Why some countries have managed catching-up, others do not?

Mehdi Shafaeddin

As explained in an earlier blog post, a number of developing countries in East Asia have managed to accelerate their growth rate of GDP, particularly Manufacturing Value Added (MVA), during recent decades. By contrast, a large number of least developed countries (LDCs), particularly in Africa, have fallen behind. Moreover, many LDCs have experienced de-industrialization, i.e., the share of MVA in their GDP has declined. I also mentioned that restrictions imposed on their policy space by international financial institutions and donors have, inter alia, contributed to their stagnation or slow growth rate of GDP and MVA.

Building on Kalecki’s views, in this brief I will explain the political economy of the catching-up process (or mechanism) and the role of internal and external factors in facilitating or inhibiting the process (See Shafaeddin, 2012). International trade and finance can facilitate the acceleration of growth, but under certain conditions it could also have some negative effects which limit the policy space of developing countries.

To explain, in a hypothetical closed economy, to accelerate growth of GDP, there is a need, inter alia, to increase the investment/income ratio, thus the savings/income ratio. Even if the latter ratio can be increased by taxation or other means, the capacity to invest is limited by the ceiling on the availability/growth of physical resources (infrastructure, capital goods, consumer goods-basic items such as food, and luxury goods- intermediate products and raw material inputs), skilled labour and institutional factors. But the supply of physical resources and skilled labour is limited, particularly at early stages of development. They are “supply determined”.¹ Hence, even if investment resources were available, their contribution to growth would be limited by physical resources and institutional factors; the increase in investment would lead to inflationary pressure.

Thus three factors are, inter alia, very important in easing the ceiling on the growth rate of GDP: foreign trade and finance, development of agriculture, particularly to expand supply of foods and industrial wage goods (necessities), and the role of institutional factors. Kalecki regards international trade as the “joker” of growth which contributes to availability of some physical resources reducing the inflationary pressure: “all the tensions and bottlenecks…can be translated into additional demand for imports” (Kalecki 1967).

Hence, during the industrialization process, rapid transition of industries, developed through import substitution, to export markets is important. It is important because it provides foreign exchange earning necessary for imports, given the limited possibilities of external financing. Nevertheless, the contribution of imports to growth is limited due to the barriers imposed by the availability of complementary factors such as infrastructure, skilled labour, and non-tradable goods and services.

Some institutional/organizational factors limit development of the agricultural and industrial sectors. Such are credit training and facilities, agricultural services, marketing boards and other marketing facilities, etc. Other important factors inhibiting development of production capacity are agricultural policies of developed countries and pre-mature trade liberalization imposed on low-income countries by International Financial Institutions (IFIs) and donors. So do conditionalities imposed on donors who provide foreign aid.

The availability of external sources of finance (foreign credits-net of interests and debts repayments- and grants) reduces the need for taxation and has positive “supply effects” and “financial effects” as it is a means for investment as well as imports. So does foreign direct investment (FDI). Hence, they facilitate accelerating growth. Nevertheless, they also have negative impacts on the process of development as IFIs and donors impose conditionalities on the recipient countries, including pre-mature, across-the-board and uniform trade liberalization, deflationary measures such as expenditure cuts, devaluation, increases in interest rates, etc.

While devaluation has many detrimental effects on development of the industrial sector, the change in the internal terms of trade in favour of primary commodities is an important one. Such a change is due to the different nature of price determination for primary commodities and manufactured goods. The price of the former is “demand determined”. Thus devaluation will increase its domestic price (in most recent years primary commodities have also been benefiting from increases in demand from China). By contrast, the price of manufactured goods is “cost determined”, and their production costs are negatively influenced by devaluation, particularly that the modern manufacturing industries are very import intensive. Often the negative impact of devaluation on production cost is greater than the positive impact of liberalization of imported inputs and intermediate products, particularly that these items had been less protected than final manufactured goods. The combination of trade liberalization and the increase in the cost of production has detrimental impact on industrial development.

Should then low-income countries take a passive stance and submit to the operation of market forces and the decision of others? I will discuss this issue in an upcoming blog.

¹These are industries the supply of which is limited, in the short/medium terms by technical, natural, organizational and/or institutional barriers. (Kalecki 1963)

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