growth at high and constant rates. The theories and strategies of development discussed in Chapter II provided the assumptions, tools and mechanisms for such activity. Moreover, this activity was encouraged by the United Nations, the World Bank and foreign aid donors (Waterston, 1982:p.44).

As we shall see in the next section, the kind of planning a country adopts is dependent on its political, social and economic context as well as its stage of development.

* For instance, the series of legislative and administrative actions taken under “New Deal” by the government in USA during 1933-37 to deal with the problems thrown up by the great depression of the 1930s. Similarly in the 1930s, the British government provided price support to agriculture, imposed import quotas on meat products and encouraged, by specific legislation, cartel arrangements in the coal industry (Meier and Baldwin, 1957:pp.462-472). Likewise, Waterston (1982:p.40) states that in Germany several state governments already engage in planning and the Federal Ministries of Transport, Post offices and Health have each prepared multi annual investment programmes in their fields of activity.

^ Union of Soviet Socialist Republics (Soviet Russia).

Also, because of differences in these concepts in developing countries, the scope of development planning varies accordingly. Thus, we shall see in section 3.5 that development plans range from the limited and piecemeal, project by project approach found in mixed economies in early phases of development, to the comprehensive, centralised planning found in socialised economies. Similarly, the scope and content of state intervention and market processes also change with each stage of development.

3.4.1 Case for development planning and state intervention^

The proponents of state intervention in economic processes in general, and for securing development in particular, describe the conditions which necessitate intervention. The main instrument of this intervention is development planning which concretises and puts into operation economic development policies. Some of the issues involving state intervention are identified below.

Firstly, the importance o f a strong state — As we have noted earlier, the state has

an important role to play in social and economic change. However, the perceived or actual need of governments to take care of things by across-the-board interventions will, of course, differ markedly across time and space. It is the strong role played by the state which has led to the success of the East Asian economies. Whereas the “softness” of the states is blamed by Myrdal for failure to implement declared policy goals of socio­ economic development (Myrdal, 1968). Even the World Bank has started to realise the importance of capable state institutions for implementing good economic policies (World Bank, 1997a).

Secondly, competitive market as a public good — Streeten (1995) argues that the

free, competitive market is a public good. There are indeed several ways in which government intervention can contribute to a better functioning of the market. In addition

’ Based on Lewis, 1951 and 1966; Grossman, 1974; Rosenstein-Rodan, 1955 and 1984; Hirschman, 1981; Umitia and Yukawa, 1988 and Chakravarty, 1991.

to providing a framework for regulation and promotion of private sector activity, in terms of enforcement of contracts, property rights, anti-monopoly laws, the government can, in certain cases, by getting prices “wrong”^ achieve the desired objectives of efficiency. In Oman, for example, as we describe in Chapter IV, the government policy of pricing crude oil to the domestic refinery at a price exceeding the international oil price^ was able to achieve a number of development objectives.

Thirdly, œmplementarity o f public and private investment — Government

intervention has also been blamed for “crowding-out” private sector investment. However, it has been proved that government investment in roads, ports and industrial estates has actually stimulated private investment. For instance, in Oman, the government has encouraged the private sector to set up many industrial projects by establishing a number of modem industrial estates. The same has been the case, throughout the semi­ industrial world (Taylor, 1994:p.75).

Fourthly, state intervention to overcome market failures — A principal

justification for public policy intervention lies in the frequent and numerous shortcomings

of market outcomes. Although Lai (1985) for example, considers all development

economics to be misguided because it advocates a role for government in overcoming market failure, Myrdal, (1968) sees the absence of intervention as inevitably causing systems to deviate from both growth and equity because of the prevalence of market failures. However, even the World Bank supports government intervention to rectify market failures (World Bank, 1991a; 1996).

Fifthly, in many developing economies, the market is relatively undeveloped or highly imperfect in some important sectors, for example, in subsistence agriculture.

’ This has been the case in all late-industrialising countries, “states have intervened to get prices “wrong” because initially firms could not compete even in labour-intensive industries on the basis of low wages”

(Amsden, 1992:p.61).

^ About half o f the crude oil supplied to the refinery is being charged at a fixed price o f US$ 30 per barrel, while the other half, is charged at export prices charged for other buyers of Omani crude oil. See for more details Chapter IV.

traditional small industries, finance, labour, etc. Here state intervention operates as a surrogate market by intervening through allocation of resources, pricing, and so on. Hence the concepts of market failure, particularly of externalities and public goods, acquire much wider meaning. For example, government subsidies or direct provision are justified in education and technology — because they yield positive externalities (benefits) for society at large in addition to the benefits derived by the recipients; in increasing returns industries — markets vrill fail to generate efficient outcomes where production is subject to increasing returns (falling marginal costs), e.g. public utilities^ “[T]he provision of such “overhead costs” for the economy as a whole requires a large minimum size of investment in each infrastructure project and an irreducible minimum industry mix of different public utilities” (Rosenstein-Rodan, 1984:p.214). In promoting distributional equity, it is well acknowledged, that the distributional results of even well-functioning markets may not accord with socially accepted standards of equity. Hence, state intervention in markets is often required to correct adverse distributional effects, and instances of market imperfections—these include problems of immobility of labour, capital and entrepreneurship, absence or inadequacy of information, and high transaction costs^.

Sixthly, ‘'Big Push \ market and planning — The market-mechanism is incapable

of handling big changes. Rosenstein-Rodan suggests that investment programming (planning) is desirable because of the indivisibility of capital required in development projects and where large rather than small changes are involved. According to him, the price mechanism works perfectly only under the assumption of small changes (Rosenstein-

’ As Hirschman (1981:pp.80-81) states about the provision of public goods by the state: “There are many well-known public or semi-public goods of this sort, from power, transportation and irrigation to

education and public health often designated as “infrastructure”, as though they were preconditions for

the more directly productive activities, these goods have been provided in response to urgent demand

emanating from such activities ... [T]hese conditions point to the domain of public goods that must be

supplied by the state i f they are to be supplied at alF (emphasis added by the present author).

^ As Toye (1993:p.l04) argues: “If, despite all the theoretical juggling, distortions in income distribution and the price of labour in developing countries refuse to disappear, and if applied welfare economics provides only an incomplete method of correcting for them in the direction of economic development, what is to be done? Either economic events can be left to take their own course, or governments must have recourse again to familiar techniques of macroeconomic planning to establish the overall framework within which microeconomic choices can be rationally made”.

Rodan, 1955:p.513). By their very nature, developmental projects involve big, massive changes which cannot be absorbed through marginal adjustments. Small independent economic agents cannot visualise the need for such changes. Nor do they have the capacity or willingness to undertake the large risks and initial investment involved in these projects^

Seventhly, planning and macroeconomic management — for some of the

arguments put forward by the proponents of ‘market-friendly’ development policies, for example, the desirability of balanced budgets, free private capital flows to finance development and balanced external current accounts, it is difficult to see how these can be achieved without decisive action to remedy the weaknesses which made state intervention relatively ineffective in the first place. Clearly the debt crisis of the 1980s and its pervasive negative effects on development in highly indebted countries is a good example of market failure.

Since most developing countries suffer from an investment gap, (shortage of domestic savings to cover investment requirements) and a foreign exchange gap (inability of exports to cover imports of goods and services), it is inconceivable to rely on market mechanism to manage these gaps in a manner that would meet the multiple goals of development. What is needed is a long-term macroeconomic planning framework to ensure that growth rate is sustained, inflation is under control, fiscal deficits are sustainable and external debt is manageable. At the same time, governments have to ensure that the economy generates adequate savings to support the investments required to achieve sustainable development and the real exchange rate is in line with the real rate required for internal and external balances. “Governments have a clear responsibility to ensure that growth prospects are not undermined by problems created by macroeconomic

’ According to Rosenstein-Rodan (1955:pp.513-515), in the case of big investment projects, the life time of equipment is long (say 10 years) and so “the individual investor’s risk may be higher than that confronting an overall investment programme” based on complementarity of industries. Again, “because of the indivisibility (lumpiness) of capital, large rather than small changes are involved”(/7>/<i.).

balances^” (Weiss, 1995:p.ll). Similarly, state intervention is considered necessary to manage all the issues related to balance of payments, foreign aid and external borrowing, regional development, countering the effects of the ‘Dutch disease’ and creating the necessary mechanism for dealing with windfalls and volatility in the prices of primary produce — as we shall see when discussing the experience of Oman in Chapters IV and V.

Thus in the 1950s and 1960s, for most of the developing economies the only escape route from the low equilibrium trap and vicious circle of poverty was to give a big push to the economy through state intervention by substantially raising the rate of capital formation and allocating the same to various sectors/industries in accordance with a plan. This was to be achieved either through the application of a balanced or an unbalanced growth strategy, adoption of import substituting or outward-oriented industrialisation policies, or sequential combination of all, depending on the specific circumstances of a developing country.