Community, Market and State in Development

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Author: Kaliappa Kalirajan | Keijiro Otsuka

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Community, Market and State in Development

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Community, Market and State in Development Edited by

Keijiro Otsuka and

Kaliappa Kalirajan

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Editorial and selection matter © Keijiro Otsuka and Kaliappa Kalirajan 2010 Individual chapters © Contributors 2010 All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission. No portion of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, Saffron House, 6–10 Kirby Street, London EC1N 8TS. Any person who does any unauthorized act in relation to this publication may be liable to criminal prosecution and civil claims for damages. The authors have asserted their rights to be identified as the authors of this work in accordance with the Copyright, Designs and Patents Act 1988. First published 2010 by PALGRAVE MACMILLAN Palgrave Macmillan in the UK is an imprint of Macmillan Publishers Limited, registered in England, company number 785998, of Houndmills, Basingstoke, Hampshire RG21 6XS. Palgrave Macmillan in the US is a division of St Martin’s Press LLC, 175 Fifth Avenue, New York, NY 10010. Palgrave Macmillan is the global academic imprint of the above companies and has companies and representatives throughout the world. Palgrave® and Macmillan® are registered trademarks in the United States, the United Kingdom, Europe and other countries. ISBN: 978–0–230–27458–7 hardback This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources. Logging, pulping and manufacturing processes are expected to conform to the environmental regulations of the country of origin. A catalogue record for this book is available from the British Library. A catalog record for this book is available from the Library of Congress. 10 9 8 7 6 5 4 3 2 1 19 18 17 16 15 14 13 12 11 10 Printed and bound in Great Britain by CPI Antony Rowe, Chippenham and Eastbourne

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A Festschrift volume for Professor Yujiro Hayami

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Contents List of Figures

ix

List of Tables

xi

Preface

xiv

Part I An Overview 1 Community, Market and State in Development: An Introduction Keijiro Otsuka and Kaliappa Kalirajan 2

Crossing Borders: A Tribute to Yujiro Hayami Gustav Ranis

3 Pushing Frontiers of Development Thought Cristina C. David

3 11 14

Part II Role of State 4

5

6

7

8

The Role of the Government in Facilitating TFP Growth during Japan’s Rapid-growth Era Shuhei Aoki, Julen Esteban-Pretel, Tetsuji Okazaki, and Yasuyuki Sawada Development Performance across Indian States and the Role of Governments Kaliappa Kalirajan, Shashanka Bhide, and Kanhaiya Singh

45

The Role of Traditional Chinese State and the Origin of Modern East Asia Debin Ma

64

Government Distortions of Agricultural Prices: Lessons from Rich and Emerging Economies Kym Anderson

80

The Human Capital Basis of the Japanese Miracle: A Historical Perspective Yoshihisa Godo

Part III 9

21

103

State to Community

Community Governance and Public-Goods Investments in China’s Villages Renfu Luo, Linxiu Zhang, Jikun Huang, and Scott Rozelle

123

vii

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viii

Contents

10

Poverty, Politics and Projects under Community Participation in Zambia Alain de Janvry, Hideyuki Nakagawa, and Elisabeth Sadoul

11 Political Competition and the Impact of Local Governance on Pro-Poor Programs Pranab Bardhan and Dilip Mookherjee 12

Promises and Realities of Community-Based Agricultural Extension Gershon Feder, Jock R. Anderson, Regina Birner, and Klaus Deininger

148

172

187

Part IV Community and Market 13 The Community Mechanism of Contract Enforcement: What are the Differences between Rural Communities and Industrial Clusters? Keijiro Otsuka and Tetsushi Sonobe 14

The Transformation of Hayami’s Village Jonna P. Estudillo, Yasuyuki Sawada, Kei Kajisa, Nobuhiko Fuwa, and Masao Kikuchi

15 Recent Developments of Agricultural Markets in East Africa Takashi Yamano, Yoko Kijima, Tomoya Matsumoto, and Megumi Muto 16 Private-Sector Industrialization in China: Evidence from Wenzhou John Strauss, Edward Y. Qian, Minggao Shen, Dong Liu, Mehdi Majbouri, Qi Sun, Qianfan Ying, and Yi Zhu 17

The Role of Markets for Managing Agricultural Risks in Developing Countries Peter Hazell

211 224

245

262

291

Notes

311

List of Contributors

317

Index

319

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Figures 4.1 4.2 4.3 4.4 4.5 4.6 4.7 5.1 7.1

7.2

7.3

7.4 7.5 7.6 7.7 8.1 8.2 10.1 10.2

Changes in Japan’s gross domestic product per capita in logarithm of real GDP expressed in 1990 US dollars Changes in productivity of Japanese economy relative to the US Changes in sectoral total factor productivity indexes during the postwar period in Japan Changes in net technology import and R and D expenditures relative to GNP in Japan Changes in number of Type A technological assistance contracts Ratio of net payment for technology import to GDP and productivity growth by industry Comparison of average years of schooling in Japan and the US Pattern of India’s economic growth from 1951 to 2008 Nominal rates of assistance to agriculture in High-Income Countries (HIC) and European transition economies and in developing countries, 1955 to 2004 (percent, weighted averages, with “decoupled” payments included in the dashed HIC line) Nominal rates of assistance to exportable, import-competing and all covered agricultural products, high-income and developing countries, 1955 to 2004 (percent) Nominal rates of assistance to agricultural and nonagricultural tradable sectors and relative rate of assistance, developing and high-income countries, 1955 to 2004 (percent, production-weighted averages across countries) Trade reduction and welfare reduction indexes for tradable farm products, by region, 1960 to 2007 (percent) Nominal and relative rates of assistance, China and India, 1965 to 2005 (percent) RRAs and log of real per capita GDP, India and Northeast Asian focus economies, 1955 to 2005 NRAs for Japan, Korea and China and date of accession to GATT or WTO, 1955 to 2005 (percent) The Japan/US ratios in average schooling, GDP per capita, and physical capital per worker The percentage of graduate courses in the total enrollment of tertiary education Operational rules under SIF, CDD and decentralization Timeline for Zambia’s social programs and elections

22 24 25 27 27 29 38 48

84

85

87 88 94 98 99 110 116 150 152

ix

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x

Figures

10.3 15.1 15.2 15.3

Targeting of projects by ward characteristics across programs Farm-gate prices of milk and bananas Simplified milk-market structure in Kenya Banana market before and after mobile phone coverage in Uganda

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Tables 4.1 TFP decomposition 26 4.2 Number and composition of licenses by industry 28 4.3 Decomposition of R and D expenditure in terms of share in total R and D expenditure in selected countries 33 5.1 Size and income of India’s state and union territories (2005–6) 49 5A.1 Explaining the variations in real per-capita growth in the post-reform periods 51 5.2 Explaining the variations in real per capita growth in the post-reform periods 52 5.3 The pace of development and spatial balance in development: Selected human development indicators 56 5.4 The pace of development and spatial balance in development: Selected infrastructural development indicators 56 5.5 Trends in state’s own revenue receipts and revenue expenditures 57 5.6 Finance Commission (FC), Planning Commission and nonstatutory transfer of resources from the centre to states 58 5.7 Results of regression analysis of interstate disparity in state government expenditures 61 7.1 Nominal rates of assistance to agricultural and nonagricultural tradables and relative rate of assistance, Asian developing economies and Japan, 1960 to 2004 (percent) 90 7.2 NRAs for Asian developing-country farmers, by product, 1960 to 2004 (percent, at primary product level) 92 7.3 Trade reduction indexes, Asian countries and other regions, all covered tradable farm products, 1960 to 2004 (percent) 93 7.4 Welfare reduction indexes, Asian countries and other regions, all covered tradable farm products, 1960 to 2004 (percent) 94 8.1 Human-capital accumulation through school education in Japan and the United States 109 8.2 Comparison in average schooling by levels of education between Japan and the United States 112 9.1 The way in which village leaders acceded to their office in 131 rural China, 1998–2003 (%) 9.2 The differences in the number (amount) of annual public-goods projects (investments) and the way in which village leaders acceded to their offices over time in rural China, 1998 and 2003 133 9.3 Baseline analysis (OLS) of the impact of directly electing the village leader on public investment in rural China 134 xi

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xii Tables

9.4 9.5 9.6

10.1 10.2 10.3 10.4 10.5 10.6 10.7 10.8 11.1 11.2 11.3 11.4 11.5 11.6 11.7 11.8 11.9 11.10 13.1 13.2 13.3 13.4

14.1 14.2 14.3 14.4

Fixed-effect analysis of the impact of directly electing village leader on rural public investment in rural China (1998–2003) Relationship between public-goods investment, size of the project and reelection in rural China, 1998–2003 Fixed-effects estimation of the effect of the annual number of public-goods projects (amount of investments) in latest term and reelection (reappointment) of village leader in rural China Number of projects implemented under SRP I, SRP II and ZAMSIF Distribution of wards by number of projects Targeting of projects by ward characteristics across programs Poverty targeting: Choice of wards within districts based on relative welfare From votes to projects in presidential elections From projects to votes in the 2006 presidential elections From votes in local elections to projects From projects to votes in local elections District-wise allocation of sample villages Village characteristics in sample villages, 1978 and 1998 Land reforms Trends in public supplies of agricultural inputs Trends in farm productivity, incomes and wages Left Front share regressions Land-reform panel regressions Targeting of IRDP credit subsidies Targeting of mini-kits Targeting of fiscal grants Proportions of enterprise managers by former occupation and formal schooling in Bingo, 1968–98 Previous occupation and years of schooling of enterprise managers by timing of new entry in Jili, China Characteristics of enterprise founders in the electric appliance industry by timing of new entry in Wenzhou, China Characteristics of enterprise managers by period of establishment in the garment industry in the suburbs of Hanoi Number of households in Hayami’s village in the Philippines, 1966–2006 Adoption of modern rice varieties and yield in Hayami’s village, 1966–2006 Tenure distribution of plots in Hayami’s village in the Philippines, 1966–2006 Sources of household income in Hayami’s village in the Philippines, 1966–2006

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138 141

142 157 157 158 160 162 165 167 168 176 176 178 178 179 180 182 183 183 184 216 217 218

218 225 227 228 229

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Tables xiii

15.1 Milk marketing of dairy farmers in Kenya 15.2 Average milk price by sales outlet in Kenya 15.3 Determinants of milk price at the household level (Sublocation fixed-effects model) 15.4 Mobile phone network coverage and ownership in Uganda 15.5 Ratio of banana sellers and sales by mobile phone coverage in Uganda 15.6 Market participation and mobile phone coverage/possession: Banana production 16.1 Distribution of sampled firms by industries and regions 16.2 Distribution of type of ownership across period of establishment 16A.1 Logit regression of whether the firm was surveyed 16.3 How many founders did the enterprise have? 16.4 The shareholder’s relationship with the chief leader at the time of establishment 16.5 Characteristics of founders at the time of establishment 16.6 Sources of initial funding 16.7 Sources of funding during firm growth (% of funds) 16.8 What was the distance between your company and the nearest company making the same product? 16.9 Which firms export? 16.10 Channels of export (sales percentages) 16.11 Characteristics of interviewed workers 16.12 How did you find the job in this enterprise? 16.13 Migration 16.14 Income (yuan) 2005 and holding shares 16.15 Fringe benefits 17.1 Types of risk and losses, and the effectiveness of local capacity to manage 17.2 Financial performance: BASIX weather-insurance portfolio

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252 253 254 256 257 258 267 268 269 270 271 272 274 275 279 279 280 282 283 283 284 285 293 304

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Preface A person with an untiring quest for frontier discovery and an unshakeable commitment to his teaching and research pursuits in development economics – that is the quintessential Professor Yujiro Hayami. He is one of the most versatile development economists of our time. The breadth and depth of his academic achievements and contributions stand testimony to this fact. One of the major contributions of Professor Hayami to development economics is highlighting the importance of “community” as an important economic system. Conventionally, development economists have classified economic systems based on the combinations of the involvement of state and market in economic activities. Thus, there is the “free market” system at the one end, the “central planning” system at the other extreme, or some mixture of the two. By his logical argument, Professor Hayami has introduced “community” as the third pillar of development along with the conventional pillars, market and state. His novel proposition of including “community” as one of the important pillars of development has been widely accepted by leading development economists, and also appreciated by policy-makers around the world. But the role of community in economic development is the critical issue in development economics that needs further exploration. This volume, which is entitled Community, Market, and State in Development, is a token of appreciation for the invaluable contributions he has made as an academician. It is not an ordinary, but a special festschrift volume in the sense that all the authors are internationally recognized academicians, and they have extended Professor Hayami’s development model of “community, market, and state” by making new contributions with a clear focus on the role of community in economic development, and its interactions with the state and the market. This volume is also unique because various studies were well coordinated by prior discussions between the editors and authors. Therefore the editors are thankful to the authors who have cordially accepted our request. It is the hope of both editors and authors that this volume will command wide readership and contribute to policy discourse, now and in the near future. These papers were presented at the Festschrift Conference held on 27 and 28 February 2009 at the National Graduate Institute for Policy Studies in Tokyo. Each presentation was followed by discussion with a specialist in the concerned area, and general discussion by participants at the conference. We are grateful to Professor Hayami, who was present at the conference, and distinguished personalities from around the world, for their valuable contributions to this volume. We would like to acknowledge the contribution of Prabhu Pingali, who kindly participated in the discussion during the xiv

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conference. We are thankful to the FASID staff and the GRIPS staff, particularly Ms Mayuko Tanaka and Ms Yoko Saigo, for their kind support in organizing the conference successfully. We would also like to thank Ms Tanaka, who tirelessly edited the manuscripts following the guidelines of Palgrave Macmillan, and Paul Kandasamy, who edited the language of the manuscripts. We are grateful for the financial support of the Global Centers of Excellence Program of the Ministry of Education, Culture, Sports, Science, and Technology of the Japanese government. We appreciate Palgrave Macmillan, especially Ms Taiba Batool, and Ms Gemma Papageorgiou, for their understanding and cooperation in bringing out this volume with flying colours. K EIJIRO O TSUKA AND K ALIAPPA K ALIRAJAN February 2010

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Part I An Overview

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1 Community, Market and State in Development: An Introduction Keijiro Otsuka and Kaliappa Kalirajan

1.1

Aim of the book

The classical economists rejected the mercantilist doctrine of state intervention and regulation, and called for a retrenchment of state activity in order to allow for the operation of free-market forces. However, a market cannot exist in a vacuum. It is artificially created, and can function only if the players in the market, such as producers, wholesale traders, retailers, and consumers, follow the rules of the free market. The implication here is that the government has to play a very positive role to encourage the smooth functioning of the market by enforcing rules and regulations to eliminate constraints to overall economic growth and development. Thus, the successful operation of a free-market economy is greatly dependent on the effective functioning of the competent government. However, there can be market failure and government failure, either individually or together. Market failure occurs in the supply of public goods and can occur in the case of pure private goods too. The latter can happen due to information asymmetry and also due to the presence of externalities. The consequence of information asymmetry and externalities is that transactions in the market will be different from the socially optimum level. Then the market does not guarantee economic efficiency, and possibly worsens equity in income distribution. Thus, government intervention may be needed whenever the market fails or market-induced income distribution is not socially desirable. Hirschman (1958) earlier strongly argued for governmental intervention to counteract the “polarization effects” of freemarket forces in order to mitigate the misfortune of the “backward regions.” The state has a monopoly on legal coercion within the jurisdiction recognized by other states, and it may use this for good or ill, for the interests of the governed or the interests of those doing the governing. Drawing on Locke’s theory of the social contract, if governments were for the interests of the governed, this means that government is created by individuals to solve problems that they alone cannot solve. Governments are supposed 3

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Keijiro Otsuka and Kaliappa Kalirajan

to mitigate market failure to improve the overall welfare of the society. The governments’ failure, however, occurs from (a) misuse of budgets, (b) diversion of principal-agent interests, and (c) excessive regulation due to seeking “institutional rents” (Hayami, 2001). Moreover, government cannot solve market failure arising from the problem of asymmetric information, as it does not have access to unobservable information. Herein lies the important role to be played by the community, whose members know one another and can often detect cheating, shirking, and other dishonest behaviors of its fellow members. In other words, as forcefully argued by Hayami (1998, 2001, and 2009), the community can support market transactions by reducing information asymmetry. The case of the jeepney in the Philippines discussed in Otsuka et al. (1986) provides an example, which vividly demonstrates how asymmetric information is dealt with by the community. Furthermore, as argued by Otsuka and Kalirajan (2006), the contribution of markets towards improving economic welfare will gradually be increased, in response to the new opportunities opened up by the introduction of new technologies. So, what are the sources of technological inventions and innovations? Who would discourage or promote technological change? The key process in the economic force of technological change is described by Schumpeter as the introduction of innovation, and the cultural innovator is the entrepreneur. Schumpeterian literature argues that technological innovations emanate from a class of entrepreneurial community members, who are constantly trying to be on the frontier of technology in terms of production and management. What drives entrepreneurs to undertake innovation is nothing but profit motives shaped by free-market forces. In this context, the role of “community” as an important economic system introduced by Hayami (1998) assumes added importance. A prominent question in this context is whether there will be any community failure, as in the case of market failure and state failure. Hayami (2001) has not overlooked this possibility. While admitting the possibility of community failure in the sense that it would take a long time for communities to adjust their norms and traditions to their changing resource endowments and technologies, he has pointed out that it would not be universally true all the time. He has cited the Japanese experience, which shows that communities’ adjustment capabilities cannot be underestimated. Japan developed its “sub-contracting” system, which is still being followed in many developing countries, through community-type cooperation. Subcontracting is particularly effective when new parts and components which embody new technological ideas are introduced. Needless to say, the introduction and development of the subcontracting system is an institutional innovation. The implication is that any economic system built with inappropriate reliance on state, community, and market should lead to inefficiency and inequality. In these circumstances, it may appear that market competition

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would be useful to minimize or eradicate the failures of state and community, but it may well be that a competitive market works if and only if it is supported by state or community, or both. Then, an important task of policy-makers is to promote the effective working of “induced innovation” mechanisms to adjust cultural and institutional environments to be consistent with competitive market systems. Though it may look like a difficult task for governments to perform, historical evidence, particularly based on East Asian performance, shows that it is possible even with those countries’ different traditions. Given the fact that state, market, and community are strongly interrelated with each other, and also that there can be government failure, market failure, and community failure, the most important question, drawing on Hayami (2009), is how to arrive at an optimal combination of the roles of community, market, and state in promoting a country’s welfare. As Karl Marx said, the institution that exploited productive potential at a certain stage of development would become a restraint on further development. The implication is that appropriate institutional innovations and the effective functioning of such institutions are required, not based on abstract theory alone, but more importantly on dynamically changing empirical realities to provide sustained economic growth to developing and developed economies. As aptly pointed out by Hayami (2009, p. 118), “how to combine the community, the market and the state in the total economic system is probably the most important agenda for economists geared toward the reduction of poverty in developing economies, as well as the maintenance of economic vitality and social harmony in developed economies.” Accordingly, this volume, which is entitled as Community, Market, and State in Development, explores the different modes of interactions of government, market, and community followed in different countries to promote the welfare of their people, drawing from both theories and realities reflected in empirical data. This volume is a token of appreciation for the invaluable contributions Hayami has made as an academician. We, the authors of this volume, are proud and extremely privileged to have had the opportunity to be among his colleagues, to have worked under his research guidance, to have been able to derive wisdom from his rich experience, and most importantly to have had a long-term association with such a notable and noble person. It is not an ordinary, but a special festschrift volume in the sense that the authors, all of them internationally recognized academicians, have extended Professor Hayami’s development model of “community, market, and state” by making new contributions with a clear focus on the role of community in economic development, and its interactions with the state and market. To our knowledge, there are no other books available with similar objectives, or which contain consistent empirical findings from different countries around the world.

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1.2

Scope of the book

Following this chapter, there are two special tributes to Hayami’s research contributions on community, market, and state discussed by Ranis and David. Ranis has summarized Hayami’s contributions to the literature as follows: “His work has been both Main Street and Side Street, broad as well as deep, concerned with such well-travelled issues as the government and the market, education and rural poverty, as well as more esoteric subjects including the economics of the commons, the economic consequences of Japanese colonialism, the economics of agricultural contract choice (with our workshop organizer) and his innovative proposal (of course, not implemented) of an alternative land reform paradigm for the Philippines.” David has pointed out that Hayami, through his intensive and convincing research, has drawn the attention of researchers and policy-makers to the role of communities in economic development. She concludes by saying, “Surely, Yujiro Hayami is not just ‘anyone’ of Japan, but one of the great economists concerned with development in this generation.” The research findings presented in this book are divided into three parts under the following headings: (i) role of state; (ii) state to community; and (iii) community and market. Hayami has cautioned that any economic system built with inappropriate reliance on state and community would lead to inefficiency and increase in inequality. In this context, the first set of five papers concern discussions on state success, state failure, and community failure in improving the overall socioeconomic welfare of people. Aoki, Esteban-Pretel, Okazaki, and Sawada have documented the role of different government policies that had contributed to high growth in Japan after World War Two. They have found that in nonagricultural sectors, total factor productivity (TFP) growth occurred at first through the import of foreign technologies via licensing, and subsequently through the innovation of its own technologies. Unique to the case of Japan is the establishment of R and D consortia of enterprises by the government, which reduces unnecessary duplication of basic research activities and promotes research cooperation based on “community-type” inter-enterprise relationships. Following the successful intervention by the state in Japan in promoting economic growth, Kalirajan, Bhide, and Singh discuss the importance of the community–state nexus. They show that government in India within a federal framework has mechanisms that foster development equitably across its states, particularly through health and education expenditures aimed at promoting humancapital development. However, they point out that the scheduled tribe communities, which are economically backward, are not taking part effectively in the human-capital development programs implemented by states due to their social and cultural backgrounds. Thus, in this context of community failure in India, as Hayami (2001) has argued, the authors conclude that it is imperative for the states to intervene by approaching the communities layer

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by layer to win their confidence, and to educate them in the benefits of participating in welfare programs, something not found in tribal thinking. While traditional beliefs and norms have been the major reason for community failure in certain states in India, Ma discusses how traditional norms and cultures have laid the foundation for modern economic growth in China. The traditional Chinese state, due to its “dynasty” characteristic, simulates a community with ties that go beyond blood relations. Particularly, within this political structure, the dominance of an autocracy in a unified empire gave birth to an enduring bureaucratic tradition of technocracy and impersonal rule, and a tradition of community mechanism of contract enforcement and public-good provision at the local level. These institutional endowments paved the way for the rise of a modern nationalist ideology and a bureaucratic developmental state for modern East Asia. After examining the country-specific experiences of the role of state in promoting economic welfare and the interaction of communities with state in nurturing growth, Anderson examines the impact of growth on implementing macroeconomic policies such as agricultural trade policies. Drawing on results from a new multi-country World Bank research project, he summarizes evidence on the changing extent of distortions to prices of farm products nationally, regionally, and globally by examining the extent to which later-emerging economies of Asia and elsewhere are following the policy trajectory of a gradual reduction in anti-agricultural policies and eventual transition to pro-agricultural pricing. Behind such changes are the changing politics of interest groups formed by communities of farmers. Godo examines the education policy since the Meiji Restoration to the present. He argues that the Japanese government as well as business communities failed to foresee the emerging need for building a system of strong tertiary education, especially research-oriented graduate schools at a world-class level, before catch-up growth occurred in the 1980s. He concludes that government failure in tertiary education policy is one of the major factors underlying the poor performance of the Japanese economy since the beginning of the 1990s. One of the major contributions of Hayami to understanding the effectiveness of local governance in economic development concerns the role of communities. He has argued elegantly that communities play a central role in making local governments accountable and effectively implementing development programs. Expanding Hayami’s work on the community–state nexus, the next set of four papers discuss how communities influence state administration, and state dissemination of information such as extension advice in developing countries, by analyzing community-level data collected particularly from China, India, Zambia, Kenya, and Uganda. Luo, Zhang, Huang, and Rozelle, using data from nearly 2450 randomly selected villages, examine the link between village governance reforms and the provision of public goods in rural China between 1998 and 2004. They

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conclude that democratization has increased the quantity of public-goods investment at the village level because those elected village leaders who are able to implement more public projects during their terms of office are more likely to be reelected. Thus, the rural community in China is able to influence the state administration in providing pubic good through their election process. Similarly, de Janvry, Nakagawa, and Sadoulet argue that Zambia offers a unique laboratory to analyze the role of community participation in the provision of local public goods. They have shown that poverty correlates positively with politics, reinforcing the value of local politicization of projects when there is stronger community participation. Their result vindicates the detailed work of Professor Hayami on the rural community’s role in complementing the functioning of state by effectively participating in the delivery of local public-goods. Their analysis also shows greater state involvement in reinforcing the capacity of the community to participate in Zambia, which is consistent with the findings in China. Bardhan and Mookherjee, using nearly 90 village surveys, analyze the role of community in making local governments accountable by examining the link between the distribution of development program benefits and voting behavior in the state of West Bengal in India. The results of the analysis show that the intravillage distribution of benefits has been pro-poor, reflecting effective functioning of communities to promote equity. On the other hand, the intervillage allocation of benefits does not seem to be pro-poor. This suggests some evidence for political clientelism in voter behavior. Feder, Anderson, Birner, and Deininger examine the conceptual underpinnings of community-based extension approaches to influence what is attempted and how it is achieved in such service systems. The organizational structures represent vehicles for bringing what Hayami called “the social capital” and engaged linkage to help in the delivery of information and other services that can be provided through advisory endeavor. They indicate that the community-based extension service in Uganda was a community failure, while that in India was successful. They conclude by saying that Yujiro Hayami’s work on social capital and communities can guide this field of research as it provides an insightful perspective for analyzing the potentials and limitations of the community mechanism in agricultural development. Hayami has forcefully argued that the community’s role in development is complementary to the state, and to the market too. Each pillar of development is prone to failure due to their functioning mechanisms; nevertheless, the failure of one can always be mitigated by the functioning of the other. The final set of five papers provide strong evidence from developing countries of Asia and Africa to support Hayami’s thesis that the community’s role is complementary to the market. Otsuka and Sonobe consider the fact that transactions among manufacturers, and between them and traders, are highly active in industrial clusters in a large number of countries.

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They argue that industrial clusters are equipped with an excellent mechanism of contract enforcement which reduces transaction costs and facilitates the division of labor. Thus, in the case of industrial clusters, drawing on Hayami’s forceful arguments, the community and the market are complementary, as the community mitigates market failures. Therefore, in this respect, industrial clusters are no different from rural communities. In order to sustain the development of industrial clusters, government must invest in infrastructure, such as the establishment of industrial zones, and provide credit. Hence, they conclude that community, market, and state, which are the three pillars of economic organizations ought to play complementary roles in the development of industrial clusters. Estudillo, Sawada, Kajisa, Fuwa, and Kikuchi jointly discuss how community has been playing a complementary role to that of state and market, to facilitate growth over four decades in the well-researched “Hayami’s village” in the Philippines. Through their primary long-term panel data on historical changes in the village, they have disproved the common belief that the community is the yoke of underdevelopment because it strictly obeys traditional institutions and norms that are slow to respond to changes in economic opportunities. In particular, this study reviews the multifaceted roles of rural communities in irrigation management, land and labor relations, risks coping, social capital, and the development of the rural nonfarm sector. They conclude that rural communities are far from static, but respond systematically and dynamically to changes in technology, resource endowments, and market conditions. Although the generality of the findings in one village would need to be interpreted with caution, they believe that the finding that community principles of mutual help and income-sharing tend to be consistent with the market principle of profit-seeking is valid in many rural areas in Asia. Then the question immediately arises as to how communities in rural Africa behave in relation to state and market. Yamano, Kijima, Matsumoto, and Muto, using panel data from Kenya and Uganda, have examined the role of community-based mechanisms on market transactions. They have shown how the technology-induced market expansion for banana farmers in Uganda has increased their income by reducing market transaction costs through community participation and cooperation among farmers. For example, as long as one representative among farmers has access to a mobile phone, this person can make arrangements with traders on behalf of fellow farmers. This would encourage farmers to form farmer groups, which may help farmers not only in terms of marketing but also in terms of technology diffusions or other knowledge sharing. Strauss, Qian, Shen, Liu, Majbouri, Sun, Ying, and Zhu compare the process of the Wenzhou industrialization to date with the East Asian model of industrialization, and observe certain commonalities, particularly the role of communities. They argue that just as in the case of Taiwan and Japan before

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10 Keijiro Otsuka and Kaliappa Kalirajan

World War Two, it was small-scale family firms that initiated new industrial production in Wenzhou, with finance coming initially from family members and friends. Thus, the community mechanism of contract enforcement based on social and family ties was certainly critical in the early growth stages of these firms, as is emphasized by Godo and Hayami (2002). Hazell discusses the role of markets for managing agricultural risks in developing countries in the context of the withdrawal of many public risk-management schemes. He argues that due to the inability of farmers and rural communities to handle covariate yield and price risks over wide areas effectively, market-mediated solutions to risk management would be the preferred solution. He cautions that it is becoming clear that market-mediated approaches to risk management are not achieving on anything like the scale needed. Thus, he recommends the intervention of governments or international agencies like the World Bank to initiate and strengthen such activities. We believe that the diverse empirical studies included in this volume are complementary and contribute significantly to a deeper understanding of the roles of community, market, and state in economic development. The volume also indicates that much more research needs to be done in this area to shed clearer light on the proper division of labor among the three pillars of economic organizations.

References Godo, Y. and Hayami, Y. (2002) “Catching Up in Education in the Economic Catch-up of Japan with the United States, 1890–1990,” Economic Development and Cultural Change, 50 (4), 961–78. Hayami, Y. (1998) “Community, Market and State,” in C. K. Eicher and J. M. Staatz (eds.), International Agricultural Development, 3rd edition (Baltimore: Johns Hopkins University Press), 90–102. Hayami, Y. (2001) Development Economics: From the Poverty to the Wealth of Nations, 2nd edition (Oxford: Oxford University Press). Hayami, Y. (2009) “Social Capital, Human Capital and the Community Mechanism: Toward a Conceptual Framework for Economists,” Journal of Development Studies, 45 (1), 96–123. Hirschman, A. (1958) The Strategy of Economic Development (New Haven, CT: Yale University Press). Otsuka, K. and Kalirajan, K. (2006) “Rice Green Revolution in Asia and Its Transferability to Africa: An Introduction,” Developing Economies, 44 (2), 1–10. Otsuka, K., Kikuchi, M. and Hayami, Y. (1986) “Community and Market in Contract Choice: The Jeepney in the Philippines,” Economic Development and Cultural Change, 34 (2), 279–98.

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2 Crossing Borders: A Tribute to Yujiro Hayami Gustav Ranis

Yujiro Hayami has always been ahead of the curve; he has always had what might be called a nose for the jugular. He has been an intellectual pioneer but never an intellectual ideologue. He has consistently crossed borders, across disciplines and within disciplines – even when it wasn’t fashionable. Let me count the ways in which he has reached across the various intellectual boundaries which many of us, ensconced in our various fiefdoms, have been all too prone to erect.

2.1 Between agricultural economics and development economics We all know this is where he started and where he never really left. His interest increasingly moved from Japanese agricultural development, historically and in the contemporary context, toward its role in overall economic development. His contrasting of the Japanese intensive with the Mexican extensive styles of agricultural development, and their differential impact on their respective historical development patterns, has been a truly seminal contribution.

2.2

Between agricultural and rural nonagricultural activities

Yujiro is one of the few economists who early on recognized the importance for overall economic success, in terms of growth as well as distribution and poverty alleviation objectives, of encouraging the blossoming of rural industrial and service activities in balanced and mutual enhancement with agricultural productivity change.

2.3

Between macro and micro analysis

Yujiro is one of the few researchers I know who is comfortable in both paradigms, as his prodigious bibliography indicates, ranging from broad-gauged 11

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Gustav Ranis

treatises like Development Economics: From the Poverty to the Wealth of Nations to Anatomy of a Peasant Economy, in which he analyzes household behavior in “his” adopted village in great detail. What distinguishes his microanalysis is that, in contrast to many others laboring in this field, he has always been interested in mobilizing such research to gain a better understanding of the macro economy and macro policies, and not simply for its own sake or for impressing other, microoriented, development economists.

2.4

Between classical and neoclassical analytical tools

Yujiro was never doctrinaire in these matters. He is well-versed in the history of thought, again not a common phenomenon these days. Most of his contributions are quite orthodox. Yet in his work with Kikuchi on Indonesian and Philippine agriculture, to cite but one example, he was ready to deviate from the conventional wisdom which, of course, warmed the cockles of my partisan heart: ... the wage adjustment process toward equilibrium seems to involve a mechanism very different from the market mechanism assumed in neo-classical economics. The fact that labor’s share in the traditional output-sharing contract is institutionally fixed implies that wage rates cannot adjust directly to change in labor’s marginal productivity ... only through modification of institutional arrangements. Arthur Lewis and I agree. Even Ken Arrow, a high priest of neoclassical economics, argues that equilibrium is achieved only with time – in the case of developing countries it may be anywhere from 10 to 30 years – before the “turning point” is reached.

2.5

Between economics and neighboring disciplines

Increasingly, Yujiro ventured into the no man’s land of political economy and institutional economics. His work with Vernon Ruttan on induced institutional innovations was an early indication of this, and his collaboration with Masahiko Aoki, on the Institutional Foundations of East Asian Economic Development, a more recent one.

2.6

Between theory and policy

Yujiro was not a reclusive ivory-tower economist, but deeply concerned with policy issues. Domestically he labored long and hard over a lifetime – if not always successfully – to alter the Japanese government’s rice policy, for example via his volume on Japanese Agriculture Under Siege: The Political

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Economy of Agricultural Policies, as well as via his shorter public policyoriented pieces and his participation in government rice price policy committees, which I well remember his complaining about. Abroad, he once again made major academic contributions, comparing the political economy of agricultural protection in various countries of East Asia as well as making several hands-on contributions as the agricultural economist working with the International Rice Research Institute in the Philippines; as a valued member of my Comprehensive Employment Strategy Mission for the Philippines, where he, inter alia, developed the idea that irrigation, the application of fertilizer, and resorting to intensive agriculture, are generally likely to eventuate once the land frontier is reached; as a member of the Board of Trustees at IFPRI; as a participant in the World Bank’s CGIAR review; to cite but a few examples.

2.7 Between being a prolific and an innovative contributor Yujiro Hayami has 18 books and roughly 200 journal articles to his credit. Yet, he seldom repeated himself – a very distinctive accomplishment in our profession – and managed to be consistently path-breaking and innovative. His work has been both Main Street and Side Street, broad as well as deep, concerned with such well-travelled issues as the government and the market, and education and rural poverty, as well as more esoteric subjects including the economics of the commons, the economic consequences of Japanese colonialism, the economics of agricultural contract choice (with our workshop organizer), and his innovative proposal (of course, not implemented) of an alternative land-reform paradigm for the Philippines. If there is one area where there is no “trespassing” or exploring boundaries, but just a walk – or rather, a dash – down Main Street, it is his love of tennis and the high quantity and quality of it.

2.8

Finally, between research, teaching, and service

He has done it all and done it all exceedingly well. I have always thought of Kazushi Ohkawa as the Simon Kuznets of Japan, and I think of Yujiro Hayami as the Ted Schultz of Japan, distinguished as a scholar, as teacher, and a kind caretaker of others. The Emperor of Japan has already recognized this remarkable individual’s contributions. All of us, and many others who are not here today, count themselves lucky to have had lots of intellectual and personal contacts with him. Here’s hoping that these will continue for many more years to come.

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3 Pushing Frontiers of Development Thought Cristina C. David

The theme of this festschrift, “Markets, State, and Communities,” in honor of Yujiro Hayami, is quite appropriate. It represents, thus far, the culmination of the evolution of his economic thought and contributions. As noted in his latest writings, the most important agenda for economists currently concerned with the reduction of poverty in developing economies, the maintenance of economic vitality and social harmony in developed countries, and the preservation of the environment globally, is how to combine the roles of markets, the state, and the community in the total economic system suited to each country’s culture and social values to achieve these objectives; as by nature, each is subject to failures – market failure, government failure, and community failure. I am honored to express this tribute, on behalf of the authors of this festschrift, to one of the most deserving economists in this generation. Yujiro Hayami devoted his entire professional life to the relentless pursuit of understanding the process of economic change, not just as an academic interest but with the clear goal of influencing the course of economic development through appropriate policy and institutional reforms. The quality of his research is evident from its strong theoretical underpinnings: macro, micro, and down to grassroots perspectives, and with interdisciplinary appreciation. And he dealt with big rather than trivial questions. The breadth and depth of his research contributions are undeniably exceptional, and many are path-breaking. The findings of his numerous researches on wide-ranging issues, reported in more than 200 journal articles and book chapters, are integrated into a series of books in English, Japanese, and even Chinese editions. The analytical syntheses of literature contained in his books alone are invaluable to students and professionals. Let me highlight a number of his most significant contributions:

3.1 Agriculture development and induced innovation Hayami-Ruttan’s book entitled Agricultural Development: An International Perspective (1971 and 1985) won the Enduring Quality Publication Award of 14

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the American Agricultural Economics Association for its definitive analysis of the agricultural development process. It is predictable that technological change embodied in modern inputs played the key role in explaining differences in agricultural productivity observed across countries, and this was found as expected; however, it was novel to empirically prove that technical change is endogenous, induced by changing factor endowments – as reflected in relative factory prices, changing output prices, and research production function. Moreover, rapid population growth on limited land supply and technical change were also found to induce institutional innovations to overcome market failures, such as property rights, financial markets, public investments in agricultural research and extension, irrigation, and other factors of land and market infrastructure. These factors facilitated the adaptation of new and borrowed technologies for different production environments and effective use by farmers.

3.2 Green Revolution, Institutional changes, and communities Yujiro Hayami, working with many others, wrote on a variety of issues related to the three topics above. But the unique and important body of work that profoundly influenced his thoughts on the process of economic development, and sharpened his grassroots perspective, is the set of intensive and extensive village studies conducted in the Philippines and Indonesia over three decades with Masao Kikuchi, as well as Toshihikoe Kawagoe. These village studies provided opportunities to observe and collect detailed data for learning about the complexity of village economic activities and analyzing agrarian change – how product and factor markets adjust in response to population pressure, technological change, land redistribution and tenancy regulations, commercialization, and rural industrialization; and their impacts on production, incomes and their distribution, class structure, and traditional institutions in a different agro-ecological, socioeconomic, and cultural environment than Japan’s. While recognizing the value of an interdisciplinary approach in fully understanding these processes, he consistently applied neoclassical microeconomic reasoning throughout the analysis, including those for understanding contractual arrangements, institutional changes, and even social norms. These village studies clarified the confusion about the effects of the Green Revolution and rapid growth in population, and land-reform regulations. Because modern rice technology was essentially scale-neutral, the adoption rate of modern varieties did not vary by farm size or by tenure. Indeed, their analysis indicates that it is the inadequate spread of the new technology in the face of rapid population growth and limited land supply that have caused the polarization in the villages. On the other hand, rapid population growth and land market regulations have deepened stratification of

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Cristina C. David

village population, increasing the landless households and creating a class of subtenants. Factor market adjustments to changes in technology and population growth have not always been explicitly through adjustments in wages and rental rates, but were caused by changes in the traditional institutions for paying labor and land inputs, such as the shift from “hunusan” to “gama” in the Philippine case, or from the “bawon” to the “tebasan” system in the Indonesian case. The choice of labor contracts, and hence institutional rather than wage adjustments, can be explained by the efforts to minimize risks and transaction costs and, at least in the Philippine case, by the social norm of mutual help and income-sharing within the village community. By quantifying implicit wages under different institutional arrangements and alternative land rentals and market and technological conditions, the achievement of a reasonably efficient resource allocation in a neoclassical sense through these institutional adjustments was demonstrated. Indeed, it was further suggested that the villages’ social norm of mutual help and income-sharing within the community itself may also be explained by economic rationality. They do acknowledge that social norms or cultural factors may constrain factor market adjustments. For example, the caste system in India, which strictly establishes the division of labor among different castes, segmented the labor market, preventing landless households from meeting higher labor demand for tasks traditionally reserved for cultivator households, and thus may have promoted mechanization prematurely, and promoted social conflicts. Social norms and cultural factors may also determine how well communities are able to organize and perform economic functions, in which they perform better than the state or the market because of transaction costs, moral hazard, asymmetric information, or public-good characteristics. The deterioration of the irrigation system in the village after the state drastically reduced support for operation and maintenance was not arrested by efforts to shift responsibility to irrigators’ associations or the village community. Unlike in East Asia where communities successfully manage irrigation systems because they are tightly knit, as agro-ecological conditions historically required collective action for certain economic activities, the efforts to organize irrigators’ associations in the Philippine village were less successful, in part due to the loosely structured nature of the village community that had little experience of collective action.

3.3 Political economy of agricultural protection Yujiro Hayami’s versatility is again demonstrated in his series of papers quantifying the welfare effects of agricultural price and trade policies in Japan, and explaining their causes in political economy terms. With Anderson and others (1986), they analyzed how political economy factors explain the

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rising trend of agricultural protection in the course of economic development in East Asia. But most illuminating is his 1988 book entitled Japanese Agriculture Under Siege: The Political Economy of Agricultural Policies, which analyzed the cause of Japan’s sharp increases in agricultural protection and the difficulty of reversing that policy, particularly for rice, drawing on his broad and deep understanding of his country’s agriculture, institutional structure, and political economy. Agricultural protectionism was initially a response to the problem of agricultural adjustment in the era of rapid economic development, based on technology-borrowing as the gap between farm and nonfarm income widened sharply. Efficient response to the changing comparative advantage through factor and product market adjustments, however, was severely constrained by land market regulations, rural industrialization, and the phenomenon of part-time farming. Increasing farm size to facilitate larger-scale mechanization lowers costs, raising labor productivity through increasing human capital and specialization of labor, and the shift to higher-valued products per unit of scarce land resources has been too slow. But even more insidious is the political power exerted by vested interests involved in the marketing of agricultural outputs and inputs to maintain high rates of agricultural protection. In fact, under the pressure to conform with international trade agreements, Japan managed to increase market access, instead of lowering tariffs and allowing private-sector imports of rice; which caused little reduction of domestic rice production as much of the increased rice imports ended up being used as livestock feed.

3.4 Development economics and the roles of the market, state, and communities By the late 1990s, Hayami again drew on his growing economic thought to undertake a more comprehensive analysis of the process of economic development and identify the appropriate strategies, policy, and institutional frameworks for the poor countries to catch up with the level of development of wealthier nations. The nature and processes of industrial development were integrated throughout his writing. Again, his conclusion is that technological change, specifically technology-borrowing would be the driving force of economic development. And the state is able to ensure that the incentive structure reflects the scarcity value of inputs and outputs, public goods are provided, and other market and community failures are addressed through appropriate policy and institutional frameworks. This is critical in ensuring markets and communities function efficiently in harnessing modern technologies borrowed from more advanced countries. The set of papers presented in this workshop to honor Yujiro Hayami is our response to his challenge of designing the combination of markets, state, and communities to alleviate poverty in developing economies, maintain

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18 Cristina C. David

economic vitality and social harmony in developed countries, and preserve the environment globally. From the intensive use of official statistics, to field surveys and recordkeeping of farm-households’ activities, his “random walks” across villages, and “pedestrian” interviews of traders, Hayami stayed focused on the use of economic rationality principles in explaining the processes of economic, technical, and institutional change. Yet he was strongly convinced from the start that social norms and other cultural factors are important in understanding why people from different backgrounds express their economic rationality in different forms, so that there is some degree of path dependency, as well as multiple equilibrium paths to economic development. By the late 1990s, his exploration of those phenomena, especially from the village studies, led him to highlight the important role of communities, and not just markets and the state, in the process of economic development. However, we do hope that in the years ahead he will be able to push further the frontiers of understanding cultural endowments, their effects and determinants, to improve the design of policies and programs that will enhance the functioning of markets, the state, and communities. Many individuals who had the opportunity to work with Yujiro Hayami in his fascinating and highly productive journey: his former students and now colleagues in Japan – Otsuka, Kikuchi, Kawagoe, Godo, Honma; international colleagues – Ruttan, Barker, Herdt, Anderson; and Filipinos – the IRRI research staff, Adriano, Quisumbing, Crisostomo-David, among others too many to mention, all join us in honoring him today. Surely, Yujiro Hayami is not just “anyone” of Japan, but one of the great economists concerned with development in this generation.

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Part II Role of State

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4 The Role of the Government in Facilitating TFP Growth during Japan’s Rapid-growth Era*1 Shuhei Aoki, Julen Esteban-Pretel, Tetsuji Okazaki, and Yasuyuki Sawada

4.1

Introduction

It is widely known that Japan experienced rapid economic growth in the late 1950s and 1960s, when per capita gross domestic product grew at a remarkable rate of over 10 percent (Figure 4.1). There are numerous books and academic papers written on the reasons behind this success of the postwar Japanese economy. Some studies rely on descriptive macro-level statistics (Inada et al., 1993; Kosai and Kaminski, 1986; Minami, 1994; Nakamura, 1995; Ohkawa and Rosovsky, 1973) and others employ the growth-accounting framework to decompose the high-growth rate into different factors (Denison and Chung, 1976; Hayami and Ogasawara, 1999, 2002; Yasuba, 2002; Young, 1995). More recent works on the Japanese economy rely on modern calibration techniques to replicate the postwar rapid growth (Braun et al., 2006; Braun et al., 2009; Chen et al., 2006; Otsu, 2007; Parente and Prescott, 2004). There is an emerging consensus, both in the growth-accounting studies, such as Young (1995) and Hayami and Ogasawara (1999), and in the calibration works, such as Otsu (2007) and Esteban-Pretel and Sawada (2009), that Japan’s postwar rapid growth was driven by a high-growth rate of total factor productivity (TFP). These studies, while careful in their analysis and accurate in their results, assume that the evolution of TFP is exogenous to their models, and, thus, do not address questions related to the sources of the high rates of TFP growth. However, uncovering the determinants of TFP growth is important, especially when studying government policies, * This paper has been prepared for the Festschrift Conference for Yujiro Hayam on State, Community, and Market in Development, February 27–28, 2009. We would like to thank Tina David, Yoshihisa Godo, Jikun Huang, Kaliappa Kalirajan, Keijiro Otsuka, Gustav Ranis, Scott Rozelle, Tetsushi Sonobe, John Strauss, and other participants for helpful comments.

21

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22

Shuhei Aoki et al. 11 10 9 8 7

1870 1875 1880 1885 1890 1895 1900 1905 1910 1915 1920 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

6

Figure 4.1 Changes in Japan’s gross domestic product per capita in logarithm of real GDP expressed in 1990 US dollars Source: Maddison’s Database .

since some of these policies could have affected the economy by influencing TFP. This chapter studies the main forces behind the high growth of Japanese TFP in the postwar period, and the role that the government played in the evolution of Japanese technology. We argue that it is necessary to analyze the evolution of TFP for the agricultural and nonagricultural sectors separately. This is due to the changing level of economic development of the Japanese economy in the postwar period, and the initial importance of the agricultural sector, both in share of employment and total output, right after the war. We show that, for the nonagricultural sector, technology improvement in the early years following World War Two started with the import and licensing of specific foreign technologies. With time, the adoption of foreign technologies was gradually replaced by the development of Japan’s own domestic technologies. We argue that the government played a role during both stages. In the foreign technology adoption phase, the main impact of the government was through heavily regulating the number and type of technologies which companies were allowed to license and import from foreign firms. As for the phase of the development of their own new technologies, the stage in which the Japanese economy is still immersed, the government has not contributed as much as governments in other developed countries in terms of expenditures. However, its main influence has been through the establishment of R and D consortia, but not by affecting the R and D activities with distortionary subsidy systems, and finally by not strengthening patent laws. In particular, it is argued that the positive

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outcomes on the R and D consortia can be attributed to the community mechanism of enforcing agreement between government and industrial leaders in the sense of Hayami and Godo (2005). The remainder of this chapter is organized as follows. In Section 4.2 we decompose aggregate Japanese TFP into agricultural and nonagricultural sectors, and explain their main characteristics. In Section 4.3, we present evidence of foreign technology adoption and innovation in postwar Japan in the nonagricultural sector. Section 4.4 discusses the determinants of agricultural TFP. In Section 4.5 we focus on the domestic diffusion of technology. Finally, Section 4.6 summarizes and concludes.

4.2 Evidence on overall Japanese TFP and its sectoral decomposition It has been well established in the economic literature that the innovation and adoption of new technologies are the two key driving forces of the TFP growth. Models of endogenous technological innovation can be broadly split into three categories: first, new variety models (Romer, 1990); second, quality ladder models (Aghion and Howitt, 1992; Grossman and Helpman, 1991); and, third, the induced technological innovation model (Hayami and Ruttan, 1971 and 1985). Moreover, technologies can be adopted rather than innovated through three broad channels: First, imported intermediate inputs directly improve technology level (Coe and Helpman, 1995; Eaton and Kortum, 2002). Second, foreign direct investment (FDI) facilitates technology transfers (Markusen, 2002). Finally and more generally, sufficient stock of domestic knowledge and technology is a necessary condition for a country to be able to import, adapt, and absorb new technologies from overseas (Barro and Sala-i-Martin, 1997; Benhabib and Spiegel, 2005). The following sections review how new technologies were created and diffused, and how the government facilitated these processes in the postwar Japanese economy. When the Second World War ended in 1945, the Japanese economy found itself far behind the technology frontier of the world. In 1964, the Agency of Industrial Science and Technology, which was in charge of industrial R and D under the Ministry of International Trade and Industry (MITI), looked back at the 1940s and 1950s and wrote: “The technology gap between Japan and the advanced countries in the prewar period was preserved, and it further expanded due to the vacuum of technology adoption during the war” (Agency of Industrial Science and Technology, 1964). Indeed, in 1952 the productivity gap between Japan and the US was substantial. According to the estimate by Christensen et al. (1995), Japanese TFP was as low as 43 percent of that of the US. However, the productivity of the Japanese economy increased rapidly after that, and it became 80 percent of that of the US in the early 1970s, when the high growth came to an end (Figure 4.2).

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24 Shuhei Aoki et al. 0.8

0.6

0.4

0.2

1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973

0

TFP Figure 4.2

Output per capita

Changes in productivity of Japanese economy relative to the US

Source: Christensen et al. (1995), pp. 316–20.

In the following sections, we divide the economy into the agricultural and nonagricultural sectors. The reason behind this division is twofold. First, right after World War Two, the share of output and employment in the agricultural sector was more than 50 percent. As is shown in Esteban-Pretel and Sawada (2009), accounting for the structural change that took place in Japan in the postwar period is essential to understanding the rapid growth. During a structural change process, TFP growth, or more precisely, labor productivity growth in the agricultural sector, is an important determinant of economic growth. In models with non-homothetic preferences (e.g., Eswaran and Kotwal, 1993; Esteban-Pretel and Sawada, 2009; Gollin et al., 2007), households first consume the subsistence level of food that is essential for their survival, and then consume other goods such as manufacturing goods or services. In such models, if agricultural TFP level is low, even if the TFP level in the nonagricultural sector is high, the economy needs to allocate a large fraction of resources to unproductive food production, which reduces economic growth. Second, while the adoption of foreign technologies in the manufacturing sector is widespread and has been documented for many developing economies, the international diffusion of agricultural technologies is often very difficult due to differences in climatic conditions. As we discuss later, given these difficulties, the Japanese agricultural sector was forced to innovate independently, while in the other economic sectors the adoption of foreign technologies was more common, at least right after World War Two.

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25

300 250 200 150 100 50

1956 1958 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000

0

Non-agriculture

Agriculture

Figure 4.3 Changes in sectoral total factor productivity indexes during the postwar period in Japan Note: Labor input is total hours. Source: Esteban-Pretel and Sawada (2009) dataset.

Figure 4.3 shows the evolution of TFP in the agricultural and nonagricultural sectors in postwar Japan. We can observe that both TFP series increase significantly until the first oil crisis, although the growth rate of nonagricultural TFP was significantly higher than that of agriculture. In order to further understand the relative contribution of the sector-specific TFP to the overall TFP level, we decompose aggregate TFP, A, into four components: Agricultural TFP, Aa, nonagricultural TFP, Am, and the contribution of the reallocation of capital and labor. We follow Syrquin (1984) and Basu and Fernald (2002) and decompose aggregate TFP as follows: A A  r ⫺ r  K i  wi ⫺ w  L i A ⫽ sVa a ⫹ sVm m ⫹ ∑ sVi sKi  i  ⫹ ∑ sVi sLi   , A Aa Am i ∈{a, m}  ri  Ki i ∈{a, m}  wi  Li where K is capital; L is labor; r and w are capital and labor returns, respectively; sVi, sKi, and sLi are the nominal value-added share, capital share, and labor share of sector i, respectively. Note that variables without subscripts denote aggregate levels, and those with subscripts are those in the agriculture (a) or nonagriculture (m) sectors. The final two terms on the right-hand side of the previous equation are the “growth bonus” effect arising from reallocating capital and labor from a low to a high marginal productivity sector. When capital or labor are reallocated to a sector with higher marginal product, the third and fourth terms are positive. We refer to these last two terms as the capital and labor reallocation effects.

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26 Shuhei Aoki et al.

Table 4.1 TFP decomposition

1956–73 1973–83 1983–91 1991–2000

Aggregate TFP (%)

Agr. TFP (%)

Non-agr. TFP (%)

4.78 0.50 2.26 0.17

0.11 0.00 –0.01 –0.01

3.96 0.25 2.13 0.09

Capital reallocation (%)

Labor reallocation (%)

0.05 0.04 0.01 0.01

0.66 0.21 0.13 0.08

Note: Labor input is total hours. Source: Esteban-Pretel and Sawada (2009) dataset.

Table 4.1 shows the decomposition of aggregate TFP for various subperiods starting in 1956. We can see that the main contributors to aggregate TFP growth are nonagricultural TFP and the reallocation of labor. Both terms are high during the rapid-growth era, from 1956 to 1973. The importance of the labor reallocation effect is consistent with the findings of Hayashi and Prescott (2008) and Esteban-Pretel and Sawada (2009), which show that the elimination of migration barriers from rural to urban areas can be seen as one of the important determinants for Japan’s postwar economic miracle.1 The contribution of agricultural TFP is low, which is partly due to the declining share of agricultural production in total output over the period of study.

4.3 Foreign technology adoption and innovation in the nonagricultural sector We now move on to study the way in which the remarkable improvement of nonagricultural technology occurred in Japan. Initially Japan relied on imported foreign technologies, and later started the development of its own technologies. This sequence, which is also observed in other countries that are not technology leaders, can be clearly seen in Figure 4.4. The ratio of net technology imports to GNP, which was initially high, has declined gradually over time. Simultaneous with this decline, Japan experienced a rise in the ratio of R and D expenditures to GNP. This indicates that over time, Japan substituted the import and adoption of foreign technologies for the development of their own. We now study these two processes in more detail. Foreign technology adoption As can be seen in Figure 4.2, the technology gap between Japan and the US was greatly reduced during the 1950s and 1960s. A major driving force of this rapid technological progress in the decades following World War Two was the adoption of foreign technologies. Figure 4.5 shows the trend of technology adoptions measured by the number of “Type A” technological

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0.20

3.0

0.15

2.3

0.10

1.5

0.05

0.8

27

R&D/GNP (%)

Net technology import/GNP (%)


0

Net technology import/GNP

1988

1986

1984

1982

1980

1978

1976

1974

1972

1970

1968

1966

1964

1962

1960

1958

1956

0

R&D/GNP

Figure 4.4 Changes in net technology import and R and D expenditures relative to GNP in Japan Note: The left-hand vertical axis is for “net technology import/GNP,” while the right-hand is for “R&D/GNP.” Source: Science and Technology Agency (1972, 1974, and 1991) and SNA.

2000

1500

1000

500

Figure 4.5

1978

1976

1974

1972

1970

1968

1966

1964

1962

1960

1958

1956

1954

1952

1950

0

Changes in number of Type A technological assistance contracts

Source: Science and Technology Agency (1980).

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Shuhei Aoki et al.

Table 4.2 Number and composition of licenses by industry 1950–4 1955–9 1960–4 1965–9 1970–4 1974–9 Number Total Chemical products Petrochemical plant engineering Petroleum and coal products Iron, steel, and nonferrous metals Fabricated metal products General machinery Transportation equipment Precision instruments and machinery Electric machinery Food and tobacco Textile products Ceramic, stone, and clay products Plastic products Others Percentage Total Chemical products Petrochemical plant engineering Petroleum and coal products Iron, steel, and nonferrous metals Fabricated metal products General machinery Transportation equipment Precision instruments and machinery Electric machinery Food and tobacco Textile products Ceramic, stone, and clay products Plastic products Others

454 82 0

575 116 19

2039 280 38

3926 678 73

8295 1048 82

7846 808 92

15

17

24

73

217

84

38

56

96

181

201

147

6 98 42 0

20 120 34 8

74 589 94 48

124 1021 209 125

225 1973 438 261

217 1759 391 304

108 0 24 10

109 1 33 8

469 8 83 45

664 58 172 81

1251 260 794 206

1451 151 1060 134

1 30

5 29

94 97

209 258

403 936

187 1061

100.0 18.1 0.0

100.0 20.2 3.3

100.0 13.7 1.9

100.0 17.3 1.9

100.0 12.6 1.0

100.0 10.3 1.2

3.3

3.0

1.2

1.9

2.6

1.1

8.4

9.7

4.7

4.6

2.4

1.9

1.3 21.6 9.3 0.0

3.5 20.9 5.9 1.4

3.6 28.9 4.6 2.4

3.2 26.0 5.3 3.2

2.7 23.8 5.3 3.1

2.8 22.4 5.0 3.9

23.8 0.0 5.3 2.2

19.0 0.2 5.7 1.4

23.0 0.4 4.1 2.2

16.9 1.5 4.4 2.1

15.1 3.1 9.6 2.5

18.5 1.9 13.5 1.7

0.2 6.6

0.9 5.0

4.6 4.8

5.3 6.6

4.9 11.3

2.4 13.5

Source: Science and Technology Agency (1980).

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29

assistance contracts, that is, contracts whose terms were longer than one year, from 1950 to 1979. While the number of foreign technology adoptions per year was around 100 until 1959, it increased to around 2000 by the late 1960s. Breaking down these numbers by industry, we find that they were concentrated in a few industries, that is, chemical products, general machinery, and electrical machinery, from the 1950s to the 1970s (Table 4.2). The license share of these three industries over the total number of licenses was on average about 60 percent in the 1950s and 1960s. This large contribution of imported technologies to postwar Japanese economic development is widely accepted in the preceding studies. For example, Peck and Tamura (1976) characterize postwar Japanese technological development as one with “high returns from importing technology.” Goto and Odagiri (1996) point out that Japan efficiently utilized the channels of technology transfer such as import of machinery and equipment, and purchase of technology and technological services. Figure 4.6 shows a scatter diagram showing the ratio of net payment for technology import to GDP and productivity growth by industry. The horizontal axis denotes the number of foreign technological adoptions from 1955 to 1969, normalized by the average real value added in 1955 and 1970, while the vertical axis denotes the productivity growth from 1955 to 1970 (TFP in panel [a] and labor productivity in panel [b]). We can clearly observe a positive correlation between technology adoption and growth, both for TFP and labor productivity. The impact of technology adoptions on the different industries, suggested in Figure 4.6, has been well documented in the literature. Previous work on the industrial development of postwar Japan is full of anecdotes about the positive effects of technology imports (e.g., Agency of Industrial

200

(a) TFP growth (%)

(b) Labor Productivity 300

Electrical Machinery p=0.702 Transportation equipment

150

Machinery

p=0.702 Chemicals

Chemicals

Transportation equipment

225

Machinery

100

Fabricated metal Textile mill Primary metal

50

150

Others

75

0

Electric Machinery

Fabricated metal Primary metal Textile mill Others Food

Food

−50

0 0

0.75

1.5

2.25

3

0

0.75

1.5

2.25

3

Figure 4.6 Ratio of net payment for technology import to GDP and productivity growth by industry Sources: Economic and Social Research Institute of Cabinet Office (2001) and Economic Research Institute of Economic Planning Agency (1998).

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Science and Technology, 1964; Kohama, 2001; Society for Industrial Studies, 1995; Yonekawa et al., 1990–1). In particular, the Committee for Foreign Technology Survey (1961) comprehensively describes technology imports by individual industries and their impacts in the early stage of postwar growth. Let us briefly look at the cases of electric machinery, automobiles, and iron and steel, which became the major export industries of Japan. Electric machinery is usually subdivided into “heavy electric machinery” and “light electric machinery.” The former is composed of investment goods for electricity companies, while the latter encompasses consumption goods for households. With respect to heavy electric machinery, three of the major companies, Toshiba, Mitsubishi Electric, and Fuji Electric, entered into comprehensive technology adoption contracts with GE, Westinghouse, and Siemens, respectively, in the early 1950s. One of the most remarkable results of these contracts was that the Japanese electric machinery companies became able to produce thermal generators of large capacity. In the early 1950s, they started to shift from hydroelectric generation to thermal generation. It was for that purpose that they imported advanced thermal generators larger than 200,000 KW each, which they could not produce. Owing to foreign technology adoptions, they acquired the ability to produce these advanced machines. Concerning light electric machinery, foreign technology adoptions created a new industry, that is, the television set industry. TV broadcasting started in Japan in 1953. Since R and D for producing TV sets was suspended during the war, and the start of TV broadcasting occurred at a later time than in advanced countries, Japanese technology for TV production was substantially behind. Many basic patents for TV sets were owned by foreign companies, in particular RCA, Westinghouse, and EMI. Hence, more than 30 Japanese electric machinery companies entered into technology assistance contracts with these foreign companies in the early 1950s. While the cumulative number of TV sets produced in Japan until 1954 was 75,000, in 1959 alone 2.9 million TV sets were produced, and out of those, 27,000 sets were exported. The occupation authority (SCAP) allowed the production of automobiles in 1949, although at this time automobiles were just remodeled small trucks whose performance was 10 to 20 years behind the world standard. In the early 1950s, three major automobile companies, Nissan, Hino, and Isuzu, entered into technology adoption contracts with Austin Motors, Renault Corporation, and Roots Motors, respectively. According to the contracts, information on design, specifications, materials, processing, and other aspects, was provided to Japanese companies, which enabled them to produce world-class automobiles. Furthermore, accompanying these technologies, the mass-production system based on transfer-machines was introduced to the Japanese automobile industry.

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31

The iron and steel industry developed fairly well in Japan, but the technology for producing strip metal, whose demand was increasing as the durable consumption goods industry developed, lagged behind. In order to catch up with the advanced countries, MITI and iron and steel companies drew up the “First Iron and Steel Rationalization Plan” in 1951, the focus of which was the construction of strip mills. Based on the plan, Fuji Iron Works and Yawata Iron Works, the two largest iron and steel companies in Japan, entered into technological assistance contracts with Armco Steel to obtain know-how on the design, construction, and operation of strip mill factories. A similar contract was entered into between Kawasaki Iron Works and Republic Steel in 1958. The “First Iron and Steel Rationalization Plan” was followed by the “Second Iron and Steel Rationalization Plan” in 1956. The focus of the second plan was the introduction of the basic oxygen furnace (BOF), which was a substitute for the open hearth. In 1956, Nippon Kokan Corporation (NKK) acquired a general license in Japan with Alpine Co., and six other major Japanese steel companies acquired the sublicense of BOF from NKK in the late 1950s. There are few studies that quantitatively identify the effect of foreign technology adoption in 1950s and 1960s Japan. Kiyota and Okazaki (2005) examined the effect of technology adoption on the firm’s performance using firm-level data from 1957 to 1970. They matched the complete list of individual technology adoptions by the firms listed on the Tokyo Stock Exchange in that period with the financial data from the JDB database. They found that in the 1950s, technology adoption had a positive impact on labor productivity, value-added, the capital-labor ratio, and the R and D-sales ratio, although not on TFP. In a different study, Nakamura and Ohashi (2008) reveal that the adoption of BOF raised the annual TFP growth rate of the steel industry from 7 percent (counterfactual) to 17 percent (actual in 1957–68). At the same time, they find that just after a plant introduced BOF, its TFP dropped 9 percent and it took two years before TFP reached the level achieved by the old open-hearth technology. This is likely to be due to the learning effect, which seems to explain the result of Kiyota and Okazaki (2005) that technology adoption did not have a positive impact on TFP. Policy framework for technology adoption The Japanese government played an important role in the import of the technologies described above, by imposing a strict framework for such adoptions.2 This policy framework, which started in 1950 with the enactment of the Foreign Investment Law and had mostly disappeared by 1968, was intended for the selective adoption of what were thought of as key technologies. The 1950 law required government approval of all “Type A” technological assistance contracts. By this approval system, the government aimed at selectively importing technologies that would contribute to Japan’s balance of payments and the development of “important” industries.

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Meanwhile, the government guaranteed and protected the investments and contracts that were approved, and thereby intended to promote the adoption of desirable technology. In the late 1950s, requests for relaxing regulations on technology adoption were made by domestic industries as well as those from foreign countries. The domestic industries were keen to adopt more foreign technology to cope with the trade liberalization expected in the near future. Responding to these requests, the government simplified the examination procedure of technology adoption in 1959, which was called the “new method for capital import.” This measure was meant to be tentative until a more substantial deregulation, which was conducted in 1961. After the deregulation in 1961, foreign technology adoptions were approved automatically, except for cases which were thought to be detrimental to the Japanese economy, while the government continued to examine each application of technology adoption. In 1968, the government finally ceased the individual examination process, except for certain cases, such as aircraft, weapons, gun powder, and nuclear power. In other words, government intervention in technology adoption was basically abolished. We can observe in Figure 4.5 several qualitative jumps in the range of imported technologies. These jumps divide the sample period into the four phases generated by the deregulations of 1959, 1961, and 1968. Figure 4.5 suggests that the government regulation indeed affected technology adoptions in Japan. Studying the influence of such regulation of the number of imported technologies, Kiyota and Okazaki (2005) use firm-level data and find a negative impact of the regulation on the amount of technology adoptions. They also find that the government regulation affected the composition of the adopted technologies. Peck and Tamura (1976) point out that MITI gave priority to adopting technologies for intermediate and capital goods for heavy industries in the 1950s. The relatively high percentage of chemical products and “iron, steel and non-ferrous metals” in the 1950s seems to reflect the priorities of MITI. The advantages and disadvantages of government intervention in foreign technology adoptions in Japan have been controversial. Johnson (1982) and Lynn (1982 and 1998) evaluate the contribution of MITI’s control over technology adoptions, arguing that thanks to MITI’s intervention, Japanese industries were able to obtain cutting-edge technologies at lower prices. Their rationale is that MITI’s intervention and controlled competition among Japanese firms helped reduce the concerns of foreign technology suppliers, who otherwise may not have dealt with Japanese firms that did not have international reputations. Nakamura and Ohashi (2008) argue that, given the high estimated learning costs of new technologies in the steel industry, MITI’s intervention encouraged Japanese steel companies to adopt the more productive BOF technology through lowering royalties.

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33

In contrast, others have stressed that MITI’s intervention hindered or delayed competent Japanese firms from accessing foreign technologies. A case cited often is that of Sony in the early 1950s (Goto and Odagiri, 1996; Okimoto, 1989; Peck and Tamura, 1976). Sony had to wait for two years until the adoption of the transistor technology from Western Electric was approved by MITI. This delay was due to MITI’s skepticism about the abilities of Sony, a small start-up firm at that time. This anecdote is consistent with MITI’s general policy of screening applications for technology adoption. Kiyota and Okazaki (2005) reduced the number of technology adoptions by a firm based on its attributes including the cumulative number of technologies it had adopted, and found that its coefficient was significantly positive in the 1950s, whereas it was around zero after deregulation in the 1960s. This implies that MITI preferred to approve technology adoption by experienced firms, and this had an unfavorable effect on competent start-up firms like Sony in the 1950s. Innovation of new technologies As the Japanese economy caught up with the developed countries, it gradually shifted from the foreign technology adoption process to the innovation process, where Japanese firms engaged in R and D investments more intensively. The R and D expenditure to GNP ratio in Japan increased from about 50 percent of the US level in 1961 to about the same level in 1989.3 As in the case of the US, around 40 percent of R and D expenditure in Japan is used for basic and applied research, and the rest is used for the development of new products.4 Similar to the US, firms’ R and D activities also contributed to the development of science. Two Japanese Nobel laureates in the natural sciences were corporate researchers when they achieved their scientific breakthroughs. Table 4.3 Decomposition of R and D expenditure in terms of share in total R and D expenditure in selected countries

Government

Industry

University

Private laboratory

Provider User Provider User Provider User Provider (%) (%) (%) (%) (%) (%) (%) Japan (1988) US (1988) West Germany (1987) France (1983) UK (1987)

User (%)

18.4 48.0

9.3 11.5

76.3 47.9

73.9 71.8

4.5 2.8

12.6 13.8

0.7 1.4

4.3 2.9

36.6 53.8 38.7

3.4 26.4 15.1

62.3 42.0 49.7

73.1 56.8 67.0

– 0.2 0.6

12.9 15.9 14.2

– 0.4 1.9

10.6 0.9 3.7

Source: Westney (1994) (Originally taken from Science and Technology Agency, 1990).

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Shuhei Aoki et al.

One characteristic of R and D in Japan is that the government’s share of R and D expenditure is the lowest among the developed countries. Table 4.3 shows that while the US government provided around 50 percent of R and D expenditure in 1988, the Japanese government only provided around 20 percent. Japanese firms accounted for almost all the remaining expenditure, 74 percent. At the user level, however, Japan’s R and D expenditure is similar to those of other developed countries. Policies on technology innovation One implication of the endogenous growth theory is that R and D investment in laissez-faire economies is lower than the social optimum. This is due to the existence of externalities and imperfect competition arising naturally from increasing-returns-to-scale technologies. Such externalities justify the intervention of the government through policies such as the provision of financial incentives via subsidies and tax benefits to R and D investment, or the strengthening of patent rights. However, evidence seems to suggest that the Japanese government did not pursue the pro-incentive policies to correct market failures, as is suggested by the endogenous growth theory. As we see in Table 4.3, the Japanese government’s subsidies for R and D investments were much smaller than those in other developed countries. Moreover, according to Okimoto (1989), specific tax incentives for R and D investment were also small compared with the US. The avoidance of such policies, which can easily generate an excuse for pork-barrel spending, might be one of the reasons why R and D policies in Japan were relatively free from distortions arising from government failures. According to Okimoto (1989), MITI has traditionally refused to protect depressed industries, while the declining sectors tend to be the biggest beneficiaries of tax exceptions in the US. These relatively nondistortionary tax policies of the Japanese government towards the R and D sector may have been beneficial for competition and ultimately innovation, making the R and D sector one of the highest-growth industries in Japan. On the other hand, Beason and Weinstein (1996) argue that the Japanese government, including MITI, allocated a disproportionate amount of resources to lowgrowth industries.5 They also find that the financial support by the government did not positively affect TFP. MITI also avoided other types of policy distortions. Okimoto (1989) argues that after World War Two, Japan discarded superpower aspirations. As a result, the Japanese government did not promote defense-related industries, which meant that, unlike other countries, the government did not spend substantial quantities on R and D investment in the defense industry. He also argues that the Japanese government de-emphasized the importance of national prestige. This implied that, unlike France and other European countries, MITI has not followed a strategy of cultivating one or two “national

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champions.” For example, Japan has had nothing like the US’s Strategic Defense Initiative, and no supersonic jet or Airbus-type project. The Japanese patent system had been traditionally beneficial to the user. While a user-favorable patent system helps and promotes the import of technologies in the adoption process, it is harmful to the innovation process. This is one of the reasons why patent rights in Japan were strengthened in 1988 through a substantial patent reform. However, the benefits of such a reform are debatable, since Sakakibara and Branstetter (2001) show that the 1988 Japanese patent reform does not seem to have increased either R and D expenditures or product innovation. The endogenous growth theory emphasizes the importance of knowledge spillover in the process of technological change. Since this kind of spillover is a type of externality, policies aimed at internalizing the benefits of such knowledge spillover can be justified. One such policy is the establishment of R and D consortia, where potentially competiting firms cooperate on the R and D of targeted technologies, and exchange and share their knowledge.6 Probably, the most famous R and D consortium is the project on very largescale integrated circuits. However, cooperation among the participants, which is indispensable for the success of an R and D consortium, is not easy to achieve. For instance, if participant firms compete in the product market, they are less likely to cooperate in R and D, because their efforts for innovation in the consortium help the competitors. Similarly, if differences in technology level among firms are large, leading firms are not willing to participate in R and D consortia, because they will gain little by participating. What, then, was the performance of R and D consortia in Japan? Findings in a series of papers by Branstetter and Sakakibara suggest that the Japanese R and D consortia have had positive effects on the innovation of participating firms. They find that even after controlling for fixed effects, a firm’s participation in R and D consortia increased the firm’s R and D expenditure and patent production (Branstetter and Sakakibara, 1998, 2002). They also note that the design of an R and D consortium was more important to its success than the level of resources expended on it (Branstetter and Sakakibara, 2002). These results indicate that although government financial support for R and D consortia was modest in Japan (Sakakibara, 1997), the role of such consortia may have been substantial. Okimoto (1989) attributes the success of R and D consortia to the relationship of trust between MITI and the private firms. He also notes MITI’s ability to consult with them. In this sense, the R and D consortia utilize what Hayami (2006) refers to as “the community enforcement mechanism in modern business societies in Japan.” On the other hand, Okimoto and Sakakibara point out that the success of the Japanese R and D consortia was owed to the special circumstances of the catch-up period. During that period, the Japanese firms evenly fell behind

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their Western counterparts in terms of the technology level and felt the need to catch up in order to prepare for the competition with Western firms after direct foreign trade liberalization (Okimoto, 1989; Sakakibara, 1997). In addition, a firm’s participation in R and D consortia was a sign of the firm’s ability to outsiders, such as buyer industries and banks (Sakakibara, 1997). However, the circumstances changed after the catch-up period ended. Differences in the technology capabilities of Japanese firms have become larger. The signaling effect was likely to have decreased too, because the government did not have superior information to the private firms. Another policy that promotes the development and sharing of knowledge is the promotion of institutions such as research institutes and universities. According to Okimoto (1989), the laboratories of Nippon Telegraph and Telephone Public Corporation, and its successor Nippon Telegraph and Telephone Corporation (NTT), have played an important role in R and D activities in Japan, as AT and T has done in the US. On the other hand, while the university share of R and D expenditure in Japan is similar to that of other developed countries (Table 4.3), Okimoto and Nishi (1994) report that the relations between firms and universities have been traditionally inactive, which has limited the knowledge-sharing between these two types of institution. Furthermore, Aldrich and Sasaki (1995) report that university-based R and D is not allowed in Japanese R and D consortia. All this suggests that university R and D in Japan has been conducted independently from that of industry.

4.4 Foreign technology adoption and innovation in the agricultural sector Unlike in the nonagricultural sector, foreign technology adoption is not easy in agriculture, primarily due to the fact that agriculture is strongly constrained by environmental conditions (Hayami and Godo, 2005). The induced innovation theory by Hicks (1932) and Hayami and Ruttan (1971 and 1985) formalizes the idea that technological innovations are directed toward technologies that use smaller amounts of relatively scarce factors. However, such innovations are not always possible with the effort of private farm producers because of the public-good nature of many biological and chemical technologies, such as new rice seeds and production practices. Hence, to facilitate TFP growth in agriculture, it is essential to develop the appropriate public-sector research, and extension systems. For this reason, the government must potentially play a very important role in the agricultural sector (Rustichini and Schmitz, 1991). In Japan, modern technological progress in the agricultural sector has taken place in two phases, the prewar and postwar eras. As Hayami (1975) notes, the rapid TFP growth in the prewar period was supported by a backlog of technological potential accumulated before the Meiji era, when superior

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methods and advanced knowledge were developed by the wealthy veteran farmers (“Rounou”). After the Meiji Restoration, these veteran farm leaders started identifying and disseminating their knowledge across regions. The government helped the exploitation and diffusion of the backlog of indigenous technologies by sponsoring “seed-exchange meetings” and “agricultural discussion meetings,” and by promoting scientific agricultural research and extension activities (Minami, 1994). These activities were complemented by irrigation investments by the government, and their maintenance performed by the neighboring communities in mobilizing the community mechanism of collective work is emphasized by Hayami (1975). Agricultural TFP improvement during the early postwar era shown in Table 4.1 was the consequence of many technological advancements that had been accumulated during the prewar period (Hayami and Ruttan, 1985). TFP growth in the postwar years played an essential role in growth of agricultural output (Hayami, 1975; Kuroda, 1995, 1997). It is argued that the postwar TFP growth in the agricultural sector has come from two main sources: the mechanization of agriculture, and the introduction of high-yielding varieties.7 As to the first source, mini-tractorization based on the adoption of small-scale machinery became an important factor in agricultural growth during the rapid-growth era. In this process, the research conducted during the war for nonagricultural purposes formed a backlog used in the advancement of agricultural techniques (Hayami, 1975). Lau and Yotopoulos (1989) show that there is a positive association between scale economies and tractorization, and Hayami and Kawagoe (1989) find that increasing returns to agricultural production emerged in Japan as agriculture developed and wages increased during the mid-1960s. These increasing returns and rises in wages occurred because of the substitution of large-scale machinery, such as riding tractors, for small hand tractors. As to the second source, the Japanese government played an important role in this process of agricultural technological improvement. In particular, the R and E efforts of the Ministry of Agriculture, Forestry and Fishery (MAFF) resulted in the development of new rice varieties, from both the pure-line and crossbred “Norin” selections.8 These R and E activities were crucial in the early postwar period because they allowed for the reduction of costs in agricultural production. However, the effect of R and E on TFP growth dramatically decreased after the late 1960s, despite the fact that the level of R and E investment did not decrease. The diminished impact of R and E on TFP growth is what Kuroda (1997) identifies as the main source of the agricultural growth slowdown after 1969.

4.5

Domestic diffusion of technology

The preceding sections have focused on the role of the Japanese government in the development and dissermination of foreign technologies. In

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Shuhei Aoki et al.

the theoretical model of economic growth it is commonly assumed that once a new technology is developed, or imported from overseas, it is readily available for use by any firm willing to pay its price. While this perfect and instantaneous diffusion of technology may be a reasonable simplification for these models, in reality, technologies and know-how do not immediately diffuse within a country. Indeed, using a numerical dynamic generalequilibrium model with endogenous TFP, Oshima (2009) shows that a major part of TFP growth in Japan’s postwar rapid-growth era can be explained by domestic knowledge diffusion. In this section we discuss the factors that affect the domestic diffusion of existing technologies, including the role of the Japanese government. The level of human capital is an important lubricant for the diffusion of technologies. Once a new technology is imported or invented, for it to be widely used, workers in firms need to be able to learn how to use it. The ability of the labor force to learn and implement new techniques is strongly linked to the educational level of a country. Godo in Chapter 8 compares the progress of education between Japan and the US in the period from 1890 to 1990, finding that while Japan greatly caught up with the US in terms of education in the prewar period, there was a missing link between improvements in education and the macro performance of Japan. This missing link can be clearly observed in the postwar period, when Japan rapidly caught up with the US in terms of per capita GDP, although the catching-up process in terms of schooling was much less dramatic (Figure 4.7). Godo and Hayami (2002) argue that the weak contemporaneous correlation between education and TFP growth in the postwar period is due to the fact that what 15 12 9 6 3

1888 1893 1898 1903 1908 1913 1918 1923 1928 1933 1938 1943 1948 1953 1958 1963 1968 1973 1978 1983 1988 1993

0

Japan Figure 4.7

U.S.

Comparison of average years of schooling in Japan and the US

Source: Godo and Hayami (2002).

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39

was important in the diffusion of technologies after the war was the available educational level, rather than its current improvements. In particular, Godo and Hayami (2002) state that it was the sharp increase in Japanese vocational training prior to 1940 that was critical to the diffusion of technologies in the 1950s and 1960s. The government has implemented several policies that have been important in increasing the human-capital level of Japan. It introduced mandatory elementary education in the late-nineteenth century, made tuition-free in 1900, and started to implement vocational training programs as early as 1893. It also provided certificates for technicians through exams, such as the National Trade Skill Testing and Certification System (“Ginou Kentei Seido”) of the Ministry of Health, Welfare, and Labor, introduced in 1959, which helped workers move across jobs and diffuse the existing technologies. It is widely accepted that physical infrastructure plays an important role in the process of economic development. One way it helps is by facilitating the diffusion and adoption of technological advancements. Since the classical works of development theory, such as Hirschman (1958) and RosensteinRodan (1943), development economists have considered infrastructure as an indispensable precondition of industrialization. A government’s industrialization program would be successful when physical infrastructure is shared among the firms and investors, since the coordination of various investments generates strong pecuniary externalities, which is identified as the key to successful industrialization (Ciccone and Matsuyama, 1996; Murphy et al., 1989). In facilitating the diffusion of technologies, the Japanese government played an important role by providing physical infrastructures such as the postal system, telecommunications, railways, and paved roads and highways (Kohsaka et al., 2007). For instance, the government built the crucial transportation infrastructure that was needed to implement the BOF technology explained in section 3 (Okazaki, 2001). In diffusing borrowed technologies imported from advanced foreign countries, or those developed domestically, imitation through industrial clusters may have also been important. As an example of technology spillovers in clusters, Yamamura et al. (2005) examine the evolution of the motorcycle industry in Japan from 1948 to 1964. Using individual firm data, they show that the industry’s rapid growth in the early phase is explained by the massive entry and imitation of simple technologies. On the other hand, the sustained growth in the later phases is explained by domestic innovations and subsequent imitations by other local firms, as well as the exit of inefficient firms. Sonobe and Otsuka (2006) found similar patterns in different industries in Japan and other East Asian countries. The motorcycle industry example of Yamamura et al. (2005) also highlights the role of the government as the enactor and enforcer of patent laws, since most of the industry’s growth is explained by imitation of the

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competitor’s technology. Japan’s patent system somehow allows these types of imitation patterns. It is a system that promotes easy opposition to patents before they are even issued. As pointed out by Flath (2005), this provides incentives to firms to license their new inventions on terms favorable to users, and encourages the early revelation of new technologies.

4.6

Concluding remarks

In this chapter we have shown that the growth of aggregate TFP in postwar Japan was mainly driven by that of nonagricultural TFP, although agricultural TFP also played an important role in the structural transformation of the economy. The Japanese government played a role in the technological growth of both sectors, and its contributions comprise both financial support and the provision of the necessary organizational infrastructure. The high growth of nonagricultural TFP in the postwar period was driven initially by the adoption of foreign technologies and later by domestic innovation. Most of the initial adoption of technologies was done through licensing by Japanese firms under the strict supervision of the government. The government influenced the types and quantities of technologies imported by setting a very restrictive process for the approval of the import of foreign technologies. The government’s share of R and D in Japan is smaller than that in other developed countries, but it has been highly involved in the establishment of R and D consortia. This suggests that the role of the Japanese government in the innovation phase has been primarily to avoid distorting the incentives of innovating firms through subsidies, and to enhance coordination through R and D consortia by, for example, employing the community enforcement mechanism between government and industry in the sense of Hayami (Hayami and Godo, 2005). In the agricultural sector, TFP growth was driven mostly by innovations of new technologies. The mechanization of agriculture through locally invented mini-tractors, as well as the development of high-yielding crop varieties, has been the source of growth in agricultural TFP. The government’s participation in this process was crucial since many of these technologies were developed directly by the Ministry of Agriculture, Forestry and Fishery. The Japanese government also helped nonfarm sectors by investing in the human-capital level, building much of the necessary physical infrastructure, and by establishing a patent system that is fairly favorable to imitators. In summary, the Japanese government played a part in the growth of TFP in the rapid-growth era by directing the adoption of foreign technologies, promoting the coordination of R and D activities, and setting up ways in which available technology could be diffused across the country. Yet, we should also note that the Japanese government was not immune from failure. Indeed, the government failed to foresee the importance of higher

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41

education in the post-catch-up growth era. Japan was not successful in accumulating a high level of knowledge due to insufficient investments in tertiary or postgraduate education. Therefore, intangible capital-intensive technological progress was not fully induced (see Chapter 8). This government failure is reflected in the low TFP growth of the 1990s.

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Denison, E. and Chung, W. (1976) “Economic Growth and Its Sources,” in H. Patrick and H. Rosovsky (eds.), Asia’s Next Giant: How the Japanese Economy Works (Washington, DC: Brookings Institution), 63–151. Eaton, J. and Kortum, S. (2002) “Technology, Geography, and Trade,” Econometrica, 70 (5), 1741–79. Economic Research Institute of Economic Planning Agency (1998) Gross Capital Stock of Private Enterprises, 1955–1996 (Tokyo: Economic Planning Agency). Economic and Social Research Institute of Cabinet Office (2001) Report on National Accounts from 1955 to 1998 (Tokyo: Cabinet Office). Esteban-Pretel, J. and Sawada, Y. (2009) “On the Role of Policy Interventions in Structural Change and Economic Development: The Case of Japan’s Postwar Japan,” Research Institute of Economy, Trade and Industry (RIETI) Discussion Paper No. 09-E-001. Eswaran, M. and Kotwal, A. (1993) “A Theory of Real Wage Growth in LDCs,” Journal of Development Economics, 42 (2), 243–69. Flath, D. (2005) The Japanese Economy, 2nd edition (Oxford: Oxford University Press). Godo, Y. and Hayami, Y. (2002) “Catching Up in Education in the Economic Catch-up of Japan with the United States, 1890–1990,” Economic Development and Cultural Change, 50 (4), 961–78. Gollin, D., Parente, S. L. and Rogerson, R. (2007) “The Food Problem and the Evolution of the International Income Levels,” Journal of Monetary Economics, 54 (4), 1230–55. Goto, A. and Odagiri, H. (1996) Technology and Industrial Development in Japan: Building Capabilities by Learning, Innovation and Public Policy (Oxford: Clarendon Press). Grossman, G. M. and Helpman, E. (1991) “Quality Ladders in the Theory of Growth,” The Review of Economic Studies, 58 (1), 43–61. Hayami, Y. in association with Akino, M., Shintani, M. and Yamada, S. (1975) A Century of Agricultural Growth in Japan: Its relevance to Asian Development (Tokyo: University of Tokyo Press). Hayami, Y. (2006) “The Role of Community and Market in Economic Growth (in Japanese),” in Y. Sawada and T. Sonobe (eds.), Market and Economic Growth (Tokyo: Toyo Keizai Shinposha). Hayami, Y. and Godo, Y. (2005) Development Economics, 3rd edition (Oxford: Oxford University Press). Hayami, Y. and Kawagoe, T. (1989) “Farm Mechanization, Scale Economies and Polarization: The Japanese Experience,” Journal of Development Economics, 31 (2), 221–39. Hayami, Y. and Ogasawara, J. (1999) “Changes in the Sources of Modern Economic Growth: Japan Compared with the United States,” Journal of the Japanese and International Economies, 13 (1), 1–21. Hayami, Y. and Ogasawara, J. (2002) “Reply to Yasuba’s Rejoinder,” Journal of the Japanese and International Economies, 16 (2), 286–7. Hayami, Y. and Ruttan, V. W. (1971) Agricultural Development: An International Perspective (Baltimore: Johns Hopkins University Press). Hayami, Y. and Ruttan, V. W. (1985) Agricultural Development: An International Perspective (Baltimore: Johns Hopkins University Press). Hayashi, F. and Prescott, E. C. (2008) “The Depressing Effect of Agricultural Institutions on the Prewar Japanese Economy,” Journal of Political Economy, 116 (4), 573–632.

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Hicks, J. (1932) Theory of Wages (London: Macmillan). Hirschman, A. O. (1958) The Strategy of Economic Development (New Haven, CT: Yale University Press). Inada, K., Sekiguchi, S. and Shoda, Y. (1993) The Mechanism of Economic Development: Growth in the Japanese and East Asian Economies (Clarendon Press). Johnson, C. (1982) MITI and the Japanese Miracle: The Growth of Industrial Policy, 1925– 1975 (Stanford, CA: Stanford University Press). Kiyota, K. and Okazaki, T. (2005) “Foreign Technology Acquisition Policy and Firm Performance in Japan: 1957–1970: Micro-Aspects of Industrial Policy,” International Journal of Industrial Organization, 23, 563–86. Kohama, H. (2001) Sengo Nihon no Sangyo Hatten (Industrial Development in Postwar Japan) (Tokyo: Nihon Hyoronsha). Kohsaka, A., Yoshino, N. and Nakahigashi, M. (2007) “Japan,” in A. Kohsaka (ed.), Infrastructure Development in the Pacific Region, Routledge Studies in International Business and the World Economy (London: Routledge). Kosai, Y. and Kaminski, J. (1986) The Era of High-Speed Growth: Notes on the Postwar Japanese Economy (Tokyo: University of Tokyo Press). Kuroda, Y. (1995) “Labor Productivity Measurement in Japanese Agriculture,” Agricultural Economics, 12 (1), 55–68. Kuroda, Y. (1997) “Research and Extension Expenditure and Productivity in Japanese Agriculture, 1960–90,” Agricultural Economics, 16 (XXX), 111–24. Lau, L. and Yotopoulos, P. A. (1989) “The Meta-Production Function Approach to Technological Change in World Agriculture,” Journal of Development Economics, 31 (2), 241–69. Lynn, L. H. (1982) How Japan Innovates, A Comparison with the US In the Case of the Oxygen Steelmaking (Boulder, CO: Westview Press). Lynn, L. H. (1998) “Japan’s Technology-Import Policies in the 1950s and 1960s: Did They Increase Industrial Competitiveness?” International Journal of Technology Management, 15 (6/7), 556–67. Markusen, J. (2002) Multinational Firms and the Theory of International Trade (Cambridge, MA: MIT Press). Minami, R. (1994) Economic Development of Japan (New York: St Martin’s Press). Mundlak, Y. and Strauss, J. (1978) “Occupational Migration Out of Agriculture in Japan,” Journal of Development Economics, 5, 55–77. Murphy, K. M., Shleifer, A., and Vishny, R. W. (1989) “Industrialization and the Big Push,” Journal of Political Economy, 97 (5), 1003–26. Nakamura, T. (1995) The Postwar Japanese Economy: Its Development and Structure, 1937–1994 (Tokyo: University of Tokyo Press). Nakamura, T. and Ohashi, H. (2008) “Effects of Technology Adoption on Productivity and Industry Growth: A Study of Steel Refining Furnaces,” Journal of Industrial Economics, 56 (3), 470–99. Ohkawa, K. and Rosovsky, H. (1973) Japanese Economic Growth: Trend Acceleration in the Twenty Century (Stanford, CA: Stanford University Press). Okazaki, T. (2001) “The Government-Firm Relationship in Postwar Japan,” in J. E. Stiglitz and S. Yusuf (eds.), Rethinking the East Asian Miracle (Washington, DC: The World Bank). Okimoto, D. I. (1989) Between MITI and the Market: Japanese Industrial Policy for High Technology (Stanford, CA: Stanford University Press). Okimoto, D. I. and Nishi, Y. (1994) “R and D Organization in Japanese and American Semiconductor Firms,” in M. Aoki and R. Dore (eds.), The Japanese Firm: Sources of Competitive Strength (Oxford: Oxford University Press).

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Oshima, A. (2009) “Knowledge Diffusion and the Japanese Growth Miracle,” mimeographed, Department of Economics, University of Iowa. Otsu, K. (2007) “A Neoclassical Analysis of the Postwar Japanese Economy,” IMES Discussion Paper Series 07-E-01, Institute for Monetary and Economic Studies, Bank of Japan. Ozaki, R. S. (1972) The Control of Imports and Foreign Capital in Japan (New York: Praeger Publishers). Ozawa, T. (1974) Japan’s Technological Challenge to the West, 1950–1974: Motivation and Accomplishment (Cambridge, MA: MIT Press). Parente, S. and Prescott, E. (2004) Barrier to Riches (Cambridge, MA: MIT Press). Peck, M. J. and Tamura, S. (1976) “Technology,” in H. Patrick and H. Rosovsky (eds.), Asia’s New Giant (Washington, DC: Brookings Institution). Romer, P. M. (1990) “Endogenous Technological Change,” Journal of Political Economy, 98 (5, part 2), S71-S102. Rosenstein-Rodan, P. N. (1943) “Problems of Industrialization of South-Eastern Europe,” Economic Journal, 53 (210–11). Rustichini, A. and Schmitz, J. A., Jr. (1991) “Research and Imitation in Long-run growth,” Journal of Monetary Economics, 27 (1), 271–92. Sakakibara, M. (1997) “Evaluating Government-Sponsored R and D Consortia in Japan,” Research Policy, 26 (4–5), 447–73. Sakakibara, M. and Branstetter, L. (2001) “Do Stronger Patents Induce More Innovation? Evidence from the 1988 Japanese Patent Law Reforms,” RAND Journal of Economics, 31 (1), 77–100. Science and Technology Agency (1972, 1974, and 1991) White Paper on Science and Technology, available from http://www.mext.go.jp/b_menu/hakusho/hakusho.htm. Science and Technology Agency (1974, 1990, and 1991) Indicators of Science and Technology (Tokyo: Ministry of Finance Printing Bureau). Science and Technology Agency (ed.) (1980) Gaikoku Gijutsu Donyu Nenji Hokokusho (Annual Report of Foreign Technology Adoptions) (Tokyo: Printing Office of the Ministry of Finance). Society for Industrial Studies (1995) Sengo Nihon Sangyo Shi (Industrial History in Postwar Japan) (Tokyo: Toyo Keizai Shinposha). Sonobe, T. and Otsuka, K. (2006) Cluster-Based Industrial Development: An East Asian Model (London: Palgrave Macmillan). Syrquin, M. (1984) “Resource Reallocation and Productivity Growth,” in M. Syrquin, L. Taylor, and L. E. Westphal (eds.), Economic Structure and Performance: Essays in Honor of Harris B. Chenery (Orlando, FL: Academic Press). Westney, D. E. (1994) “The Evolution of Japan’s Industrial Research and Development,” in M. Aoki and R. Dore (eds.), The Japanese Firm: Sources of Competitive Strength (Oxford: Oxford University Press). Yamamura, E., Sonobe, T. and Otsuka, K. (2005) “Time Path in Innovation, Imitation, and Growth: The Case of the Motorcycle Industry in Postwar Japan,” Journal of Evolutionary Economics, 15 (2), 169–86. Yasuba, Y. (2002) “Rejoinder to Hayami and Ogasawara,” Journal of the Japanese and International Economies, 16 (2), 284–5. Yonekawa, S., Shimokawa, K. and Yamazaki, H. (eds) (1990–1) Sengo Nihon Keieishi (Business History in Postwar Japan) Vols. 1–3 (Tokyo: Toyo Keizai Shinposha). Young, A. (1995) “The Tyranny of Numbers: Confronting the Statistical Realities of the East Asian Growth Experience,” Quarterly Journal of Economics, 110 (3), 641–80.

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5 Development Performance across Indian States and the Role of Governments Kaliappa Kalirajan,* Shashanka Bhide, and Kanhaiya Singh

5.1

Background

In the context of balanced regional development, drawing on the East Asian model of industrial development recently discussed in Sonobe and Otsuka (2006), a relevant point that needs to be made at the outset is that less equitable spatial development is not necessarily an indicator of constraints to overall growth of the economy. Yet, if large and populous spatial segments of the economy remain backward while the other regions move ahead for long periods of time, the overall national development strategy becomes unsustainable (World Bank, 2009). The crucial questions in this context are about how to bring spatially equitable development in a country, and which institution has the primary responsibility for bringing such equitable development. Conventionally, an economic system is comprised of state and market, which means the primary responsibility for spatially equitable development rests with either state or market, or both. While a federal framework provides for allocation of state resources in an equitable manner, the market operates based on business perspectives that may not aim for spatially equitable development. In contrast to the conventional method of assigning factors contributing to socioeconomic development either to the state or to the market, Hayami (2004) introduced another relevant entity: “community.” Communities are expected to maintain benefits for their members in a sustainable manner at the local level, a strategy that may again not have spatial equity as an objective. The task of achieving balanced development has, therefore, been primarily assigned to “state,” and neither to “market” nor to “community.” Even Hirschman (1958), who was a proponent * The authors are grateful to Keijiro Otsuka, Tetsushi Sonobe, and participants at the 2009 FASID Hakone Conference for their valuable comments and suggestions, which materially improved this paper.

45

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of focused or “unbalanced” industrialization, earlier strongly argued for governmental intervention to counteract the “polarization effects” of freemarket forces in order to mitigate the misfortune of the “backward regions.” Though state has to take a leading role towards achieving balanced regional development, as Hayami (2001) has argued, the final outcome with respect to development, including equitable regional development, is a result of the interaction between the state, market, and community. India has a federal system of governance with both the state, or provincial, and the central governments responsible for the development of the nation as a whole. Policies at the central as well as state-level influence state-level variations in economic conditions, in turn. In this context, this chapter examines whether governments in India within a federal framework have been able to foster development equitably across its states, and whether there is any “community failure” in complementing the role of the state. The following section describes the approach followed in this chapter to examining equitable development across states in India. Spatial diversity of the Indian economy concerning its overall growth is shown in the next section, which is followed by a discussion of the existing spatial diversity in terms of basic development indicators. The next section attempts to explain the probable causes for variation in development across states in India. Empirical identification of factors influencing variations in development across states is presented in the following section. A final section brings out the overall conclusions of this chapter.

5.2

The approach

To provide a bird’s-eye view of the development of a country, per capita gross domestic product (GDP) is generally used as a measure. It is understood that GDP alone says nothing about distribution of income, nor about how it is used. If development is about people and how they live, then one needs a measure of the level of living of the population, into which is built a distributive element of income. In this context, it is worth citing the statement from the Indian prime minister’s foreword to the Planning Commission’s Eleventh Five-Year Plan: “The transition to high growth is an impressive achievement, but we must not forget that growth is not the only measure of development. Our ultimate objective is to achieve broad-based improvement in the living standards of all our people” (Planning Commission, 2008, p. iii). Drawing on the United Nations Research Institute for Social Development (UNRISD, 1968), and based on the uniform availability of data, the following variables, which represent a wide range of basic developmental aspects of an economy, all of which tend to change more or less simultaneously as the society develops, are considered in this study: infant mortality rate (IMR), life expectancy at birth (LE), literacy rate (LR), telecom density per

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Development Performance across Indian States 47

thousand population (TD), and per capita electricity consumption in kwh (EC).9 These indicators refer to the very basic needs of life, and it is expected that the state and central governments at different levels would strive to bridge the spatial gap in these dimensions of development within India. Thus, first, spatial distribution of the above variables, along with gross state domestic product (GSDP), is used over the years to gauge the effectiveness of region-specific constraints or accelerators of development. One of the region-specific factors considered in this study is “community.”

5.3

Spatial diversity in overall growth of the Indian economy

India’s overall growth performance from 1951–2 to 2007–8 is shown in Figure 5.1, with probable reasons for its fluctuations. India’s past record, even before the launching of economic reforms in the early 1990s, points to wide variations across its subnational units, including states.10 The federal framework is expected to achieve more balanced development of the diverse country than centralized rule, as decentralized governance can be expected to utlilize the available resources more efficiently to meet the aspirations of the local population (Hayami, 2001). At a general level, the extent of variation in the Indian economy can be illustrated by broad measures of the size of state economies. There are 29 states in India with their own democratically elected assemblies. Among these, 10 states have populations of more than 50 million. There are 8 states with populations below 5 million. Six states have a gross state domestic product (GSDP) of more than $50 billion. Table 5.1 provides profiles of the states in terms of size of populations and economies. Some insights into the trends concerning divergence in economic growth across states can be obtained through the coefficient of variation in per-capita income across the states over time. Following Kalirajan and Akita (2002), the weighted coefficient of variation of per-capita gross state domestic product (GSDP) in constant 1993–4 prices for the period 1980–1 to 2004–5 is calculated.11 The trend indicates that there has not been a significant increase in disparity concerning per-capita gross state domestic product as captured by this measure. The weighted coefficient of variation for 1980–1 was 0.2297, and it increased to 0.2307 in 2004–5, which is not significant. This period had been one of relative stability in spatial disparity in India. What are the factors that contribute to such relative stability in development?

5.4

Explaining the growth differential across states

Following the seminal work of Barro (1991), based on theory and on the availability of uniform data across states, the following reduced-form equation was formulated to examine the conditional convergence of per-capita

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1963–4

1961–2

1959–0

1957–8

1953–4

1971–2

1967–8

1965–6

3.5 3.75 100

4.57

1965–6

3.8 3.94 67

4.51

1957–8

1961–70

1973–4

1972–3 and 1979–80

4.64

3.6 3.16 105

1971–80

1951–2

5.40

5.4 5.40 70

–

TG = 7.9

Drought East Asian Crisis (97), Drought Gulf War, oil prices, USA economic reforms, fiscal deficit, Crises economic sanctions (98), Kargil war, 9/11/01 attack and global slowdown, swelling fiscal deficit

1981–90

Pattern of India’s economic growth from 1951 to 2008

Trend growth Average growth Coefficient of variation (percent) Average growth without drought and crisis years Years of the drought and crises

1969–70

1951–60

1975–6

Percentage growth

Figure 5.1

1955–6

Data

1977–8

−6.0 1981–2

−4.0

1979–80

War, oil prices, drought, current Drought A/C deficit, monetary Capital-intensive First 5tightening year plan, Stringent fiscal Drought, Nehru and Shatri and F Exchange control died, war, high fiscal deficit, Drought, oil crisis, current A/C deficit US aid suspended

1983–4

0.0

1987–8

−2.0

1991–2 and 1997–8

6.27

6.2 5.59 43

1991–2000

1991–2

2.0

1989–90

4.0

1993–4

6.0

1985–6

TG = 6.2

1995–6

8.0

TG = 5.4

8.34

7.9 7.58 22

2001–9

2002–3, 2008–9

1997–8

TG = 3.6

2001–2

TG = 3.5

1999–2000

TG = 3.8

2003–4

10.0

2005–6

12.0

2007–8

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Table 5.1

Size and income of India’s state and union territories (2005–6) GSDP

Sl. No. State/UT 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29

Andhra Arunachal Pradesh Assam Bihar Jharkhand Goa Gujarat Haryana Himachal Jammu and Kashmir Karnataka Kerala Madhya Pradesh Chattisgarh Maharashtra Manipur Meghalaya Mizoram Nagaland Orissa Punjab Rajasthan Sikkim Tamil Nadu Tripura Uttar Pradesh Uttaranchal West Bengal Pondicherry All India

Population million Rs billion

Per capita GSDP Billion US$

Rs

US$

80.4 1.2 28.5 90.2 29.1 1.6 54.6 23.1 6.6 10.9

2360 29 575 802 622 124 2198 1064 255 265

53.32 0.66 13.00 18.11 14.06 2.80 49.65 24.03 5.75 5.99

29,369 25,086 20,186 8891 21,377 79,389 40,221 45,974 38,457 24,397

663 567 456 201 483 1793 909 1038 869 551

56.0 33.4 65.9 22.7 104.2 2.5 2.5 1.0 2.5 38.8 26.5 61.8 0.6 64.9 3.4 181.9 9.2 84.8 2.6 1116.1

1680 1190 1163 519 4381 57 63 27 57 785 1097 1242 18 2235 94 2798 262 2347 68 32,757

37.94 26.88 26.28 11.73 98.95 1.29 1.43 0.61 1.28 17.74 24.79 28.06 0.41 50.49 2.12 63.19 5.91 53.02 1.45 739.93

29,999 35,601 17,649 22,873 42,056 22,684 25,699 27,027 22,736 20,251 41,420 20,095 31,186 34,424 27,694 15,382 28,572 27,668 25,712 29,350

678 804 399 517 950 512 581 610 514 457 936 454 704 778 626 347 645 625 588 663

real gross domestic product across states, after controlling for important human capital, physical capital, and decentralization indicators: SYPC1 a1 a2 SYPC8081 a3 LIT8081 a4 STPOP a5 DCI a6 Cst u1

(1)

With the expected results of either convergence or divergence, the next interesting question is whether the initial conditions of the structure of the economy (agriculture share and manufacturing share) have been important variables explaining differences in growth of per-capita real gross domestic product.

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50 Kaliappa Kalirajan et al.

Here, two periods of initial conditions were considered: 1993–4 was the period immediately after the institution of economic reforms in India, and 1980–1 was the period of recovery, with a 7-per-cent growth rate, from a severe drought and current-account deficit crisis. The following equations were formulated: SYPC2 b0 b1SYPC9394 b2 AGR9394 b3MFG9394 b4 LIT9394 b5STPOP b6DCI b7Cst u2

(2)

SYPC2 b0 b1SYPC8081 b2 AGR8081 b3MFG8081 b4 LIT8081 b5STPOP b6DCI b7Cst u2

(3)

The further interesting issues to be explored in this study are: (i) whether a productive agricultural sector is a prerequisite for the growth of the manufacturing sector, or whether a comparative disadvantage in agriculture stimulates the growth of manufacturing sector for survival; and (ii) whether richer states achieve higher growth of both manufacturing and agricultural sectors. The potential variables in testing the above hypothesis include percapita growth in agricultural real gross state domestic product, per capita growth in manufacturing real gross state domestic product, selected structural variables of initial conditions of income, agricultural share and manufacturing share, literacy rate, demographic composition, a decentralization index, and the coastal region. AGRI_GSDP g0 g1YPC8081 g2 AGR8081 g3MFG8081 g4 LIT8081 g5STPOP g6DCI g7Cst u3

(4)

AGRI_GSDP g0 g1YPC9394 g2 AGR9394 g3MFG9394 g LIT9394 g STPOP g DCI g Cst u3

(5)

MFG_GSDP d0 d1YPC8081 d2AGR8081 d3MFG8081 d4LIT8081 d5STPOP d6DCI d7Cst u4

(6)

4

5

6

7

MFG_GSDP d0 d1YPC9394 d2AGR9394 d3MFG9394 d4LIT9394 d5STPOP d6DCI d7Cst u4

(7)

The symbols in the estimated equations are as follows: SYPC = per capita growth of real gross state domestic product, YPC8081 and YPC9394 = per-capita gross state domestic product in 1980–1 and 1993–4 respectively; AGRI_GSDP = per-capita growth in agricultural real gross state domestic product; MFG_GSDP = per-capita growth in

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manufacturing real gross state domestic product; AGR8081 and AGR9394 = initial agricultural conditions, which are 1980–1 and 1993–4 respectively of shares of the agriculture sector in GSDP; MFG8081 and MFG9394 = initial manufacturing conditions, which are 1980–1 and 1993–4 shares of manufacturing sector in GSDP (all in fractions); LIT8081 and LIT9394 = literacy rates in 1980–1 and 1993–4 respectively as initial conditions variables; DCI = fiscal decentralization index, which is the share of state revenue including statutory transfers to denote fiscal decentralization in its expenditures; Cst = dummy variable, taking the value of 1 for the presence of coastal area and zero otherwise; STPOP = Schedule Tribe community, which is shown as a fraction of the population; and ST components are from the 1991 census data. Each of the above growth equations was estimated using the data for 29 Indian states for the post-reform period of 1993–4 to 1999–2000 following a general-to-specific approach, and the results are given in Table 5A.1 using 1993–4 initial conditions. Relevant variables are presented at 1993–4 constant prices.

Table 5A.1 Explaining the variations in real per-capita growth in the post-reform periods Variables

SYPC 1

SYPC 2

AGRI_GSDP

MFG_GSDP

Constant

AGR9394

–0.289** (0.140) 0.202 (0.198) –

MFG9394

–

–0.155* (0.052) 0.138 (0.146) 0.121 (0.098) 0.482** (0.228) 0.115** (0.050) 0.025 (0.019) 0.048** (0.022) 0.048** (0.023) 0.78 0.36 [0.54] 0.16 [0.23]

0.072** (0.034) 0.132 (0.148) 0.148 (0.104) –0.149 (0.172) –0.255 (0.364) 0.018** (0.008) 0.035 (0.038) –0.008 (0.007) 0.74 0.37 [0.58] 0.18 [0.28]

0.292** (0.136) 0.128 (0.146) –0.119 (0.109) 0.822** (0.409) 0.680** (0.338) -0.015 (0.025) 0.032** (0.015) 0.042** (0.020) 0.72 0.28 [0.52] 0.14 [ 0.25]

YPC9394

LIT9394 STPOP DCI Cst R-bar square Functional form CHSQ(1) Heteroskedasticity CHQ(1)

0.114** (0.052) 0.028 (0.026) 0.044** (0.020) 0.045** (0.022) 0.80 0.38 [0.57] 0.21 [0.28]

Notes: 1. Variables have been defined in the text. 2. Figures reported below each coefficient estimate are its standard errors. 3. * means significant at the 1 percent level. 4. ** means significant at the 5 percent level. 5. Figures in square brackets are critical values.

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52


Table 5.2 periods

Explaining the variations in real per capita growth in the post-reform

Variables

SYPC 1

SYPC 2

AGRI_GSDP

MFG_GSDP

Constant

AGR8081

–0.277** (0.132) 0.252** (0.122) –

MFG8081

– 0.125** (0.052) 0.033** (0.016) 0.048** (0.022) 0.048** (0.024)

–0.164* (0.048) 0.138 (0.146) 0.142** (0.069) 0.458** (0.219) 0.116** (0.051) 0.026** (0.012) 0.058** (0.027) 0.044** (0.021)

0.065** (0.031) 0.128 (0.143) 0.162* (0.047) –0.145** (0.072) –0.262 (0.388) 0.023** (0.011) 0.032 (0.037) –0.012** (0.005)

0.266** (0.126) 0.131 (0.142) –0.122* (0.036) 0.768** (0.376) 0.782** (0.388) –0.022 (0.028) 0.046** (0.022) 0.062** (0.030)

0.89 0.42 [0.54] 0.18 [ 0.23]

0.81 0.36 [0.54] 0.16 [0.23]

0.72 0.38 [0.54] 0.12 [0.23]

0.76 0.29 [0.54] 0.10 [ 0.23]

YPC8081

LIT8081 STPOP DCI Cst R-bar square Functional form CHSQ(1) Heteroskedasticity CHQ(1)

Notes: 1. Variables have been defined in the text. 2. Figures reported below each coefficient estimate are its standard errors. 3. * means significant at the 1 percent level. 4. ** means significant at the 5 percent level. 5. Figures in square brackets are critical values.

Results using 1980–1 initial conditions are better in terms of number of significant variables and R bar squares, and hence these results are presented in Table 5.2, which are used for further analysis. This finding suggests that the influence of the selected macroeconomic variables on agriculture, manufacturing, and overall growth in the post-reform period is clearly different from growth in the pre-reform period. The selected model with 1980–1 initial conditions significantly captures some of the features of social and economic diversity across states. The results presented below discuss only those variables that are found to be important in terms of statistical significance for Indian states. The important results are that there is divergence with respect to per-capita growth in real gross state domestic product across states, and that unlike in the East Asian model of economic growth, having a productive agricultural sector as the initial condition for the growth of the manufacturing sector is not valid in the Indian context. The inference is that having comparative disadvantage in agriculture stimulates the growth of the manufacturing sector for

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survival.12 Another interesting result is that decentralization and initial conditions of income level have a significant effect on manufacturing growth. The results of the SYPC1 equation clearly show that there is divergence in the growth of real gross state domestic product across states (see Rao et al., 1999). The principal force driving convergence in the neoclassical growth model is diminishing returns to reproducible capital. Thus, states with lower initial values of capital–labor ratios will have high marginal products of capital and, therefore, will tend to grow at higher rates. However, as Hayami (2001) has argued, inefficient and poor-quality institutions and organizations could lead to violation of the critical assumption of diminishing returns on reproducible capital. This means divergence of income for a considerable period of time in the development process. Thus, it is logical to argue that the convergence hypothesis will hold only when country-specific institutions and organizations do not intervene in the process negatively to delay or constrain the convergence process. The distinction between growth that translates into “a rising tide lifts all the boats,” and growth that is disproportionately favorable to some states, has been recognized by the central government in its Eleventh Five-Year Plan document. The implication here is that lack of effective functioning of proper institutions at the central and state levels has been a problem. In the case of manufacturing, the inference is that integration of rural industries with urban sectors through the subcontracting system, which is built on community trust and cooperation in East Asia à la Hayami, is missing in the Indian growth process (see Sonobe and Otsuka, 2006). In the context of agriculture, the dynamism that was generated by the Green Revolution had worked its way fully into production in the 1980s, and there was no alternative source of strong productivity growth (Kalirajan et al., 2001). A lack of infrastructure and various policy constraints affecting agricultural productivity and trade have been major constraints on technological breakthrough in agriculture, as discussed by Vaidyanathan (1995). Results of SYPC2, which show a smaller coefficient for agriculture relative to manufacturing, appear to support these inferences, particularly with respect to an urgent need for improvement in agricultural productivity. Decentralization has a positive effect on overall gross state domestic product growth and on manufacturing growth. The coefficient implies that India’s overall growth rate can still be substantially stepped up should the central government decentralize economic policy, further allowing states to make important economic decisions based on their state-specific production environments. Significant and crucial fiscal, infrastructure, and regulatory decisions on economic management still remain at the central government level. The inference from the coefficient is that the decentralized system of governance would help the states to be more attractive to prospective domestic and foreign direct investors, which has a bearing on manufacturing growth. The second set of variables that are found to be important in the growth process across states is the structure of the economy. For the 1993–2000

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54


data sets, the structure of the economy during 1980–1 is considered as one of the initial conditions in this chapter, as the 1993–4 initial conditions did not provide better results. The coefficient of initial income level, YPC80-81 in the SYPC2, and MFG_GSDP equations are positive, and statistically significant. The significant negative coefficient of initial manufacturing conditions in the AGRI_GSDP equation implies that states with comparative disadvantage in manufacturing appear to grow faster in agriculture for their survival. Similarly, the negative coefficient of initial agricultural condition in the MFG_GSDP equation means that states with comparative disadvantage in agriculture appear to grow faster in manufacturing for survival. The third set of variables found to be significant in explaining variations in per-capita overall growth, and growth in agriculture and manufacturing, are related to the social fabric of the Indian states.13 Drawing on Hayami (2001), they relate to to certain patterns of behavior of state governments, welfare organizations, and general culture. The variables falling into this category are initial literacy rate across states, and share of population of the scheduled tribal communities. Motivation for considering the latter community variable à la Hayami is rather complex, and needs some explanation. The effect of share of ST population is positive and statistically significant on AGRI_GSDP, SYPC1, and SYPC2, while it is negative but statistically not significant in the case of MFG_GSDP. It is important to understand the genesis of these two different results. The people in tribal regions are mostly isolated from the cosmopolitan culture and bound tightly by their local culture and traditional way of life. The presence of the tribal community across states varies significantly. For example, based on 1991 census data, 95%, 88%, 86%, and 64% of the population respectively in the states of Mizoram, Nagaland, Meghalaya, and Arunachal Pradesh are tribal communities. The desire to change is lacking in tribal regions, where the majority of members work as agricultural laborers in places near their habitations (see XaXa, 2001). It is true that states having larger ST population enjoy more welfare programs compared to other states, sponsored by both state and central governments. Such welfare programs, which are mainly focused on rural areas, have spillover effects and are likely to benefit all segments of the rural population. Thus, the welfare programs provide a link between the presence of ST community and agricultural growth, though these programs have not made significant impacts on the welfare conditions of the ST communities. The important question here is whether such a situation is due to state failure in not having proper institutions to implement the welfare programs effectively, or due to community failure in lack of enthusiasm for participating in the welfare programs. In this context, it is worth mentioning the study by Kijima (2006), which argues that despite policies targeting scheduled tribes (ST), there remain large disparities between living standards of ST and non-ST households in India. Much of the disparity between ST and non-ST comes from the fact that areas where the ST live are

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different from those where the non-ST live, and the education level of the ST is remarkably low compared to the non-ST population. In this context, it is worth citing the Indian prime minister’s recent statement: “The rapid growth achieved in the past several years demonstrates that we have learnt how to bring about growth, but we have yet to achieve comparable success in inclusiveness” (Planning Commission, 2008, p.iii). Quantitatively, each percentage-point difference in the ST community leads to an increase in per-capita agricultural growth of 0.02 percent. The presence of the ST community has no significant growth impact on manufacturing, which could be due to the poor literacy rate and unwillingness of the ST population to travel to urban areas. These results have significant implications for states like Mizoram, Nagaland, Meghalaya, and Arunachal Pradesh, where tribal communities are predominant. There is a need to end the region’s insulation from the dynamism of the rest of India. The average performance of these communities need to be improved, and lack of enthusiasm among the community to change its lifestyle is a kind of “community failure” discussed by Hayami (2009). As Hayami (2001) has argued, it is imperative for states to approach communities layer by layer to win their confidence and to educate them about the benefits of integrating with the rest of the society, which is not found in tribal thinking (see for example, XaXa, 2001). Another important result is that states with high initial levels of literacy appear to have higher per-capita growth in gross state domestic product, and also higher per-capita manufacturing growth, while such a relationship cannot be established in the case of agricultural growth. The coastal area can stimulate industrial growth, and overall growth is due to its capability of serving both domestic and international markets: hence its coefficient is positive in all equations except the AGR_GSDP equation. The much faster growth of coastal China provides solid evidence for the influence of coastal areas on industrial and overall economic growth.

5.5

Measures of spatial disparity in development

We present disparity patterns in other selected developmental indicators across states. We adopt the measure of weighted coefficient of variation to examine the trends in spatial balance in the basic development indicators: infant mortality rate (IMR), life expectancy at birth (LE), literacy rate (LR), telecom density per thousand population (TD), and per capita electricity consumption in kwh (EC), and the results are given in Tables 5.3 and 5.4. The trends clearly show that there is a reduction in disparity in literacy rate, and life expectancy at birth. In the case of infant mortality rate, the trends are less clear (Table 5.3). The trends in infrastructure development, which include telephone density and per capita electricity consumption, also show a general improvement, particularly in very recent times (see Table 5.4).

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Table 5.3 The pace of development and spatial balance in development: Selected human development indicators Life expectancy at birth

Infant mortality rate (per thousand)

Year

Average

CV

Year

Average

1983 1988 1990 1991 1993 1995 1999 2000 2001 2003

60.2 61.1 59.2 59.7 60.5 61.2 62.1 62.3 62.5 63.0

0.7398 0.7299 0.7541 0.7472 0.7376 0.7298 0.7197 0.7175 0.7157 0.7107

1971 1976 1981 1986 1991 1994 1998 2005 – –

121 123 107 95 77 53 66 54 – –

Literacy rate

CV

Year

Average

CV

0.0565 0.0650 0.0681 0.0685 0.0708 0.1237 0.0670 0.0680 – –

1971 1981 1991 2001 – – – – – –

32.8 42.2 51.2 63.9 – – – – – –

0.0830 0.0655 0.0575 0.0370 – – – – – –

Note: The coefficient of variation is calculated over data for 15 major states of India. The CV is estimated as a weighted measure using population shares of the states as weights.

Table 5.4 The pace of development and spatial balance in development: Selected infrastructural development indicators Telecom density (% population)

Year

Average

1980 1985 1987 1988 1989 1990 1991 1992 1993 1994 1995 1998 1999 2000 2003 2004 2006 2007

0.38 0.40 0.47 0.48 0.52 0.55 0.62 0.71 0.83 1.00 1.20 1.68 2.37 2.68 4.24 5.69 10.74 15.85

Electricity consumption (kwh)

CV

Year

0.3350 0.1661 0.1717 0.1720 0.1726 0.1670 0.1654 0.1603 0.1592 0.1606 0.1629 0.1275 0.1499 0.1498 0.1555 0.1618 0.1250 0.1139

1975 1980 1983 1985 1987 1990 1991 1992 1993 1994 1996 2002 2004 – – – – –

Average (per capita) 97 121 150 168 196 232 247 263 288 306 336 359 387 – – – – –

CV 0.1157 0.1322 0.1335 0.1298 0.1352 0.1285 0.1244 0.1268 0.1197 0.1234 0.1235 0.1597 0.1523 – – – – –

See Note to Table 5.3.

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Thus, there has been an improvement in recent times in four out of the five development indicators considered, and progress appears to be more spatially balanced than before. The movement towards more equitable levels of performance along with rising development indicates that there are factors facilitating spatially equitable development. It is important to identify such factors, which is attempted in the following pages. Factors facilitating spatially equitable development The central government aims to ensure equal access to basic services such as primary education, primary health care, infrastructure such as roads, drinking water, electricity, and communication services across states. However, Table 5.5 shows that states could finance their current expenditures or revenue expenditures by their own revenues only to about 56 percent. Therefore, the centre shares with states some of its revenues from sources such as income tax. The norms for allocation of resources from the centre to states are mostly “formula”-based, which depends on factors such as population without any distinction between ST and non-ST populations. There are two main institutions that are constitutionally created every five years by the president of India to transfer resources from the centre to states: the Finance Commission and the Planning Commission. Both institutions first fix the amount of tax revenue that needs to be transferred from the centre to states, which is called “vertical transfer,” and then distributes the allocated amount to states, which is called “horizontal transfer,” using different formulas. The Planning Commission also makes specific-purpose transfers for various central schemes implemented by different ministries of the central government without using a formula, which are called “non-statutory” transfers (Rao and Chelliah, 1995). Table 5.6 shows the vertical transfer from the centre to states over

Table 5.5

Trends in state’s own revenue receipts and revenue expenditures

Year

State’s own receipts State’s rev. expend. State’s own rev. receipts to total receipts (%) to total expend. (%) to state’s rev. expend. (%)

1990–1 1995–6 1999–2000 2000–1 2001–2 2002–3 2003–4 2004–5 2005–6

35.2 39.2 38.6 37.8 40.2 38.28 37.54 38.10 37.07

54.6 57.0 56.4 56.0 56.9 54.31 56.27 56.28 56.59

53.1 58.6 49.8 48.6 50.0 56.01 53.83 60.05 56.07

Source: Table 7 in Rao et al. (2008).

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12.11 13.56 14.48 10.57 10.39

5

25 50 10 7.5 7.5

Population Per-capita income Tax effort Fiscal management

60 25 7.5 7.5

Weight (%)

1.66 1.54 1.06 0.63 0.82

6

Source: Authors’ compilation from various Planning Commission plan reports and Finance Commission reports.

Population Income Area Tax effort Fiscal discipline

Weight (%)

Criteria

24.35 22.77 24.79 23.75 26.13

4

Criteria

1.96 2.52 3.42 2.34 5.2

3

Gadgil Formula used in X Plan (2002–7)

22.39 20.25 21.37 21.4 20.93

2

B. Horizontal Transfer Formula of 12th Finance Commission (2005–10)

VII FC VIII FC IX FC X FC XI FC (first two years)

1

Period

13.77 15.1 15.54 11.19 11.21

7

38.11 37.86 40.33 35.79 37.2

8

Total transfers Total other Total through Finance Grants through Share in central Share in Commission (2+3) Planning Non-plan grants transfers transfer taxes (%) grants (%) Commission (%) (nonstatutory) (%) (5+6) (%) (4+7) (%) (%)

Finance Commission transfers

Other transfers

Finance Commission (FC), Planning Commission and nonstatutory transfer of resources from the centre to states

A. Vertical transfer Transfers from centre to states as percentage of gross revenue receipts of the centre

Table 5.6


the years, which indicates the overall transfer of about 38 percent of the centre’s revenues to states. The formula used for horizontal transfer by the XII Finance Commission covering the period 2005–10 is given in Table 5.6 along with the Planning Commission’s Gadgil formula used in the X Plan (2002–7).14 The Gadgil formula is binding on the Planning Commission, but not for the Finance Commission (Rao, 2005). How have the instruments of state and central governments worked in achieving spatial equitable distribution in development, in the Indian context? We examine this dimension of the process in the rest of this chapter.

5.6

Disparities in state government expenditures

What has been the pattern of expenditures across states since the beginning of a policy regime which has been more reliant on markets to deliver growth than in the past? We have used revenue (or, broadly, current expenditures) of the state governments for analysis, as they make up about 77 percent of total expenditures today. Within revenue expenditures, “development expenditures” make up to 80 percent of spending. “Development expenditures” refers to expenditures on various socioeconomic development programs in the social sectors and economic sectors. The “development expenditures” of the state governments are grouped into two broad categories: social services and economic services. Social services includes health and education. Economic services includes development programs in different sectors of the economy, particularly in infrastructure. For example, revenue expenditures on programs relating to agriculture, roads, electricity, and industries are grouped under economic services. These are not capital expenditures but relate to expenditures on operation and maintenance of ongoing programs. Data are obtained from the Handbook of Statistics on State Government Finances (RBI, 2004) and previous publications on state finances by the Reserve Bank of India (RBI). The state-level population estimates are obtained by interpolating decadal census estimates to obtain per-capita expenditures for the states. The values in current figures are deflated by the wholesale price index to obtain expenditures and GSDP in real or constant figures. The trends in government development expenditures are examined in a regression model in the framework of the “convergence analysis.” Although the underlying theoretical arguments are quite different, the methodology of income convergence analysis of Barro and Sala-i-Martin (1995) provides a useful tool to examine whether the disparity across states in state government expenditures is increasing. The conditional convergence regression model we used is:  1   PCREt   1    ln   ln PCREt0 + a2 ln PCYt0  a0 a1  t − t PCRE  0 t0    t − t0  a3 STPOP + a4 DCI u

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(8)

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60


where PCRE = Per-capita real state government expenditures; PCY = Per-capita real gross state domestic product (average of three years ending in year t or t0 in all cases except for 1980–1 where the average is for three years beginning in 1980–81; the averages are taken to remove abnormal data points); t0 = First year of the time period; t = Final year of the time period; and the rest of the variables are as defined earlier. Given our interest in welfare indicators, we have extended the analysis to cover four types of development expenditures of the state governments: (1) expenditure on economic services within development expenditures; (2) expenditure on social services within development expenditures; (3) expenditure on medical and public health services within social expenditures; and (4) expenditure on education services within expenditures on social services. We have examined the pattern of expenditure for two periods: Pre-reform periods 1980–1 to 1985–6 Post-reform periods 1993–4 to 1999–2000 We are not particularly interested in the steady-state levels of expenditures, but merely wish to examine whether the expenditures across states are likely to be “converging” or “diverging” over time. Convergence would imply that the disparity is likely to be declining, and divergence would imply the opposite. In the above equation, if the coefficient “a1“ is positive, the percapita expenditures of the different states would be moving at different rates, with the “higher expenditure states” increasing expenditures faster than the “lower expenditure states.” Therefore, there would be no convergence of percapita expenditures across states and the disparity would increase over time. If the coefficient is negative, then the per-capita expenditures would be converging or disparity would decrease over time. If the coefficient is zero, then again disparity would not be rising. The role of per capita real GSDP in the equation is to control for overall “initial conditions” of the state economy. If the average income (per-capita GSDP) is larger in one state as compared to the other, the expenditures may also be higher because of the availability of larger resources (through their state taxes) to that state. Once we control for this variable, the pattern that remains should reflect the influence of the other factors, including the devolution of resources from the central government to the states, on the tendencies of the states to spend. In order to control for this latter aspect of central government transfer, and also the

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Table 5.7 Results of regression analysis of interstate disparity in state government expenditures Expenditures

PCREt 0

PCYt 0

STPOP

DCI

1980–5 Econ. services 0.3268**(0.1552) Social services –0.2283(0.1992) Pub. health 0.1165(0.1237) Education –0.0987(0.1013)

0.2572(0.2116) 0.1976(0.1882) 0.2001(0.1980) 0.1879(0.2011)

0.1872**(0.0884) 0.1743**(0.0820) 0.1552(0.1821) 0.1390(0.1542)

0.1932(0.1878) 0.1667(0.1740) 0.1223(0.1452) 0.1086(0.1277)

1999–2000 Econ. services 0.3129(0.2952) Social services –0.2627**(0.1292) Pub. health –0.2772**(0.1355) Education –0.2028**(0.1004)

0.2882(0.2416) 0.1955**(0.0899) 0.2174**(0.1080) 0.2072**(0.1033)

0.1762**(0.0807) 0.1881**(0.0920) 0.1825**(0.0875) 0.1954**(0.0961)

0.1774**(0.0878) 0.1375**(0.0640) 0.1448**(0.0723) 0.1220**(0.0589)

Note: ** Means significant at the 5 percent level.

capacity of the state to collect revenue, the decentralization index has been used as another controlling variable. As the earlier results show that the presence of the ST population has positive impact on overall economic growth, it is also used as a conditional variable in equation (8). The results obtained from applying the ordinary least-squares method of estimation to equation (8) with different dependent variables, with concerned independent variables explained above, are summarized in Table 5.7. Given our interest in finding out whether there is convergence or divergence in per-capita real state government expenditure and its components across states, it may be observed that the expenditures on “social services” show a statistically significant convergence pattern more consistently than the expenditures on “economic services.” In fact, the expenditures on “economic services” show no convergence for any subperiods considered, while the “social expenditures” show convergence in the post-reform periods. Thus, state government expenditures on social sectors appear to be more pro-spatially equitable than expenditures on “economic services.” Within the “social services,” expenditures on both “health” and “education” services show statistically significant convergence in the post-reform periods, indicating that the mechanisms driving these expenditures are based more uniformly on the needs of population across all regions of the country. The coefficients of decentralization index and the ST population are positive and significant at the 5 percent level for social services, medical and public health, and education expenditures. These results corroborate earlier findings that greater decentralization improves overall economic growth, which in turn facilitates higher expenditure on social services. Further, the significant and positive coefficient of the ST population implies that state

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governments do pay special attention to the improvement of welfare of the ST population, though the central transfer to states does not make any allowance for the presence of ST population in states. However, these coefficients are not significant for the economic services expenditures. The analysis presented here does not clarify whether the patterns of divergence or convergence are a result of higher growth of expenditures by the low expenditure states, or declining rates of growth of expenditures in the high expenditure states. In other words, the fiscal imbalances that result from increased expenditures may also act as a moderator of spending behavior at the state level. The initial condition of average per-capita GSDP does not influence the dynamics of expenditures.

5.7

Conclusions

Though the Indian government’s specific objective of keeping the disparities in development indicators from widening has been achieved with respect to some development indicators, there has been a growing concern that the less developed states continue to lag behind the developed states and that this cleavage is increasing. The policy concern is explicit in the latest Eleventh Five-Year Plan (2007–8 to 2011–12), where inclusive growth has been a watchword. In this context, this chapter refers to the sources of disparity and the role that may be played by the three pillars of development, the state, market, and community, articulated by Hayami (2004). The economic reforms of the 1990s have given more space to the markets in the allocation of resources, as compared to the state relative to the pre-reform days. What implication does this have for spatial equity in development? The state continues to be responsible for the supply of public goods including basic human capital and infrastructural development services across the country. Analyses presented in this chapter suggest that the mechanisms by which state governments provide resources for such services do not continuously lead to higher interstate disparity. If this pattern is a result of equitable sharing of central resources by the states through decentralization, this element of state behavior is important in keeping the interstate disparities from widening. Further, the results point out that the expenditures on basic services such as health and education are pro-spatially more equitable than in the case of economic services. Overall, the results in this chapter indicate that government in India within a federal framework has mechanisms that foster development equitably across its states, particularly through health and education expenditures aimed at improving human-capital development. However, the slowly rising disparities in economic services across states, and community failures in the sense of not participating in government welfare programs that exist in certain states, which make some communities less educated than others, warrant the attention of the central and state governments. Drawing on

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Hayami (2001), it is conjectured that such tendencies arise mainly due to lack of appropriate and efficient institutions at state and central government levels in India, which indicates the need for further institutional reforms.

References Barro, R. J. (1991) “Economic Growth in a Cross Section of Countries,” Quarterly Journal of Economics, 106, 407–33. Barro, R. J. and Sala-i-Martin, X. (1995) Economic Growth (New York: McGraw-Hill). Hayami, Y. (1998, 2001) Development Economics (Oxford: Oxford University Press). Hayami, Y. (2004) “The Community, the Market, and the State in Economic Development,” Paper presented at the Beijing Forum. Hayami, Y. (2009) “Social Capital, Human Capital and the Community Mechanism: Toward a Conceptual Framework for Economists,” Journal of Development Studies, 45 (1), 96–123. Hirschman, A. (1958) The Strategy of Economic Development (New Haven, CT: Yale University Press). Kalirajan, K. P. and Akita, T. (2002) “Institutions and Interregional Inequalities in India: Finding a Link Using Hayami’s Thesis and Convergence Hypothesis,” Indian Economic Journal, 50 (2), 47–59. Kalirajan, K. P., Mythili, G. and Sankar, U. (2001) Accelerating Growth Through Globalization of Indian Agriculture (New Delhi: Macmillan). Kijima, Y. (2006) “Caste and Tribe Inequality: Evidence from India, 1983–1999,” Economic Development and Cultural Change, 54 (2), 369–404. Planning Commission (2008) Eleventh Five Year Plan 2007–2012, Volume 1 – Inclusive Growth (New Delhi: Oxford University Press). Rao, C. H. H. (2005) Essays on Development Strategy, Regional Disparities and CentreState Financial Relations in India (New Delhi: Academic Foundation). Rao, M. G. and Chelliah, R. J. (1995) A Survey of Research in Fiscal Federalism in India (New Delhi: Indian Council of Social Science Research). Rao, M. G., Shand, R. T. and Kalirajan, K. P. (1999) “Convergence of Incomes across Indian States: A Divergent View,” Economic and Political Weekly, XXXIV (13), 769–78. Rao, M. G., Sen, T. K. and Jena, P. R. (2008) “Issues before the Thirteenth Finance Commission,” Working Paper 2008–55, National Institute of Public Finance and Policy, New Delhi. Reserve Bank of India (2004 and selected previous issues) State Government Finances (Mumbai: RBI). Sonobe, T. and Otsuka, K. (2006) Cluster-Based Industrial Development: An East Asian Model (New York: Palgrave Macmillan). UNRISD (1968) Research Notes – A Review of Recent and Current Studies Conducted at the Institute, No. 1 (Geneva: United Nations Research Institute for Social Development). Vaidyanathan, A. (1995) The Indian Economy: Crisis, Response, and Prospects (New Delhi: Orient Longman). World Bank (2009) World Development Report 2009: Reshaping Economic Geography (The World Bank Group). XaXa, V. (2001) “Protective Discrimination: Why Scheduled Tribes Lag Behind Scheduled Castes,” Economic and Political weekly, July 21, 2765–72.

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6 The Role of Traditional Chinese State and the Origin of Modern East Asia Debin Ma

6.1

Introduction

Part of Professor Yujiro Hayami’s lifelong research agenda has been to engage the large question of the growth and causal mechanism of modern economic growth in East and Southeast Asia. In a series of highly influential publications, he succinctly outlined the sequence of the East Asian miracle in dimensions of economic theory, empirical analysis, and historical implication (Hayami, 1998, 2001). He characterized the East Asian miracle initiated by Japan since the Meiji as a process of rapid catch-up with Western advanced economies based on massive technology and institutional borrowing. However this capacity to borrow did not come automatically, but was built on a creative adaptive learning process that was in turn preceded and supported by rapid improvements in human-capital formation (Godo and Hayami, 2002). Underlying this process is a more fundamental mechanism as explicated in Professor Hayami’s tripartite framework of market, community, and state. The rise of what he termed agricultural fundamentalism in East Asia underpinned by the prevalence of small and independent (relatively homogeneous) peasant holdings throughout East Asia is the historical linchpin to this framework. As “... rice farming demands care and judgment under diverse and variable natural environments, small farms dependent on family labor requiring little supervision and work enforcement tend to dominate” (Hayami, 1998, p. 27). Professor Hayami’s illuminating reinterpretation turned the old Wittfogel thesis of “oriental despotism” on its head. He pointed out that “in densely populated, highly stable settlements these small ‘peasants’ had to collaborate closely for the control of water ...”, which led to the rise of the irrigation community (Wittfogel, 1976, p. 23). This sense of community prevalent in East Asian agriculture laid the social capital foundation for industrialization, as the internal organization of modern firms also simulates a community to enhance trust and coordination. This community-based social capital coupled with a relatively homogeneous 64

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population also supplied the ideological base for nationalism in the modern era that in turn led to the rise of a bureaucratic developmental state. Modern states in East Asia managed to maintain a sustained, strong role in the domestic economy with a relatively small government (as measured by its share of total GDP). This is possible precisely because the government operated through implicit agreements with firms through the community nexus such as trade associations (Hayami, 1998, p. 24). Meanwhile, nationalist ideology may have acted as a brake on governmental failures and corruption, which are ever-present. Furthermore, long-term stable employment of bureaucrats, with a structure relatively independent of politics, may be resistant to rent-seeking pressures from vested interest groups (p. 19). A notable contribution in Professor Hayami’s analysis is the utilization of a broad framework that encompasses culture, history, and ideology. My chapter is part of a large project to show the relevance of the political economy of the traditional Chinese state to its long-term growth trajectory. Acknowledging the importance of Professor Hayami’s tripartite framework, my article will focus mostly on the role of the early modern Chinese state and how it could shed light on many of the fundamental features, as identified by Professor Hayami, of modern East Asia. Drawing on the insights of several important recent studies related to institutions and economic growth as championed by Douglas North, Avner Greif, Daron Acemouglou, and others, this article delineates the political logic of the Chinese empire in the framework of three major actors: the emperor, the bureaucracy, and the people, each with their own objective functions and incentive schemes. In the framework of principal-agent and asymmetric information, the historical interplay of these three agents with their respective incentive schemes and structures of private information shape the internal logic of the political structure and the rationale of Confucian ideology. I argue that in the absolutist regime of traditional China, the absence of credible government commitment can be partially alleviated through the rulers’ monopoly of power and a long time-horizon, which led to a virtuous equilibrium of low extraction and the operation of a relatively free private economy. With a long time-horizon of monopoly rule, the rulers’ objective function switched from short-run revenue maximization to the long-term defence of monopoly rents. This traditional political structure generates important historical implications for the patterns of property rights and an incentive structure that not only sheds light on both the longterm growth as well as stagnation of the Chinese economy, but is also relevant for explaining the rapid catch-up of China and East Asia in general in the modern era. I divide the rest of the chapter into three sections. The next section provides a narrative model of the political structure and its historical evolution. The third section applies this model to Qing China (1644–1911), with a comparative perspective on English and Western European states in the

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early modern era, a perspective of relevance for explaining the economic divergence. The concluding section discusses how the legacy of this political regime is helpful for understanding some of the fundamental features of modern East Asia depicted by Professor Hayami as crucial for the rise of the East Asian miracle.

6.2 The historical origin of the Chinese state From the founding of the Chinese empire in Qin (221–206 BC) up until the fall of the last imperial Qing dynasty in 1911, a centralized rule with political power monopolized by a single imperial dynasty supported by a civil bureaucracy, has been indisputably one of her most distinctive characteristics. We start with a description of the theoretical model or, to borrow a terminology from Max Weber, the “ideal type,” of the Chinese empire as an absolutist regime before we proceed to historical reality. In this model of the absolutist regime, ultimate power was vested in the emperor who commanded property rights over all factors of production including land and labor. At the other or lower end of the spectrum are the people or masses (farmers or peasants in an agrarian regime) who are nominally the tenants and cultivators of land and resources owned by the emperor. The imperial household was entitled to rents from agricultural output, the bulk of which went into the supply of external defence and internal security. In this model, the dominance of a single imperial household over all social or political groups is essential. At the founding of the Qin empire, China’s First Emperor (⾺ྟⱛ) followed the advice of his legalist (⊩ᆊ) prime minister, Lishi (ᴢᮃ), and opted against a feudal (ᇕᓎ) type of political arrangement where the imperial power would coexist with various regional elites or aristocrats, often with hereditary status. Instead, the rulers implemented a regime of empire-wide administrative units and household registration. In this new regime, only the status of the imperial throne was hereditary. With the elimination of the aristocracy and self-contained political units, the administration of the empire – tax collection and the coordination and provision of basic public-goods – was governed by direct imperial rules and orders executed by a professional and impersonal bureaucracy. The subsequent rise of a Chinese bureaucracy as the administrative organ of the emperor, or the state, became a distinctively Chinese institutional innovation.15 This concept of the state, as pointed out by China historian Qian Mu, is in many ways an extension of the Chinese concept of a patriarchal household. With the elimination of the hereditary aristocracy, the transition from feudalism to central rule turned the stand-alone imperial household (ᆊ) into the national sovereign (೑). The literal translation of the Chinese character for nation-state (೑ᆊ) is really “state-family,” or what Max Weber termed a “familistic state” (Creel, 1964, p. 168). Etymology used by Qian Mu reveals

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that the equivalent Chinese term of “prime minister” (ᆄⳌ) for the empire derived from titles that denoted managers of private royal households in the pre-Qin period. Thus, for Qian Mu, the rise of central rule also marks the beginning of a separation between ownership (the imperial ruler) and management (the bureaucracy).16 This political structure, to borrow present-day industrial organization terminology, is not dissimilar to large private (family) ownership managed by outsiders. This analogy will be a useful guide to examining the economic efficiency of this political organization in light of the principal-agent theory. We thus have a political model with three actors: the emperor, the bureaucrat, and the masses or peasant farmers. Each of these actors has its own distinctive objective functions, incentive schemes, and information structures. With the emperor claiming a share of peasant farm output collected through the bureaucrats, incentive misalignment among or between the actors would potentially induce the emergence of double principal-agent problems: between the emperor and the bureaucrat, and between the bureaucrat and agent. To understand both the logic and, to certain degree, the remarkable longevity of this model of political autocracy throughout Chinese history, it may be useful to start with Mancur Olson’s benchmark model based on the analogy of stationary and roving banditry. The crux of the argument is that monopoly political rule given a long time-horizon (especially with the throne being hereditary across generations, as in dynasties) could, contrary to what is often believed, lead to a “virtuous” equilibrium of a relatively low level of predation or extraction and a high level of provision of public goods by the rulers (Olson, 1993). The key assumption is that the ruler’s self-interest in maximizing tax revenue provides incentives to support economic growth, leading to a larger tax-base. The longer the time-horizon and the more stable the rule, the more likely it was that the ruler’s interest could align with the interest of the sovereign. Thus under conditions of monopoly rule, a long time-horizon and a low discount rate, the ruler’s high valuation of the stream of future tax income with onetime or short-term extraction constitutes a self-enforcing constraint on the grabbing hands of the autocratic rulers, in the absence of formal constitutional constraint.17 This Chinese model of autocracy differs quite significantly from that of Western Europe. There, even the most absolute and centralized rulers had to contend with local power magnates whether autonomous city states, landed aristocrats, or some type of representative body, not to mention the Church. In this sense, rulers in Western Europe could be defined as a coalition or a class consisting of landed and commercial elites, some of which were organized into corporate bodies or representative assemblies. The stand-alone nature of Chinese rulers was consistent with numerous historical examples of the rulers turning against the landed or commercial elites, as well as against bureaucrats.18

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It was precisely this extremely narrow interest of the Chinese rulers that, as predicted by the Olsonian model, allowed the imperial rulers to transcend the factional interests of elites or bureaucrats and to accommodate the moral claim of the “mandate of heaven,” the much larger encompassing interest of the sovereign. Without having to contend with independent and autonomous powers, the Chinese imperial ruler stood beyond the interests of any ruling class and in fact, if strictly defined, only represented the interests of himself and his lineage. Given the relatively small and unchanging size of the imperial household, the presence of asymmetric information in the bureaucratic structure and the possibility of insurrection, fiscal predation, and revenue maximization were of secondary relevance to the imperial objective: to survive and preserve its monopoly position. There were fundamental difficulties – both theoretical and technical – with a monolithic empire in the premodern era. Externally, it needed to deal with the periodic threat emanating largely from China’s unruly northern frontiers. Internally, the legitimacy of one ruler above all was itself highly contentious, and his rule was susceptible to dynastic struggles and internal rebellion. Chinese history is replete with violent rebellions and dynastic breakdowns led by regional magnates, frontier generals, or entrenched bureaucrats. The formidable information problem posed a fundamental dilemma for a unitary empire with premodern monitoring technology: the larger and more complex an empire grew, the more dependent a ruler would be on local, well-informed agents under conditions of asymmetric information. This dependence would in turn render the ruler vulnerable to the risk of an alternative power base built up locally. While in Europe this dilemma simply created conditions for permanent and entrenched political fragmentation, in China two complementary institutional changes in fiscal regime and civil bureaucracy gradually steered the country onto a path of state centralization. Both institutional changes took shape from the second millennium onward, forming what Wang Yanan claimed were the dual pillars of traditional Chinese polities. They were to have lasting consequences, producing long-term economic change in China. A key advantage of a centralized state is its capacity to control and mobilize all factors of production to achieve state objectives. In this case, China accomplished a precocious transition into a traditional fiscal state which rested on revenue obtained from taxing the economy in its entire territory, as distinguished from the domain states (or demesne states) in Western Europe, which drew income primarily from crown-owned property such as estates, forests, mines, and so on (see He, 2008, chapter 6). To ensure state revenue, Chinese imperial rulers throughout dynasties had actively engaged in the allocation of land to peasants who could in therefore cultivate and contribute taxes. The well-known equal-field system as practiced in Tang (618–907 AD) allocated land to a male adult according to his productive capacity, upon which the state levied the so-called triple tax (⾳ᒌ䇗).

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Depending on the category of land title, some of the allocated land could be returned back to the state once the cultivator left or died. The equal-field system was aimed at directly taxing individual producers, and preventing the rise of large-scale land-holding and a regional power base. It required comprehensive household and land registration and a strong administrative and coercive governmental power to tie labor down to an immobile factor, the land. In reality, state extractions or bureaucratic lapses often drove the farmers into the tax shelter of powerful regional lords, who, in turn, built up the productive and fighting capacities of their dependents, posing a constant threat to the throne. In this light, the change from the triple-tax system to the dual-tax system (ϸ⿢ࠊ) around 780 was a landmark transition. The dual-tax system proposed by the then prime minister, Yang Yan (ᴼ♢), shifted the taxation from labor to land irrespective of its ownership. This marked the beginning of a land-based taxation system which was to become the hallmark of Chinese fiscal regime all the way down to the twentieth century. A taxation system targeting the immobile factor of land also enabled, or led, the state to eventually relinquish control and regulation of property rights vested in land, opening the way to recognizing de facto private property rights and the development of a vibrant private land market. Imperial property rights in land and people began to transform into rights to taxation (Qian, 1966, chapter 2; Twitchett et al., 1986). This institutional change in the fiscal regime went hand in hand with another transformation in Chinese bureaucracy. As indicated earlier, Qin’s military success partly depended on his ability to draw loyal talents from below. However, before the Tang dynasty, the system of directly recruiting bureaucrats from the populace remained ad hoc, relying on a combination of informal recommendations and official examinations. By the Tang era, as the civil service examination system developed and became increasingly important, it had gradually fallen under the control of official schools monopolized by elite lineages who were turned into a social class of ruling bureaucrats with hereditary status. The rise of an entrenched and closed bureaucratic class became one of the fundamental destabilizing forces undermining central imperial rule. It was around the eighth century that the system of official schools managed by the closed elite lineages began to decline, gradually opening up the civil service examination system to the general populace beyond the pupils of the official schools. This marked the rise of the second pillar of China’s political structure that survived into the twentieth century: a highly competitive and open civil service examination and an impersonal bureaucracy. This opened up the prospect of upward mobility to ordinary people, and more or less allowed a Chinese style of political participation from the bottom up. From the ruler’s perspective, the creation of a body of career officials having no autonomous territorial or functional power base was

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indispensable to the long-term stability of the empire. With the installation of a system of rotating bureaucrats empire-wide in a period of three to five years, and the rule of avoidance which precluded bureaucrats from serving in their home county, the empire designed an institution that would ensure the bureaucrats’ loyalty to the emperor rather than their constituents. Their promotions and punishments were imposed through an administrative hierarchy guided by detailed administrative codes of conduct. A civil bureaucracy inculcated in Confucian ideology contributed to civilian rule and demilitarization of the empire, and was essential to its sustainability and longevity. Meanwhile the bureaucrats as a class, and the powerful agents of the rulers, were incentivized with special lifelong privileges such as exemption from taxation and favorable status in legal standing over ordinary people.19 In sum, these two pillars of institutional change which originated in the late Tang era and flourished in the Song era, constituted what historians of China have hailed as the Tang-Song Transformation (૤ᅟব䴽), which has had long-lasting historical consequences. The dual-tax policy allowed the government to retreat from direct management or regulation of property rights in land, and led to the transition from estate farming to a freestanding, family-based, owner-cum-tenant system of agricultural cultivation which was far more incentive-compatible. Another important political consequence is that state-formation in China had decidedly tilted towards stable and centralized rule under unitary imperial rule, with absolute imperial rule reigning supreme from the beginning of Ming in the fourteenth century. The rise of Chinese absolutist central rule, as predicted by this narrative model, also led a slow evolution towards fixing the target of the annual taxation base (ᅮ乱ЏН) (Huang, 1974; Iwai, 2004). The adoption of the so-called “single whip tax” around the late-sixteenth century, which denominated most land taxes in silver terms, further led to the monetization of an imperial tax-base fixed to a silver standard. Technically, setting a target of tax revenue based on a preset household and land registry record greatly simplifies the administrative procedures, requiring less information and monitoring, and thus reducing the potential for abuse. Low tax and light corvée had become the hallmark of benevolent rule in China (ҕᬓ). In fact, historically, any deviation from the policy of fixed revenue was the bad omen of a dynasty in decline or crisis. The policy of fixed revenue allowed the private sector rather than the state to capture or claim all the residuals of economic expansion brought about by rising productivity, growing territory, and increasing population.

6.3

Qing China (1644–1911) in comparative perspective

The last and possibly the most powerful and centralized Chinese dynasty, as I want to argue here, epitomizes the most prominent features of this

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political economy model in action. The Qing imperial monarchy under the rule of Manchus, from a non-Han Chinese minority in China’s Northeast frontier, became a great defender of orthodox Confucius ideology and a champion of a centralized political system with a civil bureaucracy. The more than two-and-a-half century rule of the Qing saw roughly a tripling of China’s population and a doubling of her territory, and ushered in China’s prosperous eighteenth century, the so-called “Glorious World of Kanxi and Qianlong” (ᒋђⲯϪ) (Maddison, 2007, p. 43; Spence, 1999). The road to the heyday of eighteenth-century prosperity started in 1644, the year of the Qing’s official inauguration. As with all previous rulers who managed to conquer a territory as vast as China, it took about a further two decades for the Qing army to achieve the complete suppression of the former Ming loyalists, mostly based south of the Yangzi river. It was only by 1683, under the reign of emperor Kangxi (1661–1722), that Qing managed to quash the rebellion of these so-called “three feudatories” and annex their territories into his centralized administration. Two years later, after a longterm blockade and military campaign, Kanxi finally broke the resistance of the rebellious naval kingdom of Zheng Chenggong and officially integrated the island of Taiwan as an administrative unit of China. In the final decades of the seventeenth century, Qing’s attention turned to China’s northwestern territory, an area of recurrent threat to previous Chinese dynasties. Qing rulers managed to contain the threat from an expansionary Russia by signing the Treaty of Nerchinsk in 1689, and to conquer China’s Northwestern territory in 1696. From 1720, Qing achieved the control of Tibet with the installation of a new Dalai Lama (Spence, 1999). Clearly, by the early eighteenth century, the Qing had succeeded in the consolidation of power and the establishment of monopoly rule over a territory that had become the largest ever in Chinese history. More importantly, the Qing’s sphere of influence extended beyond its vast territory to other parts of Asia through the socalled tributary order, with states such as Korea, Vietnam, Burma, and other Southeast Asian states recognizing various degrees of Chinese suzerainty. With the closing of Japan under the Tokugawa era (1680–1866), the dominance of Qing throughout Asia had been placed beyond challenge.20 Consolidation of power and monopoly of rule had set out the kind of long time-horizon needed for Qing to move towards the low-taxation equilibrium of the eighteenth century. Our own Western model of political economy lends insight to the confident declaration by Kangxi emperor in 1712 that there would be no additional taxes on a newly added taxable population. Ten years later, the policy was firmly set in place by the fiscal reform measure of consolidating head tax into land tax (᨞ϕܹഄ), the total amount of which would be fixed to the level recorded in the national record of 1710 (Shen, 1996, p. 184). This was clearly the most concrete and dramatic step towards the principle of fixed fiscal revenue. Empirical evidence confirms the largely stationary character of fiscal revenue from the early eighteenth

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century until right before the mid-nineteenth century, which saw the breakout of the devastating Taiping Rebellion. If deflated by the rice price, real expenditure (or taxation) actually declined throughout the seventeenth and eighteenth centuries, and stabilized until the mid-nineteenth century. If we factor in population, real per-capita expenditure and tax burden declined even more sharply from the late-seventeenth century. Converted into kilograms of rice, per-capita Chinese taxation was remarkably modest, amounting to something like two or three days of the wage of an unskilled laborer.21 This seems consistent with Wang Yeh-chien’s more comprehensive calculation of tax revenue (which includes guesstimates for costs of tax collection as well as various extralegal local surcharges) as amounting to merely 2.4 percent of NNP even in the 1910s (p. 133). If Wang’s figure can be relied on for the 1910s, we have good reason to believe that government revenue as a percentage of GDP would have been even lower in the eighteenth century. It is possible that Qing tax rates were the lowest across the dynasties, especially in per-capita terms.22 Overall, land tax predominated in total government revenue, amounting to as much as 74 percent of the total (Wang, 1973, p. 80). Official government data on the expenditure side of the imperial government reported for 1776 reveals that the upkeep of armies took up 78 percent of the total budget, followed by 11.3 percent that went into the payment of bureaucrats. The imperial household or Nei-wu-fu (‫ࡵݙ‬ᑰ) consumption took up a mere 1 percent of the total budget.23 Of course, the major issue with taxation and expenditure in traditional China occurred outside the imperial center. As the traditional Chinese taxation system was highly centralized, most of the collected revenue was accrued or allocated by the imperial fiscal administration: the Board of Revenue, local finance, or fiscal needs at the lowest level of official bureaucracy, figured little in this system. It has long been recognized that the official tax revenue allocated to the local government fell far short of the requirements of normal administration, often being insufficient to cover the salaries of official bureaucrats, let alone their expenses and support staffs. Over time, it had become a tolerated practice for almost all levels of bureaucrats to find informal earnings, in particular the infamous extralegal surcharges (㢯ᤤᴖ⿢), beyond the official level. At the local level, administration needs led the county magistrates to employ a large number of secretaries, clerks, runners, and personal servants. Yet none of these staffs were on the official rolls, being employed personally by the magistrates out of their extralegal extractions. Zelin’s study documents in detail the sources of these additional revenues, including the levying of various surcharges, manipulation of weights and measures, currency conversion in tax collection, falsifying reports, shifting funds across fiscal season years, retaining commercial tax revenue, hoarding tax revenue from newly claimed land, and exacting contributions and

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donations from local farmers or merchants. Provincial-level officials and their “unofficial” staffs relied on the extraction of gifts and contributions from lower-level officials, and engaged in practises such as skimming funds off at purchase and allocation – buying at a low price but reporting at a high price (Zelin, 1985, p. 46–71). This kind of corruption at the local level is a pale reflection of the much larger networks of collusion at different levels of the state machinery. Because of the prevalence of informal revenue and often imperial acquiescence towards corruption, it is difficult to gauge how these methods of informal taxation could change the picture of fiscal revenue or extraction at the national level. It is important to note that Wang Yieh-chien’s calculation of total tax revenue included his guesstimates of various extralegal surcharges, which amounted to about 24 percent of the final total for 1753.24 Clearly more research is needed in this field, but given Wang’s inclusive figure which represents such a low share of the national income, I don’t believe any reasonable upper estimate would change the conclusion that the overall level of tax extraction remained modest. The real problem of informal taxation may not lie so much in its level of extraction, but rather in its distortionary effects on economic incentives. On the surface, there seemed to be a fundamental contradiction between the Qing imperial ideology of benevolence based on a fixed target of taxation, and their tolerance of, and to certain degree reliance on, informal fiscal extraction at the lower level of society. However, the structure of political economy in the historical context reconciles this seeming contradiction. With tax collection being one of the most important functions of bureaucracy, the imperial policy of fixed revenue meant a fixed number of bureaucratic and administrative units from the imperial perspective. Second, like other agents of the economy, bureaucrats were their own revenue maximizers, who were prone to fiscal expansion if unchecked. Imperial attempts to expand tax bases rarely curbed unofficial extractions on the part of bureaucrats, but rather ended up legitimizing a higher tax target at the expense of the imperial reputation for benevolence. Third, with the hierarchical command structure any “visible” bases of tax revenue at the lower level incurred the risk of extraction from the top. In this sense informal taxation, being outside the official purview, ironically became the most secure source of local finance. In fact, throughout the dynasties, corruption itself was connived at within the system as long as it was not excessive enough to disturb social stability and induce insurrection. Fiscal comparison with Western Europe, in particular with England, contributes a unique perspective to the question of economic divergence between China and Northwestern Europe, which had emerged at least by the early modern era. While revenue accrued to the Board of Revenue (᠌䚼) of Qing China remained largely stagnant or declined slightly in real terms, tax receipts at the Exchequer of Britain rose by a stunning 17-fold

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from 1665 to 1815. The total British revenue as a share of national income, before China’s Glorious Revolution of 1688, surged from slightly more than 3 percent – a rate not hugely different from that of the Qing in the eighteenth to nineteenth centuries – to about 18 percent by 1810 (O’Brien, 1988, p. 3). By the eighteenth century, Britain was the second most heavily taxed nation in the world after Holland (Prak and van Zanden, 2006, p. 130). Again, as distinct from Chinese revenue which had been firmly locked into direct taxes on land, the surge in British tax receipts came disproportionately from indirect taxes such as customs and excise duties, which accounted for nearly 80 percent of total revenue towards the end of the eighteenth century (O’Brien, 1988, p. 9–10). More importantly, as noted by various scholars, fiscal expansion transformed Britain into a modern fiscal state marked by the rise of a Weberian type of professional bureaucracy, which more than tripled in size between the 1690s and the 1780s (Brewer, 1989, p. 66–7). The British development of a civil and fiscal administration that evolved towards professionalism, political neutrality, transparency, and accountability presents a sharp contrast to the stagnation of Chinese bureaucracy, which continued to rely on informal staffs and extralegal revenue sources. The administrative capacity to generate greater revenue from the growing sectors of the economy enabled the British state to capitalize (or mortgage) its future revenue through the financial sector. Thus the growth of a modern fiscal state laid the foundation for the growth of a modern financial market and financial institutions (North and Weingast, 1989). Enhanced state capacity not only strengthened British warfare capabilities and financed overseas explorations in Europe and beyond, but also extended formal state power to the economic sphere.25 By contrast, in China there emerged a reverse incentive problem once the Chinese imperial state switching to a fixed target of tax revenue. The central government no longer had a stake in the growth of the economy, which led to the rise of “laissez-faire” Chinese-style, or what Avner Greif (2005) described as the absent government in some of the private sectors, where growth and expansion in scale increasingly required the involvement of formal state power. It is clear that by the eighteenth century, the bulk of Qing involvement in the private sector was aimed at risk reduction and social stability rather than economic expansion: encouraging the opening up of new land to accommodate a growing population, tax exemption, and famine relief in hard times. In areas not directly related to social stability or government tax revenue, formal imperial power rarely reached: the sectors of commerce, trade, finance and monetary remained largely unregulated and unprotected. Clearly, it was the fear of insurrection rather than the interests of the stakeholders that was the driving force behind the Qing policy. In the absence or weakness of formal state power, semi-official or informal local community organizations in the form of lineage organization,

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village societies, native place merchant groups, and so on, often took on the role of economic regulation and dispute resolution, as well as the provision of a local granary system, charities, and schooling.26 While these informal organizations helped to provide some basic local public-goods for a largely agrarian society, where production units were small and properly incentivized, they became a problem when the scale of production and marketing grew to require a level of collective action beyond the organizational capacities of private agents or local communities. In short, there was a missing or weak link between the private agents and state power embedded in the incentive structure of the absolute regime of early modern China.

6.4 Concluding discussion: The traditional Chinese state and the origin of modern east Asia The narrative model of the traditional Chinese state in this article argues that institution, particularly the political structure of states, may be a far more important and relevant explanatory factor to account for both China’s long-term economic growth and the great divergence between China and Western Europe in the early modern era. I argue that the fundamental problem of incentive misalignment and asymmetric information in the traditional Chinese state institutions may have hindered the development of institutions which are essential for modern economic growth. Furthermore, with the achievement of monopoly rule in the absence of internal or external political competition, the incentives of the rulers and ruling elites (such as the bureaucratic and gentry class) led them to prioritize the defense of monopoly rents, and become resistant to social and institutional change that could disturb the traditional equilibrium. In this context, political events such as the arrival of Commodore Perry at the Japanese seashore and the outbreak of the Opium War in South China around the mid-nineteenth century, were watershed events that eventually signaled the end of China’s political isolation and exposed the monopoly rulers in East Asia to external military threat and political competition in a new global setting. Meiji Japan first recognized the possibility of complete erosion of monopoly rents previously retained through exclusive political rule, and rose to meet the challenge. With a fundamental restructuring of rulers’ incentives, economic growth, rather than the defence of monopoly rents, then emerged as the new state objective. The bureaucratic developmental state, with political legitimacy based on the growth of per-capita income, became by and large replicated throughout the East Asia in the post-World War Two era, and more recently in China since the late 1970s. It was in the context of the massive diffusion of Western technology and institutions, following the opening-up of these countries, that we rediscovered the powerful role of the institutional legacy associated with the traditional Chinese political structure.

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76 Debin Ma

What is the institutional legacy of the traditional state? How has it contributed to the rapid economic catch-up of East Asia since the mid-nineteenth century? For that, we turn to Professor Hayami’s framework of market, community, and state. Starting with market, this article traces the historical origin of the small and independent peasantry to the institutional transformation which occurred in China’s medieval period. The momentous switch in tax regime from poll tax to land tax around the eighth century gradually but decisively moved the state away from direct management or regulation of property rights vested in land, and allowed the development of de facto property rights to land.27 The resultant policy of fixed revenues also converted the imperial rulers into the equivalent of fixed-rent landlords, in the contractual setting of a landlord-tenant relationship, leaving the private sector rather than the state to capture or claim all the residuals of economic expansion and rising productivity.28 This policy turned each individual peasant household into a highly independent and incentivized producing and market unit, in direct contact with the market, and in the process nurtured a long tradition of commercialization in China and East Asia. Turning to community, we can note that the retreat of the state, as symbolized by the limited reach of the state bureaucratic apparatus at the societal level, also left open space for the growth of some form of bottom-up community-based organization. These ranged from merchant-based lineage association in Southern China and native placed based associations to farming villages. For merchants, these organizations were critical for supplying rules and regulations, standardizing weights and measurements, resolving commercial and legal disputes, enforcing contracts, providing local charities and schooling, and so on. For villages, the farming communities became important in coordinating local irrigation and supplying local public-goods such as bridges and roads. Indeed, one could even argue that the functioning of a centralized state in many ways depended on the working of various communities at the local level to supply local public-goods and provide social and economic regulation. It is important to distinguish these social groups from the formally recognized corporate bodies in Western Europe in that their legal status was often vague and weak, and often lacked the European kind of countervailing power against the state. Nonetheless, they formed the very foundation of a community-based society in East Asia.29 Finally, turning to the state, the “familistic” origin of the traditional Chinese state engendered a powerful sense of a community with shared interest and common destiny. As an extension of the family, the traditional Chinese state also simulated a community, with ties that went beyond blood relations. More importantly, within this political structure the dominance of an autocracy in a unified empire gave birth to an enduring bureaucratic tradition of technocracy and impersonal rule. These institutional endowments paved the way for the rise of a modern nationalist ideology and a bureaucratic developmental state for modern East Asia.

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Another possibly more important though unintended consequence of the traditional bureaucracy is its impact on average levels of human capital. Access to the privileged bureaucratic ruling class, or upward social mobility, was acquired through the passing of a relatively objective and standard examination system, which generated an incentive system peculiar to a traditional society such as China: a very high (often irrationally so) esteem was now attached to education and literacy in the wider society. Despite the possible welfare loss from the often wasteful efforts thrown into examination preparation, the civil service examination system bestowed a historical tradition highly conducive to human-capital accumulation in the modern era. Recent works by Baten et al. (2009) demonstrate quantitatively that, despite substantially lower per-capita income, level of literacy and numeracy in China (possibly in East Asia in general) may have come close to that attained by advanced Northwestern European countries during the early modern era before the onset of the Industrial Revolution. This finding offers a historical antecedent to the rapid build-up of human capital in modern East Asia in the nineteenth and twentieth century, as captured by the findings of Godo and Hayami (2002).

References In English Baten, J., Ma, D., Morgan, S. and Wang, Q. (2009) “Evolution of Living Standards and Human Capital in China in the Eighteenth to the Twentieth Century: Evidences from Real Wage and Anthropometrics,” Working Paper No.122/09, Department of Economic History, London School of Economics, London. Bogart, D. and Richardson, G. (2008) “Parliament, Property Rights and Public Goods in England: 1600 to 1815,” Working paper, Department of Economics, University of California, Irvine. Brewer, J. (1989) The Sinews of Power: War, Money and the English State, 1688–1783 (London: Unwin Hyman). Chang, C. L. (1955) The Chinese Gentry: Studies on their Role in Nineteenth-century Chinese Society (Seattle, WA: University of Washington Press). Chang, T. A. (1972) “The Economic Role of the Imperial Household in the Ch’ing Dynasty,” Journal of Asian Studies, 31 (2), February, 243–73. Ch’u, T. T. (1962) Local Government in China under the Ching (Cambridge: Harvard University Press). Creel, H. G. (1964) “The Beginnings of Bureaucracy in China: The Origin of the Hsien,” The Journal of Asian Studies, 23 (2), February, 155–84. Godo, Y. and Hayami, Y. (2002) “Catching Up in Education in the Economic Catch-up of Japan with the United States, 1890–1990,” Economic Development and Cultural Change, 50 (4), 961–78. Greif, A. (2005) “Commitment, Coercion, and Markets: The Nature and Dynamics of Institutions Supporting Exchange,” in C. Menard and M. M. Shirley (eds.), Handbook for New Institutional Economics, Chapter 28 (Norwell, MA: Kluwer Academic Publishers).

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78

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Hayami, Y. (1998) “Towards an East Asian Model of Economic Development,” in Yujiro Hayami and Masahiko Aoki (eds.), The Institutional Foundations of East Asian Economic Development (Basingstoke: Macmillan), 3–36. Hayami, Y. (2001) Development Economics, 2nd edition (Oxford: Oxford University Press). Hayami, Y., Quisumbing, M.A.R. and Adriano, L. S. (1990) Towards an Alternative Land Reform Paradigm: A Philippines Perspective (Manila: Ateneo de Manila University Press). He, W. (2008) Paths Toward a Modern Fiscal State: England (1642–1750), Japan (1868–1895), and China (1850–1911) Ph.d Thesis (Cambridge: MIT Press). Huang, R. (1974) Taxation and Governmental Finance in Sixteenth-Century Ming China (Cambridge Studies in Chinese History, Literature and Institutions) (London: Cambridge University Press). Liu, G. (2005) Wrestling for Power: The State and the Economy in Later Imperial China, 1000–1770, Phd. Thesis (Harvard University Press). Ma, D. (2004) “Growth, Institutions and Knowledge: A Review and Reflection on the Historiography of Eighteenth- to Twentieth-century China,” Australian Economic History Review, 44 (3) (Special Issue on the Economic History of Asia), 259–77. Ma, D. (2009a) “Incentives and Information: An Institutional Perspective on the Traditional Chinese State and Great Divergence in the Early Modern Era,” Unpublished working paper, LSE Economic History Dept. Ma, D. (2009b) “Law and Economic Change in Traditional China: A Comparative Perspective,” LSE working paper No. 124, 2009 at http://www.lse.ac.uk/collections/ economicHistory/pdf/WP124.pdf. Maddison, A. (2007) Chinese Economic Performance in the Long Run, 2nd edition, revised and updated: 960–2030 AD, ed. Development Centre Studies (Paris: Development Centre of the Organisation for Economic Cooperation and Development). North, D. C. (1981) Structure and Change in Economic History (New York and London: Norton). North, D. C. and Weingast, B. R. (1989) “Constitutions and Commitment: The Evolution of Institutions Governing Public Choice in Seventeenth-Century England,” Journal of Economic History, 49, December, 803–32. O’Brien, K. J. (1988) “China’s National People’s Congress: Reform and Its Limits,” Legislative Studies Quarterly, 13 (3), 343–74. Olson, M. (1993) “Dictatorship, Democracy, and Development,” American Political Science Review, 87 (3), September, 567–76. Otsuka, K., Chuma, H. and Hayami, Y. (1992) “Land and Labor Contracts in Agrarian Economies: Theories and Facts,” Journal of Economic Literature, XXX, December, 1965–2018. Prak, M. and van Zanden, J. L. (2006) “Towards an Economic Interpretation of Citizenship: The Dutch Republic between Medieval Communes and Modern Nation-States,” European Review of Economic History, 10, 111–45. Spence, J. D.(1999) The Search for Modern China, 2nd edition (New York and London: Norton). Twitchett, D. C., Loewe, M. and Fairbank, J. K. (1986) The Cambridge History of China, Volume1, The Ch’in and Han Empires, 221 BC–AD 220 (Cambridge: Cambridge University Press). Wang, Y.-C. (1973) Land Taxation in Imperial China, 1750–1911, Harvard East Asian Series 73 (Cambridge, MA: Harvard University Press). Wittfogel, K. A. (1976) Oriental Despotism: A Comparative Study of Total Power (New York: Yale University Press).

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The Role of Traditional Chinese State 79 Zelin, M. (1985) The Magistrate’s Tael: Rationalizing Fiscal Reform in Eighteenth-Century Ch’ing China (Berkeley, CA and London: University of California Press).

In Chinese Qian Mu (䪅〚) (1966) Ё೑ग़ҷᬓ⊏ᕫ༅ (The Gains and Losses of Chinese Dynastic Politics) (佭␃: ໻Ё೑ॄࠋॖ). Shi, Z. (৆ᖫᅣ) (2008) ⏙ҷ᠌䚼䫊ᑧᬊᬃ੠ᑧᄬ㒳䅵 (Statistics on the Stocks, Receipts, and Expenditures of the Vaults of the Qing Board of Revenue) (⽣ᓎҎ⇥ߎ⠜⼒). Shen, X. (ᄿ㖞߮) (1996) Џ㓪 Ё೑䊺⿢৆ (A History of Chinese Taxation) (Ё೑䋶ᬓ㒣⌢ ߎ⠜⼒). Wang, Y. (⥟Ѯफ) (2005) Ё೑ᅬ‫ڮ‬ᬓ⊏ⷨお (The Politics of Chinese Bureaucracy) (Ё೑⼒ Ӯ⾥ᄺߎ⠜⼒). Xu, M. M. (ᕤ㣖ᯢ) (2004) ∳फ຿㒙Ϣ∳फ⼒Ӯ: 1368–1911 ᑈ(Jiangnan Gentry and Jiangnan Society: 1368–1911) (࣫Ҁ: ଚࡵॄк佚).

In Japanese Iwai, S. (ችѩ㣖‍) (2004) Ё೑䖥Ϫ䉵ᬓ৆ȃⷨお (A Study on the Early Modern Fiscal History of China) (Kyoto: Kyoto University Press).

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7 Government Distortions of Agricultural Prices: Lessons from Rich and Emerging Economies* Kym Anderson

7.1

Introduction

For many decades agricultural protection and subsidies in high-income (and some middle-income) countries have been depressing international prices of farm products, which lowers the earnings of farmers and associated rural businesses in developing countries. That worsened between the 1950s and the early 1980s (Anderson et al., 1986), thereby adding to global inequality and poverty because three-quarters of the world’s poorest people depend directly or indirectly on agriculture for their main income (World Bank, 2007). In addition to that external policy influence on rural poverty, however, the governments of many developing countries have directly taxed their farmers over the past half-century. A well-known example is the taxing of exports of plantation crops in postcolonial Africa (Bates, 1981). At the same time, many developing countries chose also to pursue an import-substituting industrialization strategy, predominantly by restricting imports of manufactures, and to overvalue their currency. Together those measures indirectly taxed producers of other tradable products in developing economies, by far the majority of them being farmers (Krueger et al., 1988, 1991).

* Financial assistance from World Bank Trust Funds (particularly those provided by the governments of Japan, the Netherlands and the United Kingdom), GRIPS and the Australian Research Council is gratefully acknowledged, as are the contributions of the country case study contributors to the Agricultural Distortions project, computational assistance by a team of research assistants led by Ernesto Valenzuela, and helpful comments from festschrift discussants and also commentators on numerous related conference and seminar papers over the past year. Views expressed are the author’s alone and not necessarily those of the World Bank or its Executive Directors. 80

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Government Distortions of Agricultural Prices

81

This disarray in world agriculture, as Johnson (1973) described it in the title of his seminal book, means there has been overproduction of farm products in high-income countries and underproduction in more-needy developing countries. It also means there has been less international trade in farm products than would be the case under free trade, thereby thinning markets for these weather-dependent products and thus making these markets more volatile. Using a stochastic model of world food markets, Tyers and Anderson (1992, Table 6.14) found that instability of international food prices in the early 1980s was three times greater than it would have been under free trade in those products. During the past quarter-century, however, numerous countries have begun to reform their agricultural price and trade policies. To get a sense of how much that has reduced the distortions to global markets for farm products, the present chapter draws on the results of a recent World Bank multicountry study of policies affecting agricultural price incentives over the past 5 decades. That study includes 75 countries that together account for 92 percent of the world’s population and agricultural GDP, and 95 percent of total GDP. Specifically, this chapter summarizes estimates of the nominal rates of assistance (NRAs) for more than 70 different farm products, with an average of almost a dozen per country. Not all countries had data for the entire 1955–2007 period, but the average number of years covered is 41 per country. Having such a comprehensive coverage of countries, products and years offers the prospect of obtaining a reliable picture of long-term trends in price-distorting policies (as well as annual fluctuations around those trends, not reported here) for country groups, regions, and the world as a whole. The chapter begins with a summary of the methodology used to generate annual indicators of the extent of government interventions in markets, details of which are provided in Anderson et al. (2008). The NRA estimates are then summarized across regions and over the half-decades since the mid-1950s. A summary is also provided of an additional set of indicators of agricultural price distortions that are based on the trade restrictiveness index first developed by Anderson and Neary (2005) and modified for the Bank’s research project by Lloyd et al. (2009). Then a new set of results from a global economy-wide model provides quantification of the impacts on global agricultural trade of the reforms since the early 1980s and of the policies still in place as of 2004. The chapter concludes by drawing on the lessons learned to speculate on the prospects for further reform, while considering the political economy of agricultural protection backed by agricultural communities, in the sense of Hayami and Godo (2005) as well as the earlier study by Anderson et al. (1986).

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82 Kym Anderson

7.2

Methodology

Government-imposed distortions can create a gap between domestic prices and what they would be under free markets. The Nominal Rate of Assistance (NRA) for each farm product is computed as the percentage by which government policies have raised gross returns to farmers above what they would be without the government’s intervention (or lowered them, if NRA

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