Historical Debates and Development Banking

The history of development banking is intertwined with the role of state inter- vention in economics. An important development which raised the importance of state in economy is the ”Great Recession”. Active state intervention was adopted in many countries followed by the failure of free market economies in the optimal re- source allocation. The inter–war economic turbulences resulted in a gradual swing of economic theory and practice towards interventionism. Interventionist policies have seen great approval by the policymakers which firmly endorsed that state can be a key player in a well–functioning economy, with an urgent need for post–war re- construction. For several reasons, which are not directly related to the scope of this

chapter, state interventionism could not be sustainable. By the 1980s, the collapse of the state interventionism produced a significant attack on the presence of state in economy. The advanced countries renounced welfare statism, whereas develop- ing countries opted for liberalisation programmes which dismantled socialist central planning in several other developing countries.

The political outcome of the World War II was the formation of new political structures in developed countries with a stronger representation of organised labour. With the new formation, the objectives of the working class have been on the top agenda of the economic policymaking. Moreover, the success of Keynesian policy tools to smooth the business cycles in the inter–war period encouraged policymakers to inject more money into the system by creating budget deficits. Hence, the golden rule of the free market economy which takes balanced budget granted at all costs was broken. The fiscal policy that uses budgetary sources for investments to reduce high unemployment rate was deemed to be successful. In this vein, the state was expected to help stabilise the economy by automatically increasing/reducing spending in the recessionary/boom phase of the business cycle.

In many advanced countries, the role of state went beyond the maintenance of economic activity through aggregate demand management. The level of coordination in economic activities has increased considerably. Japan and France, for instance, combined sectoral industrial policy with centralised investment through five year indicative planning. Scandinavian countries engaged in centralised wage bargaining process with active labour market policy otherwise wage setting would have been only possible through a pure market mechanism. Even in the UK and the USA, the countries which were accepted to be the least open to the idea of centralised industrial development, the state substantially involved in industrial development. The evolution of the European Coal and Steel Community and European Economic Community during this period established a ground for collaboration for joint in- dustrial policies (Sanderson, 1958).

vanced countries. The desire of newly independent countries to acquire economic independence instigated these countries to meet the demands for more rapid policy implementation. During this period, it was widely accepted that state–led industri- alisation was the fastest and surest way to achieve this aim (Cameron, 1972, 1953). The traditional development strategy of developing countries, which was believed to be the reliance on commodity exports to finance manufactured imports, was no longer sustainable. Three reasons can explain this thought more explicitly:

i. First, the volatile economic conditions and falling terms of trade for primary commodity exports,

ii. Second, the fragility of the international economy as a result of the damage caused by the ”Great Recession”, and

iii. Third, the low income elasticities of primary commodities which limited the scope for increase in export.

Developing countries abandoned primary commodity production to attain self– reinforcing growth mechanism, and targeted manufacturing industries as a plausible way for development. In order for an uninterrupted industrialisation, state took the role of main coordinator and financier, since a capitalist class was non–existent in developing countries (Rosenstein-Rodan, 1943; Nurkse, 1966). Acknowledging the necessity of coordination led by state, Gerschenkron (1962) discussed the impor- tance of institutions, which will be the baseline for the raison d’´etre of development banking.

The 1950s has been the period when the idea of state interventionism for rapid industrialisation has flourished. Rosenstein-Rodan (1943) argues that more equal distribution of income could be achieved via faster growth in depressed areas where underdevelopment was widespread. Arguing that demographics of depressed areas quite differ in terms of skilled labour, fair income distribution could be achieved via two ways of mobilisation, either labour through capital (immigration) or capital

through labour (industrialisation). According to Rosenstein-Rodan (1943), the im- migration would be a costly option for industrialisation. He, instead, supports the idea that critical amount of resources should be allocated for development activities in a coordinative action. If coordination could not be maintained, an economy that has all the pre–conditions for industrialisation would fail to industrialise because of a failure to coordinate complementary investments. Possible coordination failures are interpreted as the call for a ”big push” industrialisation which would be centrally controlled by the state.

Nurkse (1966) proposes the idea that developing economies should grow in all sectors of the economy so that demand across the industries could be well–balanced. Nurkse (1966) perceives balanced growth as a necessity for mutually supportive in- vestment environment. Besides the very argument of balanced growth, he empha- sizes the importance of capital formation, which was deemed to be a result of enough capacity to save. Therefore, he argued that poor nations remained poor because of a vicious circle of being poor.

Rostow (1956) defines economic development categorically. He argues that the process of economic growth is a combination of two or three decades which he calls it as ”take–off” process. In order for take–off to take place, three pre–conditions should be well set: a long period (a century or slight more) when preparation are met, take–off (two or three decades), and long–time of growth when growth itself becomes normal and automatic. In this formulation, the take–off is underpinned as the interval during which the rate of investment proliferates in such a way that real output per capita rises and this initial increase brings about radical changes in production techniques. Meanwhile, there would be a need for a group of people (entrepreneurial and managerial class) who have the will and authority to apply and disseminate the techniques. During the initial stage of growth, the rise in income should be diverted to productive investment. Hence, the take–off requires a group of society who has the command over the income generation warranted to create productive investment. Rostow (1956) argues that the take–off requires social and

institutional changes that accompany the increase in investment. The central idea of Rostow (1956) is the emergence of entrepreneurial and managerial class that makes productive investment available. As opposed to the studies of Nurkse (1966) and Rosenstein-Rodan (1943), Rostow (1956) does not mention the role of state in this process. Nonetheless, the deficiency of entrepreneurial capacity is still evident in some developing countries. The industrialisation in the absence of this class is not mentioned within the context of ”take off” formulation.

The mechanism how state should support development is not explicitly defined in Nurkse (1966) and Rosenstein-Rodan (1943). Gerschenkron (1962) and Cameron (1972)13 fill this gap and focus on the institutional aspect of state–interventionism.

Gerschenkron (1962) argues that a number of important historical instances of indus- trialisation which took place in a backward country exhibits considerable differences not only with regard to the speed of development but also with regard to produc- tive and organisational structures. These differences, according to Gerschenkron (1962), is a result of the application of different institutional instruments. On the exploration of the remedies of backwardness, Gerschenkron (1962) underlines the importance of specialised financial institutions to foster industrialisation. He points out that gradual character of industrialisation requires a special form of an institu- tional device that would provide long–term capital to industry.

2.2.2 Development Banking in Retrospective: Advanced versus Devel-